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| FFKT > SEC Filings for FFKT > Form 10-K on 12-Mar-2009 | All Recent SEC Filings |
12-Mar-2009
Annual Report
Dividend payout
Cash dividends paid on common shares, divided by net income.
Basis points
Each basis point is equal to one hundredth of one percent. Basis points are
calculated by multiplying percentage points times 100. For example: 3.7
percentage points equals 370 basis points.
Interest rate sensitivity
The relationship between interest sensitive earning assets and interest bearing
liabilities.
Net charge-offs
The amount of total loans charged off net of recoveries of loans that have been
previously charged off.
Net interest income
Total interest income less total interest expense.
Net interest margin
Taxable equivalent net interest income expressed as a percentage of average
earning assets.
Net interest spread
The difference between the taxable equivalent yield on earning assets and the
rate paid on interest bearing funds.
Other real estate owned
Real estate not used for banking purposes. For example, real estate acquired
through foreclosure.
Provision for loan losses
The charge against current income needed to maintain an adequate allowance for
loan losses.
Return on average assets (ROA)
Net income divided by average total assets. Measures the relative profitability
of the resources utilized by the Company.
Return on average equity (ROE)
Net income divided by average shareholders' equity. Measures the relative
profitability of the shareholders' investment in the Company.
Tax equivalent basis (TE)
Income from tax-exempt loans and investment securities have been increased by an
amount equivalent to the taxes that would have been paid if this income were
taxable at statutory rates. In order to provide comparisons of yields and
margins for all earning assets, the interest income earned on tax-exempt assets
is increased to make them fully equivalent to other taxable interest income
investments.
Weighted average number of common shares outstanding The number of shares determined by relating (a) the portion of time within a reporting period that common shares have been outstanding to (b) the total time in that period.
Management's Discussion and Analysis of Financial Condition and Results of Operations
The following pages present management's discussion and analysis of the consolidated financial condition and results of operations of Farmers Capital Bank Corporation (the "Company" or "Parent Company"), a financial holding company, and its bank and nonbank subsidiaries. Bank subsidiaries include Farmers Bank & Capital Trust Co. ("Farmers Bank") in Frankfort, KY and its significant wholly-owned subsidiaries Leasing One Corporation ("Leasing One") and Farmers Capital Insurance Corporation ("Farmers Insurance"). Leasing One is a commercial leasing company in Frankfort, KY and Farmers Insurance is an insurance agency in Frankfort, KY; First Citizens Bank in Elizabethtown, KY ("First Citizens"); United Bank & Trust Co. in Versailles, KY which, during 2008, was the surviving company after the merger with two sister companies of Farmers Bank and Trust Company ("Farmers Georgetown") and Citizens Bank of Jessamine County ("Citizens Jessamine"); The Lawrenceburg Bank and Trust Company in Lawrenceburg, KY; Kentucky Banking Centers, Inc. in Glasgow, KY ("KBC"), which was sold during 2006; and Citizens Bank of Northern Kentucky, Inc. in Newport, KY ("Citizens Northern").
The Company has four active nonbank subsidiaries, FCB Services, Inc. ("FCB Services"), Kentucky General Holdings, LLC ("Kentucky General"), FFKT Insurance Services, Inc. ("FFKT Insurance"), and EKT Properties, Inc. ("EKT"). FCB Services is a data processing subsidiary located in Frankfort, KY that provides services to the Company's banks as well as unaffiliated entities. Kentucky General holds a 50% voting interest in KHL Holdings, LLC, which is the parent company of Kentucky Home Life Insurance Company. FFKT Insurance is a captive property and casualty insurance company insuring primarily deductible exposures and uncovered liability related to properties of the Company. EKT was created in 2008 to manage and liquidate certain real estate properties repossessed by the Company. In addition, the Company has three subsidiaries organized as Delaware statutory trusts that are not consolidated into its financial statements. These trusts were formed for the purpose of issuing trust preferred securities.
For a complete list of the Company's subsidiaries, please refer to the discussion under the heading "Organization " included in Part 1, Item 1 of this Form 10-K. The following discussion should be read in conjunction with the audited consolidated financial statements and related Notes that follow.
