UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2010
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ____________________ to ___________________
Commission File Number: 000-52598
KENTUCKY BANCSHARES, INC.
(Exact name of registrant as specified in its charter)
Kentucky 61-0993464
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
P.O. Box 157, Paris, Kentucky 40362-0157
(Address of principal executive offices) (Zip Code)
Registrant?s telephone number, including area code: (859) 987-1795
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
Yes X No _____
Indicate by check mark whether the registrant has submitted electronically
and posted on its corporate Web site, if any, every Interactive Data File
required to be submitted and posted pursuant to Rule 405 of Regulation S-T
(Section 232.405 of this chapter) during the preceding 12 months (or for such
shorter period that the registrant was required to submit and post such
files).
Yes _____ No _____
Indicate by check mark whether the registrant is a large accelerated filer,
an accelerated filer, a non-accelerated filer, or a smaller reporting
company. See definitions of ?large accelerated filer,? ?accelerated filer?
and ?smaller reporting company? in Rule 12b-2 of the Exchange Act.
Large accelerated filer ____
Accelerated filer ____
Non-accelerated filer X (Do not check if a smaller reporting company)
Smaller reporting company ____
Indicate by check mark whether the registrant is a shell company (as defined
in Rule 12b-2 of the Exchange Act). Yes No X _
Number of shares of Common Stock outstanding as of July 31, 2010: 2,741,536.
KENTUCKY BANCSHARES, INC.
Table of Contents
Part I - Financial Information
Item 1. Financial Statements
Consolidated Balance Sheets 3
Consolidated Statements of Income and
Comprehensive Income 4
Consolidated Statement of Changes in
Stockholders? Equity 6
Consolidated Statements of Cash Flows 7
Notes to Consolidated Financial Statements 8
Item 2. Management?s Discussion and Analysis of Financial
Condition and Results of Operations 19
Item 3. Quantitative and Qualitative Disclosures About
Market Risk 28
Item 4. Controls and Procedures 29
Part II - Other Information 29
Signatures 30
Exhibits
31.1 Certifications of Chief Executive Officer pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002. 31
31.2 Certifications of Chief Financial Officer pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002. 33
32 Certifications of Chief Executive Officer and Chief
Financial Officer pursuant to 18 U.S.C. Section 1350,
as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002. 35
Item 1 - Financial Statements
KENTUCKY BANCSHARES, INC.
CONSOLIDATED BALANCE SHEETS (unaudited)
(in thousands) 6/30/2010 12/31/2009
Assets
Cash and due from banks $ 13,567 $ 12,387
Federal funds sold 16,837 22,034
Cash and cash equivalents 30,404 34,421
Securities available for sale 191,625 168,411
Mortgage loans held for sale 295 191
Loans 416,475 425,418
Allowance for loan losses (6,461)
(7,600)
Net loans 410,014 417,818
Federal Home Loan Bank stock 6,731 6,731
Real estate owned, net 5,548 4,542
Bank premises and equipment, net 17,778 17,610
Interest receivable 4,392 4,620
Mortgage servicing rights 835 822
Goodwill 13,117 13,117
Other intangible assets 1,135 1,263
Other assets 5,281 5,685
Total assets $ 687,155 $ 675,231
Liabilities and Stockholders' Equity
Deposits
Non-interest bearing $ 117,023 $ 97,005
Time deposits, $100,000 and over 122,787 105,036
Other interest bearing 315,121 334,405
Total deposits 554,931 536,446
Repurchase agreements and other borrowings 6,844 8,226
Federal Home Loan Bank advances 49,110 56,096
Subordinated debentures 7,217 7,217
Interest payable 3,893 2,123
Other liabilities 2,301 4,158
Total liabilities 624,296 614,266
Stockholders' equity
Preferred stock, 300,000 shares
authorized and unissued - -
Common stock, no par value; 10,000,000 shares
authorized; 2,742,536 and 2,739,511 shares
issued and outstanding on June 30, 2010 and
December 31, 2009 12,445 12,416
Retained earnings 48,187 47,213
Accumulated other comprehensive income 2,227 1,336
Total stockholders' equity 62,859 60,965
Total liabilities & stockholders' equity $ 687,155 $ 675,231
See Accompanying Notes
KENTUCKY BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (unaudited)
(in thousands, except per share amounts) Six Months Ending
6/30/2010 6/30/2009
INTEREST INCOME:
Loans, including fees $ 12,027 $ 12,303
Securities available for sale 3,397 3,787
Other 24 14
Total interest income 15,448 16,104
INTEREST EXPENSE:
Deposits 4,241 4,896
Other 1,206 1,783
Total interest expense 5,447 6,679
Net interest income 10,001 9,425
Loan loss provision 1,250 900
Net interest income after provision 8,751 8,525
NON-INTEREST INCOME:
Service charges 2,387 2,522
Loan service fee income 70 50
Trust department income 310 235
Securities available for sale gains, net 214 203
Gain on sale of mortgage loans 309 811
Other 827 744
Total other income 4,117 4,565
NON-INTEREST EXPENSE:
Salaries and employee benefits 4,943 5,986
Occupancy expenses 1,359 1,293
Repossession expenses 762 245
FDIC insurance 496 711
Legal and professional fees 350 182
Data processing 388 380
Debit card expenses 296 293
Amortization 128 131
Advertising and marketing 291 253
Taxes other than payroll, property and income 394 366
Other 1,101 1,009
Total other expenses 10,508 10,849
Income before taxes 2,360 2,241
Income taxes 234 170
Net income $ 2,126 $ 2,071
Other Comprehensive Income, net of tax:
Change in Unrealized Gains on Securities 891 819
Comprehensive Income $ 3,017 $ 2,890
Earnings per share
Basic $ 0.78 $ 0.76
Diluted 0.78 0.76
Dividends per share 0.42 0.40
See Accompanying Notes
KENTUCKY BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (unaudited)
(in thousands, except per share amounts) Three Months Ending
6/30/2010 6/30/2009
INTEREST INCOME:
Loans, including fees $ 6,117 $ 6,224
Securities available for sale 1,747 1,679
Other 13 4
Total interest income 7,877 7,907
INTEREST EXPENSE:
Deposits 2,149 2,363
Other 596 871
Total interest expense 2,745 3,234
Net interest income 5,132 4,673
Loan loss provision 800 450
Net interest income after provision 4,332 4,223
NON-INTEREST INCOME:
Service charges 1,291 1,376
Loan service fee income 45 23
Trust department income 195 126
Securities available for sale gains (losses), net 211 199
Gain on sale of mortgage loans 183 433
Other 445 407
Total other income 2,370 2,564
NON-INTEREST EXPENSE:
Salaries and employee benefits 2,494 3,437
Occupancy expenses 671 636
Repossession expenses 426 155
FDIC insurance 254 480
Legal and professional fees 226 135
Data processing 185 178
Debit card expenses 153 154
Amortization 63 65
Advertising and marketing 162 129
Taxes other than payroll, property and income 199 178
Other 503 418
Total other expenses 5,336 5,965
Income before taxes 1,366 822
Income taxes (benefit) 185 (82)
Net income $ 1,181 $ 904
Other Comprehensive Income (Loss), net of tax:
Change in Unrealized Gains on Securities 685 (217)
Comprehensive Income $ 1,866 $ 687
Earnings per share
Basic $ 0.43 $ 0.33
Diluted 0.43 0.33
Dividends per share 0.21 0.20
See Accompanying Notes
KENTUCKY BANCSHARES, INC.
