Item 1. Business.
General
K-Fed Bancorp (or the “Company”) is a federally-chartered stock corporation that was formed in July 2003 as a wholly-owned subsidiary of K-Fed Mutual Holding Company, a federally-chartered mutual holding company, in connection with the mutual holding company reorganization of Kaiser Federal Bank (or the “Bank”), a federally chartered stock savings association. Upon completion of the mutual holding company reorganization in July 2003, the Company acquired all of the capital stock of the Bank. On March 30, 2004, the Company completed a minority stock offering in which it sold 5,686,750 shares, or 39.09%, of its outstanding common stock to eligible depositors of the Bank and the Bank’s Employee Stock Ownership Plan in a subscription offering. The remaining 8,861,750 outstanding shares of the Company’s common stock are owned by K-Fed Mutual Holding Company. At June 30, 2008, K-Fed Mutual Holding Company owned 65.79% of the outstanding shares of common stock of the Company, with the remaining 34.21% held by public stockholders.
K-Fed Mutual Holding Company and the Company are subject to regulation by the Office of Thrift Supervision. K-Fed Mutual Holding Company’s principal assets are its investment in K-Fed Bancorp and approximately $11,000 in cash. So long as K-Fed Mutual Holding Company is in existence, it will at all times own at least a majority of the outstanding common stock of K-Fed Bancorp.
At June 30, 2008, K-Fed Bancorp had total consolidated assets of $849.0 million, net loans of $742.2 million, deposits of $495.1 million and stockholders’ equity of $90.7 million. The Company’s business activities generally are limited to passive investment activities and oversight of its investment in the Bank. Unless the context otherwise requires, all references to the Company include the Bank and the Company on a consolidated basis.
The Bank is a community oriented financial institution offering a variety of financial services to meet the needs of the communities it serves. We are headquartered in Covina, California, with branches or financial service centers in Pasadena, Bellflower, Harbor City, Los Angeles and Panorama City to serve Los Angeles County, financial service centers in Fontana and Riverside to serve San Bernardino and Riverside Counties, and a financial service center in Santa Clara to serve Santa Clara County. Financial service centers provide all the services as our full service branches except they do not disburse cash; however, there is an on-site ATM that dispenses cash.
The Bank began operations as a credit union in 1953 initially serving the employees of the Kaiser Foundation Hospital in Los Angeles, California. As the Kaiser Permanente Medical Care Program evolved so did the credit union, and in 1972, it changed its name to Kaiser Permanente Federal Credit Union. The credit union grew to primarily serve Kaiser Permanente employees and physicians who worked or lived in California. The credit union serviced members with two branches, Pasadena and Santa Clara, and a network of ATMs primarily located in Kaiser Permanente medical centers. However, as a credit union, the credit union was legally restricted to serve only individuals who shared a “common bond” such as a common employer.
After receiving the necessary regulatory and membership approvals, on November 1, 1999, Kaiser Permanente Federal Credit Union converted to a federal mutual savings association known as Kaiser Federal Bank which serves the general public as well as Kaiser Permanente employees. Our principal business consists of attracting retail deposits from the general public and investing those funds primarily in permanent loans secured by first mortgages on owner-occupied, one-to-four family residences, multi-family residences and commercial real estate properties. We also originate automobile and other consumer loans. Historically, we have not made, or purchased, commercial business, commercial construction, or residential construction loans and have no current plans to do so.
Our revenues are derived principally from interest on loans and mortgage-backed and related securities. We also generate revenue from service charges and other income.
We offer a variety of deposit accounts having a wide range of interest rates and terms, which generally include savings accounts, money market accounts, demand deposit accounts and certificate of deposit accounts with varied terms ranging from 90 days to five years. We solicit deposits in our primary market areas of Los Angeles, Orange, San Diego, San Bernardino, Riverside, and Santa Clara Counties, in California.
Available Information
Our Internet address is www.k-fed.com. We make available free of charge, through our web site, annual reports on Form 10-K, quarterly reports on Form 10-Q, and current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission. All SEC filings of the Company are also available at the SEC’s website, www.sec.gov.
Market Area
Our California market area provides a large, increasing base of potential customers with per capita income levels favorable to the national average. Los Angeles County’s economy consists of a diversified mix of high-technology commercial endeavors, by-products of the defense related industries, which capitalized on the highly educated and skilled labor force. Emerging growth areas include telecommunications, electronics, computers, software and biomedical technologies as well as international trade. The western portion of San Bernardino and Riverside Counties are adjacent to higher housing cost areas of Los Angeles, Orange and San Diego Counties and are a magnet for new residents seeking affordable housing as well as many local business operations. Manufacturing, transportation and distribution companies provide thousands of jobs in this area. Santa Clara County is in the “Silicon Valley” where the per capita income exceeds the state and national averages.
Competition
We face strong competition in originating real estate and other loans and in attracting deposits. Competition in originating real estate loans comes primarily from other savings institutions, commercial banks, credit unions and mortgage bankers. Other savings institutions, commercial banks, credit unions and finance companies provide vigorous competition in consumer lending. We also face competition from other lenders and investors with respect to loans that we may purchase.
We attract all of our deposits through our branch and ATM network. Competition for those deposits is principally from other savings institutions, commercial banks and credit unions, as well as mutual funds and other alternative investments. We compete for these deposits by offering superior service and a variety of deposit accounts at competitive rates. We have less than a 1% market share of deposits in each of the markets in which we compete.
Lending Activities
General. We originate and purchase one-to-four family real estate loans. The Bank, however, has not purchased any one-to-four family real estate loans since February 2007 as the Bank has focused its efforts on originating multi-family residential and commercial real estate loans. We also originate consumer loans, primarily automobile loans. We do not offer adjustable rate loans where the initial rate is below the otherwise applicable index rate (i.e., teaser rates). Our loans carry either a fixed or an adjustable rate of interest. Consumer loans are generally short term and amortize monthly or have interest payable monthly. Mortgage loans generally have a longer term amortization, with maturities up to 30 years, depending upon the type of property with principal and interest due each month. We also have loans in our portfolio that only require interest payments on a monthly basis. At June 30, 2008, our net loan portfolio totaled $742.2 million, which constituted 87.4% of our total assets. We underwrite each purchased loan in accordance with our underwriting standards. The majority of the loans that we purchase are acquired with servicing released to allow for greater investments in real-estate lending without having to significantly increase our servicing and operations costs. We generally purchase these loans without recourse against the seller.
At June 30, 2008, the maximum amount which we could have loaned to any one borrower and the borrower’s related entities under applicable regulations was $11.1 million, or 15% of our unimpaired capital. At June 30, 2008, we had no loans or group of loans to related borrowers with outstanding balances in excess of this amount. Our five largest lending relationships at June 30, 2008 were as follows: (1) three loans to an individual totaling $7.8 million, secured by a multi-tenant medical office building and two multi-family dwellings; (2) seven loans to an individual for $7.7 million secured by seven multi-family dwellings ranging from eight to 50 units; (3) three loans to an individual for $7.1 million secured by a single tenant retail building, a single tenant supermarket building and a 15 tenant mixed use office building; (4) two loans to an individual for $5.9 million secured by a single tenant industrial building and a single tenant office building; and (5) two loans to an individual for $5.8 million secured by a 32 tenant shopping center and a single tenant building. All of the loans noted in the above relationships are current as of June 30, 2008.
The following table presents information concerning the composition of Kaiser Federal Bank’s loan portfolio in dollar amounts and in percentages as of the dates indicated.
The following table shows the composition of Kaiser Federal Bank’s loan portfolio by fixed and adjustable rate at the dates indicated.
Loan Maturity. The following schedule illustrates certain information at June 30, 2008 regarding the dollar amount of loans maturing in Kaiser Federal Bank’s portfolio based on their contractual terms-to-maturity, but does not include scheduled payments or potential prepayments. Demand loans, loans having no stated schedule of repayments and no stated maturity are reported as due in one year or less. Loan balances do not include undisbursed loan proceeds, unearned discounts, unearned income and allowance for loan losses.
The following table sets forth the dollar amount of all loans due after June 30, 2009, which have fixed interest rates and adjustable interest rates.
One-to-four family Residential Lending. At June 30, 2008, our first lien one-to-four family residential mortgage loans totaled $428.7 million, or 57.5%, of our gross loan portfolio. We generally underwrite our one-to-four family loans based on the applicant’s employment and credit history and the appraised value of the subject property. With respect to purchased loans, we underwrite each loan based upon our underwriting standards prior to making the purchase. Presently, we lend up to 80% of the lesser of the appraised value or purchase price for one-to-four family residential loans. Properties securing our one-to-four family loans are appraised by independent state licensed fee appraisers approved by our board of directors. We require our borrowers to obtain title and hazard insurance, and flood insurance, if necessary, in an amount not less than the value of the property improvements.
We currently originate one-to-four family mortgage loans on a fixed rate and adjustable rate basis. Our pricing strategy for mortgage loans includes setting interest rates that are competitive with other local financial institutions and consistent with our internal needs. Adjustable rate loans are tied to indices based on the one year London Inter Bank Offering Rate and U.S. Treasury securities adjusted to a constant maturity of one year. A majority of our adjustable rate loans carry an initial fixed rate of interest for either three or five years which then converts to an interest rate that is adjusted annually based upon the applicable index. Our home mortgages are structured with a five to thirty year maturity, with amortizations up to a 30-year period. All of our one-to-four family loans are secured by properties located in California.
All our real estate loans contain a “due on sale” clause allowing us to declare the unpaid principal balance due and payable upon the sale of the security property
Adjustable rate mortgage loans generally pose different credit risks than fixed rate loan mortgages, primarily because as interest rates rise, the borrower’s payment rises, increasing the potential for default. The Company has not experienced significant delinquencies for these types of loans. However, the majority of these loans have been purchased or originated within the past four years. See “- Asset Quality - Non-Performing Assets” and “- Classified Assets.” At June 30, 2008, our one-to-four family adjustable rate mortgage loan portfolio totaled $93.3 million, or 12.5% of our gross loan portfolio. At that date, the fixed rate one-to-four family mortgage loan portfolio totaled $335.5 million, or 45.0% of the Company’s gross loan portfolio.
In addition, the Company has purchased and originated interest-only one-to-four family mortgage loans. One-to-four family interest-only mortgage loans have decreased by $10.2 million, or 10.2% to $90.2 million at June 30, 2008 from $100.4 million at June 30, 2007. The Company has also purchased loans underwritten based upon stated income. A stated income loan is a loan where the borrower’s income source is not subject to verification through the application process, but the reasonableness of the stated income is verified through review of other sources, such as compensation surveys. We have no plans to significantly increase the number of interest-only or stated income loans held in our loan portfolio at this time. One-to-four family stated income mortgage loans have decreased by $11.6 million, or 9.8% to $107.2 million at June 30, 2008 from $118.8 million at June 30, 2007. As of June 30, 2008, $73.9 million were fixed rate loans and $33.3 million were adjustable rate loans.
In 2005, we began to underwrite interest-only loans assuming a fully amortizing monthly payment and for adjustable rate loans to qualify the borrower based upon the rate that would apply upon the first interest rate adjustment. An interest-only loan typically provides for the payment of interest (rather than both principal and interest) for a fixed period of three, five or seven years, thereafter the loan payments adjust to include both principal and interest for the remaining term. By imposing these additional underwriting standards we believe these loans should not present greater risk than other loans in our one-to-four family loan portfolio.
The following table describes certain risk characteristics of the Company’s one-to four-family non-conforming mortgage loans held for investment as of June 30, 2008:
(1)
The credit score is one factor in determining the credit worthiness of a borrower based on the borrower’s credit history.
(2)
LTV (loan-to-value) is the ratio calculated by dividing the original loan balance by the appraised value of the real estate collateral.
(3)
Seasoning describes the number of years since the funding date of the loan.
(4)
Stated income is defined as a borrower provided level of income which is not subject to verification during the loan origination process through the borrower’s application, but the reasonableness of the borrower’s income is verified through other sources. Included in interest-only loans are $37.0 million in stated-income loans.
Multi-Family Residential Lending. We also offer multi-family residential loans. These loans are secured by real estate located in our primary market area. At June 30, 2008, multi-family residential loans totaled $132.3 million, or 17.8%, of our gross loan portfolio.
Our multi-family residential loans are originated with adjustable interest rates. We use a number of indices to set the interest rate, including a rate based on the constant maturity of one year U.S. Treasury securities. Our adjustable rate loans carry an initial fixed rate of interest for either three or five years which then convert to an interest rate that is adjusted annually based upon the applicable index. Presently, we lend up to 70% of the lesser of the appraised value or purchase price for multi-family residential loans. These loans require monthly payments, amortize over a period of up to thirty years and have maximum maturity of thirty years. These loans are secured by properties located in California. We originate these loans through our loan officers.
Loans secured by multi-family residential real estate are underwritten based on the income producing potential of the property and the financial strength of the borrower. The net operating income, which is the income derived
from the operation of the property less all operating expenses, must be sufficient to cover the payments related to the outstanding debt. We may require an assignment of rents or leases in order to be assured that the cash flow from the project will be used to repay the debt. Appraisals on properties securing multi-family residential loans are performed by independent state licensed fee appraisers approved by our Board of Directors. See “- Loan Originations, Purchases, Sales and Repayments.”
Loans secured by multi-family residential properties are generally larger and involve a greater degree of credit risk than one-to-four family residential mortgage loans. Because payments on loans secured by multi-family residential properties are often dependent on the successful operation or management of the properties, repayment of such loans may be subject to adverse conditions in the real estate market or the economy. If the cash flow from the project is reduced, or if leases are not obtained or renewed, the borrower’s ability to repay the loan may be impaired. In order to monitor the adequacy of cash flows on income-producing properties, the borrowers are required to provide periodic financial information. See “- Asset Quality - Non-Performing Assets.”
Commercial Real Estate Lending. We also offer commercial real estate loans. These loans are secured primarily by small retail establishments, rental properties and small office buildings located in our primary market area and are both owner and non-owner occupied. We originate commercial real estate loans through our own staff. Generally, we do not purchase commercial real estate loans. At June 30, 2008, commercial real estate loans totaled $115.8 million, or 15.5% of our gross loan portfolio, of which $28.5 million or 24.6% of this portfolio was to borrowers who occupy the property.
We originate only adjustable rate commercial real estate loans. The interest rate on these loans is tied to a rate based on the constant maturity of one year U.S. Treasury securities. A majority of our adjustable rate loans carry an initial fixed rate of interest for either three or five years which then converts to an interest rate that is adjusted annually based upon the index. Presently, we lend up to 70% of the lesser of the appraised value or purchase price for commercial real estate loans. These loans require monthly payments, amortize up to thirty years, have maturities of up to fifteen years and carry prepayment penalties.
Loans secured by commercial real estate are underwritten based on the income producing potential of the property, the financial strength of the borrower and any guarantors. The net operating income, which is the income derived from the operation of the property less all operating expenses, must be sufficient to cover the payments related to the outstanding debt. We may require an assignment of rents or leases in order to be assured that the cash flow from the project will be used to repay the debt. Appraisals on properties securing commercial real estate loans are performed by independent state licensed fee appraisers approved by the Board of Directors. All the properties securing our commercial real estate loans are located in California. See “- Loan Originations, Purchases, Sales and Repayments.”
Loans secured by commercial real estate properties are generally larger and involve a greater degree of credit risk than one-to-four family residential mortgage loans. Because payments on loans secured by commercial real estate properties are often dependent on the successful operation or management of the properties, repayment of such loans may be subject to adverse conditions in the real estate market or the economy. If the cash flow from the project is reduced, or if leases are not obtained or renewed, the borrower’s ability to repay the loan may be impaired. In order to monitor the adequacy of cash flows on income-producing properties, the borrowers are required to provide periodic financial information. See “- Asset Quality - Non-Performing Loans.”
Consumer Loans. We offer a variety of secured consumer loans, including home equity lines of credit, new and used automobile loans, and loans secured by savings deposits. We also offer a limited amount of unsecured
loans. Consumer loans generally have shorter terms to maturity, which reduces our exposure to changes in interest rates, and carry higher rates of interest than do one-to-four family residential mortgage loans. At June 30, 2008, our consumer loan portfolio, exclusive of automobile loans, totaled $16.3 million, or 2.2%, of our gross loan portfolio.
The most significant component of our consumer lending is automobile loans. We originate automobile loans only on a direct basis with the borrower. Loans secured by automobiles totaled $52.3 million, or 7.0%, of our gross loan portfolio at June 30, 2008. Automobile loans may be written for up to seven years for new automobiles and a maximum of five years for used automobiles (with an age limit of five years) and have fixed rates of interest. Loan-to-value ratios for automobile loans are up to 100% of the sales price for new automobiles and up to 100% of value on used cars, based on valuation from official used car guides.
Each automobile loan requires the borrower to keep the financed vehicle fully insured against loss or damage by fire, theft and collision. In addition, we have the right to force place insurance coverage in the event the required physical damage insurance on an automobile is not maintained by the borrower. Nevertheless, there can be no assurance that each financed vehicle will continue to be covered by physical damage insurance provided by the borrower during the entire term which the related loan is outstanding.
Our primary focus when originating automobile loans is on the ability of the borrower to repay the loan rather than the value of the underlying collateral. The amount financed by us is generally up to the full sales price of the financed vehicle plus sales tax, dealer preparation fees, license fees and title fees, plus the cost of service and warranty contracts obtained in connection with the vehicle.
Consumer loans may entail greater risk than do one-to-four family residential mortgage loans, particularly in the case of consumer loans which are secured by rapidly depreciable assets, such as automobiles. In these cases, any repossessed collateral for a defaulted loan may not provide an adequate source of repayment of the outstanding loan balance. As a result, consumer loan collections are dependent on the borrower’s continuing financial stability and, thus, are more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy.
Loan Originations, Purchases, Sales and Repayments
We originate loans through employees located at our offices. Walk-in customers and referrals from our current customer base, advertisements, real estate brokers and mortgage loan brokers are also important sources of loan originations.
While we originate adjustable rate and fixed rate loans, our ability to originate loans is dependent upon customer demand for loans in our market area. Demand is affected by local competition and the interest rate environment. In prior years, we have also purchased real estate whole loans as well as participation interests in real estate loans. However, we have not purchased any loans since February 2007. At June 30, 2008, our real estate loan portfolio totaled $676.8 million or 90.8% of the gross loan portfolio. Purchased real estate loans at June 30, 2008 totaled $351.6 million, or 47.2% of the real estate loan portfolio. At June 30, 2007, our real estate loan portfolio totaled $635.4 million or 90.5% of the gross loan portfolio. Purchased real estate loans at June 30, 2007 totaled $406.5 million, or 64.0% of the real estate loan portfolio.
The following table shows the loan originations, purchases, sales and repayment activities of Kaiser Federal Bank for the years indicated.
Asset Quality
The asset quality of the Bank has remained strong and consistent over the past year. This has been accomplished by the strict adherence to its long standing disciplined credit culture that emphasizes the consistent application of the Bank’s underwriting standards to all loans. In this regard, the Bank fully underwrites all loans based on an applicant’s employment history, credit history and an appraised value of the subject property. With respect to purchased loans, the Bank underwrites each loan based upon our own underwriting standards prior to making the purchase. The following underwriting guidelines have been used by the Bank as underwriting tools to further limit the Bank’s potential loss exposure:
1.
All variable rate loans are underwritten using the fully indexed rate.
2.
All interest-only loans are underwritten using the fully amortized payment.
3.
We only lend up to 80% of the lesser of the appraised value or purchase price for one-to-four family residential loans.
Additionally, the Bank’s portfolio has remained strongly anchored in traditional mortgage products. In this regard, we do not originate, purchase or hold in portfolio construction loans, teaser option-adjustable rate mortgage loans, negatively amortizing loans or high LTV loans.
At June 30, 2008, one-to-four family residential mortgage loans totaled $428.8 million, or 57.5%, of our gross loan portfolio of which $335.5 million were fixed rate and $93.2 million were adjustable rate loans. Adjustable rate mortgages generally pose different credit risks than fixed rate loan mortgages, primarily because as interest rates rise, the borrower’s payment rises, increasing the potential for default. However, the Company has not experienced significant delinquencies for these loans.
For one-to-four family residential, multi-family and commercial real estate loans serviced by us, a delinquency notice is sent to the borrower when the loan is eight days past due. When the loan is twenty days past due, we mail a subsequent delinquency notice to the borrower. Typically, before the loan becomes thirty days past due, contact with the borrower is made requesting payment of the delinquent amount in full, or the establishment of an acceptable repayment plan to bring the loan current. If an acceptable repayment plan has not been agreed upon, loan personnel will generally prepare a notice of intent to foreclose. The notice of intent to foreclose allows the borrower up to ten days to bring the account current. Once the loan becomes sixty days delinquent, and an acceptable repayment plan has not been agreed upon, the servicing officer will turn over the account to the deed of trust trustee with instructions to initiate foreclosure.
