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SYBT > SEC Filings for SYBT > Form 10-Q on 6-May-2013All Recent SEC Filings

Show all filings for S Y BANCORP INC | Request a Trial to NEW EDGAR Online Pro

Form 10-Q for S Y BANCORP INC


6-May-2013

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 months ended March 31, 2013 and compares this period with the same period 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 three months of 2013 compared to the year ended December 31, 2012. 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 2013 through March 31

Bancorp completed the first quarter of 2013 with record net income of $6.77 million or 4% more than the comparable period of 2012. The increase is primarily due to a lower provision for loan losses, partially offset by higher non-interest expenses, slightly lower net interest income, and higher income tax expense. Diluted earnings per share for the first quarter of 2013, also a record, were $0.49, compared to the first quarter of 2012 at $0.47.

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 decreased $87,000, or 0.5%, for the first three months of 2013, compared to the same period in 2012. The net interest margin declined to 3.83% for the first quarter of 2013, compared to 4.07% for the same period in 2012. The negative effect of declining interest rates earned offset the positive effect of increased volumes on earning assets. To a lesser extent, interest expense declined due to lower funding costs on deposits arising from lower interest rates, a more favorable deposit mix, and fewer outstanding FHLB borrowings.

Also favorably impacting 2013 results, Bancorp's provision for loan losses was $2.3 million in the first quarter compared to $4.1 million in the first quarter of 2012, in response to Bancorp's assessment of inherent risk in the loan portfolio. 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 a methodology that reflects the impact on risk ratings from ongoing economic stress on borrowers witnessed from 2008 through 2013. Bancorp's allowance for loan losses was 2.00% of total loans at March 31, 2013, compared to 2.01% of total loans at December 31, 2012, and 2.04% at March 31, 2012.


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Total non-interest income in the first quarter of 2013 decreased $17,000 compared to the same period in 2012, and remained consistent at 33% of total revenues. Record income from investment management and trust services, which constitutes an average of 40% of non-interest income, increased 11% to $3.9 million for the first quarter of 2013 due to higher asset values and an expanding client base. The magnitude of investment management and trust revenue distinguishes Bancorp from other similarly sized community banks. Trust assets under management rose to $2.01 billion at March 31, 2013, compared to $1.84 billion at March 31, 2012. While fees are based on market values, they typically do not fluctuate directly with the overall stock market. Accounts usually contain fixed income and equity asset classes, which generally react inversely to each other. Nonrecurring fees such as estate, financial planning, insurance, and some retirement fees are not affected by the fluctuations in the market. Gains on sales of mortgage loans increased $128,000, or 17%, in the first three months of 2013 compared to the same period in 2012, as customers continued to take advantage of historically low rates to refinance as well as purchase homes. In addition, Bancorp experienced a $74,000 increase in brokerage income. The first quarter 2012 results included $627,000 of income from Bancorp's investment in a domestic private investment fund, which it liquidated in 2012.

Total non-interest expense in the first quarter of 2013 increased $843,000, or 6%, compared to the same period in 2012 due to increases in personnel costs, reflecting higher staffing levels and normal salary increases, and higher other non-interest expense. These increases were partially offset by a decrease in net occupancy expense, due to a one-time rent refund, which lowered rent expense in 2013.

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 9.82% as of March 31, 2013, compared to 9.52% at December 31, 2012. See the Non-GAAP Financial Measures section for details on reconcilement to US GAAP measures.

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

a) Results Of Operations

Net income of $6,768,000 for the three months ended March 31, 2013 increased $266,000, or 4.1%, from $6,502,000 for the comparable 2012 period. Basic net income per share was $0.49 for the first quarter of 2013, an increase of 4.3% from the $0.47 for the first quarter of 2012. Net income per share on a diluted basis was $0.49 for the first quarter of 2013, compared to $0.47 for the first quarter of 2012; a 4.3% increase. Reflecting increased net income, annualized return on average assets and annualized return on average stockholders' equity were 1.30% and 13.18%, respectively, for the first quarter of 2013, compared to 1.29% and 13.70%, respectively, for the same period in 2012.

Net Interest Income

The following tables present the average balance sheets for the three month periods ended March 31, 2013 and 2012 along with the related calculation 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 March 31
                                        2013                                2012
                            Average                 Average     Average                 Average
(Dollars in thousands)     Balances     Interest     Rate      Balances     Interest     Rate
Earning assets:
Federal funds sold        $   110,472   $      80      0.29 % $    93,724   $      72      0.31 %
Mortgage loans held for
sale                            7,851          64      3.31 %       5,776          63      4.39 %
Securities:
Taxable                       229,938       1,311      2.31 %     199,505       1,417      2.86 %
Tax-exempt                     47,293         389      3.34 %      52,210         458      3.53 %
FHLB stock and other
securities                      6,180          59      3.87 %       5,949          60      4.06 %
Loans, net of unearned
income                      1,577,394      19,180      4.93 %   1,513,154      20,113      5.35 %
Total earning assets        1,979,128      21,083      4.32 %   1,870,318      22,183      4.77 %
Less allowance for loan
losses                         32,850                              30,566
                            1,946,278                           1,839,752
Non-earning assets:
Cash and due from banks        31,686                              30,065
Premises and equipment         36,434                              37,467
Accrued interest
receivable and other
assets                         91,598                             114,756
Total assets                2,105,996                         $ 2,022,040

