UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2006
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ____________________ to ___________________
Commission File Number: 33-96358
KENTUCKY BANCSHARES, INC.
(Exact name of registrant as specified in its charter)
Kentucky 61-0993464
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
P.O. Box 157, Paris, Kentucky 40362-0157
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (859)987-1795
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
Yes X No _____
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act.
Large accelerated filer _ Accelerated filer _ Non-accelerated filer X
Indicate by check mark whether the registrant is a shell company (as defined
in Rule 12b-2 of the Exchange Act). Yes No X___
Number of shares of Common Stock outstanding as of November 13, 2006:
2,859,157.
KENTUCKY BANCSHARES, INC.
Table of Contents
Part I - Financial Information
Item 1. Financial Statements
Consolidated Balance Sheets 3
Consolidated Statements of Income and
Comprehensive Income 4
Consolidated Statements of Changes in
Stockholders' Equity 6
Consolidated Statements of Cash Flows 7
Notes to Consolidated Financial Statements 8
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 14
Item 3. Quantitative and Qualitative Disclosures About
Market Risk 20
Item 4. Controls and Procedures 22
Part II - Other Information 22
Signatures 23
Exhibits
31.1 Certifications of Chief Executive Officer pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002. 24
31.2 Certifications of Chief Financial Officer pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002. 26
32 Certifications of Chief Executive Officer and Chief
Financial Officer pursuant to 18 U.S.C. Section 1350,
as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002. 28
Item 1 - Financial Statements
KENTUCKY BANCSHARES, INC.
CONSOLIDATED BALANCE SHEETS (unaudited)
(thousands) 9/30/2006 12/31/2005
Assets
Cash and due from banks $ 12,511 $ 11,456
Federal funds sold 167 2,708
Cash and cash equivalents 12,678 14,164
Securities available for sale 142,456 160,652
Loans 439,492 370,912
Allowance for loan losses (5,142) (4,310)
Net loans 434,350 366,602
Federal Home Loan Bank stock 6,372 5,398
Bank premises and equipment, net 14,482 10,702
Interest receivable 5,812 3,719
Goodwill 12,471 9,111
Other intangible assets 2,127 766
Mortgage servicing rights 748 802
Other assets 1,304 834
Total assets $ 632,800 $ 572,750
Liabilities and Stockholders' Equity
Deposits
Non-interest bearing $ 89,190 $ 72,193
Time deposits, $100,000 and over 65,873 61,597
Other interest bearing 299,996 297,841
Total deposits 455,059 431,631
Repurchase agreements and other borrowings 20,185 16,838
Federal Funds Purchased 15,620 -
Federal Home Loan Bank advances 75,339 66,749
Subordinated debentures 7,217 7,217
Interest payable 2,889 2,714
Other liabilities 1,454 1,055
Total liabilities 577,763 526,204
Stockholders' equity
Common stock 12,442 6,813
Retained earnings 43,034 40,666
Accumulated other comprehensive income (loss) (439) (933)
Total stockholders' equity 55,037 46,546
Total liabilities & stockholders' equity $ 632,800 $ 572,750
See Accompanying Notes
KENTUCKY BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (unaudited)
(thousands, except per share amounts) Nine Months Ending
9/30/2006 9/30/2005
INTEREST INCOME:
Loans, including fees $ 20,911 $ 17,265
Securities available for sale 4,779 3,637
Other 99 172
Total interest income 25,789 21,074
INTEREST EXPENSE:
Deposits 8,593 5,527
Other 3,359 2,695
Total interest expense 11,952 8,222
Net interest income 13,837 12,852
Loan loss provision 334 583
Net interest income after provision 13,503 12,269
NON-INTEREST INCOME:
Service charges 3,767 3,377
Loan service fee income 201 197
Trust department income 455 332
Securities available for sale gains (losses), net 41 63
Gain on sale of mortgage loans 178 265
Other 758 873
Total other income 5,400 5,107
NON-INTEREST EXPENSE:
Salaries and employee benefits 6,985 6,420
Occupancy expenses 1,705 1,686
Amortization 289 259
Advertising and marketing 363 330
Taxes other than payroll, property and income 439 407
Other 2,550 2,499
Total other expenses 12,331 11,601
Income before taxes 6,572 5,775
Income taxes 1,849 1,496
Net income $ 4,723 $ 4,279
Other Comprehensive Income, net of tax:
Change in Unrealized Gains (Losses) on Securities 494 (803)
Comprehensive Income $ 5,217 $ 3,476
Earnings per share
Basic $ 1.73 $ 1.60
Diluted 1.72 1.59
See Accompanying Notes
KENTUCKY BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (unaudited)
(thousands, except per share amounts) Three Months Ending
9/30/2006 9/30/2005
INTEREST INCOME:
Loans, including fees $ 7,726 $ 5,937
Securities available for sale 1,751 1,234
Other 16 150
Total interest income 9,493 7,321
INTEREST EXPENSE:
Deposits 3,274 2,191
Other 1,369 884
Total interest expense 4,643 3,075
Net interest income 4,850 4,246
Loan loss provision 94 167
Net interest income after provision 4,756 4,079
NON-INTEREST INCOME:
Service charges 1,474 1,182
Loan service fee income 68 66
Trust department income 138 117
Securities available for sale gains (losses), net 64 10
Gain on sale of mortgage loans 74 78
Other 281 266
Total other income 2,099 1,719
NON-INTEREST EXPENSE:
Salaries and employee benefits 2,536 2,119
Occupancy expenses 628 566
Amortization 128 88
Advertising and marketing 123 110
Taxes other than payroll, property and income 150 135
Other 939 809
Total other expenses 4,504 3,827
Income before taxes 2,351 1,971
Income taxes 637 541
Net income $ 1,714 $ 1,430
Other Comprehensive Income, net of tax:
Change in Unrealized Gains (Losses) on Securities 1,976 (604)
Comprehensive Income $ 3,690 $ 826
Earnings per share
Basic $ 0.60 $ 0.54
Diluted 0.60 0.54
See Accompanying Notes
KENTUCKY BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (unaudited)
