$KFFB Risk Factor changes from 00/09/28/21/2021 to 00/10/03/24/2024
Item 1A. Risk Factors. Interest Rate Risk Rising interest rates may hurt our profits and asset values. Beginning in March, 2022, the Federal Reserve Board’s Open Market Committee (“FOMC”) started raising interest rates to combat elevated inflation and a strong labor market. Rates continued to increase through August 2023. The increase in interest rates has caused our net interest income to decline. Net interest income decreased $1.8 million or 20.1 million, or 74. 3% compared to the fiscal year ended June 30, 2023 primarily due to an increase in interest expense of $5.4 million or 137.1 million, or 74. 9%, offset somewhat by an increase in interest income $3.5 million or 27.1 million, or 74. 6%. Our funding sources repriced more quickly during the interest rate increases than our assets. Consequently, the increase in our interest expense was attributed primarily to higher average rates paid on both deposits and FHLB advances, while the increase in our interest income was a combination of both higher average balances and higher rates earned on those assets. In September 2024, the FOMC decided to lower the target range for the federal funds rate by 50 basis points to 43/4 to 5 percent. Nevertheless, if interest rates rise in the future, our net interest income may decline in the short term since, due to the generally shorter terms of interest-bearing liabilities, interest expense paid on interest-bearing liabilities, increases more quickly than interest income earned on interest-earning assets, such as loans and investments. If interest rates rise, our net interest income may decline in the short term since, due to the generally shorter terms of interest-bearing liabilities, interest expense paid on interest-bearing liabilities, increases more quickly than interest income earned on interest-earning assets, such as loans and investments. In addition, rising interest rates may hurt our income because of reduced demand for new loans and refinancing loans may in turn result in reduced interest and fee income earned on new loans and loan refinancings. While we believe that modest interest rate increases will not significantly hurt our interest rate spread over the long term due to our high level of liquidity and the presence of a significant amount of adjustable-rate mortgage loans in our loan portfolio, interest rate increases may initially reduce our interest rate spread until such time as our loans and investments reprice to higher levels. Changes in interest rates also affect the value of our interest-earning assets, and in particular our securities portfolio. Generally, the value of fixed-rate securities fluctuates inversely with changes in interest rates. Unrealized gains and losses on securities available for sale are reported as separate components of equity. Decreases in the fair value of securities available for sale resulting from increases in interest rates therefore could have an adverse effect on stockholders’ equity. At June 30, 2024, this decrease in fair value of the securities, otherwise known as Accumulated other comprehensive loss totaled $336,000 or 3.4% of our securities portfolio. Rising interest rates may adversely affect the ability of borrowers to repay loans. We offer fixed-rate and adjustable-rate mortgage loans with terms of up to 30 years; however, across our loan portfolio, interest rates and payments adjust annually after a one-, three-, five- or seven-year initial fixed period. At June 30, 2024, 83.3% of our residential real estate loan portfolio were adjustable-rate loans. Rising interest rates could have a negative impact on our results of operations by reducing the ability of borrowers to repay their current loan obligations as interest rates rise, the borrower’s payments rise, increasing the potential for delinquencies and defaults. 18 Risks Related to Our Lending Activities Inflationary pressures and rising prices may affect our results of operations and financial condition. 18 Risks Related to Our Lending Activities If our allowance for loan losses is not sufficient to cover actual loan losses, our results of operations would be negatively affected. Inflation has risen sharply since the end of 2021 to levels not seen for over 40 years. Inflationary pressures are currently expected to remain elevated throughout 2024. Inflation could lead to increased costs to our customers, making it more difficult for them to repay their loans or other obligations. High interest rates may be needed to tame persistent inflationary price pressures, which could also push down asset prices and weaken economic activity. A deterioration in economic conditions in the United States and our markets could result in an increase in loan delinquencies and non-performing assets, decreases in loan collateral values and a decrease in demand for our products and services, all of which, in turn, would adversely affect our business, financial condition and results of operations. If our allowance for credit losses is not sufficient to cover actual loan losses, our results of operations would be negatively affected. In determining the amount of the allowance for credit loss, we analyze our loss and delinquency experience by loan categories and we consider the effect of existing economic conditions. In determining the amount of the allowance for loan losses, we analyze our loss and delinquency experience by loan categories and we consider the effect of existing economic conditions. In addition, we make various assumptions and judgments about the collectability of our loan portfolio, including the creditworthiness of our borrowers and the value of the real estate and other assets serving as collateral for the repayment of many of our loans. If the actual results are different from our estimates, or our analyses are incorrect, our allowance for credit loss may not be sufficient to cover losses inherent in our loan portfolio, which would require additions to our allowance and would decrease our net income. An emphasis on loan growth or shifting the types of loans the banks make, as well as any future credit deterioration, could require us