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (unaudited)
(in thousands, except share information)
Accumulated
Other Total
--Common Stock(1)-- Retained Comprehensive Stockholders'
Shares Amount Earnings Income Equity
Balances, January 1, 2010 2,739,511 $ 12,416 $ 47,213 $ 1,336 $ 60,965
Common stock issued, including tax
benefit, net 3,676 - - - -
Stock based compensation expense - 55 - - 55
Common stock purchased and retired (651) (26) (26)
Net change in unrealized gain (loss)
on securities available for sale,
net of tax - - - 891 891
Net income - - 2,126 - 2,126
Dividends declared - $0.42 per share - - (1,152) - (1,152)
Balances, June 30, 2010 2,742,536 $ 12,445 $ 48,187 $ 2,227 $ 62,859
(1)Common Stock has no par value; amount includes Additional Paid-in Capital
See Accompanying Notes
KENTUCKY BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
(in thousands) Six Months Ended
6/30/2010 6/30/2009
Cash Flows From Operating Activities
Net Income $ 2,126 $ 2,071
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation and amortization 787 691
Securities amortization, net 426 811
Stock based compensation expense 55 57
Provision for loan losses 1,250 900
Securities gains, net (214)
(203)
Originations of loans held for sale (11,086)
(36,455)
Proceeds from sale of loans 11,291 37,266
Losses on sale of fixed assets 1 -
Gains on other real estate, net (40)
(57)
Gain on sale of mortgage loans (309)
(811)
Changes in:
Interest receivable 228 736
Real estate owned, net 545 980
Other assets 372
(2,872)
Interest payable 1,770 1,314
Other liabilities (2,316) 2,143
Net cash from operating activities 4,886 6,571
Cash Flows From Investing Activities
Purchases of securities (81,558)
(53,208)
Proceeds from sales of securities 9,511 17,515
Proceeds from principal payments, maturities and
calls of securities 49,972 37,085
Net change in loans 4,963 5,805
Purchases of bank premises and equipment (769)
(336)
Proceeds from the sale of bank premises 3 -
Net cash from investing activities (17,878) 6,861
Cash Flows From Financing Activities:
Net change in deposits 18,485
(26,713)
Net change in repurchase agreements -
and other borrowings (982) 4,670
Payments on Federal Home Loan Bank advances (6,950)
(13,417)
Payments on note payable (400)
(200)
Purchase of common stock (26)
(79)
Dividends paid (1,152)
(1,099)
Net cash from financing activities 8,975
(36,838)
Net change in cash and cash equivalents (4,017)
(23,406)
Cash and cash equivalents at beginning of period 34,421 37,106
Cash and cash equivalents at end of period $ 30,404 $ 13,700
Supplemental disclosures of cash flow information
Cash paid during the year for:
Interest expense $ 3,677 $ 6,679
Income taxes - 200
Supplemental disclosures of non-cash investing
activities
Real estate acquired through foreclosure $ 2,125 $ 3,941
See Accompanying Notes
KENTUCKY BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The financial information presented as of any date other than December 31
has been prepared from the Company?s books and records without audit. The
accompanying consolidated financial statements have been prepared in
accordance with the instructions to Form 10-Q and Rule 10-01 of Regulation
S-X. Certain financial information that is normally included in annual
financial statements prepared in accordance with accounting principles
generally accepted in the United States of America, but is not required
for interim reporting purposes, has been condensed or omitted. In the
opinion of management, all adjustments, consisting of normal recurring
adjustments, necessary for a fair presentation of such financial
statements, have been included. The results of operations for the interim
periods are not necessarily indicative of the results to be expected for
the full year.
For further information, refer to the consolidated financial statements
and footnotes thereto included in the Company's Annual Report on Form 10-K
for the year ended December 31, 2009.
Basis of Presentation: The consolidated financial statements include the
accounts of Kentucky Bancshares, Inc. (the ?Company?, ?we?, ?our? or ?us?),
its wholly-owned subsidiary, Kentucky Bank (the Bank), and the Bank?s
wholly-owned subsidiary, KB Special Assets Unit, LLC. Intercompany
transactions and balances have been eliminated in consolidation.
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 Department 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, real estate owned,
goodwill and fair value of financial instruments are particularly subject to
change.
Adoption of New Accounting Standards
Accounting Standards Codification (?ASC?) Topic 820, ?Fair Value
Measurements and Disclosures?. The Financial Accounting Standards Board
issued new accounting guidance under Accounting Standards Update (ASU) No.
2010-06 that requires new disclosures and clarifies existing disclosure
requirements about fair value measurement as set forth in ASC Subtopic
820-10. The objective of the new guidance is to improve these disclosures
and increase transparency in financial reporting. Specifically, the new
guidance requires:
A reporting entity to disclose separately the amounts of significant
transfers in and out of Level 1 and Level 2 fair value measurements
and describe the reasons for the transfers; and
In the reconciliation for fair value measurements using significant
unobservable inputs, a reporting entity should present separately
information about purchases, sales, issuances, and settlements.
In addition, the guidance clarifies the requirements of the following
existing disclosures:
For purposes of reporting fair value measurement for each class of
assets and liabilities, a reporting entity needs to use judgment in
determining the appropriate classes of assets and liabilities; and
A reporting entity should provide disclosures about the valuation
techniques and inputs used to measure fair value for both recurring
and nonrecurring fair value measurements.
ASU 2010-06 is effective for interim and annual reporting periods
beginning after December 15, 2009, except for the disclosures about
purchases, sales, issuances, and settlements in the roll forward of
activity in Level 3 fair value measurements. Those disclosures are
effective for fiscal years beginning after December 15, 2010, and for
interim periods within those fiscal years. Early application is
permitted. Additional disclosures have been made.
ASC Topic 860, ?Transfers and Servicing?. Effective January 1, 2010, the
Company adopted new accounting guidance under ASC Topic 860 that requires
more information about transfers of financial assets, including
securitization transactions, and where entities have continuing exposure
to the risks related to transferred financial assets. The guidance
eliminates the concept of a ?qualifying special-purpose entity,? changes
the requirements for derecognizing financial assets, and requires
additional disclosures about continuing involvements with transferred
financial assets including information about gains and losses resulting
from transfers during the period. The adoption of this accounting
guidance did not have a material impact on the Company?s consolidated
financial position or results of operations.
ASC Topic 810, ?Consolidation?. Effective January 1, 2010, the Company
adopted new accounting guidance under ASC Topic 810 that amends prior
guidance to change how a reporting entity determines when an entity that
is insufficiently capitalized or is not controlled through voting (or
similar rights) should be consolidated. The determination of whether a
reporting entity is required to consolidate another entity is based on,
among other things, the other entity?s purpose and design and the
reporting entity?s ability to direct the activities of the other entity
that most significantly impact the other entity?s economic performance.
The new guidance requires a number of new disclosures about an entity?s
involvement with variable interest entities and any significant changes in
risk exposure due to that involvement. A reporting entity will also be
required to disclose how its involvement with a variable interest entity
affects the reporting entity?s financial statements. The adoption of this
accounting guidance did not have a material impact on the Company?s
consolidated financial position or results of operations.
2. SECURITIES AVAILABLE FOR SALE
INVESTMENT SECURITIES
Period-end securities are as follows:
(in thousands)
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
Available for Sale
June 30, 2010
U.S. government agencies $ 65,354 $ 475 $ (1) $ 65,828
States and political subdivisions 85,209 1,867 (373) 86,703
Mortgage-backed - residential 37,418 1,377 - 38,795
Equity securities 270 29 - 299
Total $ 188,251 $ 3,748 $ (374) $ 191,625
December 31, 2009
U.S. government agencies $ 45,168 $ 13 $ (448) $ 44,733
States and political subdivisions 78,794 1,691 (362) 80,123
Mortgage-backed - residential 42,155 1,259 (151) 43,263
Equity securities 270 22 - 292
Total $ 166,387 $ 2,985 $ (961) $ 168,411
The amortized cost and fair value of securities at June 30, 2010, 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.