Forward-Looking Statements
This report contains forward-looking statements under the Private Securities
Litigation Reform Act of 1995 that involve risks and uncertainties. In general,
forward-looking statements relate to a discussion of future financial results or
projections, future economic performance, future operational plans and
objectives, and statements regarding the underlying assumptions of such
statements. Although the Company believes that the assumptions underlying the
forward-looking statements contained herein are reasonable, any of the
assumptions could be inaccurate, and therefore, there can be no assurance that
the forward-looking statements included herein will prove to be accurate.
Factors that could cause actual results to differ from the results discussed in
the forward-looking statements include, but are not limited to: economic
conditions (both generally and more specifically in the markets in which the
Company and its subsidiaries operate) and lower interest margins; competition
for the Company's customers from other providers of financial services; deposit
outflows or reduced demand for financial services and loan products; government
legislation, regulation, and changes in monetary and fiscal policies (which
changes from time to time and over which the Company has no control); changes in
interest rates; changes in prepayment speeds of loans or investment securities;
inflation; material unforeseen changes in the liquidity, results of operations,
or financial condition of the Company's customers; changes in the level of
non-performing assets and charge-offs; changes in the number of common shares
outstanding; the capability of the Company to successfully enter into a
definitive agreement for and close anticipated transactions; the possibility
that acquired entities may not perform as well as expected; unexpected claims or
litigation against the Company; technological or operational difficulties; the
impact of new accounting pronouncements and changes in policies and practices
that may be adopted by regulatory agencies; acts of war or terrorism; and other
risks or uncertainties detailed in the Company's filings with the Securities and
Exchange Commission, all of which are difficult to predict and many of which are
beyond the control of the Company. The Company expressly disclaims any intent or
obligation to update any forward-looking statements after the date hereof to
conform such statements to actual results or to changes in the Company's
opinions or expectations.
Discontinued Operations
In June 2006, the Company announced that it had entered into a definitive
agreement to sell KBC, its former wholly-owned subsidiary based in Glasgow,
Kentucky. In addition, Farmers Georgetown entered into a definitive agreement
during August 2006 to sell its Owingsville and Sharpsburg branches in Bath
County (the "Branches"). These sales were completed during the fourth quarter of
2006. Results prior to 2006 included herein have been reclassified to conform to
the 2006 presentation which displays the operating results of KBC and the
Branches as discontinued operations. These reclassifications had no effect on
net income or shareholders' equity.
Application of Critical Accounting Policies The Company's audited consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America and follow general practices applicable to the banking industry. Application of these principles requires management to make estimates, assumptions, and judgments 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
reported period. These estimates, assumptions, and judgments are based on information available as of the date of the financial statements; accordingly, as this information changes, the financial statements could reflect different estimates, assumptions, and judgments. Certain policies inherently have a greater reliance on the use of estimates, assumptions, and judgments and as such have a greater possibility of producing results that could be materially different than originally reported. Estimates, assumptions, and judgments are necessary when assets and liabilities are required to be recorded at fair value, when a decline in the value of an asset warrants an impairment write-down or valuation reserve to be established, or when an asset or liability needs to be recorded contingent upon a future event. Carrying assets and liabilities at fair value inherently results in more financial statement volatility. The fair values and the information used to record valuation adjustments for certain assets and liabilities are based either on quoted market prices or are provided by other third-party sources, when available. When third-party information is not available, valuation adjustments are estimated in good faith by management primarily through the use of internal cash flow modeling techniques.
The most significant accounting policies followed by the Company are presented in Note 1 of the Company's 2008 audited consolidated financial statements. These policies, along with the disclosures presented in the other financial statement notes and in this management's discussion and analysis of financial condition and results of operations, provide information on how significant assets and liabilities are valued in the financial statements and how those values are determined. Based on the valuation techniques used and the sensitivity of financial statement amounts to the methods, assumptions, and estimates underlying those amounts, management has identified the determination of the allowance for loan losses and accounting for business acquisitions to be the accounting areas that requires the most subjective or complex judgments, and as such could be most subject to revision as new information becomes available.
