UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 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 November 8, 2010:
2,739,319.
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) 9/30/2010 12/31/2009
Assets
Cash and due from banks $ 18,115 $ 12,387
Federal funds sold 7,855 22,034
Cash and cash equivalents 25,970 34,421
Securities available for sale 176,487 168,411
Mortgage loans held for sale 149 191
Loans 415,417 425,418
Allowance for loan losses (7,372)
(7,600)
Net loans 408,045 417,818
Federal Home Loan Bank stock 6,731 6,731
Real estate owned, net 6,380 4,542
Bank premises and equipment, net 17,670 17,610
Interest receivable 4,627 4,620
Mortgage servicing rights 862 822
Goodwill 13,117 13,117
Other intangible assets 1,072 1,263
Other assets 4,997 5,685
Total assets $ 666,107 $ 675,231
Liabilities and Stockholders' Equity
Deposits
Non-interest bearing $ 112,890 $ 97,005
Time deposits, $100,000 and over 120,253 105,036
Other interest bearing 305,711 334,405
Total deposits 538,854 536,446
Repurchase agreements and other borrowings 6,437 8,226
Federal Home Loan Bank advances 43,567 56,096
Subordinated debentures 7,217 7,217
Interest payable 2,361 2,123
Other liabilities 2,981 4,158
Total liabilities 601,417 614,266
Stockholders' equity
Preferred stock, 300,000 shares
authorized and unissued - -
Common stock, no par value; 10,000,000 shares
authorized; 2,742,506 and 2,739,511 shares
issued and outstanding on September 30, 2010 and
December 31, 2009 12,489 12,416
Retained earnings 49,185 47,213
Accumulated other comprehensive income 3,016 1,336
Total stockholders' equity 64,690 60,965
Total liabilities & stockholders' equity $ 666,107 $ 675,231
See Accompanying Notes
KENTUCKY BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (unaudited)
(in thousands, except per share amounts) Nine Months Ending
9/30/2010 9/30/2009
INTEREST INCOME:
Loans, including fees $ 17,936 $ 18,640
Securities available for sale 4,955 5,361
Other 33 15
Total interest income 22,924 24,016
INTEREST EXPENSE:
Deposits 6,296 7,100
Other 1,717 2,566
Total interest expense 8,013 9,666
Net interest income 14,911 14,350
Loan loss provision 1,950 1,350
Net interest income after provision 12,961 13,000
NON-INTEREST INCOME:
Service charges 3,707 3,918
Loan service fee income, net 65 69
Trust department income 431 377
Securities available for sale gains, net 1,267 351
Gain on sale of mortgage loans 650 1,026
Other 1,303 1,114
Total other income 7,423 6,855
NON-INTEREST EXPENSE:
Salaries and employee benefits 7,574 8,618
Occupancy expenses 2,080 2,031
Repossession expenses, net 947 264
FDIC insurance 768 921
Legal and professional fees 586 300
Data processing 579 558
Debit card expenses 469 479
Amortization 191 195
Advertising and marketing 446 372
Taxes other than payroll, property and income 594 553
Other 1,983 1,862
Total other expenses 16,217 16,153
Income before taxes 4,167 3,702
Income taxes 467 277
Net income $ 3,700 $ 3,425
Other Comprehensive Income, net of tax:
Change in Unrealized Gains on Securities 1,680 4,109
Comprehensive Income $ 5,380 $ 7,534
Earnings per share
Basic $ 1.35 $ 1.25
Diluted 1.35 1.25
Dividends per share 0.63 0.60
See Accompanying Notes
KENTUCKY BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (unaudited)
(in thousands, except per share amounts) Three Months Ending
9/30/2010 9/30/2009
INTEREST INCOME:
Loans, including fees $ 5,909 $ 6,337
Securities available for sale 1,558 1,574
Other 9 1
Total interest income 7,476 7,912
INTEREST EXPENSE:
Deposits 2,055 2,204
Other 511 783
Total interest expense 2,566 2,987
Net interest income 4,910 4,925
Loan loss provision 700 450
Net interest income after provision 4,210 4,475
NON-INTEREST INCOME:
Service charges 1,320 1,396
Loan service fee income, net (5) 19
Trust department income 121 142
Securities available for sale gains (losses), net 1,053 148
Gain on sale of mortgage loans 341 215
Other 476 370
Total other income 3,306 2,290
NON-INTEREST EXPENSE:
Salaries and employee benefits 2,631 2,632
Occupancy expenses 719 738
Repossession expenses, net 319 66
FDIC insurance 272 210
Legal and professional fees 236 118
Data processing 191 178
Debit card expenses 173 186
Amortization 63 64
Advertising and marketing 155 119
Taxes other than payroll, property and income 200 187
Other 750 806
