UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 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: 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
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as
defined in Rule 405 of the Securities Act. Yes No _X_
Indicate by check mark if the registrant is not required to file reports to
Section 13 or Section 15(d) of the Exchange Act. Yes No _X_
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 if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ___ ]
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
Aggregate market value of voting stock held by non-affiliates as of June 30,
2007 was approximately $67.5 million. For purposes of this calculation, it
is assumed that the Bank's Trust Department, directors, executive officers
and beneficial owners of more than 5% of the registrant's outstanding voting
stock are affiliates.
Number of shares of Common Stock outstanding as of March 5, 2008:
2,850,590.
PART I
Item 1. Business
General
Kentucky Bancshares, Inc. ("Company" or "Kentucky") is a bank holding
company headquartered in Paris, Kentucky. The Company was organized in 1981
and is registered under the Bank Holding Company Act of 1956, as amended
("BHCA") and the Home Owners Loan Act of 1933, as amended ("HOLA").
The Company conducts its business in the Commonwealth of Kentucky through
one banking subsidiary, Kentucky Bank.
Kentucky Bank is a commercial bank and trust company organized under the
laws of Kentucky. Kentucky Bank has its main office in Paris (Bourbon
County), with additional offices in Paris, Cynthiana (Harrison County),
Georgetown (Scott County), Morehead (Rowan County), Nicholasville (Jessamine
County), North Middletown (Bourbon County), Sandy Hook (Elliott County),
Versailles (Woodford County), Wilmore (Jessamine County) and Winchester
(Clark County). The deposits of Kentucky Bank are insured up to prescribed
limits by the Deposit Insurance Fund ("DIF") of the Federal Deposit
Insurance Corporation ("FDIC").
On July 6, 2007, Kentucky Bank acquired Peoples Bancorp of Sandy
Hook, Inc. and its subsidiary bank, Peoples Bank, with offices in
Sandy Hook and Morehead, Kentucky.
The Company had total assets of $631 million, total deposits of $486 million
and stockholders' equity of $59 million as of December 31, 2007. The
Company's principal executive office is located at 339 Main Street, Paris,
Kentucky 40361, and the telephone number at that address is (859) 987-1795.
Business Strategy
The Company's current business strategy is to operate a well-capitalized,
profitable and independent community bank with a significant presence in
Central and Eastern Kentucky. Management believes the optimum way to grow
the Company is by attracting new loan and deposit customers within its
existing markets through it product offerings and customer service.
Management continues to consider opportunities for branch expansion and will
also consider acquisition opportunities that help advance its strategic
objectives.
Lending
Kentucky Bank is engaged in general full-service commercial and consumer
banking. A significant part of Kentucky Bank's operating activities include
originating loans, approximately 71% of which are secured by real estate at
December 31, 2007. Kentucky Bank makes commercial, agricultural and real
estate loans to its commercial customers, with emphasis on small-to-medium-
sized industrial, service and agricultural businesses. It also makes
residential mortgage, installment and other loans to its individual and
other non-commercial customers.
Loan Rates: Kentucky Bank offers variable and fixed rate loans. Loan rates
on variable rate loans generally adjust upward or downward based on changes
in the loan's index. Rate adjustments on variable rate loans are made from
1 day to 5 years. Variable rate loans may contain provisions that cap the
amount of interest rate increases or decreases over the life of the loan.
In addition to the lifetime caps and floors on rate adjustments, loans
secured by residential real estate may contain provisions that limit annual
increases at a maximum of 200 basis points. There is usually no annual
limit applied to loans secured by commercial real estate.
Credit Risk: Commercial lending and real estate construction
lending, generally includes a higher degree of credit risk than other
loans, such as residential mortgage loans. Commercial loans, like
other loans, are evaluated at the time of approval to determine the
adequacy of repayment sources and collateral requirements.
Collateral requirements vary to some degree among borrowers and
depend on the borrower's financial strength, the terms and amount of
the loan, and collateral available to secure the loan. Credit risk
results from the decreased ability or willingness to pay by a
borrower. Credit risk also results when a liquidation of collateral
occurs and there is a shortfall in collateral value as compared to a
loans outstanding balance. For construction loans, inaccurate
initial estimates of a project's costs and the property's completed
value could weaken the Company's position and lead to the property
having a value that is insufficient to satisfy full payment of the
amount of funds advanced for the property. Secured and unsecured
consumer loans generally are made for automobiles, boats, and other
motor vehicles. In most cases loans are restricted to the
subsidiaries' general market area.
Other Products: Kentucky Bank offers its customers a variety of other
services, including checking, savings, money market accounts, certificates
of deposits, safe deposit facilities, a credit card and other consumer-
oriented financial services. Kentucky Bank has Internet banking, including
bill payment available to its customers at www.kybank.com. Through its
Wealth Management Department, Kentucky Bank provides brokerage services,
annuities, life and long term care insurance, personal trust and agency
services (including management agency services).
Competition and Market Served
Competition: The banking business is highly competitive. Competition
arises from a number of sources, including other bank holding companies and
commercial banks, consumer finance companies, thrift institutions, other
financial institutions and financial intermediaries. In addition to
commercial banks, savings and loan associations, savings banks and credit
unions actively compete to provide a wide variety of banking services.
Mortgage banking firms, finance companies, insurance companies, brokerage
companies, financial affiliates of industrial companies and government
agencies provide additional competition for loans and for many other
financial services. Kentucky Bank also currently competes for interest-
bearing funds with a number of other financial intermediaries, including
brokerage firms and mutual funds, which offer a diverse range of investment
alternatives. Some of the Company's competitors are not subject to the same
degree of regulatory review and restrictions that apply to the Company and
its subsidiary bank. In addition, the Company must compete with much larger
financial institutions that have greater financial resources than the
Company.
Market Served. The Company's primary market areas consist of Bourbon,
Clark, Elliott, Harrison, Jessamine, Rowan, Scott, Woodford and surrounding
counties in Kentucky.
Supervision and Regulation
Governing Regulatory Institutions: As a bank holding company, the Company
is subject to the regulation and supervision of the Federal Reserve Board.
The Company's subsidiary is subject to supervision and regulation by
applicable state and federal banking agencies, including the Federal Reserve
Board, the Federal Deposit Insurance Corporation and the Kentucky Office of
Financial Institutions. Kentucky Bank is also subject to various
requirements and restrictions under federal and state law, including
requirements to maintain reserves against deposits, restrictions on the
types and amounts of loans that may be granted and the interest that may be
charged thereon, and limitations on the types of investments that may be
made and the types of services that may be offered. In addition to the
impact of regulation, Kentucky Bank is affected significantly by the actions
of the Federal Reserve Board as it attempts to control the money supply and
credit availability in order to influence the economy.
Laws Protecting Deposits: There are a number of obligations and
restrictions imposed on bank holding companies and their depository
institution subsidiaries by federal law and regulatory policy that are
designed to reduce potential loss exposure to the depositors of such
depository institutions and to the FDIC insurance funds in the event the
depository institution becomes in danger of default or is in default. For
example, under a policy of the Federal Reserve Board with respect to bank
holding company operations, a bank holding company is required to serve as a
source of financial strength to its subsidiary depository institutions and
commit resources to support such institutions in circumstances where it
might not do so absent such policy. In addition, the "cross-guarantee"
provisions of federal law require insured depository institutions under
common control to reimburse the FDIC for any loss suffered or reasonably
anticipated as a result of the default of a commonly controlled insured
depository institution or for any assistance provided by the FDIC to a
commonly controlled insured depository institution in danger of default.
The federal banking agencies have broad powers under current federal law to
take prompt corrective action to resolve problems of insured depository
institutions. The extent of these powers depends upon whether the
institutions in question are "well capitalized", "adequately capitalized",
"undercapitalized", "significantly undercapitalized" or "critically
undercapitalized", as such terms are defined under uniform regulation
defining such capital levels issued by each of the federal banking agencies.
Consumer Regulations: In addition to the laws and regulations discussed
above, Kentucky Bank is also subject to certain consumer laws and
regulations that are designed to protect consumers in transactions with
banks. While the list set forth herein is not exhaustive, these laws and
regulations include the Truth in Lending Act, the Truth in Savings Act, the
Electronic Funds Transfer Act, the Expedited Funds Availability Act, the
Equal Credit Opportunity Act, the Real Estate Settlement Procedures Act, the
Fair Housing Act and the Fair and Accurate Transactions Act, among others.
These laws and regulations mandate certain disclosure requirements and
regulate the manner in which financial institutions must deal with clients
when taking deposits or making loans. These laws also limit Kentucky Bank's
ability to share information with affiliated and unaffiliated entities. The
bank must comply with the applicable provisions of these consumer protection
laws and regulations as part of its ongoing business operations.
Dividend Restrictions: There are various legal and regulatory limits on the
extent to which the Company's subsidiary bank may pay dividends or otherwise
supply funds to the Company. In addition, federal and state regulatory
agencies also have the authority to prevent a bank or bank holding company
from paying a dividend or engaging in any other activity that, in the
opinion of the agency, would constitute an unsafe or unsound practice.
Dividends paid by the subsidiary bank have provided substantially all of the
Company's operating funds, and this may reasonably be expected to continue
for the foreseeable future.
Employees
At December 31, 2007, the number of full time equivalent employees of the
Company was 204.
Nature of Company's Business
The business of the Company is not seasonal. The Company's business does
not depend upon a single customer, or a few customers, the loss of any one
or more of which would have material adverse effect on the Company. No
material portion of the Company's business is subject to renegotiation of
profits or termination of contracts or subcontracts at the election of any
governmental entity.
Available Information
The Company files annual reports on Form 10-K, quarterly reports on Form 10-
Q, current reports on Form 8-K, and amendments to those reports with the
Securities and Exchange Commission ("SEC") pursuant to section 13(a) or
15(d) of the Securities Exchange Act of 1934. The public may read and copy
any material the Company files with the SEC at the SEC's Public Reference
Room at 100 F Street, NE, Washington, DC 20549 and may obtain information
on the operation of the Public Reference Room by calling the SEC at 1-800-
SEC-0330. The SEC maintains an Internet site that contains reports, proxy
and information statements, and other information regarding issuers that
file electronically with the SEC on its website at www.sec.gov.
Item 1A. Risk Factors
There are factors, many beyond our control, which may significantly change
the results or expectations of the Company. Some of these factors are
described below in the sections titled financial risk, business risk and
operational risk. These risks are not totally independent of each other.
Some factors affect more than one type of risk. These include regulatory,
economic, and competitive environments. As part of the annual audit plan,
our internal risk management department meets with management to assess
these risks throughout the Company. Many risks are further addressed in
other sections of this Form 10-K document.
The exercise of regulatory power may have negative impact on our results of
operations and financial condition. We are subject to extensive regulation,
supervision and examination by federal and state banking authorities. Any
change in applicable regulations or federal or state legislation could have
a substantial impact on our operations. Additional legislation and
regulations may be enacted or adopted in the future that could significantly
affect our powers, authority and operations, which could have a material
adverse effect on the financial condition and results of operations.
Further, regulators have significant discretion and power to prevent or
remedy unsafe or unsound practices or violations of laws by banks and bank
holding companies in the performance of their supervisory and enforcement
duties.
Significant decline in general economic conditions, locally and nationally,
will negatively affect the financial results of our banking operations. Our
success depends on general economic conditions both locally and nationally.
Most of our customers are in the Central Kentucky area. Our customers are
directly impacted by the local economy, as well as the national or global
economies. Local economic conditions (such as the effect of the tobacco
buyout on the agricultural industry) have an impact on the demand of
customers for loans, the ability of some borrowers to repay these loans and
the value of the collateral securing these loans. Factors influencing
general national economic conditions include the change in interest rates
(particularly mortgage lending rates), oil prices, inflation, recession and
unemployment. As these factors impact the overall business climate, they
can have a significant effect on loan demand. Loan growth is critical to
our profitability.
We face vigorous competition from banks and other financial institutions.
This competition may reduce or limit our margins on banking services, reduce
market share and adversely affect results of operations and financial
condition. A number of these banks and other financial institutions have
substantially greater resources and lending limits, larger branch systems
and a wider array of banking services. Additionally, we encounter
competition from both de novo and smaller community banks entering the
markets we are currently in. We also compete with other providers of
financial services, such as money market mutual funds, brokerage firms,
consumer finance companies and insurance companies.
Financial Risk
Financial risk components include, but are not limited to, credit risk,
interest rate risk, market risk and liquidity risk. We have adopted various
policies to minimize potential adverse effects of interest rate, market and
liquidity risks. However, even with these policies in place, a change in
interest rates could negatively impact our results of operations or
financial position.
Defaults in the repayment of loans may negatively impact our business.
Credit risk is most closely associated with lending activities at financial
institutions. Credit risk is the risk to earnings and capital when a
customer fails to meet the terms of any contract or otherwise fails to
perform as agreed. Credit risk arises from all activities where the Company
is dependent on issuer, borrower, or counterparty performance, not just
traditional lending activities. For example, the investment security
portfolio has inherent credit risk as do counterparties in derivative
contracts. Credit risk encompasses a broad range of financial institution
activities and includes items reflected both on and off the balance sheet.
Management makes various assumptions and judgments about the collectibility
of our loan portfolio, including the creditworthiness of its borrowers and
the value of real estate and other assets serving as collateral for
repayment of many of the loans. In determining the size of the allowance
for loan losses, management considers, among other factors, the Company's
loan loss experience and an evaluation of economic conditions. If these
assumptions prove to be incorrect, the current allowance may not be
sufficient to cover future loan losses and adjustments may be necessary to
allow for different economic conditions or adverse developments in the loan
portfolio. Material additions to the Company's allowance would materially
decrease our net income.
Fluctuations in interest rates may negatively impact our banking business.
Interest rate risk focuses on the impact to earnings and capital arising
from movements in interest rates. Interest rate risk focuses on the value
implications for accrual portfolios (e.g., held-to-maturity and available-
for-sale portfolios) and includes the potential impact to the Company's
accrual earnings as well as the economic perspective of the market value of
portfolio equity. The interest rate risk is comprised of repricing risk,
basis risk, yield curve risk and options risk. Repricing risk represents
the risk associated with the differences in timing of cash flows and rate
changes with our products. Basis risk represents the risk associated with
changing rate relationships among varying yield curves. Yield curve risk is
associated with changing rate relationships over the maturity structure.
Options risk is associated with interest-related options, which are embedded
in our products.
Changes in market factors may negatively affect the value of our investment
assets. Market risk focuses on the impact to earnings and capital arising
from changes in market factors (e.g., interest rates, market liquidity,
volatilities, etc.) that affect the value of traded instruments. Market
risk includes items reflected both on and off the balance sheet. Market
risk focuses primarily on mark-to-market portfolios (e.g., accounts revalued
for financial statement presentation), including trading accounts and
certain derivatives.
Our inability to maintain appropriate levels of liquidity may have a
negative impact on our results of operations and financial condition.
Liquidity risk focuses on the impact to earnings and capital resulting from
our inability to meet our obligations as they become due in the normal
course of business without incurring significant losses. It also includes
the management of unplanned decreases or changes in funding sources as well
as managing changes in market conditions, which could affect the ability to
liquidate assets in the normal course of business without incurring
significant losses. Liquidity risk includes items both on and off the
balance sheet.
Business Risk
Business risk is composed mainly of legal (compliance) risk, strategic risk
and reputation risk.
Our results of operations and financial condition are susceptible to legal
or compliance risks. Legal or compliance risk is the risk to earnings or
capital arising from the impact of unenforceable contracts, lawsuits,
adverse judgments, violations or nonconformance with laws, rules,
regulations, prescribed practices, or ethical standards. The risk also
arises in situations where laws or rules governing certain products or
activities of our customers may be ambiguous or untested. This risk is not
limited to the traditional thinking that legal/compliance risk is only
associated with consumer protection laws. It includes the exposure to
litigation from all aspects of both traditional and nontraditional financial
institution activities.
Incorrect strategic decisions may have a negative impact on our results of
operations and financial condition. Strategic risk is the risk to earnings
and capital arising from adverse business decisions or improper
implementation of those decisions. Strategic risk focuses on more than an
analysis of the written strategic plan. Its focus is on how plans, systems
and implementation affect franchise value. It also incorporates how
management analyzes external factors that affect the Company's strategic
direction.
Adverse publicity may have a negative impact on our business. Reputation
risk is the risk to earnings and capital arising from negative public
opinion. This affects the ability to establish new relationships or
services or to continue servicing existing relationships. Examiners will
assess reputation risk by recognizing the potential effect the public's
opinion could have on our franchise value.
Operational Risk
An inability to process transactions may have a negative impact on our
business. Operational risk is present on a daily basis through our
processing of transactions and is pervasive in all products and services
provided to our customers. It can be defined as the impact to earnings and
capital from problems encountered in processing transactions. Operational
risk is a function of internal controls, operating processes, management
information systems, and employee integrity.
Item 1B. Unresolved Staff Comments
None.
