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KTYB > SEC Filings for KTYB > Form 10-Q on 14-Nov-2011All Recent SEC Filings

Show all filings for KENTUCKY BANCSHARES INC /KY/

Form 10-Q for KENTUCKY BANCSHARES INC /KY/


14-Nov-2011

Quarterly Report


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 subsidiary's customers from other providers of financial and mortgage services; government legislation, regulation and monetary policy (which changes from time to time and over which 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 subsidiary's customers; adequacy of the allowance for losses on loans and the level of future provisions for losses on loans; 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.

You are cautioned not to place undue reliance on any forward-looking statements made by us or on our behalf. 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.


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Summary

The Company recorded net income of $4.5 million, or $1.65 basic earnings and diluted earnings per share for the first nine months ending September 30, 2011 compared to $3.7 million or $1.35 basic earnings and diluted earnings per share for the nine month period ending September 30, 2010. The first nine months earnings reflects an increase of 20.5% compared to the same time period in 2010, due primarily to an increase in net interest income of $3.3 million and a decrease in repossession expense of $291 thousand. These positive changes to net income during 2011 were partially offset by a decrease of $311 thousand in service charges, a decrease of $777 thousand in gains recognized on the sale of loans and an increase of $1.3 million in employee salaries and benefits. The earnings for the three months ending September 30, 2011 were $1.8 million, or $0.67 basic and diluted earnings per share compared to $1.6 million or $0.57 basic and diluted earnings per share for the three month period ending September 30, 2010. The earnings for the three month period in 2011 reflect a 12.7% increase compared to the same time period in 2010.

Return on average assets was 0.91% for the nine months ended September 30, 2011 and 0.70% for the nine month period ended September 30, 2010. Return on average assets was 1.09% for the three months ended September 30, 2011 and 0.91% for the three months ended September 30, 2010. Return on average equity was 9.3% for the nine month period ended September 30, 2011 and 7.9% for the same period in 2010. Return on average equity was 10.7% for the three months ended September 30, 2011 and 10.0% for the same time period in 2010. Gross Loans decreased $3.6 million from $411.8 million on December 31, 2010 to $408.2 million on September 30, 2011. The overall decrease is attributed mostly to a decrease of $8.2 million in non-farm and non-residential loans. Increases in the loan portfolio from December 31, 2010 to September 30, 2011 included an increase of $3.9 million in commercial loans, an increase of $1.1 million in real estate construction loans and an increase of $1.2 million in 1-4 family residential property loans.

Total deposits decreased from $537.4 million on December 31, 2010 to $508.1 million on September 30, 2011, a decrease of $29.3 million. The overall decrease is mostly attributed to a decrease of $27.8 million in pubic fund deposits from December 31, 2010 to September 30, 2011. Public fund deposits will typically be higher at the end of the calendar year due to tax monies collected and will decrease during the first half of the following year as those funds are dispersed. Non-interest bearing demand deposit accounts increased $24.9 million from December 31, 2010 to September 30, 2011. This increase is not all attributed to additional deposits being placed with the bank as part of the increase is from deposit accounts changing from time deposits to non-interest bearing demand deposit accounts. Time deposits $100 thousand and over decreased $19.8 million and other interest bearing deposit accounts decreased $34.4 million.

Net Interest Income

Net interest income is the difference between interest income earned on interest-earning assets and the interest expense paid on interest-bearing liabilities.


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Net interest income was $18.2 million for the nine months ended September 30, 2011 compared to $14.9 million for the nine months ended September 30, 2010, an increase of 22.1%. The interest spread of 4.06% for the first nine months of 2011 is up from 3.06% reported for the same period in 2010, an increase of 100 basis points. Rates have remained fairly low in the past year. The significant increase in the net interest spread is largely attributed to a decrease in the cost of certificate of deposit accounts. For the first nine months ending September 30, 2011, the cost of total deposits was 0.79% compared to 1.47% for the same time period in 2010. Increasing non-interest bearing deposit accounts has also helped to lower the cost of deposits. Net interest income was $6.2 million for the three months ending September 30, 2011 compared to $4.9 million for the three months ending September 30, 2010, an increase of 25.5%. The interest spread was 4.15% for the three month period ending September 30, 2011 compared to 3.07% for the three month period in 2010, an increase of 108 basis points.

