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, 2007
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: 000-52598
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 9, 2007:
2,850,889.
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 Statement 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 13
Item 3. Quantitative and Qualitative Disclosures About
Market Risk 19
Item 4. Controls and Procedures 20
Part II - Other Information 20
Signatures 21
Exhibits
31.1 Certifications of Chief Executive Officer pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002. 22
31.2 Certifications of Chief Financial Officer pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002. 24
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. 26
Item 1 - Financial Statements
KENTUCKY BANCSHARES, INC.
CONSOLIDATED BALANCE SHEETS (unaudited)
(thousands) 9/30/2007 12/31/2006
Assets
Cash and due from banks $ 13,420 $ 14,905
Federal funds sold 9,188 4,106
Cash and cash equivalents 22,608 19,011
Securities available for sale 125,596 127,891
Mortgage loans held for sale 255 -
Loans 423,130 444,150
Allowance for loan losses (4,781) (4,991)
Net loans 418,349 439,159
Federal Home Loan Bank stock 6,468 6,468
Bank premises and equipment, net 16,035 14,327
Interest receivable 5,706 5,654
Goodwill 13,117 13,117
Other intangible assets 1,855 2,058
Mortgage servicing rights 691 746
Other assets 1,310 1,111
Total assets $ 611,990 $ 629,542
Liabilities and Stockholders' Equity
Deposits
Non-interest bearing $ 87,409 $ 87,503
Time deposits, $100,000 and over 81,251 67,255
Other interest bearing 294,116 314,050
Total deposits 462,776 468,808
Repurchase agreements and other borrowings 13,042 11,327
Federal Home Loan Bank advances 64,306 80,030
Subordinated debentures 7,217 7,217
Interest payable 4,351 3,683
Other liabilities 2,807 3,196
Total liabilities 554,499 574,261
Stockholders' equity
Common stock 12,440 12,474
Additional paid-in capital 134 59
Retained earnings 46,362 44,062
Accumulated other comprehensive income (loss) (1,445) (1,314)
Total stockholders' equity 57,491 55,281
Total liabilities & stockholders' equity $ 611,990 $ 629,542
See Accompanying Notes
KENTUCKY BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (unaudited)
(thousands, except per share amounts) Nine Months Ending
9/30/2007 9/30/2006
INTEREST INCOME:
Loans, including fees $ 24,106 $ 20,911
Securities available for sale 4,774 4,779
Other 761 99
Total interest income 29,641 25,789
INTEREST EXPENSE:
Deposits 11,373 8,593
Other 3,001 3,359
Total interest expense 14,374 11,952
Net interest income 15,267 13,837
Loan loss provision 650 334
Net interest income after provision 14,617 13,503
NON-INTEREST INCOME:
Service charges 4,194 3,767
Loan service fee income 46 28
Trust department income 395 455
Securities available for sale gains (losses), net 33 41
Gain on sale of mortgage loans 312 178
Other 1,002 758
Total other income 5,982 5,227
NON-INTEREST EXPENSE:
Salaries and employee benefits 8,051 6,985
Occupancy expenses 1,864 1,705
Amortization 204 116
Advertising and marketing 405 363
Taxes other than payroll, property and income 513 439
Other 2,503 2,550
Total other expenses 13,540 12,158
Income before taxes 7,059 6,572
Income taxes 1,909 1,849
Net income $ 5,150 $ 4,723
Other Comprehensive Income, net of tax:
Change in Unrealized Gains on Securities (112) 494
Comprehensive Income $ 5,038 $ 5,217
Earnings per share
Basic $ 1.80 $ 1.73
Diluted 1.79 1.72
See Accompanying Notes
KENTUCKY BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (unaudited)
(thousands, except per share amounts) Three Months Ending
9/30/2007 9/30/2006
INTEREST INCOME:
Loans, including fees $ 8,012 $ 7,726
Securities available for sale 1,590 1,751
Other 199 16
Total interest income 9,801 9,493
INTEREST EXPENSE:
Deposits 3,663 3,274
Other 990 1,369
Total interest expense 4,653 4,643
Net interest income 5,148 4,850
Loan loss provision 330 94
Net interest income after provision 4,818 4,756
NON-INTEREST INCOME:
Service charges 1,421 1,474
Loan service fee income 14 8
Trust department income 121 138
Securities available for sale gains (losses), net 30 64
Gain on sale of mortgage loans 102 74
Other 357 281
Total other income 2,045 2,039
NON-INTEREST EXPENSE:
Salaries and employee benefits 2,669 2,536
Occupancy expenses 621 628
Amortization 68 68
Advertising and marketing 135 123
Taxes other than payroll, property and income 171 150
Other 928 939
Total other expenses 4,592 4,444
Income before taxes 2,271 2,351
Income taxes 601 637
Net income $ 1,670 $ 1,714
Other Comprehensive Income, net of tax:
Change in Unrealized Gains on Securities 1,269 1,976
Comprehensive Income $ 2,939 $ 3,690
Earnings per share
Basic $ 0.58 $ 0.60
Diluted 0.58 0.60
See Accompanying Notes
KENTUCKY BANCSHARES, INC.