(thousands, except number of shares)
Accumulated
Other Total
----Common Stock---- Retained Comprehensive Stockholders'
Shares Amount Earnings Income Equity
Balances, December 31, 2005 2,666,897 $ 6,813 $ 40,666 $ (933) $ 46,546
Common stock issued, includes 198,836
shares issued in business combination 204,811 5,633 - 5,633
Common stock purchased (12,151) (53) (303) - (356)
Noncash compensation expense
attributed to stock option and
employee stock purchase plan grants - 49 - - 49
Net change in unrealized gain (loss)
on securities available for sale,
net of tax - - - 494 494
Net income - - 4,723 - 4,723
Dividends declared - $0.75 per share - - (2,052) - (2,052)
Balances, September 30, 2006 2,859,557 $ 12,442 $ 43,034 $ (439) $ 55,037
See Accompanying Notes
KENTUCKY BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
(thousands) Nine Months Ending
9/30/2006 9/30/2005
Cash Flows From Operating Activities
Net Income $ 4,723 $ 4,279
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation 709 707
Amortization 289 259
Amortization of premium on debt (56) (74)
Securities amortization (accretion), net 33 266
Noncash compensation expense 49 -
Provision for loan losses 334 583
Securities (gains) losses, net (41) (64)
Originations of loans held for sale (11,624) (14,612)
Proceeds from sale of loans 11,802 14,838
Federal Home Loan Bank stock dividends (246) (184)
Losses (gains) on sale of fixed assets - (71)
Gain on sale of mortgage loans (178) (265)
Changes in:
Interest receivable (2,093) (619)
Other assets 1,364 264
Interest payable 175 48
Other liabilities 724 134
Net cash from operating activities 5,964 5,489
Cash Flows From Investing Activities
Purchases of securities available for sale (3,215) (23,520)
Proceeds from sales of securities available for sale 17,486 1,323
Proceeds from principal payments, maturities and
calls of securities available for sale 36,542 13,676
Cash paid in bank acquisition (6,411) -
Net change in loans (17,157) (1,478)
Purchases of bank premises and equipment (1,448) (643)
Proceeds from the sale of bank premises and equipment - 582
Net cash from investing activities 25,797 (10,060)
Cash Flows From Financing Activities:
Net change in deposits (48,851) 26,857
Net change in securities sold under agreements to
repurchase, federal funds purchased
and other borrowings 15,097 (9,682)
Advances from Federal Home Loan Bank 80,000 15,000
Payments on Federal Home Loan Bank advances (78,118) (7,675)
Proceeds from note payable 8,000 -
Payment on note payable (7,000) -
Proceeds from issuance of common stock 33 19
Purchase of common stock (356) (436)
Dividends paid (2,052) (1,849)
Net cash from financing activities (33,247) 22,234
Net change in cash and cash equivalents (1,486) 17,663
Cash and cash equivalents at beginning of period 14,164 15,455
Cash and cash equivalents at end of period $ 12,678 $ 33,118
See Accompanying Notes
KENTUCKY BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities as of the date of the financial statements and the reported
amounts of revenues and expenses during the reporting period. Estimates
used in the preparation of the financial statements are based on various
factors including the current interest rate environment and the general
strength of the local economy. Changes in the overall interest rate
environment can significantly affect the Company's net interest income and
the value of its recorded assets and liabilities. Actual results could
differ from those estimates used in the preparation of the financial
statements.
The financial information presented as of any date other than December 31
has been prepared from the Company's books and records without audit. The
accompanying consolidated financial statements have been prepared in
accordance with the instructions to Form 10-Q and Rule 10-01 of Regulation
S-X. Certain financial information that is normally included in annual
financial statements prepared in accordance with accounting principles
generally accepted in the United States of America, but is not required for
interim reporting purposes, has been condensed or omitted. In the opinion
of management, all adjustments, consisting of normal recurring adjustments,
necessary for a fair presentation of such financial statements, have been
included. The results of operations for the interim periods are not
necessarily indicative of the results to be expected for the full year.
For further information, refer to the consolidated financial statements and
footnotes thereto included in the Company's Annual Report on Form 10-K for
the year ended December 31, 2005.
New Accounting Pronouncements -
In December 2004, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 123 (revised
2004), "Share-Based Payment", that requires the cost resulting from stock
options be measured at fair value and recognized in earnings. This
Statement replaces SFAS No. 123, "Accounting for Stock-Based Compensation"
and supersedes Accounting Principles Board ("APB") Opinion No. 25,
"Accounting for Stock Issued to Employees," which permitted the recognition
of compensation expense using the intrinsic value method. The Company
adopted SFAS No. 123(R) on January 1, 2006, and recognizes stock option
expense based on fair value at date of grant. All new awards and awards
that are modified, repurchased, or cancelled after the date of adoption are
accounted for under the provisions of SFAS No. 123(R). As a result of
adopting SFAS No. 123(R), the Company's income before income taxes for the
three and nine months ended September 30, 2006 includes stock option
compensation cost of $16 thousand and $49 thousand, respectively. Prior
periods have not been revised. See Note 6, Stock Compensation, for
additional information.
In February 2006, the FASB issued SFAS No. 155, "Accounting for Certain
Hybrid Financial Instruments", an amendment of SFAS No. 133 and SFAS No.
