Material Income Tax Consequences
Although the reorganization may be effected in any manner approved by the
Office of Thrift Supervision that is consistent with the purposes of the plans
of reorganization and stock issuance and applicable law, regulations and
policies, it is intended that the reorganization will be effected through a
merger. Completion of the reorganization is conditioned upon prior receipt of
either a ruling or an opinion of counsel with respect to federal tax laws, and
either a ruling or an opinion with respect to Kentucky tax laws, that no gain or
loss will be recognized by First Federal of Hazard, Kentucky First or First
Federal MHC as a result of the reorganization or by account holders receiving
subscription rights, except to the extent, if any, that subscription rights are
deemed to have fair market value on the date such rights are issued. We believe
that the tax opinions
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summarized below address all material federal income tax consequences that are
generally applicable to First Federal of Hazard, Kentucky First and First
Federal MHC and persons receiving subscription rights.
Muldoon Murphy Faucette & Aguggia LLP has issued an opinion to First Federal
of Hazard that, for federal income tax purposes:
(1) the reorganization will constitute a reorganization under Internal
Revenue Code section 368(a)(1)(F), and First Federal of Hazard (in either
its mutual form (the "Mutual Bank") or its stock form (the "Stock Bank")
will recognize no gain or loss as a result of the reorganization;
(2) the basis of each asset of the Mutual Bank received by the Stock Bank in
the reorganization will be the same as the Mutual Bank's basis for such
asset immediately before the reorganization;
(3) the holding period of each asset of the Mutual Bank received by the Stock
Bank in the reorganization will include the period during which such
asset was held by the Mutual Bank before the reorganization;
(4) for purposes of Internal Revenue Code section 381(b), the Stock Bank will
be treated as if there had been no reorganization and, accordingly, the
taxable year of the Mutual Bank will not end on the effective date of the
reorganization and the tax attributes of the Mutual Bank (subject to
application of Internal Revenue Code sections 381, 382, and 384) will be
taken into account by the Stock Bank as if the reorganization had not
occurred;
(5) the Mutual Bank's members will recognize no gain or loss upon their
constructive receipt of shares of the Stock Bank common stock solely in
exchange for their mutual ownership interest in the Mutual Bank;
(6) no gain or loss will be recognized by members of the Mutual Bank upon the
issuance to them of deposits in the Stock Bank in the same dollar amount
as their deposits in the Mutual Bank;
(7) with respect to the members of the Mutual Bank's exchange of the stock of
the Stock Bank constructively received for the mutual ownership interests
in First Federal MHC, the exchange will qualify as an exchange of
property for stock under Internal Revenue Code section 351, the initial
stockholders of the Stock Bank will recognize no gain or loss upon the
constructive transfer to First Federal MHC of the shares of the Stock
Bank they constructively received and First Federal MHC will recognize no
gain or loss upon its receipt of the common stock of the Stock Bank in
exchange for mutual ownership interests in the Mutual Bank;
(8) with respect to First Federal MHC's transfer of 100% of the common stock
of the Stock Bank to Kentucky First, Kentucky First will recognize no
gain or loss upon its transfer of 100% of the common stock of the Stock
Bank from First Federal MHC and First Federal MHC will recognize no gain
or loss upon its transfer of 100% of the common stock of the Stock Bank
from First Federal MHC to Kentucky First;
(9) it is more likely than not that the fair market value of the
non-transferable subscription rights to purchase shares of common stock
of Kentucky First to be issued to eligible account holders, supplemental
eligible account holders and other members is zero and, accordingly, that
no income will be realized by eligible account holders, supplemental
eligible account holders and other members upon the issuance to them of
the subscription rights or upon the exercise of the subscription rights;
(10) it is more likely than not that the tax basis to the holders of shares of
common stock purchased in the reorganization pursuant to the exercise of
the subscription rights will be the amount paid therefor, and that the
holding period for such shares of common stock will begin on the date of
completion of the reorganization; and
(11) the holding period for shares of common stock purchased in the community
offering or syndicated community offering will begin on the day after the
date of the purchase.
The opinions set forth in the 9th and 10th bullet points above are based on
the position that the subscription rights do not have any market value when they
are distributed or exercised. Whether subscription rights have a market value
for federal income tax purposes is a question of fact, depending upon all
relevant facts and circumstances. According to our counsel, the Internal Revenue
Service will not issue rulings on whether subscription rights have a market
value. Counsel has also advised us that they are unaware of any instance in
which the Internal Revenue Service has taken the position that nontransferable
subscription rights issued by a converting financial institution have a market
value. Counsel also noted that the subscription rights will be granted at no
cost to the recipients, will be nontransferable and of short duration, and will
afford the
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recipients the right only to purchase our common stock at a price equal to its
estimated fair market value, which will be the same price as the purchase price
for the unsubscribed shares of common stock.
Unlike a private letter ruling issued by the Internal Revenue Service, an
opinion of counsel is not binding on the Internal Revenue Service and the
Internal Revenue Service could disagree with the conclusions reached in the
opinion. If there is a disagreement, no assurance can be given that the
conclusions reached in an opinion of counsel would be sustained by a court if
contested by the Internal Revenue Service.
First Federal of Hazard has also received an opinion from Grant Thornton,
LLP, Cincinnati, that, assuming the reorganization does not result in any
federal income tax liability to First Federal of Hazard, its account holders, or
Kentucky First, implementation of the plans of reorganization and stock issuance
will not result in any Kentucky income tax liability to those entities or
persons.
The opinions of Muldoon Murphy Faucette & Aguggia LLP and Grant Thornton,
LLP, are filed as exhibits to the registration statement that we have filed with
the Securities and Exchange Commission. See "Where You Can Find More
Information."
Interpretation, Amendment and Termination
To the extent permitted by law, all interpretations by us of the plans of
reorganization and stock issuance will be final; however, such interpretations
have no binding effect on the Office of Thrift Supervision. The plans of
reorganization and stock issuance provide that, if deemed necessary or
desirable, we may substantively amend the plans of reorganization and stock
issuance as a result of comments from regulatory authorities or otherwise,
without the further approval of our members.
Completion of the reorganization requires the sale of all shares of the
common stock within 24 months following approval of the plan of reorganization
by our members. If this condition is not satisfied, the plan of reorganization
will be terminated and we will continue our business in the mutual form of
organization. We may terminate the plan of reorganization at any time.
The Merger
Form of the Merger
The boards of directors of Frankfort First and First Federal of Hazard have
approved a merger agreement that provides for the merger of Frankfort First with
a merger subsidiary of Kentucky First. Upon completion of the merger, each share
of Frankfort First common stock will be converted into the right to receive
either 2.35 shares of Kentucky First common stock or $23.50 in cash, without
interest. A Frankfort First shareholder's receipt of either cash or stock,
however, is subject to the allocation and proration procedures as well as other
provisions in the merger agreement.
Cash or Stock Election
Under the terms of the merger agreement, Frankfort First shareholders may
elect to convert their shares into cash or shares of Kentucky First common stock
or indicate on the election form that they have no elective preference. All
elections of Frankfort First shareholders are further subject to the allocation
and proration procedures described in Section 2.8 of the merger agreement.
Section 2.8 of the merger agreement provides formulas to calculate a "minimum
stock number" and a "maximum stock number." The "minimum stock number" is the
minimum number of shares of Frankfort First common stock that must each be
exchanged for the stock consideration (i.e., 2.35 shares of Kentucky First
common stock) in the merger, regardless of whether the reorganization offering
is consummated at the minimum, midpoint, maximum or maximum, as adjusted, of the
offering range. The minimum stock number is based on the "continuity of
interest" test which determines whether the reorganization is tax-free under
Section 368(a) of the Internal Revenue Code and assumes that 1,266,613 shares of
Frankfort First common stock and options to purchase 147,230 shares of Frankfort
First common stock are outstanding at the effective time of the merger. The
minimum stock number assures that at least 40% of the value of the merger
consideration received by Frankfort First shareholders is in the form of
Kentucky First common stock. Based on these assumptions, 530,879 shares of
Frankfort First common stock must be exchanged for at least 1,247,565 shares of
Kentucky First common stock in the merger. The minimum stock number would
decrease if the number of shares of Frankfort First common stock or the number
of options to purchase shares of Frankfort First common stock decreased before
the effective time of the merger.
The "maximum stock number" is the maximum number of shares of Frankfort
First common stock that may be exchanged for the stock consideration. The
maximum stock number is based on the requirement that, except in order to
satisfy the minimum stock number requirement described above, no more than 45%
of the Kentucky First shares outstanding immediately following the
reorganization and the merger and owned by persons other than First Federal MHC
may be owned by the former Frankfort First shareholders who receive their shares
in the merger. Under no circumstance will Frankfort First shareholders receive
more than 49% of the Kentucky First shares issued to persons other than First
Federal MHC. A description of the impact of the minimum and maximum stock
numbers on the elections of Frankfort First shareholders follows (assuming that
there are 1,266,613 shares, and options to purchase 147,230 shares, of Frankfort
First common stock outstanding at the effective time of the merger).
If Frankfort First shareholders, in the aggregate, elect to exchange more
shares of Frankfort First stock than the maximum stock number for Kentucky First
stock in the merger (i.e., elect to receive more Kentucky First stock than the
parties agreed Kentucky First would issue in the merger), then persons who
elected to receive stock would, instead, receive a combination of Kentucky First
stock and cash based on the merger agreement's allocation and proration
procedures. If Frankfort First shareholders, in the aggregate, elect to exchange
fewer than the minimum stock number of Frankfort First shares for Kentucky First
shares (which would result in the election to receive fewer than 1,247,565
shares of Kentucky First common stock) in the merger, then persons electing to
receive cash and/or persons not making elections would, instead, receive a
combination of Kentucky First stock and cash based on the merger agreement's
allocation and proration procedures.