Total other expenses 5,709 5,304
Income before taxes 1,807 1,461
Income taxes 233 108
Net income $ 1,574 $ 1,353
Other Comprehensive Income (Loss), net of tax:
Change in Unrealized Gains on Securities 789 3,290
Comprehensive Income $ 2,363 $ 4,643
Earnings per share
Basic $ 0.57 $ 0.49
Diluted 0.57 0.49
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 3,646 - - - -
Stock based compensation expense - 83 - - 83
Common stock purchased and retired (651) (10) - - (10)
Net change in unrealized gain (loss)
on securities available for sale,
net of tax - - - 1,680 1,680
Net income - - 3,700 - 3,700
Dividends declared - $0.63 per share - - (1,728) - (1,728)
Balances, September 30, 2010 2,742,506 $ 12,489 $ 49,185 $ 3,016 $ 64,690
(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) Nine Months Ended
9/30/2010 9/30/2009
Cash Flows From Operating Activities
Net Income $ 3,700 $ 3,425
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation and amortization 1,234 1,128
Securities amortization, net 695 1,156
Stock based compensation expense 83 86
Provision for loan losses 1,950 1,350
Securities gains, net (1,267)
(351)
Originations of loans held for sale (23,125)
(45,213)
Proceeds from sale of loans 23,817 46,239
Gains on sale of fixed assets 3 -
Losses (gains on) other real estate, net 39
(78)
Gain on sale of mortgage loans (650)
(1,026)
Changes in:
Interest receivable (7) 78
Real estate owned, net 700 1,137
Other assets 382
(2,947)
Interest payable 238
(286)
Other liabilities (2,042)
(797)
Net cash from operating activities 5,750 3,901
Cash Flows From Investing Activities
Purchases of securities (105,577)
(60,799)
Proceeds from sales of securities 37,345 20,646
Proceeds from principal payments, maturities and
calls of securities 63,273 48,850
Net change in loans 5,324
(5,181)
Purchases of bank premises and equipment (975)
(555)
Proceeds from the sale of bank premises 3 -
Net cash from investing activities (607) 2,961
Cash Flows From Financing Activities:
Net change in deposits 2,408
(24,225)
Net change in repurchase agreements
and other borrowings (1,189) 7,657
Advances from Federal Home Loan Bank - 10,000
Payments on Federal Home Loan Bank advances (12,475)
(23,817)
Payments on note payable (600)
(200)
Purchase of common stock (10)
(150)
Dividends paid (1,728)
(1,647)
Net cash from financing activities (13,594)
(32,382)
Net change in cash and cash equivalents (8,451)
(25,520)
Cash and cash equivalents at beginning of period 34,421 37,106
Cash and cash equivalents at end of period $ 25,970 $ 11,586
Supplemental disclosures of cash flow information
Cash paid during the year for:
Interest expense $ 8,251 $ 9,952
Income taxes - 400
Supplemental disclosures of non-cash investing
activities
Real estate acquired through foreclosure $ 3,494` $ 4,109
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, Elliott, 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.
Reclassifications: Some items in the prior year financial statements were
reclassified to conform to the current presentation.
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
September 30, 2010
U.S. government agencies $ 54,758 $ 206 $ (14) $ 54,950
States and political subdivisions 83,523 4,026 (100) 87,449
Mortgage-backed - residential 33,367 443 (23) 33,787
Equity securities 270 31 - 301
Total $ 171,918 $ 4,706 $ (137) $ 176,487
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 September 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 $ 1,513 $ 1,631
Due after one year through five years 40,808 41,087
Due after five years through ten years 39,402 41,005
Due after ten years 56,558 58,676
138,281 142,399
Mortgage-backed - residential 33,367 33,787
Equity 270 301
Total $ 171,918 $ 176,487
Proceeds from sales of securities during the first nine months of 2010 and 2009
were $37.3 million and $20.6 million. Gross gains of $1.268 million and $352
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 $431 thousand and $120 thousand, respectively. Proceeds from sales
of securities during the third quarter of 2010 and 2009 were $27.8 million and
$3.1 million. Gross gains of $1.053 million and $149 thousand and gross losses
of $0 and $1 thousand were realized on those sales, respectively. The tax
provision related to these realized gains and losses was $358 thousand and $51
thousand, respectively.