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (unaudited)
(thousands, except share information)
Accumulated
Additional Other Total
----Common Stock---- Paid-in Retained Comprehensive Stockholders'
Shares Amount Capital Earnings Income Equity
Balances, December 31, 2006 2,864,586 $ 12,474 $ 59 $ 44,062 $ (1,314) $ 55,281
Common stock issued, including tax
benefit, net (including stock grants
of 5,605 shares and employee gifts
of 93 shares) 8,554 56 - - - 56
Stock based compensation expense - - 75 - - 75
Common stock purchased and retired (20,469) (90) - (531) - (621)
Net change in unrealized gain (loss)
on securities available for sale,
net of tax - - - - (112) (112)
Net change in SFAS No. 158, net of tax - - - - (19) (19)
Net income - - - 5,150 - 5,150
Dividends declared - $0.81 per share - - - (2,319) - (2,319)
Balances, September 30, 2007 2,852,671 $ 12,440 $ 134 $ 46,362 $ (1,445) $ 57,491
See Accompanying Notes
KENTUCKY BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
(thousands) Nine Months Ending
9/30/2007 9/30/2006
Cash Flows From Operating Activities
Net Income $ 5,150 $ 4,723
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation 772 709
Amortization 361 289
Accretion of premium on debt (20) (56)
Securities amortization (accretion), net (131) 33
Noncash compensation expense 75 49
Provision for loan losses 650 334
Securities (gains) losses, net (33) (41)
Originations of loans held for sale (10,356) (11,624)
Proceeds from sale of loans 10,413 11,802
Federal Home Loan Bank stock dividends - (246)
Gain on sale of mortgage loans (312) (178)
Changes in:
Interest receivable (52) (2,093)
Other assets (422) 1,364
Interest payable 668 175
Other liabilities (230) 724
Net cash from operating activities 6,533 5,964
Cash Flows From Investing Activities
Purchases of securities available for sale (70,496) (3,215)
Proceeds from sales of securities available for sale 19,324 17,486
Proceeds from principal payments, maturities and
calls of securities available for sale 53,461 36,542
Cash paid in bank acquisition - (6,411)
Net change in loans 20,160 (17,157)
Purchases of bank premises and equipment (2,480) (1,448)
Net cash from investing activities 19,969 25,797
Cash Flows From Financing Activities:
Net change in deposits (6,032) (48,851)
Net change in securities sold under agreements to
repurchase, federal funds purchased and
other borrowings 2,215 15,097
Advances from Federal Home Loan Bank - 80,000
Payments on Federal Home Loan Bank advances (15,704) (78,118)
Proceeds from note payable - 8,000
Payment on note payable (500) (7,000)
Proceeds from issuance of common stock 56 33
Purchase of common stock (621) (356)
Dividends paid (2,319) (2,052)
Net cash from financing activities (22,905) (33,247)
Net change in cash and cash equivalents 3,597 (1,486)
Cash and cash equivalents at beginning of period 19,011 14,164
Cash and cash equivalents at end of period $ 22,608 $ 12,678
See Accompanying Notes
KENTUCKY BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
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, 2006.
New accounting pronouncements -
In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements".
