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KTYB > SEC Filings for KTYB > Form 10-Q on 15-May-2013All Recent SEC Filings

Show all filings for KENTUCKY BANCSHARES INC /KY/ | Request a Trial to NEW EDGAR Online Pro

Form 10-Q for KENTUCKY BANCSHARES INC /KY/


15-May-2013

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 $1.7 million, or $0.63 basic earnings and diluted earnings per share for the first three months ending March 31, 2013 compared to $1.6 million or $0.60 basic earnings and diluted earnings per share for the three month period ending March 31, 2012. The first three months earnings reflect an increase of 5.6% compared to the same time period in 2012, largely due to an increase in the gain on sold mortgage loans of $148 thousand, an increase of $129 thousand in gains on sold securities and a decrease of $262 thousand in net repossession expense. These positive changes to net income during 2013 were partially offset by a decrease of $50 thousand in service charges, a decrease of $139 thousand in loan service fee income and an increase of $209 thousand in employee salaries and benefits.


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Return on average assets was 0.96% for the three months ended March 31, 2013 and March 31, 2012. Return on average equity was 9.2% for the three month period ended March 31, 2013 and March 31, 2012. Gross Loans decreased $7.7 million from $430.0 million on December 31, 2012 to $422.3 million on March 31, 2013. The overall decrease is mostly attributed to a decrease of $3.8 million in agricultural loans, a decrease of $3.3 million in real estate construction loans, a decrease of $3.2 million in non-farm and non-residential loans and a decrease of $1.3 million in commercial loans. Included in the decrease in agricultural loans is a decrease of $2.2 million in loans associated with the tobacco buyout program. The decrease in these loans is attributed to contractual payments received on these loans during the first quarter of 2013. Further, the decrease in real estate construction loans is mostly attributed to one loan customer whose loan had an outstanding balance of approximately $3.0 million at December 31, 2012 and a $0 balance at March 31, 2013. The decrease in this loan balance is attributed to receiving payments of approximately $2.5 million and charging off $578 thousand. Also, the decrease in non-farm and non-residential loans is largely attributed to one loan customer who paid off two loans early totaling approximately $1.8 million. Increases in the loan portfolio from December 31, 2012 to March 31, 2013 included an increase of $3.9 million in 1-4 family residential loans and an increase of $634 thousand in multi-family residential loans.

Total deposits increased from $590.4 million on December 31, 2012 to $594.3 million on March 31 2013, an increase of $3.9 million. Non-interest bearing demand deposit accounts increased $3.3 million from December 31, 2012 to March 31, 2013. Time deposits $100 thousand and over increased $2.6 million and other interest bearing deposit accounts decreased $2.0 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 $6.1 million for the three months ended March 31, 2013 compared to $6.1 million for the three months ended March 31, 2012, an increase of 0.4%. The interest spread of 3.71% for the first three months of 2013 is down from 3.95% reported for the same period in 2012, a decrease of 24 basis points. Rates have remained fairly low in the past year. For the first three months ending March 31, 2013, the cost of total deposits was 0.40% compared to 0.49% for the same time period in 2012. Increasing non-interest bearing deposit accounts and lower rates on certificates of deposit accounts have helped to lower the cost of deposits.

For the first three months, the yield on assets decreased from 4.66% in 2012 to 4.24% in 2013. The yield on loans decreased 28 basis points in the first three months of 2013 compared to 2012 from 5.72% to 5.44%. The yield on securities decreased 53 basis points in the first three months of 2013 compared to 2012 from 2.82% in 2012 to 2.29% in 2013. The cost of liabilities decreased from 0.71% in 2012 to 0.53% in 2013. Year to date average loans, excluding overdrafts, increased $15.1 million, or 3.7% from March 31, 2012 to March 31, 2013. Loan interest income decreased $136 thousand for the first three months of 2013 compared to the first three months of 2012. Year to date average total deposits increased from March 31, 2012 to March 31, 2013, up $47.9 million or 8.6%. Year to date average interest bearing deposits increased $38 million, or 9.2%, from March 31, 2012 to March 31, 2013. Deposit interest expense decreased $95 thousand for the first three months of 2013 compared to the same period in 2012. Year to date average borrowings decreased $11.6 million, or 28.0% from March 31, 2012 to March 31, 2013. The decrease is mostly attributed to paying off FHLB advances as they mature. Interest expense on borrowed funds decreased $135 thousand for the first three months of 2013 compared to the same period in 2012.