Securities with unrealized losses at September 30, 2010 and at December 31,
2009 not recognized in income are as follows:
September 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 $ 5,031 $ (14) $ - $ - $ 5,031 $ (14)
States and municipals 3,992 (99) 226 (1) 4,218 (100)
Mortgage-backed - residential 3,062 (23) - - 3,062 (23)
Total temporarily impaired $12,085 $ (136) $ 226 $ (1) $12,311 $ (137)
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) all rated securities are investment grade
and 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)
9/30/10 12/31/09
Commercial $ 24,409 $ 21,933
Real estate construction 13,855 16,865
Real estate mortgage 279,420 287,444
Agricultural 80,295 80,619
Consumer 17,127 18,277
Other 311 280
Total $ 415,417 $ 425,418
Activity in the allowance for loan losses for the nine month periods indicated
was as follows:
(in thousands)
9/30/10 9/30/09
Beginning balance $ 7,600 $ 5,465
Charge-offs (3,421) (1,602)
Recoveries 1,243 1,125
Provision for loan losses 1,950 1,350
Ending balance $ 7,372 $ 6,338
Individually impaired loans were as follows:
(in thousands)
9/30/10 12/31/09
Period-end loans with no allocated
allowance for loan losses $ 20,448 $ 19,206
Period-end loans with allocated
allowance for loan losses 11,378 14,266
Total $ 31,826 $ 33,472
Amount of the allowance for loan
losses allocated $ 3,709 $ 4,064
Nine Months Ended
9/30/10 9/30/09
Average of individually impaired loans
during the period $ 12,822 $ 13,013
Cash-basis interest income recognized 135 1
Nonperforming loans were as follows:
(in thousands)
9/30/10 12/31/09
Loans past due over 90 days still
on accrual $ 628 $ 2,526
Nonaccrual loans 15,680 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 nine months of 2010, $3.5 million of impaired loans was
transferred to real estate owned and $3.4 million recorded in chargeoffs. The
increase in nonaccrual loans was primarily from various smaller balance loans
being added during the first quarter of 2010. During the third quarter, the
non-accrual loan portfolio increased largely due to one loan which was placed
on non-accrual in the amount of $2.2 million. However, also during the third
quarter, the Company received a principal payment of $2.9 million of which $2.3
million reduced non-accrual loan balances and $555 thousand was a recovery for
the amount previously charged off.
The Company has no troubled debt restructurings as of September 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:
Nine Months Ended
September 30
2010 2009
(in thousands)
Basic Earnings Per Share
Net Income $ 3,700 $ 3,425
Weighted average common shares outstanding 2,732 2,736
Basic earnings per share $ 1.35 $ 1.25
Diluted Earnings Per Share
Net Income $ 3,700 $ 3,425
Weighted average common shares outstanding 2,732 2,736
Add dilutive effects of assumed exercise
of stock options - -
Weighted average common and dilutive
potential common shares outstanding 2,732 2,736
Diluted earnings per share $ 1.35 $ 1.25
Three Months Ended
September 30
2010 2009
(in thousands)
Basic Earnings Per Share
Net Income $ 1,574 $ 1,353
Weighted average common shares outstanding 2,732 2,732
Basic earnings per share $ 0.57 $ 0.49
Diluted Earnings Per Share
Net Income $ 1,574 $ 1,353
Weighted average common shares outstanding 2,732 2,732
Add dilutive effects of assumed exercise
of stock options - -
Weighted average common and dilutive
potential common shares outstanding 2,732 2,732
Diluted earnings per share $ 0.57 $ 0.49
Stock options for 33,240 shares of common stock for the nine and three months
ended September 30, 2010 and 37,844 shares of common stock for the nine and
three months ended September 30, 2009 was excluded from diluted earnings per
share because their impact was antidilutive. Stock grants of 21,705 shares
of common stock for the nine and three months ended September 30, 2010 and
17,655 shares of common stock for the nine and three months ended September
30, 2009 was 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 (the ?1999 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 (together with the 1999 Plan, the ?Stock Option
Plans?), 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. For each Stock Option Plan, 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.