(in thousands) Amortized Fair
Cost Value
Due in one year or less $ 1,628 $ 1,733
Due after one year through five years 45,726 46,104
Due after five years through ten years 46,636 47,885
Due after ten years 56,573 56,809
150,563 152,531
Mortgage-backed - residential 37,418 38,795
Equity 270 299
Total $ 188,251 $ 191,625
Proceeds from sales of securities during the first six months of 2010 and 2009
were $9.5 million and $17.5 million. Gross gains of $215 thousand and $204
thousand and gross losses of $1 thousand and $1 thousand, were realized on
those sales, respectively. The tax provision related to these realized gains
and losses was $73 thousand and $69 thousand, respectively. Proceeds from
sales of securities during the three months of 2010 and 2009 were $9.5 million
and $17.5 million. Gross gains of $212 thousand and $200 thousand and gross
losses of $1 thousand and $1 thousand, were realized on those sales,
respectively. The tax provision related to these realized gains and losses was
$72 thousand and $68 thousand, respectively.
Securities with unrealized losses at June 30, 2010 and at December 31, 2009
not recognized in income are as follows:
June 30, 2010
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 agencies $ 2,033 $ (1) $ - $ - $ 2,033 $ (1)
States and municipals 28,269 (373) - - 28,269 (373)
Total temporarily impaired $30,302 $ (374) $ - $ - $30,302 $ (374)
December 31, 2009
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 agencies $35,216 $ (448) $ - $ - $35,216 $ (448)
States and municipals 25,126 (348) 870 (14) 25,996 (362)
Mortgage-backed - residential 11,930 (151) - - 11,930 (151)
Total temporarily impaired $72,272 $ (947) $ 870 $ (14) $73,142 $ (961)
We evaluate securities for other than temporary impairment at least on a
quarterly basis, and more frequently when economic or market concerns warrant
such evaluation. In analyzing an issuer?s financial condition, we may
consider many factors including, (1) whether the securities are issued by the
federal government or its agencies, (2) whether downgrades by bond rating
agencies have occurred, (3) the results of reviews of the issuer?s financial
condition and near-term prospects, (4) the length of time and the extent to
which the fair value has been less than cost, and (5) whether we intend to
sell the investment security or more likely than not will be required to sell
the investment security before its anticipated recovery..
Unrealized losses on securities included in the tables above have not been
recognized into income because (1) management believes the issues are of high
credit quality, (2) management does not intend to sell and it is more likely
than not that management would not be required to sell the securities prior
to their anticipated recovery, (3) management believes the decline in fair
value is largely due to changes in interest rates and (4) management believes
the declines in fair value are temporary. The Company believes the fair
value is expected to recover as the securities approach maturity.
3. LOANS
Loans at period-end are as follows:
(in thousands)
6/30/10 12/31/09
Commercial $ 24,725 $ 21,933
Real estate construction 14,691 16,865
Real estate mortgage 279,820 287,444
Agricultural 80,933 80,619
Consumer 16,018 18,277
Other 288 280
Total $ 416,475 $ 425,418
Activity in the allowance for loan losses for the six month periods indicated
was as follows:
(in thousands)
6/30/10 6/30/09
Beginning balance $ 7,600 $ 5,465
Charge-offs (2,904) (818)
Recoveries 515 826
Provision for loan losses 1,250 900
Ending balance $ 6,461 $ 6,373
Individually impaired loans were as follows:
(in thousands)
6/30/10 12/31/09
Period-end loans with no allocated
allowance for loan losses $ 20,083 $ 19,206
Period-end loans with allocated
Allowance for loan losses 14,003 14,266
Total $ 34,086 $ 33,472
Amount of the allowance for loan
losses allocated $ 2,905 $ 4,064
6/30/10 6/30/09
Average of individually impaired loans
during the period $ 32,260 $ 6,460
Cash-basis interest income recognized 77 1
Nonperforming loans were as follows:
(in thousands)
6/30/10 12/31/09
Loans past due over 90 days still
on accrual $ 300 $ 2,526
Nonaccrual loans 14,433 12,038
Nonaccrual loans are included in impaired loans. A loan is impaired when full
payment under the contractual terms is not expected.
Nonaccrual loans and loans past due 90 days still on accrual include both
smaller balance homogeneous loans that are collectively evaluated for
impairment and individually classified impaired loans.
During the first six months of 2010, $2.1 million of impaired loans was
transferred to real estate owned and $2.9 million recorded in chargeoffs. The
increase in nonaccrual loans was primarily from various smaller balance loans
being added during the first quarter of 2010.
We have no troubled debt restructurings as of June 30, 2010 and December 31,
2009.
4. EARNINGS PER SHARE
Basic earnings per common share is net income divided by the weighted
average number of common shares outstanding during the period. Diluted
earnings per common share includes the dilutive effect of additional
potential common shares issuable under stock options.
The factors used in the earnings per share computation follow:
Six Months Ended
June 30
2010 2009
(in thousands)
Basic Earnings Per Share
Net Income $ 2,126 $ 2,071
Weighted average common shares outstanding 2,732 2,737
Basic earnings per share $ 0.78 $ 0.76
Diluted Earnings Per Share
Net Income $ 2,126 $ 2,071
Weighted average common shares outstanding 2,732 2,737
Add dilutive effects of assumed exercise
of stock options - 1
Weighted average common and dilutive
potential common shares outstanding 2,732 2,738
Diluted earnings per share $ 0.78 $ 0.76
Three Months Ended
June 30
2010 2009
(in thousands)
Basic Earnings Per Share
Net Income $ 1,181 $ 904
Weighted average common shares outstanding 2,732 2,738
Basic earnings per share $ 0.43 $ 0.33
Diluted Earnings Per Share
Net Income $ 1,181 $ 904
Weighted average common shares outstanding 2,732 2,738
Add dilutive effects of assumed exercise
of stock options - 1
Weighted average common and dilutive
potential common shares outstanding 2,732 2,739
Diluted earnings per share $ 0.43 $ 0.33
Stock options of 33,490 shares common stock for the six and three months
ended June 30, 2010 and 37,844 shares common stock for the six and three
months ended June 30, 2009 were excluded from diluted earnings per share
because their impact was antidilutive. Stock grants of 21,705 shares common
stock for the six and three months ended June 30, 2010 and 13,505 shares
common stock for the six and three months ended June 30, 2009 were excluded
from diluted earnings per share because their impact was antidilutive.
5. STOCK COMPENSATION
We have four share based compensation plans as described below.
Two Stock Option Plans
Under our now expired 1999 Employee Stock Option Plan, we granted certain
officers and key employees stock option awards which vest and become fully
exercisable at the end of five years and provide for issuance of up to 100,000
options. Under the now expired 1993 Non-Employee Directors Stock Ownership
Incentive Plan, we also granted certain directors stock option awards which
vest and become fully exercisable immediately and provide for issuance 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 our stock on the date of grant.
Summary of activity in the stock option plan for 2010 follows:
Weighted
Weighted Average
Average Remaining Aggregate
Exercise Contractual Intrinsic
Shares Price Term Value
Outstanding, beginning of year 36,250 $29.42
Granted - -
Forfeited or expired (2,760) 27.93
Exercised - -
Outstanding, end of period 33,490 $29.54 44.4 months $ -
Vested and expected to vest 33,490 $29.54 44.4 months $ -
Exercisable, end of period 33,490 $29.54 44.4 months $ -
As of June 30, 2010, there was $0 of total unrecognized compensation cost
related to nonvested stock options granted under the Plan. Since both stock
option plans have expired, as of June 30, 2010 no additional options can be
granted under either of these plans.