Item 2. Properties
The main banking office of Kentucky Bank is located at 401 Main Street,
Paris, Kentucky 40361. The principal office of Kentucky Bancshares, Inc. is
located at 339 Main Street, Paris, KY 40631. In addition, Kentucky Bank
serves customer needs at 14 other locations. All locations offer a full
range of banking services. Kentucky Bank owns all of the properties at
which it conducts its business. The Company owns approximately 83,000
square feet of office space.
Note 5 to the Company's consolidated financial statements included in this
report contains additional information relating to amounts invested in
premises and equipment.
Item 3. Legal Proceedings
The Company and its subsidiary are from time to time involved in routine
legal proceedings occurring in the ordinary course of business that, in the
aggregate, management believes will not have a material impact on the
Company's financial condition and results of operation.
Item 4. Submission of Matters to a Vote of Security Holders
Not Applicable.
PART II
Item 5. Market for Common Equity and Related Stockholder Matters
There is no established public trading market for the Company's Common
Stock. The Company's Common Stock is not listed on any national securities
exchange nor is it quoted on the NASDAQ system. However, it is traded on
the OTC Bulletin Board under the symbol "KTYB.OB". Trading in the Common
Stock has been infrequent, with retail brokerage firms making the market.
The following table sets forth the high and low closing sales prices of the
Common Stock from the OTC Bulletin Board and the dividends declared thereon,
for the periods indicated below:
High Low Dividend
2007 Quarter 4 $34.00 $31.75 $.27
Quarter 3 34.00 30.50 .27
Quarter 2 30.50 29.00 .27
Quarter 1 32.35 30.00 .27
2006 Quarter 4 $32.00 $29.50 $.25
Quarter 3 30.00 26.65 .25
Quarter 2 29.75 27.00 .25
Quarter 1 30.00 29.00 .25
Note 16 to the Company's consolidated financial statements included in this
report contains additional information relating to amounts available to be
paid as dividends.
As of December 31, 2007 the Company had 2,849,056 shares of Common Stock
outstanding and approximately 555 holders of record of its Common Stock.
The table below lists 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 or Programs
10/1/07 -
10/31/07 100 $32.00 100 61,221 shares
11/1/07 -
11/30/07 8,500 32.00 8,500 52,721 shares
12/1/07 -
12/31/07 1,133 31.75 1,133 51,588 shares
Total 9,733 9,733 51,588 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 December 31, 2007, 148,412 shares have been purchased, with the most
recent share repurchase under the Board-approved stock repurchase program
having occurred on December 31, 2007.
Item 6. Selected Financial Data
The following selected financial data should be read in conjunction with
the Company's Consolidated Financial Statements and the accompanying
notes presented elsewhere herein.
CONDENSED STATEMENT OF INCOME:
Total Interest Income $39,219 $35,593 $28,897 $25,846 $22,329
Total Interest Expense 19,034 16,718 11,766 9,067 7,875
Net Interest Income 20,185 18,875 17,131 16,779 14,454
Provision for Losses 1,000 475 508 840 1,300
Net Interest Income After
Provision for Losses 19,185 18,400 16,623 15,939 13,154
Noninterest Income 7,936 7,236 6,495 6,547 6,707
Noninterest Expense 18,131 16,682 15,220 14,506 14,171
Income Before Income
Tax Expense 8,990 8,954 7,898 7,980 5,690
Income Tax Expense 2,404 2,468 2,078 2,218 1,457
Net Income 6,586 6,486 5,820 5,762 4,233
SHARE DATA:
Basic Earnings per Share (EPS) $2.31 $2.35 $2.17 $2.09 $1.52
Diluted EPS 2.30 2.34 2.16 2.07 1.50
Cash Dividends Declared 1.08 1.00 0.92 0.84 0.76
Book Value 20.65 19.59 17.45 16.77 16.90
Average Common Shares-Basic 2,852 2,762 2,677 2,757 2,781
Average Common Shares-Diluted 2,862 2,774 2,692 2,777 2,827
SELECTED BALANCE SHEET DATA:
Loans, including loans held for sale $412,509 $439,159 $366,602 $354,294 $316,941
Investment Securities 147,750 127,891 160,652 126,767 128,790
Total Assets 630,939 629,542 572,750 528,544 500,852
Deposits 486,005 468,808 431,631 387,955 384,599
Securities sold under agreements to
repurchase and other borrowings 6,735 11,327 16,838 25,593 7,285
Federal Home Loan Bank advances 63,993 80,030 66,749 59,750 53,232
Stockholders' Equity 58,844 55,281 46,546 45,027 46,057
PERFORMANCE RATIOS:
(Average Balances)
Return on Assets 1.04% 1.09% 1.08% 1.11% 1.00%
Return on Stockholders' Equity 11.59% 12.82% 12.69% 12.57% 9.31%
Net Interest Margin (1) 3.56% 3.48% 3.50% 3.60% 3.79%
Equity to Assets (annual average) 8.97% 8.48% 8.50% 8.82% 10.73%
SELECTED STATISTICAL DATA:
Dividend Payout Ratio 46.89% 42.68% 42.30% 39.97% 50.00%
Number of Employees (at period end) 204 203 172 167 182
ALLOWANCE COVERAGE RATIOS:
Allowance to Total Loans 1.17% 1.12% 1.16% 1.16% 1.19%
Net Charge-offs as a Percentage of
Average Loans 0.26% 0.14% 0.10% 0.15% 0.43%
(1) Tax equivalent
Item 7. Management's Discussion and Analysis
The following discussion and analysis of financial condition and results
of operations should be read in conjunction with the Consolidated
Financial Statements and accompanying notes included as Exhibit 13.
When necessary, reclassifications have been made to prior years' data
throughout the following discussion and analysis for purposes of
comparability with 2007 data.
Critical Accounting Policies
The accounting and reporting policies of the Company and its
subsidiary are in accordance with accounting principles generally
accepted in the United States and conform to general practices within
the banking industry. Significant accounting policies are listed in
Note 1 in the "Notes to Consolidated Financial Statements". Critical
accounting and reporting policies include accounting for loans and
the allowance for loan losses. Different assumptions in the
application of these policies could result in material changes in the
consolidated financial position or consolidated results of
operations.
Loans are stated at the amount of unpaid principal, reduced by an
allowance for loan losses. Interest on loans is recognized on the
accrual basis, except for those loans on the nonaccrual status.
Interest income received on such loans is accounted for on the cash
basis or cost recovery method. The allowance for loan losses is a
valuation allowance for probable incurred credit losses. 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. The accounting policies relating to
the allowance for loan losses involve the use of estimates and
require significant judgments to be made by management.
Forward-Looking Statements
This discussion contains forward-looking statements under the Private
Securities Litigation Reform Act of 1995 that involve risks and
uncertainties. 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 (both
generally and more specifically in the markets, including the tobacco
market, in which the Company and its bank operate); competition for the
Company's customers from other providers of financial and mortgage
services; government legislation, regulation and monetary policy (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.
Overview
Net income for the year ended December 31, 2007 was $6.6 million, or
$2.31 per common share compared to $6.5 million, or $2.35 for 2006 and
$5.8 million, or $2.17 for 2005. Earnings per share assuming dilution
were $2.30, $2.34 and $2.16 for 2007, 2006 and 2005, respectively. For
2007, net income increased $100 thousand, or 1.5%. Net interest income
increased $1.3 million, the loan loss provision increased $525 thousand,
other income increased $700 thousand, while total other expenses
increased $1.4 million. In July 2006, the Company purchased Peoples
Bancorp of Sandy Hook, Inc. (Peoples Bancorp) and its subsidiary,
Peoples Bank (Peoples) of Sandy Hook, to strengthen its business and
grow its customer base.
For 2006, net income increased $666 thousand, or 11.4%. Net interest
income increased $1.7 million, the loan loss provision decreased $33
thousand, other income increased $741 thousand, while total other
expenses increased $1.5 million.
Return on average equity was 11.6% in 2007 compared to 12.8% in 2006 and
12.7% in 2005. Return on average assets was 1.04% in 2007 compared to
1.09% in 2006 and 1.08% in 2005.
Non-performing loans as a percentage of loans (including held for sale)
were 1.57%, 0.59% and 0.26% as of December 31, 2007, 2006 and 2005,
respectively.
RESULTS OF OPERATIONS
Net Interest Income
Net interest income, the Company's largest source of revenue, on a tax
equivalent basis increased from $17.7 million in 2005 to $19.5 million
in 2006 and to $20.9 million in 2007. The taxable equivalent adjustment
(nontaxable interest income on state and municipal obligations net of
the related non-deductible portion of interest expense) is based on our
Federal income tax rate of 34%.
Average earning assets and interest bearing liabilities both increased
from 2006 to 2007. Average earning assets increased $28 million, or 5%.
Investment securities decreased $13 million primarily due to payoff
borrowing used to fund the Peoples acquisition in July 2006. Loans
increased $23 million as a result of the acquisition in July 2006,
offset by a slower demand during 2007. Average interest bearing
liabilities increased $21 million, or 5% during this same period. This
change was primarily from the acquisition less the loss of some public
funds on deposit. The Company continues to actively pursue quality
loans and fund these primarily with deposits and FHLB advances.
During the second half of 2004 rates started increasing and this pattern
continued into the middle of 2006. Bank prime rates increased 125 basis
points during 2004, another 200 basis points in 2005 and another 100
basis points in 2006. Starting in September 2007, rates have been
decreasing. Bank prime rates decreased 100 basis points in 2007. As a
result of this, the tax equivalent yield on earning assets increased
from 6.47% in 2006 to 6.80% in 2007.
The volume rate analysis that follows, during 2007, indicates that $2.0
million of the increase in interest income is attributable to the change
in volume, while the higher level of rates contributed to an increase of
$1.6 million in interest income. This higher level of rates also caused
an increase in the cost of interest bearing liabilities. The average
rate of these liabilities increased from 3.62% in 2006 to 3.94% in 2007.
In addition, the change in volume contributed to an increase of $915
thousand in interest expense, while the higher level of rates was
responsible for a $1.4 million increase in interest expense. As a
result, the 2007 net interest income increase is primarily attributed to
increases in volume.
The volume rate analysis for 2006 that follows indicates that $3.4
million of the increase in interest income is attributable to the change
in volume, while the higher level of rates contributed to an increase of
$3.3 million in interest income. The rate increase also caused an
increase in the cost of interest bearing liabilities. The average rate
of these liabilities increased from 2.82% in 2005 to 3.62% in 2006.
Based on the volume rate analysis that follows, the change in volume
contributed to an increase of $1.3 million to interest expense, while
the higher level of rates was responsible for a $3.7 million increase in
interest expense. As a result, the 2006 net interest income increase is
attributed to increases in volume.
In addition to the negative impact on net interest income that may
result from the decreasing rate environment beginning in 2007 and
continuing into 2008, competitive pressures on interest rates will
continue and are likely to result in continued downward pressure on net
interest margins.
The accompanying analysis of changes in net interest income in the
following table shows the relationships of the volume and rate portions
of these changes in 2007 and 2006. Changes in interest income and
expenses due to both rate and volume are allocated on a pro rata basis.
2007 vs. 2006 2006 vs. 2005
Increase (Decrease) Due to Change in Increase (Decrease) Due to Change in
Volume Rate Net Change Volume Rate Net Change
INTEREST INCOME
Loans $ 1,656 $ 1,073 $ 2,729 $ 3,169 $ 2,527 $ 5,696
Investment Securities (604) 571 (33) 618 691 1,309
Federal Funds Sold and
Securities Purchased under
Agreements to Resell 919 9 928 (405) 90 (315)
Deposits with Banks - 1 1 5 1 6
Total Interest Income 1,971 1,654 3,625 3,387 3,309 6,696
INTEREST EXPENSE
Deposits
Demand 99 (160) (61) 204 1,345 1,549
Savings (62) (75) (137) 68 214 282
Negotiable Certificates of
Deposit and Other
Time Deposits 1,739 1,466 3,205 351 1,754 2,105
Securities sold under
agreements to
repurchase and
other borrowings (750) 94 (656) 298 261 559
Federal Home Loan
Bank advances (111) 76 (35) 358 99 457
Total Interest Expense 915 1,401 2,316 1,279 3,673 4,952
Net Interest Income $ 1,056 $ 253 $ 1,309 $ 2,108 $ (364) $ 1,744
Average Consolidated Balance Sheets and Net Interest Analysis (dollars in thousands)
2007 2006 2005
Average Average Average Average Average Average
Balance Interest Rate Balance Interest Rate Balance Interest Rate
ASSETS
Interest-Earning Assets
Securities Available for Sale (1)
U.S. Treasury and Federal Agency Securities 74,648 3,727 4.99% 101,130 4,354 4.31% 92,524 3,366 3.64%
State and Municipal obligations 52,674 2,134 4.05% 41,030 1,666 4.06% 34,888 1,444 4.14%
Other Securities 8,046 510 6.34% 6,622 384 5.80% 6,085 285 4.68%
Total Securities Available for Sale 135,368 6,371 4.71% 148,782 6,404 4.30% 133,497 5,095 3.82%
Total Investment Securities 135,368 6,371 4.71% 148,782 6,404 4.30% 133,497 5,095 3.82%
Tax Equivalent Adjustment 715 0.53% 624 0.42% 614 0.46%
Tax Equivalent Total 7,086 5.23% 7,028 4.72% 5,709 4.28%
Federal Funds Sold and Agreements to Repurchase 20,735 1,030 4.97% 2,212 102 4.61% 11,471 417 3.64%
Interest-Bearing Deposits with Banks 432 19 4.40% 432 18 4.17% 321 12 3.74%
Loans, Net of Deferred Loan Fees (2)
Commercial 46,508 3,731 8.02% 46,194 3,520 7.62% 31,151 1,958 6.29%
Real Estate Mortgage 370,699 26,802 7.23% 351,239 24,597 7.00% 321,619 20,660 6.42%
Installment 13,677 1,265 9.25% 10,698 952 8.90% 8,962 755 8.42%
Total Loans 430,884 31,798 7.38% 408,131 29,069 7.12% 361,732 23,373 6.46%
Total Interest-Earning Assets 587,419 39,933 6.80% 559,557 36,217 6.47% 507,021 29,511 5.82%
Allowance for Loan Losses (4,935) (4,766) (4,401)
Cash and Due From Banks 13,642 11,844 10,927
Premises and Equipment 15,246 12,421 11,025
Other Assets 21,934 17,676 15,054
Total Assets 633,306 596,732 539,626
LIABILITIES
Interest-Bearing Deposits
Negotiable Order of Withdrawal ("NOW")
and Money Market Investment Accounts 117,610 3,320 2.82% 114,195 3,381 2.96% 103,625 1,832 1.77%
Savings 31,722 380 1.20% 36,425 517 1.42% 29,303 235 0.80%
Certificates of Deposit and Other Deposits 244,408 11,424 4.67% 204,649 8,219 4.02% 193,986 6,114 3.15%
Total Interest-Bearing Deposits 393,740 15,124 3.84% 355,269 12,117 3.41% 326,914 8,181 2.50%
Securities sold under agreements to
repurchase and other borrowings 18,935 1,001 5.29% 33,213 1,657 4.99% 26,689 1,098 4.11%
Federal Home Loan Bank advances 70,132 2,909 4.15% 72,843 2,944 4.04% 63,918 2,487 3.89%
Total Interest-Bearing Liabilities 482,807 19,034 3.94% 461,325 16,718 3.62% 417,521 11,766 2.82%
Noninterest-Bearing Earning Demand Deposits 86,951 80,904 73,320
Other Liabilities 6,745 3,919 2,929
Total Liabilities 576,503 546,148 493,770
STOCKHOLDERS' EQUITY 56,803 50,584 45,856
Total Liabilities and Shareholders' Equity 633,306 596,732 539,626
Average Equity to Average Total Assets 8.97% 8.48% 8.50%
Net Interest Income 20,184 18,875 17,131
Net Interest Income (tax equivalent) (3) 20,899 19,499 17,745
Net Interest Spread (tax equivalent) (3) 2.86% 2.85% 3.00%
Net Interest Margin (tax equivalent) (3) 3.56% 3.48% 3.50%
Noninterest Income and Expenses
Noninterest income was $7.9 million in 2007 compared to $7.2 million in
2006 and $6.5 million in 2005. In 2007, increasing service charges and
increasing gain on sale of mortgage loans account for the majority of
the increase. In 2006, service charges and trust department income
increased.
Securities gains were $37 thousand in 2007, $34 thousand in 2006 and $64
thousand in 2005. These are primarily attributable to rising interest
rates and the related inverse relationship of interest rates and market
values. Some equity gains were taken in 2006 and used to offset losses
on sales of agency and municipal securities.
Gains on loans sold were $432 thousand, $290 thousand and $334 thousand
in 2007, 2006 and 2005, respectively. Loans held for sale are generally
sold after closing to the Federal Home Loan Mortgage Corporation.
During 2007, the loan service fee income increased $25 thousand,
compared to an increase of $24 thousand in 2006. Proceeds from the sale
of loans were $16 million, $17 million and $19 million in 2007, 2006 and
2005, respectively. The volume of loan originations is inverse to rate
changes. The volume of loan originations during 2007 was $16 million,
comparable to $17 million in 2006, and $18 million in 2005.