At the minimum of the offering range, Frankfort First shareholders must
receive 1,247,565 shares (22.6%) of Kentucky First common stock and $18.7
million in cash (including the payment of $1.4 million to holders of options to
purchase Frankfort First common stock in exchange for the cancellation of such
options). At the maximum of the offering range, if Frankfort First shareholders
elect to receive the maximum amount of Kentucky First common stock available to
them in the merger, the aggregate merger consideration will consist of 1,513,687
shares (20.2%) of Kentucky First common stock and $16.1 million in cash. If
Frankfort First shareholders receive only 1,247,565 shares of Kentucky First
common stock in the merger (either because they elect to receive the minimum
number, or fewer than the minimum number, of shares that must be issued in the
merger), then the aggregate merger consideration will consist of 1,247,565
shares (16.7%) of Kentucky First common stock and $18.7 million in cash. See
"Summary-Number of Shares to be Sold" and "How We Determined the Offering Range
and the $10.00 Purchase Price" for a more detailed discussion on the number of
shares to be issued in the reorganization and merger offering, as well as the
percentages of the shares of Kentucky First common stock that will be
outstanding following the reorganization and the merger of the different points
of the reorganization offering range. No fractional shares will be issued in the
merger, and each holder of a fractional interest in Kentucky First common stock,
after aggregation of all of his or her fractional interests shall in lieu of
such fractional interest be paid an amount equal to the fractional interest
multiplied by $23.50. Neither we nor Frankfort First is making any
recommendation as to whether Frankfort First's shareholders should elect to
receive cash or Kentucky First common stock in the merger. Each holder of
Frankfort First's common stock must make his own decision with respect to such
election.
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Background of the Merger
The board of directors of First Federal of Hazard has occasionally reviewed
its strategic options, including converting to a stock form financial
institution, continued independence, acquisitions of other institutions and
mergers with and acquisitions by other institutions, all with a view towards
improving First Federal of Hazard's competitive posture for the long-term,
supporting future lending and growth, improving its financial performance and
expanding the services available to its customers. On an annual basis, First
Federal of Hazard prepares a budget and reviews and updates its business plan.
In late 2003, First Federal of Hazard's President, Tony Whitaker, had an
informal discussion with a representative of Capital Resources Group, the
financial advisor for First Federal of Hazard and the parent of Capital
Resources, Inc., the marketing agent for the reorganization offering, regarding
a reorganization and merger transactions in general. In January 2004,
Mr. Whitaker was contacted by the Capital Resources Group representative to
discuss the concept of a possible business combination between First Federal of
Hazard and Frankfort First. The potential business combination would involve
First Federal of Hazard's reorganization into the mutual holding company
structure, including a minority stock offering, and simultaneous acquisition of
all of the outstanding shares of Frankfort First common stock. In late
February 2004, a representative of Capital Resources Group met with the Chairman
of the Board of Frankfort First to discuss in concept a merger with First
Federal of Hazard as part of a mutual holding company reorganization and the
reorganization offering and the strategic benefits of combining the two banks as
wholly owned subsidiaries of a newly formed holding company. While no price to
be paid to the stockholders of Frankfort First was discussed at that time, the
meeting included a discussion of the form of the consideration to be paid as
stock and cash and that Frankfort First would have significant representation on
the stock holding company board of directors and in its management. This meeting
was reported to the Frankfort First's board of directors during its March 2004
meeting.
Mr. Whitaker reported his discussions with the Capital Resources Group
representative to First Federal of Hazard's board at its March 2004 board
meeting. The board instructed Mr. Whitaker to continue such discussions with the
Capital Resources Group representative and Frankfort First. Mr. Whitaker updated
the board at its meeting on April 8, 2004 and was instructed by the board to
continue the discussions. Periodic informal telephone discussions continued over
the next several weeks and on April 15, 2004, a meeting was held with
representatives of Frankfort First's and First Federal of Hazard's management
and a representative of Capital Resources Group to further discuss the proposed
transaction.
On May 11, 2004, management updated Frankfort First's board of directors
regarding the status of the discussions of the proposed transaction. At that
meeting, the board of Frankfort First authorized management to continue the
discussions with First Federal of Hazard and to retain legal and financial
advisors. On May 13, 2004, Mr. Whitaker made a presentation to First Federal of
Hazard's board regarding the status of the discussion of the proposed
transaction. At the meeting, the board authorized Mr. Whitaker to continue the
discussions with Frankfort First. On May 21, 2004, representatives of the
Frankfort First's and First Federal of Hazard's management, a representative of
Capital Resources Group and representatives from the law firm Muldoon Murphy
Faucette & Aguggia LLP met to discuss in more detail the proposed transaction.
During the meeting, various structural alternatives were discussed as well as
possible board and management positions. During that meeting, it was suggested
that the proposed price might be in the range of $23.00 per share. Given the
unusual nature of transaction, it was recommended that meetings take place with
Frankfort First's and First Federal of Hazard's principal bank regulator, the
Office of Thrift Supervision, to discuss the regulatory structure.
On June 10, 2004, the President of Frankfort First and the President of First
Federal of Hazard together with representatives from Capital Resources Group and
Muldoon Murphy Faucette & Aguggia LLP met with the Southeast Regional Office of
the OTS and on June 15, 2004, representatives of Capital Resources Group and
Muldoon Murphy Faucette & Aguggia LLP met with the OTS in Washington, D.C. to
discuss the regulatory structure of the proposed transaction. On June 17, 2004,
Mr. Whitaker reported to the First Federal of Hazard board the results of the
June 10, 2004 meeting with the OTS and the proposed schedule for pursuing the
proposed transaction. Following Mr. Whitaker's presentation, the board
authorized and instructed Mr. Whitaker to retain legal and financial advisors in
connection with the proposed transaction. During the latter part of June 2004
and the first two weeks in July 2004, a definitive merger agreement was
negotiated by the parties. On July 8, 2004, Capital Resources Group made a
detailed presentation to First Federal of Hazard's board of directors regarding
the structure of the proposed transaction and the fairness of the merger
consideration to First Federal of Hazard. The board authorized and instructed
Mr. Whitaker, with the assistance of legal counsel and Capital Resources Group,
to continue to negotiate the terms of a definitive merger agreement. In early
July, the parties conducted due diligence to better familiarize themselves with
the operations of the respective institutions. On July 15, 2004, the board of
directors of First Federal of Hazard met to consider the agreement.
Presentations were made by Mr. Whitaker, Muldoon Murphy Faucette & Aguggia LLP
and Capital Resources Group. On July 15, 2004, the Frankfort First board of
directors met to consider the agreement. Presentations were made by counsel as
well as a representative of Howe Barnes Investments, Inc. The merger agreement
was executed on July 15, 2004.
On July 15, 2004, Capital Resources Group rendered its fairness opinion to
the board of directors of First Federal of Hazard that the merger consideration
equal to $23.50 per share of Frankfort First stock is fair, from a financial
point of view, to First Federal of Hazard. In rendering such opinion, Capital
Resources Group made inquiries of First Federal of Hazard's and Frankfort
First's management; Muldoon Murphy Faucette &
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Aguggia, LLP, legal counsel for First Federal of Hazard in connection with the
offer and merger; and representatives of First Federal of Hazard's independent
accounting firm. In connection with its opinion, Capital Resources Group
reviewed, analyzed and relied upon material bearing upon the financial and
operating condition of First Federal of Hazard, Frankfort First, Kentucky First
and the merger, which included the (i) merger agreement; (ii) Frankfort First's
annual and quarterly reports through March 31, 2004 as well as other reports and
communications to stockholders; (iii) First Federal of Hazard's and Frankfort
First's periodic financial reports submitted to various regulatory agencies and
(iv) other financial information concerning the business and operations of First
Federal of Hazard and Frankfort First. Capital Resources Group also held
discussions with senior management of First Federal of Hazard and Frankfort
First regarding the past and current business operations, regulatory relations,
financial condition and future prospects of their respective companies.
On November 3, 2004, the board of directors of each party met to amend the
merger agreement to remove a provision that permitted First Federal of Hazard to
elect to exclude shares of Kentucky First common stock purchased by the employee
stock ownership plan in the reorganization offering from the number of
outstanding shares of Kentucky First stock for purposes of calculating the
maximum number of shares that may be issued to Frankfort First shareholders in
the merger. In order to preserve the tax-free nature of the Kentucky First
common stock received in the merger, on November 30, 2004, the board of
directors of each party met to amend the merger agreement to provide that
Frankfort First shareholders will receive that number of Kentucky First shares
having a value of at least 40% of the total merger consideration paid in the
merger (including cash payments made to holders of options to purchase Frankfort
First common stock).
In connection with the rendering of it fairness opinion, Capital Resources
Group considered that, while no staff reductions are contemplated as a result of
the merger, the rationale and synergies of the transaction include complementary
balance sheets, an expanded geographical market area, broader array of products
and services and improved depth of management.
For purposes of supporting its fairness opinion conclusion, Capital Resources
Group performed a comparative pricing analysis that compared certain financial
and stock market trading data for Frankfort First with similar data for a peer
group of publicly traded thrifts. Also, Capital Resources Group reviewed the
financial terms and acquisition pricing ratios of certain other merger
transactions involving comparable thrifts in order to confirm that the offer
price being paid to Frankfort First was reasonable and fair to First Federal of
Hazard. Capital Resources Group also analyzed the pro forma financial impact of
the merger with Frankfort First to First Federal of Hazard and Kentucky First.
The full text of Capital Resources Group's opinion which sets forth the
assumptions made, procedures followed, matters considered, and limits on the
review undertaken by Capital Resources Group is attached as Appendix A and is
incorporated herein by reference. The description of the opinion set forth in
this prospectus is qualified in its entirety by reference to the full text of
such opinion.
Delivery of Stock Certificates
After the completion of the merger, the exchange agent will mail to Frankfort
First's shareholders who do not submit election forms a letter of transmittal,
together with instructions for the exchange of their Frankfort First common
stock certificates for the merger consideration. Until Frankfort First
shareholders surrender their Frankfort First stock certificates for exchange
after completion of the merger, they will not be paid dividends or other
distributions declared after the merger with respect to any Kentucky First
common stock into which Frankfort First shares have been converted. When
Frankfort First shareholders surrender their Frankfort First stock certificates,
Kentucky First will pay any unpaid dividends or other distributions, without
interest. After the completion of the merger, there will be no further transfers
of Frankfort First common stock. Frankfort First's stock certificates presented
for transfer after the completion of the merger will be canceled and exchanged
for the merger consideration.
If Frankfort First stock certificates have been lost, stolen or destroyed,
Frankfort First shareholders will have to prove ownership of these certificates
and that they were lost, stolen or destroyed before such shareholders receive
any consideration for the shares. Any such stockholder must sign an affidavit
that his or her stock certificate has been lost, stolen or destroyed and may in
our discretion be required to post a bond as indemnity against any claim that
may be made with respect to such certificate.