For the first nine months, the yield on assets increased from 4.74% in 2010 to 5.06% in 2011. The year to date average balance of federal funds sold decreased $26.5 million for the first nine months in 2011 compared to 2010 due to an influx of short term deposits in 2010. This helped to increase the yield on earning assets in 2011 because of the low rates earned on federal funds sold. Also, the yield on loans increased 16 basis points in the first nine months of 2011 compared to 2010 from 5.71% to 5.87%. The cost of liabilities decreased from 1.68% in 2010 to 1.00% in 2011. Year to date average loans decreased $11.7 million, or 2.8% from September 30, 2010 to September 30, 2011. Loan interest income has increased $23 thousand for the first nine months of 2011 compared to the first nine months of 2010. Year to date average deposits decreased from September 30, 2010 to September 30, 2011, down $36.9 million or 6.5%. The decrease is primarily the result of a decrease in time deposits that matured during the fourth quarter of 2010. Year to date average interest bearing deposits decreased $53.4 million, or 11.6%, from September 30, 2010 to September 30, 2011. Deposit interest expense has decreased $3.2 million for the first nine months of 2011 compared to the same period in 2010. Year to date average borrowings decreased $12.8 million, or 19.7% from September 30, 2010 to September 30, 2011. The decrease is mostly attributed to paying off Federal Home Loan Bank advances when they come due and not replacing them. Interest expense on borrowed funds has decreased $458 thousand for the first nine months of 2011 compared to the same period in 2010.

The volume rate analysis for 2011 that follows indicates that $1.1 million of the decrease in interest income is attributable to the decrease in volume, while the change in rates contributed to an increase of $775 thousand in interest income. Even more affected by volume and rate changes was the liability side of the balance sheet. The average rate of the Company's total outstanding deposits and borrowing liabilities decreased from 1.68% in 2010 to 1.00% in 2011. Based on the volume rate analysis that follows, the lower level of interest rates contributed to a decrease of $2.2 million in interest expense, while the change in volume was responsible for a $1.4 million decrease in interest expense. As a result, the 2011 net interest income increase is mostly attributed to decreases in rates on deposits and an increase in rates on loans.


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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 2011. 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



                                                              2011 vs. 2010
                                                                                 Due to
                                                 Increase       (Decrease)      Change in
(in thousands)                                    Volume           Rate        Net Change

INTEREST INCOME
Loans                                           $      (681 )  $        704    $        23
Investment Securities                                  (395 )            85           (310 )
Other                                                  (335 )           303            (32 )
Total Interest Income                                (1,411 )         1,092           (319 )
INTEREST EXPENSE
Deposits
Demand                                                   56             (81 )          (25 )
Savings                                                   9             (22 )          (13 )
Negotiable Certificates of Deposit and Other
Time Deposits                                        (1,104 )        (2,009 )       (3,113 )
Securities sold under agreements to
repurchase and other borrowings                          (3 )           (49 )          (52 )
Federal Home Loan Bank advances                        (343 )           (63 )         (406 )
Total Interest Expense                               (1,385 )        (2,224 )       (3,609 )
Net Interest Income                             $       (26 )  $      3,316    $     3,290


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Non-Interest Income

Non-interest income decreased $932 thousand for the nine months ended September 30, 2011 compared to the same period in 2010 to $6.5 million. The decrease was due primarily to a decrease of $777 thousand in gains recognized on sold securities, a decrease of $311 thousand in service charges and a decrease of $117 thousand in gains on sold loans. The decrease in service charges is largely attributed to a decrease of $264 thousand in overdraft income. Increases to non-interest income for the first nine months of 2011 compared to the first nine months of 2010 included an increase of $173 thousand in debit card interchange income, an increase in trust department income of $66 thousand and an increase of $55 thousand in other income. The increase in other income is attributed to the $54 thousand gain on the sale of bank premises that was recorded in May 2011 when the Company sold the former Nicholasville branch building. Non-interest income decreased $916 thousand for the three months ended September 30, 2011 compared to the three months ended September 30, 2010. The decrease was mostly the result of a decrease of $787 thousand in recognized gains on the sale of securities, a decrease of $91 thousand in gains on the sale of mortgage loans and a decrease in service charges of $79 thousand. The decrease in service charges includes a decrease of $34 thousand in overdraft income for the three months ending September 30, 2011 compared to the same time period one year ago. Increases to non-interest income for the three month period ending September 30, 2011 compared to the three months ending September 30, 2010 include an increase of $53 thousand in debit card interchange income and increase of $25 thousand in trust department income.