The volume rate analysis for the three months ending March 31, 2013 that follows indicates that $2.1 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 $1.9 million in interest income.


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The average rate of the Company's total outstanding deposits and borrowing liabilities decreased from 0.92% in 2012 to 0.68% in 2013. Based on the volume rate analysis that follows, the lower level of interest rates contributed to a decrease of $165 thousand in interest expense, while the change in volume was responsible for a $65 thousand decrease in interest expense. As a result, the increase in net interest income for the first three months in 2013 is mostly attributed to increases in volume in the loan and security portfolios and paying down Federal Home Loan Bank advances.

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 2013. 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



                                                               Three Months Ending
                                                                  2013 vs. 2012
                                                 Increase       (Decrease) Due to      Change in
(in thousands)                                    Volume              Rate            Net Change

INTEREST INCOME
Loans                                           $     1,004    $            (1,140 )  $      (136 )
Investment Securities                                   855                   (925 )          (70 )
Other                                                    (2 )                    2              -
Total Interest Income                                 1,857                 (2,063 )         (206 )
INTEREST EXPENSE
Deposits
Demand                                                   66                    (57 )            9
Savings                                                  10                     (6 )            4
Negotiable Certificates of Deposit and Other
Time Deposits                                           (24 )                  (84 )         (108 )
Securities sold under agreements to
repurchase and other borrowings                          40                    (49 )           (9 )
Federal Home Loan
Bank advances                                          (157 )                   31           (126 )
Total Interest Expense                                  (65 )                 (165 )         (230 )
Net Interest Income                             $     1,922    $            (1,898 )  $        24

Non-Interest Income

Non-interest income increased $107 thousand for the three months ended March 31, 2013, compared to the same period in 2012, to $2.6 million. The increase was due primarily to an increase of $148 thousand in gains recognized on sold mortgage loans and an increase of $129 thousand in gains recognized on sold securities. Decreases to non-interest income for the first three months of 2013 compared to the first three months of 2012 included a decrease of $139 thousand in loan service fee income and a decrease of $50 thousand in service charges.


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The gain on the sale of mortgage loans increased from $478 thousand in the first three months of 2012 to $626 thousand during the first three months of 2013, an increase of $148 thousand. The volume of loans originated to sell during the first three months of 2013 decreased $121 thousand compared to the same time period in 2012. 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 $(52) thousand for the three months ending March 31, 2013 compared to $87 thousand for the three months ending March 31, 2012 a decrease of $139 thousand. During the first three months of 2013, the carrying value of the mortgage servicing right was written down a net amount of $73 thousand, as the fair value of this asset decreased. For the three months ending March 31, 2012, the carrying value of the mortgage servicing right had a positive valuation adjustment in the amount of $63 thousand.

Non-Interest Expense

Total non-interest expenses decreased $32 thousand for the three month period ended March 31, 2013 compared to the same period in 2012.

For the comparable three month periods, salaries and benefits increased $209 thousand, an increase of 6.4%. The increase is attributed largely to additional employees being hired throughout 2012 and 2013 and normal pay increases at the beginning of 2013. The number of full time equivalent employees at March 31, 2013 was 205 compared to 199 one year ago.

Occupancy expenses increased $9 thousand to $718 thousand for the first three months of 2013 compared to the same time period in 2012.