Treatment of Frankfort First Stock Options
Immediately prior to the effective time of the merger (after all of the
conditions to the consummation of the merger, as described in the merger
agreement, have been satisfied) each outstanding option to purchase shares of
Frankfort First common stock will be cancelled in exchange for a cash payment
from Frankfort First. The cash payment for each option will be equal to the
excess of the $23.50 merger consideration over the exercise price per share of
each option, net of any cash that must be withheld under the federal and state
income and employment tax requirements.
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Tax Aspects
Muldoon Murphy Faucette & Aguggia LLP, our counsel, has delivered to us its
opinion, dated the date of this prospectus, that the merger will qualify as a
"reorganization" within the meaning of Section 368(a) of the Internal Revenue
Code and that, consequently, the merger will be tax-free to First Federal MHC,
Kentucky First, Frankfort First, First Federal of Hazard and First Federal of
Hazard's account holders. Such opinion has been rendered on the basis of facts,
representations and assumptions set forth or referred to in such opinion and
factual representations contained in certificates of officers of Kentucky First,
all of which must continue to be true and accurate in all material respects as
of the effective time of the merger.
Reasons for the Merger
Our board of directors believes that the merger will enhance the competitive
position of the combined entities and will enable the resulting institution to
compete more effectively than either First Federal of Hazard or Frankfort First
could on its own. The combined entity will have greater financial resources and,
as a result of the offering, increased capital levels. Kentucky First's pro
forma shareholders' equity will amount to % of pro forma total assets at
September 30, 2004, assuming the shares of common stock are sold at the maximum
of the offering range. The reorganization and the merger will result in
increased funds being available for lending purposes and greater resources for
expansion of services. First Federal of Hazard also believes that the merger
will provide it with better opportunities for attracting and retaining qualified
personnel.
The terms of the merger agreement were the result of arm's length
negotiations between the representatives of First Federal of Hazard and
Frankfort First. Among the factors considered by the board of directors of First
Federal of Hazard were:
information concerning the financial condition, results of operations,
capital levels, asset quality and prospects of First Federal of Hazard and
Frankfort First, including consideration of both companies' historical and
projected results of operation and financial condition and a review of
Frankfort First's financial performance by comparison to a peer group;
a comparison of the terms of the merger to other merger transactions both
nationally and involving companies headquartered in the Southeastern region
of the United States;
the anticipated short-term and long-term impact the reorganization and the
merger will have on Kentucky First's consolidated results of operations,
including expanded mortgage lending by First Federal of Hazard's purchasing
or participating in mortgage loans originated by First Federal of Frankfort;
the general structure of the transaction and the perceived compatibility of
the respective management teams and business philosophies of First Federal
of Hazard and Frankfort First which First Federal of Hazard's board believed
would make it easier to integrate the operations of the two companies;
the belief that the merger will enhance First Federal of Hazard's franchise
value by the expansion of its branch network, (on a consolidated basis) by
enhancing its ability to acquire other financial institutions in the
Kentucky market, and by enhancing its ability to compete in relevant banking
and non-banking markets;
current industry and economic conditions facing First Federal of Hazard and
Frankfort First, including an increasingly competitive environment facing
both institutions characterized by intensifying competition from both
non-financial institutions as well as other banks and savings institutions,
the continuing consolidation of the financial services market and the
increasing costs and complexities of compliance with the expanding
regulatory requirements imposed on financial institutions as well as public
reporting companies;
the anticipated minimal impact of reorganization and the merger on the
depositors, employees, customers and communities served by First Federal of
Hazard and Frankfort First, due to the parties' decision to maintain that
separate identity, products, services, management and employees of each
institution following the merger; and
the understanding that, unless First Federal of Hazard and First Federal of
Frankfort merge, the members of First Federal of Frankfort will not have
priority subscription rights if First Federal MHC undertakes a second-step
conversion.
The discussion of the information and factors considered by our board of
directors is not intended to be exhaustive, but includes all material factors
considered by our board of directors. In reaching its determination to approve
and recommend the merger, our board of directors did not assign any specific or
relative weights to any of the foregoing factors, and individual directors may
have weighed factors differently.
Dissenters' Rights
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Under Delaware law, if a Frankfort First shareholder both properly makes a
demand for appraisal in writing before the vote taken at the annual meeting and
does not vote in favor of the merger, such shareholder has the right to seek an
appraisal of the fair value of their Frankfort First common stock and receive a
cash payment of such fair value. Frankfort First shareholders electing to
exercise dissenters' appraisal rights must comply with the provisions of
Section 262 of the Delaware General Corporation Law in order to perfect their
rights. Frankfort First will require strict compliance with the statutory
procedures.
Interests of Frankfort First Directors and Executive Officers in the Merger that
Differ From the Interests of Frankfort First Shareholders
Some members of Frankfort First's management and board of directors have
financial interests in the merger that are in addition to, or different from,
their interests as shareholders of Frankfort First. The Frankfort First board of
directors was aware of these interests and considered them, among other matters,
in approving the merger agreement.
Pre-Existing Employment Agreements. In addition to the employment agreement
with Don D. Jennings described under "Management of Frankfort First - Employment
Agreements," First Federal of Frankfort currently maintains virtually identical
employment agreements with Danny A. Garland, R. Clay Hulette and Teresa Kuhl,
each dated as of June 30, 2004. Frankfort First has entered into guaranty
agreements with these executives whereby Frankfort First agrees to guarantee the
payment obligations of First Federal of Frankfort under the employment
agreements. The agreements provide for three-year terms, renewable annually by
the Board of Directors of First Federal of Frankfort. The employment agreements
also provide for the payment of base salary, participation in bonus, retirement
and medical plans, and receipt of customary fringe benefits, vacation and sick
leave and expense reimbursement. The agreements terminate upon the executives'
death or disability, as defined in the agreements. First Federal of Frankfort
may terminate the agreements for just cause, as defined in the agreements. The
executives receive no additional compensation or benefits upon a termination for
just cause. Upon an executive's death, the executive's beneficiary or estate
receives the executive's base salary through the end of the month of death. Upon
termination due to disability, the executives receive continued salary and
benefits for any period during the term of the employment agreement and prior to
the establishment of disability and for any period of disability prior to
termination of employment. The executives may terminate employment voluntarily
by providing 90 days' written notice, in which case they receive only their
compensation and vested benefits through their termination date.
The employment agreements also provide that, if the executives terminate
employment involuntarily for reasons other than just cause within one year after
a change in control, they may receive a cash payment equal to the difference
between (1) 2.99 times their "base amount" as defined under Section 280G(b)(3)
of the Internal Revenue Code and (2) the sum of any other "parachute payments,"
as defined under Section 280G(b)(2) of the Internal Revenue Code. The agreements
also provide for a similar lump sum payment in the event of voluntary
termination of employment within 30 days after the effective date of a change in
control, or upon termination of employment under circumstances equivalent to a
constructive discharge (as defined in the agreements). However, effective
July 15, 2004, the executives' employment agreements were amended to provide
that neither the execution of the merger agreement, nor the consummation of the
proposed merger with First Federal of Hazard would constitute a change in
control entitling the executives to severance under their employment agreements.
New Employment Agreements. See "Management of Kentucky First - Executive
Compensation - Employment Agreements."
Appointment of the Frankfort First President and Chief Executive Officer and
Two Members of the Frankfort First Board of Directors to the Kentucky First
Board of Directors and Other Benefits. First Federal of Hazard has agreed that
two members of the Frankfort First board of directors, David R. Harrod and
Herman D. Regan, Jr., and Frankfort First's President and Chief Executive
Officer, Don D. Jennings, will be appointed to the Kentucky First board of
directors upon completion of the merger. As a result, three of Kentucky First's
seven directors will consist of current directors or officers of Frankfort
First. Kentucky First will pay Messrs. Harrod and Regan the same fees payable to
Kentucky First's nonemployee directors, based upon meeting attendance and other
factors. Mr. Jennings will also serve as President and Chief Operating Officer
of Kentucky First, and therefore will not be paid board fees in addition to his
compensation as an employee of Kentucky First.
Protection of Frankfort First Directors and Officers Against Claims. First
Federal of Hazard has agreed to indemnify and hold harmless, to the fullest
extent allowed under Delaware law, present and former directors and officers of
Frankfort First from liability and expenses arising from matters existing or
occurring at or prior to the effective time of the merger. First Federal of
Hazard has further agreed that Frankfort First may obtain an extended reporting
period endorsement under Frankfort First's director and officer liability
insurance policy for the benefit of its directors and officers. The endorsement
provides continued insurance coverage for six years following consummation of
the merger, subject to a maximum annual premium equivalent to 200% of the
current annual premium amount.
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Regulatory Approvals Needed to Complete the Merger and the Reorganization
Merger Approvals. Completion of the merger is subject to prior approval of
the Office of Thrift Supervision. In reviewing applications for transactions of
this type, the Office of Thrift Supervision must consider, among other factors,
the financial and managerial resources and future prospects of the existing and
resulting institutions, and the convenience and needs of the communities to be
served. In addition, the Office of Thrift Supervision may not approve a
transaction if it will result in a monopoly or otherwise be anticompetitive.
First Federal of Hazard filed an application with the Office of Thrift
Supervision on , 2004.
Under the Community Reinvestment Act, the Office of Thrift Supervision must
take into account the record of performance of First Federal of Hazard and First
Federal of Frankfort in meeting the credit needs of the entire community,
including low- and moderate-income neighborhoods, served by each institution. As
part of the review process, bank regulatory agencies frequently receive comments
and protests from community groups and others. First Federal of Hazard and First
Federal of Frankfort each received a "Satisfactory" rating, respectively, during
their last federal Community Reinvestment Act examinations.
In addition, a period of 15 to 30 days must expire following approval by the
Office of Thrift Supervision, within which period the United States Department
of Justice may file objections to the merger under the federal antitrust laws.
While we believe that the likelihood of objection by the Department of Justice
is remote in this case, there can be no assurance that the Department of Justice
will not initiate proceedings to block the merger.