The combined summary of activity for 2010 in the expired Stock Option Plans
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 (3,010) 28.15
Exercised - -
Outstanding, end of period 33,240 $29.53 41.4 months $ -
Vested and expected to vest 33,240 $29.53 41.4 months $ -
Exercisable, end of period 33,240 $29.53 41.4 months $ -
As of September 30, 2010, there was $0 of total unrecognized compensation
cost related to nonvested stock options granted under either Plan. Since
both Stock Option Plans have expired, as of September 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 nine months of 2010 and 288 shares forfeited during
the first nine months of 2009. As of September 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 September 30, 2010 10,990 $ 242,562
As of September 30, 2010, there was $209,106 of total unrecognized
compensation cost related to nonvested shares granted under the restricted
stock grant 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
September 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 September 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 $ 54,950 $ - $ 54,950 $ -
States and municipals 87,449 - 87,449 -
Mortgage-backed - residential 33,787 - 33,787 -
Equity securities 301 301 - -
Total $176,487 $ 301 $176,186 $ -
(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 September 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
Real estate construction $ 1,102 $ - $ - $ 1,102
Real estate mortgage 6,567 - - 6,567
Total 7,669 - - 7,669
Other real estate owned
Real estate construction 2,684 - - 2,684
Real estate mortgage 1,472 - - 1,472
Total 4,156 - - 4,156
Mortgage servicing rights 166 - - 166
(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 $7.7
million, with a valuation allowance of $3.7 million at September 30, 2010,
resulting in an additional provision of $1.95 million for loan losses for the
nine months ending September 30, 2010. The provision for the three months
ending September 30, 2010 is $700 thousand.
Other real estate owned which is measured at fair value less costs to sell,
had a net carrying amount of $4.2 million, which is made up of the
outstanding balance of $4.7 million, net of a valuation allowance of $586
thousand at September 30, 2010, resulting in a write-down of $660 thousand
for the nine months ending September 30, 2010. The write-down for the three
months ending September 30, 2010 is $187 thousand.
Fair Value of Financial Instruments
The fair values of the Company?s financial instruments at September 30, 2010
and December 31, 2009 are as follows:
September 30, 2010 December 31, 2009
Carrying Carrying
Amount Fair Value Amount Fair Value
(In Thousands)
Financial assets
Cash and cash equivalents $ 25,970 $ 25,970 $ 34,421 $ 34,421
Securities 176,487 176,487 168,411 168,411
Mortgage loans held for sale 149 153 191 192
Loans, net 408,045 407,583 417,818 417,759
FHLB stock 6,731 N/A 6,731 N/A
Interest receivable 4,627 4,627 4,620 4,620
Financial liabilities
Deposits $ 538,854 $ 542,945 $ 536,446 $ 541,691
Securities sold under
agreements to repurchase
and other borrowings 6,437 6,455 8,226 8,252
FHLB advances 43,567 46,069 56,096 57,633
Subordinated debentures 7,217 4,558 7,217 6,029
Interest payable 2,361 2,361 2,123 2,123
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
The Company recorded net income of $3.7 million, or $1.35 basic earnings and
diluted earnings per share for the first nine months ending September 30,
2010 compared to $3.4 million, or $1.25 basic earnings and diluted earnings
per share for the nine month period ending September 30, 2009. The first
nine months earnings reflects an increase of 8.0% compared to the same time
period in 2009, due primarily to an increase in net interest income of $561
thousand, an increase in the gain of sold securities of $916 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 $376 thousand and an increase in
repossession expenses of $683 thousand. The earnings for the three months
ended September 30, 2010 were $1.6 million, or $0.57 basic and diluted
earnings per share for the three month period ending September 30, 2010
compared to $1.4 million, or $0.49 basic and diluted earnings per share for
the three month period ending September 30, 2009. This three month period
earnings reflects a 16% increase compared to the same time period in 2009.