The gain on the sale of mortgage loans decreased from $650 thousand in the first nine months of 2010 to $533 thousand during the first nine months of 2011, a decrease of $117 thousand. For the three months ending September 30, 2011 compared to the same time period in 2010, the gain on the sale of mortgage loans decreased $91 thousand. The volume of loans originated to sell during the first nine months of 2011 decreased $6.2 million compared to the same time period in 2010. 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 $70 thousand for the nine months ending September 30, 2011 compared to $65 thousand for the nine months ending September 30, 2010, an increase of $5 thousand. For the three month period ending September 30, 2011, loan service fee income was a loss of $16 thousand compared to a loss of $5 thousand for the same time period one year ago. During the first nine months of 2011, the carrying value of the mortgage servicing right was written up a net amount of $8 thousand. Of this, a positive adjustment of $20 thousand was recorded in the first quarter of 2011, a positive adjustment of $21 thousand was recorded in the second quarter of 2011 and a write-down of $33 thousand was recorded during the third quarter of 2011. For the nine months ending September 30, 2010, the carrying value of the mortgage servicing right had a negative valuation adjustment in the amount of $2 thousand with a $24 thousand negative adjustment recorded during the third quarter of 2010.


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Non-Interest Expense

Total non-interest expenses increased $1.3 million for the nine month period ended September 30, 2011 compared to the same period in 2010. For the three month period ended September 30, 2011 compared to the three months ending September 30, 2010, total non-interest expense increased $284 thousand.

For the comparable nine month periods, salaries and benefits increased $1.3 million, an increase of 17.7%. The increase is attributed largely to additional employees being hired throughout 2010 and 2011. The number of full time equivalent employees at September 30, 2011 was 193 compared to 187 one year ago and 184 at December 31, 2010. In addition, $180 thousand was expensed during the first nine months of 2011 to accrue for unused vacation time that employees can carry over into future periods and unused major illness time that certain employees may be eligible to receive upon retirement. This accrual accounts for an increase of $100 thousand in employee benefits because the Company did not begin accruing for this liability until June 2010. In addition, during the first nine months of 2011, $900 thousand has been accrued for incentives compared to $450 thousand for the first nine months of 2010, an increase of $450 thousand. Salaries and employee benefits increased $407 thousand for the three month period ending September 30, 2011 compared to the same time period in 2010.

Occupancy expenses increased $190 thousand to $2.3 million for the first nine months of 2011 compared to the same time period in 2010. Occupancy expenses increased $40 thousand for the three month period ended September 30, 2011 compared to the same time period in 2010. The increase in year to date occupancy expense during 2011 is mostly the result of an increase in computer maintenance of $121 thousand.

Legal and professional fees increased $15 thousand for the first nine months ended September 30, 2011 compared to the same time period in 2010. Legal and professional fees decreased $2 thousand for the three month period ending September 30, 2011 compared to the same time period in 2010. The increase in year to date legal and professional fees is largely attributable to additional collection efforts for problem loans. Repossession expenses decreased $291 thousand for the first nine months ending September 30, 2011 compared to the same time period in 2010 and increased $44 thousand for the three months period ending September 30, 2011 compared to the same period one year ago. Repossession expenses are reported net of income earned on the repossessed properties. Repossession expenses were higher during the first nine months of 2010 when compared to the same time period in 2011 due to $697 thousand being expensed for the write-downs of other real estate owned properties in 2010 and $156 being expensed in 2011. In addition, the rents earned on other real estate properties, including new property added, increased $201 thousand to $411 thousand for the nine months ending September 30, 2011 compared to the same period last year as rental income was being generated for the full nine months in 2011. FDIC insurance expense decreased $247 thousand for the nine months ending September 30, 2011 and $204 thousand for the three months ending September 30, 2011, compared to the same time period in 2010. The decrease is mostly attributed to a change in the calculation the FDIC uses to assess insurance premiums.