Reorganization Approvals. We have adopted a plan of reorganization pursuant
to which we will convert from a federally chartered mutual savings association
to a federally chartered stock savings association. Consummation of the merger
is subject to certain conditions, including the receipt by First Federal of
Hazard of all approvals necessary to complete its reorganization. Specifically,
the reorganization must be approved by the Office of Thrift Supervision and
First Federal of Hazard must receive the non-objection of the Federal Deposit
Insurance Corporation. As of the date of this proxy statement-prospectus, First
Federal of Hazard has filed its reorganization applications with the Office of
Thrift Supervision and the Office of Thrift Supervision's approval is still
pending. On , the Federal Deposit Insurance Corporation issued its intent
not to object to the plan of reorganization. Kentucky First also filed a
Registration Statement on Form S-1 with the Securities and Exchange Commission
on . The Registration Statement was declared effective on . See "-
Conditions to Completing the Merger."
Financing the Merger
First Federal of Hazard's consummation of its reorganization to the mutual
holding company structure is a condition precedent to consummating the merger.
We will use part of the net proceeds of the reorganization offering, plus, if
necessary, the proceeds of a capital distribution from First Federal of Hazard
to Kentucky First to acquire Frankfort First, fund First Federal of Hazard's
employee stock ownership plan and capitalize First Federal MHC. We will not know
the amount of proceeds that we will raise in the reorganization offering until
after the offering has concluded and Frankfort First shareholders make their
elections to receive either cash or Kentucky First common stock in the merger.
The total value of the merger consideration to be paid to Frankfort First
shareholders (based on 1,266,613 shares, and options to purchase 147,230 shares,
of Frankfort First common stock outstanding) will be approximately $31.2 million
and will be paid as follows:
At the minimum of the reorganization offering range, the aggregate merger
consideration would consist of 1,247,565 shares of Kentucky First common
stock and $18.7 million in cash.
At the midpoint of the offering range, if Frankfort First shareholders elect
to receive the maximum amount of Kentucky First stock available to them in
the merger, the aggregate merger consideration will consist of 1,316,250
shares of Kentucky First common stock and $18.0 million in cash. If the
Frankfort First shareholders receive the minimum amount of Kentucky First
common stock they must receive at the midpoint of the offering range, then
the merger consideration will consist of 1,247,565 shares of Kentucky First
common stock and $18.7 million in cash.
At the maximum of the offering range, if Frankfort First shareholders elect
to receive the maximum amount of Kentucky First common stock available to
them in the merger, the aggregate merger consideration will consist of
1,513,687 shares of Kentucky First common stock and $16.1 million in cash.
If Frankfort First shareholders receive the minimum amount of Kentucky First
common stock they must receive in the merger at the maximum of the offering
range, then the aggregate merger consideration will consist of 1,247,565
shares of Kentucky First common stock and $18.7 million in cash.
At the maximum, as adjusted, of the offering range, if Frankfort First
shareholders elect to receive the maximum amount of Kentucky First stock
available to them in the merger, the aggregate merger consideration will
consist of 1,740,740 shares of Kentucky First common stock and $13.8 million
in cash. If the Frankfort First shareholders receive the minimum
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amount of Kentucky First common stock they must receive at the maximum, as
adjusted, of the offering range then the merger consideration will consist
of 1,247,565 shares of Kentucky First common stock and $18.7 million in
cash.
Assuming that Frankfort First shareholders elect to receive the maximum
number of shares of Kentucky First common stock in merger, the total cash funds
necessary to complete the transaction (including related fees and expenses)
would be $19.3 million, $18.6 million, $16.6 million and $14.4 million at the
minimum, midpoint, maximum and maximum, as adjusted, points in the offering
range. In these events, in order to consummate the transaction, it would be
necessary for First Federal of Hazard to make a capital distribution to Kentucky
First of $14.9 million, $11.8 million, $8.3 million and $4.1 million,
respectively. First Federal of Hazard has applied to the OTS to make a capital
distribution to address these contingencies. Please see "Use of Proceeds" in the
Kentucky First Bancorp prospectus attached to this proxy statement for a
detailed explanation of the finances of the merger. See the table under "How We
Determined the Offering Range and the $10.00 Purchase Price."
Accounting Treatment of the Merger
Kentucky First will use the purchase method of accounting for the merger.
Under this method of accounting, the assets and liabilities of Frankfort First
will be recorded on Kentucky First's consolidated statement of condition at
their estimated fair values at the effective date of the merger. The amount by
which the purchase price exceeds the fair value of the net tangible and
identifiable intangible assets acquired by Kentucky First through the merger
will be recorded as goodwill. Goodwill will not be amortized, but will instead
be subject to annual assessment for impairment, and identifiable intangible
assets will be amortized over their estimated useful lives. Kentucky First
currently expects that, based on preliminary accounting estimates, the merger
would result in the recording of goodwill of approximately $16.6 million.
Resale of Kentucky First Common Stock Issued in the Merger
The shares of Kentucky First common stock to be issued to shareholders of
Frankfort First in the merger have been registered under the Securities Act of
1933. Shares of Kentucky First common stock issued in the merger may be traded
freely and without restriction by those shareholders not deemed to be
"affiliates" of Frankfort First, as that term is defined in the rules under the
Securities Act of 1933. Kentucky First common stock received by those
shareholders of Frankfort First who are deemed to be "affiliates" of Frankfort
First at the time the merger is submitted for vote of the shareholders of
Frankfort First may be resold without registration under the Securities Act of
1933 only to the extent provided for by Rule 145 promulgated under the
Securities Act of 1933. Rule145 permits limited sales under certain
circumstances, or pursuant to another exemption from registration. An affiliate
of Frankfort First is an individual or entity that controls, is controlled by or
is under common control with, Frankfort First, as the case may be, and may
include the executive officers and directors of Frankfort First, as well as
certain principal shareholders of Frankfort First. The same restrictions apply
to certain relatives or the spouses of those persons and any trusts, estates,
corporations or other entities in which those persons have a 10% or greater
beneficial interest.
Pursuant to the terms of the merger agreement Frankfort First has caused each
person who may be deemed an affiliate of Frankfort First for purposes of
Rule 145 under the Securities Act of 1933 to deliver to Kentucky First a written
agreement intended to ensure compliance with the Securities Act of 1933.
When Will the Merger be Completed
The closing of the merger will take place on a date the parties agree upon
that occurs as promptly as practicable following the date on which the
conditions to closing as described in the merger agreement have been satisfied.
These conditions include: (1) Frankfort First obtaining approval of the merger
from its shareholders; (2) the parties obtaining the requisite regulatory
approvals for the merger and for First Federal of Hazard's reorganization (and
the last waiting period under the required regulatory approvals having expired);
(3) the absence of any legal proceedings concerning the merger which is likely
to have a material adverse effect on the interests of either Kentucky First or
Frankfort First; (4) First Federal of Hazard's reorganization having occurred
(except to the extent it must coincide with the merger); (5) Frankfort First
obtaining a fairness opinion from its financial advisors; and (6) each party
receiving a "comfort" letter with respect to the financial condition of the
other party . See "-Conditions to Completing the Merger." On the closing date,
the parties will file a certificate of merger with the Secretary of State of the
State of Delaware merging Frankfort First with a wholly owned merger subsidiary
of Kentucky First. The merger will become effective at the time stated in the
certificate of merger.
We expect to complete the merger in the first calendar quarter of 2005.
However, we cannot guarantee when or if the required regulatory approvals will
be obtained. See "The Merger-Regulatory Approvals Needed to Complete the
Merger." Furthermore, either company may terminate the merger agreement if,
among other reasons, the merger has not been completed on or before May 31,
2005, unless failure to complete the merger by that time is due to a failure to
fulfill any material obligation under the merger agreement by the party seeking
to terminate the agreement. See "-Terminating the Merger Agreement."
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Conditions to Completing the Merger
The merger agreement provides that consummation of the merger is subject to
the satisfaction of certain conditions, or the waiver of certain of such
conditions by First Federal of Hazard, on the one hand, and Frankfort First on
the other, as the case may be, at or prior to the date the merger is completed.
First Federal of Hazard and Frankfort First are referred to in the following
discussion individually as a "party" and collectively as the "parties." Each of
the parties' obligations under the merger agreement are subject to the following
conditions, among others:
approval of the merger agreement by Frankfort First's shareholders;
the absence of any legal proceedings concerning the merger which is likely
to have a material adverse effect on the interests of either Kentucky First
or Frankfort First;
receipt of all required regulatory approvals or waiver with respect to the
merger and the reorganization; provided that no such approval or waiver
imposes any condition applicable to First Federal of Hazard which is, in the
reasonable judgement of First Federal of Hazard, materially burdensome upon
the conduct of First Federal of Hazard's business or which would so
adversely impact the economic and business benefits of the merger or the
reorganization to First Federal of Hazard so as to render it inadvisable to
proceed with the merger or the reorganization;
the reorganization of First Federal of Hazard into the mutual holding
company structure shall have occurred (except to the extent any part thereof
shall occur simultaneously with the consummation of the merger);
Kentucky First's common stock being approved for quotation on the Nasdaq
Stock Market; Frankfort First's common stock remaining listed on the
Nasdaq Stock Market;
all outstanding Frankfort First stock options being terminated or cancelled
as required by the merger agreement;
holders of not more than 10% of the outstanding shares of Frankfort First
common stock entitled to vote on the merger agreement proposal having
delivered written demand for appraisal rights under Delaware law;
First Federal of Hazard delivering the merger consideration to the exchange
agent and the exchange agent certifying such receipt;
each party's representations and warranties being true (except to the extent
any breaches of a representation or warranty, either individually or in the
aggregate, do not or would not be reasonably likely to have a material
adverse effect on the other party);
each party having performed or complied in all material respects with its
covenants and obligations under the merger agreement;
each party having received all required third party consents, the absence of
which would materially and adversely affect such party;
Frankfort First having delivered to First Federal of Hazard executed
replacement employment agreement for Don D. Jennings, R. Clay Hulette, Danny
A. Garland and Teresa Kuhl;
the receipt by Frankfort First of an opinion from Howe Barnes Investments,
Inc. that the merger consideration to be paid to Frankfort First's
shareholders in the merger is fair from a financial point of view;
the receipt by First Federal of Hazard of a customary "comfort" letter from
Frankfort First's independent auditors regarding the financial condition of
Frankfort First, and the receipt by Frankfort First of a similar letter from
First Federal of Hazard's independent auditors regarding the financial
condition of First Federal of Hazard;
neither party having sustained a material adverse effect or change to its
business, operations, properties, condition, assets, liabilities or
prospects since the execution of the merger agreement; and
each party having received from the other appropriate documentation
regarding the valid existence and authorization of the other party to enter
into the transactions contemplated by the merger agreement.