Other noninterest income excluding security net gains and gain on sale
of mortgage loans was $7.5 million in 2007, $6.9 million in 2006 and
$6.1 million in 2005. Service charge income, and more particularly
overdraft income, is the largest contributor to these numbers.
Overdraft income was $4.6 million in 2007, $4.1 million in 2006 and $3.4
million in 2005. The increase in 2007 is primarily attributable to the
Peoples acquisition in July 2006. Other income was $1.1 million in
2005, $1.1 million in 2006 and $1.4 million in 2007. The increase in
2007 is primarily attributable to a $200 thousand increase in
interchange income and a $137 thousand increase in brokerage income.
Noninterest expense increased $1.5 million in 2007 to $18.1 million, and
increased $1.5 million in 2006 to $16.7 million from $15.2 million in
2005. The increases in salaries and benefits from $8.5 million in 2005
to $9.6 million in 2006 and to $10.6 million in 2007 are attributable to
normal salary and benefit increases, and in 2006 and 2007 to the Peoples
acquisition. Bonus compensation was $38 thousand higher in 2007
compared to 2006 and $160 thousand higher in 2006 compared to 2005. The
2007 increase is from higher compensation (the percentage payout of base
salaries was lower in 2007 versus 2006), while the 2006 increase is
mainly a result of higher compensation and improved net income.
Occupancy expense increased $126 thousand in 2006 to $2.3 million and
increased $240 thousand, or 10% in 2007 to $2.6 million. The largest
expense, depreciation, increased $32 thousand to $956 thousand in 2006,
and increased $85 thousand to $1.0 million in 2007. Other noninterest
expense increased from $4.5 million in 2005 to $4.7 million in 2006 and
increased to $5.0 million in 2007. Amortization of core deposits
related to the Peoples acquisition was $175 thousand in 2007, compared
to $89 thousand in 2006. See Note 6 in the notes to consolidated
financial statements included as Exhibit 13 for more detail of the
goodwill and intangible assets.
The following table is a summary of noninterest income and expense for
the three-year period indicated.
For the Year Ended December 31
(in thousands)
2007 2006 2005
NON-INTEREST INCOME
Service Charges $ 5,495 $ 5,224 $ 4,511
Loan Service Fee Income 58 33 9
Trust Department Income 515 603 458
Investment Securities Gains (Losses),net 37 34 65
Gains on Sale of Mortgage Loans 432 290 334
Other 1,399 1,052 1,118
Total Non-interest Income 7,936 7,236 6,495
NON-INTEREST EXPENSE
Salaries and Employee Benefits 10,594 9,613 8,548
Occupancy Expenses 2,560 2,320 2,194
Other 4,977 4,749 4,478
Total Non-interest Expense 18,131 16,682 15,220
Net Non-interest Expense as a
Percentage of Average Assets 1.61% 1.58% 1.62%
Income Taxes
The Company had income tax expense of $2.4 million in 2007 and $2.5
million in 2006 and $2.1 million in 2005. This represents an effective
income tax rate of 26.7% in 2007, 27.6% in 2006 and 26.3% in 2005. The
difference between the effective tax rate and the statutory federal rate
of 34% is primarily due to tax exempt income on certain investment
securities and loans.
Balance Sheet Review
Assets grew slightly from $630 million at December 31, 2006 to $631
million at December 31, 2007. Loan decline was $27 million in 2007.
Deposits grew $17 million and FHLB borrowings decreased $16 million.
The gain in deposits of 4% is primarily from normal growth. Assets at
year-end 2006 totaled $630 million compared to $573 million in 2005. In
2006, loan growth was $73 million (nearly $51 million was a result of
the Peoples acquisition) and deposit growth was $37 million. The gain
in deposits was primarily from $72 million obtained from the Peoples
acquisition, offset by the loss of public money and a large certificate
of deposit customer. See Note 15 in the notes to consolidated financial
statements included as Exhibit 13 for additional information on the
business combination. FHLB borrowings increased $13 million from 2005
to 2006.
Loans
Total loans (including loans held for sale) were $417 million at
December 31, 2007 compared to $444 million at the end of 2006 and $371
million in 2005. Loans declined in 2007, following growth in 2006. The
decline in 2007 is primarily attributable to the softening economy. The
increase in 2006 is mainly attributable to improved loan demand and $51
million from the Peoples acquisition. As of the end of 2007 and
compared to the prior year-end, commercial loans decreased $6.4 million,
real estate construction loans decreased $2.9 million, real estate
mortgage loans (including loans held for sale) decreased $19.6 million,
agricultural loans increased $1.1 million and installment loans
increased $.9 million. As of the end of 2006 and compared to the prior
year-end, commercial loans increased $2.0 million, real estate
construction loans decreased $.8 million, real estate mortgage loans
(including loans held for sale) increased $45.0 million, agricultural
loans increased $20.3 million and installment loans increased $6.7
million.
As of December 31, 2007, the real estate mortgage portfolio comprised
65% of total loans compared to 65% in 2006. Of this, 1-4 family
residential property represented 62% in 2007 and 61% in 2006.
Agricultural loans comprised 19% in 2007 and 18% in 2006 of the loan
portfolio. Approximately 72% of the agricultural loans are secured by
real estate in 2007 compared to 72% in 2006. The remainder of the
agricultural portfolio is used to purchase livestock, equipment and
other capital improvements and for general operation of the farm.
Generally, a secured interest is obtained in the capital assets,
equipment, livestock or crops. Automobile loans account for 36% in 2007
and 40% in 2006 of the consumer loan portfolio, while the purpose of the
remainder of this portfolio is used by customers for purchasing retail
goods, home improvement or other personal reasons. The commercial loan
portfolio is mainly for capital outlays and business operation.
Collateral is requested depending on the creditworthiness of the
borrower. Unsecured loans are made to individuals or companies mainly
based on the creditworthiness of the customer. Approximately 6% of the
loan portfolio is unsecured. Management is not aware of any significant
concentrations that may cause future material risks, which may result in
significant problems with future income and capital requirements.
The following table represents a summary of the Company's loan portfolio
by category for each of the last five years. There is no concentration
of loans (greater than 5% of the loan portfolio) in any industry. The
Company has no foreign loans or highly leveraged transactions in its
loan portfolio.
Loans Outstanding
December 31 (in thousands)
2007 2006 2005 2004 2003
Commercial $ 22,924 $ 29,335 $ 27,302 $ 19,999 $ 14,278
Real Estate Construction 26,172 29,034 29,822 32,256 14,313
Real Estate Mortgage 270,749 290,324 245,326 238,661 222,342
Agricultural 80,774 79,627 59,328 57,497 56,615
Installment 15,421 15,684 8,954 9,062 12,978
Other 1,603 402 368 991 289
Total Loans 417,643 444,406 371,100 358,466 320,815
Less Deferred Loan Fees 255 256 188 10 54
Total Loans, Net of
Deferred Loan Fees 417,388 444,150 370,912 358,456 320,761
Less loans held for sale - - - 175 7,759
Less Allowance For Loan Losses 4,879 4,991 4,310 4,163 3,820
Net Loans 412,509 439,159 366,602 354,118 309,182
The following table sets forth the maturity distribution and interest
sensitivity of selected loan categories at December 31, 2007.
Maturities are based upon contractual term. The total loans in this
report represent loans net of deferred loan fees, including loans held
for sale but excluding the allowance for loan losses. In addition,
deferred loan fees on the above schedule is netted with real estate
mortgage loans on the following schedule.
Loan Maturities and Interest Sensitivity
December 31, 2007 (in thousands)
One Year One Through Over Total
or Less Five Years Five Years Loans
Commercial $ 12,702 $ 9,632 $ 590 $ 22,924
Real Estate Construction 25,950 222 - 26,172
Real Estate Mortgage 99,103 148,833 22,558 270,494
Agricultural 26,261 38,998 15,515 80,774
Installment 5,788 9,245 388 15,421
Other 1,603 - - 1,603
Total Loans, Net of
Deferred Loan Fees 171,407 206,930 39,051 417,388
Fixed Rate Loans 51,437 166,220 38,917 256,574
Floating Rate Loans 119,970 40,710 134 160,814
Total Loans, Net of
Deferred Loan Fees 171,407 206,930 39,051 417,388
Mortgage Banking
The Company has been in Mortgage Banking since the early 1980's. The
activity in origination and sale of these loans fluctuates, mainly due
to changes in interest rates. Mortgage loan originations decreased from
$18 million in 2005 to $17 million in 2006, to $16 million in 2007.
Proceeds from the sale of loans were $16 million, $17 million and $18
million for the years 2007, 2006 and 2005, respectively. Mortgage loans
held for sale were zero at December 31, 2007 and December 31, 2006.
Loans are generally sold when they are made. The volume of loan
originations is inverse to rate changes. The rate environment rose in
2005 and 2006, resulting in decreased loan originations. Declining
rates toward the end of 2007, resulted in higher loan orginations in the
latter portion of 2007. The effect of these changes was also reflected
on the income statement. As a result, the gain on sale of mortgage
loans was $432 thousand in 2007 compared to $290 thousand in 2006 and
$334 thousand in 2005.
The Bank has sold various loans to the Federal Home Loan Mortgage
Corporation (FHLMC) while retaining the servicing rights. Gains and
losses on loan sales are recorded at the time of the cash sale, which
represents the premium or discount paid by the FHLMC. The Bank receives
a servicing fee from the FHLMC on each loan sold. Servicing rights are
capitalized based on the relative fair value of the rights and the
expected life of the loan and are included in intangible assets on the
balance sheet and expensed in proportion to, and over the period of,
estimated net servicing revenues. Mortgage servicing rights were $697
thousand at December 31, 2007, $746 thousand at December 31, 2006 and
$802 thousand at December 31, 2005. Amortization of mortgage servicing
rights was $214 thousand, $235 thousand and $254 thousand for the years
ended December 31, 2007, 2006 and 2005, respectively. See Note 4 in the
notes to consolidated financial statements included as Exhibit 13 for
additional information.
Deposits
Total deposits increased to $486 million in 2007, up $17 million from
2006. Noninterest bearing deposits increased $1 million, time deposits
of $100 thousand and over increased $11 million, and other interest
bearing deposits increased $5 million. Public funds totaled $59 million
at the end of 2007 ($58 million were interest bearing), a decrease of $1
million from the end of 2006.
For 2006, total deposits increased $37 million to $469 million.
Noninterest bearing deposits decreased $15 million, while time deposits
of $100 thousand and over increased $6 million, and other interest
bearing deposits increased $16 million. Public funds totaled $60
million at the end of 2006 ($59 million were interest bearing).
The table below provides information on the maturities of time deposits
of $100,000 or more at December 31, 2007:
Maturity of Time Deposits of $100,000 of More
At December 31, 2007
(in thousands)
Maturing 3 Months or Less $10,127
Maturing over 3 Months through 6 Months 21,207
Maturing over 6 Months through 12 Months 26,367
Maturing over 12 Months 20,360
Total $78,061
Borrowings
The Company utilizes both long and short term borrowings. Long term
borrowing at the Bank is mainly from the Federal Home Loan Bank (FHLB).
This borrowing is mainly used to fund longer term, fixed rate mortgages,
as part of a leverage strategy and to assist in asset/liability
management. Advances are either paid monthly or at maturity. As of
December 31, 2007, $64 million was borrowed from FHLB, a decrease of $16
million from 2006. In 2007, $16 million of FHLB advances were paid and
no additional advances were obtained. During 2006, $83 million of FHLB
borrowing was paid, and advances were made for an additional $90
million. The remaining $7 million was obtained in the Peoples
acquisition. The 2006 advances were obtained mainly to fund fixed rate
loans, as detailed above. The following table depicts relevant
information concerning our short term borrowings.
Short Term Borrowings
As of and for the year ended
December 31 (in thousands)
2007 2006 2005
Federal Funds Purchased:
Balance at Year end $ - $ - $ 1,470
Average Balance During the Year 117 8,616 3,001
Maximum Month End Balance - 27,723 15,919
Year end rate - - 4.25%
Average annual rate 5.24% 5.37% 2.95%
Repurchase Agreements:
Balance at Year end $ 5,977 $ 9,628 $14,346
Average Balance During the Year 10,415 15,661 16,014
Maximum Month End Balance 16,073 18,372 18,072
Year end rate 4.72% 3.83% 3.18%
Average annual rate 4.18% 3.79% 3.19%
Other Borrowed Funds:
Balance at Year end $ 758 $ 1,699 $ 1,021
Average Balance During the Year 1,186 1,719 457
Maximum Month End Balance 2,036 8,508 1,021
Year end rate 4.79% 5.90% 4.00%
Average annual rate 5.58% 6.15% 3.10%
Contractual Obligations
The Bank has required future payments for a defined benefit retirement
plan, time deposits and long-term debt. See Note 13 in the notes to
consolidated financial statements included as Exhibit 13 for further
information on the defined benefit retirement plan. The other required
payments under such commitments at December 31, 2007 are as follows:
Payments due by period (in thousands)
Less More
than 1 1-3 3-5 than 5
Contractual Obligations Total year years years years
FHLB advances $ 63,993 $ 15,079 $33,005 $3,039 $12,870
Subordinated debentures 7,217 - - - 7,217
Time deposits 245,391 187,127 51,555 5,978 731
Asset Quality
With respect to asset quality, management considers three categories of
assets to merit close scrutiny. These categories include: loans that
are currently nonperforming, other real estate, and loans that are
currently performing but which management believes require special
attention.
During periods of economic slowdown, the Company may experience an
increase in nonperforming loans.
The Company discontinues the accrual of interest on loans that become 90
days past due as to principal or interest unless reasons for delinquency
are documented such as the loan being well collateralized and in the
process of collection. A loan remains in a non-accrual status until
factors indicating doubtful collection no longer exist. A loan is
classified as a restructured loan when the interest rate is materially
reduced or the term is extended beyond the original maturity date
because of the inability of the borrower to service the interest
payments at market rates. Other real estate is recorded at fair market
value less estimated costs to sell. A summary of the components of
nonperforming assets, including several ratios using period-end data, is
shown below.
Nonperforming Assets
At December 31 (dollars in thousands)
2007 2006 2005 2004 2003
Non-accrual Loans $ 6,358 $ 2,379 $ 774 $ 1,781 $ 1,844
Accruing Loans which are
Contractually past due
90 days or more 195 253 206 308 779
Restructured Loans - - - - -
Total Nonperforming Loans 6,553 2,632 980 2,089 2,623
Other Real Estate 768 411 141 676 375
Total Nonperforming Assets 7,321 3,043 1,121 2,765 2,998
Total Nonperforming Loans as a
Percentage of Loans (including
loans held for sale) (1) 1.57% 0.59% 0.26% 0.58% 0.82%
Total Nonperforming Assets
as a Percentage of Total Assets 1.16% 0.48% 0.20% 0.52% 0.60%
Allowance to nonperforming assets 0.67 1.64 3.84 1.51 1.27
(1) Net of deferred loan fees
Total nonperforming assets at December 31, 2007 were $7.3 million
compared to $3.0 million at December 31, 2006 and $1.1 million at
December 31, 2005. The increase from 2006 to 2007 is attributable to
the increase in various loans being put on non-accrual and additions to
other real estate. Total nonperforming loans were $6.6 million, $2.6
million, and $1.0 million at December 31, 2007, 2006 and 2005,
respectively. The non-accrual loan increase from 2006 to 2007 is mainly
attributable to a $2.0 million loan, a $921 thousand loan and 13 other
loans greater than $100,000, but less than $245,000. All these loans
are secured by real estate. The amount of lost interest on our non-
accrual loans is immaterial. At December 31, 2007, loans currently
performing but which management believes require special attention were
not significant. The Company continues to follow its long-standing
policy of not engaging in international lending and not concentrating
lending activity in any one industry.
Impaired loans as of December 31, 2007 were $6.4 million compared to
$2.4 million in 2006 and $800 thousand in 2005. These amounts are
included in the total nonperforming and restructured loans presented in
the table above. See Note 4 in the notes to consolidated financial
statements included as Exhibit 13.
A loan is considered impaired when it is probable that all principal and
interest amounts will not be collected according to the loan contract.
The allowance for loan losses on impaired loans is determined using the
present value of estimated future cash flows of the loan, discounted at
the loan's effective interest rate or the fair value of the underlying
collateral. The entire change in present value of expected cash flows
is reported as a provision for loan losses in the same manner in which
impairment initially was recognized or as a reduction in the amount of
provision for loan losses that otherwise would be reported. The total
allowance for loan losses related to these loans was $934 thousand, $553
thousand and $240 thousand on December 31, 2007, 2006 and 2005,
respectively.
Loan Losses
The following table is a summary of the Company's loan loss experience
for each of the past five years.