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Income Taxes

The effective tax rate for the nine months ended September 30, 2011 was 14.9% compared to 11.2% in 2010. The effective tax rate for the three months ended September 30, 2011 was 16.0% compared to 12.9% for the three months ended September 30, 2010 These rates are less than the statutory rate as a result of the tax-free securities and loans and tax credits generated by certain investments held by the Company. The rates for 2011 are higher due to the higher level of income for 2011. Tax-exempt interest income decreased $277 thousand for the first nine months of 2011 compared to the first nine months of 2010.

As part of normal business, Kentucky Bank typically makes tax free loans to select municipalities in our market and invests in selected tax free securities, primarily in the Commonwealth of Kentucky. In making these investments, the Company considers the overall impact to managing our net interest margin, credit worthiness of the underlying issuer and the favorable impact on our tax position. For the nine months ended September 30, 2011, the Company averaged $77.7 million in tax free securities and $15.3 million in tax free loans. As of September 30, 2011, the weighted average remaining maturity for the tax free securities is 146 months, while the weighted average remaining maturity for the tax free loans is 163 months.

Liquidity and Funding

Liquidity is the ability to meet current and future financial obligations. The Company's primary sources of funds consist of deposit inflows, loan repayments, maturities and sales of investment securities and FHLB borrowings.

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 $14.8 million as of September 30, 2011 compared to $17.6 million at December 31, 2010. The decrease in cash and cash equivalents is mainly attributable to a decrease in federal funds sold of $5.0 million resulting primarily from a decrease in short term deposits. In addition to cash and cash equivalents, the securities portfolio provides an important source of liquidity. Securities available for sale totaled $158.1 million at September 30, 2011 compared to $176.9 million at December 31, 2010. The available for sale securities are available to meet liquidity needs on a continuing basis. However, 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.


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For the first nine months of 2011, deposits have decreased $29.3 million, mostly due to an expected decline in public fund deposit balances. The Company's investment portfolio has decreased $18.8 million and the Company's loan portfolio has decreased $3.6 million. In addition, the Company has paid down FHLB advances by $12.4 million during the first nine months of 2011. Federal Funds purchased have increased $9.5 million from $0 at December 31, 2010 to $9.5 million at September 30, 2011.

The Company has a promissory note payable that matures July 30, 2012, and has principal due at maturity and interest payable quarterly at prime, and is secured by 100% of the common stock of the bank. The 2011 loan agreement contains certain covenants and performance terms. The Bank was in compliance with its debt covenants at September 30, 2011.

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, 2011, we have sufficient collateral to borrow an additional $60 million from the Federal Home Loan Bank. In addition, as of September 30, 2011, $15 million is available in overnight borrowing through various correspondent banks and the Company has access to $214 million in brokered deposits. 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, 2011 and December 31, 2010, 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.


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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, 2011
Consolidated

Total Capital (to
Risk-Weighted Assets)          $  63,594    14.1 %  $    36,163        8 %  $       N/A      N/A
Tier I Capital (to
Risk-Weighted Assets)             57,926    12.8         18,082        4            N/A      N/A
Tier I Capital (to Average
Assets)                           57,926     9.2         25,302        4            N/A      N/A

Bank Only
Total Capital (to
Risk-Weighted Assets)          $  64,867    14.4 %  $    36,151        8 %  $    45,189       10 %
Tier I Capital (to
Risk-Weighted Assets)             59,201    13.1         18,075        4         27,113        6
Tier I Capital (to Average
Assets)                           59,201     9.4         25,293        4         31,616        5

December 31, 2010
Consolidated
Total Capital (to
Risk-Weighted Assets)          $  60,500    13.1 %  $    36,823        8 %          N/A      N/A
Tier I Capital (to
Risk-Weighted Assets)             55,489    12.1         18,412        4            N/A      N/A
Tier I Capital (to Average
Assets)                           55,489     8.5         26,218        4            N/A      N/A

Bank Only
Total Capital (to
Risk-Weighted Assets)          $  62,143    13.5 %  $    36,810        8 %  $    46,013       10 %
Tier I Capital (to
Risk-Weighted Assets)             57,131    12.4         18,405        4         27,608        6
Tier I Capital (to Average
Assets)                           57,131     8.7         26,208        4         32,760        5


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Non-Performing Assets

As of September 30, 2011, our non-performing assets totaled $18.3 million or 2.89% of assets compared to $21.6 million or 3.28% of assets at December 31, . . .

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