Real estate loans serviced by a third party are subject to the servicing institution’s collection policies. However, we track each purchased loan individually to ensure full payments are received as scheduled. Each month, third party servicers are required to provide delinquent loan status reports to our servicing officer, which are included in the month-end delinquent real estate report to management.
When a borrower fails to make a timely payment on a consumer loan, a delinquency notice is sent when the loan is ten days past due. When the loan is twenty days past due, we mail a subsequent delinquency notice to the borrower. Once a loan is thirty days past due, our staff contacts the borrower by telephone to determine the reason for delinquency and to request payment of the delinquent amount in full or to establish an acceptable repayment plan to bring the loan current. If the borrower is unable to make or keep payment arrangements, additional collection action is taken in the form of repossession of collateral for secured loans and legal action for unsecured loans.
Delinquent Loans. The following table sets forth certain information with respect to our loan portfolio delinquencies at the dates indicated.
Non-Performing Assets. The following table sets forth the amounts and categories of non-performing assets in our loan portfolio. Non-performing assets consist of non-accrual loans and foreclosed assets. Loans to a customer whose financial condition has deteriorated are considered for non-accrual status whether or not the loan is ninety days and over past due. All loans past due ninety days and over are classified as non-accrual. On non-accrual loans, interest income is not recognized until actually collected. At the time the loan is placed on non-accrual status, interest previously accrued but not collected is reversed and charged against current income. Interest is not accrued on loans greater than ninety days or more delinquent. At each date presented, we had no troubled debt restructurings (loans for which a portion of interest or principal has been forgiven and loans modified at interest rates materially less than current market rates).
Foreclosed assets consist of real estate and other assets which have been acquired through foreclosure on loans. At the time of foreclosure, assets are recorded at the lower of their estimated fair value less selling costs or the loan balance, with any write-down charged against the allowance for loan losses.
Classified Assets. Regulations provide for the classification of loans and other assets, such as debt and equity securities considered by regulators to be of lesser quality, as “substandard,” “doubtful” or “loss.” An asset is considered “substandard” if it is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. “Substandard” assets include those characterized by the “distinct possibility” that the insured institution will sustain “some loss” if the deficiencies are not corrected. Assets classified as “doubtful” have all of the weaknesses inherent in those classified “substandard,” with the added characteristic that the weaknesses present make “collection or liquidation in full,” on the basis of currently existing facts, conditions, and values, “highly questionable and improbable.” Assets classified as “loss” are those considered “uncollectible” and of such little value that their continuance as assets without the establishment of a specific loss reserve is not warranted.
When an insured institution classifies problem assets as either substandard or doubtful, it may establish general allowances for loan losses in an amount deemed prudent by management and approved by the board of directors. General allowances represent loss allowances which have been established to recognize the inherent risk associated with lending activities, but which, unlike specific allowances, have not been allocated to particular problem assets. When an insured institution classifies problem assets as “loss,” it is required either to establish a specific allowance for losses equal to 100% of that portion of the asset so classified or to charge off such amount. An institution’s determination as to the classification of its assets and the amount of its valuation allowances is subject to review by the Office of Thrift Supervision and the FDIC, which may order the establishment of additional general or specific loss allowances.
In connection with the filing of our periodic reports with the Office of Thrift Supervision and in accordance with our classification of assets policy, we regularly review the problem assets in our portfolio to determine whether any assets require classification in accordance with applicable regulations. The total amount of classified assets represented 10.4% of our equity capital and 1.11% of our total assets at June 30, 2008.
The aggregate amount of our classified and special mention assets at the dates indicated were as follows:
Allowance for Loan Losses. We maintain an allowance for loan losses to absorb probable incurred losses inherent in the loan portfolio. The allowance is based on ongoing, quarterly assessments of the probable losses inherent in the loan portfolio. Our methodology for assessing the appropriateness of the allowance consists of several key elements, which include loss ratio analysis by type of loan and specific allowances for identified problem loans, including the results of measuring impaired loans as provided in Statement of Financial Accounting Standards (“SFAS”) No. 114, “Accounting by Creditors for Impairment of a Loan” and SFAS No. 118, “Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosures.” These accounting standards prescribe the measurement methods, income recognition and disclosures related to impaired loans.
The loss ratio analysis component of the allowance is calculated by applying loss factors to outstanding loans based on the internal risk evaluation of the loans or pools of loans. Changes in risk evaluations of both performing and nonperforming loans affect the amount of the allowance. Loss factors are based both on our historical loss experience as well as on significant factors that, in management’s judgment, affect the collectability of the portfolio as of the evaluation date.
The appropriateness of the allowance is reviewed and established by management based upon its evaluation of then-existing economic and business conditions affecting our key lending areas and other conditions, such as credit quality trends (including trends in nonperforming loans expected to result from existing conditions), collateral values, loan volumes and concentrations, specific industry conditions within portfolio segments and recent loss experience in particular segments of the portfolio that existed as of the balance sheet date and the impact that such conditions were believed to have had on the collectability of the loan. Senior management reviews these conditions quarterly in discussions with our senior credit officers. To the extent that any of these conditions is evidenced by a specifically identifiable problem credit or portfolio segment as of the evaluation date, management’s estimate of the effect of such condition may be reflected as a specific allowance applicable to such credit or portfolio segment. Where any of these conditions is not evidenced by a specifically identifiable problem credit or portfolio segment as of the evaluation date, management’s evaluation of the loss related to this condition is reflected in the general allowance. The evaluation of the inherent loss with respect to these conditions is subject to a higher degree of uncertainty because they are not identified with specific problem credits or portfolio segments.
Management also evaluates the adequacy of the allowance for loan losses based on a review of individual loans, historical loan loss experience, the value and adequacy of collateral and economic conditions in our market area. This evaluation is inherently subjective as it requires material estimates, including the amounts and timing of future cash flows expected to be received on impaired loans that may be susceptible to significant change. For all specifically reviewed loans for which it is probable that Kaiser Federal Bank will be unable to collect all amounts due according to the terms of the loan agreement, Kaiser Federal Bank determines impairment by computing a fair value either based on discounted cash flows using the loan’s initial interest rate or the fair value of the collateral if the loan is collateral dependent. Large groups of smaller balance homogenous loans that are collectively evaluated for impairment and are excluded from specific impairment evaluation, and their allowance for loan losses is calculated in accordance with the allowance for loan losses policy described above.
Because the allowance for loan losses is based on estimates of losses inherent in the loan portfolio, actual losses can vary significantly from the estimated amounts. Our methodology as described permits adjustments to any loss factor used in the computation of the formula allowance in the event that, in management’s judgment, significant factors which affect the collectability of the portfolio as of the evaluation date are not reflected in the loss factors. By assessing the estimated losses inherent in the loan portfolio on a quarterly basis, we are able to adjust specific and inherent loss estimates based upon any more recent information that has become available. In addition, management’s determination as to the amount of our allowance for loan losses is subject to review by the Office of Thrift Supervision and the FDIC, which may require the establishment of additional general or specific allowances based upon their judgment of the information available to them at the time of their examination of Kaiser Federal Bank.
At June 30, 2008, our allowance for loan losses was $3.2 million or 0.43% of the total loan portfolio and 186.66% of total non-performing loans. Assessing the adequacy of the allowance for loan losses is inherently subjective as it requires making material estimates, including the amount and timing of future cash flows expected to be received on impaired loans, which may be susceptible to significant change. In the opinion of management, the allowance, when taken as a whole, is at an amount that will absorb probable incurred loan losses inherent in our loan portfolio.
The following sets forth an analysis of our allowance for loan losses.
Allocation of Allowance for Loan Losses. The distribution of the allowance for losses on loans at the dates indicated is summarized as follows.
Investment Activities
General. We are required by federal regulations to maintain an amount of liquid assets in order to meet our liquidity needs. These assets consist of certain specified securities. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Liquidity Capital Resources and Commitments.” Cash flow projections are regularly reviewed and updated to assure that adequate liquidity is provided.
We are authorized to invest in various types of liquid assets, including U.S. Treasury obligations, securities of various federal agencies, certain certificates of deposit of insured banks and savings institutions, certain bankers’ acceptances, repurchase agreements and federal funds. Subject to various restrictions, federal savings associations may also invest their assets in investment grade commercial paper and corporate debt securities and mutual funds whose assets conform to the investments that a federally chartered savings association is otherwise authorized to make directly. See “How We Are Regulated - Kaiser Federal Bank” for a discussion of additional restrictions on our investment activities.
Under the direction and guidance of the Asset and Liability Management Committee and board policy, our president has the basic responsibility for the management of our investment portfolio. Various factors are considered when making decisions, including the marketability, maturity and tax consequences of the proposed investment. The maturity structure of investments will be affected by various market conditions, including the current and anticipated short and long term interest rates, the level of interest rates, the trend of new deposit inflows, and the anticipated demand for funds via deposit withdrawals and loan originations and purchases.
The current structure of our investment portfolio provides liquidity when loan demand is high, assists in maintaining earnings when loan demand is low and maximizes earnings while satisfactorily managing risk, including credit risk, reinvestment risk, liquidity risk and interest rate risk. See “Item 7A. Quantitative and Qualitative Disclosures about Market Risk - Asset and Liability Management and Market Risk.”
At June 30, 2008, our investment portfolio totaled $16.0 million and consisted principally of investment grade collateralized mortgage obligations and mortgage-backed securities. From time to time, investment levels may increase or decrease depending upon yields available on investment alternatives and management’s projected demand for funds for loan originations, deposits, and other activities.
The following table sets forth the composition of our investment portfolio at the dates indicated.
While our collateralized mortgage-backed securities and mortgage-backed securities carry a reduced credit risk as compared to whole loans due to their issuance under government agency sponsored programs, they remain subject to the risk that a fluctuating interest rate environment, along with other factors like the geographic distribution of the underlying mortgage loans, may alter the prepayment rate of the mortgage loans and so affect both the prepayment speed, and value, of the investment securities. As a result of these factors, the estimated average lives of these securities will be shorter than the contractual maturities as shown on the following table.
Portfolio Maturities and Yields. The composition and maturities of the investment securities portfolio at June 30, 2008 are summarized in the following table. Maturities are based on the final contractual payment dates, and do not reflect the impact of prepayments or early redemptions that may occur.
Interest Earning Deposits in Other Financial Institutions. Interest earning deposits in other financial institutions consists of money market deposits placed with multiple federally insured financial institutions in amounts that do not exceed the insurable limit of $100,000. These deposits are used as short-term investments as part of our overall asset/liability management. These deposits had a weighted-average yield of 2.4% at June 30, 2008.
Federal Home Loan Bank Stock. As a member of the Federal Home Loan Bank of San Francisco, we are required to own capital stock in the Federal Home Loan Bank of San Francisco. The amount of stock we hold is based on percentages specified by the Federal Home Loan Bank of San Francisco on our outstanding advances and the requirements of their Mortgage Purchase Program. The redemption of any excess stock we hold is at the discretion of the Federal Home Loan Bank of San Francisco. The carrying value of Federal Home Loan Bank of San Francisco stock totaled $12.5 million and had a weighted-average-yield of 5.1% for the year ended June 30, 2008. The yield on the Federal Home Loan Bank of San Francisco stock is produced by stock dividends that are subject to the discretion of the board of directors of the Federal Home Loan Bank of San Francisco.
Equity Investment. At June 30, 2008, we also had an investment in an affordable housing fund totaling $1.7 million with a commitment to fund an additional $64,000 for the purposes of obtaining tax credits and for Community Reinvestment Act purposes. The investment is being accounted for using the equity method of accounting. The investment is evaluated regularly for impairment based on the remaining allocable tax credits and tax benefits.
Bank-Owned Life Insurance. In April 2005, we purchased $10.0 million in bank-owned life insurance, which covers certain key employees, to provide tax-exempt income to assist in offsetting costs associated with employee benefit plans offered by Kaiser Federal Bank. The bank-owned life insurance is recorded at its cash surrender value, or the amount that can be realized. At June 30, 2008, the cash surrender value was $11.4 million.
Sources of Funds
General. Our sources of funds are deposits, payment of principal and interest on loans, interest earned on or maturation of other investment securities, borrowings, and funds provided from operations.
Deposits. We offer a variety of deposit accounts to consumers with a wide range of interest rates and terms. Our deposits consist of time deposit accounts, savings, money market and demand deposit accounts. We have historically paid competitive rates on our deposit accounts. We primarily rely on competitive pricing policies, marketing and customer service to attract and retain these deposits. At June 30, 2008, 33.2% of the dollar amount of our deposits were from customers who are employed by the Kaiser Permanente Medical Care Program, one of the largest employers in Southern California. Our ATM’s are located in our branches and near Kaiser Permanente Medical Centers. We currently do not accept brokered deposits.
The flow of deposits is influenced significantly by general economic conditions, changes in money market and prevailing interest rates and bi-weekly direct deposits from Kaiser Permanente Medical Care Program payrolls. The variety of deposit accounts we offer has allowed us to be competitive in obtaining funds and to respond with flexibility to changes in consumer demand. We have become more susceptible to short-term fluctuations in deposit flows, as customers have become more interest rate conscious. We try to manage the pricing of our deposits in keeping with our asset/liability management, liquidity and profitability objectives, subject to competitive factors. Based on our experience, we believe that our deposits are a relatively stable source of funds. Despite this stability, our ability to attract and maintain these deposits and the rates paid on them has been and will continue to be significantly affected by market conditions.
The following table sets forth our deposit flows during the years indicated.
The following table shows the distribution of, and certain other information relating to, deposits by type of deposit, as of the dates indicated.
The following table indicates the amount of Kaiser Federal Bank’s certificates of deposit by time remaining until maturity as of June 30, 2008.
As of June 30, 2008, the aggregate amount of outstanding certificates of deposit in amounts greater than or equal to $100,000 was $99.5 million. At June 30, 2007, the amount of such deposits was $93.5 million. The following table sets forth the maturity of those certificates as of June 30, 2008.
Borrowings. Although deposits are our primary source of funds, we may utilize borrowings when they are a less costly source of funds, and can be invested at a positive interest rate spread, when we desire additional capacity to purchase loans or to fund loan demand or when they meet our asset/liability management goals. Our borrowings historically have consisted of advances from the Federal Home Loan Bank of San Francisco. See Note 8 of the Notes to our Consolidated Financial Statements.
We may obtain advances from the Federal Home Loan Bank of San Francisco upon the security of our mortgage loans and mortgage-backed securities. These advances may be made pursuant to several different credit programs, each of which has its own interest rate, range of maturities and call features. At June 30, 2008, we had $235.0 million in Federal Home Loan Bank advances outstanding. We interchange the use of deposits and borrowings to fund assets, such as the origination and purchase of loans, depending on various factors including liquidity and asset/liability management strategies. Other borrowings are comprised of $25.0 million in deposits from the State of California through the state’s time deposit program in exchange for pledging $15.8 million investment securities and $37.6 million in mortgage loans as collateral.
The following table sets forth information as to our Federal Home Loan Bank advances for the years indicated.
Employees
At June 30, 2008, we had a total of 81 full-time employees and 16 part-time employees. Our employees are not represented by any collective bargaining group. Management believes that we have good relations with our employees.
How We Are Regulated
Set forth below is a brief description of certain laws and regulations which are applicable to K-Fed Bancorp and Kaiser Federal Bank. The description of these laws and regulations, as well as descriptions of laws and regulations contained elsewhere herein, does not purport to be complete and is qualified in its entirety by reference to the applicable laws and regulations.
Legislation is introduced from time to time in the United States Congress that may affect the operations of K-Fed Bancorp and Kaiser Federal Bank. In addition, the regulations governing K-Fed Bancorp and Kaiser Federal Bank may be amended from time to time by the Office of Thrift Supervision. Any such legislation or regulatory changes in the future could adversely affect K-Fed Bancorp or Kaiser Federal Bank. No assurance can be given as to whether or in what form any such changes may occur.
K-Fed Bancorp
General. K-Fed Bancorp is a federal mutual holding company subsidiary within the meaning of Section 10(o) of the Home Owners’ Loan Act. It is required to file reports with the Office of Thrift Supervision and is subject to regulation and examination by the Office of Thrift Supervision. In addition, the Office of Thrift Supervision has enforcement authority over K-Fed Bancorp and any non-savings institution subsidiaries. This permits the Office of Thrift Supervision to restrict or prohibit activities that it determines to be a serious risk to Kaiser Federal Bank. This regulation is intended primarily for the protection of the depositors and not for the benefit of stockholders of K-Fed Bancorp.
Activities Restrictions. K-Fed Bancorp is subject to statutory and regulatory restrictions on its business activities specified by federal regulations, which include performing services and holding properties used by a savings institution subsidiary, activities authorized for savings and loan holding companies as of March 5, 1987, and non-banking activities permissible for bank holding companies pursuant to the Bank Holding Company Act of 1956 or authorized for financial holding companies pursuant to the Gramm-Leach-Bliley Act.
If Kaiser Federal Bank fails the qualified thrift lender test, K-Fed Bancorp must, within one year of that failure, register as, and will become subject to, the restrictions applicable to bank holding companies. See “- Qualified Thrift Lender Test.”
Waivers of Dividends by K-Fed Mututal Holding Company. The Office of Thrift Supervision (OTS) regulations require K-Fed Mutual Holding Company to notify the OTS of any proposed waiver of its receipt of dividends from K-Fed Bancorp. The OTS reviews dividend waiver notices on a case-by-case basis, and, in general, does not object to any such waiver if the mutual holding company provides the OTS with written notice of its intent to waive its right to receive dividends 30 days prior to the proposed date of payment of the dividend, and the OTS does not object. The OTS shall not object to a notice of intent to waive dividends if: (i) the waiver would not be detrimental to the safe and sound operation of the savings association; and (ii) the board of directors of the mutual holding company expressly determines that waiver of the dividend by the mutual holding company is consistent with the directors’ fiduciary duties to the mutual members of such company. The OTS will not consider waived dividends in determining an appropriate exchange ratio in the event of a full conversion to stock form. K-Fed Mutual Holding Company waived its right to receive dividends paid by K-Fed Bancorp during the year ended June 30, 2008 and we anticipate that K-Fed Mutual Holding Company will waive future dividends paid by K-Fed Bancorp, if any.
Conversion of K-Fed Mutual Holding Company to Stock Form. The Office of Thrift Supervision regulations permit K-Fed Mutual Holding Company to convert from the mutual form of organization to the capital stock form of organization (a “Conversion Transaction”). There can be no assurance when, if ever, a Conversion Transaction will occur, and the board of directors has no current intention or plan to undertake a Conversion Transaction. In a Conversion Transaction a new holding company would be formed as the successor to K-Fed Bancorp (the “New Holding Company”), K-Fed Mutual Holding Company’s corporate existence would end, and certain depositors of Kaiser Federal Bank would receive the right to subscribe for additional shares of the New Holding Company. In a Conversion Transaction, each share of common stock held by stockholders other than K-Fed Mutual Holding Company (“Minority Stockholders”) would be automatically converted into a number of shares of common stock in the New Holding Company determined pursuant to an exchange ratio that ensures that the Minority Stockholders own the same percentage of common stock in the New Holding Company as they owned in K-Fed Bancorp immediately prior to the Conversion Transaction (exclusive of any new purchases by the Minority Stockholders). Under Office of Thrift Supervision regulations, Minority Stockholders would not be diluted because of any dividends waived by K-Fed Mutual Holding Company (and waived dividends would not be considered in determining an appropriate exchange ratio), if K-Fed Mutual Holding Company converts to stock form.
A Conversion Transaction requires the approval of the Office of Thrift Supervision as well as a majority of the votes eligible to be cast by the members of K-Fed Mutual Holding Company and a majority of the votes eligible to be cast by the stockholders of K-Fed Bancorp other than K-Fed Mutual Holding Company.
Kaiser Federal Bank
General. As a federally chartered savings association, Kaiser Federal Bank is regulated and supervised by the Office of Thrift Supervision and the Federal Deposit Insurance Corporation. This regulation and supervision establishes a comprehensive framework of activities in which we may engage, and is intended primarily for the protection of the Federal Deposit Insurance Corporation’s deposit insurance fund and depositors. Under this system of federal regulation, financial institutions are periodically examined to ensure that they satisfy applicable standards with respect to their capital adequacy, assets, management, earnings, liquidity and sensitivity to market interest rates. After completing an examination, the federal agency critiques the financial institution’s operations and assigns its rating (known as an institution’s CAMELS). Under federal law, an institution may not disclose its CAMELS rating to the public. Kaiser Federal Bank also is a member of, and owns stock in, the Federal Home Loan Bank of San Francisco, which is one of the 12 regional banks in the Federal Home Loan Bank System. Kaiser Federal Bank also is regulated, to a lesser extent, by the Board of Governors of the Federal Reserve System, governing reserves to be maintained against deposits and other matters. The Office of Thrift Supervision examines Kaiser Federal Bank and prepares reports for consideration by our Board of Directors on any operating deficiencies. Kaiser Federal Bank’s relationship with our depositors and borrowers also is regulated to a great extent by both federal and state laws, especially in matters concerning the ownership of deposit accounts and the form and content of our loan documents.