Return on average assets was 0.70% for the nine months ended September 30,
2010 and 0.68% for the nine month period ended September 30, 2009. Return on
average assets was 0.91% for the three months ended September 30, 2010 and
0.82% for the three months ended September 30, 2009. Return on average
equity was 7.9% for the nine month period ended September 30, 2010 and 7.8%
for the same period in 2009. Return on average equity was 10.0% for the
three months ended September 30, 2010 and 9.1% for the same time period in
2009.
Gross Loans decreased $10.0 million from $425.4 million on December 31, 2009
to $415.4 million on September 30, 2010. The overall decrease is attributed
to decreases in real estate construction loans, real estate mortgage loans,
agricultural and consumer loans. Decreases to these sectors of the loan
portfolio were partially offset by an increase of $2.5 million in commercial
loans.
Total deposits increased from $536.4 million on December 31, 2009 to $538.8
million on September 30, 2010, an increase of $2.4 million. This increase
is primarily the result of an increase in non-interest bearing deposit
accounts of $15.9 million and an increase in interest bearing time deposit
accounts over $100 thousand of $15.2 million. Other interest bearing
deposits decreased $28.7 million from $334.4 million at December 31, 2009 to
$305.7 million at September 30, 2010. Deposits are up largely due to
temporary cash influxes in our existing deposit base. Of this increase, $7
million is expected to be withdrawn during the fourth quarter of 2010.
Net Interest Income
Net interest income was $14.9 million for the nine months ended September 30,
2010 compared to $14.4 million for the nine months ended September 30, 2009,
an increase of 3.9%. The interest spread of 3.06% for the first nine months
of 2010 is up from 3.04% reported for the same period in 2009, an increase of
2 basis points. Net interest income was $4.9 million for the three month
period ending September 30, 2010 compared to $4.9 million for the three month
period ending September 30, 2009, a decrease of 0.3% or $15 thousand. The
interest spread was 3.07% for three month period ending September 30, 2010
compared to 3.23% for the three month period in 2009, a decrease of 16 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 nine months, the yield on assets decreased from 5.17% in 2009
to 4.74% in 2010. The cost of liabilities decreased from 2.13% in 2009 to
1.68% in 2010. Year to date average loans increased $1.0 million, or 0.23%
from September 30, 2009 to September 30, 2010. Loan interest income has
decreased $704 thousand for the first nine months of 2010 compared to the
first nine months of 2009. Year to date average deposits increased from
September 30, 2009 to September 30, 2010, up $52.3 million or 10.0%. 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 $804 thousand for the first nine months of
2010 compared to the same period in 2009. Year to date average borrowings
decreased $22.7 million, or 25.94% from September 30, 2009 to September 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 $849 thousand for the first
nine months of 2010 compared to the same period in 2009.
The volume rate analysis for 2010 that follows indicates that $1.2 million of
the decrease in interest income is attributable to the decrease in rates,
while the change in volume contributed to an increase of $130 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 2.13% in 2009 to 1.68% in 2010. Based on the volume rate
analysis that follows, the lower level of interest rates contributed to a
decrease of $1.7 million in interest expense, while the change in volume was
responsible for a $26 thousand increase in interest expense. As a result,
the 2010 net interest income increase is mostly 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
Nine Months Ended September 30, 2010
2010 vs. 2009
Increase (Decrease) Due to Change in
Volume Rate Net Change
INTEREST INCOME
Loans $ 72 $ (776) $ (704)
Investment Securities 31 (437) (406)
Federal Funds Sold and
Securities Purchased under
Agreements to Resell 24 (3) 21
Deposits with Banks 3 (6) (3)
Total Interest Income 130 (1,222) (1,092)
INTEREST EXPENSE
Deposits
Demand 86 182 268
Savings (28) (173) (201)
Negotiable Certificates of
Deposit and Other
Time Deposits 566 (1,437) (871)
Securities sold under
agreements to
repurchase and
other borrowings (160) (18) (178)
Federal Home Loan
Bank advances (438) (233) (671)
Total Interest Expense 26 (1,679) (1,653)
Net Interest Income $ 104 $ 457 $ 561
Non-Interest Income
Non-interest income increased $568 thousand for the nine months ended
September 30, 2010 compared to the same period in 2009 to $7.4 million, due
primarily to an increase in the gain on sold securities of $916 thousand
which increased from $351 thousand for the first nine months in 2009 to
$1.267 million for the first nine months of 2010. The gain on securities
were primarily used to offset the additions to the loan loss reserve. The
gain on the sale of securities was partially offset by a decrease in service
charges of $211 thousand and the gain on the sale of mortgage loans of $376
thousand. Other non-interest income increased $189 thousand for the nine
months ended September 30, 2010 compared to the same period one year ago.