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We cannot guarantee whether all of the conditions to the merger will be
satisfied or waived by the party permitted to do so. If the merger is not
completed on or before May 31, 2005, either party may terminate the merger
agreement by a vote of a majority of its board of directors.
Conduct of Business Before the Merger
Frankfort First has agreed that, until the completion of the merger,
Frankfort First and First Federal of Frankfort will:
Ordinary Course of Business
diligently conduct their affairs only in the ordinary course of business
consistent with past practices;
Use of Assets
use manage and maintain all assets in a normal business manner;
use reasonable effort to maintain its insurance policies;
Preserving the Business Organization Intact
use best efforts to preserve their business organizations intact, to retain
the services of their present officers and key employees and to preserve the
goodwill of depositors, borrowers and other customers, suppliers, creditors
and others with business relationships;
Compliance with Laws
comply with applicable laws (except where noncompliance would not have a
material adverse effect on Frankfort First and First Federal of Frankfort,
taken as a whole);
File Tax Returns and Pay Taxes
timely and properly file all taxes required to be filed and pay or make
provision for taxes owed; and
Cancel Awards Under Junior Officer Recognition Plan in Exchange for Cash
Payments
use best efforts to cause the participants in the Frankfort First, Inc.
Junior Officer Recognition Plan to agree that such plan be terminated as of
the effective time of the merger with all outstanding awards thereunder
being exchanged for future cash payments (the payment to occur at times
which coincide with the vesting schedule of the awards, provided that the
employee is an employee at the time of the vesting).
Stock Options
use best efforts to cause each holder of an outstanding option to purchase
Frankfort First common stock to agree to cancel all outstanding options in
exchange for cash consideration. The cash consideration for each outstanding
stock option will equal the difference between $23.50 and the exercise price
of each option. The cash payments will be made by Frankfort First
immediately before the consummation of the merger.
Frankfort First has also agreed that, except as otherwise expressly
contemplated or permitted by the merger agreement, as required by law or
regulation or to the extent First Federal of Hazard consents in writing,
Frankfort First will not, and will not permit any of its subsidiaries to:
Contracts
take any act or omit to do any act which would cause a breach of any
existing contract (except where such breach would not have a material
adverse effect on Frankfort First and First Federal of Frankfort, taken as a
whole);
enter into any new contract or engage in a transaction not in the ordinary
course of business and consistent with past practices and not purchase,
lease, sell or dispose or any capital asset, except for capital asset
transactions which individually do not amount to more than $10,000 and
which, in the aggregate do not amount to more than $25,000;
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Employee Benefits
except as otherwise agreed to with First Federal of Hazard and other than
increases of 5% or less with respect to nonofficer employees (consistent
with past practices): (1) increase employee salaries or rates of pay;
(2) adopt a new employee benefit plan; (3) enter or modify an employment
agreement; (4) made any discretionary contributions to employee benefit
plans; (5) make any allocation to the account of a plan participant other
than in the normal course;
Indebtedness
create, incur or assume indebtedness or assume not in the ordinary course of
business, or incur costs and expenses in connection with the transaction
which materially exceed those previously agreed to by the parties;
Capital Stock
declare, pay or set aside for payment any dividend or other distribution on
its capital stock, provided that Frankfort First may pay its regular
quarterly dividends at a rate not to exceed $0.28 per share;
issue or sell or obligate itself to issue or sell any shares of its capital
stock or any warrants, rights or options to acquire, or any securities
convertible into, any shares of its capital stock, other than shares issued
upon the exercise of outstanding stock options;
Policy Changes
materially change any lending, investment, management or other material
policies concerning their business or operations; and
Agreement Not to Solicit Other Proposals
authorize or permit its directors, officers, employees, agents and
representatives, to initiate, solicit or knowingly encourage or take any
action to facilitate any inquiries or the making of any proposal that
constitutes or may reasonably be expected to lead to, or provide any
information to or negotiate with any other party in furtherance of, any
proposal that could reasonably be expected to lead to the merger,
consolidation, acquisition or sale of all or substantially all of the assets
or any shares of capital stock of Frankfort First to a third party. However,
Frankfort First may engage in these actions provided that the Frankfort
First board of directors determines in good faith, after consultation with
its legal counsel, based on the advice from counsel, that such action is
required for the board of directors to comply with its fiduciary duties to
shareholders imposed by applicable laws. If Frankfort First receives a
proposal from a third party, Frankfort First must notify First Federal of
Hazard of the proposal, receive a confidentiality agreement from the third
party prior to furnishing it with any information and furnish First Federal
of Hazard with written notice that information will be furnished to the
third party.
Certain Other Agreements
The merger agreement also contains other agreements which address Frankfort
First's conduct in connection with the execution of the merger agreement and
Frankfort First's conduct and obligations following the execution of the
agreement but before consummation of the merger. These agreements include:
(1) the confidential treatment of information exchanged in the merger process;
(2) the preparation and delivery of disclosure schedules by each party to the
other party as required by the merger agreement or as necessary to qualify
certain representations and/or warranties made by the parties in the merger
agreement; (3) the coordination of announcements relating to the merger; (4) the
obligation of each party to use best efforts to cause their respective
representations and warranties to be true and correct at the effective time of
the merger, to use best efforts to cause all of the conditions precedent in the
agreement to be satisfied, and to use best efforts to take all actions necessary
to consummate the transactions contemplated by the merger agreement and First
Federal of Hazard's reorganization; and (5) Frankfort First's obligation to
advise its affiliates of the resale restrictions imposed on them by certain
federal securities laws and to use reasonable best efforts to obtain a written
commitment from each affiliate to comply with such laws. These other agreements
also address the following matters:
Deliveries of Information and Consultation. Each party will promptly furnish
the other with copies of: (1) significant reports or other documents filed or
received by a party under federal or state banking or securities laws; (2) its
consolidated monthly financial statements; (3) a summary of board actions; and
(4) all other significant information concerning the business of each party.
First Federal of Hazard and Frankfort First have also agreed to consult with one
another on a regular basis to report on operational matters, and will also
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consult regarding regulatory matters directly affecting either party. The
parties will also consult regarding any litigation that may be commenced,
threatened or proposed by any person relating to the merger and shall cooperate
in all respects in connection with such ligation.
Indemnification of Frankfort First Officers and Directors. Kentucky First
will indemnify and advance expenses in matters that may be subject to
indemnification, to each present and former director and officer of Frankfort
First and its subsidiaries for a period of six years from liability and expenses
arising out of matters existing or occurring at or before the consummation of
the merger to the fullest extent allowable under Kentucky First's charter and
bylaws and under applicable law. Kentucky First will permit Frankfort First and
First Federal of Frankfort to obtain an extended reporting period endorsement
under Frankfort First directors' and officers' liability insurance policy for
the benefit of Frankfort First directors and officers which provides such
officers and directors with continued insurance coverage under such policy for
at least three years following consummation of the merger, subject to a cap on
the amount of the annual premium equal to 200% of Frankfort First's current
annual premium.
Comfort Letters. First Federal of Hazard and Frankfort First have each agreed
to use their best efforts to cause their respective independent auditors to
deliver to the other party a letter (addressed to the other party), in form and
substance reasonably satisfactory to the other party and customary in scope and
substance for letters delivered by independent public accountants in connection
with registration statements similar to the registration Kentucky First is
filing and proxy statements similar to this proxy statement. These "comfort
letters" are to be delivered within three business days before Kentucky First's
registration statement on Form S-1 is to be declared effective.
Legal Conditions to the Merger. First Federal of Hazard and Frankfort First
have each agreed to take all reasonable actions necessary to comply with all
legal requirements relating to the merger (including filings and other matters
relating to the regulatory applications), to furnish each other with information
necessary to satisfy such requirements, and to obtain all third party consents
necessary to undertake the transactions contemplated by the merger.
Stock Listings. Frankfort First has agreed to use its best efforts to
maintain the listing of its common stock on the Nasdaq National Market. First
Federal of Hazard will use all reasonable efforts to cause the shares of
Kentucky First to be listed on the Nasdaq Stock Market.
Employee Matters. Under the terms of the merger agreement, following the
merger, First Federal of Frankfort will continue to employ substantially all
employees without employment agreements as employees at will, subject to
determinations by First Federal of Frankfort's management and First Federal of
Frankfort's and Kentucky First's boards of directors. First Federal of
Frankfort's Defined Benefit Plan, as well as First Federal of Frankfort's health
and welfare benefit plans, programs, insurance and policies shall continue after
the merger until such time as First Federal of Frankfort's board of directors
elects to take alternative action. To the extent that any such plan is replaced
after the merger, employees of Frankfort First (or its affiliates) will be
entitled to credit for prior service with First Federal of Frankfort for
purposes of determining eligibility to participate and vesting, unless such
service results in the duplication of benefits. Any eligibility waiting period
and pre-existing condition exclusion applicable to such plans and programs will
be waived with respect to each Frankfort First employee and their eligible
dependents. Kentucky First will also provide full credit to each continuing
Frankfort First employee and their eligible dependents under Kentucky First,
Inc.'s corresponding benefit plans for any deductibles incurred by the
continuing employees and their covered dependents during the portion of the
calendar year prior to the closing of the merger. After the merger, Kentucky
First will be liable for all obligations for continued health coverage under
Sections 601 through 609 of ERISA ("COBRA") with respect to each Frankfort First
qualified beneficiary who incurs a qualifying event and for continued health
coverage under COBRA from and after the merger, and for continued health
coverage under COBRA from and after the merger for each Frankfort First
qualified beneficiary who incurs a qualifying event before the merger.
Conduct of First Federal of Hazard's Business. First Federal of Hazard has
agreed to maintain its corporate existence in good standing and conduct its
business so as to be able to consummate the transactions contemplated by the
merger agreement. It has also agreed to give prompt written notice to Frankfort
First of, and to use its best efforts to prevent or promptly remedy, an
impending or threatened occurrence of any event or condition which would cause
or constitute a breach of any of its representations or obligations under the
merger agreement or would be reasonably likely to cause it not to be able to
satisfy any condition precedent to consummation of the merger.