For the Year Ended December 31 (in thousands)
2007 2006 2005 2004 2003
Balance at Beginning of Year $ 4,991 $ 4,310 $ 4,163 $ 3,820 $ 3,395
Balance of Allowance for Loan
Losses of Acquired Bank
at Acquisition Date - 775 - - 363
Amounts Charged-off:
Commercial 131 15 146 197 569
Real Estate Construction 374 28 - - -
Real Estate Mortgage 289 232 134 110 276
Agricultural 25 3 21 88 24
Consumer 449 365 225 293 529
Total Charged-off Loans 1,268 643 526 688 1,398
Recoveries on Amounts
Previously Charged-off:
Commercial 24 2 3 10 11
Real Estate Construction 19 - - - -
Real Estate Mortgage 10 2 11 42 1
Agricultural 64 21 16 21 21
Consumer 39 49 135 118 127
Total Recoveries 156 74 165 191 160
Net Charge-offs 1,112 569 361 497 1,238
Provision for Loan Losses 1,000 475 508 840 1,300
Balance at End of Year 4,879 4,991 4,310 4,163 3,820
Total Loans (1)
Average 430,884 408,131 361,732 338,465 290,502
At December 31 417,388 444,150 370,912 358,456 320,761
As a Percentage of Average Loans (1):
Net Charge-offs 0.26% 0.14% 0.10% 0.15% 0.43%
Provision for Loan Losses 0.23% 0.12% 0.14% 0.25% 0.45%
Allowance as a Percentage of
Year-end Loans (1) 1.17% 1.12% 1.16% 1.16% 1.19%
Beginning Allowance as a Multiple
of Net Charge-offs 4.5 7.6 11.5 7.7 2.7
Ending Allowance as a Multiple
of Nonperforming Assets 0.67 1.64 3.84 1.51 1.27
(1) Including loans held for sale, net of deferred loan fees
Loans are typically charged-off after being 120 days delinquent.
Limited exceptions for not charging-off a loan would be well documented
and approved by the appropriate responsible party or committee. The
provision for loan losses for 2007 was $1 million dollars compared to
$475 thousand in 2006 and $508 thousand in 2005. Net charge-offs were
$1.1 million in 2007, $569 thousand in 2006 and $361 thousand in 2005.
Net charge-offs to average loans were 0.26%, 0.14% and 0.10% in 2007,
2006 and 2005, respectively. Based on the quality of the loan
portfolio, the loan loss provision increased $525 thousand from 2006 to
2007 and decreased slightly from 2005 to 2006. In evaluating the
allowance for loan losses, management considers the composition of the
loan portfolio, the historical loan loss experience, the overall quality
of the loans and an assessment of current economic conditions. The
recent decline in the economy has resulted in more loan losses, higher
loan loss provision and declining loan quality numbers over the past
year. At December 31, 2007, the allowance for loan losses was 1.17% of
loans outstanding compared to 1.12% at year-end 2006 and 1.16% at year-
end 2005. Management believes the allowance for loan losses at the end
of 2007 is adequate to cover probable incurred credit losses within the
portfolio.
The following tables set forth an allocation for the allowance for loan
losses and loans by category and a percentage distribution of the
allowance allocation. In making the allocation, management evaluates
the risk in each category, current economic conditions and charge-off
experience. An allocation for the allowance for loan losses is an
estimate of the portion of the allowance that will be used to cover
future charge-offs in each loan category, but it does not preclude any
portion of the allowance allocated to one type of loan being used to
absorb losses of another loan type.
Allowance for Loan Losses
2007 2006 2005 2004 2003
Dollars Percentage Dollars Percentage Dollars Percentage Dollars Percentage Dollars Percentage
Commercial $ 537 11.01% $ 594 11.90% $ 507 11.77% $ 350 8.41% $ 262 6.86%
Real Estate Construction 633 12.97% 638 12.78% 566 13.14% 566 13.60% 266 6.96%
Real Estate Mortgage 1,827 37.45% 1,806 36.19% 1,785 41.42% 1,801 43.26% 1,804 47.23%
Agricultural 1,180 24.18% 1,241 24.86% 1,023 23.74% 1,028 24.69% 995 26.05%
Consumer 702 14.39% 712 14.27% 428 9.93% 418 10.04% 493 12.91%
Total 4,879 100.00% 4,991 100.00% 4,309 100.00% 4,163 100.00% 3,820 100.00%
Loans
2007 2006 2005 2004 2003
Dollars Percentage Dollars Percentage Dollars Percentage Dollars Percentage Dollars Percentage
Commercial $ 22,924 5.49% $ 29,335 6.60% $ 27,302 7.36% $ 19,999 5.58% $ 14,278 4.45%
Real Estate Construction 26,172 6.27% 29,034 6.54% 29,822 8.04% 32,256 9.00% 14,313 4.46%
Real Estate Mortgage 270,494 64.81% 290,068 65.31% 245,138 66.09% 238,651 66.58% 222,288 69.30%
Agricultural 80,774 19.35% 79,627 17.93% 59,328 16.00% 57,497 16.04% 56,615 17.65%
Consumer 15,421 3.69% 15,684 3.53% 8,954 2.41% 9,062 2.53% 12,978 4.05%
Other 1,603 0.39% 402 0.09% 368 0.10% 991 0.28% 289 0.09%
Total, Net (1) 417,388 100.00% 444,150 100.00% 370,912 100.00% 358,456 100.00% 320,761 100.00%
(1) Including loans held for sale, net of deferred loan fees
Off-balance Sheet Arrangements
Some financial instruments, such as loan commitments, credit lines, letters of
credit, and overdraft protection, are issued to meet customer financing needs.
These are agreements to provide credit or to support the credit of others, as
long as conditions established in the contract are met, and usually have
expiration dates. Commitments may expire without being used. Off-balance
sheet risk to credit loss exists up to the face amount of these instruments,
although material losses are not anticipated. The same credit policies are
used to make such commitments as are used for loans, including obtaining
collateral at exercise of the commitment.
Financial instruments with off-balance sheet risk were as follows at year-end:
2007 2006
Unused lines of credit $ 65,298,282 $ 67,921,443
Commitments to make loans 1,871,000 658,000
Letters of credit 907,335 639,538
Unused lines of credit are substantially all at variable rates. Commitments to
make loans are generally made for a period of 60 days or less and are primarily
fixed at current market rates ranging from 5.50% to 6.50% with maturities
ranging from 15 to 30 years and are intended to be sold.
Capital
As displayed by the following table, the Company's Tier I capital (as
defined by the Federal Reserve Board under the Board's risk-based
guidelines) at December 31, 2007 increased $3.1 million to $51.5
million. During 2007, the Company purchased 30,202 shares of its stock
for $933 thousand. These repurchases partially offset the $6.6 million
in net income for 2007. Stockholders' equity, excluding accumulated
other comprehensive income, was $59.4 million at December 31, 2007.
Included in Tier I capital is $7 million of trust preferred securities
issued in August 2003. The disallowed amount of stockholders' equity is
mainly attributable to the goodwill and core deposit intangible,
resulting from the Peoples acquisition in 2006 and the Kentucky First
acquisition in 2003(see Note 6 in the notes to consolidated financial
statements included as Exhibit 13 for more information on the goodwill
and core deposit intangible assets). The Company's risk-based capital
and leverage ratios, as shown in the following table, exceeded the
levels required to be considered "well capitalized". The leverage ratio
compares Tier I capital to total average assets less disallowed amounts
of goodwill.
At December 31 (dollars in thousands)
2007 2006 Change
Stockholders' Equity (1) $ 59,432 $ 56,595 2,837
Trust Preferred Securities 7,000 7,000 -
Less Disallowed Amount 14,904 15,175 (271)
Tier I Capital 51,528 48,420 3,108
Allowance for Loan Losses 4,954 5,067 (113)
Other 9 5 4
Tier II Capital 4,963 5,072 (109)
Total Capital 56,491 53,492 2,999
Total Risk Weighted Assets 414,171 426,900 (12,729)
Ratios:
Tier I Capital to Risk-weighted Assets 12.4% 11.3% 1.1%
Total Capital to Risk-weighted Assets 13.6% 12.5% 1.1%
Leverage 8.4% 7.8% 0.6%
(1) Excluding accumulated other comprehensive income.
The Federal Deposit Insurance Corporation Improvement Act of 1991
("FDICIA") established five capital categories for insured depository
institutions under its Prompt Corrective Action Provisions. The bank
regulatory agencies adopted regulations, which became effective in 1992,
defining these five capital categories for banks they regulate. The
categories vary from "well capitalized" to "critically
undercapitalized". A "well capitalized" bank is defined as one with a
total risk-based capital ratio of 10% or more, a Tier I risk-based
capital ratio of 6% or more, a leverage ratio of 5% or more, and one not
subject to any order, written agreement, capital directive, or prompt
corrective action directive to meet or maintain a specific capital
level. At December 31, 2007, the bank had ratios that exceeded the
minimum requirements established for the "well capitalized" category.
In management's opinion, there are no other known trends, events or
uncertainties that will have or that are reasonably likely to have a
material effect on the Company's liquidity, capital resources or
operations.
Securities and Federal Funds Sold
Securities, classified as available for sale, increased from $127.9
million at December 31, 2006 to $147.8 million at December 31, 2007.
The increase is mainly attributable to a short term increase in deposits
and a decline in loans. Federal funds sold totaled $10.4 million at
December 31, 2007 and $4.1 million at December 31, 2006.
Per Company policy, fixed rate asset backed securities will not have an
average life exceeding seven years, but final maturity may be longer.
Adjustable rate securities shall adjust within three years per Company
policy. As of December 31, 2007 and 2006, the Company held no
adjustable rate mortgage backed securities. Unrealized gains (losses)
on investment securities are temporary and change inversely with
movements in interest rates. In addition, some prepayment risk exists
on mortgage-backed securities and prepayments are likely to increase
with decreases in interest rates. The following tables present the
investment securities for each of the past three years and the maturity
and yield characteristics of securities as of December 31, 2007.
Investment Securities at market value
At December 31 (in thousands)
2007 2006 2005
Available for Sale
U.S. treasury $ - $ - $ 2,974
U.S. government agencies 36,021 31,492 67,033
States and political subdivisions 59,361 44,130 37,463
Mortgage-backed
Fixed -
GNMA, FNMA, FHLMC Passthroughs 40,261 38,262 33,566
GNMA, FNMA, FHLMC CMO's 11,817 13,720 17,390
Total 52,078 51,982 50,956
Variable -
GNMA, FNMA, FHLMC Passthroughs - - 1,081
GNMA, FNMA, FHLMC CMO's - - 303
Total - - 1,384
Total mortgage-backed 52,078 51,982 52,340
Other 290 287 842
Total 147,750 127,891 160,652
Maturity Distribution of Securities
December 31, 2007 (in thousands)
Over One Over Five Asset
Year Years Backed
One Year Through Through Over Ten & Equity
or Less Five Years Ten Years Years Securities Total
Available for Sale
U.S. treasury $ - $ - $ - $ - $ - $ -
U.S. government agencies 23,190 9,992 2,839 - - 36,021
States and political subdivisions 1,180 7,513 16,335 34,333 - 59,361
Mortgage-backed - - - - 52,078 52,078
Equity Securities - - - - 290 290
Total 24,370 17,505 19,174 34,333 52,368 147,750
Percent of Total 16.5% 11.8% 13.0% 23.2% 35.4% 100.0%
Weighted Average Yield (1) 4.25% 4.24% 5.67% 6.41% 5.27% 5.30%
(1) Tax Equivalent yield
Impact of Inflation and Changing Prices
The majority of the Company's assets and liabilities are monetary in
nature. Therefore, the Company differs greatly from most commercial and
industrial companies that have significant investments in nonmonetary
assets and inventories. However, inflation does have an important
impact on the growth of assets in the banking industry and the resulting
need to increase equity capital at higher than normal rates in order to
maintain an appropriate equity to assets ratio. Inflation also affects
other expenses, which tend to rise during periods of inflation.
Item 7A. Asset/Liability Management, Interest Rate Sensitivity, Market
Risk and Liquidity
Asset/Liability management control is designed to ensure safety and
soundness, maintain liquidity and regulatory capital standards, and
achieve acceptable net interest income. The Company's exposure to
market risk is reviewed on a regular basis by the Asset/Liability
Committee.
Management considers interest rate risk to be the most significant
market risk. 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. Certain assumptions, such as
prepayment risks, are included in the model. However, actual
prepayments may differ from those assumptions. In addition, immediate
withdrawal of interest checking and other savings accounts may have an
effect on the results of the 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. The projections are
based on balance sheet growth assumptions and repricing opportunities
for new, maturing and adjustable rate amounts. In addition, the
projected percentage changes from level rates are outlined below along
with the Board of Directors approved limits. As of December 31, 2007
the projected net interest income percentages are within the Board of
Directors limits. The projected net interest income report summarizing
the Company's interest rate sensitivity as of December 31, 2007 and
December 31, 2006 is as follows:
Projected Net Interest Income (December 31, 2007)
Level
Rate Change: -300 -100 Rates +100 +300
Year One (1/08 - 12/08)
Net interest income 21,293 21,608 21,815 21,758 21,943
Net interest income dollar change (522) (207) - (57) 128
Net interest income percentage change -2.4% -0.9% N/A -0.3% 0.6%
Limitation on % Change >-18.0% >-6.0% N/A >-4.0% >-10.0%
Projected Net Interest Income (December 31, 2006)
Level
-300 -100 Rates +100 +300
Year One (1/07 - 12/07)
Net interest income 16,102 17,505 18,064 18,557 19,374
Net interest income dollar change (1,962) (559) - 493 1,310
Net interest income percentage change -10.9% -3.1% N/A 2.7% 7.3%
Limitation on % Change >-18.0% >-6.0% N/A >-4.0% >-10.0%
The numbers in 2007 show less fluctuation when compared to 2006. In
2007, year one reflected a decrease in net interest income of 0.9%
compared to 3.1% projected decrease from 2006 with a 100 basis point
decline. The 300 basis point increase in rates reflected a 0.6%
increase in net interest income in 2007 compared to a 7.3% increase in
2006. The risk is less in 2007 due to the current status of existing
interest rates and their effect on rate sensitive assets and rate
sensitive liabilities. Based on the model, a decrease in rates or a 100
basis point increase in rates would result in a decrease in net interest
income, and a 300 basis point increase in rates would increase net
interest income.
Management measures the Company's interest rate risk by computing
estimated changes in net interest income in the event of a range of
assumed changes in market interest rates. The Company's exposure to
interest rates is reviewed on a monthly basis by senior management and
quarterly with the Board of Directors. Exposure to interest rate risk
is measured with the use of interest rate sensitivity analysis to
determine the change in net interest income in the event of hypothetical
changes in interest rates, while interest rate sensitivity gap analysis
is used to determine the repricing characteristics of the Company's
assets and liabilities. If estimated changes to net interest income are
not within the limits established by the Board, the Board may direct
management to adjust the Company's asset and liability mix to bring
interest rate risk within Board approved limits.
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
meet the needs of borrowers, depositors and creditors. Excess liquidity
generally has a negative impact on earnings resulting from the lower
yields on short-term assets.
In addition to cash and cash equivalents, the securities portfolio
provides an important source of liquidity. Total securities maturing
within one year along with cash and cash equivalents totaled $50.1
million at December 31, 2007. Additionally, securities available-for-
sale with maturities greater than one year totaled $123.4 million at
December 31, 2007. The available for sale securities are available to
meet liquidity needs on a continuing basis.
The Company maintains a relatively stable base of customer deposits and
its steady growth is expected to be adequate to meet its funding
demands. In addition, management believes the majority of its $100,000
or more certificates of deposit are no more volatile than its core
deposits. At December 31, 2007 these balances totaled $78.1 million,
approximately 16% of total deposits.
The Company also 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. We have
sufficient collateral to borrow an additional $49 million from the FHLB
at December 31, 2007.
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
believes there is sufficient cash flow from operations to meet investing
and liquidity needs related to reasonable borrower, depositor and
creditor needs in the present economic environment.
The cash flow statements for the periods presented provide an indication
of the Company's sources and uses of cash as well as an indication of
the ability of the Company to maintain an adequate level of liquidity.
A number of other techniques are used to measure the liquidity position,
including the ratios presented below. These ratios are calculated based
on annual averages for each year.
Liquidity Ratios
December 31
2007 2006 2005
Average Loans (including loans held
for sale)/Average Deposits 89.6% 93.6% 90.4%
Average Securities sold under
agreements to repurchase and other
borrowings/Average Assets 3.0% 5.6% 4.9%
This chart shows that the loan to deposit ratio decreased in 2007 and
increased in 2006. The decrease in the ratio in 2007 compared to 2006
is mainly attributable to an increase in deposits and a decrease in
loans. The increase in the ratio in 2006 compared to 2005 is mainly
attributable to a larger increase in loans compared to deposits.
Item 8. Financial Statements
The consolidated financial statements of the Company together with the
notes thereto and report of independent registered public accountants
are contained in the Company's 2007 Annual Report to Stockholders
included as Exhibit 13, and are incorporated herein by reference. No
other portion of the 2007 Annual Report to Stockholders is to be deemed
"filed" as part of this filing.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Audit Committee
Kentucky Bancshares, Inc.