The allowance for loan losses represents credit losses specifically identified in the loan portfolio, as well as management's estimate of probable incurred credit losses in the loan portfolio at the balance sheet date. Determining the amount of the allowance for loan losses and the related provision for loan losses is considered a critical accounting estimate because it requires significant judgment and the use of estimates related to the amount and timing of expected future cash flows on impaired loans, estimated losses on pools of homogeneous loans based on historical loss experience, and consideration of current economic trends and conditions, all of which may be susceptible to significant change. The loan portfolio also represents the largest asset group on the consolidated balance sheets. Additional information related to the allowance for loan losses that describes the methodology and risk factors can be found under the captions "Asset Quality" and "Nonperforming Assets" in this management's discussion and analysis of financial condition and results of operation, as well as Notes 1 and 5 of the Company's 2008 audited consolidated financial statements.
Prior to the adoption of Statement of Financial Accounting Standards ("SFAS") No. 141(R) effective January 1, 2009, the Company accounted for business acquisitions as purchases in accordance with SFAS No. 141. Under SFAS No. 141 the purchase price is allocated to the tangible and intangible assets acquired and liabilities assumed based on their estimated fair value. The excess of the purchase price over estimated fair value of the net identifiable assets is allocated to goodwill. The Company engages third-party appraisal firms to assist in determining the fair values of certain assets acquired and liabilities assumed. Determining fair value of assets and liabilities requires many assumptions and estimates. These estimates and assumptions are sometimes refined subsequent to the initial recording of the transaction with adjustments to goodwill as information is gathered and final appraisals are completed. The changes in these estimates could impact the amount of tangible and intangible assets (including goodwill) and liabilities ultimately recorded on the Company's balance sheet as a result of an acquisition, and could impact the Company's operating results subsequent to such acquisition. The Company believes that its estimates have been materially accurate in the past.
The Company offers a variety of financial products and services at its 37 banking locations in 23 communities throughout Central and Northern Kentucky. The most significant products and services include consumer and commercial lending and leasing, receiving deposits, providing trust services, and offering other traditional banking products and services. The primary goals of the Company are to continually improve profitability and shareholder value, maintain a strong capital position, provide excellent service to our customers through our community banking structure, and to provide a challenging and rewarding work environment for our employees.
The Company generates a significant amount of its revenue, cash flows, and net income from interest income and net interest income, respectively. Interest income is generated by earnings on the Company's earning assets, primarily loans and investment securities. Net interest income is the excess of the interest income earned on earning assets over the interest expense paid on amounts borrowed to support those earning assets. Interest expense is paid primarily on deposit accounts and other short and long-term borrowing arrangements. The ability to properly manage net interest income under changing market environments is crucial to the success of the Company.
· The overall economic environment that began to show signs of weakness during 2007 deteriorated significantly in 2008, particularly in the third and fourth quarters. Financial markets experienced widespread illiquidity and unprecedented levels of volatility. Slower economic growth (including negative GDP growth in the third and fourth quarters), declines in credit availability, lower consumer confidence, increasing unemployment rates, and lower corporate earnings all contributed to significant economic challenges for the Company in 2008. As a result of the unprecedented market conditions, U.S. government agencies, including the U.S. Department of Treasury ("Treasury"), the Federal Reserve Board, and others, has intervened by enacting broad legislation and regulatory initiatives attempting to stabilize the U.S. financial system. Efforts include injecting hundreds of billions of dollars into banks and other financial services firms, lowering overnight targeted interest rates to near zero percent, increasing deposit insurance coverage, and guaranteeing certain debt, among other actions.
· Housing market declines, falling home prices, increasing foreclosures, and higher unemployment have negatively impacted the credit quality and certain collateral values of the Company's real estate loan portfolio, particularly in real estate development. This has resulted in higher nonperforming assets and charge-offs and negatively impacted net interest margin.
· Extreme market conditions and its placement into conservatorship led to a $14.0 million pre-tax impairment charge during the third quarter of the Company's aggregate investment in Federal National Mortgage Association ("Fannie") and Federal Home Loan Mortgage Corporation ("Freddie", collectively referred to as "GSE's") preferred stocks. The Company subsequently sold its entire GSE holdings during the fourth quarter and recorded an additional $766 thousand pre-tax loss.
· During the fourth quarter, the Company received preliminary approval from the Treasury to receive $30 million of equity capital via the Treasury's Capital Purchase Program ("CPP"). Participation in the CPP will increase the Company's regulatory capital ratios, which are already in excess of the "well capitalized" category, by approximately 200 basis points. The transaction closed in the first quarter of 2009.
