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SYBT > SEC Filings for SYBT > Form 10-Q on 6-Nov-2012All Recent SEC Filings

Show all filings for S Y BANCORP INC

Form 10-Q for S Y BANCORP INC


6-Nov-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

This item discusses the results of operations for S.Y. Bancorp, Inc. ("Bancorp" or "Company"), and its subsidiary, Stock Yards Bank & Trust Company ("Bank") for the three and nine months ended September 30, 2012 and compares these periods with the same periods of the previous year. Unless otherwise indicated, all references in this discussion to the Bank include Bancorp. In addition, the discussion describes the significant changes in the financial condition of Bancorp and the Bank that have occurred during the first nine months of 2012 compared to the year ended December 31, 2011. This discussion should be read in conjunction with the consolidated financial statements and accompanying notes presented in Part 1, Item 1 of this report.

This report contains forward-looking statements under the Private Securities Litigation Reform Act that involve risks and uncertainties. Although Bancorp believes the assumptions underlying the forward-looking statements contained herein are reasonable, any of these assumptions could be inaccurate. Factors that could cause actual results to differ from results discussed in forward-looking statements include, but are not limited to the following:
economic conditions both generally and more specifically in the markets in which Bancorp and the Bank operate; competition for Bancorp's customers from other providers of financial services; government legislation and regulation which change from time to time and over which Bancorp has no control; changes in interest rates; material unforeseen changes in liquidity, results of operations, or financial condition of Bancorp's customers; and other risks detailed in Bancorp's filings with the Securities and Exchange Commission, all of which are difficult to predict and many of which are beyond the control of Bancorp.

Overview of 2012 through September 30

Bancorp completed the first nine months of 2012 with net income of $19.29 million or 12% more than the comparable period of 2011. The increase is due to an improvement in net interest income and increasing non-interest income, partially offset by increasing non-interest expenses. Diluted earnings per share for the first nine months of 2012 were $1.38 compared to the first nine months of 2011 at $1.25.

As is the case with most banks, the primary source of Bancorp's revenue is net interest income and fees from various financial services provided to customers. Net interest income is the difference between interest income earned on loans, investment securities and other interest earning assets less interest expense on deposit accounts and other interest bearing liabilities. Loan volume and the interest rates earned on those loans are critical to overall profitability. Similarly deposit volume is crucial to funding loans and rates paid on deposits directly impact profitability. Business volumes are influenced by overall economic factors including market interest rates, business spending, consumer confidence and competitive conditions within the marketplace.

Net interest income increased $2.9 million, or 6%, for the first nine months of 2012, compared to the same period in 2011. The positive effect of increased volumes on earning assets offset the negative effect of declining interest rates earned over the past year. Interest expense declined due to lower funding costs on deposits and borrowings arising from lower interest rates and a more favorable deposit mix. The net interest margin declined to 3.99% for the first nine months of 2012, compared to 4.02% for the same period in 2011. Net interest income for the first three quarters of 2012 included prepayment fees and late penalties totaling approximately $900,000 associated with a surge in loan refinancing activity.

Bancorp's magnitude of investment management and trust revenue distinguishes it from other similarly sized community banks, making total non-interest income a continuing key contributor to earnings in the first nine months of 2012. Income from investment management and trust services, which constitutes an average of 40% of non-interest income, was up slightly in the first nine months of 2012 compared to the same period in 2011. Assets under management rose to $1.92 billion at September 30, 2012, compared to $1.74 billion at December 31, 2011. While fees are based on market values, because of asset allocation and diversification of asset classes


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in customer accounts, they typically do not fluctuate directly with the overall stock market. Accounts typically contain both fixed income and equity assets, which generally react inversely to each other. Nonrecurring fees such as estate, financial planning, insurance, and some retirement fees are not affected by fluctuations in the market. Recurring fees, which generally make up over 95% of the investment management and trust revenue, increased 3% for the first nine months of 2012, compared to the same period in 2011, while non-recurring fees for the first nine months of 2012 are less than the same period in 2011.

The mortgage department reported a 106% increase in gains on the sales of mortgage loans for the first nine months of 2012 compared with the same period of 2011.

Bancorp experienced increases in most categories of non-interest income over the first nine months of 2012. Non-interest income as a percentage of total revenues was 33% in the first nine months of 2012, compared to 31% for the same period of 2011.