There can be no assurance that changes to existing laws, rules and regulations, or any other new laws, rules or regulations, will not be adopted in the future, which could make compliance more difficult or expensive or otherwise adversely affect our business, financial condition or prospects. Any change in these laws or regulations, or in regulatory policy, whether by the Federal Deposit Insurance Corporation, the Office of Thrift Supervision or Congress, could have a material adverse impact on our business, financial condition or operations.
Federal Banking Regulation
Business Activities. A federal savings association derives its lending and investment powers from the Home Owners’ Loan Act, and the regulations of the Office of Thrift Supervision. Under these laws and regulations, Kaiser Federal Bank may invest in mortgage loans secured by residential and commercial real estate, commercial business and consumer loans, certain types of debt securities and certain other loans and assets subject to applicable limits. Kaiser Federal Bank also may establish subsidiaries that may engage in activities not otherwise permissible for Kaiser Federal Bank directly, including real estate investment, securities brokerage and insurance agency services subject to applicable registration and licensing requirements.
Loans to One Borrower. A federal savings association generally may not make a loan or extend credit to a single or related group of borrowers in excess of 15% of unimpaired capital and surplus. An additional amount may be loaned, not in excess of 10% of unimpaired capital and surplus, if the loan is secured by readily marketable collateral, which generally does not include real estate. As of June 30, 2008, Kaiser Federal Bank was in compliance with the loans-to-one-borrower limitations.
Qualified Thrift Lender Test. As a federal savings association, Kaiser Federal Bank is subject to the qualified thrift lender, or “QTL,” test. Under the QTL test, Kaiser Federal Bank must maintain at least 65% of its “portfolio assets” in “qualified thrift investments” in at least nine months of the most recent twelve-month period. “Portfolio assets” generally means total assets of a savings institution, less the sum of specified liquid assets up to 20% of total
assets, goodwill and other intangible assets, and the value of property used in the conduct of the institution’s business.
“Qualified thrift investments” include various types of loans made for residential and housing purposes, investments related to such purposes, including certain mortgage-backed and related securities, and loans for personal, family, household and certain other purposes up to a limit of 20% of portfolio assets. “Qualified thrift investments” also include 100% of an institution’s credit card loans, education loans and small business loans. Kaiser Federal Bank also may satisfy the QTL test by qualifying as a “domestic building and loan association” as defined in the Internal Revenue Code of 1986.
A savings association that fails the QTL test must either convert to a bank charter or operate under specified restrictions. At June 30, 2008, Kaiser Federal Bank maintained 86.1% of its portfolio assets in qualified thrift investments, and therefore satisfied the QTL test.
Capital Distributions. Office of Thrift Supervision regulations govern capital distributions by a federal savings association, which include cash dividends, stock repurchases and other transactions charged to the institution’s
capital account. A savings association must file an application with the Office of Thrift Supervision for approval of a capital distribution if:
·
the total capital distributions for the applicable calendar year exceed the sum of the savings association’s net income for that year to date plus the savings association’s retained net income for the preceding two years;
·
the savings association would not be at least adequately capitalized following the distribution;
·
the distribution would violate any applicable statute, regulation, agreement or Office of
·
the savings association is not eligible for expedited treatment of its filings.
Even if an application is not otherwise required, every savings association that is a subsidiary of a holding company must still file a notice with the Office of Thrift Supervision at least 30 days before the Board of Directors
declares a dividend or approves a capital distribution. The Office of Thrift Supervision may disapprove a notice or application if:
·
the savings association would be undercapitalized following the distribution;
·
the proposed capital distribution raises safety and soundness concerns; or
·
the capital distribution would violate a prohibition contained in any statute, regulation or agreement.
Liquidity. A federal savings association is required to maintain a sufficient amount of liquid assets to ensure its safe and sound operation.
Community Reinvestment Act and Fair Lending Laws. All savings associations have a continuing responsibility under the Community Reinvestment Act and related regulations of the Office of Thrift Supervision to help meet the credit needs of their communities, including low- and moderate- income neighborhoods. In connection with its examination of a federal savings association, the Office of Thrift Supervision is required to assess the savings association’s record of compliance with the Community Reinvestment Act. In addition, the Equal Credit Opportunity Act and the Fair Housing Act prohibit lenders from discriminating in their lending practices on the basis of
characteristics specified in those statutes. A savings association’s failure to comply with the provisions of the Community Reinvestment Act could, at a minimum, result in regulatory restrictions on its activities. The failure to comply with the Equal Credit Opportunity Act and the Fair Housing Act could result in enforcement actions by the Office of Thrift Supervision, as well as other federal regulatory agencies and the Department of Justice. Kaiser Federal Bank received a “Satisfactory” Community Reinvestment Act rating in its most recent federal examination. The Community Reinvestment Act requires all FDIC-insured institutions to publicly disclose their rating.
characteristics specified in those statutes. A savings association’s failure to comply with the provisions of the Community Reinvestment Act could, at a minimum, result in regulatory restrictions on its activities. The failure to
comply with the Equal Credit Opportunity Act and the Fair Housing Act could result in enforcement actions by the Office of Thrift Supervision, as well as other federal regulatory agencies and the Department of Justice. Kaiser
Federal Bank received a “Satisfactory” Community Reinvestment Act rating in its most recent federal examination. The Community Reinvestment Act requires all FDIC-insured institutions to publicly disclose their rating.
Transactions with Related Parties. A federal savings association’s authority to engage in transactions with its “affiliates” is limited by Office of Thrift Supervision regulations and Regulation W of the Federal Reserve Board, which implements Sections 23A and 23B of the Federal Reserve Act. The term “affiliates” for these purposes generally means any company that controls or is under common control with an institution. K-Fed Bancorp and its non-savings institution subsidiaries will be affiliates of Kaiser Federal Bank. In general, transactions with affiliates must be on terms that are as favorable to the savings association as comparable transactions with non-affiliates. In addition, certain types of these transactions are restricted to an aggregate percentage of the savings association’s capital. Collateral in specified amounts must usually be provided by affiliates in order to receive loans from the savings association. In addition, Office of Thrift Supervision regulations prohibit a savings association from lending to any of its affiliates that are engaged in activities that are not permissible for bank holding companies and from purchasing the securities of any affiliate, other than a subsidiary.
Kaiser Federal Bank’s authority to extend credit to its directors, executive officers and 10% or greater stockholders, as well as to entities controlled by such persons, is currently governed by the requirements of Sections 22(g) and 22(h) of the Federal Reserve Act and Regulation O of the Federal Reserve Board and regulations of the Office of Thrift Supervision. Among other things, these provisions require that extensions of credit to insiders (i) be made on terms that are substantially the same as, and follow credit underwriting procedures that are not less stringent than, those prevailing for comparable transactions with unaffiliated persons and that do not involve more than the normal risk of repayment or present other unfavorable features, and (ii) not exceed certain limitations on the amount of credit extended to such persons, individually and in the aggregate, which limits are based, in part, on the amount of Kaiser Federal Bank’s capital. In addition, extensions of credit in excess of certain limits must be approved by Kaiser Federal Bank’s Board of Directors.
Enforcement. The Office of Thrift Supervision has primary enforcement responsibility over federal savings associations and has the authority to bring enforcement actions against all “institution- affiliated parties,” including stockholders, attorneys, appraisers and accountants who knowingly or recklessly participate in wrongful action likely to have an adverse effect on an institution. Formal enforcement action may range from the issuance of a capital directive or cease and desist order to removal of officers and/or directors of the savings association, receivership, conservatorship or the termination of deposit insurance. Civil penalties cover a wide range of violations and actions, and range up to $25,000 per day, unless a finding of reckless disregard is made, in which case penalties may be as high as $1.0 million per day. The Federal Deposit Insurance Corporation also has the authority to recommend to the Director of the Office of Thrift Supervision that enforcement action be taken with respect to a particular savings association. If action is not taken by the Director of the Office of Thrift Supervision, the Federal Deposit Insurance Corporation has authority to take action under specified circumstances.
Standards for Safety and Soundness. Federal law requires each federal banking agency to prescribe certain standards for all insured depository institutions. These standards relate to, among other things, internal controls, information systems and audit systems, loan documentation, credit underwriting, interest rate risk exposure, asset growth, compensation, and other operational and managerial standards as the agency deems appropriate. The federal banking agencies have adopted Interagency Guidelines Prescribing Standards for Safety and Soundness. The guidelines set forth the safety and soundness standards that the federal banking agencies use to identify and address problems at insured depository institutions before capital becomes impaired. The guidelines address internal controls and information systems, internal audit systems, credit underwriting, loan documentation, interest rate risk exposure, asset growth, compensation, fees and benefits. If the appropriate federal banking agency determines that an institution fails to meet any standard prescribed by the guidelines, the agency may require the institution to submit to the agency an acceptable plan to achieve compliance with the standard. If the institution fails to submit an acceptable plan or implement an accepted compliance plan, the agency may take further enforcement action against the institution, including the issuance of a cease and desist order or the imposition of civil money penalties.
Capital Requirements. The Office of Thrift Supervision regulations require savings associations to meet three minimum capital standards: a 1.5% tangible capital ratio, a 4% leverage ratio (3% for institutions receiving the highest CAMELS rating) and an 8% risk-based capital ratio.
The risk-based capital standard for savings associations requires the maintenance of Tier 1 (core) and total capital (which is defined as core capital and supplementary capital) to risk-weighted assets of at least 4% and 8%, respectively. In determining the amount of risk-weighted assets, all assets, including certain off-balance sheet assets, are multiplied by a risk-weight factor of 0% to 100%, assigned by the Office of Thrift Supervision capital regulation based on the risks inherent in the type of asset. Core capital is defined as common stockholders’ equity (including retained earnings), certain noncumulative perpetual preferred stock and related surplus and minority interests in equity accounts of consolidated subsidiaries, less intangibles other than certain mortgage servicing rights and credit card relationships. The components of supplementary capital currently include cumulative preferred stock, long-term perpetual preferred stock, mandatory convertible securities, subordinated debt and intermediate preferred stock, allowance for loan and lease losses up to a maximum of 1.25% of risk-weighted assets, and up to 45% of net unrealized gains on available -for-sale equity securities with readily determinable fair market values. Overall, the amount of supplementary capital included as part of total capital cannot exceed 100% of core capital.
In assessing an association’s capital adequacy, the Office of Thrift Supervision takes into consideration not only these numeric factors but also qualitative factors as well, and has the authority to establish higher capital requirements for individual associations where necessary. Kaiser Federal Bank, as a matter of prudent management, targets as its goal the maintenance of capital ratios which exceed these minimum requirements and that are consistent with Kaiser Federal Bank’s risk profile. At June 30, 2008, Kaiser Federal Bank exceeded each of its capital requirements.
The Office of Thrift Supervision and other federal banking agencies risk-based capital standards also take into account interest rate risk, concentration of risk and the risks of non-traditional activities. The Office of Thrift Supervision monitors the interest rate risk of individual institutions through the Office of Thrift Supervision requirements for interest rate risk management, the ability of the Office of Thrift Supervision to impose individual minimum capital requirements on institutions that exhibit a high degree of interest rate risk, and the requirements of Thrift Bulletin 13a, which provides guidance on the management of interest rate risk and the responsibility of boards of directors in that area.
The Office of Thrift Supervision continues to monitor the interest rate risk of individual institutions through analysis of the change in net portfolio value. Net portfolio value is defined as the net present value of the expected
future cash flows of an entity’s assets and liabilities and, therefore, hypothetically represents the value of an institution’s net worth. The Office of Thrift Supervision has also used this net portfolio value analysis as part of its
evaluation of certain applications or notices submitted by savings banks. The Office of Thrift Supervision, through its general oversight of the safety and soundness of savings associations, retains the right to impose minimum
capital requirements on individual institutions to the extent the institution is not in compliance with certain written guidelines established by the Office of Thrift Supervision regarding net portfolio value analysis. The Office of Thrift
Supervision has not imposed any such requirements on Kaiser Federal Bank.
At June 30, 2008, Kaiser Federal Bank’s capital exceeded all applicable requirements.
Prompt Corrective Action Regulations. Under the prompt corrective action regulations, the Office of Thrift Supervision is authorized and, under certain circumstances, required to take supervisory actions against undercapitalized savings associations. For this purpose, a savings association is placed in one of the following five categories based on the savings association’s capital:
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well-capitalized (at least 5% leverage capital, 6% tier 1 risk-based capital and 10% total risk-based capital);
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adequately capitalized (at least 4% leverage capital, 4% tier 1 risk-based capital and 8% total risk-based capital);
·
undercapitalized (less than 3% leverage capital, 4% tier 1 risk-based capital or 8% total risk-based capital);
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significantly undercapitalized (less than 3% leverage capital, 3% tier 1 risk-based capital or 6% total risk-based capital); or
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critically undercapitalized (less than 2% tangible capital).
Generally, the Office of Thrift Supervision is required to appoint a receiver or conservator for a savings association that is “critically undercapitalized.” The regulation also provides that a capital restoration plan must be filed with the Office of Thrift Supervision within forty-five days of the date a savings association receives notice that it is “undercapitalized,” “significantly undercapitalized” or “critically undercapitalized” or is deemed to have notice and the plan must be guaranteed by any parent holding company. The aggregate liability of a parent holding company is limited to the lesser of:
·
an amount equal to 5% of the savings association’s total assets at the time it became
“undercapitalized”; and
·
the amount that is necessary (or would have been necessary) to bring the association into compliance with all capital standards applicable with respect to such association as of the time it fails to comply withy a capital restoration plan.
If a savings association fails to submit an acceptable plan, it is treated as if it were “significantly undercapitalized.” In addition, numerous mandatory supervisory restrictions become immediately applicable to the savings association, including, but not limited to, restrictions on growth, investment activities, capital distributions and affiliate transactions. The Office of Thrift Supervision may also take any one of a number of discretionary supervisory actions against undercapitalized savings associations, including the issuance of a capital directive and the replacement of senior executive officers and directors. At June 30, 2008, Kaiser Federal Bank met the criteria for being
considered “well-capitalized.”
Deposit Insurance. Kaiser Federal Bank is a member of the Deposit Insurance Fund, maintained by the FDIC, and Kaiser Federal Bank pays its deposit insurance assessments to the Deposit Insurance Fund. The Deposit Insurance Fund was formed on March 31, 2006 following the merger of the Bank Insurance Fund and the Savings Association Insurance Fund in accordance with the Federal Deposit Insurance Reform Act of 2005 (the “Deposit Insurance Fund Act”).
In addition to merging the insurance funds, the Deposit Insurance Fund Act established a statutory minimum and maximum designated reserve ratio for the Deposit Insurance Fund and granted the FDIC greater flexibility in establishing the required reserve ratio. In its regulations implementing the Deposit Insurance Fund Act, the FDIC has set the current annual designated reserve ratio for the Deposit Insurance Fund at 1.25%.
In order to maintain the Deposit Insurance Fund, member institutions are assessed an insurance premium. The amount of each institution’s premium is currently based on the balance of insured deposits and the degree of risk the institution poses to the Deposit Insurance Fund. Under the assessment system, the FDIC assigns an institution to one of nine risk categories using a two-step process based first on capital ratios (the capital group assignment) and then on other relevant information (the supervisory subgroup assignment). Each risk category is assigned an assessment rate. Assessment rates currently range from .05% of deposits for an institution in the highest category (i.e., well-capitalized and financially sound, with no more than a few minor weaknesses) to 0.43% of deposits for an institution in the lowest category (i.e., undercapitalized and substantial supervisory concerns). The FDIC is authorized to raise the assessment rates as necessary to maintain the Deposit Insurance Fund. The Kaiser Federal Bank assessment rate at June 30, 2008 was .05% per $100 of deposits. Any increase in insurance assessments could have an adverse effect on the earnings of insured institutions, including Kaiser Federal Bank. As a result of a number of FDIC insured institution failures in 2008 and the expectation of more failures over the next few years, FDIC recently announced that the assessment rates are likely to increase.
In addition, all FDIC insured institutions are required to pay a pro rata portion of the interest due on obligations issued by the Financing Corporation to fund the closing and disposal of failed thrift institutions by the Resolution Trust Corporation. At December 31, 2007, the FDIC assessed Deposit Insurance Fund- insured deposits was 1.21 basis points (0.0121%) per $100 of deposits to cover those obligations. The Financing Corporation rate is adjusted quarterly to reflect changes in assessment base of the Deposit Insurance Fund. This obligation will continue until the Financing Corporation bonds mature in 2017.
Assessments. The Office of Thrift Supervision charges assessments to recover the cost of examining federal savings associations and their affiliates. These assessments are based on three components: (i) the size of the institution on which the basic assessment is based; (ii) the institution’s supervisory condition, which results in an additional assessment based on a percentage of the basic assessment for any savings institution with a composite rating of 3, 4 or 5 in its most recent safety and soundness examination; and (iii) the complexity of the institution’s operations, which results in an additional assessment based on a percentage of the basic assessment for any savings institution that managed over $1 billion in trust assets, serviced for others loans aggregating more than $1 billion, or had certain off-balance sheet assets aggregating more than $1 billion.
The Office of Thrift Supervision also assesses fees against savings and loan holding companies, such as K-Fed Bancorp. The Office of Thrift Supervision semi-annual assessment for savings and loan holding companies includes a $3,000 base assessment with an additional assessment based on the holding company’s risk or complexity, organizational form and condition.
Prohibitions Against Tying Arrangements. Federal savings associations are prohibited, subject to some exceptions, from extending credit to or offering any other service, or fixing or varying the consideration for such extension of credit or service, on the condition that the customer obtain some additional service from the savings association or its affiliates or not obtain services of a competitor of the savings association.
Federal Home Loan Bank System. Kaiser Federal Bank is a member of the Federal Home Loan Bank System, which consists of twelve regional Federal Home Loan Banks each of which is subject to regulation and supervision of the Federal Housing Finance Board. The Federal Home Loan Bank System provides a central credit facility primarily for member institutions as well as other entities involved in home mortgage lending. It is funded primarily from proceeds derived from the sale of consolidated obligations of the Federal Home Loan Banks. It makes loans or advances to members in accordance with policies and procedures, including collateral requirements, established by the respective boards of directors of the Federal Home Loan Banks. These policies and procedures are subject to the regulation and oversight of the Federal Housing Finance Board. All long-term advances are required to provide funds for residential home financing. The Federal Housing Finance Board has also established standards of community or investment service that members must meet to maintain access to such long-term advances. As a member of the Federal Home Loan Bank of San Francisco, Kaiser Federal Bank is required to acquire and hold shares of capital stock in the Federal Home Loan Bank. As of June 30, 2008, Kaiser Federal Bank was in compliance with this requirement.
Federal Reserve System
Institutions must maintain a reserve of 3% against aggregate transaction accounts between $7.8 million and $48.3 million (subject to adjustment by the Federal Reserve Board) plus a reserve of 10% (subject to adjustment by the Federal Reserve Board between 8% and 14%) against that portion of total transaction accounts in excess of $48.3 million. The first $7.8 million of otherwise reservable balances is exempt from the reserve requirements. Kaiser Federal Bank is in compliance with the foregoing requirements. Because required reserves must be maintained in the form of either vault cash, a non- interest-bearing account at a Federal Reserve Bank or a pass-through account as defined by the Federal Reserve Board, the effect of this reserve requirement is to reduce Kaiser Federal Bank’s interest-earning assets. At June 30, 2008, Kaiser Federal Bank was in compliance with these reserve requirements. The balances maintained to meet the reserve requirements imposed by the Federal Reserve Board may be used to satisfy liquidity requirements imposed by the Office of Thrift Supervision.
The USA PATRIOT Act
The Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 or the USA PATRIOT Act gives the federal government new powers to address terrorist threats through enhanced domestic security measures, expanded surveillance powers, increased information sharing and broadened anti-money laundering requirements. Certain provisions of the Act impose affirmative obligations on a broad range of financial institutions, including federal savings associations, like Kaiser Federal Bank. These obligations include enhanced anti-money laundering programs, customer identification programs and regulations relating to private banking accounts or correspondence accounts in the United States for non-United States persons or their representatives (including foreign individuals visiting the United States).
Kaiser Federal Bank has established policies and procedures to ensure compliance with the USA PATRIOT Act’s provisions, and the impact of the USA PATRIOT Act on our operations has not been material.