This Statement provides clarification of the definition of fair value,
methods used to measure fair value, and additional disclosures about fair
value measurements. This Standard is applicable in circumstances in which
other Standards require or permit assets or liabilities to be measured at
fair value. Therefore, this Standard does not require any new fair value
measurements. This Standard is effective for financial statements issued
for fiscal years beginning after November 15, 2007, and interim periods
within those fiscal years. The Company is still evaluating the impact, if
any, the adoption of this Statement on January 1, 2008 will have on its
results of operations and consolidated financial condition.
On February 15, 2007, the FASB issued SFAS No. 159, "The Fair Value Option
for Financial Assets and Financial Liabilities". SFAS No. 159 allows
companies to record certain financial assets and financial liabilities at
full fair value if they so choose. SFAS No. 159 was issued to mitigate
volatility in reported earnings caused by an accounting model utilizing
multiple measurement attributes. The adoption of the fair value option is
recorded as a cumulative-effect adjustment to the opening balance of
retained earnings. Upon adoption, the difference between the carrying
amount and the fair value of the items chosen is included in the
cumulative-effect adjustment. Subsequent changes in fair value are
recorded through the income statement. SFAS No. 159 is effective as of the
beginning of the first fiscal year after November 15, 2007, which is
January 1, 2008 for the Company. The Company does not expect the adoption
of this Statement to have a material impact on its results of operations
and consolidated financial condition.
The Company adopted FASB Interpretation 48, Accounting for Uncertainty in
Income Taxes ("FIN 48"), as of January 1, 2007. A tax position is
recognized as a benefit only if it is "more likely than not" that the tax
position would be sustained in a tax examination, with a tax examination
being presumed to occur. The amount recognized is the largest amount of
tax benefit that is greater than 50% likely of being realized on
examination. For tax positions not meeting the "more likely than not"
test, no tax benefit is recorded. The adoption had no effect on the
Company's financial statements, and the Company had no unrecognized tax
benefits at January 1, 2007 or September 30, 2007.
The Company and its subsidiaries are subject to U.S. federal income tax.
The Company is no longer subject to examination by taxing authorities for
years before 2002. The Company does not expect the total amount of
unrecognized tax benefits to significantly increase in the next twelve
months.
The Company recognizes interest related to income tax matters as interest
expense and penalties related to income tax matters as other expense. The
Company did not have any amounts accrued for interest and penalties at
January 1, 2007 or September 30, 2007.
2. 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, 2007
U.S. government agencies $ 19,110 $ 375 $ - $ 19,485
States and political subdivisions 55,657 422 (658) 55,421
Mortgage-backed 51,441 31 (1,069) 50,403
Equity securities 270 17 - 287
Total 126,478 845 (1,727) 125,596
December 31, 2006
U.S. government agencies 31,524 93 (125) 31,492
States and political subdivisions 43,609 703 (182) 44,130
Mortgage-backed 53,200 - (1,218) 51,982
Equity securities 270 17 - 287
Total 128,603 813 (1,525) 127,891
3. LOANS
Loans at period-end are as follows:
(in thousands)
9/30/2007 12/31/2006
Commercial $ 21,967 $ 29,335
Real estate construction 27,768 29,034
Real estate mortgage 276,827 290,068
Agricultural 80,723 79,627
Consumer 15,845 16,086
Total 423,130 444,150
4. EARNINGS PER SHARE
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
2007 2006
(in thousands, except per share information)
Basic Earnings Per Share
Net Income $5,150 $4,723
Weighted average common shares outstanding 2,855 2,730
Basic earnings per share $ 1.80 $ 1.73
Diluted Earnings Per Share
Net Income $5,150 $4,723
Weighted average common shares outstanding 2,855 2,730
Add dilutive effects of assumed exercise
of stock options 10 11
Weighted average common and dilutive
potential common shares outstanding 2,865 2,741
Diluted earnings per share $ 1.79 $ 1.72
Three Months Ended
September 30
2007 2006
(in thousands, except per share information)
Basic Earnings Per Share
Net Income $1,670 $1,714
Weighted average common shares outstanding 2,845 2,854
Basic earnings per share $ 0.58 $ 0.60
Diluted Earnings Per Share
Net Income $1,670 $1,714
Weighted average common shares outstanding 2,845 2,854
Add dilutive effects of assumed exercise
of stock options 10 11
Weighted average common and dilutive
potential common shares outstanding 2,855 2,865
Diluted earnings per share $ 0.58 $ 0.60
Stock options for 10,407 shares of common stock for the nine months and three
months ended September 30, 2007, and for 32,400 shares of common stock for the
nine and three months ended September 30, 2006 were excluded from diluted
earnings per share because their impact was antidilutive.