140. This statement permits fair value re-measurement for any hybrid
financial instrument that contains an embedded derivative that otherwise
would require bifurcation. It establishes a requirement to evaluate
interests in securitized financial assets to identify interests that are
freestanding derivatives or that are hybrid financial instruments that
contain an embedded derivative requiring bifurcation. In addition, SFAS
155 clarifies which interest-only strips and principal-only strips are not
subject to the requirements of Statement 133. It also clarifies that
concentrations of credit risk in the form of subordination are not embedded
derivatives. SFAS 155 amends Statement 140 to eliminate the prohibition on
a qualifying special-purpose entity from holding a derivative financial
instrument that pertains to a beneficial interest other than another
derivative financial instrument. This Statement is effective for all
financial instruments acquired or issued after the beginning of an entity's
first fiscal year that begins after September 15, 2006. The Company is
evaluating the impact, if any, of the adoption of this Statement on the
Company's result of operations and financial condition.
In June 2006, FASB Interpretation No. 48 ("FIN 48"), Accounting for
Uncertainty in Income Taxes - an interpretation of FAS 109 was issued. FIN
48 clarifies the accounting for uncertainty in income taxes recognized in
an entity's financial statements in accordance with FASB Statement No. 109,
Accounting for Income Taxes. FIN 48 prescribes a recognition threshold and
measurement attribute for the financial statement recognition and
measurement of a tax position taken or expected to be taken in a tax
return. FIN 48 also provides guidance on de-recognition, classification,
interest and penalties, accounting in interim periods, disclosure, and
transition. FIN 48 is effective for fiscal years beginning after December
15, 2006. Earlier application is encouraged if an entity has not yet
issued financial statements, including interim financial statements, in the
period FIN 48 is adopted. The Company is currently evaluating the impact,
if any, the adoption of FIN 48 will have on its consolidated financial
position, results of operations or cash flows.
In September 2006, the United States Securities and Exchange Commission's
("SEC") Office of the Chief Accountant and Divisions of Corporation Finance
and Investment Management released Staff Accounting Bulletin ("SAB") 108,
"Considering the Effects of Prior Year Misstatements when Quantifying
Misstatements in Current Year Financial Statements". SAB 108 was issued in
order to eliminate the diversity of practice surrounding how public
companies quantify financial statement misstatements. SAB 108 provides
interpretive guidance on how the effects of the carryover or reversal of
prior year misstatements should be considered in quantifying a current year
misstatement.
SAB 108 identifies two approaches that have been widely used by public
companies for quantifying the effects of financial statement misstatements:
the "rollover" and "iron curtain" approaches. With the rollover approach,
companies quantify the impact of misstatements based on the amount of the
error originating in the current year income statement, thus ignoring the
carryover effect of prior year misstatements. This approach can lead to
the accumulation of misstatements on the balance sheet. The iron curtain
approach focuses on the effect of correcting the period-end balance sheet,
regardless of the misstatement's year of origination. The Company
currently uses the rollover method for quantifying identified financial
statement misstatements.
In SAB 108 the SEC staff establishes a dual approach that requires
quantification of financial statement errors based on the effects of the
error on each of the Company's financial statements and the related
financial statement disclosures. The dual approach requires quantification
of misstatements under both the rollover and iron curtain methods.
Companies adopting the dual approach are permitted to record a one-time
cumulative effect adjustment to the carrying values of assets and
liabilities with an offsetting adjustment recorded to retained earnings as
of the beginning of the fiscal year of adoption to correct errors existing
in prior years that previously had been considered immaterial based on
appropriate use of their previous approach. The Company is in the process
of evaluating the impact, if any, of the adoption of this SAB on the
Company's results of operations and financial condition.
In September 2006, the FASB issued SFAS No. 158, "Employers' Accounting for
Defined Benefit Pension and Other Postretirement Plans, an amendment of
FASB Statements No. 87, 88, 106, and 132(R)." SFAS No. 158 requires an
employer to recognize the funded status of defined benefit postretirement
plans as an asset or a liability on its balance sheet. The funded status
is measured as the difference between plan assets at fair value and the
benefit obligation. The Company has an unfunded postretirement benefit
plan that is subject to the provisions of SFAS No. 158. For this plan, the
funded status is represented by the accumulated postretirement benefit
obligation. SFAS No. 158 also requires the Company to measure the funded
status of its plan's assets and obligations that determine its funded
status as of the balance sheet date and to recognize those changes in the
year in which the changes occur as a component of other comprehensive
income, net of taxes. SFAS No. 158 has no impact on how postretirement
benefits are accounted for and reported in the income statement. The
Company is evaluating the impact, if any, of the adoption of this Statement
on the Company's result of operations and financial condition.
2. BUSINESS COMBINATION
On July 7, 2006, the Company acquired 100% of the outstanding shares of
Peoples Bancorp of Sandy Hook, Inc. (Peoples), parent of Peoples Bank of
Sandy Hook. Operating results of Peoples are included in the consolidated
financial statements since the date of acquisition.
The purchase price of $14 million was 40 percent stock and 60 percent cash.
The purchase price resulted in approximately $3,360,000 in goodwill, and
$1,477,000 in core deposit intangible. The core deposit intangible asset
will be amortized over 10 years, using an accelerated method. Goodwill
will not be amortized but instead evaluated periodically for impairment.
Management is still in the process of evaluating the purchase accounting
entries, and additional adjustments may be made.
Peoples was a $91 million asset bank holding company, and on the merger
date, had loans of $51 million and deposits of $72 million.