Higher non-interest expense in 2012 was reflected in most categories resulting largely from costs of market expansion and growth in support functions, including normal salary increases and a higher performance-based bonus accrual. Compounding the effect of the increase in personnel costs was the impact of the elimination of the performance-based bonus accrual in the third quarter of 2011, compared with an increase in the accrual in 2012.

During the third quarter Bancorp took additional charge-downs on certain other real estate owned (OREO) to target a shorter timeframe for the opportunistic disposition of these properties, thus helping limit Bancorp's exposure to market risk, which may occur if the dispositions occur over a longer period of time.

Also favorably impacting 2012 results, Bancorp's provision for loan losses decreased to $9.0 million in the first nine months compared to $9.5 million in the same period of 2011, reflecting Bancorp's ongoing efforts to identify risk in its portfolio. Overall, management believes that the economy is improving, but problem loan resolution challenges still lie ahead. The provision for loan losses is calculated after considering credit quality factors, and ultimately relies on an overall internal analysis of the risk in the loan portfolio. The provision results from an allowance methodology driven by risk ratings which reflect the ongoing economic stress on borrowers since 2008. Bancorp's allowance for loan losses was 1.98% of total loans at September 30, 2012, compared with 1.93% of total loans at December 31, 2011, and 1.89% at September 30, 2011.

For purposes of comparability and to provide additional insight into the strength of Bancorp's operations, it should be noted that 2012 earnings included a first quarter gain on an investment in a domestic private investment fund, which contributed approximately $0.03 per diluted share after tax to the Bancorp's earnings, compared to a negative impact in the year-earlier period of approximately ($0.03) per diluted share.

Tangible common equity (TCE), a non-GAAP measure, is a measure of a company's capital which is useful in evaluating the quality and adequacy of capital. The ratio of tangible common equity to total tangible assets was 9.55% as of September 30, 2012, compared to 9.11% at December 31, 2011. See the Non-GAAP Financial Measures section for details on reconcilement to US GAAP measures.


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The following sections provide more details on subjects presented in this overview.

a) Results Of Operations

Net income of $6,682,000 for the three months ended September 30, 2012 increased $908,000, or 15.7%, from $5,774,000 for the comparable 2011 period. Basic and diluted net income per share were both $0.48 for the third quarter of 2012, compared to $0.42 for the third quarter of 2011, a 14.3% increase. Annualized return on average assets and annualized return on average stockholders' equity were 1.27% and 13.31%, respectively, for the third quarter of 2012, compared to 1.16% and 12.59%, respectively, for the same period in 2011.

Net income of $19,287,000 for the nine months ended September 30, 2012 increased $2,025,000, or 11.7%, from $17,262,000 for the comparable 2011 period. Basic net income per share was $1.39 for the first nine months of 2012, compared to $1.25 for the same period of 2011, an 11.2% increase. Net income per share on a diluted basis was $1.38 for the first nine months of 2012 compared to $1.25 for the same period of 2011, a 10.4% increase. Annualized return on average assets and annualized return on average stockholders' equity were 1.26% and 13.20%, respectively, for the first nine months of 2011, compared to 1.19% and 13.03%, respectively, for the same period in 2011.

Net Interest Income

The following tables present average balance sheets for the three and nine month periods ended September 30, 2012 and 2011 along with the related calculations of tax-equivalent net interest income, net interest margin and net interest spread for the related periods. See the notes following the tables for further explanation.


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Average Balances and Interest Rates - Taxable Equivalent Basis



                                               Three months ended September 30
                                          2012                                2011
                              Average                 Average     Average                 Average
(Dollars in thousands)       Balances     Interest     Rate      Balances     Interest     Rate
Earning assets:
Federal funds sold          $   110,263   $      82      0.30 % $    98,996   $      72      0.29 %
Mortgage loans held for
sale                             11,776          98      3.31 %       4,279          46      4.27 %
Securities:
Taxable                         211,424       1,321      2.49 %     160,517       1,267      3.13 %
Tax-exempt                       49,195         371      3.00 %      50,075         445      3.53 %
FHLB stock and other
securities                        6,180          58      3.73 %       5,949          52      3.47 %
Loans, net of unearned
income                        1,551,423      20,107      5.16 %   1,511,446      20,104      5.28 %
Total earning assets          1,940,261      22,037      4.52 %   1,831,262      21,986      4.76 %
Less allowance for loan
losses                           32,786                              27,878
                              1,907,475                           1,803,384
Non-earning assets:
Cash and due from banks          32,279                              26,334
Premises and equipment           37,760                              34,875
Accrued interest
receivable and
other assets                    115,998                             113,815
Total assets                $ 2,093,512                         $ 1,978,408

