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KTYB > SEC Filings for KTYB > Form 10-Q on 13-Nov-2012All Recent SEC Filings

Show all filings for KENTUCKY BANCSHARES INC /KY/

Form 10-Q for KENTUCKY BANCSHARES INC /KY/


13-Nov-2012

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.

Summary

The Company recorded net income of $5.1 million, or $1.88 basic earnings and diluted earnings per share for the first nine months ending September 30, 2012 compared to $4.5 million or $1.65 basic earnings and diluted earnings per share for the nine month period ending September 30, 2011. The first nine months earnings reflects an increase of 14.3% compared to the same time period in 2011, due primarily to an increase in the gain on sold mortgage loans of $940 thousand, an increase of $397 thousand in gains on sold securities, an increase in net interest income of $346 thousand and a decrease of $300 thousand in the provision for loan losses. These positive changes to net income during 2012 were partially offset by an increase of $353 thousand in employee salaries and benefits, an increase of $364 thousand in repossession expenses and an increase of $253 thousand in loan fees. The earnings for the three months ending September 30, 2012 were $1.7 million, or $0.63 basic and diluted earnings per share compared to $1.8 million or $0.67 basic and diluted earnings per share for the three month period ending September 30, 2011. The earnings for the three month period in 2012 reflect a 4.3% decrease compared to the same time period in 2011.


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Return on average assets was 1.00% for the nine months ended September 30, 2012 and 0.91% for the nine month period ended September 30, 2011. Return on average assets was 1.00% for the three months ended September 30, 2012 and 1.09% for the three months ended September 30, 2011. Return on average equity was 9.5% for the nine month period ended September 30, 2012 and 9.3% for the same period in 2011. Return on average equity was 9.3% for the three months ended September 30, 2012 and 10.7% for the same time period in 2011. Gross Loans increased $14.6 million from $411.9 million on December 31, 2011 to $426.5 million on September 30, 2012. The overall increase is attributed mostly to an increase of $12.8 million in non-farm and non-residential real estate loans, an increase of $8.8 million in 1-4 family residential real estate loans and an increase of $2.7 million in commercial loans. Decreases in the loan portfolio from December 31, 2011 to September 30, 2012 included a decrease of $4.9 million in agricultural loans, a decrease of $2.9 million in real estate construction loans and a decrease of $2.0 million in multi-family residential real estate loans.

Total deposits decreased from $542.9 million on December 31, 2011 to $540.6 million on September 30, 2012, a decrease of $2.3 million. Non-interest bearing demand deposit accounts increased $8.9 million from December 31, 2011 to September 30, 2012. This increase is not all attributable to additional deposits being placed with the bank. 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 $7.5 million and other interest bearing deposit accounts decreased $3.8 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.

Net interest income was $18.5 million for the nine months ended September 30, 2012 compared to $18.2 million for the nine months ended September 30, 2011, an increase of 1.9%. The interest spread of 3.97% for the first nine months of 2012 is down from 4.06% reported for the same period in 2011, a decrease of 9 basis points. Rates have remained fairly low in the past year. For the first nine months ending September 30, 2012, the cost of total deposits was 0.46% compared to 0.79% for the same time period in 2011. Increasing non-interest bearing deposit accounts and lower rates on certificates of deposit accounts have helped to lower the cost of deposits. Net interest income was $6.1 million for the three months ending September 30, 2012 compared to $6.2 million for the three months ending September 30, 2011, a decrease of 1.4%. The interest spread was 3.91% for the three month period ending September 30, 2012 compared to 4.15% for the three month period in 2011, a decrease of 24 basis points.