3. INVESTMENT SECURITIES
INVESTMENT SECURITIES
Period-end securities are as follows:
(in thousands)
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
Available for Sale
September 30, 2006
U.S. government agencies 53,634 200 (699) 53,135
States and political subdivisions 45,128 990 (232) 45,886
Mortgage-backed 43,836 - (1,377) 42,459
Equity securities 525 451 - 976
Total 143,123 1,641 (2,308) 142,456
December 31, 2005
U.S. Treasury $ 3,006 $ - $ (32) $ 2,974
U.S. government agencies 67,845 14 (826) 67,033
States and political subdivisions 37,045 756 (338) 37,463
Mortgage-backed 53,645 4 (1,309) 52,340
Equity securities 524 318 - 842
Total 162,065 1,092 (2,505) 160,652
4. LOANS
Loans at period-end are as follows:
(in thousands)
9/30/2006 12/31/2005
Commercial $ 29,009 $ 27,302
Real estate construction 33,037 29,822
Real estate mortgage 285,544 245,138
Agricultural 75,315 59,328
Consumer 16,587 9,322
Total 439,492 370,912
5. Basic earnings per common share is net income divided by the weighted
average number of common shares outstanding during the period. Diluted
earnings per common share includes the dilutive effect of additional
potential common shares issuable under stock options.
The factors used in the earnings per share computation follow:
Nine Months Ended
September 30
2006 2005
(in thousands, except per share data)
Basic Earnings Per Share
Net Income $4,723 $4,279
Weighted average common shares outstanding 2,730 2,680
Basic earnings per share $ 1.73 $ 1.60
Diluted Earnings Per Share
Net Income $4,723 $4,279
Weighted average common shares outstanding 2,730 2,680
Add dilutive effects of assumed exercise
of stock options 11 15
Weighted average common and dilutive
potential common shares outstanding 2,741 2,695
Diluted earnings per share $ 1.72 $ 1.59
Three Months Ended
September 30
2006 2005
(in thousands, except per share data)
Basic Earnings Per Share
Net Income $1,714 $1,430
Weighted average common shares outstanding 2,854 2,682
Basic earnings per share $ 0.60 $ 0.54
Diluted Earnings Per Share
Net Income $1,714 $1,430
Weighted average common shares outstanding 2,854 2,682
Add dilutive effects of assumed exercise
of stock options 11 15
Weighted average common and dilutive
potential common shares outstanding 2,865 2,697
Diluted earnings per share $ 0.60 $ 0.54
Stock options for 32,400 shares of common stock for the nine and three
months ended September 30, 2006, and for 31,100 shares of common stock for
the nine months ended September 30, 2005 and for 27,600 shares of common
stock for the three months ended September 30, 2005 were excluded from
diluted earnings per share because their impact was antidilutive.
6. Stock Compensation
The Company grants certain officers and key employees stock option awards,
which vest and become fully exercisable at the end of five years. The
Company also grants certain directors stock option awards, which vest and
become fully exercisable immediately. The exercise price of each option,
which has a ten year life, was equal to the market price of the Company's
stock on the date of grant. The Company also provides to certain officers
and key employees restricted stock grants, which fully vest at the end of
five years. The Company records employee expense ratably over the five year
period, based on the market price of the common stock on the date of grant.
Total shares issuable under the restricted stock grant plan are 50,000
shares. In January 2006, 3,875 shares were granted under the plan.
In December 2004, the Financial Accounting Standards Board issued a revised
version of Statement of Financial Accounting Standards No. 123. It
requires that the fair value of stock options and other share-based
compensation be measured as of the date the grant is awarded and expensed
over the period of employee service, typically the vesting period.
Compensation cost will also be recorded for previously awarded options to
the extent that they vest after the effective date.
The following table summarizes stock option activity:
Nine Months Ended
September 30, 2006
Option Weighted Average
Shares Exercise Price
Outstanding, beginning of year 77,064 $ 25.32
Granted 1,300 29.50
Exercised (2,100) 16.19
Outstanding, end of period 76,264 25.64
Options exercisable at period end 50,242 23.23
The aggregate intrinsic value of the stock options exercised totaling 2,100
shares was $27,788 and the total intrinsic value of the stock options
outstanding of 76,264 shares is $361,776.
The following details stock options outstanding:
September 30, 2006 December 31, 2005
Stock options vested and currently exercisable:
Number 50,242 42,116
Weighted average exercise price $ 23.23 $ 21.38
Aggregate intrinsic value $ 341,994 $ 358,646
Weighted average remaining
contractual life 50.1 months 47.7 months
The intrinsic value for stock options is calculated based on the exercise
price of the underlying awards and the market price of our common stock as
of the reporting date. The Company recorded $49 thousand in stock
compensation expense during the nine months ended September 30, 2006 to
salaries and employee benefits. The after tax effect on net income for the
nine months ended September 30, 2006 was $49 thousand, resulting in a one
percent decline in earnings per share on both the basic and diluted basis.
Prior to 2006, employee compensation expense under stock options was
reported using the intrinsic value method. No stock-based compensation
cost was reflected in net income, as all options granted had an exercise
price equal to or greater than the market price of the underlying common
stock at date of grant. Effective January 1, 2006, the Company adopted the
fair value recognition provision of FASB Statement No. 123(R), Accounting
for Stock-Based Compensation, and recognizes stock option expense based on
fair value at date of grant. The following table illustrates for 2005 the
effect on net income and earnings per share if expense was measured using
the fair value recognition provisions of FAS 123.
2005
(In thousands, except per share amounts)
Net income as reported $ 4,279
Less: Stock-based compensation expense
determined under fair value based method (41)
Pro forma net income $ 4,238
Basic earnings per share as reported $ 1.60
Pro forma basic earnings per share 1.58
Diluted earnings per share as reported 1.59
Pro forma diluted earnings per share 1.57
The weighted-average assumptions for options granted during the year and
the resulting estimated weighted average fair values per share used in
computing 2006 recognized compensation expense and 2005 for pro forma
disclosures are as follows.