Representations and Warranties Made by First Federal of Hazard and Frankfort
First in the Merger Agreement
We have made certain customary representations and warranties to each other
in the merger agreement relating to our businesses. The representations and
warranties must be true in all material respects (except to the extent any
breaches of a representation or warranty, either individually or in the
aggregate, do not or would not be reasonably likely to have a material adverse
effect on the other party) through the completion of the merger. See
"-Conditions to Completing the Merger."
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Terminating the Merger Agreement
The merger agreement may be terminated at any time prior to the completion of
the merger, either before or after approval of the merger agreement by Frankfort
First's shareholders, as follows:
by the mutual agreement of First Federal of Hazard and Frankfort First;
by either party, if the merger is not consummated by May 31, 2005, unless
failure to complete the merger by that time is due to the failure to perform
an obligation by the party seeking to terminate the agreement;
by either party, if (1) the other party has not satisfied any of its
obligations to close under the merger agreement , or (2) within 30 days
after receiving notice from the other party that it has sustained a material
adverse effect which cannot be reasonably expected to be cured;
by Frankfort First, if Frankfort First enters into a definitive agreement or
letter of intent for an acquisition proposal with a third party that the
board of directors makes a good faith determination, in consultation with
its legal counsel, is necessary to comply with its fiduciary duties to
shareholders imposed by applicable laws (provided that Frankfort First has
complied with its obligations to notify and furnish information to First
Federal of Hazard regarding the third party acquisition proposal or complies
with applicable proxy rules;
by First Federal of Hazard, if: (1) the Frankfort First board of directors
resolves, publicly announces or discloses to any third party its intention
to accept an acquisition proposal from a third party; (2) the Frankfort
First board of directors recommends to its shareholders (or resolves to
recommend) that they tender their shares in a tender or exchange offer
commenced by a third party; (3) if a tender offer or exchange offer for 25%
of more of Frankfort First's common stock is commenced or a registration
statement with respect thereto is filed and, within 10 days, the Frankfort
First board of directors either fails to recommend against such offer or
takes no position with respect to such offer; or (4) Frankfort First's board
of directors withdraws or modifies its recommendation of approval of the
merger agreement to its shareholders in a manner adverse to First Federal of
Hazard or recommends (or resolves to recommend) to Frankfort First's
shareholders that they approve an acquisition proposal from a third party.
by either party, if any suit, action or proceeding is pending or threatened
before any court in which the consummation of the merger is restrained or
enjoined or in which the relief requested is to restrain, enjoin or prohibit
the merger and, in the reasonable judgement of either party, such action
suit, action or proceeding is likely to have a material adverse effect with
respect to such party's interest;
by either party, upon disapproval by any regulatory authority whose approval
is required to consummate the merger or First Federal of Hazard's
reorganization, or if an approval contains a condition applicable to First
Federal of Hazard which is, in its reasonable judgement, materially
burdensome upon the conduct of First Federal of Hazard's business or which
would so adversely impact the economic and business benefits of the merger
or reorganization to First Federal of Hazard so as to render it inadvisable
to proceed with the merger or the reorganization;
by either party, if Frankfort First's shareholders fail to approve the
merger agreement; and
by either party, if First Federal of Hazard's reorganization has not
occurred (except for any part of the reorganization which can occur
simultaneously with or subsequent to the merger).
Termination Fee
The merger agreement requires Frankfort First to pay First Federal of Hazard
a $1.5 million termination fee if First Federal of Hazard terminates the merger
agreement as a result of:
Frankfort First's failure to receive shareholder approval of the merger
agreement;
Frankfort First's failure to comply in all material respects with its
covenants, agreements and other obligations under the merger agreement;
Frankfort First's failure to undertake all appropriate corporate actions
necessary to be taken in conjunction with the merger;
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A breach of Frankfort First's representations and warranties under the
merger agreement are not true and correct (except for those breaches which
individually or in the aggregate do not or would not reasonably be likely to
have a material adverse effect on Frankfort First;
Frankfort First's failure to deliver the necessary documents and
certificates to establish its existence and authorization for it to enter
into the merger agreement;
Frankfort First's failure to deliver a comfort letter to First Federal of
Hazard regarding Frankfort First's financial condition;
Frankfort First's failure to enter into replacement agreements with its
executives (so as to avoid the transactions contemplated by the merger
agreement triggering termination rights under the executives' employment
agreements;
Frankfort First's failure to terminate all outstanding stock options or
right to receive stock options, in exchange for cash payments;
Frankfort First's failure to obtain necessary regulatory approvals and third
party consents; or
Frankfort First's failure to perform an obligation under the merger that has
delayed the consummation of the merger past May 31, 2005,
And any of the following conditions exist:
Frankfort First or any of its subsidiaries, without having received First
Federal of Hazard's prior written consent, enters into a written agreement
to engage in an acquisition proposal with any person other than First
Federal of Hazard (or any of its affiliates) or the Frankfort First board of
directors recommends that Frankfort First shareholders approve or accept any
acquisition proposal with any person other than First Federal of Hazard; or
after a bona fide written proposal is made by any person other than First
Federal of Hazard (or any of its affiliates) to engage in an acquisition
proposal, either:
Frankfort First breaches any covenant or obligation contained in the
merger agreement and such breach would entitle First Federal of Hazard to
terminate the merger agreement;
Frankfort First shareholders do not approve the merger agreement at the
Frankfort First annual meeting, the annual meeting is not held in a timely
manner or is postponed, delayed or enjoined prior to termination of the
merger agreement except as a result of judicial or administrative
proceeding or Frankfort First's board of directors having:
a. withdrawn or adversely modified its recommendation with respect to the
merger agreement, or announced or disclosed to any third party its
intention to do so; or
b. failed to recommend, in the case of a tender or exchange offer for
Frankfort First common stock, against acceptance of such tender or
exchange offer to its shareholders or takes no position with respect
to acceptance of such tender or exchange offer by its shareholders; or
c. Frankfort First's board of directors makes the certain provisions of
Frankfort First's Certificate of Incorporation that limit a third
party's ability to acquire a substantial amount of Frankfort First
common stock or acquire or merge with Frankfort First altogether.
Payment of this termination fee shall be due or payable prior to Frankfort
First entering into a written definitive agreement with a third party with
respect to an acquisition proposal within 18 months after termination of the
merger agreement or within such 18-month period any third-party person or entity
acquires 25% or more of the Frankfort First's outstanding common stock.
Expenses
Each of us and Frankfort First will pay our own costs and expenses incurred
in connection with the merger. Capital Resources Group, Inc., the parent company
of Capital Resources, Inc., has provided financial and advisory services to
First Federal of Hazard in connection with the merger and provided it with a
fairness opinion with respect thereto. In exchange for these services, Capital
Resources Group, Inc. was paid a fee of $85,000 upon the execution of the merger
agreement. In addition, upon the completion of the merger, Capital
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Resources Group, Inc. shall be paid a success fee equal to 1.25% of the total
consideration paid on the merger. First Federal of Hazard will also reimburse
Capital Resources Group, Inc. for certain out-of-pocket expenses incident to the
above services.
Changing the Terms of the Merger Agreement
Before the completion of the merger, Frankfort First may agree to waive,
amend or modify any provision of the merger agreement. However, after the vote
by Frankfort First's shareholders, Frankfort First cannot do the following
without the approval of Frankfort First's shareholders: (1) change the merger
consideration to be received by Frankfort First shareholders under the terms of
the merger agreement; (2) alter or change any term of Kentucky First's charter
other than as contemplated by the merger agreement; or (3) alter or change any
of the terms and conditions of the merger agreement is such change or alteration
would adversely affect Frankfort First's shareholders.
Regulation and Supervision
General
First Federal of Hazard and First Federal of Frankfort are subject to
extensive regulation, examination and supervision by the Office of Thrift
Supervision, as their primary federal regulator, and the Federal Deposit
Insurance Corporation, as their deposits insurer. First Federal of Hazard and
First Federal of Frankfort are each members of the Federal Home Loan Bank System
and their deposit accounts are insured up to applicable limits by the Savings
Association Insurance Fund managed by the Federal Deposit Insurance Corporation.
First Federal of Hazard and First Federal of Frankfort must each file reports
with the Office of Thrift Supervision and the Federal Deposit Insurance
Corporation concerning their activities and financial condition in addition to
obtaining regulatory approvals before entering into certain transactions such as
mergers with, or acquisitions of, other financial institutions. There are
periodic examinations by the Office of Thrift Supervision and, under certain
circumstances, the Federal Deposit Insurance Corporation to evaluate First
Federal of Hazard's and First Federal of Frankfort's safety and soundness and
compliance with various regulatory requirements. This regulatory structure is
intended primarily for the protection of the insurance fund and depositors. The
regulatory structure also gives the regulatory authorities extensive discretion
in connection with their supervisory and enforcement activities and examination
policies, including policies with respect to the classification of assets and
the establishment of adequate loan loss reserves for regulatory purposes. Any
change in such policies, whether by the Office of Thrift Supervision, the
Federal Deposit Insurance Corporation or Congress, could have a material adverse
impact on our operations. Kentucky First and First Federal MHC, as savings and
loan holding companies, will be required to file certain reports with, will be
subject to examination by, and otherwise will have to comply with the rules and
regulations of the Office of Thrift Supervision. Kentucky First will also be
subject to the rules and regulations of the Securities and Exchange Commission
under the federal securities laws.
Certain of the regulatory requirements that are or will be applicable to
First Federal of Hazard, First Federal of Frankfort, Kentucky First and First
Federal MHC are described below. This description of statutes and regulations is
not intended to be a complete explanation of such statutes and regulations and
their effects on First Federal of Hazard, First Federal of Frankfort, Kentucky
First and First Federal MHC and is qualified in its entirety by reference to the
actual statutes and regulations.
Regulation of Federal Savings Associations
Business Activities. Federal law and regulations, primarily the Home Owners'
Loan Act and the regulations of the Office of Thrift Supervision, govern the
activities of federal savings banks, such as First Federal of Hazard and First
Federal of Frankfort. These laws and regulations delineate the nature and extent
of the activities in which federal savings banks may engage. In particular,
certain lending authority for federal savings banks, e.g., commercial,
non-residential real property loans and consumer loans, is limited to a
specified percentage of the institution's capital or assets.
Branching. Federal savings banks are authorized to establish branch offices
in any state or states of the United States and its territories, subject to the
approval of the Office of Thrift Supervision.
