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SYBT > SEC Filings for SYBT > Form 10-Q on 7-Nov-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


7-Nov-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 and nine months ended September 30, 2013 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 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 September 30

Bancorp completed the first nine months of 2013 with net income of $20.9 million or 8% more than the comparable period of 2012. The increase is due primarily to a lower provision for loan losses, higher non-interest income and net interest income, partially offset by increased non-interest expenses and income tax expense. Diluted earnings per share for the first nine months of 2013 were $1.47, compared to the first nine months of 2012 at $1.38. Bancorp's results for the first nine months of 2013 included the effect of several unusual items. Excluding these items, net income for the year-to-date period ended September 30, 2013, was $21.1 million or $1.49 per diluted share. See the Non-GAAP Financial Measures section for details on reconciliation to US GAAP measures.

On April 30, 2013, Bancorp completed the acquisition of 100% of the outstanding shares of THE BANCorp, Inc. ("Oldham"), parent company of THE BANK - Oldham County, Inc. As a result of the transaction, THE BANK - Oldham County merged into Stock Yards Bank & Trust Company. Since the acquisition date, results of operations acquired in the Oldham transaction have been included in Bancorp's financial results. The Oldham transaction has been accounted for using the acquisition method of accounting and, accordingly, assets acquired, liabilities assumed and consideration transferred were recorded at estimated fair value on the acquisition date. The fair value adjustments resulted in net assets acquired in excess of the consideration paid. Accordingly, a non-taxable gain of $449,000 was recognized. In connection with the Oldham acquisition, Bancorp incurred expenses totaling $1,548,000 related to executing the transaction and integrating and conforming acquired operations with and into Bancorp.

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.


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Net interest income increased $1,815,000, or 3.3%, for the first nine months of 2013, compared to the same period in 2012. The net interest margin declined to 3.78% for the first nine months of 2013, compared to 3.99% for the same period in 2012. Interest income decreased as the negative effect of declining interest rates earned offset the positive effect of increased volumes on earning assets. Interest expense decreased even further due to lower funding costs on deposits arising from lower interest rates, a more favorable deposit mix, and fewer outstanding FHLB borrowings. Core net interest margin is addressed in the notes to the average balance sheets later in this section.

Also favorably impacting 2013 results, Bancorp's provision for loan losses was $5.0 million for the first nine months of 2013, compared to $9.0 million in the first nine months of 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. Bancorp's allowance for loan losses was 1.70% of total loans at September 30, 2013, compared to 2.01% of total loans at December 31, 2012, and 1.98% at September 30, 2012.

Total non-interest income in the first nine months of 2013 increased $861,000 compared to the same period in 2012, and remained consistent at 34% of total revenues, reflecting increases in investment management and trust services, service charges on deposit accounts, bankcard transaction revenue, and the gain on the Oldham acquisition, partially offset by a decrease in gains on sales of mortgage loans.

Total non-interest expense in the first nine months of 2013 increased $3.7 million, or 7.6%, compared to the same period in 2012 due to one-time acquisition costs related to the Oldham transaction, increases in personnel costs and data processing expenses. These increases were partially offset by decreases in furniture and equipment expense and other expenses.

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 9.78% as of September 30, 2013, compared to 9.52% at December 31, 2012. See the Non-GAAP Financial Measures section for details on reconciliation to US GAAP measures.

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

a) Results Of Operations

Net income of $7,682,000 for the three months ended September 30, 2013 increased $1.0 million, or 15.0%, from $6,682,000 for the comparable 2012 period. Basic net income per share was $0.53 for the third quarter of 2013, an increase of 10.4% from the $0.48 for the third quarter of 2012. Net income per share on a diluted basis was $0.53 for the third quarter of 2013, compared to $0.48 for the third quarter of 2012, a 10.4% increase.

Annualized return on average assets and annualized return on average stockholders' equity were 1.35% and 13.70%, respectively, for the third quarter of 2013, compared to 1.27% and 13.31%, respectively, for the same period in 2012.

Net income of $20,857,000 for the nine months ended September 30, 2013 increased $1,570,000, or 8.1%, from $19,287,000 for the comparable 2012 period. Basic net income per share was $1.47 for the first nine months of 2013, an increase of 5.8% from the $1.39 for the first nine months of 2012. Net income per share on a diluted basis was also $1.47 for the first nine months of 2013 compared to $1.38 for the same period of 2012, an increase of 6.5%.