5. 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 2007, 5,095 shares were granted under the plan and in
May 2007, 510 shares were granted under the plan.
The following table summarizes stock option activity:
Nine Months Ended
September 30, 2007
Weighted Average
Options Exercise Price
Outstanding, beginning of year 69,914 $ 26.54
Granted 800 31.00
Expired (880) 31.59
Exercised (2,960) 20.17
Outstanding, end of period 66,874 26.81
Options exercisable at period end 49,984 25.68
The following details stock options outstanding:
September 30, 2007 December 31, 2006
Stock options vested and
currently exercisable:
Number 49,984 44,072
Weighted average exercise price $ 25.68 $ 24.35
Aggregate intrinsic value $ 391,875 $ 308,190
Weighted average remaining
contractual life 51.5 months 52.3 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 $75 thousand in stock
compensation expense during the nine months ended September 30, 2007 to
salaries and employee benefits.
The weighted-average assumptions for options granted during the year and
the resulting estimated weighted average fair values per share used in
computing 2007 and 2006 recognized compensation expense follow:
2007 2006
Weighted-average fair value of options
granted during the year $4.22 $3.14
Risk-free interest rate 4.51% 4.59%
Expected option life 8 years 8 years
Expected stock price volatility 12.69% 7.99%
Expected dividend yield 3.48% 3.39%
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 in effect at the time of
grant.
6. DIVIDENDS
Dividends per share paid for the quarter ended September 30, 2007 were
$0.27 compared to $0.25 for September 30, 2006. This is the same rate of
dividend paid for the first two quarters of the respective years.
7. RETIREMENT PLAN
Components of Net Periodic Benefit Cost
Nine months ended September 30
(in thousands)
Pension Benefits
2007 2006
Service cost $ 355 $ 354
Interest cost 304 273
Expected return on plan assets (328) (298)
(Gain) loss amortization 26 31
Net Periodic Benefit Cost $ 357 $ 360
Three months ended September 30
(in thousands)
Pension Benefits
2007 2006
Service cost $ 128 $ 118
Interest cost 102 91
Expected return on plan assets (111) (99)
(Gain) loss amortization 9 10
Net Periodic Benefit Cost $ 128 $ 120
Employer Contributions
The Company contributed $503 thousand as its 2007 annual contribution to
the Pension Plan in July 2007.
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); 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 update or revise
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 $5.2 million, or $1.80 basic
earnings per share and $1.79 diluted earnings per share for the first nine
months ended September 30, 2007 compared to $4.7 million, or $1.73 basic
earnings per share and $1.72 diluted earnings per share for the nine month
period ending September 30, 2006. The first nine months earnings reflects an
increase of 9.0% compared to the same time period in 2006. The earnings for
the three months ended September 30, 2007 were $1.7 million, or $0.58 basic
and diluted earnings per share for the three month period ending September 30,
2007 compared to $1.7 million, or $0.60 basic and diluted earnings per share
for the three month period ending September 30, 2006. This three months
period earnings reflects a decrease of 2.6% compared to the same time period
in 2006. The issuance of 198,836 shares of common stock, in connection with
our merger with Peoples Bancorp, Inc. in July 2006, had a slightly dilutive
effect on earnings per share.
Return on average assets was 1.08% for the nine months ended September 30,
2007 and for the nine month period ended September 30, 2006. Return on
average equity was 12.2% for the nine month period ended September 30, 2007
and 12.9% for the same period in 2006. Return on average assets was 1.08% for
the three months ended September 30, 2007 and 1.09% for the three month period
September 30, 2006. Return on average equity was 12.0% for the three months
ended September 30, 2007 and 13.0% for the same time period in 2006.
Loans decreased $21.0 million from $444.1 million on December 31, 2006 to
$423.1 million on September 30, 2007. Increases in agricultural loans were
offset by a decrease in commercial, real estate mortgage, real estate
construction and consumer loans. Management attributes the decline in loans
to the slow down in the real estate economy and to competitive pressures.