to increase our allowance further in the future. In addition, our banking regulators periodically review our allowance for loan losses and could require us to increase our provision for loan losses. Any increase in our allowance for credit loss or loan charge-offs as required by regulatory authorities may have a material adverse effect on our results of operations and financial condition. A large percentage of our loans are collateralized by real estate and disruptions in the real estate market may result in losses and hurt our earnings. Approximately 96.1% of our loan portfolio at June 30, 2024 was comprised of loans collateralized by real estate. Disruptions in the real estate market could significantly impair the value of our collateral and our ability to sell the collateral upon foreclosure. The real estate collateral in each case provides an alternate source of repayment in the event of default by the borrower and may deteriorate in value during the time the credit is extended. If real estate values decline, it will become more likely that we would be required to increase our allowance for loan losses. If during a period of reduced real estate values, we are required to liquidate the collateral securing a loan to satisfy the debt or to increase our allowance for credit losses, it could materially reduce our profitability and adversely affect our financial condition. If during a period of reduced real estate values, we are required to liquidate the collateral securing a loan to satisfy the debt or to increase our allowance for loan losses, it could materially reduce our profitability and adversely affect our financial condition. Our concentration of residential mortgage loans exposes us to increased lending risks. At June 30, 2024, $256. At June 30, 2021, $224. 2 million, or 76.1 million, or 74. 5%, of our loan portfolio was secured by one-to-four family real estate, all of which is located in the Commonwealth of Kentucky, and we intend to continue this type of lending in the foreseeable future. One-to-four family residential mortgage lending is generally sensitive to regional and local economic conditions that significantly impact the ability of borrowers to meet their loan payment obligations, making loss levels difficult to predict. A decline in residential real estate values as a result of a downturn in the local housing markets or in the markets in neighboring states in which we originate residential mortgage loans could reduce the value of the real estate collateral securing these types of loans. Declines in real estate values could cause some of our residential mortgages to be inadequately collateralized, which would expose us to a greater risk of loss if we seek to recover on defaulted loans by selling the real estate collateral. The distressed economy in First Federal of Hazard’s market area could hurt our profits and slow our growth. Our banks operate in three distinct market areas. First Federal of Hazard’s market area consists of Perry and surrounding counties in eastern Kentucky. The economy in this market area has been distressed in recent years due to the decline in the coal industry on which the economy has been dependent. While the region has seen improvement in the economy from the influx of other industries, such as health care and manufacturing, the competition provided by new methods of extracting natural gas has recently hurt the coal industry. As a consequence, the economy in First Federal of Hazard’s market area continues to lag behind the economies of Kentucky and the United States and First Federal of Hazard has experienced insufficient loan demand in its market area. Moreover, the slow economy in First Federal of Hazard’s market area will limit our ability to grow our asset base in that market. 19 Our mortgage banking revenue and the value of our mortgage servicing rights can be volatile. We plan to continue to sell our longer-term, conforming and non-conforming fixed-rate loans that we originate to generate noninterest income. We also earn revenue from fees we receive for servicing mortgage loans. Changes in interest rates may impact our mortgage banking revenues, which could negatively impact our noninterest income. When rates rise, the demand for mortgage loans usually tends to fall, reducing loan origination volume and the related amount of gains on the sales of loans. Under the same conditions, net revenue from our mortgage servicing activities can increase due to slower prepayments, which reduces our amortization expense for mortgage servicing rights. When rates fall, mortgage originations usually tend to increase and the value of our mortgage servicing rights usually tends to decline, also with some offsetting revenue effect. During the fiscal year ended June 30, 2024, non-interest income decreased $51,000 or 16.9% and totaled $251,000, primarily due to decreased participation and service fee income. In addition, our results of operations are affected by the amount of noninterest expenses associated with mortgage banking activities, such as salaries and employee benefits (including commissions), occupancy, equipment and data processing expense, and other operating costs. During periods of reduced loan demand, our results of operations may be adversely affected to the extent that we are unable to reduce expenses commensurate with the decline in mortgage loan origination activity. Liquidity Risk Financial challenges at other banking institutions could lead to depositor concerns that spread within the banking industry causing disruptive and destabilizing deposit outflows. In March 2023, Silicon Valley Bank and Signature Bank experienced large deposit outflows coupled with insufficient liquidity to meet withdrawal demands, resulting in the institutions being placed into FDIC receivership. In May 2023, First Republic Bank was also placed into FDIC receivership. In the aftermath of these events, there has been substantial market disruption and concerns that diminished depositor confidence could spread across the banking industry, leading to deposit outflows that could destabilize other institutions. To strengthen public confidence in the banking system, the FDIC took action to protect funds held in uninsured deposit accounts at Silicon Valley Bank, Signature Bank and First Republic Bank. However, the FDIC has not committed to protecting uninsured deposits in other institutions that experience outsized withdrawal demands. To further bolster the banking system, the Federal Reserve Board created a new Bank Term Funding Program to provide an additional source of liquidity. At June 30, 2024, we had $27.9 million in available liquidity, including $18.3 million in cash and cash equivalents. Our uninsured deposits are estimated to be approximately $17.5 million or 6.1 million, or 74. 