Paris, Kentucky
We have audited the accompanying balance sheets of Kentucky Bancshares, Inc.
as of December 31, 2007 and 2006, and the related statements of operations,
stockholders' equity, and cash flows for each of the three years in the period
ended December 31, 2007. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we
plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. The Company is not
required to have, nor were we engaged to perform, an audit of its internal
control over financial reporting. Our audit included consideration of
internal control over financial reporting as a basis for designing audit
procedures that are appropriate in the circumstances, but not for the purpose
of expressing an opinion on the effectiveness of the Company's internal
control over financial reporting. Accordingly, we express no such opinion.
An audit includes examining, on a test basis, evidence supporting the amounts
and disclosures in the financial statements. An audit also includes assessing
the accounting principles used and significant estimates made by management,
as well as evaluating the overall financial statement presentation. We believe
that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of the Company as of December
31, 2007 and 2006, and the results of its operations and its cash flows for
each of the three years in the period ended December 31, 2007, in conformity
with U.S. generally accepted accounting principles.
/s/Crowe Chizek and Company LLC
Crowe Chizek and Company LLC
Lexington, Kentucky
March 3, 2008
KENTUCKY BANCSHARES, INC.
Paris, Kentucky
CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2007, 2006 and 2005
CONSOLIDATED BALANCE SHEETS
December 31
2007 2006
ASSETS
Cash and due from banks $ 15,445,596 $ 14,905,672
Federal funds sold 10,361,000 4,106,000
Cash and cash equivalents 25,806,596 19,011,672
Securities available for sale 147,749,546 127,890,612
Loans 417,388,048 444,150,390
Allowance for loan losses (4,878,732) (4,991,277)
Net loans 412,509,316 439,159,113
Federal Home Loan Bank stock 6,468,200 6,468,200
Bank premises and equipment, net 16,323,314 14,327,050
Interest receivable 5,219,814 5,653,869
Mortgage servicing rights 696,826 745,834
Goodwill 13,116,710 13,116,710
Other intangible assets 1,787,413 2,058,149
Other assets 1,261,106 1,111,094
Total assets $ 630,938,841 $ 629,542,303
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits
Non-interest bearing $ 88,520,944 $ 87,503,263
Time deposits, $100,000 and over 78,060,572 67,255,274
Other interest bearing 319,423,702 314,049,382
Total deposits 486,005,218 468,807,919
Repurchase agreements and other borrowings 6,734,630 11,326,913
Federal Home Loan Bank advances 63,993,472 80,030,283
Subordinated debentures 7,217,000 7,217,000
Interest payable 4,983,549 3,682,785
Other liabilities 3,160,874 3,196,604
Total liabilities 572,094,743 574,261,504
Stockholders' equity
Preferred stock, 300,000 shares
authorized and unissued - -
Common stock, no par value; 10,000,000
shares authorized; 2,849,056 and
2,864,586 shares issued and
outstanding in 2007 and 2006 12,517,029 12,474,039
Additional paid-in capital 155,553 59,375
Retained earnings 46,759,262 44,061,889
Accumulated other comprehensive income (loss) (587,746) (1,314,504)
Total stockholders' equity 58,844,098 55,280,799
Total liabilities and stockholders' equity $ 630,938,841 $ 629,542,303
See Accompanying notes.
CONSOLIDATED STATEMENTS OF INCOME
Years Ended December 31
2007 2006 2005
Interest income
Loans, including fees $ 31,798,307 $ 29,068,728 $ 23,373,434
Securities
Taxable 3,810,348 4,395,404 3,388,793
Tax exempt 2,134,600 1,666,382 1,444,090
Other 1,475,831 462,333 690,660
39,219,086 35,592,847 28,896,977
Interest expense
Deposits 15,124,114 12,117,444 8,180,571
Repurchase agreements and other
borrowings 506,835 1,162,350 603,812
Federal Home Loan Bank advances 2,908,818 2,944,217 2,487,062
Subordinated debentures 494,338 494,197 494,227
19,034,105 16,718,208 11,765,672
Net interest income 20,184,981 18,874,639 17,131,305
Provision for loan losses 1,000,000 475,000 508,100
Net interest income after provision
for loan losses 19,184,981 18,399,639 16,623,205
Other income
Service charges 5,495,499 5,223,973 4,511,270
Loan service fee income, net 57,867 33,020 9,023
Trust department income 515,149 602,884 458,328
Securities gains (losses), net 36,556 34,259 64,395
Gain on sale of mortgage loans 432,314 290,035 333,742
Other 1,398,673 1,051,765 1,118,289
7,936,058 7,235,936 6,495,047
Other expenses
Salaries and employee benefits 10,593,544 9,612,798 8,547,607
Occupancy expenses 2,560,353 2,320,418 2,194,431
Amortization 270,736 184,736 95,736
Advertising and marketing 545,648 519,685 473,848
Taxes other than payroll, property
and income 683,443 537,485 547,509
Other 3,477,231 3,506,589 3,361,280
18,130,955 16,681,711 15,220,411
Income before income taxes 8,990,084 8,953,864 7,897,841
Provision for income taxes 2,404,132 2,467,810 2,077,741
Net income $ 6,585,952 $ 6,486,054 $ 5,820,100
Earnings per share:
Basic $ 2.31 $ 2.35 $ 2.17
Diluted 2.30 2.34 2.16
See Accompanying notes.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Years Ended December 31
2007 2006 2005
Net income $ 6,585,952 $ 6,486,054 $ 5,820,100
Other comprehensive income (loss)
Unrealized gains (losses) on
securities arising during
the period 892,171 735,236 (1,839,887)
Reclassification of realized amount (36,556) (34,259) (64,395)
Net change in unrealized
gain (loss) on securities 855,615 700,977 (1,904,282)
Less: Tax impact 290,909 238,332 (647,456)
Changes related to SFAS No. 158:
Net gain (loss) 210,941 - -
Amortization of net gain (loss) 34,592 - -
Total recognized in other
comprehensive income 245,533
Less: Tax impact 83,481 - -
Comprehensive income $ 7,312,710 $ 6,948,699 $ 4,563,274
See Accompanying notes.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
Years Ended December 31, 2007, 2006 and 2005
Accumulated
Additional Other Total
Common Stock Paid-in Retained Comprehensive Stockholders'
Shares Amount Capital Earnings Income Equity
Balances, January 1, 2005 2,684,498 $ 6,818,664 $ - $ 37,884,215 $ 323,932 $ 45,026,811
Common stock issued (including
employee gifts of 75 shares) 3,375 47,595 - - - 47,595
Common stock purchased (20,976) (53,454) - (575,945) - (629,399)
Net change in unrealized gain (loss)
on securities available for sale,
net of tax - - - - (1,256,826) (1,256,826)
Net income - - - 5,820,100 - 5,820,100
Dividends declared - $0.92 per share - - - (2,462,038) - (2,462,038)
Balances, December 31, 2005 2,666,897 $ 6,812,805 $ - $ 40,666,332 $ (932,894) $ 46,546,243
Common stock issued including tax
benefit, net (including
stock grants of 3,845 shares) 11,754 117,741 - - - 117,741
Stock compensation expense - - 59,375 - - 59,375
Common stock purchased (12,901) (56,385) - (322,069) - (378,454)
Common stock issued in connection
with Purchase of Peoples
Bancorp, Inc. 198,836 5,599,878 - - - 5,599,878
Net change in unrealized gain (loss)
on securities available for sale,
net of tax - - - - 462,645 462,645
Adjustment to initially apply
SFAS No. 158, net of tax - - - - (844,255) (844,255)
Net income - - - 6,486,054 - 6,486,054
Dividends declared - $1.00 per share - - - (2,768,428) - (2,768,428)
Balances, December 31, 2006 2,864,586 $12,474,039 $ 59,375 $ 44,061,889 $(1,314,504) $ 55,280,799
Common stock issued including tax
benefit, net (including
stock grants of 4,961 shares and
employee gifts of 93 shares) 14,672 175,387 - - - 175,387
Stock compensation expense - - 96,178 - - 96,178
Common stock purchased (30,202) (132,397) - (800,680) - (933,077)
Net change in unrealized gain (loss)
on securities available for sale,
net of tax - - - - 564,706 564,706
Net change related to
SFAS No. 158, net of tax - - - - 162,052 162,052
Net income - - - 6,585,952 - 6,585,952
Dividends declared - $1.08 per share - - - (3,087,899) - (3,087,899)
Balances, December 31, 2007 2,849,056 $12,517,029 $ 155,553 $ 46,759,262 $ (587,746) $ 58,844,098
See Accompanying notes.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31
2007 2006 2005
Cash flows from operating activities
Net income $ 6,585,952 $ 6,486,054 $ 5,820,100
Adjustments to reconcile net
income to net cash from
operating activities
Depreciation and amortization 1,499,855 1,313,476 1,174,954
Provision for loan losses 1,000,000 475,000 508,100
Securities amortization
(accretion), net (178,289) (14,717) 331,355
Securities (gains) losses, net (36,556) (34,259) (64,395)
Originations of loans held
for sale (16,061,200) (17,156,711) (18,036,701)
Proceeds from sale of loans 16,493,514 17,446,746 18,545,914
Gain on sale of mortgage loans (432,314) (290,035) (333,742)
Stock based compensation expense 96,178 59,375 -
Federal Home Loan Bank stock
dividends - (342,200) (261,600)
Losses (gain) on sale of fixed
assets (2,672) (1,100) (71,045)
Changes in:
Interest receivable 434,055 (1,318,246) (492,656)
Other assets (315,071) (1,906,617) 425,569
Interest payable 1,300,764 836,125 865,038
Other liabilities (164,587) 723,683 624,374
Net cash from operating activities 10,219,629 6,276,574 9,035,265
Cash flows from investing activities
Purchases of securities (100,874,783) (30,905,332) (53,539,693)
Proceeds from sales of securities 19,323,795 42,207,571 1,323,500
Proceeds from principal payments
and maturities of securities 62,762,514 53,343,210 16,159,467
Cash paid for bank acquisition - (2,841,873) -
Net change in loans 25,649,797 (22,106,318) (13,067,340)
Purchases of bank premises and equipment (3,037,632) (1,540,977) (758,929)
Proceeds from sale of bank premises and
Equipment 2,672 1,100 581,881
Net cash from investing activities 3,826,363 38,157,381 (49,301,114)
Cash flows from financing activities
Net change in deposits 17,197,299 (35,102,694) 43,676,556
Net change in repurchase agreements and
other borrowings (3,892,283) (9,380,282) (8,755,271)
Advances from Federal Home Loan Bank - 90,000,000 15,000,000
Payments on Federal Home Loan
Bank advances (16,010,495) (83,074,662) (7,902,073)
Proceeds from note payable - 8,000,000 -
Payments on note payable (700,000) (7,000,000) -
Proceeds from issuance of common stock,
including options and grants, including
tax benefits 175,387 117,741 47,595
Purchase of common stock (933,077) (378,454) (629,399)
Dividends paid (3,087,899) (2,768,428) (2,462,038)
Net cash from financing activities (7,251,068) (39,586,779) 38,975,370
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31
2007 2006 2005
Net change in cash and cash equivalents $ 6,794,924 $ 4,847,176 $ (1,290,479)
Cash and cash equivalents at
beginning of year 19,011,672 14,164,496 15,454,975
Cash and cash equivalents at end of year $ 25,806,596 $ 19,011,672 $ 14,164,496
Supplemental disclosures of cash flow information
Cash paid during the year for:
Interest expense $ 17,733,341 $ 15,749,929 $ 10,900,634
Income taxes 2,600,000 2,498,021 1,971,443
Supplemental schedules of non-cash investing
activities
Real estate acquired through foreclosure $ 914,000 $ 396,472 $ 391,743
Common stock issued in connection with
purchase of Peoples Bancorp, Inc. - 5,599,878 -
See Accompanying notes.
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation: The consolidated financial statements include the
accounts of Kentucky Bancshares, Inc. (the Company) and its wholly-owned
subsidiary, Kentucky Bank (the Bank). Intercompany transactions and balances
have been eliminated in consolidation. 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 and Morehead in Elliott and
Rowan Counties, Kentucky, as discussed in Note 15.
Nature of Operations: The Bank operates under a state bank charter and
provides full banking services, including trust services, to customers located
in Bourbon, Clark, Elliot, Harrison, Jessamine, Rowan, Scott, Woodford and
adjoining counties in Kentucky. As a state bank, the Bank is subject to
regulation by the Kentucky Office of Financial Institutions and the Federal
Deposit Insurance Corporation (FDIC). The Company, a bank holding company, is
regulated by the Federal Reserve.
Estimates in the Financial Statements: 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 at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates. The allowance for loan
losses, mortgage servicing rights and fair value of financial instruments are
particularly subject to change.
Cash Flows: For purposes of reporting cash flows, cash and cash equivalents
include cash on hand, amounts due from banks, federal funds sold, and certain
short-term investments with maturities of less than three months. Generally,
federal funds are sold for one-day periods. Net cash flows are reported for
loan, deposit and short-term borrowing transactions.
Securities: The Company is required to classify its securities portfolio into
one of three categories: trading securities, securities available for sale and
securities held to maturity. Fair value adjustments are made to the securities
based on their classification with the exception of the held to maturity
category. The Company has no investments classified as trading securities, or
securities held to maturity. Securities available for sale are carried at fair
value, with unrealized holding gains and losses reported in other
comprehensive income.
Interest income includes amortization of purchase premium or discount.
Premiums and discounts on securities are amortized on the level-yield method
without anticipating prepayments, except for mortgage backed securities where
prepayments are anticipated. Gains and losses on sales are recorded on the
settlement date and determined using the specific identification method.
Declines in the fair value of securities below their cost that are other than
temporary are reflected as realized losses. In estimating other than
temporary losses, management considers: the length of time and extent that
fair value has been less than cost, the financial condition and near term
prospects of the issuer, and the Company's ability and intent to hold the
security for a period sufficient to allow for any anticipated recovery in fair
value.
Loans Held for Sale: Loans held for sale are valued at the lower of cost or
market as determined by outstanding commitments from investors or current
secondary market prices, calculated on the aggregate loan basis. The Company
also provides for any losses on uncovered commitments to lend or sell.
Loans: Loans are stated at the amount of unpaid principal, reduced by an
allowance for loan losses. Interest income on loans is recognized on the
accrual basis except for those loans on a nonaccrual status. The accrual of
interest on impaired loans is discontinued when management believes, after
consideration of economic and business conditions and collection efforts, that
the borrowers' financial condition is such that collection of interest is
doubtful. Interest income on mortgage and consumer loans is discontinued at
the time the loan is 90 days delinquent, and interest income on commercial
loans is discontinued at the time the loan is 120 days delinquent, unless the
loan is well-secured and in process of collection. Past due status is based
on the contractual terms of the loan. When interest accrual is discontinued,
interest income received on such loans is accounted for on the cash-basis or
cost-recovery method, until qualifying for return to accrual. Loans are
returned to accrual status when all the principal and interest amounts
contractually due are brought current and future payments are reasonably
assured. Consumer and credit card loans are typically charged off no later
than 120 days past due. Loans are placed on nonaccrual or charged-off at an
earlier date if collection of principal or interest is considered doubtful.
Loan origination fees and certain direct origination costs are capitalized and
recognized as an adjustment of the yield on the related loan.
Allowance for Loan Losses: The allowance for loan losses is a valuation
allowance for probable incurred credit losses, increased by the provision for
loan losses and decreased by charge-offs less recoveries. 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.
Allocations of the allowance may be made for specific loans, but the entire
allowance is available for any loan that, in management's judgment, should be
charged-off. Loan losses are charged against the allowance when management
believes the uncollectibility of a loan balance is confirmed.
A loan is impaired when full payment under the loan terms is not expected.
Impairment is evaluated in total for smaller-balance loans of similar nature
such as residential mortgage, consumer, and credit card loans, and on an
individual loan basis for other loans. If a loan is impaired, a portion of the
allowance is allocated so that the loan is reported, net, at the present value
of estimated future cash flows using the loan's existing rate or at the fair
value of collateral if repayment is expected solely from the collateral. Large
groups of smaller balance homogeneous loans, such as consumer and residential
real estate loans are collectively evaluated for impairment, and accordingly,
they are not separately identified for impairment disclosures.
Mortgage Servicing Rights: The Bank has sold certain residential mortgage
loans to the Federal Home Loan Mortgage Corporation (FHLMC) while retaining the
servicing rights.