The Company reported net income of $4.4 million or $.60 per share for the twelve months ended December 31, 2008, a decrease of $11.2 million or $1.43 per share compared to $15.6 million or $2.03 per share reported for the same twelve months a year earlier. The results of the current year are driven mainly by a $14.7 million aggregate loss ($9.7 million after tax) on the Company's investments in preferred stock of Fannie and Freddie. The Company recorded a non-cash other-than-temporary impairment ("OTTI") charge of $14.0 million related to the GSE's in the third quarter following a sharp decline in value after the announcement that the GSE's were suspending dividend payments and being placed into conservatorship by the Federal Housing Finance Agency. The rating agencies also downgraded the preferred stocks of the GSE's to below investment grade. The Company had $1.1 million market value in GSE preferred stock following the impairment charge at September 30, 2008 and subsequently sold its entire holdings during the fourth quarter for a loss of $766 thousand.
Other significant factors impacting net income in the yearly comparison include the following:
§ Net interest income increased $572 thousand or 1.0% as a result of a $909 thousand or 1.6% decrease in interest expense that outpaced a $337 thousand or .3% decrease in interest income. Net interest income for 2008 was helped by an additional $3.1 million attributed to the Company's leverage transaction that occurred during the fourth quarter of 2007.
§ The provision for loan losses increased $1.7 million or 46.3% as the Company increased its allowance for loan losses as a result of continued credit deterioration. The allowance for loan losses was 1.28% of net loans at year-end 2008, up from 1.10% a year earlier.
§ Excluding investment securities related transactions, noninterest income was relatively flat at $23.9 million for the current year compared to $24.2 million a year earlier.
† Noninterest expenses increased $1.3 million or 2.2%. Lower salary and benefit expenses of $1.2 million attributed mainly to lower benefit costs were offset by higher net other expenses of $2.5 million. Higher expenses occurred across a broad range of line items, led by increases in FDIC deposit insurance premiums and Financing Corporation ("FICO") assessments of $812 thousand, higher net expenses related to properties acquired through foreclosure of $761 thousand, and data processing and communication expenses of $653 thousand.
§ Income tax benefit was $1.2 million for the current twelve months compared to income tax expense of $4.3 million in the prior year. The income tax benefit recorded in the current year is due mainly to the impact of the losses associated with the GSE preferred stock investments in the third and fourth quarters of 2008.
Return on assets ("ROA") was .21% in 2008, a decrease of 62 basis points from .83% for the prior year-end. The OTTI write-down and net interest margin contributed 65 basis points and 39 basis points, respectively to lower ROA in the comparison. These negative effects were partially offset by 31 basis points lower noninterest expenses as a percentage of average assets and a benefit of 30 basis points attributed to income taxes. The return on equity ("ROE") decreased 626 basis points to 2.62% compared to 8.88% in the prior year. The lower ROE is mainly a result of the $11.2 million or 72% decline in net income that was influenced heavily by the OTTI write-down.
Interest Income
Interest income results from interest earned on earning assets, which primarily
include loans and investment securities. Interest income is affected by volume
(average balance), composition of earning assets, and the related rates earned
on those assets. Total interest income for 2008 was $114 million, a slight
decrease of $337 thousand or .3% from the previous year driven primarily by
lower average rates earned in a lower overall interest rate environment.
Interest from investment securities was up $10.3 million in the yearly
comparison, nearly offsetting an interest decrease from loans of $8.3 million or
8.8% and temporary investments of $2.1 million or 64.0%. The Company's tax
equivalent yield on earning assets for the current year was 6.2%, a decrease of
83 basis points compared to 7.0% for the same period a year ago.
Interest on taxable investment securities was $22.9 million for 2008, an increase of $10.3 million or 81.3% compared to $12.6 million a year ago. The increase is primarily driven by volume related to the Company's $200 million balance sheet leverage transaction that occurred during the fourth quarter of 2007. This transaction added $11.9 million to interest income on taxable investment securities in the current year compared to $1.5 million a year ago as the transaction occurred near the end of 2007.