Total deposits decreased from $468.8 million on December 31, 2006 to $462.8
million on September 30, 2007, a decrease of $6.0 million. This decrease is
primarily the result of an increase in certificates of deposit, reported in
time deposits, $100,000 or greater, but offset by a decrease in other interest
bearing deposits (the loss of public funds placed by competitive bid during
the third quarter).
Net Interest Income
Net interest income was $15.3 million for the nine months ended September 30,
2007 compared to $13.8 million for the nine months ended September 30, 2006,
an increase of 10.3%. The interest spread was 3.35% for the first nine months
of 2007 compared to 3.27% for the same period in 2006, an increase of 8 basis
points. Net interest income was $5.1 million for the three months ended
September 30, 2007 compared to $4.8 million for the three months ended
September 30, 2006, an increase of 6.1%. The interest spread for the three
month period ended September 30, 2007 was 3.44% compared to 3.22% for the same
period in 2006, an increase of 22 basis points. Net interest margins have
increased slightly in 2007 compared to 2006.
For the first nine months, the yield on assets increased from 6.27% in 2006 to
6.70% in 2007. The cost of liabilities increased from 3.00% in 2006 to 3.35%
in 2007. Year to date average loans are up $38.3 million, or 9.6% from
September 30, 2006 to September 30, 2007. Approximately $51 million in loans
were acquired with the Peoples Bancorp, Inc. (Peoples) merger in July 2006.
Loan interest income has increased $3.2 million for the first nine months of
2007 compared to the first nine months of 2006. Year to date average deposits
increased from September 30, 2006 to September 30, 2007, up $53.4 million, or
12.4%. About $72 million in deposits were acquired in the Peoples merger in
July 2006. The slight increase, excluding the Peoples merger, is a result of
slower deposit growth, resulting from the loss of a large certificate of
deposit customer and public funds placed by competitive bid. Deposit interest
expense has increased $2.8 million for the first nine months of 2007 compared
to the same period in 2006.
Non-Interest Income
Non-interest income increased $755 thousand for the nine months ended
September 30, 2007 compared to the same period in 2006 to $6.0 million, due
primarily to an increase in overdraft income of $414 thousand (primarily from
the deposit relationships acquired with the Peoples merger in July 2006).
There was a slight increase in non-interest income for the three months ended
September 30, 2007 compared to the same time period in 2006.
Gain on sale of mortgage loans increased from $178 thousand in the first nine
months of 2006 to $312 thousand during the first nine months of 2007. The
increase was $28 thousand for the three month period ended September 30, 2007
compared to the same time period in 2006. A selected group of loans sold
servicing released account for most of the increase. The volume of mortgage
loan originations and sales is generally inverse to rate changes. A change in
the mortgage loan rate environment can have a significant impact on the
related gain on sale of mortgage loans.
Non-Interest Expense
Total non-interest expenses increased $1.4 million for the nine month period
ended September 30, 2007 compared to the same period in 2006. For the three
month period ended September 30, 2007 total non-interest expense increased
$148 thousand.
For the comparable nine month periods, salaries and benefits increased $1.1
million, an increase of 15.3%. Salaries and incentives represented $804
thousand and employee benefits represented $263 thousand of the increase in
salaries and employee benefits expense during these comparable periods.
Salaries and benefits increased $133 thousand for the three month period ended
September 30, 2007 compared to the same time period in 2006. These increases
are primarily attributable to the Peoples merger completed in July 2006.
Occupancy expenses increased $159 thousand to $1.9 million for the first nine
months of 2007 compared to the same time period in 2006. Occupancy expenses
decreased $7 thousand for the three month period ended September 30, 2007
compared to the same time period in 2006. The increase in year to date 2007
is mainly attributable to two additional facilities acquired in the Peoples
merger in July 2006. With the upcoming opening of additional facilities in
Paris, Morehead and Nicholasville, occupancy expense is expected to increase
starting in the fourth quarter of 2007.
The increases in amortization, advertising and marketing, and taxes are also
primarily attributable to the Peoples merger completed in July 2006.