Servicing rights are recognized separately when they are acquired through
sales of loans. For sales of mortgage loans prior to January 1, 2007, a
portion of the cost of the loan was allocated to the servicing right based on
relative fair values. The Company adopted SFAS No. 156 on January 1, 2007,
and for sales of mortgage loans beginning in 2007, servicing rights are
initially recorded at fair value with the income statement effect recorded in
gain on sale of mortgage loans. Fair value is based on market prices for
comparable mortgage servicing contracts, when available, or alternatively, is
based on a valuation model that calculates the present value of estimated
future net servicing income. The valuation model incorporates assumptions
that market participants would use in estimating future net servicing income,
such as the cost to service, the discount rate, the custodial earnings rate,
an inflation rate, ancillary income, prepayment speeds and default rates and
losses. The Company compares the valuation model inputs and results to
published industry data in order to validate the model results and
assumptions. All classes of servicing assets are subsequently measured using
the amortization method which requires servicing rights to be amortized into
non-interest income in proportion to, and over the period of, the estimated
future net servicing income of the underlying loans.
Servicing assets are evaluated for impairment based upon the fair value of the
rights as compared to carrying amount. Impairment is determined by
stratifying rights into groupings based on predominant risk characteristics,
such as interest rate, loan type and investor type. Impairment is recognized
through a valuation allowance for an individual grouping, to the extent that
fair value is less than the carrying amount. If the Company later determines
that all or a portion of the impairment no longer exists for a particular
grouping, a reduction of the allowance may be recorded as an increase to
income. The fair values of servicing rights are subject to significant
fluctuations as a result of changes in estimated and actual prepayment speeds
and default rates and losses.
Servicing fee income, which is reported on the income statement as loan
service income, net, is recorded for fees earned for servicing loans. The
fees are based on a contractual percentage of the outstanding principal; or a
fixed amount per loan and are recorded as income when earned. The
amortization of mortgage servicing rights is netted against loan servicing fee
income. Servicing fees totaled $271,934, $268,194 and $262,629 for the years
ended December 31, 2007, 2006 and 2005. Late fees and ancillary fees related
to loan servicing are not material.
Federal Home Loan Bank (FHLB) Stock: The Bank is a member of the FHLB system.
Members are required to own a certain amount of stock based on the level of
borrowings and other factors, and may invest in additional amounts. FHLB
stock is carried at cost, classified as a restricted security, and
periodically evaluated for impairment based on ultimate recovery of par value.
Both cash and stock dividends are reported as income.
Bank Premises and Equipment: Land is carried at cost. Bank premises and
equipment are stated at cost less accumulated depreciation. Buildings and
related components are depreciated using the straight-line method with useful
lives ranging from 5 to 50 years. Furniture, fixtures and equipment are
depreciated using the straight-line (or accelerated) method with useful lives
ranging from 3 to 10.
Real Estate Acquired Through Foreclosure: Real estate acquired through
foreclosure is initially recorded at fair value less costs to sell when
acquired, establishing a new cost basis. The value of the underlying loan is
written down to the fair value of the real estate to be acquired by a charge to
the allowance for loan losses, if necessary. Any subsequent write-downs are
charged to operating expenses. Operating expenses of such properties, net of
related income, and gains and losses on their disposition are included in other
expenses.
Repurchase Agreements: Substantially all repurchase agreement liabilities
represent amounts advanced by various customers. Securities are pledged to
cover these liabilities, which are not covered by federal deposit insurance.
Stock Compensation: Effective January 1, 2006, the Company adopted Statement
of Financial Accounting Standards ("SFAS") No. 123(R), Share-based Payment,
using the modified prospective transition method. Accordingly, the Company
has recorded stock-based employee compensation cost using the fair value
method starting in 2006.
Prior to January 1, 2006, employee compensation expense under stock options
was reported using the intrinsic value method; therefore, no stock-based
compensation cost is reflected in net income for the year ending December 31,
2005, 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.
The following table illustrates the effect on net income and earnings per
share if expense was measured using the fair value recognition provisions of
FASB Statement No. 123, Accounting for Stock-Based Compensation, for the year
ending December 31, 2005.
Net income
As reported $ 5,820,100
Deduct: Stock-based compensation
expense determined under fair
value based method (56,241)
Pro forma 5,763,859
2005
Basic earnings per share
As reported $ 2.17
Pro forma 2.15
Diluted earnings per share
As reported $ 2.16
Pro forma 2.14
Income Taxes: Income tax expense is the total of the current year income tax
due or refundable and the change in deferred tax assets and liabilities.
Deferred tax assets and liabilities are the expected future tax amounts for the
temporary differences between carrying amounts and tax bases of assets and
liabilities, computed using enacted tax rates. A valuation allowance, if
needed, reduces deferred tax assets to the amount expected to be realized.
The Company adopted FASB Interpretation 48, Accounting for Uncertainty in
Income Taxes ("FIN 48"), as of January 1, 2007. A tax position is recognized
as a benefit only if it is "more likely than not" that the tax position would
be sustained in a tax examination, with a tax examination being presumed to
occur. The amount recognized is the largest amount of tax benefit that is
greater than 50% likely of being realized on examination. For tax positions
not meeting the "more likely than not" test, no tax benefit is recorded. The
adoption had no affect on the Company's financial statements.
The Company recognizes interest related to income tax matters as interest
expense and penalties related to income tax matters as other expense.
Retirement Plans: Pension expense is the net of service cost, interest cost,
return on plan assets and amortization of gains and losses not immediately
recognized. Employee 401(k) and profit sharing plan expense is the amount of
matching contributions.
Goodwill: Goodwill results from prior business acquisitions and represents
the excess of the purchase price over the fair value of acquired tangible
assets and liabilities and identifiable intangible assets. Goodwill is
assessed at least annually for impairment and any such impairment will be
recognized in the period identified.
Intangible Assets: Intangible assets consist of core deposit intangible assets
arising from whole bank and branch acquisitions. They are initially measured
at fair value and then are amortized on either an accelerated or straight-line
basis, over ten or fifteen years.
Earnings Per Common Share: Basic earnings per common share is net income
divided by the weighted average number of common shares outstanding during the
period. Diluted earnings per common share include the dilutive effect of
additional potential common shares issuable under stock options. Earnings and
dividends per share are restated for all stock splits and dividends through the
date of issuance of the financial statements.
Comprehensive Income: Comprehensive income consists of net income and other
comprehensive income. Other comprehensive income includes unrealized gains and
losses on securities available for sale, which are also recognized as a
separate component of equity.
Derivatives: The Company periodically enters into non-exchange traded
mandatory forward sales contracts in conjunction with its mortgage banking
operation. These contracts, considered derivatives, typically last 60 to 90
days and are used to offset the risk of interest rate changes between the time
of the commitment to make a loan to a borrower at a stated rate and when the
loan is sold. These derivatives are carried at fair value. The Company did
not have any mandatory forward sales contracts at December 31, 2007 and 2006.
Adoption of New Accounting Standards: In February 2006, the FASB issued SFAS
No. 155, Accounting for Certain Hybrid Financial Instruments, which permits
fair value remeasurement for hybrid financial instruments that contain an
embedded derivative that otherwise would require bifurcation. Additionally,
SFAS No. 155 clarifies the accounting guidance for beneficial interests in
securitizations. Under SFAS No. 155, all beneficial interests in a
securitization will require an assessment in accordance with SFAS No. 133 to
determine if an embedded derivative exists within the instrument. In January
2007, the FASB issued Derivatives Implementation Group Issue B40, Application
of Paragraph 13(b) to Securitized Interests in Prepayable Financial Assets
(DIG Issue B40). DIG Issue B40 provides an exemption from the embedded
derivative test of paragraph 13(b) of SFAS No. 133 for instruments that would
otherwise require bifurcation if the test is met solely because of a
prepayment feature included within the securitized interest and prepayment is
not controlled by the security holder. SFAS No. 155 and DIG Issue B40 are
effective for fiscal years beginning after September 15, 2006. The adoption
of SFAS No. 155 and DIG Issue B40 did not have a material impact on the
Company's consolidated financial position or results of operations.
Effect of Newly Issued But Not Yet Effective Accounting Standards: In
September 2006, the FASB issued SFAS No. 157, Fair Value Measurements. This
Statement defines fair value, establishes a framework for measuring fair value
and expands disclosures about fair value measurements. This Statement
establishes a fair value hierarchy about the assumptions used to measure fair
value and clarifies assumptions about risk and the effect of a restriction on
the sale or use of an asset. The Statement is effective for fiscal years
beginning after November 15, 2007. The impact of adoption on January 1, 2008
was not material.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for
Financial Assets and Financial Liabilities. The Statement provides companies
with an option to report selected financial assets and liabilities at fair
value and establishes presentation and disclosure requirements designed to
facilitate comparisons between companies that choose different measurement
attributes for similar types of assets and liabilities. The new Statement is
effective for the Company on January 1, 2008. The Company did not elect the
fair value option for any financial assets or financial liabilities as of
January 1, 2008.
Operating Segments: While the Company's chief decision makers monitor the
revenue streams of the various Company products and services, operations are
managed and financial performance is evaluated on a Company-wide basis.
Accordingly, all of the Company's operations are considered by management to be
aggregated into one reportable operating segment.
NOTE 2 - RESTRICTIONS ON CASH AND DUE FROM BANKS
Included in cash and due from banks are certain non-interest bearing deposits
that are held at the Federal Reserve or maintained in vault cash in accordance
with average balance requirements specified by the Federal Reserve Board of
Governors. The reserve requirement at December 31, 2007 and 2006 was $369,000
and $322,000.
NOTE 3 - SECURITIES AVAILABLE FOR SALE
Year-end securities are as follows:
Fair Unrealized Unrealized
Value Gains Losses
2007
U. S. government agencies $ 36,020,468 $ 495,539 $ (10,085)
States and municipals 59,361,045 691,258 (661,819)
Mortgage-backed 52,077,818 218,221 (610,211)
Equity securities 290,215 20,215 -
Total $ 147,749,546 $ 1,425,233 $(1,282,115)
2006
U. S. government agencies 31,492,403 93,134 (124,991)
States and municipals 44,129,640 703,114 (181,988)
Mortgage-backed 51,981,681 - (1,218,655)
Equity securities 286,888 16,888 -
Total $ 127,890,612 $ 813,136 $(1,525,634)
The fair value of securities at December 31, 2007, by contractual maturity,
are shown below. Expected maturities will differ from contractual maturities
because borrowers may have the right to call or prepay obligations with or
without call or prepayment penalties. Securities not due at a single maturity
are shown separately.
Fair
Value
Due in one year or less $ 24,370,258
Due after one year through five years 17,504,764
Due after five years through ten years 19,173,452
Due after ten years 34,333,039
95,381,513
Mortgage-backed 52,077,818
Equity 290,215
Total $ 147,749,546
Proceeds from sales of securities during 2007, 2006 and 2005 were $19,323,795,
$42,207,571 and $1,323,500. Gross gains of $180,005, $452,218 and $89,943 and
gross losses of $143,449, $417,959 and $25,548, were realized on those sales,
respectively. The tax provision related to these realized gains and losses was
$12,429, $11,648 and $21,894, respectively.
Securities with an approximate carrying value of $112,499,000 and $108,120,000
at December 31, 2007 and 2006, were pledged to secure public deposits, trust
funds, securities sold under agreements to repurchase and for other purposes as
required or permitted by law.
Securities with unrealized losses at year end 2007 and 2006 not recognized in
income are as follows:
2007
Less than 12 Months 12 Months or More Total
Fair Unrealized Fair Unrealized Fair Unrealized
Description of Securities Value Loss Value Loss Value Loss
U.S. Government securities $21,947,522 $ (10,085) $ - $ - $ 21,947,522 $ (10,085)
States and municipals 21,940,792 (631,462) 7,054,136 (30,357) 28,994,928 (661,819)
Mortgage-backed 2,595,724 (4,834) 30,212,510 (605,377) 32,808,234 (610,211)
Total temporarily impaired $46,484,038 $ (646,381) $37,266,646 $ (635,734) $ 83,750,684 $(1,282,115)
2006
Less than 12 Months 12 Months or More Total
Fair Unrealized Fair Unrealized Fair Unrealized
Description of Securities Value Loss Value Loss Value Loss
U.S. Government securities 5,115,257 (9,164) 9,795,703 (115,827) 14,910,960 (124,991)
States and municipals 4,918,106 (15,531) 10,263,653 (166,457) 15,181,759 (181,988)
Mortgage-backed - - 40,662,549 (1,218,655) 40,662,549 (1,218,655)
Total temporarily impaired $10,033,363 $ (24,695) $60,721,905 $(1,500,939) $70,755,268 $(1,525,634)
The Company evaluates securities for other than temporary impairment at least
on a quarterly basis, and more frequently when economic or market concerns
warrant such evaluation. Consideration is given to the length of time and the
extent to which the fair value has been less than cost, the financial
condition and near-term prospects of the issuer, and the intent and ability of
the Company to retain its investment in the issuer for a period of time
sufficient to allow for any anticipated recovery in fair value. In analyzing
an issuer's financial condition, the Company may consider whether the
securities are issued by the federal government or its agencies, whether
downgrades by bond rating agencies have occurred, and the results of reviews
of the issuer's financial condition.
At December 31, 2007, thirteen mortgage-backed securities have unrealized
losses with aggregate depreciation of 1.8% from their amortized cost basis,
and seventy seven states and municipals have unrealized losses with aggregate
depreciation of 2.2% from their amortized cost basis. Management believes the
declines in fair value from these and other securities are largely due to
changes in interest rates. As management has the ability to hold debt
securities until maturity, or for the foreseeable future, no declines are
deemed to be other than temporary.
NOTE 4 - LOANS
Loans at year-end were as follows:
2007 2006
Commercial $ 22,924,130 $ 29,335,344
Real estate construction 26,172,120 29,033,790
Real estate mortgage 270,494,250 290,068,211
Agricultural 80,774,195 79,627,134
Consumer 15,420,647 15,683,984
Other 1,602,706 401,927
$ 417,388,048 $ 444,150,390
Activity in the allowance for loan losses was as follows:
2007 2006 2005
Beginning balance $ 4,991,277 $ 4,309,403 $ 4,163,315
Allowance from acquisition - 775,913 -
Charge-offs (1,268,568) (642,664) (526,735)
Recoveries 156,023 73,625 164,723
Provision for loan losses 1,000,000 475,000 508,100
Ending balance $ 4,878,732 $ 4,991,277 $ 4,309,403
Impaired loans totaled $6,358,000 and $2,379,000 at December 31, 2007 and 2006.
The average recorded investment in impaired loans during 2007, 2006 and 2005
was $4,253,000, $1,624,000 and $1,547,000. The total allowance for loan losses
related to these loans was $934,000 and $553,000 at December 31, 2007 and 2006.
Interest income on impaired loans of $121,000, $62,000 and $25,000 was
recognized for cash payments received in 2007, 2006 and 2005.
Nonperforming loans were as follows:
2007 2006
Loans past due over 90 days still
on accrual $ 195,000 $ 253,000
Nonaccrual loans 6,358,000 2,379,000
Nonaccrual loans secured by real estate make up 99% of the total nonaccruals.
Management does not see further material loss related to these loans.
Nonperforming loans include impaired loans and smaller balance homogeneous
loans, such as residential mortgage and consumer loans, that are collectively
evaluated for impairment.
Certain directors and executive officers of the Company and companies in which
they have beneficial ownership were loan customers of the Bank during 2007 and
2006. An analysis of the activity with respect to all director and executive
officer loans is as follows:
2007
Balance, beginning of year $ 4,893,000
New loans 504,000
Effect of changes in composition of related parties (92,000)
Repayments (1,126,000)
Balance, end of year $ 4,179,000
Loan Servicing
Mortgage loans serviced for others are not included in the accompanying
consolidated balance sheets. The unpaid principal balances of mortgage loans
serviced for others were approximately $110,175,000 and $107,766,000 at
December 31, 2007 and 2006. Custodial escrow balances maintained in connection
with the foregoing loan servicing, and included in demand deposits, were
approximately $388,000 and $369,000 at December 31, 2007 and 2006.
Changes in mortgage servicing rights were as follows:
2007 2006 2005
Beginning balance $ 745,834 $ 801,501 $ 875,633
Additions 165,059 179,507 179,474
Amortization (214,067) (235,174) (253,606)
Ending balance $ 696,826 $ 745,834 $ 801,501
The valuation allowance as of December 31, 2007 was $0, and there have been no
changes in the valuation allowance over the past three years. The fair value
of servicing rights was $1,107,000 and $1,121,000 at year-end 2007 and 2006.
Fair value at year-end 2007 was determined using a discount rate of 10.0%,
prepayment speeds ranging from 8.0% to 15.0%, depending on the stratification
of the specific right, and default rates ranging from 0.1% to 0.9%. Fair
value at year-end 2006 was determined using a discount rate of 9.5%,
prepayment speeds ranging from 8.0% to 13.5%, depending on the stratification
of the specific right, and default rates ranging from 0.1% to 0.9%.
The weighted average amortization period is 6.3 years. Estimated amortization
expense for each of the next five years is:
2008 $ 180,000
2009 136,000
2010 105,000
2011 82,000
2012 64,000
NOTE 5 - PREMISES AND EQUIPMENT
Year-end premises and equipment were as follows:
2007 2006
Land and buildings $ 17,243,311 $ 16,554,057
Furniture and equipment 11,958,611 11,756,195
Construction projects 1,163,406 217,591
30,365,328 28,527,843
Less accumulated depreciation (14,042,014) (14,200,793)
$ 16,323,314 $ 14,327,050
Depreciation expense was $1,041,368, $956,221 and $924,564 in 2007, 2006, and
2005.