Legal and professional fees decreased $47 thousand for the first three months ended March 31, 2013 compared to the same time period in 2012. Repossession expenses decreased $262 thousand for the first three months ending March 31, 2013 compared to the same time period in 2012. Repossession expenses are reported net of rental income earned on the repossessed properties.
Repossession expenses were lower in the first three months of 2013 when compared to the same time period in 2012 due to the Company selling many of the properties included in other real estate owned at March 31, 2012 throughout the remainder of 2012. FDIC insurance expense decreased $88 thousand for the three months ending March 31, 2013 compared to the same time period in 2012. 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 three months ended March 31, 2013 was 19.0% compared to 16.9% in 2012. 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 2013 are higher due to the higher level of income for 2012. Tax-exempt interest income decreased $61 thousand for the first three months of 2013 compared to the first three months of 2012.


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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 three months ended March 31, 2013, the Company averaged $77.2 million in tax free securities and $21.2 million in tax free loans. As of March 31, 2013, 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 157 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 $15.5 million as of March 31, 2013 compared to $31.8 million at December 31, 2012. The decrease in cash and cash equivalents is attributed to a decrease of $16.2 million in cash and due from banks. In addition to cash and cash equivalents, the securities portfolio provides an important source of liquidity. Securities available for sale totaled $223.0 million at March 31, 2013 compared to $192.8 million at December 31, 2012. 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 three months of 2013, deposits increased $3.9 million. The Company's investment portfolio increased $30.2 million and the Company's loan portfolio decreased $7.7 million. The borrowed funds the Company have with the FHLB decreased $1.6 million. Federal Funds purchased increased $1.5 million from $0 at December 31, 2012 to $1.5 million at March 31, 2013.

The Company has a $300 thousand 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 March 31, 2013.


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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 March 31, 2013, we have sufficient collateral to borrow an additional $85 million from the FHLB. In addition, as of March 31, 2013, $18 million is available in overnight borrowing through various correspondent banks and the Company has access to $249 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 March 31, 2013 and December 31, 2012, 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.


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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)
March 31, 2013
Consolidated

Total Capital (to Risk-Weighted
Assets)                           $ 70,039     15.0 % $    37,254         8 % $       N/A       N/A
Tier I Capital (to
Risk-Weighted Assets)               64,326     13.8        18,627         4           N/A       N/A
Tier I Capital (to Average
Assets)                             64,326      9.3        27,826         4           N/A       N/A

Bank Only
Total Capital (to Risk-Weighted
Assets)                           $ 69,351     14.9 % $    37,252         8 % $    46,566        10 %
Tier I Capital (to
Risk-Weighted Assets)               63,638     13.7        18,626         4        27,939         6
Tier I Capital (to Average
Assets)                             63,638      9.2        27,817         4        34,771         5

December 31, 2012
Consolidated
Total Capital (to Risk-Weighted
Assets)                           $ 67,956     14.5 % $    37,385         8 %         N/A       N/A
Tier I Capital (to
Risk-Weighted Assets)               62,095     13.3        18,692         4           N/A       N/A
Tier I Capital (to Average
Assets)                             62,095      9.2        27,050         4           N/A       N/A

Bank Only
Total Capital (to Risk-Weighted
Assets)                           $ 67,522     14.5 % $    37,383         8 % $    46,729        10 %
Tier I Capital (to
Risk-Weighted Assets)               61,661     13.2        18,692         4        28,037         6
Tier I Capital (to Average
Assets)                             61,661      9.1        27,040         4        33,800         5