Interest bearing
liabilities:
Deposits:
Interest bearing demand
deposits                  $   337,844   $      85      0.10 % $   301,503   $     149      0.20 %
Savings deposits               86,295           9      0.04 %      73,227          16      0.09 %
Money market deposits         561,506         299      0.22 %     520,335         465      0.36 %
Time deposits                 375,704         946      1.02 %     398,620       1,416      1.43 %
Securities sold under
agreements to
repurchase                     57,335          35      0.25 %      62,729          49      0.31 %
Fed funds purchased and
other short term
borrowings                     19,643           8      0.17 %      19,032           8      0.17 %
FHLB advances                  31,876         217      2.76 %      60,429         363      2.42 %
Long-term debt                 30,900         773     10.15 %      33,208         796      9.64 %

Total interest bearing
liabilities                 1,501,103       2,372      0.64 %   1,469,083       3,262      0.89 %
Non-interest bearing
liabilities:
Non-interest bearing
demand deposits               371,598                             316,125
Accrued interest
payable and other
liabilities                    25,094                              45,944
Total liabilities           1,897,795                           1,831,152
Stockholders' equity          208,201                             190,888
Total liabilities and
stockholders' equity      $ 2,105,996                         $ 2,022,040
Net interest income                     $  18,711                           $  18,921
Net interest spread                                    3.68 %                              3.88 %
Net interest margin                                    3.83 %                              4.07 %


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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 $248,000 and $371,000, respectively, for the three month periods ended March 31, 2013 and 2012.

Average balances for loans include the principal balance of non-accrual loans and exclude participation loans accounted for as secured borrowings.

Fully taxable equivalent net interest income of $18.7 million for the three months ended March 31, 2013 decreased $210,000, or 1.1%, from $18.9 million when compared to the same period last year. Net interest spread and net interest margin were 3.68% and 3.83%, respectively, for the first quarter of 2013 and 3.88% and 4.07%, respectively, for the first quarter of 2012.

The net interest margin for the first quarter of 2013 included the impact of penalties paid by customers due to the early repayment of loans; these prepayment penalties added an estimated six basis points to the first quarter 2013 margin, compared to seven basis points in the first quarter of 2012. Excluding this impact, the net interest margin reflected an ongoing low interest rate environment, a competitive loan market, and Bancorp's excess liquidity, all of which are likely to continue in the foreseeable future. Increasing competitive loan pricing could negatively impact net interest margin in future quarters.

Approximately $600 million, or 38%, 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 $369 million, or 61% of variable rate loans, have reached their contractual floor of 4% or higher. Approximately $87 million or 15% of variable rate loans have contractual floors below 4%. The remaining $144 million or 24% of variable rate loans have no contractual floor. The Bank intends to establish floors whenever possible upon acquisition of new customers. 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 for the first three months of 2013 increased $108.8 million, or 5.8% to $1.98 billion, compared to $1.87 billion for the same period of 2012, reflecting growth in the loan portfolio and investment securities. Average interest bearing liabilities for the first three months of 2013 increased $32.0 million, or 2.2% to $1.50 billion compared to $1.47 billion for the same period of 2012, primarily due to increases in money market and interest bearing demand deposits.


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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. By considering both on and off-balance sheet financial instruments, 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 March 31, 2013 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           (2.62 )%
Increase 100bp           (2.64 )
Decrease 100bp           (2.57 )
Decrease 200bp             N/A

Loans indexed to the prime rate, with floors of 4% or higher, comprise approximately 23% 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.

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 $2.3 million for the first three months of 2013 compared to $4.1 million for the same period in 2012. 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. Although Bancorp continues to see


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improving economic conditions in its markets, business indicators have not been uniformly positive or of a significance to signal that the economy has strengthened on a sustainable and consistent basis. Accordingly, Bancorp intends to remain cautious in assessing the potential risk in its loan portfolio and expects to maintain the allowance for loan losses at recently high levels, at least for the near term, until credit metrics improve further.

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 March 31, 2013.