Interest bearing
liabilities:
Deposits:
Interest bearing demand
deposits                    $   318,568   $     123      0.15 % $   277,462   $     149      0.21 %
Savings deposits                 80,631          16      0.08 %      70,728          25      0.14 %
Money market deposits           555,450         478      0.34 %     515,508         654      0.50 %
Time deposits                   376,228       1,108      1.17 %     422,080       1,692      1.59 %
Securities sold under
agreements to repurchase         57,878          46      0.32 %      67,079          68      0.40 %
Fed funds purchased and
other short term
borrowings                       19,366           8      0.16 %      19,148           8      0.17 %
FHLB advances                    60,424         345      2.27 %      60,435         368      2.42 %
Long-term debt                   30,900         773      9.95 %      40,900         862      8.36 %

Total interest bearing
liabilities                   1,499,445       2,897      0.77 %   1,473,340       3,826      1.03 %
Non-interest bearing
liabilities:
Non-interest bearing
demand deposits                 346,942                             277,802
Accrued interest payable
and other liabilities            47,359                              45,333
Total liabilities             1,893,746                           1,796,475
Stockholders' equity            199,766                             181,933
Total liabilities and
stockholders' equity        $ 2,093,512                         $ 1,978,408
Net interest income                       $  19,140                           $  18,160
Net interest spread                                      3.75 %                              3.73 %
Net interest margin                                      3.92 %                              3.93 %


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                                             Nine months ended September 30
                                        2012                                2011
                            Average                 Average     Average                 Average
(Dollars in thousands)     Balances     Interest     Rate      Balances     Interest     Rate
Earning assets:
Federal funds sold        $    96,366   $     216      0.30 % $    76,736   $     167      0.29 %
Mortgage loans held for
sale                            7,771         217      3.73 %       4,081         143      4.68 %
Securities:
Taxable                       208,066       4,136      2.66 %     159,550       3,645      3.05 %
Tax-exempt                     51,181       1,285      3.35 %      50,693       1,439      3.80 %
FHLB stock and other
securities                      6,096         173      3.79 %       5,883         166      3.77 %
Loans, net of unearned
income                      1,529,440      59,928      5.23 %   1,493,372      60,068      5.38 %
Total earning assets        1,898,920      65,955      4.64 %   1,790,315      65,628      4.90 %
Less allowance for loan
losses                         31,859                              27,307
                            1,867,061                           1,763,008
Non-earning assets:
Cash and due from banks        31,137                              26,009
Premises and equipment         37,794                              34,049
Accrued interest
receivable and other
assets                        115,320                             117,713
Total assets              $ 2,051,312                         $ 1,940,779

Interest bearing
liabilities:
Deposits:
Interest bearing demand
deposits                  $   312,885   $     402      0.17 % $   280,002   $     457      0.22 %
Savings deposits               77,307          48      0.08 %      70,117          89      0.17 %
Money market deposits         531,527       1,407      0.35 %     492,645       2,068      0.56 %
Time deposits                 386,653       3,795      1.31 %     421,287       5,231      1.66 %
Securities sold under
agreements to
repurchase                     59,507         138      0.31 %      59,675         199      0.45 %
Fed funds purchased and
other short term
borrowings                     20,084          24      0.16 %      22,804          31      0.18 %
FHLB advances                  60,426       1,072      2.37 %      60,438       1,093      2.42 %
Long-term debt                 31,666       2,341      9.88 %      40,900       2,586      8.45 %

Total interest bearing
liabilities                 1,480,055       9,227      0.83 %   1,447,868      11,754      1.09 %
Non-interest bearing
liabilities:
Non-interest bearing
demand deposits               329,658                             269,566
Accrued interest
payable and other
liabilities                    46,382                              46,166
Total liabilities           1,856,095                           1,763,600
Stockholders' equity          195,217                             177,179
Total liabilities and
stockholders' equity      $ 2,051,312                         $ 1,940,779
Net interest income                     $  56,728                           $  53,874
Net interest spread                                    3.81 %                              3.81 %
Net interest margin                                    3.99 %                              4.02 %


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Notes to the average balance and interest rate tables:

Net interest income, the most significant component of the Bank's earnings is total interest income less total interest expense. The level of net interest income is determined by the mix and volume of interest earning assets, interest bearing deposits and borrowed funds, and changes in interest rates.