Privacy Requirements of the Gramm-Leach-Bliley Act
The Gramm-Leach-Bliley Act of 1999 provided for sweeping financial modernization for commercial banks, savings banks, securities firms, insurance companies, and other financial institutions operating in the United States. Among other provisions, the Gramm-Leach-Bliley Act places limitations on the sharing of consumer financial information with unaffiliated third parties. Specifically, the Gramm- Leach-Bliley Act requires all financial institutions offering financial products or services to retail customers to provide such customers with the financial institution’s privacy policy and provide such customers the opportunity to “opt out” of the sharing of personal financial information with unaffiliated third parties.
Sarbanes-Oxley Act of 2002
As a public company, K-Fed Bancorp is subject to the Sarbanes-Oxley Act, which implements a broad range of corporate governance and accounting measures for public companies designed to promote honesty and transparency in corporate America and better protect investors from corporate wrongdoing. The Sarbanes-Oxley Act’s principal legislation and the derivative regulation and rule making promulgated by the SEC includes:
·
the creation of an independent accounting oversight board;
·
auditor independence provisions which restrict non-audit services that accountants may provide to their audit clients;
·
additional corporate governance and responsibility measures, including the requirement that the chief executive officer and chief financial officer certify financial statements;
·
a requirement that companies establish and maintain a system of internal control over financial reporting and that a company’s management provide an annual report regarding its assessment of the effectiveness of such internal control over financial reporting to the company’s independent accountants and that such accountants provide an attestation report with respect to the effectiveness of the company’s internal control over financial reporting;
·
the forfeiture of bonuses or other incentive-based compensation and profits from the sale of an issuer’s securities by directors and senior officers in the twelve month period following initial publication of any financial statements that later require restatement;
·
an increase in the oversight of, and enhancement of certain requirements relating to audit committees of public companies and how they interact with the company’s independent auditors;
·
requirement that audit committee members must be independent and are absolutely barred from accepting consulting, advisory or other compensatory fees from the issuer;
·
requirement that companies disclose whether at least one member of the committee is a “financial expert” (as such term is defined by the Securities and Exchange Commission) and if not, why not;
·
expanded disclosure requirements for corporate insiders, including accelerated reporting of stock transactions by insiders and a prohibition on insider trading during pension blackout periods;
·
a prohibition on personal loans to directors and officers, except certain loans made by insured financial institutions;
·
disclosure of a code of ethics and filing a Form 8-K for a change or waiver of such code;
·
mandatory disclosure by analysts of potential conflicts of interest; and
·
a range of enhanced penalties for fraud and other violations.
Section 402 of the Sarbanes-Oxley Act prohibits the extension of personal loans to directors and executive officers of issuers (as defined in Sarbanes-Oxley). The prohibition, however, does not apply to loans made by an insured depository institution, such as Kaiser Federal Bank, that are subject to the insider lending restrictions of Regulation O of the Federal Reserve Board.
Federal Securities Laws
The stock of K-Fed Bancorp is registered with the SEC under the Securities Exchange Act of 1934, as amended. K-Fed Bancorp is subject to the information, proxy solicitation, insider trading restrictions and other requirements of the SEC under the Securities Exchange Act of 1934.
K-Fed Bancorp stock held by persons who are affiliates of K-Fed Bancorp may not be resold without registration unless sold in accordance with certain resale restrictions. Affiliates are generally considered to be officers, directors and principal stockholders. If K-Fed Bancorp meets specified current public information requirements, each affiliate of K-Fed Bancorp will be able to sell in the public market, without registration, a limited number of shares in any three-month period.
TAXATION
Federal Taxation
General. K-Fed Bancorp and Kaiser Federal Bank are subject to federal income taxation in the same general manner as other corporations, with some exceptions discussed below. The following discussion of taxation is intended only to summarize pertinent federal income tax matters and is not a comprehensive description of the tax rules applicable to K-Fed Bancorp or Kaiser Federal Bank. Neither K-Fed Bancorp nor Kaiser Federal Bank’s federal income tax returns have ever been audited by the Internal Revenue Service.
Method of Accounting. For federal income tax purposes, K-Fed Bancorp and Kaiser Federal Bank currently reports their income and expenses on the accrual method of accounting and uses a fiscal year ending on June 30, for filing their federal income tax returns.
Minimum Tax. The Internal Revenue Code imposes an alternative minimum tax at a rate of 20% on a base of regular taxable income plus certain tax preferences, called alternative minimum taxable income. The alternative minimum tax is payable to the extent such alternative minimum taxable income is in excess of an exemption amount. Net operating losses can offset no more than 90% of alternative minimum taxable income. Certain payments of alternative minimum tax may be used as credits against regular tax liabilities in future years. Kaiser Federal Bank has not been subject to the alternative minimum tax, nor do we have any such amounts available as credits for carryover.
Net Operating Loss Carryovers. A financial institution may carryback net operating losses to the preceding two taxable years and forward to the succeeding twenty taxable years. This provision applies to losses incurred in taxable years beginning after August 6, 1997. At June 30, 2008, Kaiser Federal Bank had no net operating loss carryforwards for federal income tax purposes.
Corporate Dividends-Received Deduction. K-Fed Bancorp may eliminate from its income dividends received from Kaiser Federal Bank as a wholly owned subsidiary of K-Fed Bancorp if it elects to file a consolidated return with Kaiser Federal Bank. The corporate dividends-received deduction is 100% or 80%, in the case of dividends received from corporations with which a corporate recipient does not file a consolidated tax return, depending on the level of stock ownership of the payor of the dividend. Corporations which own less than 20% of the stock of a corporation distributing a dividend may deduct 70% of dividends received or accrued on their behalf.
State Taxation
K-Fed Bancorp and Kaiser Federal Bank are subject to the California Corporate (Franchise) tax which is assessed at the rate of 10.84%. For this purpose, taxable income generally means federal taxable income subject to certain modifications provided for in California law.
Item 1A.
Item 1A. Risk Factors
The following are certain risk factors that could impact our business, financial results and results of operations. Investing in our common stock involves risks, including those described below. These risk factors should be considered by prospective and current investors in our common stock when evaluating the disclosures in this Annual Report on Form 10-K (particularly the forward-looking statements.) These risk factors could cause actual results and conditions to differ materially from those projected in forward-looking statements. If the risks we face, including those listed below, actually occur, our business, financial condition or results of operations could be negatively impacted, and the trading price of our common stock could decline, which may cause you to lose all or part of your investment.
If Economic Conditions Further Deteriorate In Our Primary Market Of Southern California, Our Results Of Operations And Financial Condition Could Be Adversely Impacted As Borrowers’ Ability To Repay Loans Declines And The Value Of The Collateral Securing Loans Decreases.
Our financial results may be adversely affected by changes in prevailing economic conditions, including decreases in real estate values, changes in interest rates which may cause a decrease in interest rate spreads, adverse employment conditions, the monetary and fiscal policies of the federal and California state governments and other significant external events. As of June 30, 2008, 57.5% or $428.7 million of our loan portfolio consisted of loans secured by one-to-four family residences. All our real estate loans are secured by properties located in California. Decreases in California real estate values have adversely affected the value of property used as collateral. In the event that we are required to foreclose on a property securing a mortgage loan or pursue other remedies in order to protect our investment, there can be no assurance that we will recover funds in an amount equal to any remaining loan balance as a result of prevailing general economic or local conditions, real estate values and other factors associated with the ownership of real property. As a result, the market value of the real estate or other collateral underlying the loans may not, at any given time, be sufficient to satisfy the outstanding principal amount of the loans. Consequently, we would sustain loan losses and potentially incur a higher provision for loan loss expense. Adverse changes in the economy
may also have a negative effect on the ability of borrowers to make timely repayments of their loans, which could have an adverse impact on earnings.
Changes in Interest Rates Can Have An Adverse Effect On Our Net Income.
Net income is the amount by which net interest income and non-interest income exceeds non-interest expenses and the provision for loan losses. Net interest income makes up a majority of our income and is based on the difference between:
·
the interest income we earn on our interest-earning assets, such as loans and securities; and
·
the interest we pay on our interest-bearing liabilities, such as deposits and borrowings.
A substantial percentage of our interest-earning assets, such as residential mortgage loans, have longer maturities than our interest-bearing liabilities, which consist primarily of deposits and borrowings. As a result, our net interest income is adversely affected if the average cost of our interest-bearing liabilities increases more rapidly than the average yield on our interest-earning assets.
Our Loan Portfolio Possesses Increased Risk Due To Our Level Of Multi-Family Real Estate, Commercial Real Estate And Consumer Loans Which Could Increase Our Level Of Provision For Loan Losses.
Our outstanding multi-family real estate, commercial real estate and consumer loans accounted for 42.5% of our total loan portfolio as of June 30, 2008, an increase of 36.2% from June 30, 2007. Generally, management considers these types of loans to involve a higher degree of risk compared to permanent first mortgage loans on one-to-four family, owner occupied residential properties. These loans have higher risks than permanent loans secured by residential real estate for the following reasons:
·
Multi-Family Real Estate Loans. These loans are underwritten on the income producing potential of the property, financial strength of the borrower and any guarantors. Repayment is dependent on income being generated in amounts sufficient to cover operating expenses and debt service.
·
Commercial Real Estate Loans. These loans are underwritten on the income producing potential of the property or the successful operation of the borrowers’ or tenants’ businesses, financial strength of the borrower and any guarantors. Repayment is dependent on income being generated in amounts sufficient to cover operating expenses and debt service.
·
Consumer Loans. Collateralized consumer loans (such as automobile loans) are collateralized by assets that may not provide adequate source of repayment of the loan due to depreciation, damage or loss. As a result, consumer loan collections are dependent on the borrower’s continuing financial stability and thus, are more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy.
Management plans to increase emphasis on higher yielding products such as multi-family and commercial real estate loans, while maintaining a moderate growth of one- to-four family residential real estate loans. Many of our commercial and multi-family real estate loans are not fully amortizing and contain large balloon payments upon maturity. These balloon payments may require the borrower to either sell or refinance the underlying property in order to make the balloon payment. Further, commercial and multi-family real estate loans generally have relatively large balances to single borrowers or related groups of borrowers. Accordingly, if we make any errors in judgment in the collectability of our commercial and multi-family real estate loans, any resulting charge-offs may be larger on a per loan basis than those incurred with our residential or consumer loan portfolios. As a result of the above factors, management may determine it necessary to increase the level of provision for loan losses. Increased provisions for loan losses could negatively affect our results of operation.
Our Loan Portfolio Possesses Increased Risk Due To Its Rapid Expansion, Unseasoned Nature And Amount Of Nonconforming Loans.
From June 30, 2004 to June 30, 2008, our loan portfolio has grown by $248.8 million or 50.1%. As a result of this rapid expansion, a significant portion of our portfolio is unseasoned and may not have had sufficient time to perform to properly indicate the potential magnitude of losses. Our unseasoned adjustable rate loans have not, therefore, been subject to an interest rate environment that causes them to adjust to the maximum level and may involve risks resulting from potentially increasing payment obligations by the borrower as a result of the repricing. A significant portion of our one-to-four family residential loans are non-conforming to secondary market requirements, due mainly to the large loan size or loan terms, and are therefore, not saleable to Freddie Mac or Fannie Mae. At June 30, 2008, about 12.3% of our one-to-four family loan portfolio consisted of loans that were considered nonconforming due to loan size.
As of June 30, 2008, we held in portfolio approximately $91.6 million in one-to four-family interest-only mortgage loans. This amount represents 12.3% of our gross loan portfolio. The interest rate on these loans are initially fixed for three, five or seven year terms and then adjust in accordance with the terms of the loan to require payment of both principal and interest in order to amortize the loan for the remainder of the term. Since 2005, we have originated or purchased interest-only loans on the basis that the loan is fully amortizing and for an adjustable rate loan by qualifying the borrower based upon the rate that would apply upon the first interest rate adjustment. We have also purchased loans to borrowers who provide limited or no documentation of assets or income, known as stated income loans. A stated income loan is a loan where the borrower’s income source is not subject to verification through the application process, but the reasonableness of the stated income is verified through review of other sources, such as compensation surveys. At June 30, 2008, we had $73.9 million in fixed rate stated income loans and $33.3 million in adjustable rate stated income loans. Included in our stated income loans at June 30, 2008 were $37.0 million in interest only loans.
Non-conforming one-to-four family residential loans are generally considered to have an increased risk of delinquency and foreclosure than conforming loans and may result in higher levels of provision for loan losses. For example, if the interest rate adjustment results in the borrower being unable to make higher payments of both interest and principal or to refinance the loan, we would be required to initiate collection efforts including foreclosure in order to protect our investment. Although we have not experienced such increased delinquencies or foreclosures in the current economy, there can be no assurance that our nonconforming loan portfolio would not be adversely affected as
regional and national economic conditions further deteriorate. In addition, there can be no assurance, that we will recover funds in an amount equal to any remaining loan balance. Consequently, we could sustain loan losses and potentially incur a higher provision for loan losses.
If The Allowance For Loan Losses Is Not Sufficient To Cover Actual Losses, Net Income May Be Negatively Affected.
In the event that loan customers do not repay their loans according to their terms and the collateral security for the payments of these loans is insufficient to pay any remaining loan balance, we may experience significant loan losses. Such credit risk is inherent in the lending business, and failure to adequately assess such credit risk could have a material adverse affect on our financial condition and results of operations. Management makes various assumptions and judgments about the collectability of the loan portfolio, including the creditworthiness of the borrowers and the value of the real estate and other assets serving as collateral for the repayment of many of the loans. In determining the amount of the allowance for loans losses, management reviews the loan portfolio and Kaiser Federal Bank’s historical loss and delinquency experience, as well as overall economic conditions. If management’s assumptions are incorrect, the allowance for loan losses may be insufficient to cover probable incurred losses in the loan portfolio, resulting in additions to the allowance. The allowance for loan losses is also periodically reviewed by the Office of Thrift Supervision, who may disagree with the allowance and require us to increase such amount. Additions to the allowance for loans losses would be made through increased provisions for loan losses and could negatively affect our results of operations. At June 30, 2008, our allowance for loan losses was $3.2 million, or 0.43% of total loans and 186.66% of non-performing loans.
We Depend On Our Management Team To Implement Our Business Strategy And Execute Successful Operations And We Could Be Harmed By The Loss Of Their Services.
We are dependent upon the services of our senior management team. Our strategy and operations are directed by the senior management team. Currently, neither our president and chief executive officer nor our three other executive officers have employment agreements with Kaiser Federal Bank. Any loss of the services of the president and chief executive officer or other members of the management team could impact our ability to implement our business strategy, and have a material adverse effect on our results of operations and our ability to compete in our markets.
Strong Competition In Our Primary Market Area May Reduce Our Ability To Attract And Retain Deposits And Also May Increase Our Cost of Funds.
We operate in a very competitive market for the attraction of deposits, the primary source of our funding. Historically, our most direct competition for deposits has come from credit unions, community banks, large commercial banks and thrift institutions within our primary market areas. In recent years competition has also come from institutions that largely deliver their services over the internet. Such competitors have the competitive advantage of lower infrastructure costs. Particularly in times of extremely low or extremely high interest rates, we have faced significant competition for investors’ funds from short-term money market securities and other corporate and government securities. During periods of regularly increasing interest rates, competition for interest bearing deposits increases as customers, particularly time deposit customers, tend to move their accounts between competing businesses to obtain the highest rates in the market. As a result, Kaiser Federal Bank incurs a higher cost of funds in an effort to attract and retain customer deposits. We strive to grow our lower cost deposits, such as non-interest bearing checking accounts, in order to reduce our cost of funds.
Strong Competition In Our Primary Market Area May Reduce Our Ability To Obtain Loans And Also Decrease Our Yield On Loans.
We are located in a competitive market that affects our ability to obtain loans through origination or purchase as well as originating them at rates that provide an attractive yield. Competition for loans comes principally from mortgage bankers, commercial banks, other thrift institutions, nationally based homebuilders and credit unions. Internet based lenders have also become a greater competitive factor in recent years. Such competition for the origination and purchase of loans may limit future growth and earnings prospects.
We Operate In A Highly Regulated Environment And May Be Adversely Affected By Changes In Laws And Regulations.
Kaiser Federal Bank is subject to extensive regulation, supervision and examination by the Office of Thrift Supervision, its chartering authority, and by the Federal Deposit Insurance Corporation, which insures Kaiser Federal Bank’s deposits. As a thrift holding company, we are subject to regulation and supervision by the Office of Thrift Supervision. Such regulation and supervision govern the activities in which financial institutions and their holding companies may engage and are intended primarily for the protection of the federal deposit insurance fund and depositors. These regulatory authorities have extensive discretion in connection with their supervisory and enforcement activities, including the imposition of restrictions on the operations of financial institutions, the classification of assets by financial institutions and the adequacy of financial institutions’ allowance for loan losses. Any change in such regulation and oversight, whether in the form of regulatory policy, regulations, or legislation, could have a material impact on Kaiser Federal Bank and K-Fed Bancorp or its successor.
Kaiser Federal Bank’s operations are also subject to extensive regulation by other federal, state and local governmental authorities, and are subject to various laws and judicial and administrative decisions that impose requirements and restrictions on operations. These laws, rules and regulations are frequently changed by legislative and regulatory authorities. There can be no assurance that changes to existing laws, rules and regulations, or any other new laws, rules or regulations, will not be adopted in the future, which could make compliance more difficult or expensive or otherwise adversely affect the business, financial condition or prospects.
Item 1B.
Item 1B. Unresolved Staff Comments.
None.
Item 2.
Item 2. Properties.
At June 30, 2008, we had three full service offices and six financial service centers. Our financial service centers provide all the same services as a full service office except they do not dispense cash, but cash is available from an ATM located on site. The net book value of our investment in premises, equipment and fixtures, excluding computer equipment, was approximately $2.4 million at June 30, 2008.
The following table provides a list of our main and branch offices.
Location
Owned or Leased
Lease Expiration Date
Deposits at
June 30, 2008
(In thousands)
HOME AND EXECUTIVE OFFICE
North Grand Avenue
Covina, CA 91724
Leased
April
$61,755
BRANCH OFFICES:
South Lake Avenue
Pasadena, CA 91101
Leased
May
$49,358
Scott Boulevard, Suite 312
Santa Clara, CA 95054
Leased
May
$54,271
Sierra Avenue, Suite A
Fontana, CA 92335
Leased
September
$39,370
Van Nuys Boulevard
Panorama City, CA 91402
Leased
March
$111,689
Rosecrans Avenue
Bellflower, CA 90706
Leased
March
$48,873
Western Avenue, Suite N
Harbor City, CA 90170
Leased
February
$22,749
N. Virgil Avenue
Los Angeles, CA 90029
Leased
March
$73,544
Pierce Street, Suite 150
Riverside, CA 92505
Owned
n/a
$33,449
We believe that our current facilities are adequate to meet the present and immediately foreseeable needs of Kaiser Federal Bank and K-Fed Bancorp.
We use an in-house system with support provided by a third-party vendor to maintain our data base of depositor and borrower customer information. The net book value of our data processing and computer equipment at June 30, 2008 was $653,000.
Item 3.
Item 3. Legal Proceedings
None
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders.
No matters were submitted to a vote of security holders during the fourth quarter of the fiscal year ended June 30, 2008.
Part II.
Item 5.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
Our common stock is traded on the NASDAQ Global Market under the symbol “KFED.” K-Fed Mutual Holding Company owns 8,861,750 shares, or 65.8% of our outstanding common stock. The approximate number of holders of record of the Company’s common stock as of June 30, 2008 was 2,336. Certain shares of the Company are held in “nominee” or “street” name and accordingly, the number of beneficial owners of such shares is not known or included in the foregoing number. The following table presents quarterly market information for the Company’s common stock for the two fiscal years ended June 30, 2008 and June 30, 2007. The Company began trading on the NASDAQ Stock Market on March 31, 2004. The following information was provided by the NASDAQ Stock Market.
Dividend Policy
Dividend payments by K-Fed Bancorp are dependent primarily on dividends it receives from Kaiser Federal Bank. A regulation of the Office of Thrift Supervision imposes limitations on “capital distributions” by savings institutions. No capital distributions to K-Fed Bancorp were made during fiscal 2008. The Board of Directors of the Bank declared and paid to K-Fed Bancorp $10.0 million in dividends during fiscal 2007. The distributions made during fiscal 2007 were for the purpose of repurchasing shares of Company common stock. See “How We Are Regulated - Capital Distributions.”
Equity Compensation Plans
Set forth below is information, as of June 30, 2008, regarding equity compensation plans categorized by those plans that have been approved by stockholders and those plans that have not been approved by stockholders.
______________________
(1)
Consists of options granted to directors and employees to purchase stock under the 2004 K-Fed Bancorp Stock Option Plan.