Interest and fees earned on loans was $86.6 million for 2008, a decrease of $8.3 million or 8.8% compared to $94.9 million a year earlier. The decline in interest and fees on loans is due to a 94 basis point lower average rate earned, which more than offset a $52.0 million or 4.2% rise in average loans outstanding in the comparable period. New loans and variable rate loans adjusting during the current year have generally repriced downward as the average interest rate earned has declined. The tax equivalent yield on loans was 6.7% for 2008 compared to 7.7% for 2007.
Interest Expense
Interest expense results from incurring interest on interest bearing
liabilities, which primarily include interest bearing deposits, federal funds
purchased, securities sold under agreements to repurchase, and other short and
long-term borrowed funds. Interest expense is affected by volume, composition of
interest bearing liabilities, and the related rates paid on those liabilities.
Total interest expense was $55.1 million for 2008, a decrease of $909 thousand
or 1.63% compared to $56.0 million for the prior year. Interest expense
decreased mainly as a result of a lower average rate paid on interest bearing
liabilities in an overall lower interest rate environment. Interest expense on
deposit accounts and short-term borrowings declined $6.1 million or 13.5% and
$2.7 million or 60.4%, respectively. These declines offset higher interest
expense related to long-term borrowings of $7.9 million. The Company's average
cost of funds was 3.2% for 2008, a decrease of 59 basis points from 3.8% for
2007. The decrease in the average cost of funds was representative of rate
declines throughout much of the deposit portfolio and borrowed funds. The
average rate paid on time deposits, the largest component of interest bearing
liabilities, declined 58 basis points to 4.3% from 4.8% a year earlier.
The $6.1 million decrease in interest expense on deposits was led by a $2.4 million or 6.7% decrease related to time deposits. Interest expense on interest bearing demand and savings deposits were $1.9 million or 51.0% and $1.8 million or 34.0% lower in the current year compared to a year earlier. Overall, average interest bearing deposits increased $59.2 million or 4.7%, led by higher average time deposits of $44.6 million or 6.0%. Total interest expense on deposits decreased $6.1 million mainly as a result of a 63 basis point lower average rate paid on interest bearing deposits of 3.0% for 2008 compared to 3.6% for 2007. The 63 basis point lower average rate paid on interest bearing deposits more than offset the $59.2 million higher average balance outstanding.
The $2.7 million decrease in interest expense on short-term borrowings is due mainly to a lower average rate paid of 243 basis points and, to a lesser degree, a $16.0 million lower average balance outstanding. Interest expense on long-term borrowings increased mainly due to the Company's $200 million balance sheet leverage transaction that occurred during the fourth quarter of 2007. This transaction added $8.5 million to interest expense in 2008, $8.0 million of which is attributed to long-term borrowings. The transaction added $1.1 million of total interest expense during the prior year as the transaction occurred near the end of 2007.
Net Interest Income
Net interest income is the most significant component of the Company's earnings.
Net interest income is the excess of the interest income earned on earning
assets over the interest paid for funds to support those assets. The two most
common metrics used to analyze
net interest income are net interest spread and net interest margin. Net interest spread represents the difference between the yields on earning assets and the rates paid on interest bearing liabilities. Net interest margin represents the percentage of net interest income to average earning assets. Net interest margin will exceed net interest spread because of the existence of noninterest bearing sources of funds, principally demand deposits and shareholders' equity, which are also available to fund earning assets. Changes in net interest income and margin result from the interaction between the volume and the composition of earning assets, their related yields, and the associated cost and composition of the interest bearing liabilities. Accordingly, portfolio size, composition, and the related yields earned and the average rates paid can have a significant impact on net interest spread and margin. The table on the following page represents the major components of interest earning assets and interest bearing liabilities on a tax equivalent basis. To compare the tax-exempt asset yields to taxable yields, amounts are adjusted to pretax equivalents based on the marginal corporate Federal tax rate of 35%.
Tax equivalent net interest income was $61.1 million for 2008, an increase of $585 thousand or 1.0% compared to $60.5 million for 2007. The net interest margin was 3.3%, a decrease of 39 basis points from 3.6% in the prior year. Net interest spread accounted for 24 basis points of the lower net interest margin and was 3.0% for 2008 compared to 3.2% a year earlier. The impact of noninterest bearing sources of funds negatively impacted net interest margin by an . . .
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