2005 Restricted Stock Grant Plan
On May 10, 2005, our stockholders approved a restricted stock grant plan.
Total shares issuable under the plan are 50,000. There were 4,020 shares
issued during 2010 and 4,150 shares issued during 2009. There were 344 shares
forfeited during the first six months of 2010 and 334 shares forfeited during
the first six months of 2009. As of June 30, 2010, the restricted stock grant
plan allows for additional restricted stock share awards of up to 30,171
shares.
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, 2010 10,122 $ 261,033
Granted 4,020 65,928
Vested (2,808) (75,926)
Forfeited (344) (8,473)
Nonvested at June 30, 2010 10,990 $ 242,562
As of June 30, 2010, there was $242,562 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.
2009 Stock Award Plan
On May 13, 2009, our stockholders approved a stock award plan that provides for
the granting of both incentive and nonqualified stock options and other share
based awards. Total shares issuable under the plan are 150,000. As of June
30, 2010 no awards have been granted under the plan and 150,000 shares are
still available.
6. FAIR VALUE MEASUREMENTS
ASC Topic 820, ?Fair Value Measurements and Disclosures?, defines fair value,
establishes a framework for measuring fair value, and sets forth disclosures
about fair value measurements. ASC Topic 825, ?Financial Instruments?,
allows entities to choose to measure certain financial assets and liabilities
at fair value. The Company has not elected the fair value option for any
financial assets or liabilities.
ASC Topic 820 defines fair value as the price that would be received to sell
an asset or paid to transfer a liability in an orderly transaction between
market participants at the measurement date. It also establishes a fair
value hierarchy which requires an entity to maximize the use of observable
inputs and minimize the use of unobservable inputs when measuring fair value.
This Topic describes three levels of inputs that may be used to measure fair
value:
Level 1 ? Quoted prices (unadjusted) for identical assets or
liabilities in active markets that the entity has the ability to access
as of the measurement date.
Level 2 ? Significant other observable inputs other than Level 1 prices
such as quoted prices for similar assets or liabilities; quoted prices
in markets that are not active; or other inputs that are observable or
can be corroborated by observable market data.
Level 3 ? Significant unobservable inputs that reflect a company?s own
assumptions about the assumptions that market participants would use in
pricing an asset or liability.
The Company used the following methods and significant assumptions to
estimate the fair value:
Investment Securities: The fair values for available for sale investment
securities are determined by quoted market prices, if available (Level 1).
For securities where quoted prices are not available, fair values are
calculated based on market prices of similar securities (Level 2). For
securities where quoted prices or market prices of similar securities are not
available, fair values are calculated using discounted cash flows or other
market indicators (Level 3).
Impaired Loans: The fair value of impaired loans with specific allocations
of the allowance for loan losses is generally based on recent real estate
appraisals. These appraisals may utilize a single valuation approach or a
combination of approaches including comparable sales and the income approach.
Adjustments are routinely made in the appraisal process by the appraisers to
adjust for differences between the comparable sales and income data
available. Such adjustments are usually significant and typically result in a
Level 3 classification of the inputs for determining fair value.
Other Real Estate Owned: Nonrecurring adjustments to certain commercial and
residential real estate properties classified as other real estate owned
(OREO) are measured at the lower of carrying amount or fair value, less costs
to sell. Fair values are generally based on third party appraisals of the
property, resulting in a Level 3 classification. In cases where the
carrying amount exceeds the fair value, less costs to sell, an impairment
loss is recognized.
Mortgage Servicing Rights: Fair value is based on market prices for
comparable mortgage servicing contracts, when available, or alternatively
based on a valuation model that calculates the present value of estimated
future net servicing income, resulting in a Level 3 classification.
Assets and Liabilities Measured on a Recurring Basis
Available for sale investment securities are the Company?s only balance sheet
item that meet the disclosure requirements for instruments measured at fair
value on a recurring basis. Disclosures are as follows in the tables below.
(In thousands) Fair Value Measurements at June 30, 2010 Using:
Quoted Prices
In Active
Markets for Significant Other Significant
Identical Observable Unobservable
Carrying Assets Inputs Inputs
Description Value (Level 1) (Level 2) (Level 3)
U. S. government agencies $ 65,828 $ - $ 65,828 $ -
States and municipals 86,703 - 86,703 -
Mortgage-backed - residential 38,795 - 38,795 -
Equity securities 299 299 - -
Total $191,625 $ 299 $191,326 $ -
(In thousands) Fair Value Measurements at December 31, 2009 Using:
Quoted Prices
In Active
Markets for Significant Other Significant
Identical Observable Unobservable
Carrying Assets Inputs Inputs
Description Value (Level 1) (Level 2) (Level 3)
U. S. government agencies $ 44,733 $ - $ 44,733 $ -
States and municipals 80,123 - 80,123 -
Mortgage-backed - residential 43,263 - 43,263 -
Equity securities 292 292 - -
Total $168,411 $ 292 $168,119 $ -
Assets measured at fair value on a non-recurring basis are summarized below:
(In thousands) Fair Value Measurements at June 30, 2010 Using:
Quoted Prices
In Active
Markets for Significant Other Significant
Identical Observable Unobservable
Carrying Assets Inputs Inputs
Description Value (Level 1) (Level 2) (Level 3)
Impaired loans $ 11,098 $ - $ - $ 11,098
Other real estate
Owned 4,583 - - 4,583
Mortgage servicing
rights 262 - - 262
(In thousands) Fair Value Measurements at December 31, 2009
Using:
Quoted Prices
In Active
Markets for Significant Other Significant
Identical Observable Unobservable
Carrying Assets Inputs Inputs
Description Value (Level 1) (Level 2) (Level 3)
Impaired loans $10,202 $ - $ - $ 10,202
Other real estate
Owned 68 - - 68
Mortgage servicing
rights 626 - - 626
Impaired loans, which are measured for impairment using the fair value of the
collateral for collateral dependent loans, had a carrying amount of $14.0
million, with a valuation allowance of $2.9 million at June 30, 2010,
resulting in an additional provision of $1.1 million for loan losses for the
six months ending June 30, 2010. The provision for the three months ending
June 30, 2010 is $1.1 million.
Other real estate owned which is measured at fair value less costs to sell,
had a net carrying amount of $4.6 million, which is made up of the
outstanding balance of $5.1 million, net of a valuation allowance of $470
thousand at June 30, 2010, resulting in a write-down of $470 thousand for the
six months ending June 30, 2010. The write-down for the three months ending
June 30, 2010 is $191 thousand.
Fair Value of Financial Instruments
The fair values of the Company?s financial instruments at June 30, 2010 and
December 31, 2009 are as follows:
June 30, 2010 December 31, 2009
Carrying Carrying
Amount Fair Value Amount Fair Value
(In Thousands)
Financial assets
Cash and cash equivalents $ 30,404 $ 30,404 $ 34,421 $ 34,421
Securities 191,625 191,625 168,411 168,411
Mortgage loans held for sale 295 302 191 192
Loans, net 410,014 409,100 417,818 417,759
FHLB stock 6,731 N/A 6,731 N/A
Interest receivable 4,392 4,392 4,621 4,621
Financial liabilities
Deposits $ 554,931 $ 559,468 $ 536,446 $ 541,691
Securities sold under
agreements to repurchase
and other borrowings 6,844 6,870 8,226 8,252
FHLB advances 49,110 51,240 56,096 57,633
Subordinated debentures 7,217 5,052 7,217 6,029
Interest payable 3,893 3,893 2,122 2,122
The methods and assumptions, not previously presented, used to estimate fair
value are described as follows: Carrying amount is the estimated fair value
for cash and cash equivalents, interest bearing deposits, accrued interest
receivable and payable, demand deposits, short-term debt, and variable rate
loans or deposits that reprice frequently and fully. The methods for
determining the fair values for securities were described previously. 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 (including consideration of widening credit spreads). Fair value
of debt is based on current rates for similar financing. It was not
practicable to determine the fair value of FHLB stock due to restrictions
placed on its transferability. The fair value of off-balance sheet items is
not considered material.