Net interest spread is the difference between the taxable equivalent rate earned on interest earning assets less the rate expensed on interest bearing liabilities.

Net interest margin represents net interest income on a taxable equivalent basis as a percentage of average interest earning assets. Net interest margin is affected by both the interest rate spread and the level of non-interest bearing sources of funds, primarily consisting of demand deposits and stockholders' equity.

Interest income on a fully tax equivalent basis includes the additional amount of interest income that would have been earned if investments in certain tax-exempt interest earning assets had been made in assets subject to federal taxes yielding the same after-tax income. Interest income on municipal securities and loans have been calculated on a fully tax equivalent basis using a federal income tax rate of 35%. The approximate tax equivalent adjustments to interest income were $344,000 and $370,000, respectively, for the three month periods ended September 30, 2012 and 2011 and $1,088,000 and $1,158,000, respectively, for the nine month periods ended September 30, 2012 and 2011.

Fully taxable equivalent net interest income of $19.1 million for the three months ended September 30, 2012 increased $980,000, or 5.4%, from $18.2 million when compared to the same period last year. Net interest spread and net interest margin were 3.75% and 3.92%, respectively, for the third quarter of 2012 and 3.73% and 3.93%, respectively, for the third quarter of 2011. Net interest income for the third quarter of 2012 included prepayment fees and late penalties totaling $339,000 associated with a surge in loan refinancing activity.

Fully taxable equivalent net interest income of $56.7 million for the nine months ended September 30, 2012 increased $2.8 million, or 5.3%, from $53.9 million when compared to the same period last year. Net interest spread and net interest margin were 3.81% and 3.99%, respectively, for the first nine months of 2012 and 3.81% and 4.02%, respectively, for the first nine months of 2011. Net interest income for the first three quarters of 2012 included prepayment fees and late penalties totaling $867,000 associated with a surge in loan refinancing activity.

In October 2012, Bancorp received early payoffs of tax-free loans totaling $14.9 million. These payoffs will result in an annual decrease of net interest margin of approximately 0.07%.

Approximately $580 million, or 37%, of the Bank's loans are variable rate; most of these loans are indexed to the prime rate and may reprice as that rate changes. However, approximately $382 million, or 66% of variable rate loans, have reached their contractual floor of 4% or higher. Approximately $77 million or 13% of variable rate loans have contractual floors below 4%. The remaining $121 million or 21% of variable rate loans have no contractual floor. The Bank intends to establish floors whenever possible upon renewal of the loans. The Bank's variable rate loans are primarily comprised of commercial lines of credit and real estate loans. At inception, most of the Bank's fixed rate loans are priced in relation to the five year Treasury bond.

Average earning assets increased $108.6 million or 6.1%, to $1.90 billion for the first nine months of 2012 compared to 2011, reflecting growth in the loan portfolio, investment securities and federal funds sold.


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Average interest bearing liabilities increased $32.2 million, or 2.2%, to $1.48 billion for the first nine months of 2012 compared to 2011 primarily due to increases in interest bearing demand and money market deposits, partially offset by decreases in certificates of deposits and long term debt.

Asset/Liability Management and Interest Rate Risk

Managing interest rate risk is fundamental for the financial services industry. The primary objective of interest rate risk management is to neutralize effects of interest rate changes on net income. Bank management evaluates interest rate sensitivity while attempting to optimize net interest income within the constraints of prudent capital adequacy, liquidity needs, market opportunities and customer requirements.