2006 2005
Weighted-average fair value of options
granted during the year $3.14 $4.82
Risk-free interest rate 4.60% 3.98%
Expected option life 8 years 8 years
Expected stock price volatility 7.99% 15.11%
Expected dividend yield 3.39% 3.03%
The fair value of each stock option granted is estimated on the date of
grant using the Black-Scholes based stock option valuation model. This
model requires the input of subjective assumptions that will usually have a
significant impact on the fair value estimate. Expected volatilities are
based on historical volatility of the Company's stock, and other factors.
Expected dividends are based on dividend trends and the market price of the
Company's stock price at grant. The Company uses historical data to
estimate option exercises and employee terminations within the valuation
model. The risk-free rate for periods within the contractual life of the
option is based on the U.S. Treasury yield curve at the time of grant.
7. Dividends per share paid for the quarter ended September 30, 2006 were
$0.25 compared to $0.23 for September 30, 2005. This is the same rate of
dividend paid for the first and second quarters of the respective years.
8. Components of Net Periodic Benefit Cost
Nine months ended September 30
(in thousands)
Pension Benefits
2006 2005
Service cost $ 354 $ 324
Interest cost 273 260
Expected return on plan assets (298) (282)
(Gain) loss amortization 31 30
Net Periodic Benefit Cost $ 360 $ 332
Three months ended September 30
(in thousands)
Pension Benefits
2006 2005
Service cost $ 118 $ 108
Interest cost 91 87
Expected return on plan assets (99) (94)
(Gain) loss amortization 10 10
Net Periodic Benefit Cost $ 120 $ 111
Employer Contributions
The Company previously disclosed in its financial statements for the year
ended December 31, 2005 that it expected to contribute $204 thousand as its
2006 annual contribution to the Pension Plan. No contributions to the Pension
Plan were made during the nine months ended September 30, 2006, and the
Company anticipates making its annual contribution in the fourth quarter of
2006.
Item 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Forward-Looking Statements
This discussion contains forward-looking statements under the Private
Securities Litigation Reform Act of 1995 that involve risks and uncertainties.
Words such as "believes," "anticipates," "expects," "intends," "plans,"
"targeted," and similar expressions are intended to identify forward-looking
statements but are not the exclusive means of identifying such statements.
Although the Company believes that the assumptions underlying the
forward-looking statements contained herein are reasonable, any of the
assumptions could be inaccurate, and therefore, there can be no assurance that
the forward-looking statements included herein will prove to be accurate.
Factors that could cause actual results to differ from the results discussed
in the forward-looking statements include, but are not limited to: economic
conditions (the Company and its bank operate in areas affected by various
markets, including the tobacco market); competition for the Company's
customers from other providers of financial and mortgage services; government
legislation and regulation (which changes from time to time and over which the
Company has no control); changes in interest rates (both generally and more
specifically mortgage interest rates); material unforeseen changes in the
liquidity, results of operations, or financial condition of the Company's
customers; and other risks detailed in the Company's filings with the
Securities and Exchange Commission, all of which are difficult to predict and
many of which are beyond the control of the Company. The Company undertakes
no obligation to republish revised forward-looking statements to reflect
events or circumstances after the date hereof or to reflect the occurrence of
unanticipated events.
Summary
Kentucky Bancshares, Inc. recorded net income of $4.7 million, or $1.73 basic
and $1.72 diluted earnings per share for the nine months ended September 30,
2006 compared to $4.3 million, or $1.60 basic and $1.59 diluted earnings for
the nine month period ended September 30, 2005. The first nine months net
income reflects an increase of 10.4% compared to the same time period in 2005.
The earnings for the three months ended September 30, 2006 were $1.7 million,
or $0.60 basic and $0.60 diluted earnings per share for the three months ended
September 30, 2006 compared to $1.4 million, or $0.54 basic earnings per share
and $0.54 diluted earnings per share for the three month period ending
September 30, 2005. This three months period net income reflects an increase
of 19.9% compared to the same time period in 2005.
Return on average assets was 1.08% for the nine months ended September 30,
2006 and 1.08% for the nine month period ended September 30, 2005. Return on
average equity was 12.9% for the nine month period ended September 30, 2006
and 12.5% for the same period in 2005. Return on average assets was 1.09% for
the three months ended September 30, 2006 and 1.05% for the three month period
ended September 30, 2005. Return on average equity was 13.0% for the three
month period ended September 30, 2006 and 12.3% for the same period in 2005.
Loans increased $68.6 million from $370.9 million on December 31, 2005 to
$439.5 million on September 30, 2006. Increases in real estate construction,
real estate mortgage, agricultural and consumer loans were offset by a
decrease in commercial loans. Management attributes the growth in loans
primarily to the bank merger with Peoples ($51 million in loans at
acquisition) and the $11.7 million in lump-sum tobacco buyouts completed in
January 2006.
Total deposits increased from $431.6 million on December 31, 2005 to $455.1
million on September 30, 2006, an increase of $23.5 million, primarily the
result of the bank merger with Peoples ($72 million at acquisition), offset by
a decline in public fund deposits, reported in other interest bearing
deposits.
Net Interest Income
Net interest income was $13.8 million for the nine months ended September 30,
2006 compared to $12.9 million for the nine months ended September 30, 2005,
an increase of 7.7%. The interest spread was 3.27% for the first nine months
of 2006 compared to 3.38% for the same period in 2005, a decrease of 11 basis
points. Net interest income was $4.8 million for the three months ended
September 30, 2006 compared to $4.2 million for the three months ended
September 30, 2005, an increase of 14.2%. The interest spread was 3.22% for
the three month period ended September 30, 2006 compared to 3.20% for the same
period in 2005, an increase of 2 basis points. Generally, the increasing
interest rate environment and the increased cost related to public fund
deposits have contributed to declining net interest margins for the nine
months in 2006 compared to 2005.