Item 2 - MANAGEMENT?S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Forward-Looking Statements
This discussion contains forward-looking statements under the Private
Securities Litigation Reform Act of 1995 that involve risks and
uncertainties. These statements are not historical facts, but rather
statements based on our current expectations regarding our business
strategies and their intended results and our future performance. Forward-
looking statements are preceded by terms such as ?expects,? ?believes,?
?anticipates,? ?intends? and similar expressions.
Although we believe 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 and the thoroughbred horse industry, in which we and our
bank operate); competition for our customers from other providers of
financial and mortgage services; government legislation, regulation and
monetary policy (which changes from time to time and over which we have 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 our customers; and other
risks detailed in our filings with the Securities and Exchange Commission,
all of which are difficult to predict and many of which are beyond our
control. We undertake no obligation to republish revised forward-looking
statements to reflect events or circumstances after the date hereof or to
reflect the occurrence of unanticipated events.
Summary
We recorded net income of $2.13 million, or $0.78 basic earnings and diluted
earnings per share for the first six months ending June 30, 2010 compared
to $2.07 million, or $0.76 basic earnings and diluted earnings per share for
the six month period ending June 30, 2009. The first six months earnings
reflects an increase of 2.6% compared to the same time period in 2009, due
primarily to an increase in net interest income of $576 thousand and a
decrease in salaries and employee benefits of $1.0 million. Employee
benefits were higher in 2009 due to $860 thousand being expensed for final
costs associated with the settlement of the defined benefit plan that was
terminated as of December 31, 2008. Salaries and employee benefit expense
has decreased in 2010 also due to the voluntary separation offers that were
offered to certain employees during the third and fourth quarters of 2009.
These positive changes to net income during 2010 were partially offset by a
decrease in the gain on sold loans of $502 thousand and an increase in
repossession expenses of $517 thousand. The earnings for the three months
ended June 30, 2010 were $1.2 million, or $.43 basic and diluted earnings per
share for the three month period ending June 30, 2010 compared to $904
thousand, or $.33 basic and diluted earnings per share for the three month
period ending June 30, 2009. This three month period earnings reflects a 31%
increase compared to the same time period in 2009.
Return on average assets was 0.60% for the six months ended June 30, 2010 and
0.61% for the six month period ended June 30, 2009. Return on average assets
was 0.66% for the three months ended June 30, 2010 and 0.54% for the three
months ended June 30, 2009. Return on average equity was 6.9% for the six
month period ended June 30, 2010 and 7.1% for the same period in 2009.
Return on average equity was 7.6% for the three months ended June 30, 2010
and 6.1% for the same time period in 2009.
Gross Loans decreased $8.9 million from $425.4 million on December 31, 2009
to $416.5 million on June 30, 2010. The overall decrease is attributed to
decreases in real estate construction loans, real estate mortgage loans and
consumer loans. Decreases to these sectors of the loan portfolio were
partially offset by an increase of $2.8 million in commercial loans.
Total deposits increased from $536.4 million on December 31, 2009 to $554.9
million on June 30, 2010, an increase of $18.5 million. This increase is
primarily the result of an increase in non-interest bearing deposit accounts
of $20.0 million and an increase in interest bearing time deposit accounts
over $100 thousand of $17.8 million. Deposits are up due to temporary cash
influxes in our existing deposit base. Of this increase, $18 million is
expected to be withdrawn during the third quarter of 2010.
Net Interest Income
Net interest income was $10.0 million for the six months ended June 30, 2010
compared to $9.4 million for the six months ended June 30, 2009, an increase
of 6.1%. The interest spread of 3.05% for the first six months of 2010 is up
from 2.94% reported for the same period in 2009, an increase of 11 basis
points. Net interest income was $5.1 million for the three month period
ending June 30, 2010 compared to $4.7 million for the three month period
ending June 30, 2009, an increase of 9.8%. The interest spread was 3.08% for
three month period ending June 30, 2010 compared to 2.93% for the three month
period in 2009, an increase of 15 basis points. Rates have remained fairly
low in the past year. In addition to lower rates and tightening margins, the
net interest spread for 2010 is affected by an increase in ?lost? loan
interest during 2010 that can be attributed to an increase in non-performing
loans in our loan portfolio.
For the first six months, the yield on assets decreased from 5.13% in 2009 to
4.76% in 2010. The cost of liabilities decreased from 2.19% in 2009 to 1.71%
in 2010. Year to date average loans increased $3.7 million, or 0.89% from
June 30, 2009 to June 30, 2010. Loan interest income has decreased $276
thousand for the first six months of 2010 compared to the first six months of
2009. Year to date average deposits increased from June 30, 2009 to June 30,
2010, up $50.7 million or 9.6%. The increase is primarily the result of an
increase in non-interest bearing deposits and time deposits with balances
greater than $100 thousand. Deposit interest expense has decreased $655
thousand for the first six months of 2010 compared to the same period in
2009. Year to date average borrowings decreased $22.6 million, or 24.97%
from June 30, 2009 to June 30, 2010. The decrease is primarily the result of
paying off FHLB advances when they come due and not replacing them because of
the influx in deposits. Interest expense on borrowed funds has decreased
$577 thousand for the first six months of 2010 compared to the same period in
2009.
The volume rate analysis for 2010 that follows indicates that $834 thousand
of the decrease in interest income is attributable to the decrease in rates,
while the change in volume contributed to an increase of $178 thousand in
interest income. The rate decrease also caused a decrease in the cost of
interest bearing liabilities. The average rate of these liabilities
decreased from 2.19% in 2009 to 1.71% in 2010. Based on the volume rate
analysis that follows, the lower level of interest rates contributed to a
decrease of $1.6 million in interest expense, while the change in volume was
responsible for a $395 thousand increase in interest expense. As a result,
the 2010 net interest income increase is attributed to decreases in rates.
In addition to the negative impact on net interest income that may result
from the decreasing rate environment that began in 2007 and continued into
2010 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 2010. Changes in interest income and expenses due to both rate
and volume are allocated on a pro rata basis.