Issuer Purchases of Equity Securities
______________________
* On January 26, 2008, the Company announced its intention to repurchase an additional 10% of its outstanding publicly held common stock, or 508,788 shares of stock.
Item 6.
Item 6. Selected Financial Data
The following table sets forth certain consolidated financial and other data of the Company at the dates and for the years indicated. The information set forth below should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included herein at Item 7
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Forward Looking Statements
This Form 10-K contains forward-looking statements, which are based on assumptions and describe future plans, strategies and expectations of K-Fed Bancorp and Kaiser Federal Bank. These forward-looking statements are generally identified by use of the words “believe,” “expect,” “intend,” “anticipate,” “estimate,” “project,” or similar words. Our ability to predict results or the actual effect of future plans or strategies is uncertain. Factors which could have a material adverse effect on our operations include, but are not limited to, changes in interest rates, general economic conditions, economic conditions in the state of California, legislative and regulatory changes, monetary and fiscal policies of the U.S. Government, including policies of the U.S. Treasury and the Federal Reserve Board, fiscal policies of the California State Government, the quality or composition of our loan or investment portfolios, demand for loan products, competition for and the availability of, loans that we purchase for our portfolio, deposit flows, competition, demand for financial services in our market areas and accounting principles and guidelines. These risks and uncertainties should be considered in evaluating forward-looking statements and you should not rely too much on these statements.
Overview and Management Strategy
Our results of operations depend primarily on our net interest income, which is the difference between interest income on interest-earning assets, which principally consist of loans and investment securities, and interest expense on interest-bearing liabilities, which principally consist of deposits and borrowings. Our results of operations also are affected by the level of our provisions for loan losses, noninterest income and noninterest expenses. Noninterest income consists primarily of service charges on deposit accounts and ATM fees and charges. Noninterest expense consists primarily of salaries and employee benefits, occupancy, equipment, data processing, and ATM costs. Our results of operations may also be affected significantly by general and local economic and competitive conditions, changes in market interest rates, governmental policies and actions of regulatory authorities.
Our strategy continues to focus on operating as an independent financial institution dedicated to serving the needs of customers in our market area, which extends from Southern California to the San Francisco Bay area as a result of our history as a credit union serving the employees of the Kaiser Permanente Medical Care Program. We intend to continue to attract retail deposits, with the goal of expanding the deposit base by building upon the existing market locations. We opened new financial service centers in Los Angeles and Riverside during the 2007 fiscal year as well as Bellflower and Harbor City in fiscal year 2006 as part of this effort. Financial service centers provide all the services of a full service branch but do not dispense or accept cash except through an on-site ATM. By utilizing a “cash-less” branch we are able to reduce personnel costs at the branch and improve our efficiency in the delivery of financial services.
Remote access methods, such as our 54 ATMs, audio response unit, call center, and internet banking / bill payer continue to process over 90% of our customer transactions. Branches and financial service centers strategically located for our markets provide touchstones to attract new account holders and facilitate transactions that cannot be completed electronically.
Historically, a majority of the deposits have been used to originate or purchase one-to-four family residential real estate, multi-family or commercial real estate loans. We anticipate we will continue this practice. A large percentage of our loan portfolio consists of loans that we have purchased, using our own underwriting standards. However, we have not purchased a loan pool since February 2007 as current demand for multi-family or commercial real estate loans has been sufficient to support our growth initiatives.
We have a commitment to our customers, existing and new, to provide high quality service. Our goal is to grow Kaiser Federal Bank while providing cost effective services to our market area.
Critical Accounting Policies and Estimates
In reviewing and understanding financial information for the Company, you are encouraged to read and understand the significant accounting policies used in preparing our consolidated financial statements.
These policies are described in Note 1 to the consolidated financial statements included in Item 8 of this report and are essential in understanding Management’s Discussion and Analysis of Financial Condition and Results of Operation. The accounting and financial reporting policies of the Company conform to U.S. generally accepted accounting principles and to general practices within the banking industry. Accordingly, the consolidated financial statements require certain estimates, judgments, and assumptions, which are believed to be reasonable, based upon the information available. These estimates and assumptions affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of income and expenses during the periods presented. The following accounting policies comprise those that management believes are the most critical to aid in fully understanding and evaluating our reported financial results.
Allowance for Loan Losses. The allowance for loan losses is established through a provision for loan losses charged to expense. Loans are charged off against the allowance for loan losses when management believes that collectability of the principal is unlikely. Subsequent recoveries, if any, are credited to the allowance.
The allowance is an amount that management believes will absorb probable incurred losses relating to specifically identified loans, as well as probable incurred credit losses inherent in the balance of the loan portfolio, based on an evaluation of the collectability of existing loans and prior loss experience. This evaluation also takes into consideration such factors as changes in the nature and volume of the loan portfolio, overall portfolio quality, review of specific problem loans, and current economic conditions that may affect the borrower’s ability to pay. This evaluation does not include the effects of expected losses on specific loans or groups of loans that are related to future events or changes in economic conditions. While management uses the best information available to make its evaluation, future adjustments to the allowance may be necessary if there are significant changes in economic conditions. In addition, regulatory agencies, as an integral part of their examination process, periodically review the allowance for loan losses, and may require adjustments to the allowance based on their judgment about information available to them at the time of their examinations.
The allowance consists of specific and general components. The specific component relates to loans that are classified as doubtful, substandard, or special mention. For such loans that are also classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. The general component covers non-classified loans and is based on historical loss experience for consumer loans and peer group loss experience for real estate loans adjusted for qualitative factors.
A loan is impaired when it is probable, based on current information and events, the Bank will be unable to collect all contractual principal and interest payments due in accordance with the terms of the loan agreement. Commercial real estate loans are evaluated for impairment based on their past due status and are measured on an individual basis based on the present value of expected future cashflows discounted at the loan’s effective interest rate or, as a practical expedient, at the loan’s observable market price or the fair value of the collateral if the loan is collateral dependent. The amount of impairment, if any, and any subsequent changes are included in the allowance for loan losses.
Large groups of smaller balance homogenous loans are collectively evaluated for impairment. Accordingly, the Bank does not separately identify individual consumer and residential loans for impairment disclosures.
Fair Value of Financial Instruments. Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed in Note 16 of the Company’s consolidated financial statements contained in Item 8. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments, and other factors, especially in the absence of broad markets for particular items. Changes in assumptions or in market conditions could significantly affect the estimates.
Comparison of Financial Condition at June 30, 2008 and June 30, 2007.
General. Our total assets increased by $49.4 million, or 6.2%, to $849.0 million at June 30, 2008 compared to $799.6 million at June 30, 2007. The increase primarily reflected growth in our net loan portfolio of $43.1 million to $742.2 million at June 30, 2008 from $699.1 million at June 30, 2007. The increase in assets was funded by increases in borrowings and State of California time deposits. Borrowings from the Federal Home Loan Bank increased $25.0 million to $235.0 million at June 30, 2008 from $210.0 million at June 30, 2007. State of California Deposits increased by $25.0 million due to participation in the State of California’s Time Deposit program.
Loans. Our net loan portfolio increased $43.1 million, or 6.2%, to $742.2 million at June 30, 2008 from $699.1 million at June 30, 2007. This increase was primarily attributable to increases in multi-family real estate loans, which increased $44.2 million, or 50.1% to $132.3 million at June 30, 2008 from $88.1 million at June 30, 2007. Additional increases were experienced in commercial real estate loans, which increased $38.0 million, or 48.8% to $115.8 million at June 30, 2008 from $77.8 million at June 30, 2007. Consumer loans increased $2.0 million, or 3.0% to $68.6 million at June 30, 2008 from $66.6 million at June 30, 2007. The overall loan mix remained relatively constant, with real estate loans comprising 90.8% of the total loan portfolio at June 30, 2008, compared with 90.5% at June 30, 2007. This growth in loans is consistent with our business strategy of utilizing deposits and other funding sources to expand our income producing real estate loan portfolio. We intend to continue emphasizing the origination of multi-family and commercial real estate loans.
Investments. Our investment portfolio, consisting of available for sale and held to maturity securities (including mortgage-backed securities), decreased $18.7 million, or 53.9% to $16.0 million at June 30, 2008 from $34.7 million at June 30, 2007 due to maturity of existing securities. The decrease was primarily due to the Company’s focus on its investment in multi-family and commercial real estate loans.
Deposits. Our total deposits increased $1.0 million, or 0.2%, to $495.1 million at June 30, 2008 from $494.1 million at June 30, 2007. This limited growth was primarily due to the Bank’s focus on core customer relationships instead of special rate offerings to customers.
Equity. Total stockholders’ equity decreased $1.6 million, or 1.7%, to $90.7 million at June 30, 2008, from $92.3 million at June 30, 2007. Our equity to assets ratio under generally accepted accounting principles (“GAAP”) was 10.7% at June 30, 2008 compared to 11.6% at June 30, 2007. The decrease resulted from the repurchase of 467,319 shares of our outstanding common stock at an average price of $11.23 for a total cost of $5.0 million and cash payments of $2.0 million in dividends to stockholders of record, excluding shares held by K-Fed Mutual Holding Company, which waived the receipt of its dividends for the fiscal year ended June 30, 2008, of $0.42 per share for the year ended
June 30, 2008. This decrease was offset by $3.9 million in income earned for the year ended June 30, 2008 in addition to the allocation of ESOP shares and restricted stock awards and options earned during the same period totaling $1.3 million.
Average Balances, Net Interest Income, Yields Earned and Rates Paid
The following table sets forth certain information at June 30, 2008 and for the fiscal years ended June 30, 2008, 2007 and 2006, respectively. The average yields and costs are derived by dividing income or expense by the average balance of assets or liabilities, respectively, for the years presented. Average balances are derived primarily from month-end balances. Management does not believe that the use of month-end balances rather than daily average balances has caused any material differences in the information presented.
Rate/Volume Analysis
The following table presents the dollar amount of changes in interest income and interest expense for major components of interest-earning assets and interest-bearing liabilities. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (1) changes in volume, which are changes in volume multiplied by the old rate; (2) changes in rate, which are changes in rate multiplied by the old volume; and (3) changes in rate/volume, which are the changes in rate times the changes in volume.
Comparison of Results of Operations for the Fiscal Years Ended June 30, 2008 and 2007.
General. Net income for the year ended June 30, 2008 was $3.9 million, a decrease of $796,000, or 16.9%, from net income of $4.7 million for the year ended June 30, 2007. The decline in net income was primarily attributable to recognizing $1.3 million in stock offering costs resulting from the cancellation of the stock offering in connection with the proposed second step conversion of K-Fed Mutual Holding Company. If the stock offering had been successful, these costs would have been deducted from the proceeds of the offering as required by GAAP instead of being expensed.
Interest Income. Interest income increased $4.0 million, or 9.7%, to $45.2 million for the year ended June 30, 2008 from $41.2 million for the year ended June 30, 2007. The primary factor for the increase in interest income was an increase in the average loans receivable balance of $64.8 million, or 9.8%, to $724.0 million for the year ended June 30, 2008 from $659.2 million for the year ended June 30, 2007. The increase was primarily due to increases in multi-family and commercial real estate loans. The average yield on loans receivable increased 21 basis points to 5.88% for the year ended June 30, 2008 from 5.67% for the year ended June 30, 2007.
Interest Expense. Interest expense increased $2.7 million, or 11.7%, to $25.8 million for the year ended June 30, 2008 from $23.1 million for the year ended June 30, 2007. The average interest rates on interest-bearing liabilities increased 9 basis points to 3.77% for the year ended June 30, 2008 from 3.68% for the year ended June 30, 2007. This increase was primarily attributable to the increased volume and interest rate paid on average deposits, specifically certificates of deposit, and an increase in the average balance and interest rate on advances from the Federal Home Loan Bank of San Francisco.
The average balance of money market accounts decreased by $19.9 million, or 20.9% to $75.2 million for the year ended June 30, 2008 from $95.1 million for the year ended June 30, 2007. The average cost of money market accounts decreased 29 basis points to 2.55% for the year ended June 30, 2008 from 2.84% for the year ended June 30, 2007 as a result of a general decline in the interest rate environment. The average balance of savings accounts increased by $11.6 million, or 10.0% to $127.8 million for the year ended June 30, 2008 from $116.2 million for the year ended June 30, 2007. The average cost of savings accounts decreased one basis point to 1.65% for the year ended June 30, 2008 from 1.66% for the year ended June 30, 2007. The average balance of certificates of deposit increased by $7.4 million, or 3.2%, to $236.1 million for the year ended June 30, 2008 from $228.7 million for the year ended June 30, 2007. The average cost of certificates of deposit increased 15 basis points to 4.63% for the year ended June 30, 2008 from 4.48% for the year ended June 30, 2007. The average balance of borrowings increased $55.8 million, or 29.5%, to $245.0 million for the year ended June 30, 2008 from $189.2 million for the year ended June 30, 2007 due to new advances from the FHLB as well as participation in the State of California’s Time Deposit program and was used to fund loan growth. The average cost of borrowings increased 5 basis points to 4.42% for the year ended June 30, 2008 from 4.37% for the year ended June 30, 2007.
Provision for Loan Losses. We maintain an allowance for loan losses to absorb probable incurred losses inherent in the loan portfolio. The allowance is based on ongoing, quarterly assessments of the probable losses inherent in the loan portfolio. Our methodology for assessing the appropriateness of the allowance consists of several key elements, which include loss ratio analysis by type of loan and specific allowances for identified problem loans, including the results of measuring impaired loans as provided in Statement of Financial Accounting Standards (“SFAS”) No. 114, “Accounting by Creditors for Impairment of a Loan” and SFAS No. 118, “Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosures.” These accounting standards prescribe the measurement methods, income recognition and disclosures related to impaired loans.
The loss ratio analysis component of the allowance is calculated by applying loss factors to outstanding loans based on the internal risk evaluation of the loans or pools of loans. Changes in risk evaluations of both performing and nonperforming loans affect the amount of the formula allowance. Loss factors are based both on our historical loss experience as well as on significant factors that, in management’s judgment, affect the collectability of the portfolio as of the evaluation date.
The appropriateness of the allowance is reviewed and established by management based upon its evaluation of then-existing economic and business conditions affecting our key lending areas and other conditions, such as credit quality trends (including trends in nonperforming loans expected to result from existing conditions), collateral values, loan volumes and concentrations, specific industry conditions within portfolio segments and recent loss experience in particular segments of the portfolio that existed as of the balance sheet date and the impact that such conditions were believed to have had on the collectability of the loan. Senior management reviews these conditions quarterly in discussions with our senior credit officers. To the extent that any of these conditions is evidenced by a specifically identifiable problem credit or portfolio segment as of the evaluation date, management’s estimate of the effect of such condition may be reflected as a specific allowance applicable to such credit or portfolio segment. Where any of these conditions is not evidenced by a specifically identifiable problem credit or portfolio segment as of the evaluation date, management’s evaluation of the loss related to this condition is reflected in the general allowance. The evaluation of the inherent loss with respect to these conditions is subject to a higher degree of uncertainty because they are not identified with specific problem credits or portfolio segments.
Management also evaluates the adequacy of the allowance for loan losses based on a review of individual loans, historical loan loss experience, the value and adequacy of collateral and economic conditions in our market area. This evaluation is inherently subjective as it requires material estimates, including the amounts and timing of future cash flows expected to be received on impaired loans that may be susceptible to significant change. For all specifically reviewed loans for which it is probable that we will be unable to collect all amounts due according to the terms of the loan agreement, we determine impairment by computing a fair value either based on discounted cash flows using the loan’s initial interest rate or the fair value of the collateral if the loan is collateral dependent. Large groups of smaller balance homogenous loans that are collectively evaluated for impairment and are excluded from specific impairment evaluation, and their allowance for loan losses is calculated in accordance with the allowance for loan losses policy described above.
Because the allowance for loan losses is based on estimates of losses inherent in the loan portfolio, actual losses can vary significantly from the estimated amounts. Our methodology as described above permits adjustments to any loss factor used in the computation of the formula allowance in the event that, in management’s judgment, significant factors which affect the collectability of the portfolio as of the evaluation date are not reflected in the loss factors. By assessing the estimated losses inherent in the loan portfolio on a quarterly basis, we are able to adjust specific and inherent loss estimates based upon any more recent information that has become available. In addition, management’s determination as to the amount of our allowance for loan losses is subject to review by the Office of Thrift Supervision and the FDIC, which may require the establishment of additional general or specific allowances based upon their judgment of the information available to them at the time of their examination of Kaiser Federal Bank.
Our provision for loan losses increased $433,000 to $962,000 for the year ended June 30, 2008 as compared to $529,000 for the year ended June 30, 2007. The allowance for loan losses as a percent of total loans was 0.43% at June 30, 2008 as compared to 0.40% at June 30, 2007. The increase in provision for loan losses was primarily attributable to an increase in real estate loan delinquencies as well as general increases in multi-family and commercial real estate lending, which generally have a higher risk than traditional one-to-four family real estate lending. The assumptions were based both on current industry and economic trends in addition to our internal loan loss history. We used the same methodology and generally similar assumptions in assessing the adequacy of the allowance for consumer and real estate loans for both years.
Noninterest Income. Noninterest income increased $60,000, or 1.4%, to $4.3 million for the year ended June 30, 2008 from $4.3 million for the year ended June 30, 2007. The increase was primarily the result of an increase in referral commissions and customer service charges offset by declines in ATM fees and charges and higher losses attributable to our investment in a California Affordable Housing Program Fund.
Noninterest Expense. Our noninterest expense increased $2.3 million, or 15.9% to $16.8 million for the year ended June 30, 2008 from $14.5 million for the year ended June 30, 2007. The increase was primarily due to the recognition of $1.3 million in terminated stock offering costs, a $410,000 increase in salaries and benefits, a $223,000 increase in occupancy and equipment and an $183,000 increase in other operating expenses.
Salaries and benefits represented 47.9% and 52.5% of total noninterest expense for the years ended June 30, 2008 and 2007, respectively. Total salaries and benefits increased $410,000, or 5.4%, to $8.0 million for the year ended June 30, 2008 from $7.6 million for the year ended June 30, 2007. The increase was primarily due to annual salary increases and an increase in the number of full-time equivalent employees.
Occupancy and equipment expenses increased $223,000, or 10.6% to $2.3 million for the year ended June 30, 2008 from $2.1 million for the year ended June 30, 2007. The increase was primarily due to additional data processing hardware and software costs.
Other operating expenses increased $183,000, or 11.4% to $1.7 million for the year ended June 30, 2008 from $1.6 million for the year ended June 30, 2007. The increase in other expense was primarily due to the FDIC Deposit Insurance Fund assessments which began in the 2008 fiscal year.
Income Tax Expense. Income tax expense for the year ended June 30, 2008 was $2.2 million as compared to $2.5 million for the year ended June 30, 2007. This decrease was primarily the result of a decline in pre-tax income of $1.2 million for the year ended June 30, 2008. The effective tax rate was 35.6% and 35.0% for the years ended June 30, 2008 and 2007, respectively.
Comparison of Results of Operations for the Fiscal Years Ended June 30, 2007 and 2006.
General. Net income for the year ended June 30, 2007 was $4.7 million, a decrease of $225,000, or 4.6%, from net income of $4.9 million for the year ended June 30, 2006 due to a decline in net interest income and an increase in non-interest expense.
Interest Income. Interest income increased $5.4 million, or 15.1%, to $41.2 million for the year ended June 30, 2007 from $35.8 million for the year ended June 30, 2006. The primary factor for the increase in the interest income was an increase in the average loans receivable balance of $48.8 million, or 8.0%, to $659.2 million for the year ended June 30, 2007 from $610.4 million for the year ended June 30, 2006. The increase was primarily due to increases in multifamily loans and purchases of one-to-four family real estate loans. The average yield on loans receivable increased 28 basis points to 5.67% for the year ended June 30, 2007 from 5.39% for the year ended June 30, 2006.
Interest Expense. Interest expense increased $5.6 million, or 32.5%, to $23.1 million for the year ended June 30, 2007 from $17.5 million for the year ended June 30, 2006. The average interest rates on interest-bearing liabilities increased 65 basis points to 3.68% for the year ended June 30, 2007 from 3.03% for the year ended June 30, 2006. This increase was primarily attributable to the increased volume of average deposits, specifically certificates of deposit, and an increase in the average balance and interest rate on advances from the Federal Home Loan Bank of San Francisco.