An analysis of the changes in the allowance for loan losses and selected ratios for the three month periods ended March 31, 2013 and 2012 follows:

                                                   Three months ended March 31
(Dollars in thousands)                                2013              2012

Balance at the beginning of the period           $        31,881    $     29,745
Provision for loan losses                                  2,325           4,075
Loan charge-offs, net of recoveries                       (2,184 )        (2,614 )
Balance at the end of the period                 $        32,022    $     31,206
Average loans, net of unearned income            $     1,585,326    $  1,543,778
Provision for loan losses to average loans (1)              0.15 %          0.26 %
Net loan charge-offs to average loans (1)                   0.14 %          0.17 %
Allowance for loan losses to average loans                  2.02 %          2.02 %
Allowance for loan losses to period-end loans               2.00 %          2.04 %



(1) Amounts not annualized

Loans are charged off when deemed uncollectible and a loss is identified or after underlying collateral has been liquidated; however, collection efforts may continue and future recoveries may occur. Periodically, loans are partially charged off to the net realizable value based upon firm collateral analysis.


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An analysis of net charge-offs by loan category for the three month periods ended March 31, 2013 and 2012 follows:

                                                      Three months
(in thousands)                                       ended March 31
Net loan charge-offs (recoveries)                    2013      2012
Commercial and industrial                          $     29   $ 2,273
Construction and development                          1,836        23
Real estate mortgage - commercial investment            (13 )     188
Real estate mortgage - owner occupied commercial         38        27
Real estate mortgage - 1-4 family residential           251        87
Home equity                                              45       180
Consumer                                                 (2 )    (164 )
Total net loan charge-offs                         $  2,184   $ 2,614

The increase in net charge-offs in the construction and development category for the three months ended March 31, 2013 was largely due to one relationship which migrated from substandard to non-performing status in the first quarter. At the time of the migration, Bancorp recorded partial charge-offs on the outstanding loans.


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Non-interest Income and Expenses



The following table sets forth the major components of non-interest income and
expenses for the three month periods ended March 31, 2013 and 2012.



                                                    Three months
                                                   ended March 31
(in thousands)                                     2013       2012

Non-interest income:
Investment management and trust services         $  3,886   $  3,490
Service charges on deposit accounts                 2,000      2,055
Bankcard transaction revenue                          961        965
Gains on sales of mortgage loans held for sale        867        739
Brokerage commissions and fees                        615        541
Bank owned life insurance income                      252        257
Other                                                 647      1,198
Total non-interest income                        $  9,228   $  9,245
Non-interest expenses:
Salaries and employee benefits                      9,657   $  9,052
Net occupancy expense                               1,231      1,369
Data processing expense                             1,356      1,313
Furniture and equipment expense                       291        292
FDIC insurance expense                                350        351
Other                                               2,694      2,359
Total non-interest expenses                      $ 15,579   $ 14,736

Total non-interest income was essentially flat for the first quarter of 2013 compared to the same period in 2012.

Investment management and trust services income increased $396,000, or 11.3%, in the first quarter of 2013, as compared to the same period in 2012, primarily due to an increased market value of assets under management. Most recurring fees earned for managing accounts are based on a percentage of market value on a monthly basis. Some revenues of the investment management and trust department, most notably executor, insurance, and some employee benefit plan-related fees, are non-recurring in nature and the timing of these revenues corresponds with the related administrative activities. Along with the effects of improving broader investment market conditions, this area of the Bank continued to grow through attraction of new business and retention of existing business, despite normal attrition. Trust assets under management at March 31, 2013 were $2.01 billion, compared to $1.84 billion at March 31, 2012.

Service charges on deposit accounts decreased $55,000, or 2.7%, in the first quarter of 2013, as compared to the same period in 2012. Service charge income is driven by transaction volume, which can fluctuate throughout the year. A significant component of service charges is related to fees earned on overdrawn checking accounts. This source of income has experienced a downward trend over the past two years due to customer awareness and increased regulatory restrictions. Management expects this trend to continue.


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Bankcard transaction revenue was essentially unchanged for the first quarter of 2013, as compared to the same period in 2012 and primarily represents income the Bank derives from customers' use of debit cards. Most of this revenue is interchange income based on rates set by service providers in a competitive market. Beginning in October 2011, this rate was set by the Federal Reserve Board for banks with over $10 billion in assets. While this threshold indicates Bancorp will not be directly affected, it appears this change will affect Bancorp as vendors gravitate to lower cost interchanges. While there are many uncertainties about its effect or ultimately when these changes may take place, the Dodd-Frank legislation will negatively affect this source of income.

Gains on sales of mortgage loans increased $128,000, or 17.3%, in the first quarter of 2013, as compared to the same period in 2012. The Bank's mortgage banking department originates residential mortgage loans to be sold in the secondary market. Interest rates on the loans sold are locked with the borrower and investor prior to closing the loans, thus Bancorp bears no interest rate risk related to these loans. The department offers conventional, VA and FHA financing, for purchases and refinances, as well as programs for first time home buyers. Interest rates on mortgage loans directly impact the volume of business . . .

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