NOTE 6 - GOODWILL AND INTANGIBLE ASSETS
The change in balance for goodwill during the year is as follows:
2007 2006 2005
Beginning of year $ 13,116,710 $ 9,110,524 $ 9,110,524
Acquired goodwill - 4,006,186 -
Impairment - - -
End of year $ 13,116,710 $ 13,116,710 $ 9,110,524
Goodwill is not amortized but instead evaluated periodically for impairment.
Acquired intangible assets were as follows at year-end:
2007 2006
Gross Gross
Carrying Accumulated Carrying Accumulated
Amount Amortization Amount Amortization
Amortized intangible assets:
Core deposit intangibles $5,133,403 $3,345,990 $5,133,403 $3,075,254
Core deposit intangibles of $1,477,000 were acquired during 2006 in the Peoples
acquisition, as further described in Note 15 - Business Combination.
Aggregate amortization expense was $270,736, $184,736 and $95,736 for 2007,
2006 and 2005.
Estimated amortization expense for each of the next five years:
2008 $ 264,736
2009 259,736
2010 253,736
2011 243,736
2012 233,736
NOTE 7 - DEPOSITS
At December 31, 2007, the scheduled maturities of time deposits are as follows:
2008 $ 187,127,228
2009 47,706,515
2010 3,848,656
2011 1,082,618
2012 4,895,933
Certain directors and executive officers of the Company and companies in which
they have beneficial ownership are deposit customers of the Bank. The amount
of these deposits was approximately $2,632,000 and $3,994,000 at December 31,
2007 and 2006.
NOTE 8 - REPURCHASE AGREEMENTS AND OTHER BORROWINGS
Securities sold under agreements to repurchase are secured by U.S. Government
securities with a carrying amount of $15,179,740 and $23,665,328 at year-end
2007 and 2006.
Repurchase agreements generally mature within one year from the transaction
date and range in maturities from 1 day to 5 years. The securities underlying
the agreements are maintained in a third-party custodian's account under a
written custodial agreement. Information concerning repurchase agreements for
2007, 2006 and 2005 is summarized as follows:
2007 2006 2005
Average daily balance
during the year $ 10,415,241 $ 15,660,750 $ 16,014,304
Average interest rate
during the year 4.18% 3.79% 3.19%
Maximum month-end balance
during the year $ 16,072,679 $ 18,372,446 $ 18,071,544
Weighted average interest
rate at year end 4.72% 3.83% 3.18%
Promissory note payable of $300,000 at December 31, 2007, has principal due at
July 7, 2009, interest payable quarterly at prime less 1.75%, and is secured by
100% of the common stock of the bank.
NOTE 9 - FEDERAL HOME LOAN BANK ADVANCES
At year-end, advances from the Federal Home Loan Bank were as follows:
2007 2006
Maturities July 2008 through March
2030, fixed rates from 1.00% to 3.08% $ 14,298,815 $ 17,226,422
Maturities January 2008 through February
2026, fixed rates from 3.58% to 4.43% 28,158,277 36,060,120
Maturities February 2008 through January
2026, fixed rates from 4.77% to 7.23% 21,536,380 26,743,741
Total $ 63,993,472 $ 80,030,283
Advances are paid either on a monthly basis or at maturity. All advances
require a prepayment penalty and certain advances are callable by the FHLB at
various call dates throughout the term of the advance. Advances are secured by
the FHLB stock and substantially all first mortgage residential loans.
Scheduled principal payments due on advances during the years subsequent to
December 31, 2007 are as follows:
2008 $ 15,078,887
2009 26,755,335
2010 6,250,000
2011 1,434,789
2012 1,604,055
Thereafter 12,870,406
$ 63,993,472
NOTE 10 - SUBORDINATED DEBENTURES
In August 2003, the Company formed Kentucky Bancshares, Statutory Trust I
("Trust"). The Trust issued $217,000 of common securities to the Company and
$7,000,000 of trust preferred securities as part of a pooled offering of such
securities. The Company issued $7,217,000 subordinated debentures to the Trust
in exchange for the proceeds of the offering, which debentures represent the
sole asset of the Trust. The debentures pay interest quarterly at 7.06% for
the first 5 years. Starting September 2008, the rate converts to three-month
LIBOR plus 3.00 adjusted quarterly. The Company may redeem the subordinated
debentures, in whole or in part, beginning September 2008 at a price of 100% of
face value. The subordinated debentures must be redeemed no later than 2033.
In accordance with FASB Interpretation No. 46, the Trust is not consolidated
with the Company. Accordingly, the Company does not report the securities
issued by the Trust as liabilities, and instead reports as liabilities the
subordinated debentures issued by the Company and held by the Trust, as these
are no longer eliminated in consolidation.
NOTE 11 - INCOME TAXES
Income tax expense was as follows:
2007 2006 2005
Current $ 2,457,421 $ 2,476,648 $ 1,969,865
Deferred (53,289) (8,838) 107,876
$ 2,404,132 $ 2,467,810 $ 2,077,741
Year-end deferred tax assets and liabilities were due to the following. No
valuation allowance for the realization of deferred tax assets is considered
necessary.
2007 2006
Deferred tax assets
Allowance for loan losses $ 1,684,269 $ 1,645,241
Unrealized loss on securities - 242,249
Adjustment for SFAS No. 158 351,439 434,919
Other 280,111 327,074
Deferred tax liabilities
Unrealized gain on securities (48,660) -
Bank premises and equipment (724,892) (776,157)
FHLB stock (1,254,026) (1,254,026)
Mortgage servicing rights (236,921) (253,584)
Core deposit intangibles (464,599) (491,132)
Other (286,312) (253,075)
Net deferred tax liability $ (699,591) $ (378,491)
Effective tax rates differ from federal statutory rates applied to financial
statement income due to the following:
2007 2006 2005
U. S. federal income tax rate 34.0% 34.0% 34.0%
Changes from the statutory rate
Tax-exempt investment income (9.2) (7.8) (7.3)
Non-deductible interest expense related to
carrying tax-exempt investments 1.3 1.1 0.8
Other 0.6 0.3 (1.2)
26.7% 27.6% 26.3%
Federal income tax laws provided the Federal Savings Bank, acquired by the
Company in 2003, with additional bad debt deductions through 1987, totaling
$1.3 million. Accounting standards do not require a deferred tax liability to
be recorded on this amount, which otherwise would total a $441,000 liability at
December 31, 2007. The Company's acquisition of First Federal Savings Bank did
not require the recapture of the bad debt reserve. However, if Kentucky Bank
was liquidated or otherwise ceased to be a bank, or if tax laws were to change,
the $441,000 would be recorded as expense.
Unrecognized Tax Benefits
The Company does not have any beginning and ending unrecognized tax benefits.
The Company does not expect the total amount of unrecognized tax benefits to
significantly increase or decrease in the next twelve months.
There were no interest and penalties recorded in the income statement or
accrued for the year ended December 31, 2007 related to unrecognized tax
benefits.
The Company and its subsidiary file a consolidated U.S. Corporation income tax
return and a corporate income tax return in the state of Kentucky. The
Company is no longer subject to examination by taxing authorities for years
before 2004.
NOTE 12 - EARNINGS PER SHARE
The factors used in the earnings per share computation follow:
2007 2006 2005
Basic Earnings Per Share
Net income $ 6,585,952 $ 6,486,054 $ 5,820,100
Weighted average common
shares outstanding 2,852,094 2,761,826 2,676,890
Basic earnings per share $ 2.31 $ 2.35 $ 2.17
Diluted Earnings Per Share
Net income $ 6,585,952 $ 6,486,054 $ 5,820,100
Weighted average common
shares outstanding 2,852,094 2,761,826 2,676,890
Add dilutive effects of
assumed exercise of
stock options 10,292 11,736 14,965
Weighted average common and
dilutive potential common
shares outstanding 2,862,386 2,773,562 2,691,855
Diluted earnings per share $ 2.30 $ 2.34 $ 2.16
Stock options of 29,200 shares common stock from 2007, 11,736 shares common
stock from 2006 and 31,100 shares common stock from 2005 were excluded from
diluted earnings per share because their impact was antidilutive.
NOTE 13 - RETIREMENT PLANS
The Company has a defined benefit pension plan covering substantially all of
its employees. The Company's funding policy is to contribute annually the
maximum amount that can be deducted for federal income tax purposes. Benefits
are based on one percent of employee average earnings for the previous five
years times years of credited service.
Information about the pension plan was as follows:
2007 2006
Change in benefit obligation:
Beginning benefit obligation $ 7,084,741 $ 6,737,359
Service cost 483,518 472,140
Interest cost 405,547 364,248
Actuarial adjustment (197,530) (327,181)
Benefits paid (204,130) (161,825)
Ending benefit obligation 7,572,146 7,084,741
Change in plan assets, at fair value:
Beginning plan assets 5,345,056 5,071,504
Actual return 393,712 378,550
Employer contribution 505,175 -
Benefits paid (145,178) (104,998)
Ending plan assets 6,098,765 5,345,056
Funded status $(1,473,381) $(1,739,685)
Amounts recognized in accumulated other comprehensive income at December 31
consist of:
2007 2006
Net loss (gain) $ 1,034,012 $ 1,279,916
Transition obligation (asset) (371) (742)
$ 1,033,641 $ 1,279,174
The accumulated benefit obligation for defined benefit pension plans was
$5,821,550 and $5,312,906 at year-end 2007 and 2006.
Components of net periodic pension cost and other amounts recognized in other
comprehensive income:
2007 2006 2005
Service cost $ 483,518 $ 472,140 $ 432,429
Interest cost 405,547 364,248 346,223
Expected return on plan assets (439,253) (400,485) (376,195)
Amortization 34,592 41,249 39,818
Net periodic cost $ 484,404 $ 477,152 $ 442,275
Net loss (gain) (210,941) - -
Prior service cost (credit) - - -
Amortization of net (gain) loss (34,592) - -
Total recognized in other
comprehensive income (245,533) - -
Total recognized in net periodic
benefit cost and other
comprehensive income $ 238,871 $ 477,152 $ 442,275
The estimated net loss and transition obligation for the defined benefit
pension plan that will be amortized from accumulated other comprehensive
income into net periodic benefit cost over the next fiscal year are $15,629
and $(371).
Weighted-average assumptions used to determine pension benefit obligations at
year-end
2007 2006 2005
Discount rate on benefit obligation 6.00% 5.75% 5.75%
Rate of compensation increase 4.00% 4.00% 4.00%
Weighted-average assumptions used to determine net periodic net cost
2007 2006 2005
Discount rate on benefit obligation 6.00% 5.75% 5.75%
Long-term expected rate of return
on plan assets 8.00% 8.00% 8.00%
Rate of compensation increase 4.00% 4.00% 4.00%
The assumptions described above were determined using various factors. Based
on the history of domestic investment experience, the expected long-term rate
of return on assets for the income segment is assumed to be 6.0%. The
expected long-term return on assets for the growth segment is assumed to be
10.0%. Thus, the assumed rate of return on the total portfolio is 8.0% per
year. The discount rate assumption of 6.00% is based on the expected
movements of interest rates from economic forecasts, Federal Reserve monetary
actions and commentary, the expected pace of economic activity, the issuance
of new debt to finance significant fiscal policy deficits, and the benchmark
Moody's AA rated long term corporate bond rate. The rate of compensation
increase assumption of 4.0% is based upon historical compensation increases at
the Bank.
The Company's pension plan asset allocation at year-end and expected long-term
rate of return by asset category are as follows:
Percentage Percentage Weighted
of Plan of Plan Average
Assets at Assets at Expected
Year-End Year-End Long-Term
Asset Category 2007 2006 Rate of Return
Equity securities 63 63 10%
Debt securities 33 35 6
Cash 4 2 4
Total 100 100
The asset allocation objective for 2007 and thereafter is to be 60% in equity
securities and 40% in debt securities. These percentages may vary 5-10 basis
points based on market conditions of equity and bond markets. There is no
target allocation for cash balances.
The Company expects to contribute $0 to $500,000 to its pension plan in 2008.
The following benefit payments, which reflect expected future service, are
expected:
Pension Benefits
2008 $ 191,963
2009 207,923
2010 267,179
2011 302,885
2012 327,457
Years 2013-2017 2,361,981
The Company also has a qualified profit sharing plan which covers substantially
all employees and includes a 401(k) provision. Profit sharing contributions,
excluding the 401(k) provision, are at the discretion of the Company's Board of
Directors. Expense recognized in connection with the plan was $434,203,
$369,847 and $320,670 in 2007, 2006 and 2005.
NOTE 14 - STOCK BASED COMPENSATION
The Company has two share based compensation plans as described below. Total
compensation cost that has been charged against income for those plans was
$96,178, $59,375, and $0 for 2007, 2006 and 2005. The total income tax
benefit was $3,611, $911, and $0.
Stock Option Plan
The Company grants certain officers and key employees stock option awards which
vest and become fully exercisable at the end of five years and provides for
issue of up to 220,000 options. The Company also grants certain directors
stock option awards which vest and become fully exercisable immediately and
provides for issue of up to 20,000 options. 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 fair value of each option award is estimated on the date of grant using a
closed form option valuation (Black-Scholes) model that uses the assumptions
noted in the table below. Expected volatilities are based on historical
volatilities of the Company's common stock. The Company uses historical data
to estimate option exercise and post-vesting termination behavior. The
expected term of options granted is based on historical data and represents
the period of time that options granted are expected to be outstanding, which
takes into account that the options are not transferable. The risk-free
interest rate for the expected term of the option is based on the U.S.
Treasury yield curve in effect at the time of the grant.
The fair value of options granted was determined using the following
weighted-average assumptions as of grant date.
2007 2006 2005
Fair value of options granted $4.22 $3.14 $4.82
Risk-free interest rate 4.51% 4.59% 3.98%
Expected term 8 years 8 years 8 years
Expected stock price volatility 12.69% 7.99% 15.11%
Dividend yield 3.48% 3.39% 3.03%
Summary of activity in the stock option plan for 2007 follows:
Weighted
Weighted Average
Average Remaining Aggregate
Exercise Contractual Intrinsic
Shares Price Term Value
Outstanding, beginning of year 69,914 $26.54
Granted 800 31.00
Forfeited or expired (2,140) 31.59
Exercised (9,800) 18.23
Outstanding, end of year 58,774 $27.80 60.8 months $253,793
Vested and expected to vest 58,774 $27.80 60.8 months $253,793
Exercisable, end of year 42,324 $26.73 53.9 months $226,356
Options outstanding at year-end 2007 were as follows:
Outstanding Exercisable
Weighted
Average Weighted Weighted
Remaining Average Average
Contractual Exercise Exercise
Range of Exercise Prices Options Life Price Options Price
From $18.00 to $20.63 per share 9,990 12.1 20.51 9,990 20.51
From $23.50 to $28.00 per share 17,684 51.5 25.39 15,604 25.37
From $29.50 to $31.00 per share 20,950 86.3 30.37 10,240 30.33
From $33.90 to $34.00 per share 10,150 72.3 33.91 6,490 33.92
58,774 42,324
Information related to the stock option plan during each year follows:
2007 2006 2005
Intrinsic value of options exercised $141,258 $119,419 $53,586
Cash received from option exercises 178,692 124,756 43,650
Tax benefit realized from option exercises 3,611 911 -
Weighted average fair value of options granted 3,376 4,082 89,306
As of December 31, 2007, there was $54,617 of total unrecognized compensation
cost related to nonvested stock options granted under the Plan. The cost is
expected to be recognized over a weighted-average period of 5 years.
Stock Grant Plan
On February 15, 2005, the Company's Board of Directors adopted a restricted
stock grant plan. Total shares issuable under the plan are 50,000. There
were 5,605 shares issued during 2007 and 3,875 shares issued during 2006, and
30 shares were forfeited during 2006.
A summary of changes in the Company's nonvested shares for the year follows:
Weighted-Average
Grant-Date
Nonvested Shares Shares Fair Value
Nonvested at January 1, 2007 3,845 $ 112,466
Granted 5,605 173,755
Vested (769) (22,493)
Forfeited (644) (19,365)
Nonvested at December 31, 2007 8,037 $ 244,363
As of December 31, 2007, there was $208,648 of total unrecognized compensation
cost related to nonvested shares granted under the Plan. The cost is expected
to be recognized over a weighted-average period of 5 years. The total fair
value of shares vested during the years ended December 31, 2007, 2006 and 2005
was $23,839, $0 and $0
NOTE 15 - BUSINESS COMBINATION
On July 7, 2006, the Company acquired 100% of the outstanding shares of
Peoples Bancorp of Sandy Hook, Inc., 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.
At the acquisition date, Peoples had $96,380,000 in total assets, $50,925,000
in loans and $72,279,000 in deposits.