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For the first nine months, the yield on assets decreased from 5.06% in 2011 to 4.60% in 2012. The yield on loans decreased 23 basis points in the first nine months of 2012 compared to 2011 from 5.87% to 5.64%. The yield on securities decreased 78 basis points in the first nine months of 2012 compared to 2011 from 3.46% in 2011 to 2.68% in 2012. The cost of liabilities decreased from 1.00% in 2011 to 0.62% in 2012. Year to date average loans increased $7.8 million, or 1.9% from September 30, 2011 to September 30, 2012. Loan interest income decreased $311 thousand for the first nine months of 2012 compared to the first nine months of 2011. Year to date average deposits increased from September 30, 2011 to September 30, 2012, up $23.4 million or 4.4%. The increase is largely attributed to an increase in public funds. Year to date average interest bearing deposits increased $10.3 million, or 2.5%, from September 30, 2011 to September 30, 2012. Deposit interest expense has decreased $1.2 million for the first nine months of 2012 compared to the same period in 2011. Year to date average borrowings decreased $9.1 million, or 17.4% from September 30, 2011 to September 30, 2012. The decrease is mostly attributed to paying off FHLB advances as they mature. Interest expense on borrowed funds has decreased $298 thousand for the first nine months of 2012 compared to the same period in 2011.

The volume rate analysis for the nine months ending September 30, 2012 that follows indicates that $1.8 million of the decrease in interest income is attributable to a decrease in interest rates, while the change in volume contributed to an increase of $636 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 1.00% in 2011 to 0.62% in 2012. Based on the volume rate analysis that follows, the lower level of interest rates contributed to a decrease of $1.2 million in interest expense, while the change in volume was responsible for a $327 thousand decrease in interest expense. As a result, the increase in net interest income for the first nine months in 2012 is mostly attributed to increases in volume in the loan and security portfolios and reduced rates on deposits.

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 2012. Changes in interest income and expenses due to both rate and volume are allocated on a pro rata basis.


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Changes in Interest Income and Expense



                                                            Nine Months Ending
                                                               2012 vs. 2011
                                                   Increase (Decrease) Due to Change in
(in thousands)                                     Volume           Rate        Net Change

INTEREST INCOME
Loans                                           $         486    $      (797 )  $      (311 )
Investment Securities                                     131         (1,022 )         (891 )
Other                                                      19             (1 )           18
Total Interest Income                                     636         (1,820 )       (1,184 )
INTEREST EXPENSE
Deposits
Demand                                                    141           (347 )         (206 )
Savings                                                    13            (14 )           (1 )
Negotiable Certificates of Deposit and Other
Time Deposits                                            (261 )         (764 )       (1,025 )
Securities sold under agreements to
repurchase and other borrowings                           (47 )           31            (16 )
Federal Home Loan
Bank advances                                            (173 )         (109 )         (282 )
Total Interest Expense                                   (327 )       (1,203 )       (1,530 )
Net Interest Income                             $         963    $      (617 )  $       346

Non-Interest Income

Non-interest income increased $1.6 million for the nine months ended September 30, 2012, compared to the same period in 2011, to $8.1 million. The increase was due primarily to an increase of $940 thousand in gains recognized on sold mortgage loans, an increase of $397 thousand in gains recognized on sold securities and an increase of $155 thousand in debit card interchange income. Increases to non-interest income for the first nine months of 2012 compared to the first nine months of 2011 also included an increase of $85 thousand in service charges and an increase of $55 thousand in brokerage fee income. Non-interest income increased $698 thousand for the three months ended September 30, 2012 compared to the three months ended September 30, 2011. The increase was mostly the result of an increase of $375 thousand in gains recognized on the sale of mortgage loans and an increase of $350 thousand in gains recognized on sold securities. Increases to non-interest income for the three month period ending September 30, 2012 compared to the three months ending September 30, 2011 also included an increase of $47 thousand in debit card interchange income, a decrease of $43 thousand in service charges and a decrease of $38 thousand in loan service fee income.