Non-Performing Assets

As of March 31, 2013, our non-performing assets totaled $17.3 million or 2.44% of assets compared to $19.3 million or 2.75% of assets at December 31, 2012 (See table below.) The Company experienced a decrease of $2.3 million in non-accrual loans from December 31, 2012 to March 31, 2013. As of March 31, 2013, non-accrual loans include $1.6 million in loans secured by non-farm and non-residential properties, $1.1 million in loans secured by 1-4 family properties, $1.0 million in loans secured by agricultural properties, $689 thousand in loans secured by real estate construction properties, $311 thousand in loans secured by multi-family residential properties and $56 thousand in consumer loans. Real estate loans composed 99.0% of the non-performing loans as of March 31, 2013 and 97.7% as of December 31, 2012. Forgone interest income on non-accrual loans totaled $116 thousand for the first three months of 2013 compared to forgone interest of $53 thousand for the same time period in 2012. Accruing loans that are contractually 90 days or more past due as of March 31, 2013 totaled $1.1 million compared to $841 thousand at December 31, 2012, an increase of $259 thousand. The total nonperforming and restructured loans decreased $2.1 million from December 31, 2012 to March 31, 2013, resulting in a decrease in the ratio of nonperforming loans to loans of 42 basis points to 3.09%. In addition, the amount the Company has booked as "Other Real Estate" increased $54 thousand from December 31, 2012 to March 31, 2013. As of March 31, 2013, the amount recorded as "Other Real Estate" totaled $4.2 million compared to $4.2 million at December 31, 2012. During the first three months of 2013, $82 thousand was added to Other Real Estate properties while $28 thousand in other real estate properties were sold. The allowance as a percentage of non-performing and restructured loans and Other Real Estate Owned increased from 31% at December 31, 2012 to 33% at March 31, 2013.


Table of Contents

Nonperforming Assets



                                                          3/31/13         12/31/12
                                                               (in thousands)

Non-accrual Loans                                       $      4,746    $       7,024
Accruing Loans which are Contractually past due 90
days or more                                                   1,100              841
Troubled Debt Restructurings                                   7,191            7,227
Total Nonperforming Loans                                     13,037           15,092
Other Real Estate                                              4,222            4,168
Total Nonperforming Loans and Other Real Estate         $     17,259    $      19,260
Nonperforming Loans as a Percentage of Loans                    3.09 %           3.51 %
Nonperforming Loans and Other Real Estate as a
Percentage of Total Assets                                      2.44 %           2.75 %
Allowance as a Percentage of Period-end Loans                   1.33 %           1.41 %
Allowance as a Percentage of Non-performing Loans
and Other Real Estate                                             33 %             31 %

We maintain a "watch list" of agricultural, commercial, real estate mortgage, and real estate construction loans and review those loans on a regular basis. Generally, assets are designated as "watch list" loans to ensure more frequent monitoring. If we determine that there is serious doubt as to performance in accordance with original terms of the contract, then the loan is generally downgraded and often placed on non-accrual status. We review and evaluate nonaccrual loans, past due loans, and loans graded substandard or worse on a regular basis to determine if specific allocations are needed.

Provision for Loan Losses

The loan loss provision for the first three months was $450 thousand for 2013 and 2012. Management evaluates the loan portfolio by reviewing the historical loss rate for each respective loan type and assigns risk multiples to certain categories to account for qualitative factors including current economic conditions. The average loss rates are reviewed for trends in the analysis, as well as comparisons to peer group loss rates. Management makes allocations within the allowance for loan losses for specifically classified loans regardless of loan amount, collateral or loan type. Loan categories are evaluated utilizing subjective factors in addition to the historical loss calculations to determine a loss allocation for each of those types. As this analysis, or any similar analysis, is an imprecise measure of loss, the allowance is subject to ongoing adjustments. Therefore, management will often take into account other significant factors that may be necessary or prudent in order to reflect probable incurred losses in the total loan portfolio.

Nonperforming loans and restructured loans decreased $2.1 million since December 31, 2012 to $13.0 million as of March 31, 2013. Other real estate owned increased $54 thousand over this same time period. Additions to Other real estate totaled $82 thousand while sales totaled $28 thousand.

The March 31, 2013 unallocated allowance of $556 thousand increased slightly from the December 31, 2012 balance of $532 thousand.


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