The decrease in service charges was primarily the result of a decrease in
fees collected for title insurance of $69 thousand and a decline in overdraft
income of $152 thousand. Other non-interest income increased mostly due to
an increase in debit card interchange income of $137 thousand compared to the
same period one year ago and an increase in brokerage income of $50 thousand.
Non-interest income increased $1.016 million for the three months ended
September 30, 2010 compared to the three months ended September 30, 2009.
The increase was primarily due to an increase in the gains of sold securities
of $905 thousand and in the gains on sold mortgage loans of $126 thousand.
These positive variances to non-interest income were partially offset by a
decrease in service charges of $76 thousand, a decrease in loan service fee
income of $24 thousand and a decrease in trust commissions of $21 thousand.
The gain on the sale of mortgage loans decreased from $1.026 million in the
first nine months of 2009 to $650 thousand during the first nine months of
2010. For the three months ended September 30, 2010 compared to the same
time period in 2009, the gain on the sale of mortgage loans increased $126
thousand. The volume of loans sold during the first nine months of 2010
decreased $22.1 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. Loan service fee income was
$65 thousand for the nine months ending September 30, 2010 compared to $69
thousand for the nine months ending September 30, 2009, a decrease of $4
thousand. During the third quarter of 2010, $24 thousand was expensed for
the write-down of the mortgage servicing right due to impairment which is
reflected in the loan service fee income. A positive adjustment of $24
thousand was made during the second quarter of 2010.
Non-Interest Expense
Total non-interest expenses increased $64 thousand for the nine month period
ended September 30, 2010 compared to the same period in 2009. For the three
month period ended September 30, 2010 compared to the three months ending
September 30, 2009, total non-interest expense increased $405 thousand.
For the comparable nine month periods, salaries and benefits decreased $1.0
million, a decrease of 12.1%. 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,
the Company 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 increased
from 186 at September 30, 2009 to 187 at September 30, 2010. However, the
number of full time equivalent employees reached 194 at June 30, 2009 and has
since declined to 187 full time equivalent employees at September 30, 2010
resulting in a decline in the year to date salary and employee benefits
expense in 2010. Salaries and employee benefits decreased $1 thousand for
the three month period ending September 30, 2010 compared to the same time
period in 2009.
Occupancy expenses increased $49 thousand to $2.1 million for the first nine
months of 2010 compared to the same time period in 2009. Occupancy expenses
decreased $19 thousand for the three month period ended September 30, 2010
compared to the same time period in 2009. The increase in year to date
occupancy expense during 2010 is primarily the result of an increase in
depreciation expense of $91 thousand, an increase in taxes on premises and
equipment of $28 thousand offset by a decrease in computer maintenance of $39
thousand and a decrease in building repairs and maintenance of $43 thousand.
Legal and professional fees increased $286 thousand for the first nine months
ended September 30, 2010 compared to the same time period in 2009. Legal and
professional fees increased $118 thousand for the three month period ending
September 30, 2010 compared to the same time period in 2009. The increase is
primarily from additional collection efforts for problem loans. Repossession
expenses increased $683 thousand for the first nine months ended September
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 $253 thousand for the three month period ending September
30, 2010 compared to the same three months ending September 30, 2009.
Repossession expenses are reported net of income earned on the repossessed
properties. These increases were partially offset by a decrease in the cost
of FDIC insurance premiums of $153 thousand for the nine months ending
September 30, 2010 compared to the nine months ending September 30, 2009.