Capital Requirements. The Office of Thrift Supervision's capital regulations
require federal savings institutions to meet three minimum capital standards: a
1.5% tangible capital to total assets ratio, a 4% leverage ratio (3% for
institutions receiving the highest rating on the CAMELS examination rating
system) and an 8% risk-based capital ratio. In addition, the prompt corrective
action standards discussed below also establish, in effect, a minimum 2%
tangible capital standard, a 4% leverage ratio (3% for institutions receiving
the highest rating on the CAMELS system) and, together with the risk-based
capital standard itself, a 4% Tier 1 risk-based capital standard. The Office of
Thrift Supervision regulations also require that, in meeting the tangible,
leverage and risk-based capital standards, institutions must generally deduct
investments in and loans to subsidiaries engaged in activities as principal that
are not permissible for a national bank.
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The risk-based capital standard requires federal savings institutions to
maintain 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, recourse obligations, residual
interests and direct credit substitutes, are multiplied by a risk-weight factor
of 0% to 100%, assigned by the Office of Thrift Supervision capital regulation
based on the risks believed inherent in the type of asset. Core (Tier 1) 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, the allowance for loan and
lease losses limited to a maximum of 1.25% of risk-weighted assets and up to 45%
of 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.
The Office of Thrift Supervision also has authority to establish individual
minimum capital requirements in appropriate cases upon a determination that an
institution's capital level is or may become inadequate in light of the
particular circumstances. At September 30, 2004, First Federal of Hazard and
First Federal of Frankfort each met each of these capital requirements.
Prompt Corrective Regulatory Action. The Office of Thrift Supervision is
required to take certain supervisory actions against undercapitalized
institutions, the severity of which depends upon the institution's degree of
undercapitalization. Generally, a savings institution that has a ratio of total
capital to risk weighted assets of less than 8%, a ratio of Tier 1 (core)
capital to risk-weighted assets of less than 4% or a ratio of core capital to
total assets of less than 4% (3% or less for institutions with the highest
examination rating) is considered to be "under-capitalized." A savings
institution that has a total risk-based capital ratio of less than 6%, a Tier 1
capital ratio of less than 3% or a leverage ratio that is less than 3% is
considered to be "significantly undercapitalized" and a savings institution that
has a tangible capital to assets ratio equal to or less than 2% is deemed to be
"critically undercapitalized." Subject to a narrow exception, the Office of
Thrift Supervision is required to appoint a receiver or conservator within
specified time frames for an institution that is "critically undercapitalized."
An institution must file a capital restoration plan with the Office of Thrift
Supervision within 45 days of the date it receives notice that it is
"undercapitalized," "significantly undercapitalized" or "critically
undercapitalized." Compliance with the plan must be guaranteed by any parent
holding company. In addition, numerous mandatory supervisory actions become
immediately applicable to an undercapitalized institution, including, but not
limited to, increased monitoring by regulators and restrictions on growth,
capital distributions and expansion. "Significantly undercapitalized" and
"critically undercapitalized" institutions are subject to more extensive
mandatory regulatory actions. The Office of Thrift Supervision could also take
any one of a number of discretionary supervisory actions, including the issuance
of a capital directive and the replacement of senior executive officers and
directors.
Loans to One Borrower. Federal law provides that savings institutions are
generally subject to the limits on loans to one borrower applicable to national
banks. A savings institution may not make a loan or extend credit to a single or
related group of borrowers in excess of 15% of its unimpaired capital and
surplus. An additional amount may be lent, equal to 10% of unimpaired capital
and surplus, if secured by specified readily-marketable collateral.
Standards for Safety and Soundness. As required by statute, 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. If the
Office of Thrift Supervision determines that a savings institution fails to meet
any standard prescribed by the guidelines, the Office of Thrift Supervision may
require the institution to submit an acceptable plan to achieve compliance with
the standard.
Limitation on Capital Distributions. Office of Thrift Supervision regulations
impose limitations upon all capital distributions by a savings institution,
including cash dividends, payments to repurchase its shares and payments to
shareholders of another institution in a cash-out merger. Under the regulations,
an application to and the prior approval of the Office of Thrift Supervision is
required before any capital distribution if the institution does not meet the
criteria for "expedited treatment" of applications under Office of Thrift
Supervision regulations (i.e., generally, examination and Community Reinvestment
Act ratings in the two top categories), the total capital distributions for the
calendar year exceed net income for that year plus the amount of retained net
income for the preceding two years, the institution would be undercapitalized
following the distribution or the distribution would otherwise be contrary to a
statute, regulation or agreement with the Office of Thrift Supervision. If an
application is not required, the institution must still provide prior notice to
the Office of Thrift Supervision of the capital distribution if, like First
Federal of Hazard and First Federal of Frankfort, it is a subsidiary of a
holding company. If First Federal of Hazard's or First Federal of Frankfort's
capital were ever to fall below its regulatory requirements or the Office of
Thrift Supervision notified it that it was in need of increased supervision, its
ability to make capital distributions could be restricted. In addition, the
Office of Thrift Supervision could prohibit a proposed capital distribution that
would otherwise be permitted by the regulation, if the agency determines that
such distribution would constitute an unsafe or unsound practice.
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Qualified Thrift Lender Test. Federal law requires savings institutions to
meet a qualified thrift lender test. Under the test, a savings association is
required to either qualify as a "domestic building and loan association" under
the Internal Revenue Code or maintain at least 65% of its "portfolio assets"
(total assets less: (i) specified liquid assets up to 20% of total assets;
(ii) intangibles, including goodwill; and (iii) the value of property used to
conduct business) in certain "qualified thrift investments" (primarily
residential mortgages and related investments, including certain mortgage-backed
securities) in at least 9 months out of each 12 month period.
A savings institution that fails the qualified thrift lender test is subject
to certain operating restrictions and may be required to convert to a bank
charter. Recent legislation has expanded the extent to which education loans,
credit card loans and small business loans may be considered "qualified thrift
investments." At September 30, 2004, First Federal of Hazard and First Federal
of Frankfort each met the qualified thrift lender test.
Transactions with Related Parties. Federal law limits the authority of First
Federal of Hazard and First Federal of Frankfort to lend to, and engage in
certain other transactions with (collectively, "covered transactions"),
"affiliates" (e.g., any company that controls or is under common control with an
institution, including Kentucky First, First Federal MHC and their non-savings
institution subsidiaries). The aggregate amount of covered transactions with any
individual affiliate is limited to 10% of the capital and surplus of the savings
institution. The aggregate amount of covered transactions with all affiliates is
limited to 20% of the savings institution's capital and surplus. Loans and other
specified transactions with affiliates are required to be secured by collateral
in an amount and of a type described in federal law. The purchase of low quality
assets from affiliates from making loans is generally prohibited. Transactions
with affiliates must be on terms and under circumstances that are at least as
favorable to the institution as those prevailing at the time for comparable
transactions with non-affiliated companies. In addition, savings institutions
are prohibited from lending to any affiliate that is engaged in activities that
are not permissible for bank holding companies and no savings institution may
purchase the securities of any affiliate other than a subsidiary. Transactions
between sister depository institutions that are 80% or more owned by the same
holding company are exempt from the quantitative limits and collateral
requirements.
The Sarbanes-Oxley Act of 2002 generally prohibits a company from making
loans to its executive officers and directors. However, that act contains a
specific exception for loans by a depository institution to its executive
officers and directors in compliance with federal banking laws. Under such laws,
First Federal of Hazard's and First Federal of Frankfort's authority to extend
credit to executive officers, directors and 10% shareholders ("insiders"), as
well as entities such persons control, is limited. The law restricts both the
individual and aggregate amount of loans First Federal of Hazard and First
Federal of Frankfort may make to insiders based, in part, on First Federal of
Hazard's and First Federal of Frankfort's respective capital positions and
requires certain board approval procedures to be followed. Such loans must be
made on terms substantially the same as those offered to unaffiliated
individuals and not involve more than the normal risk of repayment. There is an
exception for loans made pursuant to a benefit or compensation program that is
widely available to all employees of the institution and does not give
preference to insiders over other employees. There are additional restrictions
applicable to loans to executive officers.
Enforcement. The Office of Thrift Supervision has primary enforcement
responsibility over federal savings institutions and has the authority to bring
actions against the institution and all institution-affiliated parties,
including stockholders, and any attorneys, appraisers and accountants who
knowingly or recklessly participate in wrongful action likely to have an adverse
effect on an insured 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 to appointment of a receiver or conservator or termination of
deposit insurance. Civil penalties cover a wide range of violations and can
amount to $25,000 per day, or even $1 million per day in especially egregious
cases. The Federal Deposit Insurance Corporation has authority to recommend to
the Director of the Office of Thrift Supervision that enforcement action to be
taken with respect to a particular savings institution. If action is not taken
by the Director, the Federal Deposit Insurance Corporation has authority to take
such action under certain circumstances. Federal law also establishes criminal
penalties for certain violations.
Assessments. Federal savings banks are required to pay assessments to the
Office of Thrift Supervision to fund its operations. The general assessments,
paid on a semi-annual basis, are based upon the savings institution's total
assets, including consolidated subsidiaries, as reported in the institution's
latest quarterly thrift financial report.
Insurance of Deposit Accounts. First Federal of Hazard and First Federal of
Frankfort are members of the Savings Association Insurance Fund. The Federal
Deposit Insurance Corporation maintains a risk-based assessment system by which
institutions are assigned to one of three categories based on their
capitalization and one of three subcategories based on examination ratings and
other supervisory information. An institution's assessment rate depends upon the
categories to which it is assigned. Assessment rates for Savings Association
Insurance Fund member institutions are determined semi-annually by the Federal
Deposit Insurance Corporation and currently range from zero basis points of
assessable deposits for the healthiest institutions to 27 basis points of
assessable deposits for the riskiest.
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The Federal Deposit Insurance Corporation has authority to increase insurance
assessments. A material increase in Savings Association Insurance Fund insurance
premiums would likely have an adverse effect on the operating expenses and
results of operations of First Federal of Hazard and First Federal of Frankfort.
Management cannot predict what insurance assessment rates will be in the future.
In addition to the assessment for deposit insurance, institutions are
required to make payments on bonds issued in the late 1980s by the Financing
Corporation to recapitalize the predecessor to the Savings Association Insurance
Fund. During the year ended June 30, 2004, Financing Corporation payments for
Savings Association Insurance Fund members averaged 1.55 basis points of
assessable deposits.