Bancorp's results for the third quarter and first nine months of 2013 included the effect of several unusual items. Excluding these items, net income for the third quarter of 2013 and year-to-date period ended


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September 30, 2013, was $7.4 million or $0.51 per diluted shares and $21.1 million or $1.49 per diluted share, respectively. See the Non-GAAP Financial Measures section for details on reconciliation to US GAAP measures.

Annualized return on average assets and annualized return on average stockholders' equity were 1.27% and 12.86%, respectively, for the first nine months of 2013, compared to 1.26% and 13.20%, respectively, for the same period in 2012.

Net Interest Income

The following tables present the average balance sheets for the three and nine month periods ended September 30, 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 September 30
                                         2013                                2012
                             Average                 Average     Average                 Average
(Dollars in thousands)      balances     Interest     rate      balances     Interest     rate

Earning assets:
Federal funds sold         $    75,705   $      63      0.33 % $   110,263   $      82      0.30 %
Mortgage loans held for
sale                             5,685          57      3.98 %      11,776          98      3.31 %
Securities:
Taxable                        301,413       1,554      2.05 %     211,424       1,321      2.49 %
Tax-exempt                      58,642         412      2.79 %      49,195         371      3.00 %
FHLB stock and other
securities                       7,347          72      3.89 %       6,180          58      3.73 %
Loans, net of unearned
income                       1,674,049      20,362      4.83 %   1,551,423      20,107      5.16 %
Total earning assets         2,122,841      22,520      4.21 %   1,940,261      22,037      4.52 %
Less allowance for loan
losses                          33,038                              32,786
                             2,089,803                           1,907,475

Non-earning assets:
Cash and due from banks         34,213                              32,279
Premises and equipment          39,910                              37,760
Accrued interest
receivable and other
assets                         101,011                             115,998
Total assets               $ 2,264,937                         $ 2,093,512

Interest bearing
liabilities:
Deposits:
Interest bearing demand
deposits                   $   402,246   $      88      0.09 % $   318,568   $     123      0.15 %
Savings deposits               100,532          11      0.04 %      80,631          16      0.08 %
Money market deposits          590,895         313      0.21 %     555,450         478      0.34 %
Time deposits                  359,861         797      0.88 %     376,228       1,108      1.17 %
Securities sold under
agreements to repurchase        64,652          38      0.23 %      57,878          46      0.32 %
Fed funds purchased and
other short term
borrowings                      19,628           9      0.18 %      19,366           8      0.16 %
FHLB advances                   31,970         221      2.74 %      60,424         345      2.27 %
Long-term debt                  30,900         773      9.92 %      30,900         773      9.95 %

Total interest bearing
liabilities                  1,600,684       2,250      0.56 %   1,499,445       2,897      0.77 %

Non-interest bearing
liabilities:
Non-interest bearing
demand deposits                413,695                             346,942
Accrued interest payable
and other liabilities           28,030                              47,359
Total liabilities            2,042,409                           1,893,746

Stockholders' equity           222,528                             199,766

Total liabilities and
stockholders' equity       $ 2,264,937                         $ 2,093,512
Net interest income                      $  20,270                           $  19,140
Net interest spread                                     3.65 %                              3.75 %
Net interest margin                                     3.79 %                              3.92 %


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                                               Nine months ended September 30
                                          2013                                2012
                              Average                 Average     Average                 Average
(Dollars in thousands)       balances     Interest     rate      balances     Interest     rate

Earning assets:
Federal funds sold          $    93,664   $     215      0.31 % $    96,366   $     216      0.30 %
Mortgage loans held for
sale                              6,661         177      3.55 %       7,771         217      3.73 %
Securities:
Taxable                         269,288       4,193      2.08 %     208,066       4,136      2.66 %
Tax-exempt                       53,860       1,220      3.03 %      51,181       1,285      3.35 %
FHLB stock and other
securities                        6,771         195      3.85 %       6,096         173      3.79 %
Loans, net of unearned
income                        1,628,261      59,150      4.86 %   1,529,440      59,928      5.23 %

Total earning assets          2,058,505      65,150      4.23 %   1,898,920      65,955      4.64 %
Less allowance for loan
losses                           33,046                              31,859
                              2,025,459                           1,867,061

