KFFB

Business Context and Reporting Period

Kentucky First Federal Bancorp (parent of First Federal Savings and Loan Association of Hazard) filed a Form 10-Q for the quarterly and six-month periods ended December 31, 2004. The company is a small business issuer currently undergoing a reorganization into a mutual holding company structure and planning a merger with Frankfort First Bancorp, Inc. The transaction involves an aggregate purchase price of $31.2 million and is expected to generate approximately $16.6 million in goodwill. As of the filing date, the company had deferred conversion costs of approximately $557,000.

Key Financial Metrics

All figures in thousands unless otherwise noted.

Material Changes vs. Prior Period

• Profitability: Net earnings increased 28.8% ($145,000) for the six months ended Dec 31, 2004, compared to the prior year. This was driven by a $144,000 increase in net interest income and a $78,000 reduction in operating expenses.
• Interest Income: Loan interest income decreased 19.4% due to a $6.0 million reduction in average loan balances and a 37 basis point drop in yield. Conversely, investment income increased 24.6% due to higher yields and increased asset balances.
• Interest Expense: Deposit interest expense decreased 19.4% due to lower average balances and a 37 basis point reduction in the cost of deposits. Borrowing interest expense increased by $134,000 as the company had no borrowings in the comparable 2003 period.
• Balance Sheet: Total assets decreased 0.6% to $138.9 million. Cash and cash equivalents dropped significantly by 72.5% ($12.2 million) as funds were deployed into investment securities, which rose 19.4%. Loans receivable declined 5.4% as repayments exceeded disbursements.
• Asset Quality: Nonperforming loans decreased slightly to $1.1 million. The allowance for loan losses covers 58.4% of nonperforming loans.

Outlook, Risks, and Management Commentary

• Reorganization and Merger: The company is proceeding with a plan to reorganize into a mutual holding company and merge with Frankfort First Bancorp. The transaction requires regulatory approval and member/shareholder votes, which have been obtained. Costs are deferred pending successful completion.
• Market Risk: Management notes no material change in market risk since the Form S-1 filing. Risks include general economic conditions, real estate prices in the market area, interest rate environments, and competitive conditions.
• Loan Loss Allowance: Management considers the allowance for loan losses a critical accounting policy. While the local economy is viewed as stable and improving, management warns that actual losses could exceed the allowance if economic conditions deteriorate, specifically citing unemployment or home price depreciation.
• Accounting Changes: The company noted the issuance of SFAS 123(R) regarding share-based payments, though it currently has no stock option plans subject to the new standard.

Investor Verification Checklist

• Merger Completion: Verify the final status of the reorganization and merger with Frankfort First Bancorp, including the issuance of shares and payment of the $31.2 million purchase price.
• Deferred Costs: Monitor the treatment of the $557,000 in deferred conversion costs; these will be charged to operations if the conversion is unsuccessful.
• Liquidity Position: Assess the impact of the 72.5% decline in cash and cash equivalents on the company's ability to meet deposit outflows and fund new loans.
• Asset Quality: Review the composition of the $1.1 million in nonperforming loans (entirely residential real estate) and the adequacy of the $670,000 allowance in light of local economic conditions.
• Regulatory Capital: Confirm continued compliance with Office of Thrift Supervision (OTS) minimum capital requirements following the merger.