For the first nine months, the yield on assets increased from 5.67% in 2005 to
6.27% in 2006. The cost of liabilities increased from 2.28% in 2005 to 3.00%
in 2006. Year to date average loans are up $35.3 million, or 9.7% from
September 30, 2005 to September 30, 2006. Loan interest income has increased
$3.6 million for the first nine months of 2006 compared to the first nine
months of 2005. Year to date average deposits increased from September 30,
2005 to September 30, 2006, up $36.8 million, or 9.4%. Deposit interest
expense has increased $3.1 million for the first nine months of 2006 compared
to the same period in 2005.
Following the 2004 enactment of federal legislation to end the federal tobacco
program and to compensate quota owners and producers, the Company offered
tobacco quota owners and producers upfront, lump-sum payment buyouts ranging
from 75% to 80% of the future stream of federal buyout payments during 2005.
The Company made $11.7 million in lump-sum payments in January 2006 under
successor in interest contracts. Similar types of buyouts are expected to
continue over the next few years, but on a smaller scale. Starting in January
2006, these buyouts have generated additional net interest income.
Non-Interest Income
Non-interest income increased $293 thousand for the nine months ended
September 30, 2006 compared to the same period in 2005 to $5.4 million.
Increases in service charges of $390 thousand and trust department income (the
collection of certain estate fees) of $123 thousand are offset by decreases in
net gains (losses) on securities of $22 thousand, and gains on sale of
mortgage loans of $87 thousand. The $380 thousand increase in non-interest
income for the three months ended September 30, 2006 compared to the same time
period in 2005 is mainly attributable to the increase in service charges.
Gain on sale of mortgage loans decreased $87 thousand during the first nine
months of 2006 compared to the same period in 2005. The decrease was $4
thousand for the three month period September 30, 2006 compared to the same
time period in 2005. The volume of mortgage loan originations and sales is
generally inverse to rate changes. The increasing rate environment has caused
the originations of mortgage loans to be lower and the related gain on sale of
mortgage loans to be lower in 2006 than in 2005.
Non-Interest Expense
Total non-interest expenses increased $730 thousand for the nine month period
ended September 30, 2006 compared to the same period in 2005. For the three
month period ended September 30, 2006, total non-interest expense increased
$677 thousand.
For the comparable nine month periods, salaries and benefits increased $565
thousand, an increase of 8.9%. Salaries represented $333 thousand and
employee benefits represented $218 thousand of the increase in salaries and
employee benefits expense during these comparable periods. Salaries and
benefits increased $417 thousand for the three month period ended September
30, 2006 compared to the same period in 2005. These increases are mainly a
result of the Peoples merger that was closed on July 7, 2006.
Occupancy expenses increased $19 thousand to $1.7 million for the first nine
months of 2006 compared to the same period in 2005. Occupancy expenses
increased $62 thousand for the three month period ended September 30, 2006
compared to the same period in 2005. These minor increases are primarily a
result of the Peoples merger mentioned earlier.
Other expenses increased $51 thousand for the nine months ended September 30,
2006 compared to the same time period in 2005, and $130 thousand for the three
months ended September 30, 2006 compared to the same time period in 2005.
Amortization, advertising and marketing, and taxes other than payroll,
property and income also increased over this time period. This is mainly a
result of the Peoples merger mentioned earlier.
Income Taxes
The tax equivalent rate for the nine months ended September 30, 2006 was 28%
compared to 26% in 2005. The tax equivalent rate for the three months ended
September 30, 2006 was 27% compared to 27% in 2005. These rates are less than
the statutory rate as a result of the tax-free securities and loans held by
the Company. Recognizing the remainder of the net operating loss carryforward
from the 2003 Cynthiana acquisition contributed to the lower rate in 2005.
Stock Repurchase Program
On October 25, 2000, the Company announced that its Board of Directors
approved a stock repurchase program. The Company is authorized to purchase up
to 100,000 shares of its outstanding common stock. On November 11, 2002, the
Board of Directors approved and authorized the Company's repurchase of an
additional 100,000 shares. In August 2004, the Board of Directors approved
and the Company repurchased 122,302 shares from a third-party shareholder.
These shares were outside of the previously mentioned stock repurchase
programs. Shares will be purchased from time to time in the open market
depending on market prices and other considerations. Through September 30,
2006, 117,460 shares have been purchased. The most recent share repurchase
occurred on October 3, 2006. The repurchase program has had a positive effect
on earnings per share calculations.
Liquidity and Funding
Liquidity risk is the possibility that the Company may not be able to meet its
cash requirements. Management of liquidity risk includes maintenance of
adequate cash and sources of cash to fund operations and meeting the needs of
borrowers, depositors and creditors. Excess liquidity has a negative impact
on earnings as a result of the lower yields on short-term assets.
Cash and cash equivalents were $12.7 million as of September 30, 2006 compared
to $14.2 million at December 31, 2005. In addition to cash and cash
equivalents, the securities portfolio provides an important source of
liquidity. Total securities available for sale totaled $142.5 million at
September 30, 2006. The available for sale securities are available to meet
liquidity needs on a continuing basis. The Company expects the customers'
deposits to be adequate to meet its funding demands.
Generally, the Company relies upon net cash inflows from financing activities,
supplemented by net cash inflows from operating activities, to provide cash
used in its investing activities. As is typical of many financial
institutions, significant financing activities include deposit gathering, and
the use of short-term borrowings, such as federal funds purchased and
securities sold under repurchase agreements along with long-term debt. The
Company's primary investing activities include purchasing investment
securities and loan originations.
Management is aware of the challenge of funding sustained loan growth.
Therefore, in addition to deposits, other sources of funds, such as Federal
Home Loan Bank (FHLB) advances, may be used. The Company relies on FHLB
advances for both liquidity, and asset/liability management purposes
(primarily to fund long-term fixed rate residential mortgage loans). As of
September 30, 2006, we have sufficient collateral to borrow an additional $36
million from the FHLB. In addition, as of September 30, 2006, over $48
million is available in overnight borrowing through various correspondent
banks. In light of this, management believes there is sufficient liquidity to
meet all reasonable borrower, depositor and creditor needs in the present
economic environment.