The average balance of money market accounts decreased by $16.4 million, or 14.7% to $95.1 million for the year ended June 30, 2007 from $111.5 million for the year ended June 30, 2006. The average cost of money market accounts increased 74 basis points to 2.84% for the year ended June 30, 2007 from 2.10% for the year ended June 30, 2006. The average balance of savings accounts increased by $21.4 million, or 22.6% to $116.2 million for the year ended June 30, 2007 from $94.8 million for the year ended June 30, 2006. The average cost of savings accounts increased 124 basis points to 1.66% for the year ended June 30, 2007 from .42% for the year ended June 30, 2006. The average balance of certificates of deposit increased by $6.3 million, or 2.8%, to $228.7 million for the year ended June 30, 2007 from $222.4 million for the year ended June 30, 2006. The average cost of certificates of deposit increased 62 basis points to 4.48% for the year ended June 30, 2007 from 3.86% for the year ended June 30, 2006.
The average balance of advances from the Federal Home Loan Bank of San Francisco increased $40.8 million, or 27.5%, to $189.2 million for the year ended June 30, 2007 from $148.4 million for the year ended June 30, 2007. The average cost of advances increased 23 basis points to 4.37% for the year ended June 30, 2007 from 4.14% for the year ended June 30, 2006.
The primary factor for the increase in the balance and average interest rates on deposits and advances was to fund real estate loan purchases to better match the Company’s debt maturity schedule with the maturities and repricing terms of our interest-earning assets.
Provision for Loan Losses. Our provision for loan losses decreased $123,000 to $529,000 for the year ended June 30, 2007 as compared to $652,000 for the year ended June 30, 2006. The allowance for loan losses as a percent of total loans was 0.40% at June 30, 2007 as compared to 0.43% at June 30, 2006. The decrease in the provision was primarily attributable to reduced loan concentrations to higher-risk automobile loan borrowers coupled with our continued history of no losses incurred in our real estate loan portfolio. We used the same methodology and generally similar assumptions in assessing the adequacy of the allowance for consumer and real estate loans for both years.
Noninterest Income. Noninterest income increased $833,000, or 24.5%, to $4.3 million for the year ended June 30, 2007 from $3.4 million for the year ended June 30, 2006. The increase was primarily the result of a $489,000 reduction in the loss on our equity investment in a California Affordable Housing Program tax credit fund, an $186,000 increase in service charges and fees from deposit accounts and a $131,000 increase in fee and transaction income related to the deployment of additional ATM’s.
We account for our equity investment in the California Affordable Housing program in accordance with APB 18 using the equity method of accounting. The reduction in loss attributable to our equity investment was based upon the most recent financial statement information.
Noninterest Expense. Our noninterest expense increased $1.0 million, or 7.4% to $14.5 million for the year ended June 30, 2007 from $13.5 million for the year ended June 30, 2006. The increase was primarily due to a $321,000 increase in salaries and benefits, a $316,000 increase in occupancy and equipment, a $162,000 increase in professional services and a $102,000 increase in other operating expenses.
Salaries and benefits represented 52.5% and 54.2% of total noninterest expense for the years ended June 30, 2007 and 2006, respectively. Total salaries and benefits increased $321,000, or 4.4%, to $7.6 million for the year ended June 30, 2007 from $7.3 million for the year ended June 30, 2006. The increase was primarily due to compensation expense arising from general salary increases, increased staffing from new financial service centers and an increase in costs related to our employee stock ownership plan as a result of an increase in our average stock price.
Occupancy and equipment expenses increased $316,000, or 17.6% to $2.1 million for the year ended June 30, 2007 from $1.8 million for the year ended June 30, 2006. The increase was primarily due to costs associated with the relocation of our Pasadena Branch and increased costs related to build-outs of financial service centers in Los Angeles and Riverside in addition to increased equipment maintenance expense.
Professional services increased $162,000, or 21.6% to $913,000 for the year ended June 30, 2007 compared to $751,000 for the year ended June 30, 2006. The increase in professional services was primarily due to increased external and internal audit services as a result of complying with Sarbanes-Oxley Section 404 audit requirements.
Other operating expenses increased $102,000, or 6.8% to $1.6 million for the year ended June 30, 2007 from $1.5 million for the year ended June 30, 2006. The increase in other expense was primarily due to increased operational costs to support continued growth of the Bank.
Income Tax Expense. Income tax expense for the year ended June 30, 2007 was $2.5 million as compared to $2.7 million for the year ended June 30, 2006. This decrease was primarily the result of a decline in pre-tax income of $417,000 for the year ended June 30, 2007. The effective tax rate was 35.0% and 35.6% for the years ended June 30, 2007 and 2006, respectively.
Liquidity, Capital Resources and Commitments
Liquidity may increase or decrease depending upon the availability of funds and comparative yields on investments in relation to the return on loans. Historically, we have maintained liquid assets at levels above the minimum requirements previously imposed by Office of Thrift Supervision regulations and above levels believed to be adequate to meet the requirements of normal operations, including potential deposit outflows. Cash flow projections are regularly reviewed and updated to assure that adequate liquidity is maintained.
Our liquidity, represented by cash and cash equivalents, interest bearing accounts and mortgage-backed and related securities, is a product of our operating, investing and financing activities. Our primary sources of funds are deposits, amortization, prepayments and maturities of outstanding loans and mortgage-backed and related securities, and other short-term investments and funds provided from operations. While scheduled payments from the amortization of loans and mortgage-backed related securities and maturing investment securities and short-term investments are relatively predictable sources of funds, deposit flows and loan prepayments are greatly influenced by general interest rates, economic conditions and competition. In addition, we invest excess funds in short-term interest-earning assets, which provide liquidity to meet lending requirements. We also generate cash through borrowings. We utilize Federal Home Loan Bank advances and State of California time deposits to leverage our capital base and provide funds for our lending and investment activities, and enhance our interest rate risk management.
Liquidity management is both a daily and long-term function of business management. Excess liquidity is generally invested in short-term investments such as overnight deposits. On a longer-term basis, we maintain a strategy of investing in various lending products as described in greater detail under “Business - Lending Activities.” We use our sources of funds primarily to meet ongoing commitments, to pay maturing certificates of deposit and savings withdrawals, to fund loan commitments and to maintain our portfolio of mortgage-backed and related securities. At June 30, 2008, total approved loan commitments amounted to $10.5 million, which includes the unadvanced portion of loans of $3.7 million. Certificates of deposit and advances from the Federal Home Loan Bank of San Francisco scheduled to mature in one year or less at June 30, 2008, were $195.0 million and $28.0 million, respectively. Based on historical experience, management believes that a significant portion of maturing deposits will remain with Kaiser Federal Bank and we anticipate that we will continue to have sufficient funds, through deposits and borrowings, to meet our current commitments.
At June 30, 2008, we had available additional advances from the Federal Home Loan Bank of San Francisco in the amount of $106.4 million.
Contractual Obligations
In the normal course of business, the Company enters into contractual obligations that meet various business needs. These contractual obligations include certificates of deposit to customers, borrowings from the Federal Home Loan Bank, lease obligations for facilities, and commitments to purchase and/or originate loans. The following table summarizes the Company’s long-term contractual obligations at June 30, 2008.
Off-Balance Sheet Arrangements
As a financial service provider, we routinely are a party to various financial instruments with off-balance sheet risks, such as commitments to extend credit and unused lines of credit. While these contractual obligations represent our future cash requirements, a significant portion of commitments to extend credit may expire without being drawn upon. Such commitments are subject to the same credit policies and approval process accorded to loans we make. For additional information, see Note 14 of the Notes to our Consolidated Financial Statements.
Capital
Consistent with our goal to operate a sound and profitable financial organization, we actively seek to continue as a “well capitalized” institution in accordance with regulatory standards. Total stockholders’ equity was $90.7 million at June 30, 2008 or 10.69%, of total assets on that date. As of June 30, 2008, we exceeded all regulatory capital requirements. The Bank’s regulatory capital ratios at June 30, 2008 were as follows: core capital 8.41%; Tier I risk-based capital 12.42%; and total risk-based capital 12.99%. The regulatory capital requirements to be considered well capitalized are 5%, 6% and 10%, respectively. See “How We Are Regulated - Capital Requirements.”
For the year ended June 30, 2008, we repurchased 467,319 shares of our common stock at an average cost of $11.23.
Impact of Inflation
The consolidated financial statements presented herein have been prepared in accordance with GAAP. These principles require the measurement of financial position and operating results in terms of historical dollars, without considering changes in the relative purchasing power of money over time due to inflation.
Our primary assets and liabilities are monetary in nature. As a result, interest rates have a more significant impact on our performance than the effects of general levels of inflation. Interest rates, however, do not necessarily move in the same direction or with the same magnitude as the price of goods and services, since such prices are affected by inflation. In a period of rapidly rising interest rates, the liquidity and maturity structure of our assets and liabilities are critical to the maintenance of acceptable performance levels.
The principal effect of inflation, as distinct from levels of interest rates, on earnings is in the area of non-interest expense. Such expense items as employee compensation, employee benefits and occupancy and equipment costs may be subject to increases as a result of inflation. An additional effect of inflation is the possible increase in the dollar value of the collateral securing loans that we have made. We are unable to determine the extent, if any, to which properties securing our loans have appreciated in dollar value due to inflation.
Recent Accounting Pronouncements
Please refer to Note 1 of the consolidated financial statements contained in Item 8.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk.
Asset and Liability Management and Market Risk
Our Risk When Interest Rates Change. The rates of interest we earn on assets and pay on liabilities generally are established contractually for a period of time. Market interest rates change over time. Our fixed rate loans generally have longer maturities than our fixed rate deposits. Accordingly, our results of operations, like those of other financial institutions, are impacted by changes in interest rates and the interest rate sensitivity of our assets and liabilities. The risk associated with changes in interest rates and our ability to adapt to these changes is known as interest rate risk and is our most significant market risk.
How We Measure Our Risk of Interest Rate Changes. As part of our attempt to manage our exposure to changes in interest rates and comply with applicable regulations, we monitor our interest rate risk. In monitoring interest rate risk, we continually analyze and manage assets and liabilities based on their payment streams and interest rates, the timing of their maturities, and their sensitivity to actual or potential changes in market interest rates. In order to minimize the potential for adverse effects of material and prolonged increases in interest rates on our results of operations, we have adopted investment/asset and liability management policies to better match the maturities and repricing terms of our interest-earning assets and interest-bearing liabilities. The board of directors recommend and set the asset and liability policies of Kaiser Federal Bank, which are implemented by the asset/liability management committee.
The purpose of the asset/liability management committee is to communicate, coordinate and control asset/liability management consistent with our business plan and board approved policies. The committee establishes and monitors the volume and mix of assets and funding sources taking into account relative costs and spreads, interest rate sensitivity and liquidity needs. The objectives are to manage assets and funding sources to produce results that are consistent with liquidity, capital adequacy, growth, risk and profitability goals.
The asset/liability management committee generally meets on a weekly basis to review, among other things, economic conditions and interest rate outlook, current and projected liquidity needs and capital position, anticipated changes in the volume and mix of assets and liabilities and interest rate risk exposure limits versus current projections pursuant to net present value of portfolio equity analysis and income simulations. The asset/liability management committee recommends appropriate strategy changes based on this review. The chairman or his designee is responsible for reviewing and reporting on the effects of the policy implementations and strategies to the board of directors at least monthly.
In order to manage our assets and liabilities and achieve the desired liquidity, credit quality, interest rate risk, profitability and capital targets, we have focused our strategies on:
·
Maintaining an adequate level of adjustable rate loans;
·
Originating a reasonable volume of short- and intermediate-term consumer loans;
·
Managing our deposits to establish stable deposit relationships; and
·
Using Federal Home Loan Bank advances and pricing on fixed-term non-core deposits to align maturities and repricing terms.
At times, depending on the level of general interest rates, the relationship between long- and short-term interest rates, market conditions and competitive factors, the asset/liability management committee may determine to increase our interest rate risk position somewhat in order to maintain our net interest margin.
The asset/liability management committee regularly reviews interest rate risk by forecasting the impact of alternative interest rate environments on net interest income and market value of portfolio equity, which is defined as the net present value of an institution’s existing assets, liabilities and off-balance sheet instruments, and evaluating such impacts against the maximum potential changes in net interest income and market value of portfolio equity that are authorized by the board of directors of Kaiser Federal Bank.
The Office of Thrift Supervision provides Kaiser Federal Bank with the information presented in the following tables, which is based on information provided to the Office of Thrift Supervision by Kaiser Federal Bank. It presents the change in Kaiser Federal Bank’s net portfolio value at June 30, 2008 and June 30, 2007 that would occur upon an immediate change in interest rates based on Office of Thrift Supervision assumptions but without giving effect to any steps that management might take to counteract that change.
The Office of Thrift Supervision uses certain assumptions in assessing the interest rate risk of savings associations. These assumptions relate to interest rates, loan prepayment rates, deposit decay rates, and the market values of certain assets under differing interest rate scenarios, among others.
As with any method of measuring interest rate risk, shortcomings are inherent in the method of analysis presented in the foregoing tables. For example, although assets and liabilities may have similar maturities or periods to repricing, they may react in different degrees to changes in the market interest rates. Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market rates. Additionally, certain assets, such as adjustable rate mortgage loans, have features, that restrict changes in interest rates on a short-term basis and over the life of the asset. Further, if interest rates change, expected rates of prepayments on loans and early withdrawals from certificates of deposit could deviate significantly from those assumed in calculating the table.
Item 8.
Item 8. Financial Statements and Supplementary Data.
Please see pages 74 through 109 following the signature page of this Form 10-K.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
None.
Item 9A.
Item 9A. Controls and Procedures.
Our management evaluated, with the participation of our Chief Executive Officer and Chief Financial Officer, the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the “Act”)) as of the end of the period covered by this report. The Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures as of the end of the period covered by this report are effective in ensuring that the information required to be disclosed by the Company in the reports it files or submits under the Act is (i) accumulated and communicated to the Company’s management (including the Chief Executive Officer and Chief Financial Officer) in a timely manner, and (ii) recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms.
There have been no changes in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Act) that occurred during the quarter ended June 30, 2008 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Please see Management’s Annual Report on Internal Control over Financial Reporting and the Attestation Report of our Independent Registered Public Accounting Firm on Pages 75 and 76.
Item 9B.
Item 9B. Other Information.
None.
Part III.
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance.
Directors and Executive Officers. The information required by this item is incorporated herein by reference from the Company’s definitive proxy statement for its 2008 Annual Meeting of Stockholders.
Section 16(a) Beneficial Ownership Reporting Compliance. The information concerning compliance with the reporting requirements of Section 16(a) of the Securities Exchange Act of 1934 by directors, officers, and ten percent stockholders of the Company required by this item is incorporated herein by reference from the Company’s definitive proxy statement for its 2008 Annual Meeting of Stockholders.
Code of Ethics. The Company has adopted a written Code of Ethics. The Code of Ethics applies to the Company’s and the Bank’s Principal Executive Officer and Principal Financial and Accounting Officer. A copy of the Company’s Code of Ethics is available on our website at www.k-fed.com.
Item 11.
Item 11. Executive Compensation.
The information concerning executive compensation required by this item is incorporated herein by reference from the Company’s definitive proxy statement for its 2008 Annual Meeting of Stockholders.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
The information concerning security ownership of certain beneficial owners and management and related stockholder matters required by this item is incorporated herein by reference from the Company’s definitive proxy statement for its 2008 Annual Meeting of Stockholders.
Item 13.
Item 13. Certain Relationships and Related Transactions and Director Independence.
The information concerning certain relationships and related transactions and director independence required by this item is incorporated herein by reference from the Company’s definitive proxy statement for its 2008 Annual Meeting of Stockholders.
Item 14.
Item 14. Principal Accountant Fees and Services.
The information concerning principal accountant fees and services is incorporated herein by reference from the Company’s definitive proxy statement for its 2008 Annual Meeting of Stockholders.
Part IV.
Item 15.
Item 15. Exhibits and Financial Statement Schedules.
(a) Financial Statements:
See Part II - Item 8. Financial Statements and Supplementary Data.
(b) Exhibits:
3.1 Charter of K-Fed Bancorp (1)
3.2 Bylaws of K-Fed Bancorp (2)
4.0 Form of Stock Certificate of K-Fed Bancorp (1)
10.1 Registrant’s Employee Stock Ownership Plan (1)
10.2 Registrant’s Executive Non-Qualified Retirement Plan (1)
10.3 Registrant’s 2004 Stock Option Plan (3)
10.4 Registrant’s 2004 Recognition and Retention Plan (3)
21.0 Subsidiaries of the Registrant (1)
23.1
Consent of Crowe Horwath LLP
31.1
Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act
31.2
Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act
32.1
Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act
32.2
Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act
(1) Filed as an exhibit to Registrant’s Registration Statement on Form S-1, as amended, initially filed on December 9, 2003 with the Securities and Exchange Commission (Registration No.333-111029), and incorporated herein by reference.
(2) Filed as an exhibit to Registrant’s Current Report on Form 8-K filed on December 3, 2007 with the Securities and Exchange Commission (Commission File No. 000-50592) and incorporated herein by reference.
(3) Incorporated by reference to the Registrant’s Proxy Statement for the 2004 Annual
Meeting of Stockholders filed with the Securities and Exchange Commission
on September 23, 2004.
SIGNATURES
Pursuant to the requirements of section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
K-Fed Bancorp
Date: September 8, 2008
/s/ Kay M. Hoveland
Kay M. Hoveland
President, Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
Date: September 8, 2008
/s/ James L. Breeden
James L. Breeden
Director and Chairman of the Board
Date: September 8, 2008
/s/ Kay M. Hoveland
Kay M. Hoveland
Director, President, Chief Executive Officer and Principal Executive Officer
Date: September 8, 2008
/s/ Dustin Luton
Chief Financial Officer
Principal Financial Officer
Date: September 8, 2008
/s/ Rita H. Zwern
Rita H. Zwern
Director and Secretary
Date: September 8, 2008
/s/ Gerald A. Murbach
Gerald A. Murbach
Director
Date: September 8, 2008
/s/ Robert C. Steinbach
Robert C. Steinbach
Director
Date: September 8, 2008
/s/ Laura G. Weisshar
Laura Weisshar
Director
EXHIBIT 23.1
Consent of Crowe Horwath LLP
We consent to the incorporation by reference in Registration Statements on Form S-8 for the K-Fed Bancorp 2004 Stock Option Plan and the K-Fed Bancorp 2004 Recognition and Retention Plan (333-120768) and the Form S-8 for the Kaiser Federal Bank Savings and Profit Sharing Plan and Trust (333-113078) of our report dated September 8, 2008 on the consolidated financial statements of K-Fed Bancorp and on the effectiveness of internal control over financial reporting of K-Fed Bancorp which report is included in Form 10-K for K-Fed Bancorp for the year ended June 30, 2008.
/s/ Crowe Horwath LLP
Crowe Horwath LLP
Oak Brook, Illinois
September 8, 2008
EXHIBIT 31.1
Certification of the Chief Executive Officer
Pursuant to Section 302 of the Sarbanes-Oxley Act
I, Kay M. Hoveland, certify that:
1.
I have reviewed this Annual Report on Form 10-K of K-Fed Bancorp;
2.
Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3.
Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4.
The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
(a)
Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
(b)
Designed such internal control over financial reporting, or cause such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
(c)
Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
(d)
Disclosed in this report any changes in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially effect, the registrant’s internal control over financial reporting; and
5.
The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):
(a)
All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
(b)
Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.
Date: September 8, 2008 /s/ Kay M. Hoveland
Kay M. Hoveland
President and Chief Executive Officer
EXHIBIT 31.2
Certification of the Chief Financial Officer
Pursuant to Section 302 of the Sarbanes-Oxley Act
I, Dustin Luton, certify that:
1.
I have reviewed this Annual Report on Form 10-K of K-Fed Bancorp;
2.
Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3.
Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4.
The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
(a)
Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
(b)
Designed such internal control over financial reporting, or cause such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
(c)
Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
(d)
Disclosed in this report any changes in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially effect, the registrant’s internal control over financial reporting; and
5.
The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):
(a)
All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.
Date: September 8,
/s/ Dustin Luton
Dustin Luton
Chief Financial Officer
EXHIBIT 32.1
Certification of the Chief Executive Officer
Pursuant to 18 U.S.C. Section 1350,
as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
In connection with the Annual Report of K-Fed Bancorp (the “Company”) on Form 10-K for the fiscal year ended June 30, 2008 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Kay M. Hoveland, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and in connection with this annual report on Form 10-K that:
1.
The Report fully complies with the requirements of sections 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, and
2.
The information contained in the report fairly presents, in all material respects, the company’s financial condition and results of operations.
Date: September 8, 2008 /s/ Kay M. Hoveland
Kay M. Hoveland
Chief Executive Officer
EXHIBIT 32.2
Certification of the Chief Financial Officer
Pursuant to 18 U.S.C. Section 1350,
as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
In connection with the Annual Report of K-Fed Bancorp (the “Company”) on Form 10-K for the fiscal year ended June 30, 2008 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Dustin Luton, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and in connection with this annual report on Form 10-K that:
1.