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The gain on the sale of mortgage loans increased from $533 thousand in the first nine months of 2011 to $1.5 million during the first nine months of 2012, an increase of $940 thousand. For the three months ending September 30, 2012 compared to the same time period in 2011, the gain on the sale of mortgage loans increased $375 thousand. The volume of loans originated to sell during the first nine months of 2012 increased $30.3 million compared to the same time period in 2011. 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, net of amortization expense, was $29 thousand for the nine months ending September 30, 2012 compared to $70 thousand for the nine months ending September 30, 2011, a decrease of $41 thousand. For the three month period ending September 30, 2012, loan service fee income, net of amortization expense, was a loss of $54 thousand compared to a loss of $16 thousand for the same time period one year ago. During the first nine months of 2012, the carrying value of the mortgage servicing right was written down a net amount of $29 thousand, as the fair value of this asset decreased. Of this, a positive adjustment of $63 thousand was recorded in the first quarter of 2012, a write-down of $23 thousand was recorded during the second quarter of 2012 and a write-down in the amount of $69 thousand was recorded during the third quarter of 2012. For the nine months ending September 30, 2011, the carrying value of the mortgage servicing right had a positive valuation adjustment in the 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.

Non-Interest Expense

Total non-interest expenses increased $1.2 million for the nine month period ended September 30, 2012 compared to the same period in 2011. For the three month period ended September 30, 2012 compared to the three months ending September 30, 2011, total non-interest expense increased $497 thousand.

For the comparable nine month periods, salaries and benefits increased $353 thousand, an increase of 4.0%. The increase is attributed largely to additional employees being hired throughout 2011 and 2012 and normal pay increases at the beginning of 2012. The number of full time equivalent employees at September 30, 2012 was 202 compared to 193 one year ago and 184 at December 31, 2011. Salaries and employee benefits increased $76 thousand for the three month period ending September 30, 2012 compared to the same time period in 2011.

Occupancy expenses decreased $41 thousand to $2.2 million for the first nine months of 2012 compared to the same time period in 2011. Occupancy expenses decreased $16 thousand for the three month period ended September 30, 2012 compared to the same time period in 2011.


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Legal and professional fees decreased $102 thousand for the first nine months ended September 30, 2012 compared to the same time period in 2011. Legal and professional fees decreased $107 thousand for the three month period ending September 30, 2012 compared to the same time period in 2011. Repossession expenses increased $364 thousand for the first nine months ending September 30, 2012 compared to the same time period in 2011 and increased $138 thousand for the three months period ending September 30, 2012 compared to the same period one year ago. Repossession expenses are reported net of rental income earned on the repossessed properties. Repossession expenses were higher during the first nine months of 2012 when compared to the same time period in 2011 due to maintaining additional other real estate owned properties in 2012. In addition, the rents earned on other real estate properties, including new property added, decreased $153 thousand to $262 thousand for the nine months ending September 30, 2012 compared to the same period last year. FDIC insurance expense decreased $88 thousand for the nine months ending September 30, 2012 and $79 thousand for the three months ending September 30, 2012, compared to the same time period in 2011. The decrease is mostly attributed to a change in the calculation the FDIC uses to assess insurance premiums.

Income Taxes

The effective tax rate for the nine months ended September 30, 2012 was 18.2% compared to 14.9% in 2011. The effective tax rate for the three months ended September 30, 2012 was 18.2% compared to 16.0% for the three months ended September 30, 2011. 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 2012 are higher due to the higher level of income for 2012. Tax-exempt interest income decreased $61 thousand for the first nine months of 2012 compared to the first nine months of 2011.

As part of normal business, the 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, 2012, the Company averaged $77.7 million in tax free securities and $17.0 million in tax free loans. As of September 30, 2012, the weighted average remaining maturity for the tax free securities is 137 months, while the weighted average remaining maturity for the tax free loans is 146 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.


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Cash and cash equivalents were $13.8 million as of September 30, 2012 compared to $17.7 million at December 31, 2011. The decrease in cash and cash equivalents is attributed to a decrease of $3.5 million in cash and due from banks and a decrease of $350 thousand in federal funds sold. In addition to cash and cash equivalents, the securities portfolio provides an important source of liquidity. Securities available for sale totaled $183.0 million at September 30, 2012 compared to $180.4 million at December 31, 2011. 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.