Other expenses decreased $47 thousand for the nine months ended September 30,
2007 compared to the same time period in 2006. For the three month period
ended September 30, 2007 other expenses decreased $11 thousand compared to the
three month period ended September 30, 2006. The year to date decrease is
mainly a result of a one time credit of $80 thousand received in the first
quarter of 2007 for debit card expenses. In addition, one-time costs
(approximately $41 thousand in the first six months of 2006), related to the
Peoples Bank merger, incurred in 2006 inflated 2006 expenses.
In August 2007, the Company starting outsourcing its account processing to
Fiserv, Inc. The Company does not expect this to have a material impact on
its results of operations and consolidated financial condition.
Income Taxes
The effective tax rate for the nine months ended September 30, 2007 was 27%
compared to 28% in 2006. The effective tax rate for the three months ended
September 30, 2007 was 26% compared to 27% for the same time period in 2006.
These rates are less than the statutory rate as a result of the tax-free
securities and loans held by the Company.
Stock Repurchase Program
On October 25, 2000, the Company announced that its Board of Directors
approved a stock repurchase program 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. Shares will be purchased from time to time in the open market
depending on market prices and other considerations. Through September 30,
2007, 138,679 shares have been purchased under the program. The most recent
share repurchase occurred on November 2, 2007. 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 to meet 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 $22.6 million as of September 30, 2007 compared
to $19.0 million at December 31, 2006. The increase in cash and cash
equivalents is mainly attributable to an increase in federal funds sold
resulting primarily from a decrease in loan demand. In addition to cash and
cash equivalents, the securities portfolio provides an important source of
liquidity. Total securities available for sale totaled $125.6 million at
September 30, 2007. 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. These
advances are used primarily to fund long-term fixed rate residential mortgage
loans. As of September 30, 2007, we have sufficient collateral to borrow an
additional $41 million from the FHLB. In addition, as of September 30, 2007,
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, 2007, the Company's non-performing loans totaled $4.4
million or 1.03% of loans compared to $2.6 million or 0.59% of loans at
December 31, 2006. (See table below) The Company experienced an increase of
$1.7 million in non-accrual loans secured by various real estate loans from
December 31, 2006 to September 30, 2007. As of September 30, 2007, non-
accrual loans include $2.6 million in loans secured by 1-4 property and $1.0
million in real estate construction. The Company believes these increases are
attributable to the general softening of the real estate market, including the
residential construction market. Real estate loans composed 94% of the non-
performing loans as of September 30, 2007 and 91% as of December 31, 2006.
Forgone interest income on the non-accrual loans for both 2007 and 2006 is
immaterial.
Nonperforming Assets
9/30/07 12/31/06
(in thousands)
Non-accrual Loans $ 4,276 $ 2,379
Accruing Loans which are
Contractually past due
90 days or more 102 253
Total Nonperforming and Restructured 4,378 2,632
Other Real Estate 705 411
Total Nonperforming and Restructured
Loans and Other Real Estate $ 5,083 $ 3,043
Nonperforming and Restructured Loans
as a Percentage of Loans 1.03% 0.59%
Nonperforming and Restructured Loans
and Other Real Estate as a Percentage
of Total Assets 0.83% 0.48%
Allowance as a Percentage of
Period-end Loans 1.13% 1.12%
Allowance as a Percentage of
Non-performing and Restructured Loans 109% 164%
Provision for Loan Losses
The loan loss provision for the first nine months was $650 thousand for 2007
and $334 thousand for the same period in 2006. The loan loss provision for
the three months ended September 30, 2007 was $330 thousand and $94 thousand
for the same period in 2006. The current level of nonperforming loans has
caused management to increase the 2007 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, 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, 2007 were $860
thousand compared to $278 thousand for the same period in 2006. Net charge-
offs for the three month period ended September 30, 2007 were $505 thousand