83% of total deposits. At June 30, 2024, we had off-balance sheet liquidity sources totaling $89.3 million, including $71.4 million in additional borrowing capacity at the Federal Home Loan Bank of Cincinnati. Notwithstanding our significant liquidity, large deposit outflows could adversely affect our financial condition and results of operations and could result in the closure of the Banks. Furthermore, the recent bank failures may result in strengthening of capital and liquidity rules which, if the revised rules apply to us, could adversely affect our financial condition and results of operations. Insufficient liquidity or liquidity related concerns could impair our ability to fund operations, pay dividends on outstanding shares of stock, and jeopardize our financial condition, growth and prospects. We require sufficient liquidity to fund loan commitments, satisfy depositor withdrawal requests, make payments on our debt obligations as they become due, and meet other cash commitments. Liquidity risk is the potential that we will be unable to meet our obligations as they become due because of an inability to liquidate assets or obtain adequate funding at a reasonable cost, in a timely manner and without adverse conditions or consequences. Our sources of liquidity consist primarily of cash, assets readily convertible to cash (such as investment securities), increases in deposits, advances, as needed, from the FHLB, borrowings, as needed, from the Federal Reserve Bank of Cleveland and other borrowings. Our access to funding sources in amounts adequate to finance our activities or on acceptable terms could be impaired by factors that affect our organization specifically or the financial services industry or economy in general. Our access to funding sources in amounts adequate to finance our activities on terms that are acceptable to us could be impaired by factors that affect us specifically or the financial services industry or economy generally. Any substantial, unexpected, and/or prolonged change in the level or cost of liquidity, or any liquidity related requirements imposed by our regulators, could impair our ability to fund operations, pay dividends on outstanding shares of stock, enact stock repurchases, and meet our obligations as they become due and could have a material adverse effect on our business, financial condition and results of operations. On January 16, 2024, the Company announced the suspension of quarterly dividends indefinitely. The suspension of our quarterly cash dividend could have an adverse impact on the market price of our common stock. Holders of our common stock are only entitled to receive such dividends as our Board of Directors may declare out of funds available for such payments under applicable law and regulatory guidance. Although we have historically declared cash dividends on our common stock, we are not required to do so, and on January 16, 2024, the Company announced the suspension of quarterly dividends indefinitely. We cannot predict when or whether the Company will be able to pay future common stock dividends and if so, the amount of any such common stock dividends. The suspension of our common stock dividend could adversely affect the market price of our common stock. 20 Risks Related to Our Business and Industry Generally Our FDIC deposit insurance premiums and assessments may increase, which would reduce our profitability. On March 12, 2023, the Department of the Treasury, the Federal Reserve and the FDIC issued a joint statement relating to the resolution of Silicon Valley Bank and Signature Bank that stated that losses to support uninsured deposits of those banks would be recovered via a special assessment on banks. On May 11, 2023 the FDIC Board of Directors approved a notice of proposed rulemaking, which would implement a special assessment to recover the cost associated with protecting uninsured depositors following the closures of Silicon Valley Bank and Signature Bank. In general, large banks with large amounts of uninsured deposits benefitted most from the protection of uninsured depositors. Banking organizations with total assets over $50 billion would pay more than 95 percent of the special assessment and banking organizations with total assets under $5 billion would not be subject to the special assessment. Under the current provisions of this notice of proposed rulemaking, we believe that we would not be impacted by the special assessment associated with the most recent banking organization closures. Strong competition within our market areas could hurt our profits and slow growth. Although we consider ourselves competitive in our market areas, we face intense competition both in making loans and attracting deposits. Price competition for loans and deposits might result in our earning less on our loans and paying more on our deposits, which reduces net interest income. Some of the institutions with which we compete have substantially greater resources than we have and may offer services that we do not provide. We expect competition to increase in the future as a result of legislative, regulatory and technological changes and the continuing trend of consolidation in the financial services industry. Our profitability will depend upon our continued ability to compete successfully in our market areas. Risks Related to Laws and Regulations We are required to comply with the terms of a formal written agreement and IMCRs issued by the OCC, and lack of compliance could result in monetary penalties and /or additional regulatory actions.