The Report fully complies with the requirements of sections 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, and
2.
The information contained in the report fairly presents, in all material respects, the company’s financial condition and results of operations.
Date: September 8, 2008 /s/ Dustin Luton
Dustin Luton
Chief Financial Officer
K-Fed Bancorp
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Pagee
Management’s Report on Internal Control
Reports of Independent Registered Public Accounting Firm
Consolidated Statements of Financial Condition at June 30, 2008 and
Consolidated Statements of Income for the Years Ended June 30, 2008, 2007, and 2006
Consolidated Statements of Stockholders’ Equity and Comprehensive Income for the Years Ended June 30, 2008, 2007, and 2006
Consolidated Statements of Cash Flows for the Years Ended June 30, 2008, 2007, and
Notes to Consolidated Financial Statements
MANAGEMENT’S REPORT ON INTERNAL CONTROL
The management of K-Fed Bancorp, Inc. (the “Company”) is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f). The Company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the financial statements for external purposes in accordance with generally accepted accounting principles. The Company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States of America, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. All internal control systems, no matter how well designed, have inherent limitations, including the possibility of human error and the circumvention of overriding controls. Accordingly, even an effective system of internal control over financial reporting can provide only reasonable assurance with respect to financial statement preparation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that degree of compliance with the policies or procedures may deteriorate.
Management has assessed the effectiveness of the Company’s internal control over financial reporting as of June 30, 2008, based on the framework set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework. Based on that assessment, management concluded that, as of June 30, 2008, the Company’s internal control over financial reporting was effective.
The effectiveness of the Company’s internal control over financial reporting as of June 30, 2008, has been audited by Crowe Horwath LLP, an independent registered public accounting firm. As stated in their attestation report, they express an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting as of June 30, 2008. See “Report of Independent Registered Public Accounting Firm.”
/s/ Kay M. Hoveland
/s/ Dustin Luton
Kay M. Hoveland
Dustin Luton
President and Chief Executive Officer
Chief Financial Officer
REPORT OF INDEPENDENT
REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors
K-Fed Bancorp
Covina, California
We have audited the accompanying consolidated statements of financial condition of K-Fed Bancorp (“Company”)as of June 30, 2008 and 2007, and the related statements of income, stockholders' equity and comprehensive income, and cash flows for each of the years in the three-year period ended June 30, 2008. We also have audited K-Fed Bancorp’s internal control over financial reporting as of June 30, 2008, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO)." K-Fed Bancorp's management is responsible for these financial statements, for maintaining effective internal control over financial reporting and for it’s assessment of internal control over financial reporting in the accompanying Management’s Report on Internal Control. Our responsibility is to express an opinion on these financial statements and an opinion on the Company's internal control over financial reporting based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of K-Fed Bancorp as of June 30, 2008 and 2007, and the results of its operations and its cash flows for each of the years in the three-year period ended June 30, 2008 in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, K-Fed Bancorp maintained, in all material respects, effective internal control over financial reporting as of June 30, 2008, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
/s/ Crowe Horwath LLP
Oak Brook, Illinois Crowe Horwath LLP
September 8, 2008
K-FED BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(Dollars in thousands, except share data)
The accompanying notes are an integral part of these consolidated financial statements
K-FED BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
(Dollars in thousands, except per share data)
The accompanying notes are an integral part of these consolidated financial statements
K-FED BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
AND COMPREHENSIVE INCOME
(Dollars in thousands, except share and per share data)
The accompanying notes are an integral part of these consolidated financial statements
K-FED BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
The accompanying notes are an integral part of these consolidated financial statements
K-FED BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2008, 2007 AND 2006
1.
NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
Nature of Business: K-Fed Bancorp (the Company) is a majority-owned subsidiary of K-Fed Mutual Holding Company (the Parent). The Company and its Parent are holding companies. The Company’s sole subsidiary, Kaiser Federal Bank (the Bank), is a federally chartered stock savings association, which provides retail and commercial banking services to individual and business customers from its nine branches throughout California. While the Bank originates many types of retail, and commercial real estate loans, the majority of its residential real estate loans have been purchased from other financial institutions. The accounting and reporting policies of the Company and the Bank conform to U.S. generally accepted accounting principles (GAAP) and general industry practices.
The Company’s business activities generally are limited to passive investment activities and oversight of its investment in the Bank. Unless the context otherwise requires, all references to the Company include the Bank and the Company on a consolidated basis.
Principles of Consolidation and Basis of Presentation: The consolidated financial statements include the accounts of the Company and the Bank. All material intercompany balances and transactions have been eliminated in consolidation. K-Fed Mutual Holding Company is owned by the depositors of the bank. These financial statements do not include the transactions and balances of K-Fed Mutual Holding Company
Use of Estimates in the Preparation of Consolidated Financial Statements: The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of income and expenses during the reporting period. Changes in these estimates and assumptions are considered reasonably possible and may have a material impact on the consolidated financial statements and thus actual results could differ from the amounts reported and disclosed herein. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, and the valuation of financial instruments.
Cash and Cash Equivalents: Cash and cash equivalents consist of vault and ATM cash, daily federal funds sold, demand deposits due from other banks, and other certificates of deposit that have an original maturity of less than ninety days. For purposes of the Statement of Cash Flows, the Company reports net cash flows for customer loan transactions (excluding loan purchases) and deposit transactions, as well as transactions involving interest bearing deposits in other financial institutions.
Interest Bearing Deposits in Other Financial Institutions: Interest bearing deposits in other financial institutions consist of money market deposits and are carried at cost.
Securities: Securities available-for-sale represent securities that may be sold prior to maturity. These securities are stated at fair value, and any unrealized net gains and losses are reported as a separate component of equity until realized, net of any tax effect. Estimated fair values for investments are obtained from quoted market prices where available. Where quoted market prices are not available, estimated fair values are based on quoted market prices of comparable instruments. Premiums or discounts are recognized in interest income using the effective interest method over the estimated life of the investment. Gains and losses on sales are recorded on the trade date and determined using the specific identification method.
Securities available-for-sale may be sold in response to changes in market interest rates, repayment rates, the need for liquidity, and changes in the availability and the yield on alternative investments. Declines in the fair value of securities below their cost that are other than temporary are reflected as realized losses. In estimating other-than temporary losses, management considers: (1) the length of time and extent that fair value has been less than cost, (2) the financial condition and near term prospectus of the issuer, and (3) the Company’s ability and intent to hold the security for a period sufficient to allow for any anticipated recovery in fair value.
Securities for which the Company has the positive intent and ability to hold until maturity are classified as securities held-to-maturity and are recorded at cost, adjusted for unamortized premiums or discounts.
Federal Home Loan Bank Stock: The Bank, as a member of the Federal Home Loan Bank of San Francisco (FHLB) system, is required to maintain an investment in capital stock of the FHLB in an amount equal to the greater of 1% of its outstanding mortgage loans or 4.7% of advances from the FHLB. No ready market exists for the FHLB stock, and it has no quoted market value. The Bank carries FHLB stock at cost. Cash and stock dividends are reported as income.
Loans: Loans are stated at the amount of unpaid principal, reduced by an allowance for loan losses and deferred net loan origination fees, and increased by net premiums (discounts) on purchased loans. Interest on loans is recognized over the terms of the loans and is accrued as earned, using the effective interest method. Net premiums (discounts) on purchased loans are recognized in interest income as a yield adjustment over the estimated lives of the loan pools using the effective interest method. The estimated lives of these loan pools are re-evaluated periodically based on actual prepayments. The current estimated lives of these loan pools range from two to six years. Loan fees and certain direct loan origination costs are deferred, and the net fee or cost is recognized as an adjustment to interest income using the effective interest method over the estimated lives of the related loans.
We underwrite purchased loans in accordance with our underwriting standards. The majority of the loans that we purchase are acquired with servicing released to allow for greater investments in real-estate lending without having to significantly increase our servicing and operations costs.
A loan is considered to be delinquent when payments have not been made according to contractual terms, typically evidenced by non-payment of a monthly installment by the due date. Accrual of interest on loans is discontinued when the loan becomes past due ninety days as to either principal or interest. All interest accrued, but not collected, for loans that are placed on non-accrual status or subsequently charged off is reversed against interest income. Income is subsequently recognized on the cash basis until, in management’s judgment, the borrower’s ability to make periodic interest and principal payments is back to normal and future payments are reasonably assured, in which case the loan is returned to accrual status.
Allowance for Loan Losses: The allowance for loan losses is established through a provision for loan losses charged to expense. Loans are charged off against the allowance for loan losses when management believes that collectability of the principal is unlikely. Subsequent recoveries, if any, are credited to the allowance.
The allowance is an amount that management believes will absorb probable incurred losses relating to specifically identified loans, as well as probable incurred credit losses inherent in the balance of the loan portfolio, based on an evaluation of the collectability of existing loans and prior loss experience. This evaluation also takes into consideration such factors as changes in the nature and volume of the loan portfolio, overall portfolio quality, review of specific problem loans, and current economic conditions that may affect the borrower’s ability to pay. This evaluation does not include the effects of expected losses on specific loans or groups of loans that are related to future events or expected changes in economic conditions. While management uses the best information available to make its evaluation, future adjustments to the allowance may be necessary if there are significant changes in economic conditions. In addition, regulatory agencies, as an integral part of their examination process, periodically review the allowance for loan losses, and may require adjustments to the allowance based on their judgment
about information available to them at the time of their examinations.
The allowance consists of specific and general components. The specific component relates to loans that are classified as doubtful, substandard, or special mention. For such loans that are also classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. The general component covers non-classified loans and is based on historical loss experience for consumer loans and peer group loss experience for real estate loans adjusted for qualitative factors.
A loan is impaired when it is probable, based on current information and events, the Bank will be unable to collect all contractual principal and interest payments due in accordance with the terms of the loan agreement. Commercial real estate loans are evaluated for impairment based on their past due status and are measured on an individual basis based on the present value of expected future cash flows discounted at the loan’s effective interest rate or, as a practical expedient, at the loan’s observable market price or the fair value of the collateral if the loan is collateral dependent. The amount of impairment, if any, and any subsequent changes are included in the allowance for loan losses.
Large groups of smaller balance homogenous loans are collectively evaluated for impairment. Accordingly, the Bank does not separately identify individual consumer and residential loans for impairment disclosures.
Transfers of Financial Assets: Transfers of financial assets are accounted for as sales, when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.
Premises and Equipment: Leasehold improvements and furniture and equipment are carried at cost, less accumulated depreciation and amortization. Buildings are depreciated using the straight-line method with a useful live of twenty-five years. Furniture and equipment are depreciated using the straight-line method over the estimated useful lives of the assets, which is usually three to five years. The cost of leasehold improvements is amortized using the straight-line method over the lesser of the terms of the related leases or their useful life, which is usually five to ten years.
Real Estate Owned: Real estate acquired in settlement of loans ("REO") consists of property acquired through foreclosure proceedings or by deed in lieu of foreclosure. Generally, all loans greater than ninety days delinquent are processed for foreclosure. The Bank acquires title to the property in most foreclosure actions that are not reinstated by the borrower. Once real estate is acquired in settlement of a loan, the property is recorded as REO at the lower of carrying value or fair market value, less estimated selling costs. Fair value is determined by an appraisal obtained at the of time foreclosure. The REO balance is reduced for any subsequent declines in fair value.
Bank-Owned Life Insurance: The Bank has purchased life insurance policies on certain key employees. Upon adoption of EITF 06-5, which is discussed further below, Company owned life insurance is recorded at the amount that can be realized under the insurance contract at the balance sheet date, which is the cash surrender value adjusted for other charges or other amounts due that are probable at settlement. Prior to adoption of EITF 06-5, the Company recorded owned life insurance at its cash surrender value.
In September 2006, the FASB Emerging Issues Task Force finalized Issue No. 06-5, Accounting for Purchases of Life Insurance - Determining the Amount That Could Be Realized in Accordance with FASB Technical Bulletin No. 85-4 (Accounting for Purchases of Life Insurance. This Issue requires that a policyholder consider contractual terms of a life insurance policy in determining the amount that could be realized under the insurance contract. It also requires that if the contract provides for a greater surrender value if all individual policies in a group are surrendered at the same time, that the surrender value be determined based on the assumption that policies will be surrendered on an individual basis. Lastly, the Issue requires disclosure when there are contractual restrictions on the Company’s ability to surrender a policy. The adoption of EITF 06-5 on July 1, 2007 had no impact on the Company’s financial condition or results of operation
Investment in Limited Liability Partnership: The Company has an investment in an affordable housing fund totaling $1,710,000 and $2,087,000 at June 30, 2008 and 2007, respectively, with a commitment to fund an additional $64,000 at June 30, 2008, for the purposes of obtaining tax credits and for Community Reinvestment Act purposes. The investment is recorded in other assets on the balance sheet and is accounted for using the equity method of accounting. Under the equity method of accounting, the Company recognizes its ownership share of the profits and losses of the fund. This investment is regularly evaluated for impairment by comparing the carrying value to the remaining tax credits and future tax benefits expected to be received. Tax credits received from the fund are accounted for in the period earned (the flow-through method) and are included in income as a reduction of income tax expense.
Goodwill and Other Intangible Assets: Goodwill results from business acquisitions and represents the excess of the purchase price over the fair value of acquired tangible assets and liabilities and identifiable intangible assets. Goodwill is assessed at least annually for impairment and any such impairment will be recognized in the period identified.
Other intangible assets consist of core deposit intangible assets arising from a branch acquisition. They are initially measured at fair value and then are amortized on an accelerated method over their estimated useful lives, which was determined to be eight years.
Long-Term Assets: Premises and equipment, core deposit and other long-term assets are reviewed for impairment when events indicate their carrying amount may not be recoverable from future undiscounted cash flows. If impaired, the assets are recorded at fair value.
Loan Commitments and Related Financial Instruments: Financial instruments include off-balance-sheet credit instruments, such as commitments to make or purchase loans. The face amount for these items represents the exposure to loss, before considering customer collateral or ability to repay. Such financial instruments are recorded when they are funded.
Stock-Based Compensation: Effective July 1, 2005, the Company adopted Statement of Financial Accounting Standards (“SFAS”) No. 123(R), Share-based Payment, using the modified prospective transition method. Accordingly, compensation cost is calculated on the date of grant using the fair value of the option as determined using the Black Scholes model. The compensation cost is then amortized straight-line over the vesting period. The Black Scholes valuation calculation requires the Company to estimate key assumptions such as expected option term, expected volatility of the Company’s stock, the risk-free interest rate, annual dividend yield and forfeiture rates to determine the stock options fair value. The estimate of these key assumptions is based on historical information and judgment regarding market factors and trends. The Company elected to adopt the modified prospective application method as provided by SFAS 123(R), and, accordingly, the Company records compensation costs as the requisite service is rendered for the unvested portion of previously issued awards that remain outstanding at the initial date of adoption and for any awards issued, modified, repurchased, or cancelled after the effective date of SFAS 123(R). The company assumes 0% on both ISO and NQSO stock options in forfeitures as a component for determining future expense related to the Stock Option Plan. Adjustments for forfeitures are recorded as incurred.
Income Taxes: The Company and its subsidiaries are subject to U.S. federal income tax as well as income tax of the state of California. The Company is no longer subject to examination by taxing authorities for years before June 30, 2004.Deferred taxes are provided on an asset and liability method whereby deferred tax assets are recognized for deductible temporary differences and operating loss and tax credit carryforwards and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax bases. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment. The Company recognizes interest and/or penalties related to income tax matters in income tax expense.
The Company adopted FASB Interpretation 48, Accounting for Uncertainty in Income Taxes (“FIN 48”), as of January 1, 2007. A tax position is recognized as a benefit only if it is "more likely than not" that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being realized on examination. For tax positions not meeting the "more likely than not" test, no tax benefit is recorded. The adoption had no affect on the Company’s financial statements.
Employee Stock Ownership Plan (ESOP): The cost of shares issued to the ESOP but not yet allocated to participants is shown as a reduction of stockholders’ equity. Compensation expense is based on the market price of shares as they are committed to be released to participant accounts. Dividends on allocated ESOP shares reduce retained earnings; dividends on unearned ESOP shares are used to service the debt.
Earnings per Common Share: Basic earnings per common share is net income divided by the weighted average number of common shares outstanding during the period. ESOP shares are considered outstanding for this calculation unless unearned. Diluted earnings per common share includes the dilutive effect of additional potential common shares issuable under stock options and stock awards.
Comprehensive Income: Comprehensive income consists of net income and other comprehensive income. Other comprehensive income includes unrealized gains and losses on securities available for sale which are also recognized as separate components of equity, net of tax.
Newly Issued But Not Yet Effective Accounting Standards: In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” which clarifies the principle that fair value should be based on the assumptions market participants would use when pricing an asset or liability and establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. Under the standard, fair value measurement would be separately disclosed by level within the fair value hierarchy. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years, with early adoption permitted. The adoption of this statement on July 1, 2008 did not have a significant impact on the Company’s financial condition or results of operations.
In February 2007, the Financial Accounting Standards Board (the “FASB”) issued Statement No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities-Including an amendment of FASB Statement No. 115”, (“FAS 159”). FAS 159 provide companies with an option to report selected financial assets and liabilities at fair value. Most of the provisions of this statement apply only to entities that elect the fair value option. However, the amendment to FASB Statement No. 115, “Accounting for Certain Investments in Debt and Equity Securities”, applies to all entities with available-for-sale and trading securities. FAS 159 also establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement attributes for similar types of assets and liabilities. This statement is effective as of the beginning of an entity’s first fiscal year that begins after November 15, 2007. Early adoption is permitted as of the beginning of a fiscal year that begins on or before November 15, 2007, provided the entity makes that election within the first 120 days of that fiscal year and also elects to apply the provisions of FASB Statement No. 157, “Fair Value Measurements”. The Company did not elect to adopt the fair value option on any financial instruments as of July 1, 2008.
In September 2006, the FASB Emerging Issues Task Force finalized Issue No. 06-4, Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements. This issue requires that a liability be recorded during the service period when a split-dollar life insurance agreement continues after participants’ employment or retirement. The required accrued liability will be based on either the post-employment benefit cost for the continuing life insurance or based on the future death benefit depending on the contractual terms of the underlying agreement. This issue is effective for fiscal years beginning after December 15, 2007. The Company does not expect the adoption to have a material impact on the Company’s consolidated financial position or results of operations.
In December 2007 the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 141R, Business Combinations. SFAS 141R replaces the current standard on business combinations and will significantly change the accounting for and reporting of business combinations in consolidated financial statements. This statement requires an entity to measure the business acquired at fair value and to recognize goodwill attributable to any non-controlling interests (previously referred to as minority interests) rather than just the portion attributable to the acquirer. The statement will also result in fewer exceptions to the principle of measuring assets acquired and liabilities assumed in a business combination at fair value. In addition, the statement will result in payments to third parties for consulting, legal, and similar services associated with an acquisition to be recognized as expenses when incurred rather than capitalized as part of the business combination. SFAS 141R is effective for fiscal years beginning on or after December 15, 2008. The Company does not expect the adoption to have a material impact on the Company’s consolidated financial position or results of operations.
On March 19, 2008, the FASB issued FASB Statement No. 161, Disclosures about Derivative Instruments and Hedging Activities - an Amendment of FASB Statement 133. Statement 161 enhances required disclosures regarding derivatives and hedging activities, including enhanced disclosures regarding how: (a) an entity uses derivative instruments; (b) derivative instruments and related hedged items are accounted for under FASB Statement No. 133, Accounting for Derivative Instruments and Hedging Activities; and (c) derivative instruments and related hedged items affect an entity's financial position, financial performance, and cash flows. Specifically, Statement 161 requires: disclosure of the objectives for using derivative instruments be disclosed in terms of underlying risk and accounting designation; disclosure of the fair values of derivative instruments and their gains and losses in a tabular format; disclosure of information about credit-risk-related contingent features; and cross-reference from the derivative footnote to other footnotes in which derivative-related information is disclosed. Statement 161 is effective for fiscal years and interim periods beginning after November 15, 2008. The Company does not expect the adoption to have a material impact on the Company’s consolidated financial position or results of operations.
In May 2008, the FASB issued FASB Statement No. 162, The Hierarchy of Generally Accepted Accounting Principles. Statement 162 identifies the sources of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements of nongovernmental entities that are presented in conformity with GAAP in the United States (the GAAP Hierarchy). The Board issued this Statement because it is the entity (not its auditor) that is responsible for selecting accounting principles for financial statements that are presented in conformity with GAAP. Accordingly, the Board concluded that the GAAP hierarchy should reside in the accounting literature established by the FASB as opposed to auditing literature established by the AICPA and PCAOB. Statement 162 is effective 60 days following the SEC’s approval of the PCAOB’s amendments to AU Section 411, “The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles.” The Company does not expect the adoption to have a material impact on the Company’s consolidated financial position or results of operations.