FDIC insurance expense increased $62 thousand for the three months ending
September 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, paid 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 $44 thousand for the
nine months ended September 30, 2010 and $40 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 nine months ended September 30, 2010 was 11.2%
compared to 7.5% in 2009. The effective tax rate for the three months ended
September 30, 2010 was 12.9% compared to 7.3% for the three months ended
September 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 the Company held related to historic and low income housing
that expired at the end of 2009. Nontaxable interest income increased $656
thousand for the first nine 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 $26.0 million as of September 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 and an
increase in our ?due from? accounts with correspondent banks. In addition to
cash and cash equivalents, the securities portfolio provides an important
source of liquidity. Securities available for sale totaled $176.5 million at
September 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 nine months of 2010, deposits have increased $2.4 million.
With loan demand being slow, the Company has been able to increase its
investment portfolio by $8 million. In addition, the Company has paid down
FHLB advances by $12.5 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 September 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 September 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)
September 30, 2010
Consolidated
Total Capital (to Risk-Weighted Assets) $ 60,600 13.2% $ 36,739 8% $ 45,924 N/A
Tier I Capital (to Risk-Weighted Assets) 54,824 11.9 18,370 4 27,554 N/A
Tier I Capital (to Average Assets) 54,824 8.1 26,987 4 33,734 N/A
Bank Only
Total Capital (to Risk-Weighted Assets) $ 62,433 13.6% $ 36,728 8% $ 45,910 10%
Tier I Capital (to Risk-Weighted Assets) 56,659 12.3 18,364 4 27,546 6
Tier I Capital (to Average Assets) 56,659 8.4 26,978 4 33,722 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 September 30, 2010, our non-performing assets totaled $22.7 million or
3.41% of assets compared to $19.1 million or 2.83% of assets at December 31,
2009. (See table below) We experienced an increase of $3.6 million in non-
accrual loans from December 31, 2009 to September 30, 2010, largely due to an
increase in non-accrual loans secured by real estate of $3.7 million. As of
September 30, 2010, non-accrual loans include $2.5 million in loans secured
by non-farm and non-residential real estate, $4.2 million in loans secured by
real estate construction, $4.7 million in loans secured by 1-4 family
residential real estate, $3.3 million in loans secured by multi-family real
estate properties and $800 thousand in loans secured by farmland. Real
estate loans composed 99.7% of the non-performing loans as of September 30,
2010 and 98% as of December 31, 2009. Forgone interest income on the non-
accrual loans was $436 thousand for the first nine months of 2010 compared to
$394 thousand for the same time period in 2009. Accruing loans that are
contractually 90 days or more past due as of September 30, 2010 totaled $628
thousand compared to $2.5 million at December 31, 2009, a decrease of $1.9
million. The decrease is primarily due to one loan amounting to $1.4 million
being paid off during the period and other loans being reclassified as non-
accrual. The total nonperforming loans increased $1.7 million from December
31, 2009 to September 30, 2010, resulting in an increase in the ratio of
nonperforming loans to loans of 51 basis points to 3.93%. In addition, the
amount the Company has booked as ?Other Real Estate? has increased $1.9
million from December 31, 2009 to September 30, 2010. As of September 30,
2010 the amount booked as ?Other Real Estate? totaled $6.4 million compared
to $4.5 million at December 31, 2009. The increase is largely attributed to
two loan customers who specialized in commercial & land development
properties that totaled $2.4 million that was previously on non-accrual. The
allowance as a percentage of non-performing and restructured loans and Other
Real Estate decreased from 40% at December 31, 2009 to 32% at September 30,
2010. The decrease is largely attributed to the addition of $1.8 million
made to the allowance for loan losses in the fourth quarter of 2009 for loans
that were charged off in the first quarter of 2010.