Changes in Interest Income and Expense
Six Months Ended June 30, 2010
2010 vs. 2009
Increase (Decrease) Due to Change in
Volume Rate Net Change
INTEREST INCOME
Loans $ 325 $ (601) $ (276)
Investment Securities (171) (219) (390)
Federal Funds Sold and
Securities Purchased under
Agreements to Resell 19 (5) 14
Deposits with Banks 5 (9) (4)
Total Interest Income 178 (834) (656)
INTEREST EXPENSE
Deposits
Demand 64 146 210
Savings (32) (139) (171)
Negotiable Certificates of
Deposit and Other
Time Deposits 777 (1,471) (694)
Securities sold under
agreements to
repurchase and
other borrowings (122) (3) (125)
Federal Home Loan
Bank advances (292) (160) (452)
Total Interest Expense 395 (1,627) (1,232)
Net Interest Income $ (217) $ 793 $ 576
Non-Interest Income
Non-interest income decreased $448 thousand for the six months ended June 30,
2010 compared to the same period in 2009 to $4.1 million, due primarily to a
decrease in the gains on the sale of mortgage loans of $502 thousand and a
decrease in service charges of $135 thousand. These reductions to income
were partially offset by an increase in other non-interest income of $83
thousand. The decrease in service charges was primarily the result of a
decrease in fees collected for title insurance of $70 thousand and a decline
in overdraft income of $70 thousand. Other non-interest income increased
mostly do to an increase in debit card interchange income of $80 thousand
compared to the same period one year ago. Non-interest income decreased $194
thousand for the three months ended June 30, 2010 compared to the three
months ended June 30, 2009. The decrease was primarily due a reduction in
the gains on sold mortgage loans of $250 thousand and a decrease in service
charges of $85 thousand. Trust department fee income increased $69 thousand,
primarily from $75 thousand collected for part of an estate fee.
The gain on the sale of mortgage loans decreased from $811 thousand in the
first six months of 2009 to $309 thousand during the first six months of
2010. For the three months ended June 30, 2010 compared to the same time
period in 2009, the gain on the sale of mortgage loans decreased $250
thousand. The volume of loans sold during the first six months of 2010
decreased $25.3 million compared to the same time period in 2009. The volume
of mortgage loan originations and sales is generally inverse to rate changes.
A change in the mortgage loan rate environment can have a significant impact
on the related gain on sale of mortgage loans.
Non-Interest Expense
Total non-interest expenses decreased $341 thousand for the six month period
ended June 30, 2010 compared to the same period in 2009. For the three month
period ended June 30, 2010 compared to the three months ending June 30, 2009,
total non-interest expense decreased $629 thousand.
For the comparable six month periods, salaries and benefits decreased $1.0
million, a decrease of 17.4%. The decrease in salaries & benefits is
primarily attributed to our terminating the defined benefit plan offered to
our employees as of December 31, 2008. During the second quarter of 2009, we
recognized $860 thousand for the final expenses related to settling the plan.
In addition, we have recognized savings during 2010 related to having fewer
full time equivalent employees compared to the same period one year ago. The
reduced staff is the result of our offering voluntary separation options to
certain employees during the third and fourth quarters of 2009. The number
of full time equivalent employees decreased from 194 at June 30, 2009 to 177
at June 30, 2010. Salaries and employee benefits decreased $943 thousand for
the three month period ending June 30, 2010 compared to the same time period
in 2009.
Occupancy expenses increased $66 thousand to $1.4 million for the first six
months of 2010 compared to the same time period in 2009. Occupancy expenses
increased $35 thousand for the three month period ended June 30, 2010
compared to the same time period in 2009. The increase in year to date
occupancy expense during 2010 is mainly attributable to an increase in
depreciation expense of $105 thousand.
Legal and professional fees increased $168 thousand for the first six months
ended June 30, 2010 compared to the same time period in 2009. Legal and
professional fees increased $91 thousand for the three month period ending
June 30, 2010 compared to the same time period in 2009. The increase is
primarily from additional collection efforts for problem loans. Repossession
expenses increased $517 thousand for the first six months ended June 30, 2010
compared to the same time period in 2009. The increase is primarily
attributable to write-downs of other real estate owned. Repossession
expenses increased $271 thousand for the three month period ending June 30,
2010 compared to the same three months ending June 30, 2009. These increases
were partially offset by a decrease in the cost of FDIC insurance premiums of
$215 thousand for the six months ending June 30, 2010 compared to the six
months ending June 30, 2009. FDIC insurance expense decreased $226 thousand
for the three months ending June 30, 2010 compared to the same time period
one year ago. Due to the downturn in the financial industry and related bank
failures, the FDIC increased the FDIC insurance premiums in 2009. The
decrease in FDIC insurance expense in 2010 compared to 2009 is attributed to
the one-time special assessment the FDIC assessed on all FDIC insured banks
in May of 2009, which cost the Company $296 thousand in 2009.
In February 2009, the FDIC adopted a long-term deposit insurance fund (?DIF?)
restoration plan as well as an additional emergency assessment for 2009. The
restoration plan increases base assessment rates for banks in all risk
categories with the goal of raising the DIF reserve ratio from its current
0.40% to 1.15% within seven years. Banks in the best risk category, which
include our subsidiary bank, will pay initial base rates ranging from 12 to
16 basis points of assessable deposits beginning April 1, 2009, up from the
initial base rate range of 12 to 14 basis points. Additionally, the FDIC
approved an interim rule imposing a special emergency assessment to all
financial institutions of five basis points as of June 30, 2009. The special
assessment amounted to $296 thousand and was paid on September 30, 2009. The
FDIC is also permitted to impose an emergency special assessment after June
30, 2009 of up to 10 basis points if necessary to maintain public confidence
in federal deposit insurance. On November 12, 2009, the FDIC adopted a final
rule requiring insured depository institutions to prepay their estimated
quarterly risk-based assessments for the fourth quarter of 2009, and for all
of 2010, 2011, and 2012. The prepaid amount will be amortized over the
prepayment period. The Company?s prepayment was $3.1 million.
Financing Corporation (?FICO?) assessment costs were $30 thousand for the six
months ended June 30, 2010 and $27 thousand for 2009. FICO is a mixed-
ownership government corporation established by the Competitive Equality
Banking Act of 1987 possessing assessment powers in addition to the FDIC.
The FDIC acts as a collection agent for FICO, whose sole purpose is to
function as a financing vehicle for the now defunct Federal Savings & Loan
Insurance Corporation.
Income Taxes
The effective tax rate for the six months ended June 30, 2010 was 9.9%
compared to 7.6% in 2009. The effective tax rate for the three months ended
June 30, 2010 was 13.5% compared to (10.0%) for the three months ended June
30, 2009. These rates are less than the statutory rate as a result of the
tax-free securities and loans held by the Company. The rates for 2010 are
higher due to the higher level of income for 2010 and also tax credits for
investments we held related to historic and low income housing that expired
at the end of 2009. Nontaxable interest income increased $431 thousand for
the first six months of 2010 compared to the same time period in 2009.
Liquidity and Funding
Liquidity risk is the possibility that we may not be able to meet our cash
requirements. Management of liquidity risk includes maintenance of adequate
cash and sources of cash to fund operations and to meet the needs of
borrowers, depositors and creditors. Excess liquidity has a negative impact
on earnings as a result of the lower yields on short-term assets.
Cash and cash equivalents were $30.4 million as of June 30, 2010 compared to
$34.4 million at December 31, 2009. The decrease in cash and cash
equivalents is mainly attributable to a decrease in federal funds sold
resulting primarily from an increase in our security portfolio. In addition
to cash and cash equivalents, the securities portfolio provides an important
source of liquidity. Securities available for sale totaled $191.6 million at
June 30, 2010 compared to $168.4 million at December 31, 2009. The available
for sale securities are available to meet liquidity needs on a continuing
basis. We expect our customers? deposits to be adequate to meet our funding
demands.
Generally, we rely upon net cash inflows from financing activities,
supplemented by net cash inflows from operating activities, to provide cash
used in our 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. Our
primary investing activities include purchasing investment securities and
loan originations.
For the first six months of 2010, deposits have increased $18 million. With
loan demand being slow, we have been able to increase our investment
portfolio by $23 million. And to a lesser degree, we have paid down FHLB
advances $7 million and will continue to pay those down as they mature.
Management is aware of the challenge of funding sustained loan growth.