Non-Performing Assets
As of September 30, 2006, the Company's non-performing loans totaled $2.0
million or 0.45% of loans compared to $1.0 million or 0.26% of loans at
December 31, 2005. (See table below) The increase in non-accrual loans is
comprised primarily of a number of various real estate loans. Real estate
loans composed 89% of the non-performing loans as of September 30, 2006 and
79% as of December 31, 2005. Forgone interest income on the non-accrual loans
for both 2006 and 2005 is immaterial.
Nonperforming Assets
9/30/06 12/31/05
(in thousands)
Non-accrual Loans $ 1,912 $ 774
Accruing Loans which are
Contractually past due
90 days or more 44 206
Total Nonperforming and Restructured 1,956 980
Other Real Estate 533 141
Total Nonperforming and Restructured
Loans and Other Real Estate $ 2,489 $ 1,121
Nonperforming and Restructured Loans
as a Percentage of Loans 0.45% 0.26%
Nonperforming and Restructured Loans
and Other Real Estate as a Percentage
of Total Assets 0.39% 0.20%
Provision for Loan Losses
The loan loss provision for the first nine months was $334 thousand for 2006
and $583 thousand for 2005. The loan loss provision for the three months
ended September 30, 2006 was $94 thousand and $167 thousand for the same time
period in 2005. The overall relative levels of nonperforming loans has
allowed management to decrease the 2006 provision in order to maintain an
allowance for loan losses that is representative of the risk of loss based on
the quality of loans currently in the portfolio. Management estimates the
allowance balance required using past loan loss experience, the nature and
volume of the portfolio (including overdrafts), information about specific
borrower situations and estimated collateral values, economic conditions, and
other factors. Net charge-offs for the nine month period ended September 30,
2006 were $278 thousand compared to $236 thousand for the same period in 2005.
Net charge-offs for the three month period ended September 30, 2006 were $136
thousand compared to $91 thousand for the same period in 2005. Future levels
of charge-offs will be determined by the particular facts and circumstances
surrounding individual loans. Management believes the current loan loss
allowance is sufficient to meet probable incurred loan losses.
Loan Losses
Nine Months Ended September 30
(in thousands)
2006 2005
Balance at Beginning of Period $ 4,310 $ 4,163
Amounts Charged-off:
Commercial 15 77
Real Estate Construction 28 -
Real Estate Mortgage 135 96
Agricultural 3 -
Consumer 682 180
Total Charged-off Loans 863 353
Recoveries on Amounts
Previously Charged-off:
Commercial 2 3
Real Estate Construction - -
Real Estate Mortgage 2 7
Agricultural 21 1
Consumer 560 106
Total Recoveries 585 117
Net Charge-offs 278 236
Provision for Loan Losses 334 583
Peoples Bank Reserve Acquired 776 -
Balance at End of Period 5,142 4,510
Loans
Average 397,492 362,029
At September 30 439,492 359,524
As a Percentage of Average Loans:
Net Charge-offs 0.07% 0.07%
Provision for Loan Losses 0.08% 0.16%
Allowance as a Percentage of
Period-end Loans 1.17% 1.25%
Allowance as a Multiple of
Net Charge-offs 9.2 14.3
Allowance as a Percentage of
Non-performing and Restructured Loans 263% 343%
Loan Losses
Quarter Ended September 30
(in thousands)
2006 2005
Balance at Beginning of Period $ 4,408 $ 4,431
Amounts Charged-off:
Commercial - 15
Real Estate Construction 28 -
Real Estate Mortgage 81 23
Agricultural - -
Consumer 158 97
Total Charged-off Loans 267 135
Recoveries on Amounts
Previously Charged-off:
Commercial 1 1
Real Estate Construction - -
Real Estate Mortgage 2 5
Agricultural - 1
Consumer 128 40
Total Recoveries 131 47
Net Charge-offs 136 88
Provision for Loan Losses 94 167
Peoples Bank Reserve Acquired 776 -
Balance at End of Period 5,142 4,510
Loans
Average 432,132 363,999
At September 30 439,492 359,524
As a Percentage of Average Loans:
Net Charge-offs 0.03% 0.02%
Provision for Loan Losses 0.02% 0.05%
Allowance as a Multiple of
Net Charge-offs 9.5 12.8
Item 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Asset/Liability management control is designed to ensure safety and soundness,
maintain liquidity and regulatory capital standards, and achieve acceptable
net interest income. Management considers interest rate risk to be the most
significant market risk. The Company's exposure to market risk is reviewed on
a regular basis by the Asset/Liability Committee. Interest rate risk is the
potential of economic losses due to future interest rate changes. These
economic losses can be reflected as a loss of future net interest income
and/or a loss of current fair market values. The objective is to measure the
effect on net interest income and to adjust the balance sheet to minimize the
inherent risk while at the same time maximize income.
Management realizes certain risks are inherent and that the goal is to
identify and minimize the risks. The primary tool used by management is an
interest rate shock simulation model. The Bank has no market risk sensitive
instruments held for trading purposes.