Nonperforming Assets
9/30/10 12/31/09
(in thousands)
Non-accrual Loans $ 15,680 $ 12,038
Accruing Loans which are
Contractually past due
90 days or more 628 2,526
Total Nonperforming and Restructured 16,308 14,564
Other Real Estate 6,380 4,542
Total Nonperforming and Restructured
Loans and Other Real Estate $ 22,688 $ 19,106
Nonperforming and Restructured Loans
as a Percentage of Loans 3.93% 3.42%
Nonperforming and Restructured Loans
and Other Real Estate as a Percentage
of Total Assets 3.41% 2.83%
Allowance as a Percentage of
Period-end Loans 1.77% 1.79%
Allowance as a Percentage of
Non-performing and Restructured Loans 32% 40%
and Other Real Estate
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 nine months was $1.95 million for 2010
and $1.35 million for 2009. The loan loss provision for the three months
ended September 30, 2010 was $700 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 for trends 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 nine month period ended September 30, 2010 were $2.2
million compared to net charge-offs of $477 thousand for the same period in
2009. Net charge-offs for the three month period ended September 30, 2010
were positive and equated to a net recovery of $211 thousand compared to net
charge-offs of $485 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 Nine Months Ended September 30
(in thousands)
2010 2009
Balance at Beginning of Period $ 7,600 $ 5,465
Amounts Charged-off:
Commercial 19 289
Real Estate Construction 547 39
Real Estate Mortgage 1,967 221
Agricultural 74 6
Consumer 814 1,047
Total Charged-off Loans 3,421 1,602
Recoveries on Amounts
Previously Charged-off:
Commercial 43 2
Real Estate Construction - 35
Real Estate Mortgage 736 393
Agricultural 11 -
Consumer 453 695
Total Recoveries 1,243 1,125
Net Charge-offs 2,178 477
Provision for Loan Losses 1,950 1,350
Balance at End of Period 7,372 6,338
Loans
Average 420,621 420,364
At September 30 415,417 427,921
As a Percentage of Average Loans:
Net Charge-offs for the period 0.52% 0.11%
Provision for Loan Losses for the period 0.46% 0.32%
Allowance as a Multiple of
Net Charge-offs (annualized) 2.5 10.0
Three Months Ended September 30
(in thousands)
2010 2009
Balance at Beginning of Period $ 6,461 $ 6,373
Amounts Charged-off:
Commercial - 222
Real Estate Construction - -
Real Estate Mortgage 175 139
Agricultural - -
Consumer 342 423
Total Charged-off Loans 517 784
Recoveries on Amounts
Previously Charged-off:
Commercial - -
Real Estate Construction - -
Real Estate Mortgage 564 6
Agricultural 1 -
Consumer 163 293
Total Recoveries 728 299
Net Charge-offs (Recoveries) (211) 485
Provision for Loan Losses 700 450
Balance at End of Period 7,372 6,338
Loans
Average 417,701 424,342
At September 30 415,417 427,921
As a Percentage of Average Loans:
Net Charge-offs for the period (0.05)% 0.11%
Provision for Loan Losses for the period 0.17% 0.11%
Allowance as a Multiple of
Net Charge-offs (annualized) (8.7) 3.3
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 September 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 September 30,
2010 is as follows:
PROJECTED NET INTEREST INCOME
(dollars in thousands)
Level
Change in basis points: - 300 - 100 Rates + 100 + 300
Year One (10/10 - 9/11)
Net interest income $22,784 $23,550 $23,853 $23,967 $24,268
Net interest income dollar change (1,069) (303) N/A 114 415
Net interest income percentage change -4.5% -1.3% N/A 0.5% 1.7%
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 September 30, 2009 is as follows:
PROJECTED NET INTEREST INCOME
(dollars in thousands)
Level
Change in basis points: - 300 - 100 Rates + 100 + 300
Year One (10/09 - 9/10)
Net interest income $20,843 $21,447 $21,938 $22,122 $22,280
Net interest income dollar change (1,095) (491) N/A 184 342
Net interest income percentage change -5.0% -2.2% N/A 0.8% 1.6%
Board approved limit >-10.0% >-4.0% N/A >-4.0% >-10.0%
Projections from September 30, 2010, year one reflected a decline in net
interest income of 1.3% with a 100 basis point decline compared to the 2.2%
decline in 2009. The 100 basis point increase in rates reflected a 0.5%
increase in net interest income in 2010 compared to 0.8% 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 September 30, 2010 balance sheet, a 100
basis point increase in rates results in a 4.0% decrease in EVE. A 100 basis
point decrease in rates results in a 0.4% decrease 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
7/1/10 ?
7/31/10 - $ - - 31,548 shares
8/1/10 ?
8/31/10 - - - 31,548 shares
9/1/10 ?
9/30/10 - - - 31,548 shares
Total - - - 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 September 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 ___11/12/10_______ __/s/Louis Prichard______________
Louis Prichard, President and C.E.O.
Date ___11/12/10_______ __/s/Gregory J. Dawson___________
Gregory J. Dawson, Chief Financial Officer
4
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