Interest Rate Simulation Sensitivity Analysis

Bancorp uses an earnings simulation model to estimate and evaluate the impact of an immediate change in interest rates on earnings in a one year forecast. The simulation model is designed to reflect the dynamics of interest earning assets, interest bearing liabilities and off-balance sheet financial instruments. By estimating the effects of interest rate increases and decreases, the model can reveal approximate interest rate risk exposure. The simulation model is used by management to gauge approximate results given a specific change in interest rates at a given point in time. The model is therefore a tool to indicate earnings trends in given interest rate scenarios and does not indicate actual expected results. The September 2012 simulation analysis, which shows very little interest rate sensitivity, indicates that an increase in interest rates of 100 to 200 basis points would have a negative effect on net interest income, and a decrease of 100 basis points in interest rates would also have a negative impact. These estimates are summarized below.

Net interest
income change

Increase 200bp           (0.08 )%
Increase 100bp           (1.29 )
Decrease 100bp           (0.85 )
Decrease 200bp             N/A

Loans indexed to the prime rate, with floors of 4% or higher, comprise approximately 24% of total loans. Since the prime rate is currently 3.25%, rates would have to increase more than 75 bp before the rates on such loans will rise. This effect, captured in the simulation analysis above, negatively impacts the effect of rising rates. Analysis indicates rates must increase more than 200 bp to result in a positive effect on net interest income.

The scenario of rates decreasing 200 bp is not reasonably possible given current low rates for short-term instruments and most deposits.

Undesignated derivative instruments described in Note 13 are recognized on the consolidated balance sheet at fair value, with changes in fair value, due to changes in prevailing interest rates, recorded in other noninterest income. Because of matching terms of offsetting contracts, in addition to collateral provisions which mitigate the impact of non-performance risk, changes in fair value subsequent to initial recognition have a minimal effect on earnings, and are therefore not included in the simulation analysis results above.

Provision for Loan Losses

The provision for loan losses was $2.5 million and $4.1 million for the third quarter of 2012 and 2011, respectively, and $9.0 million and $9.5 million for the first nine months of 2012 and 2011, respectively.


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The higher provision in earlier periods reflects Bancorp's ongoing efforts to identify risk in its portfolio early. Overall, management believes the economy is improving, but problem loan resolution challenges still lie ahead. The provision for loan losses is calculated after considering credit quality factors, and ultimately relies on an overall internal analysis of the risk in the loan portfolio. The provision reflects an allowance methodology that is driven by risk ratings. Bancorp continues to remain cautious in assessing the potential risk in the loan portfolio. Accordingly, Bancorp expects the allowance for loan losses to remain at a high level compared with historic amounts until there are clearer signs of a sustained economic recovery, improvement in our customers' financial conditions, resolution of certain problem credits, and, thus, a reduction in overall credit risk in the portfolio. Management utilizes loan grading procedures which result in specific allowance allocations for the estimated inherent risk of loss. For all loans graded, but not individually reviewed, a general allowance allocation is computed using factors typically developed over time based on actual loss experience. The specific and general allocations plus consideration of qualitative factors represent management's best estimate of probable losses contained in the loan portfolio at the evaluation date. Although the allowance for loan losses is comprised of specific and general allocations the entire allowance is available to absorb any credit losses. Based on this detailed analysis of credit risk, management considers the allowance for loan losses adequate to cover probable losses inherent in the loan portfolio at September 30, 2012.

An analysis of the changes in the allowance for loan losses and selected ratios for the three and nine month periods ended September 30, 2012 and 2011 follows:

                                         Three months ended September 30           Nine months ended September 30
(Dollars in thousands)                      2012                 2011                 2012                2011

Balance at the beginning of the
period                                $          31,773    $          27,564    $         29,745    $         25,543
Provision for loan losses                         2,475                4,100               9,025               9,500
Loan charge-offs, net of
recoveries                                       (3,003 )             (2,598 )            (7,525 )            (5,977 )
Balance at the end of the period      $          31,245    $          29,066    $         31,245    $         29,066
Average loans, net of unearned
income                                $       1,583,269    $       1,541,899    $      1,560,712    $      1,526,926
Provision for loan losses to
average loans (1)                                  0.16 %               0.27 %              0.58 %              0.62 %
Net loan charge-offs to average
loans (1)                                          0.19 %               0.17 %              0.48 %              0.39 %
Allowance for loan losses to
average loans                                      1.97 %               1.89 %              2.00 %              1.90 %
Allowance for loan losses to
period-end loans                                   1.98 %               1.89 %              1.98 %              1.89 %
. . .
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