The following table depicts the change in net interest income resulting from
100 and 300 basis point changes in rates on the Company's interest earning
assets and interest bearing liabilities. The projections are based on balance
sheet growth assumptions and repricing opportunities for new, maturing and
adjustable rate amounts. As of September 30, 2006 the projected percentage
changes are within the Board approved limits. This period's volatility is
lower when compared to the same period a year ago. The projected net interest
income report summarizing the Company's interest rate sensitivity as of
September 30, 2006 is as follows:
(dollars in thousands)
PROJECTED NET INTEREST INCOME
Level
Change in basis points: - 300 - 100 Rates + 100 + 300
Year One (10/06 - 9/07)
Interest Income $36,547 $37,424 $38,769 $40,157 $41,140
Interest Expense 17,710 18,394 19,344 20,420 21,107
Net Interest Income 18,837 19,030 19,425 19,737 20,033
PROJECTED DOLLAR INCREASE (DECREASE) FROM "LEVEL RATES"
Year One (10/06 - 9/07)
Interest Income $(2,222) $(1,345) N/A $ 1,388 $ 2,371
Interest Expense (1,634) (950) N/A 1,076 1,763
Net Interest Income (588) (395) N/A 312 608
PROJECTED PERCENTAGE INCREASE (DECREASE) FROM "LEVEL RATES"
Year One (10/06 - 9/07)
Interest Income -5.7% -3.5% N/A 3.6% 6.1%
Interest Expense -8.4% -4.9% N/A 5.6% 9.1%
Net Interest Income -3.0% -2.0% N/A 1.6% 3.1%
Board approved limit >-18.0% >-6.0% N/A >-4.0% >-10.0%
The projected net interest income report summarizing the Company's interest
rate sensitivity as of September 30, 2005 is as follows:
(dollars in thousands)
PROJECTED NET INTEREST INCOME
Level
Change in basis points: - 300 - 100 Rates + 100 + 300
Year One (10/05 - 9/06)
Interest Income $ 25,295 $ 29,367 $ 31,404 $ 33,378 $ 37,171
Interest Expense 10,610 12,597 13,754 14,910 17,224
Net Interest Income 14,685 16,770 17,650 18,468 19,947
PROJECTED DOLLAR INCREASE (DECREASE) FROM "LEVEL RATES"
Year One (10/05 - 9/06)
Interest Income $ (6,109) $ (2,037) N/A $ 1,974 $ 5,767
Interest Expense (3,144) (1,157) N/A 1,156 3,470
Net Interest Income (2,965) (880) N/A 818 2,297
PROJECTED PERCENTAGE INCREASE (DECREASE) FROM "LEVEL RATES"
Year One (10/05 - 9/06)
Interest Income -19.5% -6.5% N/A 6.3% 18.4%
Interest Expense -22.9% -8.4% N/A 8.4% 25.2%
Net Interest Income -16.8% -5.0% N/A 4.6% 13.0%
Board approved limit >-18.0% >-6.0% N/A >-4.0% >-10.0%
These projected changes in net interest income as of September 30, 2006 are
less when compared to the projected changes in net interest income as of
September 30, 2005. Projections from September 30, 2006, year one reflected a
decline in net interest income of 2.0% with a 100 basis point decline compared
to the 5.0% decline in 2005. The 300 basis point increase in rates reflected
a 3.1% increase in net interest income in 2006 compared to 13.0% in 2005.
Item 4 - CONTROLS AND PROCEDURES
As of the end of the period covered by this report, the Company carried out an
evaluation, under the supervision and with the participation of the Company's
management, including the Company's Chief Executive Officer and Chief
Financial Officer, of the effectiveness of the design and operation of the
Company's disclosure controls and procedures (as defined in Rule 13a-15(e) or
Rule 15d-15(e) under the Exchange Act). Based on the foregoing, the Company's
Chief Executive Officer and Chief Financial Officer concluded that the
Company's disclosure controls and procedures were effective, in all material
respects, to ensure that information required to be disclosed in the reports
the Company files and submits under the Exchange Act is recorded, processed,
summarized and reported as and when required.
The Company also conducted an evaluation of internal control over financial
reporting to determine whether any changes occurred during the quarter covered
by this report that have materially affected, or are reasonably likely to
materially affect, the Company's internal control over financial reporting.
Based on this evaluation, there has been no such change during the quarter
covered by this report.
Part II - Other Information
Item 1. Legal Proceedings
The Company is not a party to any material legal proceedings.
Item 1A. Risk Factors
There have been no material changes in risk factors, as previously
disclosed in the December 31, 2005 Form 10-K.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
ISSUER PURCHASES OF EQUITY SECURITIES
Period (a) Total (b) (c) Total Number (d) Maximum Number
Number of Average of Shares (or Units) (or Approximate Dollar
Shares (or Price Paid Purchased as Part Value) of Shares (or
Units) Per Share of Publicly Units) that May Yet Be
Purchased (or Unit) Announced Plans Purchased Under the
Or Programs Plans of Programs
7/1/06 -
7/31/06 1,670 $28.31 1,670 93,021 shares
8/1/06 -
8/31/06 4,241 28.98 4,241 88,780 shares
9/1/06 -
9/30/06 6,240 29.74 6,240 82,540 shares
Total 12,151 12,151 82,540 shares
On October 25, 2000, the Company announced that its Board of Directors
approved a stock repurchase program. The Company is authorized to purchase up
to 100,000 shares of its outstanding common stock. On November 11, 2002, the
Board of Directors approved and authorized the Company's repurchase of an
additional 100,000 shares. In August 2004, the Board of Directors approved
and the Company repurchased 122,302 shares from a third-party shareholder at a
price of $28 per share. These shares were outside of the previously mentioned
stock repurchase programs. Shares will be purchased from time to time in the
open market depending on market prices and other considerations. Through
September 30, 2006, 117,460 shares have been purchased.
Item 3. Defaults upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
None
Item 6. Exhibits
31.1 Certifications of Chief Executive Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Certifications of Chief Financial Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
32 Certifications of Chief Executive Officer and Chief
Financial Officer pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
KENTUCKY BANCSHARES, INC.
Date _____11/14/06________ __/s/Louis Prichard______________
Louis Prichard, President and C.E.O.
Date _____11/14/06________ __/s/Gregory J. Dawson___________
Gregory J. Dawson, Chief Financial Officer
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