compared to $136 thousand for the same period in 2006. 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)
2007 2006
Balance at Beginning of Period $ 4,991 $ 4,310
Amounts Charged-off:
Commercial 127 15
Real Estate Construction 330 28
Real Estate Mortgage 167 135
Agricultural 25 3
Consumer 693 682
Total Charged-off Loans 1,342 863
Recoveries on Amounts
Previously Charged-off:
Commercial 5 2
Real Estate Construction 14 -
Real Estate Mortgage 2 2
Agricultural 64 21
Consumer 397 560
Total Recoveries 482 585
Net Charge-offs 860 278
Provision for Loan Losses 650 334
Peoples Bank Reserve Acquired - 776
Balance at End of Period 4,781 5,142
Loans
Average 435,797 397,492
At September 30 423,130 439,492
As a Percentage of Average Loans:
Net Charge-offs 0.20% 0.07%
Provision for Loan Losses 0.15% 0.08%
Allowance as a Multiple of
Net Charge-offs 4.2 13.9
Loan Losses
Quarter Ended September 30
(in thousands)
2007 2006
Balance at Beginning of Period $ 4,956 $ 4,408
Amounts Charged-off:
Real Estate Construction 330 28
Real Estate Mortgage 76 81
Agricultural 25 -
Consumer 211 158
Total Charged-off Loans 642 267
Recoveries on Amounts
Previously Charged-off:
Commercial 4 1
Real Estate Construction 4 -
Real Estate Mortgage - 2
Agricultural 35 -
Consumer 94 128
Total Recoveries 137 131
Net Charge-offs 505 136
Provision for Loan Losses 330 94
Peoples Bank Reserve Acquired - 776
Balance at End of Period 4,781 5,142
Loans
Average 428,273 432,132
At September 30 423,130 439,492
As a Percentage of Average Loans:
Net Charge-offs 0.12% 0.03%
Provision for Loan Losses 0.08% 0.02%
Allowance as a Multiple of
Net Charge-offs 2.4 9.5
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 tools used by management are
interest rate shock and economic value of equity (EVE) simulations. The Bank
has no market risk sensitive instruments held for trading purposes.
Using interest rate shock simulations, 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, 2007 the projected percentage changes are within the Board approved
limits. This period's volatility is similar to the same period a year ago.
The projected net interest income report summarizing the Company's interest
rate sensitivity as of September 30, 2007 is as follows:
(dollars in thousands)
PROJECTED NET INTEREST INCOME
Level
Change in basis points: - 300 - 100 Rates + 100 + 300
Year One (10/07 - 9/08)
Net interest income $21,742 $22,020 $22,373 $22,520 $22,675
Net interest income dollar change (631) (353) N/A 147 302
Net interest income percentage change -2.8% -1.6% N/A 0.7% 1.3%
Board approved limit >-10.0% >-4.0% N/A >-4.0% >-10.0%
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)
Net interest income $18,837 $19,030 $19,425 $19,737 $20,033
Net interest income dollar change (588) (395) N/A 312 608
Net interest income percentage change -3.0% -2.0% N/A 1.6% 3.1%
Board approved limit >-18.0% >-6.0% N/A >-4.0% >-10.0%
These projected changes in net interest income as of September 30, 2007 are
slightly different when compared to the projected changes in net interest
income as of September 30, 2006 for the 100 and 300 basis point changes.
Projections from September 30, 2007, year one reflected a decline in net
interest income of 1.6% with a 100 basis point decline compared to the 2.0%
decline in 2006. The 100 basis point increase in rates reflected a 0.7%
increase in net interest income in 2007 compared to 1.6% in 2006.
EVE applies discounting techniques to future cash flows to determine the
present value of assets, liabilities, and therefore equity. Based on applying
these techniques to the September 30, 2007 balance sheet, a 300 basis point
increase in rates results in a 21% decline in EVE. A 300 basis point decrease
in rates results in a 10% increase in EVE. These are within the Board
approved limits.
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. 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, 2006 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
7/1/07 -
7/31/07 4,774 $30.86 4,774 64,403 shares
8/1/07 -
8/31/07 2,882 31.07 2,882 61,521 shares
9/1/07 -
9/30/07 200 32.43 200 61,321 shares
Total 7,856 7,856 61,321 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. Shares will be purchased from time to time in the
open market depending on market prices and other considerations. Through
September 30, 2007, 138,679 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 _____11/13/07_______ __/s/Louis Prichard______________
Louis Prichard, President and C.E.O.
Date _____11/13/07_______ __/s/Gregory J. Dawson___________
Gregory J. Dawson, Chief Financial Officer
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