In June 2008, the FASB issued Staff Position EITF 03-6-1, Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities (“FSP EITF 03-6-1”). The FSP EITF 03-6-1 addresses whether instruments granted in share-based payment transactions are participating securities prior to vesting and, therefore, need to be included in the earnings allocation in computing earnings per share under the two-class method. The FSP affects entities that accrue cash dividends on share-based payment awards during the awards’ service period when the dividends do not need to be returned if the employees forfeit the awards. FSP EITF 03-6-1 is effective for fiscal years beginning after December 15, 2008. The Company does not accrue cash dividends and therefore does not anticipate there to be an impact on the Company’s consolidated financial position, results of operations, or cash flows.
Loss Contingencies: Loss contingencies, including claims and legal actions arising in the ordinary course of business, are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated. Management does not believe there now are such matters that will have a material effect on the financial statements.
Restrictions on Cash: The Company is required to maintain reserve balances in cash or on deposit with the Federal Reserve Bank, based on a percentage of deposits. The total of those reserve balances was $1,212,000 and $1,174,000 at June 30, 2008 and 2007, respectively.
Fair Value of Financial Instruments: Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed in Note 15. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments, and other factors, especially in the absence of broad markets for particular items. Changes in assumptions or in market conditions could significantly affect the estimates.
Operating Segments: While the chief decision-makers monitor the revenue streams of the various products and services, the identifiable segments are not material and operations are managed and financial performance is evaluated on a Company-wide basis. Accordingly, all of the financial service operations are considered by management to be aggregated in one reportable operating segment.
Reclassifications: Some items in the prior year financial statements were reclassified to conform to the current presentation.
2.
INVESTMENTS
The fair value of available for sale securities and the related gross unrealized gains and losses recognized in accumulated other comprehensive income (loss) were as follows:
K-FED BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2008, 2007 AND 2006
The carrying amount, unrecognized gains and losses, and fair value of securities held to maturity were as follows:
There were no sales of securities during the years ending June 30, 2008, 2007, and 2006.
The fair value of debt securities and carrying amount, if different, at June 30, 2008 by contractual maturity were as follows:
K-FED BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2008, 2007 AND 2006
Securities not due at a single maturity date, primarily mortgage-backed securities and collateralized mortgage obligations, are shown separately.
Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Securities with unrealized losses at June 30, 2008 and 2007, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, are as follows:
The Company evaluates securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. Consideration is given to the length of time and the extent to which the fair value has been less than cost, the financial condition and near-term prospects of the issuer, and the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. In analyzing an issuer’s financial condition, the Company may consider whether the securities are issued by the federal government or its agencies, whether downgrades by bond rating agencies have occurred, and the results of reviews of the issuer’s financial condition.
At June 30, 2008, nine debt securities had unrealized losses with aggregate depreciation of 1.3% of the Company’s amortized cost basis. At June 30, 2007, fifteen debt securities had unrealized losses with aggregate depreciation of 2.3% of the Company’s amortized cost basis. The unrealized losses relate principally to the general change in interest rate levels that has occurred since the securities purchase dates, and such unrecognized losses or gains will continue to vary with general interest rate level fluctuations in the future. As management has the ability to hold debt securities until recovery, which may be maturity, no declines are deemed to be other-than-temporary.
3.
LOANS
The composition of loans consists of the following:
The Company has purchased real-estate loan participations originated by other financial institutions. All of these loan participations were purchased without recourse and are secured by real property. The originating financial institution performs all servicing functions on these loans.
The Company’s one-to-four family interest-only mortgages loans totaled $90,220,000 and $100,424,000 at June 30, 2008 and June 30, 2007, respectively.
K-FED BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2008, 2007 AND 2006
The following is an analysis of the changes in the allowance for loan losses:
Nonaccrual loans and loans past due 90 days still on accrual were as follows:
Nonaccrual loans include both smaller balance homogeneous loans that are collectively evaluated for impairment and individually classified impaired loans.
Loans on which accrual of interest has been discontinued or reduced amounted to $1,730,000, $1,141,000 and $67,000 at June 30, 2008, 2007, and 2006 respectively. If interest on those loans had been accrued, such income would have been $49,000, $17,000, and $1,000 for the years ended June 30, 2008, 2007, and 2006 respectively. The effects of troubled debt restructurings are not considered material to the Company’s financial position and results of operations.
4.
CONCENTRATIONS OF CREDIT RISK
The Kaiser Permanente Medical Care Program employs a large percentage of the Bank’s account holders. Further, a significant concentration of the Bank’s borrowers resides in California. Although the Bank has a diversified loan portfolio, borrowers’ ability to repay loans may be affected by the economic climate of either the health care industry or the overall geographic region in which borrowers reside.
5.
PREMISES AND EQUIPMENT
Premises and equipment are summarized as follows:
Depreciation expense on premises and equipment totaled $880,000, $742,000, and $507,000 for the years ended June 30, 2008, 2007, and 2006, respectively.
The Company leases office space in eight buildings. The operating leases contain renewal options and provisions requiring the Company to pay property taxes and operating expenses over base period amounts. All rental payments are dependent only upon the lapse of time. Minimum rental payments under operating leases with initial or remaining terms of one year or more at June 30, 2008 are as follows (in thousands):
Rental expense, including property taxes and common area maintenance for the years ended June 30, 2008, 2007, and 2006 for all facilities leased under operating leases totaled $1,026,000, $967,000, and $874,000, respectively.
6.
GOODWILL AND INTANGIBLE ASSETS
Goodwill
The activity in balance for goodwill during the year is as follows (in thousands):
Acquired Intangible Assets
Acquired intangible assets were as follows (in thousands):
Aggregate amortization expense was $97,000, $114,000 and $131,000 for the years ended June 30, 2008, 2007, and 2006, respectively.
Estimated amortization expense for each of the next five years is as follows (in thousands):
K-FED BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2008, 2007 AND 2006
7.
DEPOSITS
The following table shows the distribution of, and certain other information relating to, deposits by type of deposit, as of the dates indicated.
Deposits by maturity are summarized as follows:
The aggregate amount of certificates of deposit in denominations of $100,000 or more at June 30, 2008 and 2007 was $99,525,000 and $93,547,000, respectively.
Interest expense by major category is summarized as follows:
K-FED BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2008, 2007 AND 2006
8.
FEDERAL HOME LOAN BANK ADVANCES
At June 30, 2008, the stated interest rates on the Bank’s advances from the FHLB ranged from 3.60% to 5.28%, with a weighted average stated rate of 4.46%. At June 30, 2007, the stated interest rates on the Bank’s advances from the FHLB ranged from 3.18% to 5.28%, with a weighted average stated rate of 4.44%. The contractual maturities by year of the Bank’s advances are as follows:
The Bank’s advances from the FHLB are collateralized by certain real estate loans of an aggregate unpaid principal balance of $558,195,000 and $623,792,000 as of the most recent notification date for June 30, 2008 and 2007, respectively. At June 30, 2008 and June 30, 2007, the amount available to borrow under this agreement was $106,431,000 and $101,407,000, respectively. Each advance is payable at its maturity date. At June 30, 2008, the Bank had a $20,000,000 callable FHLB advance scheduled to mature on June 28, 2012, which gives the FHLB the option to require repayment of the advance quarterly after June 28, 2009. FHLB advances are subject to a prepayment penalty if repaid before the maturity date.
The average balance of FHLB advances for the years ended June 30, 2008 and June 30, 2007 were $226,173,000 and $189,217,000 with average costs of 4.50% and 4.37%, respectively.
In August 2004, the Bank paid-off and replaced a $50 million advance from the Federal Home Loan Bank of San Francisco with five $10 million advances. The prepayment penalty of $473,000 assessed by the Federal Home Loan Bank of San Francisco is being amortized over the life of the new advances using the interest method in accordance with EITF 96-19, issued by the Financial Accounting Standards Board in 1996.
9.
STATE OF CALIFORNIA TIME DEPOSIT
In July 2007, the Company began participating in the State of California’s Time Deposit program. Under this program, the State of California will deposit funds at the Bank in exchange for the pledging of certain investment and real estate loan collateral. At June 30, 2008, the $25 million deposit has a rate of 2.03% and a maturity date of December 4, 2008. The company has pledged $15.8 million investment securities and $37.6 million in mortgage loans as collateral.
10.
EMPLOYEE BENEFITS
401(k) Plan: The Company has a 401(k) pension plan that allows eligible employees to defer a portion of their salary into the 401(k) plan. The Company matches 50% of the first 10% of employees’ wage reductions. The Company contributed $114,000, $120,000, and $145,000 respectively, to the plan for the years ended June 30, 2008, 2007, and 2006.
Deferred Compensation Plan: The Company has an executive salary deferral program for the benefit of certain senior executives that have been designated to participate in the program. The program allows an additional opportunity for key executives to defer a portion of their compensation into a non-qualified deferral program to supplement their retirement earnings. At June 30, 2008 and 2007 the Company has accrued a liability for executive deferrals of $1,060,000 and $1,013,000, respectively. Expenses related to the plan are limited to interest expense on the deposit accounts in which these funds are invested, which was $47,000, $41,000, $34,000 for the year ended June 2008, 2007, and 2006, respectively.
Incentive Plan: The Company maintains an Annual Incentive Plan for key employees. Participants are awarded a percentage of their base salary for attaining certain personal performance goals. The compensation expense related to these plans for the year ended June 2008, 2007, and 2006 totaled $368,000, $71,000 and $227,000 respectively.
11.
EMPLOYEE STOCK COMPENSATION
Recognition and Retention Plan (“RRP”): The Company’s RRP provides for issue of shares to directors, officers, and employees. Compensation expense is recognized over the vesting period of the shares based on the market value at date of grant. These shares vest over a five year period. Pursuant to the Company’s 2004 RRP, 227,470 shares of the Company’s common stock may be awarded. There were 66,560 restricted shares outstanding and the Company had an aggregate of 74,250 restricted shares available for future issuance under the RRP at June 30, 2008.
A summary of changes in the Company’s RRP shares for the year follows:
Shares
Weighted Average
Grant Date
Fair Value
RRP shares at July 1, 2007
107,660
$
15.23
Granted
5,000
12.00
Vested
(29,780
)
14.92
Forfeited
(16,320
)
16.66
RRP shares at June 30, 2008
66,560
$
14.78
As of June 30, 2008, there was $731,000 of total unrecognized compensation cost related to nonvested shares under the plan. The cost is expected to be recognized over a weighted average period of five years. The weighted average remaining period for the outstanding options is less than eighteen months at June 2008. The total fair value of shares vested during the years ended June 30, 2008, 2007 and 2006 was $357,000, $342,000 and $461,000.
Stock Option Plan (“SOP”): The Company’s SOP provides for issue of options to directors, officers and employees. Pursuant to the Company’s 2004 SOP, 568,675 shares of the Company’s common stock may be awarded. The Company implemented the SOP to promote the long-term interest of the Company and its stockholders by providing an incentive to those key employees who contribute to the operational success of the Company. The options become exercisable in equal installments over a five-year period beginning one year from the date of grant. The options expire ten years from the date of grant and are subject to certain restrictions and limitations. Compensation expense, net of tax effects related to the SOP was $261,000, $228,000 and $329,000 for years ended June 30, 2008, 2007 and 2006, respectively. A summary of the status of the Company’s stock option plan and changes is presented below:
Information related to the stock option plan during each year follows:
K-FED BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2008, 2007 AND 2006
There were no options granted in the year ended June 30, 2006. Stock options granted during the years ended June 30, 2008 and June 30, 2007 were computed using the Black-Scholes option pricing model to determine the fair value of options with the following assumptions as of the date of grant:
June 30,
June 30,
June 30,
Risk-free interest rate
3.88
%
4.67
%
-
%
Expected option life
7.00 years
6.52 years
-
Expected price volatility
22.79
%
23.35
%
-
%
Expected dividend yield
2.90
%
2.33
%
-
%
The risk-free interest rate is the implied yield available on U.S. Treasury zero-coupon issues with a remaining term equal to the expected term of the stock option in effect at the time of the grant. Although the contractual term of the stock options granted is ten years, the expected term of the stock is less because option restrictions do not permit recipients to sell or hedge their options, and therefore, we believe, encourage exercise of the option before the end of the contractual term. The Company does not have sufficient historical information about its own employees vesting behavior; therefore, the expected term of stock options was estimated using the average of the vesting period and contractual term. The expected stock price volatility is estimated by considering the Company’s own stock volatility for the period since March 31, 2004, the initial trading date. Expected dividends are the estimated dividend rate over the expected term of the stock options. At June 30, 2008, the Company used a forfeiture rate of 0% due to the remaining recipient mix and their ability to hold the options until expiration.
At June 30, 2008, the Company had an aggregate of 234,555 options available for future issuance under the SOP.
As of June 30, 2008, there was $521,000 of unrecognized compensation cost related to nonvested stock options. The remaining cost is expected to be recognized over a weighted average period of 1.33 years. Expense will vary based on actual forfeitures.
12.
EMPLOYEE STOCK OWNERSHIP PLAN (ESOP)
During 2004, the Company implemented the Employee Stock Ownership Plan (ESOP), which covers substantially all of its employees. In connection with the stock offering, the Company issued 454,940 shares of common stock for allocation under the ESOP in exchange for a ten-year note in the amount of $4.5 million. The $4.5 million for the ESOP purchase was borrowed from the Company. The ESOP shares initially were pledged as collateral for the loan.
The loan is secured by shares purchased with the loan proceeds and will be repaid by the ESOP with funds from the Company’s contributions to the ESOP and earnings on ESOP assets. Shares issued to the ESOP are allocated to ESOP participants based on the proportion of debt service paid in the year. Principal and interest payments are scheduled to occur over a ten-year period. Contributions to the ESOP were $429,000, $417,000, and $442,000 for the years ended June 30, 2008, 2007, and 2006, respectively.
During the year ended June 30, 2008, 45,494 shares of stock with an average fair value of $11.94 per share were committed to be released, resulting in ESOP compensation expense of $543,000. During the year ended June 30, 2007, 45,494 shares of stock with an average fair value of $17.36 per share were committed to be released, resulting in ESOP compensation expense of $790,000. During the year ended June 30, 2006, 45,494 shares of stock with an average fair value of $12.66 per share were committed to be released, resulting in ESOP compensation expense of $576,000. Shares held by the ESOP at June 30, 2008 and 2007 are as follows:
13.
INCOME TAXES
The components of income tax expense are as follows:
K-FED BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2008, 2007 AND 2006
The income tax provision differs from the amount of income tax determined by applying the United States federal income tax rate to pretax income due to the following:
The Company’s total net deferred tax assets are as follows:
14.
CAPITAL REQUIREMENTS AND RESTRICTIONS ON RETAINED EARNINGS
The Bank is subject to various regulatory capital requirements administered by federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Bank’s financial statements. The regulations require the Bank to meet specific capital adequacy guidelines that involve quantitative measures of Bank’s assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Bank’s capital classification is also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the following table) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined) and Tier 1 capital to total assets (as defined). Management’s opinion, as of June 30, 2008, is that the Bank meets all capital adequacy requirements to which it is subject.
As of June 30, 2008 and 2007, the most recent notification from the Office of Thrift Supervision, categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, an institution must maintain minimum total risk-based, Tier 1 risk based and Tier 1 leverage ratios as set forth in the table below. There are no conditions or events since the notification that management believes have changed the Bank’s category. The Bank’s actual capital amounts and ratios are presented in the following table.
K-FED BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2008, 2007 AND 2006
The following is a reconciliation of the Bank’s equity under accounting principles generally accepted in the United States of America (“GAAP”) to regulatory capital.
Office of Thrift Supervision regulations impose various restrictions on savings institutions with respect to their ability to make distributions of capital, which include dividends, stock redemptions or repurchases, cash-out mergers and other transactions charged to the capital account.
Generally, savings institutions, such as Kaiser Federal Bank, that before and after the proposed distribution are well-capitalized, may make capital distributions during any calendar year up to 100% of net income for the year-to-date plus retained net income for the two preceding years. However, an institution deemed to be in need of more than normal supervision by the Office of Thrift Supervision may have its dividend authority restricted by the Office of Thrift Supervision. The amount of retained earnings available for dividends was $3.5 million at June 30, 2008. Kaiser Federal Bank may pay dividends to K-Fed Bancorp in accordance with this general authority.
The Qualified Thrift Lender test requires at least 65% of assets be maintained in housing-related finance and other specified areas. If this test is not met, limits are placed on growth, branching, new investments, FHLB advances and dividends, or the Bank must convert to a commercial bank charter. Management believes that this test is met.
K-Fed Bancorp is not currently subject to prompt corrective action regulations.
15.
LOAN COMMITMENTS AND OTHER RELATED ACTIVITIES
The Company is a party to various legal actions normally associated with collections of loans and other business activities of financial institutions, the aggregate effect of which, in management’s opinion, would not have a material adverse effect on the financial condition or results of operations of the Company.
At June 30, 2008 and 2007, there were $32,687,000 and $14,285,000, respectively, in cash and cash equivalents with balances in excess of insured limits.
Outstanding mortgage loan commitments at June 30, 2008 and 2007 amounted to $6.8 million and $7.5 million, respectively. As of June 30, 2008, $645,000 of commitments are issued at a weighted average fixed rate of 5.9%. There were no commitments to purchase mortgage loans at June 30, 2008 and 2007, respectively.
Available credit on home equity and unsecured lines of credit is summarized as follows:
Commitments for home equity and unsecured lines of credit may expire without being drawn upon. Therefore, the total commitment amount does not necessarily represent future cash requirements of the Company. These commitments are not reflected in the financial statements.
16.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair value amounts have been determined by the Company using available market information and appropriate valuation methodologies. However, considerable judgment is necessarily required to interpret market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company could realize in a market exchange. The use of different assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.
The following methods and assumptions were used to estimate fair value of each class of financial instruments for which it is practicable to estimate fair value:
Investments
Estimated fair values for investments are obtained from quoted market prices where available. Where quoted market prices are not available, estimated fair values are based on quoted market prices of comparable instruments.
Loans
The estimated fair value for all fixed rate loans and variable rate loans with an initial fixed rate feature is determined by discounting the estimated cash flows using the current rate at which similar loans would be made to borrowers with similar credit ratings and maturities.
The estimated fair value for variable rate loans with no initial fixed rate feature is the carrying amount.
Deposits
The estimated fair value of deposit accounts (savings, non interest bearing demand and money market accounts) is the carrying amount. The fair value of fixed-maturity time certificates of deposit is estimated by discounting the estimated cash flows using the current rate at which similar certificates would be issued.
FHLB Advances
The fair values of the FHLB advances are estimated using discounted cash flow analyses, based on the Company’s current incremental borrowing rates for similar types of borrowing arrangements.
Other On-Balance-Sheet Financial Instruments
Other on-balance-sheet financial instruments include cash and cash equivalents, accrued interest receivable, FHLB stock and accrued expenses and other liabilities. The carrying value of each of these financial instruments is a reasonable estimation of fair value. It was not practicable to determine the fair value of FHLB stock due to restrictions placed on its transferability.
Off-Balance-Sheet Financial Instruments
The fair values for the Company’s off-balance sheet loan commitments are estimated based on fees charged to others to enter into similar agreements taking into account the remaining terms of the agreements and credit standing of the Company’s customers. The estimated fair value of these commitments is not significant.
The estimated fair values of the Company’s financial instruments are summarized as follows:
K-FED BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2008, 2007 AND 2006
17.
EARNINGS PER COMMON SHARE
The factors used in the earnings per share computation follow (dollars in thousands).
Stock options for 322,400, 40,000, 352,300 shares of common stock were not considered in computing diluted earnings per common share for the years ended June 30, 2008, 2007 and 2006, respectively, because to do so would be anti-dilutive.
18.
OTHER COMPREHENSIVE LOSS (INCOME)
Other comprehensive (loss) income components and related taxes were as follows:
K-FED BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2008, 2007 AND 2006
19.
CONDENSED CONSOLIDATED QUARTERLY RESULTS OF OPERATIONS (Unaudited)
The following table sets forth our Company’s unaudited results of operations for the four quarters ended 2008 and 2007. The sum of the quarterly data may not be equal to the annual data.
K-FED BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2008, 2007 AND 2006
20. PARENT COMPANY ONLY CONDENSED FINANCIAL STATEMENTS
Condensed financial information of K-Fed Bancorp follows:
CONDENSED BALANCE SHEETS
(In thousands)
CONDENSED STATEMENTS OF INCOME
(Dollars in thousands)
CONDENSED STATEMENTS OF CASH FLOWS
(Dollars in thousands)