For the first nine months of 2012, deposits decreased $2.3 million. The Company's investment portfolio increased $2.6 million and the Company's loan portfolio increased $14.7 million. The borrowed funds the Company have with the FHLB increased $2.6 million. The Company paid down FHLB advances by $42.4 million during the first nine months of 2012 but replaced some of those maturing advances with new short-term borrowings. Federal Funds purchased increased $1.9 million from $0 at December 31, 2011 to $1.9 million at September 30, 2012.

The Company has a promissory note payable that matures July 28, 2013, 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 loan agreement contains certain covenants and performance terms. The Bank was in compliance with the non-performing asset covenant at September 30, 2012.

Management is aware of the challenge of funding sustained loan growth. Therefore, in addition to deposits, other sources of funds, such as 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, 2012, we have sufficient collateral to borrow an additional $58 million from the FHLB. In addition, as of September 30, 2012, $22 million is available in overnight borrowing through various correspondent banks and the Company has access to $229 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.


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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, 2012 and December 31, 2011, that the Company and the Bank meet all capital adequacy requirements to which they are subject.

The most recent notification from the FDIC 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, 2012
Consolidated

Total Capital (to
Risk-Weighted Assets)          $ 67,329    14.5 %  $    37,086        8 %  $       N/A      N/A
Tier I Capital (to
Risk-Weighted Assets)            61,512    13.3         18,543        4            N/A      N/A
Tier I Capital (to Average
Assets)                          61,513     9.4         26,311        4            N/A      N/A

Bank Only
Total Capital (to
Risk-Weighted Assets)          $ 67,216    14.5 %  $    37,084        8 %  $    46,356       10 %
Tier I Capital (to
Risk-Weighted Assets)            61,400    13.3         18,542        4         27,813        6
Tier I Capital (to Average
Assets)                          61,400     9.3         26,301        4         32,877        5

December 31, 2011
Consolidated
Total Capital (to
Risk-Weighted Assets)          $ 64,279    14.0 %  $    36,718        8 %          N/A      N/A
Tier I Capital (to
Risk-Weighted Assets)            58,525    12.8         18,359        4            N/A      N/A
Tier I Capital (to Average
Assets)                          58,525     9.2         25,414        4            N/A      N/A

Bank Only
Total Capital (to
Risk-Weighted Assets)          $ 65,229    14.2 %  $    36,705        8 %  $    45,882       10 %
Tier I Capital (to
Risk-Weighted Assets)            59,476    13.0         18,353        4         27,529        6
Tier I Capital (to Average
Assets)                          59,476     9.4         25,405        4         31,756        5


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Non-Performing Assets

As of September 30, 2012, our non-performing assets totaled $21.9 million or 3.25% of assets compared to $15.8 million or 2.35% of assets at December 31, 2011 (See table below.) The Company experienced an increase of $673 thousand in non-accrual loans from December 31, 2011 to September 30, 2012. As of September 30, 2012, non-accrual loans include $3.0 million in loans secured by real estate construction, $973 thousand in loans secured by farmland, $1.0 million in loans secured by 1-4 family residential properties, $1.1 million in loans secured by non-farm & non-residential real estate and $471 thousand in loans secured by multi-family residential real estate. Real estate loans composed 99.0% of the non-performing loans as of September 30, 2012 and 99.3% as of December 31, 2011. Forgone interest income on non-accrual loans totaled $273 thousand for the first nine months of 2012 compared to forgone interest of $558 thousand for the same time period in 2011. Accruing loans that are contractually 90 days or more past due as of September 30, 2012 totaled $907 thousand compared to $398 thousand at December 31, 2011, an increase of $509 thousand. The total nonperforming and restructured loans increased $7.4 million from December 31, 2011 to September 30, 2012, resulting in an increase in the ratio of nonperforming loans to loans of 166 basis points to 3.49%. In addition, the amount the Company has booked as "Other Real Estate" has decreased $1.3 million from December 31, 2011 to September 30, 2012. As of September 30, 2012, the amount recorded as "Other Real Estate" totaled $7.0 million compared to $8.3 million at December 31, 2011. The overall decrease in total "Other Real Estate" properties is mostly attributed to sales of Other Real Estate properties exceeding new additions. During the first nine months of 2012, $2.3 million was . . .

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