Therefore, in addition to deposits, other sources of funds, such as Federal
Home Loan Bank (FHLB) advances, may be used. We rely on FHLB advances for
both liquidity and asset/liability management purposes. These advances are
used primarily to fund long-term fixed rate residential mortgage loans. As
of June 30, 2010, we have sufficient collateral to borrow an additional $40
million from the FHLB. In addition, as of June 30, 2010, over $33 million is
available in overnight borrowing through various correspondent banks. In
light of this, management believes there is sufficient liquidity to meet all
reasonable borrower, depositor and creditor needs in the present economic
environment.
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 June 30, 2010 and
December 31, 2009, 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)
June 30, 2010
Consolidated
Total Capital (to Risk-Weighted Assets) $ 59,577 12.8% $ 37,230 8% $ 46,538 N/A
Tier I Capital (to Risk-Weighted Assets) 53,739 11.6 18,615 4 27,923 N/A
Tier I Capital (to Average Assets) 53,739 7.6 28,257 4 35,321 N/A
Bank Only
Total Capital (to Risk-Weighted Assets) $ 61,674 13.3% $ 37,223 8% $ 46,528 10%
Tier I Capital (to Risk-Weighted Assets) 55,836 12.0 18,611 4 27,917 6
Tier I Capital (to Average Assets) 55,836 7.9 28,235 4 35,293 5
December 31, 2009
Consolidated
Total Capital (to Risk-Weighted Assets) $ 58,398 12.6% $ 36,957 8% $ 46,196 N/A
Tier I Capital (to Risk-Weighted Assets) 52,593 11.4 18,478 4 27,718 N/A
Tier I Capital (to Average Assets) 52,593 8.0 26,201 4 32,752 N/A
Bank Only
Total Capital (to Risk-Weighted Assets) $ 60,675 13.1% $ 36,941 8% $ 46,177 10%
Tier I Capital (to Risk-Weighted Assets) 54,869 11.9 18,471 4 27,706 6
Tier I Capital (to Average Assets) 54,869 8.4 26,200 4 32,750 5
Non-Performing Assets
As of June 30, 2010, our non-performing assets totaled $20.2 million or 2.95%
of assets compared to $19.1 million or 2.83% of assets at December 31, 2009.
(See table below) We experienced an increase of $2.4 million in non-accrual
loans from December 31, 2009 to June 30, 2010, largely due to an increase in
non-accrual loans secured by real estate of $2.5 million. As of June 30,
2010, non-accrual loans include $4.7 million in loans secured by non-farm and
non-residential real estate, $4.2 million in loans secured by real estate
construction, $3.7 million in loans secured by 1-4 family residential real
estate, $900 thousand in loans secured by multi-family real estate properties
and $800 thousand in loans secured by farmland. Real estate loans composed
99% of the non-performing loans as of June 30, 2010 and 98% as of December
31, 2009. Forgone interest income on the non-accrual loans was $355 thousand
for the first six months of 2010 compared to $367 thousand for the same time
period in 2009. Accruing loans that are contractually 90 days or more past
due as of June 30, 2010 totaled $300 thousand compared to $2.5 million at
December 31, 2009, a decrease of $2.2 million. The decrease is primarily due
to one loan amounting to $1.4 million being paid off during the period. The
total nonperforming loans increased $169 thousand from December 31, 2009 to
June 30, 2010, resulting in a slight increase in the ratio of nonperforming
loans to loans of 12 basis points to 3.54%. In addition, the amount the
Company has booked as ?Other Real Estate? has increased $1.0 million from
December 31, 2009 to June 30, 2010. As of June 30, 2010 the amount booked as
?Other Real Estate? totaled $5.5 million compared to $4.5 million at December
31, 2009. The increase is largely attributed to one loan customer who
specialized in commercial & land development properties that totaled $1.2
million, that was previously on non-accrual. The allowance as a percentage
of non-performing and restructured loans increased slightly from 40% at
December 31, 2009 to 44% at June 30, 2010.
Nonperforming Assets
6/30/10 12/31/09
(in thousands)
Non-accrual Loans $ 14,433 $ 12,038
Accruing Loans which are
Contractually past due
90 days or more 300 2,526
Total Nonperforming and Restructured 14,733 14,564
Other Real Estate 5,548 4,542
Total Nonperforming and Restructured
Loans and Other Real Estate $ 20,281 $ 19,106
Nonperforming and Restructured Loans
as a Percentage of Loans 3.54% 3.42%
Nonperforming and Restructured Loans
and Other Real Estate as a Percentage
of Total Assets 2.95% 2.83%
Allowance as a Percentage of
Period-end Loans 1.55% 1.79%
Allowance as a Percentage of
Non-performing and Restructured Loans 44% 40%
We maintain a ?watch list? of agricultural, commercial, real estate mortgage,
and real estate construction loans and reviews those loans on a regular
basis. Generally, assets are designated as ?watch list? loans to ensure more
frequent monitoring. If we determine that there is serious doubt as to
performance in accordance with original terms of the contract, then the loan
is generally downgraded and often placed on non-accrual status. We review
and evaluate nonaccrual loans, past due loans, and loans graded substandard
or worse on a regular basis to determine if specific allocations are needed.
Provision for Loan Losses
The loan loss provision for the first six months was $1.25 million for 2010
and $900 thousand for 2009. The loan loss provision for the three months
ended June 30, 2010 was $800 thousand and $450 thousand for the same period
in 2009. Management evaluates the loan portfolio by reviewing the historical
loss rate for each respective loan type and assigns risk multiples to certain
categories to account for qualitative factors including current economic
conditions. The average loss rates are reviewed in the analysis, as well as
comparisons to peer group loss rates. Management makes allocations within
the allowance for loan losses for specifically classified loans regardless of
loan amount, collateral or loan type. Loan categories are evaluated
utilizing subjective factors in addition to the historical loss calculations
to determine a loss allocation for each of those types. As this analysis, or
any similar analysis, is an imprecise measure of loss, the allowance is
subject to ongoing adjustments. Therefore, management will often take into
account other significant factors that may be necessary or prudent in order
to reflect probable incurred losses in the total loan portfolio.
Net charge-offs for the six month period ended June 30, 2010 were $2.4
million compared to net recoveries of $8 thousand for the same period in
2009. Net charge-offs for the three month period ended June 30, 2010 were
$103 thousand compared to $76 thousand during the same period in 2009. Based
on our internal loan review as of December 31, 2009, an addition of $1.8
million was made to the allowance for loan losses in the fourth quarter of
2009. Three borrowers that total $1.8 million were charged off in the first
quarter of 2010 and were directly related to the additional provision in the
fourth quarter of 2009. Future levels of charge-offs will be determined by
the particular facts and circumstances surrounding individual loans. Based
on the above information, Management believes the current loan loss allowance
is sufficient to meet probable incurred loan losses.