NOTE 16 - LIMITATION ON BANK DIVIDENDS
The Company's principal source of funds is dividends received from the Bank.
Banking regulations limit the amount of dividends that may be paid by the Bank
without prior approval of regulatory agencies. Under these regulations, the
amount of dividends that may be paid in any calendar year is limited to the
current year's net profits, as defined, combined with the retained net profits
of the preceding two years. During 2008 the Bank could, without prior
approval, declare dividends on any 2008 net profits retained to the date of the
dividend declaration less $363,000.
NOTE 17 - DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
The fair values of the Company's financial instruments at December 31, 2007 and
2006 are as follows:
2007 2006
Carrying Carrying
Amount Fair Value Amount Fair Value
(In Thousands)
Financial assets
Cash and cash equivalents $ 25,807 $ 25,807 $ 19,012 $ 19,012
Securities 147,750 147,750 127,891 127,891
Loans, net 412,509 409,134 439,159 433,610
FHLB stock 6,468 6,468 6,468 6,468
Interest receivable 5,220 5,220 5,654 5,654
Financial liabilities
Deposits $ 486,005 $ 489,276 $ 468,808 $ 470,799
Securities sold under
agreements to repurchase
and other borrowings 6,735 6,843 11,327 11,249
FHLB advances 63,993 63,643 80,030 77,711
Subordinated debentures 7,217 7,098 7,217 7,232
Interest payable 4,984 4,984 3,683 3,683
Carrying amount is the estimated fair value for cash and cash equivalents,
short-term borrowings, Federal Home Loan Bank stock, accrued interest
receivable and payable, demand deposits, short-term debt, and variable rate
loans or deposits that reprice frequently and fully. Security fair values are
based on market prices or dealer quotes, and if no such information is
available, on the rate and term of the security and information about the
issuer. For fixed rate loans or deposits and for variable rate loans or
deposits with infrequent repricing or repricing limits, fair value is based on
discounted cash flows using current market rates applied to the estimated life
and credit risk. Fair values for impaired loans are estimated using discounted
cash flow analysis or underlying collateral values. Fair value of debt is
based on current rates for similar financing. The fair value of commitments to
extend credit and standby letters of credit is not considered material.
NOTE 18 - OFF-BALANCE SHEET ACTIVITIES AND COMMITMENTS
Some financial instruments, such as loan commitments, credit lines, letters of
credit, and overdraft protection, are issued to meet customer financing needs.
These are agreements to provide credit or to support the credit of others, as
long as conditions established in the contract are met, and usually have
expiration dates. Commitments may expire without being used. Off-balance
sheet risk to credit loss exists up to the face amount of these instruments,
although material losses are not anticipated. The same credit policies are
used to make such commitments as are used for loans, including obtaining
collateral at exercise of the commitment.
Financial instruments with off-balance sheet risk were as follows at year-end:
2007 2006
Unused lines of credit $ 65,298,282 $ 67,921,443
Commitments to make loans 1,871,000 658,000
Letters of credit 907,335 639,538
Unused lines of credit are substantially all at variable rates. Commitments to
make loans are generally made for a period of 60 days or less and are primarily
fixed at current market rates ranging from 5.50% to 6.50% with maturities
ranging from 15 to 30 years and are intended to be sold.
NOTE 19 - CONTINGENT LIABILITIES
The Bank is a defendant in legal actions arising from normal business
activities. Management believes these actions are without merit or that the
ultimate liability, if any, resulting from them will not materially affect the
Company's consolidated financial position or results of operations.
NOTE 20 - CAPITAL REQUIREMENTS
The Company and the Bank are subject to various regulatory capital
requirements administered by the federal banking agencies. Failure to meet
minimum capital requirements can initiate certain mandatory and possible
additional discretionary actions by regulators that, if undertaken, could have
a direct material effect on the Company's financial statements. Under capital
adequacy guidelines and the regulatory framework for prompt corrective action,
the Company and the Bank must meet specific capital guidelines that involve
quantitative measures of the Company's and the Bank's assets, liabilities, and
certain off-balance sheet items as calculated under regulatory accounting
practices. The Company and Bank capital amounts and classifications are also
subject to qualitative judgments by regulators about components, risk
weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Company and the Bank to maintain minimum amounts and ratios (set
forth in the following table) of Total and Tier I capital (as defined in the
regulations) to risk-weighted assets (as defined), and of Tier I capital to
average assets (as defined). Management believes, as of December 31, 2007 and
2006, that the Company and the Bank meet all capital adequacy requirements to
which they are subject.
The most recent notification from the Federal Deposit Insurance Corporation
categorized the Bank as well capitalized under the regulatory framework for
prompt corrective action. To be categorized as well capitalized, the Bank
must maintain minimum Total risk-based, Tier I risk-based and Tier I leverage
ratios as set forth in the following table. There are no conditions or events
since that notification that management believes have changed the
institution's category.
The Company's and the Bank's actual amounts and ratios are presented in the
table below:
To Be Well
Capitalized
Under Prompt
For Capital Corrective
Actual Adequacy Purposes Action Provisions
Amount Ratio Amount Ratio Amount Ratio
(Dollars in Thousands)
2007
Consolidated
Total Capital (to Risk-Weighted Assets) $ 56,491 13.6% $ 33,134 8% $ 41,417 N/A
Tier I Capital (to Risk-Weighted Assets) 51,528 12.4 16,567 4 24,850 N/A
Tier I Capital (to Average Assets) 51,528 8.4 24,493 4 30,616 N/A
Bank Only
Total Capital (to Risk-Weighted Assets) $ 56,350 13.6% $ 33,130 8% $ 41,413 10%
Tier I Capital (to Risk-Weighted Assets) 51,387 12.4 16,565 4 24,848 6
Tier I Capital (to Average Assets) 51,387 8.4 24,491 4 30,614 5
2006
Consolidated
Total Capital (to Risk-Weighted Assets) $ 53,491 12.5% $ 34,181 8% $ 42,727 N/A
Tier I Capital (to Risk-Weighted Assets) 48,420 11.3 17,091 4 25,636 N/A
Tier I Capital (to Average Assets) 48,420 7.8 24,758 4 30,947 N/A
Bank Only
Total Capital (to Risk-Weighted Assets) $ 53,370 12.5% $ 34,159 8% $ 42,699 10%
Tier I Capital (to Risk-Weighted Assets) 48,299 11.3 17,079 4 25,619 6
Tier I Capital (to Average Assets) 48,299 7.8 24,723 4 30,904 5
NOTE 21 - PARENT COMPANY FINANCIAL STATEMENTS
Condensed Balance Sheets
December 31
2007
2006
(In
Thousands)
ASSETS
Cash on deposit with subsidiary $ 175 $ 940
Investment in subsidiary 65,703 62,160
Securities available for sale 20 20
Other assets 482 412
Total assets $ 66,380 $ 63,532
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities
Subordinated debentures $ 7,217 $ 7,217
Notes payable 300 1,000
Other liabilities 19 34
Stockholders' equity
Preferred stock - -
Common stock 12,517 12,474
Additional paid-in capital 156 59
Retained earnings 46,759 44,062
Accumulated other comprehensive income (loss) (588) (1,314)
Total liabilities and stockholders' equity $ 66,380 $ 63,532
Condensed Statements of Income and Comprehensive Income
Years Ended December 31
2007 2006 2005
(In Thousands)
Income
Dividends from subsidiary $ 4,300 $ 9,800 $ 3,750
Securities gains (losses), net - 409 60
Interest income 1 16 13
Total income 4,301 10,225 3,823
Expenses
Interest expense 531 577 494
Other expenses 128 250 134
Total expenses 659 827 628
Income before income taxes and equity in
undistributed income of subsidiary 3,642 9,398 3,195
Applicable income tax (expense) benefits 224 166 178
Income before equity in undistributed
income of subsidiary 3,866 9,564 3,373
Equity in undistributed income of subsidiary 2,720 (3,078) 2,447
Net income 6,586 6,486 5,820
Other comprehensive income (loss), net of tax:
Unrealized gains (losses) on securities
arising during the period 589 486 (1,215)
Reclassification of realized amount (24) (23) (42)
Net change in unrealized gain (loss)
on securities 565 463 (1,257)
Comprehensive income $ 7,151 $ 6,949 $ 4,563
Condensed Statements of Cash Flows
Years Ended December 31
2007 2006 2005
(In Thousands)
Cash flows from operating activities
Net income $ 6,586 $ 6,486 $ 5,820
Adjustments to reconcile net income to net
cash from operating activities
Equity in undistributed earnings of
subsidiary (2,720) 3,083 (2,447)
Securities (gains) losses, net - (409) (60)
Change in other assets (58) 43 32
Change in other liabilities (27) 18 (3)
Net cash from operating activities 3,781 9,221 3,342
Cash flows from investing activities
Proceeds from sales of securities
available for sale - 664 143
Acquisition of Peoples Bancorp, Inc. - (8,080) -
Net cash from investing activities - (7,416) 143
Cash flows from financing activities
Proceeds from note payable - 8,000 -
Payments on note payable (700) (7,000) -
Dividends paid (3,088) (2,768) (2,462)
Proceeds from issuance of common stock 175 118 48
Purchase of common stock (933) (378) (629)
Net cash from financing activities (4,546) (2,028) (3,043)
Net change in cash (765) (223) 442
Cash at beginning of year 940 1,163 721
Cash at end of year $ 175 $ 940 $ 1,163
NOTE 22 - QUARTERLY FINANCIAL DATA (UNAUDITED)
Interest Net Interest Net Earnings Per Share
Income Income Income Basic Fully Diluted
2007
First quarter $ 9,806 $ 4,972 $ 1,562 $ .55 $ .54
Second quarter 10,034 5,147 1,918 .67 .67
Third quarter 9,801 5,148 1,670 .58 .58
Fourth quarter 9,578 4,918 1,436 .51 .51
2006
First quarter $ 8,051 $ 4,476 $ 1,293 $ .48 $ .48
Second quarter 8,245 4,511 1,716 .65 .64
Third quarter 9,493 4,850 1,714 .60 .60
Fourth quarter 9,804 5,038 1,763 .62 .62
Item 9. Changes In and Disagreements with Accountants on Accounting and
Financial Disclosure
None
Item 9A. Controls and Procedures
The Company's management, with participation of the Company's Chief
Executive Officer and Chief Financial Officer, has evaluated the
effectiveness of the Company's disclosure controls and procedures as of
December 31, 2007. Based on the evaluation, the Company's Chief
Executive Officer and Chief Financial Officer concluded that the
Company's disclosure controls and procedures were effective as of
December 31, 2007. There was no change in the Company's internal
control over financial reporting during the fourth quarter of 2007 that
has materially affected, or is reasonably likely to materially affect,
such internal control over financial reporting.
Item 9B. Other Information
None
PART III
Item 10. Directors and Executive Officers of the Registrant
The information required by Item 10 is hereby incorporated by reference from
the Company's definitive proxy statement in connection with its annual meeting
of shareholders scheduled for May 14, 2008, which will be filed with the
Commission on or about April 10, 2008, pursuant to Regulation 14A.
Item 11. Executive Compensation
The information required by Item 11 is hereby incorporated by reference from
the Company's definitive proxy statement in connection with its annual meeting
of shareholders scheduled for May 14, 2008, which will be filed with the
Commission on or about April 10, 2008, pursuant to Regulation 14A.
Item 12. Security Ownership of Certain Beneficial Owners and Management
The information required by Item 12 is hereby incorporated by reference from
the Company's definitive proxy statement in connection with its annual meeting
of shareholders scheduled for May 14, 2008, which will be filed with the
Commission on or about April 10, 2008, pursuant to Regulation 14A.
Item 13. Certain Relationships and Related Transactions
The information required by Items 13 is hereby incorporated by reference from
the Company's definitive proxy statement in connection with its annual meeting
of shareholders scheduled for May 14, 2008, which will be filed with the
Commission on or about April 10, 2008, pursuant to Regulation 14A.
Item 14. Principal Accountant Fees and Services
The information required by Item 14 is hereby incorporated by reference from
the Company's definitive proxy statement in connection with its annual meeting
of shareholders scheduled for May 14, 2008, which will be filed with the
Commission on or about April 10, 2008, pursuant to Regulation 14A.
Part IV
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a)(1) Financial Statements
The following financial statements are included in Item 8 of this Form
10-K.
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets
Consolidated Statements of Income
Consolidated Statements of Changes in Shareholders' Equity
Consolidated Statements of Cash Flow
Notes to Consolidated Financial Statements
(a)(2) Financial Statement Schedules.
All financial statement schedules have been omitted as the required
information is inapplicable or the required information has been included
in the Consolidated Financial statements or notes thereto.
(a)(3) Exhibits
The following exhibits are incorporated by reference herein or made a part
of this Form 10-K:
2.1 Agreement and Plan of Merger with Peoples Bancorp of Sandy
Hook is incorporated by reference to Exhibit 2.1 of the
Registrant's Current Report on Form 8-K dated February 24,
2006.
3.1 Articles of Incorporation of the Registrant are incorporated by
reference to Exhibit 3.1 of the Registrant's Quarterly Report
on Form 10-Q for the quarterly period ending March 31, 2000.
3.2 Bylaws of the Registrant are incorporated by reference to
Exhibit 3.1 of the Registrant's Quarterly Report on Form 10-Q
for the quarterly period ending June 30, 2000.
3.3 Articles of Amendment to Amended and Restated Articles of
Incorporation of the Registrant are incorporated by reference
to Exhibit 3.3 of the Registrant's Annual Report on Form 10-K
for the period ending December 31, 2005.
10.1 Kentucky Bancshares, Inc. 1993 Employee Stock Ownership
Incentive Plan is incorporated by reference to Exhibit 10.2 of
the Registrant's Registration Statement on Form S-4 (File No.
33-96358).
10.2 Kentucky Bancshares, Inc. 1993 Non-Employee Directors Stock
Ownership Incentive Plan is incorporated by reference to
Exhibit 10.3 of the Registrant's Registration Statement on Form
S-4 (File No. 33-96358).
10.3 Kentucky Bancshares, Inc. 1999 Employee Stock Option Plan is
incorporated by reference to Exhibit 99.1 of the Registrant's
Form 10-K for the fiscal year ended December 31, 1998.
10.4 Schedule of 2006 Compensation Arrangements for Named Executive
Officers is incorporated by reference to the Registrant's Current
Report on Form 8-K dated December 20, 2005.
10.5 2005 Restricted Stock Grant Plan, including form of Award
Agreement, as incorporated by reference to Exhibit 10.1 of the
Registrant's Current Report on Form 8-K dated February 15, 2005.
11 Computation of earnings per share - See Note 12 in the notes to
consolidated financial statements included as Exhibit 13.
21 Subsidiaries of Registrant
23 Consent of Crowe Chizek and Company LLC
31.1 Certification of Chief Executive Officer pursuant to Rule 13a-
14(a) and Rule 15d-14(a) of the Securities Exchange Act, as
amended.
31.2 Certification of Chief Financial Officer pursuant to Rule 13a-
14(a) and Rule 15d-14(a) of the Securities Exchange Act, as
amended.
32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
32.2 Certification of Chief Financial Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
(b) Exhibits
See response to Item 15(a)(3).
(c) Financial Statement Schedules
See response to Item 15(a)(2).
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be
signed on its behalf by the undersigned, thereunto duly authorized.
Kentucky Bancshares, Inc.
By: _/s/Louis Prichard __
Louis Prichard, President and Chief Executive Officer, Director
March 28, 2008
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of
the registrant and in the capacities and on the dates indicated.
/s/Louis Prichard _____ March 28, 2008
Louis Prichard, President and Chief Executive Officer, Director
/s/Gregory J. Dawson ______ March 28, 2008
Gregory J. Dawson, Chief Financial and Accounting Officer
/s/Buckner Woodford ________ March 31, 2008
Buckner Woodford, Chairman of the Board, Director
_/s/William Arvin____________ March 28, 2008
William Arvin, Director
/s/B. Proctor Caudill ____ March 28, 2008
B. Proctor Caudill, Director
/s/Henry Hinkle _ _ __ ____ March 28, 2008
Henry Hinkle, Director
_/s/Theodore Kuster__________ March 28, 2008
Theodore Kuster, Director
/s/Betty J. Long __________ March 28, 2008
Betty J. Long, Director
/s/Ted McClain ___________ March 28, 2008
Ted McClain, Director
_/s/Edwin S. Saunier_________ March 28, 2008
Edwin S. Saunier, Director
/s/Robert G. Thompson _____ March 28, 2008
Robert G. Thompson, Director
_____________________________ March __, 2008
Woodford Van Meter, Director
SUPPLEMENTAL INFORMATION TO BE FURNISHED WITH REPORTS FILED PURSUANT TO
SECTION 15(d) OF THE ACT BY REGISTRANTS WHICH HAVE NOT REGISTERED
SECURITIES PURSUANT TO SECTION 12 OF THE ACT.
The Registrant refers to Exhibit 13 to the Form 10-K.
6
22
BOURBON BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2000, 1999 and 1998
44
58
63