The Federal Deposit Insurance Corporation may terminate an institution's
insurance of deposits upon a finding that the institution has engaged in unsafe
or unsound practices, is in an unsafe or unsound condition to continue
operations or has violated any applicable law, regulation, rule, order or
condition imposed by the Federal Deposit Insurance Corporation or the Office of
Thrift Supervision. The management of each of First Federal of Hazard and First
Federal of Frankfort do not know of any practice, condition or violation that
might lead to termination of deposit insurance for each respective institution.
Federal Home Loan Bank System. First Federal of Hazard and First Federal of
Frankfort are members of the Federal Home Loan Bank System, which consists of 12
regional Federal Home Loan Banks. The Federal Home Loan Bank provides a central
credit facility primarily for member institutions. As members of the Federal
Home Loan Bank, First Federal of Hazard and First Federal of Frankfort are
required to acquire and hold shares of capital stock in that Federal Home Loan
Bank in an amount at least equal to 1.0% of the aggregate principal amount of
its unpaid residential mortgage loans and similar obligations at the beginning
of each year, or 1/20 of its advances (borrowings) from the Federal Home Loan
Bank, whichever is greater. First Federal of Hazard and First Federal of
Frankfort were in compliance with this requirement with an investment in Federal
Home Loan Bank of Cincinnati stock at September 30, 2004 of $1.8 million and
$3.0 million, respectively.
The Federal Home Loan Banks are required to provide funds for the resolution
of insolvent thrifts in the late 1980s and to contribute funds for affordable
housing programs. These requirements could reduce the amount of dividends that
the Federal Home Loan Banks pay to their members and could also result in the
Federal Home Loan Banks imposing a higher rate of interest on advances to their
members. If dividends were reduced, or interest on future Federal Home Loan Bank
advances increased, our net interest income would likely also be reduced.
Community Reinvestment Act. Under the Community Reinvestment Act, as
implemented by Office of Thrift Supervision regulations, a savings association
has a continuing and affirmative obligation consistent with its safe and sound
operation to help meet the credit needs of its entire community, including low
and moderate income neighborhoods. The Community Reinvestment Act does not
establish specific lending requirements or programs for financial institutions
nor does it limit an institution's discretion to develop the types of products
and services that it believes are best suited to its particular community,
consistent with the Community Reinvestment Act. The Community Reinvestment Act
requires the Office of Thrift Supervision, in connection with its examination of
a savings association, to assess the institution's record of meeting the credit
needs of its community and to take such record into account in its evaluation of
certain applications by such institution.
The Community Reinvestment Act requires public disclosure of an institution's
rating and requires the Office of Thrift Supervision to provide a written
evaluation of an association's Community Reinvestment Act performance utilizing
a four-tiered descriptive rating system.
First Federal of Hazard and First Federal of Frankfort each received a
"Satisfactory" rating as a result of their most recent Community Reinvestment
Act assessments.
Holding Company Regulation
General. Kentucky First and First Federal MHC will be savings and loan
holding companies within the meaning of federal law. As such, they will be
registered with the Office of Thrift Supervision and will be subject to Office
of Thrift Supervision regulations, examinations, supervision, reporting
requirements and regulations concerning corporate governance and activities. In
addition, the Office of Thrift Supervision will have enforcement authority over
Kentucky First and First Federal MHC and their non-savings institution
subsidiaries. Among other things, this authority permits the Office of Thrift
Supervision to restrict or prohibit activities that are determined to be a
serious risk to First Federal of Hazard and/or First Federal of Frankfort.
Restrictions Applicable to Mutual Holding Companies. According to federal law
and Office of Thrift Supervision regulations, a mutual holding company, such as
First Federal MHC, may generally engage in the following activities:
(1) investing in the stock of insured depository institutions and acquiring them
by means of a merger or acquisition; (2) investing in a corporation the capital
stock of which may be lawfully purchased by a savings association under federal
law; (3) furnishing or performing management services for a savings association
subsidiary of a savings and loan holding company; (4) conducting an insurance
agency or
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escrow business; (5) holding, managing or liquidating assets owned or acquired
from a savings association subsidiary of the savings and loan holding company;
(6) holding or managing properties used or occupied by a savings association
subsidiary of the savings and loan holding company; (7) acting as trustee under
deed or trust; (8) any activity permitted for multiple savings and loan holding
companies by Office of Thrift Supervision regulations; (9) any activity
permitted by the Board of Governors of the Federal Reserve System for bank
holding companies and financial holding companies; and (10) any activity
permissible for service corporations. Recent legislation, which authorized
mutual holding companies to engage in activities permitted for financial holding
companies, expanded the authorized activities. Financial holding companies may
engage in a broad array of financial services activities, including insurance
and securities.
Federal law prohibits a savings and loan holding company, including a federal
mutual holding company, from directly or indirectly, or through one or more
subsidiaries, acquiring more than 5% of the voting stock of another savings
institution, or its holding company, without prior written approval of the
Office of Thrift Supervision. Federal law also prohibits a savings and loan
holding company from acquiring or retaining control of a depository institution
that is not insured by the Federal Deposit Insurance Corporation. In evaluating
applications by holding companies to acquire savings institutions, the Office of
Thrift Supervision must consider the financial and managerial resources and
future prospects of the company and institution involved, the effect of the
acquisition on the risk to the insurance funds, the convenience and needs of the
community and competitive factors.
The Office of Thrift Supervision is prohibited from approving any acquisition
that would result in a multiple savings and loan holding company controlling
savings institutions in more than one state, except: (1) the approval of
interstate supervisory acquisitions by savings and loan holding companies, and
(2) the acquisition of a savings institution in another state if the laws of the
state of the target savings institution specifically permit such acquisitions.
The states vary in the extent to which they permit interstate savings and loan
holding company acquisitions.
If a savings institution subsidiary of a savings and loan holding company
fails to meet the qualified thrift lender test set, the holding company must
register with the Federal Reserve Board as a bank holding company within one
year of the savings institution's failure to so qualify.
Stock Holding Company Subsidiary Regulation. The Office of Thrift Supervision
has adopted regulations governing the two-tier mutual holding company form of
organization and subsidiary stock holding companies that are controlled by
mutual holding companies. We have adopted this form of organization and it will
be in place after the proposed offering. Kentucky First is the stock holding
company subsidiary of First Federal MHC. Kentucky First is only permitted to
engage in activities that are permitted for First Federal MHC subject to the
same restrictions and conditions.
Waivers of Dividends by First Federal MHC. Office of Thrift Supervision
regulations require First Federal MHC to notify the Office of Thrift Supervision
if it proposes to waive receipt of our dividends from Kentucky First. The Office
of Thrift Supervision reviews dividend waiver notices on a case-by-case basis,
and, in general, does not object to any such waiver if: (i) the waiver would not
be detrimental to the safe and sound operation of the savings association; and
(ii) the mutual holding company's board of directors determines that such waiver
is consistent with such directors' fiduciary duties to the mutual holding
company's members. The Office of Thrift Supervision will not consider the amount
of dividends waived by the mutual holding company in determining an appropriate
exchange ratio in the event of a full conversion to stock form. We anticipate
that First Federal MHC will waive dividends that Kentucky First may pay, if any.
Conversion of First Federal MHC to Stock Form. Office of Thrift Supervision
regulations permit First Federal MHC to convert from the mutual form of
organization to the capital stock form of organization. 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 our successor, First Federal MHC's corporate existence would end, and certain
depositors of First Federal of Hazard 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 First Federal MHC would be
automatically converted into a number of shares of common stock of the new
holding company based on an exchange ratio determined at the time of conversion
that ensures that stockholders other than First Federal MHC own the same
percentage of common stock in the new holding company as they owned in us
immediately before conversion. Under Office of Thrift Supervision regulations,
stockholders other than First Federal MHC would not be diluted because of any
dividends waived by First Federal MHC (and waived dividends would not be
considered in determining an appropriate exchange ratio), in the event First
Federal MHC converts to stock form. The total number of shares held by
stockholders other than First Federal MHC after a conversion transaction also
would be increased by any purchases by stockholders other than First Federal MHC
in the stock offering conducted as part of the conversion transaction.
Acquisition of Control. Under the federal Change in Bank Control Act, a
notice must be submitted to the Office of Thrift Supervision if any person
(including a company), or group acting in concert, seeks to acquire "control" of
a savings and loan holding company or savings association. An acquisition of
"control" can occur upon the acquisition of 10% or more of the voting stock of a
savings and loan holding company or savings
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institution or as otherwise defined by the Office of Thrift Supervision. Under
the Change in Bank Control Act, the Office of Thrift Supervision has 60 days
from the filing of a complete notice to act, taking into consideration certain
factors, including the financial and managerial resources of the acquirer and
the anti-trust effects of the acquisition. Any company that so acquires control
would then be subject to regulation as a savings and loan holding company.
Remutualization Transactions. Current Office of Thrift Supervision
regulations permit a mutual holding company to be acquired by a mutual
institution in a remutualization transaction. However, the Office of Thrift
Supervision has issued a policy statement indicating that it views
remutualization transactions as raising significant issues concerning disparate
treatment of minority stockholders and mutual members of the target entity and
as raising issues concerning the effect on the mutual members of the acquiring
entity. Under certain circumstances, the Office of Thrift Supervision intends to
give these issues special scrutiny and reject applications for the
remutualization of a mutual holding company unless the applicant can clearly
demonstrate that the Office of Thrift Supervision's concerns are not warranted
in the particular case.
Federal Securities Laws
We have filed with the Securities and Exchange Commission a registration
statement under the Securities Act of 1933 for the registration of the common
stock to be issued pursuant to the offering. Upon completion of the offering,
our common stock will continue to be registered with the Securities and Exchange
Commission under the Securities Exchange Act of 1934. We will be subject to the
information, proxy solicitation, insider trading restrictions and other
requirements under the Securities Exchange Act of 1934.
The registration, under the Securities Act of 1933, of the shares of common
stock to be sold in the reorganization offering does not cover the resale of
those shares. Shares of common stock purchased by persons who are not affiliates
of us may be resold without registration. Shares purchased by an affiliate of us
will be subject to the resale restrictions of Rule 144 under the Securities Act
of 1933. If we meet the current public information requirements of Rule 144,
each affiliate of us th