Loan Losses Six Months Ended June 30
(in thousands)
2010 2009
Balance at Beginning of Period $ 7,600 $ 5,465
Amounts Charged-off:
Commercial 19 67
Real Estate Construction 547 39
Real Estate Mortgage 1,793 82
Agricultural 74 6
Consumer 471 624
Total Charged-off Loans 2,904 818
Recoveries on Amounts
Previously Charged-off:
Commercial 43 2
Real Estate Construction - 35
Real Estate Mortgage 172 387
Agricultural 10 -
Consumer 290 402
Total Recoveries 515 826
Net Charge-offs (Recoveries) 2,389 (8)
Provision for Loan Losses 1,250 900
Balance at End of Period 6,461 6,373
Loans
Average 422,081 418,375
At June 30 416,475 417,556
As a Percentage of Average Loans:
Net Charge-offs for the period 0.57% 0.00%
Provision for Loan Losses for the period 0.30% 0.22%
Allowance as a Multiple of
Net Charge-offs (annualized) 1.4 (398.3)
Three Months Ended June 30
(in thousands)
2010 2009
Balance at Beginning of Period $ 5,763 $ 5,999
Amounts Charged-off:
Commercial - 67
Real Estate Construction - 36
Real Estate Mortgage 80 34
Agricultural - 353
Consumer 235 -
Total Charged-off Loans 315 490
Recoveries on Amounts
Previously Charged-off:
Commercial - 2
Real Estate Construction - 35
Real Estate Mortgage 69 152
Agricultural 2 -
Consumer 142 225
Total Recoveries 213 414
Net Charge-offs 102 76
Provision for Loan Losses 800 450
Balance at End of Period 6,461 6,373
Loans
Average 420,998 418,038
At June 30 416,475 417,556
As a Percentage of Average Loans:
Net Charge-offs for the period 0.02% 0.02%
Provision for Loan Losses for the period 0.19% 0.11%
Allowance as a Multiple of
Net Charge-offs (annualized) 15.7 21.0
Item 3 ? QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Asset/Liability management control is designed to ensure safety and
soundness, maintain liquidity and regulatory capital standards, and achieve
acceptable net interest income. Management considers interest rate risk to
be the most significant market risk. Our exposure to market risk is reviewed
on a regular basis by the Asset/Liability Committee. Interest rate risk is
the potential of economic losses due to future interest rate changes. These
economic losses can be reflected as a loss of future net interest income
and/or a loss of current fair market values. The objective is to measure the
effect on net interest income and to adjust the balance sheet to minimize the
inherent risk, while at the same time, maximize income.
Management realizes certain risks are inherent and that the goal is to
identify and minimize the risks. The primary tools used by management are
interest rate shock and economic value of equity (EVE) simulations. We have
no market risk sensitive instruments held for trading purposes.
Using interest rate shock simulations, the following table depicts the change
in net interest income resulting from 100 and 300 basis point changes in
rates on the Company?s interest earning assets and interest bearing
liabilities. The projections are based on balance sheet growth assumptions
and repricing opportunities for new, maturing and adjustable rate amounts.
As of June 30, 2010, the projected percentage changes are within the Board
approved limits. Although management does analyze and monitor the projected
percentage change in a declining interest rate environment, due to the
current rate environment many of the current deposit rates cannot decline an
additional 100 basis points. Therefore, management places more emphasis in
the rising rate environment scenarios. This period?s volatility is higher in
each rate shock simulation both in a falling and rising rate environment when
compared to the same period a year ago. The projected net interest income
report summarizing our interest rate sensitivity as of June 30, 2010 is as
follows:
PROJECTED NET INTEREST INCOME
(dollars in thousands)
Level
Change in basis points: - 300 - 100 Rates + 100 + 300
Year One (7/10 - 6/11)
Net interest income $22,943 $23,738 $23,932 $24,190 $24,622
Net interest income dollar change (989) (193) N/A 258 690
Net interest income percentage change -4.1% -0.8% N/A 1.1% 2.9%
Board approved limit >-10.0% >-4.0% N/A >-4.0% >-10.0%
The projected net interest income report summarizing the Company's interest
rate sensitivity as June 30, 2009 is as follows:
PROJECTED NET INTEREST INCOME
(dollars in thousands)
Level
Change in basis points: - 300 - 100 Rates + 100 + 300
Year One (7/09 - 6/10)
Net interest income $20,407 $21,487 $22,415 $22,957 $23,420
Net interest income dollar change (2,008) (928) N/A 542 1,005
Net interest income percentage change -9.0% -4.1% N/A 2.4% 4.5%
Board approved limit >-10.0% >-4.0% N/A >-4.0% >-
10.0%
Projections from June 30, 2010, year one reflected a decline in net interest
income of 0.8% with a 100 basis point decline compared to the 4.1% decline in
2009. The 100 basis point increase in rates reflected a 1.1% increase in net
interest income in 2010 compared to 2.4% in 2009.
EVE applies discounting techniques to future cash flows to determine the
present value of assets, liabilities, and therefore equity. Based on
applying these techniques to the June 30, 2010 balance sheet, a 100 basis
point increase in rates results in a 7.4% decrease in EVE. A 100 basis point
decrease in rates results in a 4.9% increase in EVE. These are within the
Board approved limits.
Item 4 ? CONTROLS AND PROCEDURES
As of the end of the period covered by this report, our management, including
the Chief Executive Officer and the Chief Financial Officer, carried out an
evaluation of the effectiveness of the design and operation of our disclosure
controls and procedures. Based on the foregoing, our Chief Executive Officer
and Chief Financial Officer concluded that the Company?s disclosure controls
and procedures were effective, in all material respects, to ensure that
information required to be disclosed in the reports the Company files and
submits under the Exchange Act is recorded, processed, summarized and
reported as and when required.
We also conducted an evaluation of internal control over financial reporting
to determine whether any changes occurred during the quarter covered by this
report that have materially affected, or are reasonably likely to materially
affect, our internal control over financial reporting. Based on this
evaluation, there has been no such change during the quarter covered by this
report.
Part II - Other Information
Item 1. Legal Proceedings
We are not a party to any material legal proceedings.
Item 1A. Risk Factors
A wide range of regulatory initiatives directed at the financial
services industry have been proposed in recent months. One of those
initiatives, the Dodd-Frank Wall Street Reform and Consumer Protection
Act of 2010 (the ?Dodd-Frank Act?), was signed into law by President
Obama on July 21, 2010. The Dodd-Frank Act represents a comprehensive
overhaul of the financial services industry within the United States,
establishes the new federal Bureau of Consumer Financial Protection
(the ?BCFP?), and will require the BCFP and other federal agencies to
implement many new rules. At this time, it is difficult to predict the
extent to which the Dodd-Frank Act or the resulting regulations will
impact the Company?s business. However, compliance with these new
laws and regulations will result in additional costs, which may
adversely impact the Company?s results of operations, financial
condition or liquidity, any of which may impact the market price of the
Company?s common stock.
Other than the additional risk factor mentioned above, there are no
material changes from the risk factors set forth under Part I, Item 1A
?Risk Factors? in our Annual Report on Form 10-K for the year ended
December 31, 2009.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
ISSUER PURCHASES OF EQUITY SECURITIES
(a) (b) (c) Total Number (d) Maximum Number
Total of Shares (or Units) (or Approximate
Dollar
Number of Average Purchased as Part Value) of Shares (or
Shares (or Price Paid of Publicly Units) that May Yet
Be
Units) Per Share Announced Plans Purchased Under the
Period Purchased (or Unit) Or Programs Plans of Programs
4/1/10 ?
4/30/10 - $ - - 32,199 shares
5/1/10 ?
5/31/10 - - - 32,199 shares
6/1/10 ?
6/30/10 651 15.75 651 31,548 shares
Total 651 - 651 31,548 shares
On October 25, 2000, we announced that our Board of Directors approved a
stock repurchase program and authorized the Company 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. On May 20, 2008, the Board of Directors approved and
authorized the Company to purchase 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 June 30, 2010, 268,452 shares have been
purchased.
Item 6. Exhibits
31.1 Certifications of Chief Executive Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Certifications of Chief Financial Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
32 Certifications of Chief Executive Officer and Chief
Financial Officer pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
KENTUCKY BANCSHARES, INC.
Date _____8/13/10_______ __/s/Louis Prichard______________
Louis Prichard, President and C.E.O.
Date _____8/13/10_______ __/s/Gregory J. Dawson___________
Gregory J. Dawson, Chief Financial Officer
22
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