Non-earning assets:
Cash and due from banks          33,212                              31,137
Premises and equipment           38,255                              37,794
Accrued interest
receivable and other
assets                           96,084                             115,320

Total assets                $ 2,193,010                         $ 2,051,312

Interest bearing
liabilities:
Deposits:
Interest bearing demand
deposits                    $   375,408   $     274      0.10 % $   312,885   $     402      0.17 %
Savings deposits                 94,807          29      0.04 %      77,307          48      0.08 %
Money market deposits           574,991         911      0.21 %     531,527       1,407      0.35 %
Time deposits                   369,247       2,619      0.95 %     386,653       3,795      1.31 %
Securities sold under
agreements to repurchase         58,881         106      0.24 %      59,507         138      0.31 %
Fed funds purchased and
other short term
borrowings                       20,370          26      0.17 %      20,084          24      0.16 %
FHLB advances                    31,904         657      2.75 %      60,426       1,072      2.37 %
Long-term debt                   30,900       2,318     10.03 %      31,666       2,341      9.88 %

Total interest bearing
liabilities                   1,556,508       6,940      0.60 %   1,480,055       9,227      0.83 %

Non-interest bearing
liabilities:
Non-interest bearing
demand deposits                 393,319                             329,658
Accrued interest payable
and other liabilities            26,304                              46,382
Total liabilities             1,976,131                           1,856,095

Stockholders' equity            216,879                             195,217

Total liabilities and
stockholders' equity        $ 2,193,010                         $ 2,051,312
Net interest income                       $  58,210                           $  56,728
Net interest spread                                      3.63 %                              3.81 %
Net interest margin                                      3.78 %                              3.99 %


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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 $253,000 and $344,000, respectively, for the three month periods ended September 30, 2013 and 2012 and $755,000 and $1,088,000, respectively, for the nine month periods ended September 30, 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 $20.3 million for the three months ended September 30, 2013 increased $1.2 million, or 5.9%, from $19.1 million when compared to the same period last year. Net interest spread and net interest margin were 3.65% and 3.79%, respectively, for the third quarter of 2013 and 3.75% and 3.92%, respectively, for the third quarter of 2012. Net interest income for the third quarter of 2013 continued to reflect a higher amount of prepayment fees, late penalties and interest adjustments, and also included approximately $378 thousand for an interest adjustment on a non-accrual loan. Adjusting for these sources of additional income, Bancorp's more normalized or core net interest margin was 3.63% for the third quarter of 2013. The table below shows the most recent five quarters of net interest margin and core net interest margin. See the Non-GAAP Financial Measures section for details on reconciliation to US GAAP measures.

                            9/30/2013    6/30/2013    3/31/2013    12/31/2012    9/30/2012
Net interest margin              3.79 %       3.72 %       3.83 %        3.78 %       3.92 %
Prepayment penalties /
late charges                    -0.06 %      -0.04 %      -0.06 %       -0.04 %      -0.07 %
Interest adjustment on
non-accrual loan                -0.07 %
Accretion of fair value
adjustments                     -0.03 %      -0.02 %
Core net interest margin         3.63 %       3.66 %       3.77 %        3.74 %       3.85 %

Fully taxable equivalent net interest income of $58.2 million for the nine months ended September 30, 2013 increased $1.5 million, or 2.6%, from $56.7 million when compared to the same period last year. Net interest spread and net interest margin were 3.63% and 3.78%, respectively, for the first nine months of 2013 and 3.81% and 3.99%, respectively, for the first nine months of 2012.


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The net interest margin for the first nine months of 2013 and 2012 included the impact of interest adjustments and penalties paid by customers due to the early repayment of loans which added an estimated 10 and 6 basis points to the 2013 and 2012 margins, respectively. The net interest margin was negatively affected by an ongoing low interest rate environment and a competitive loan market, both of which are likely to continue in the foreseeable future. Increasing competitive loan pricing could negatively impact net interest margin in future quarters.

Approximately $621.6 million, or 36%, 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 $331.6 million of variable rate loans have reached their contractual floor of 4% or higher. Approximately $102.2 million of variable rate loans have contractual floors below 4%. The remaining $187.8 million 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 increased $159.6 million or 8.4%, to $2.06 billion for the first nine months of 2013 compared to 2012, reflecting growth in the loan portfolio and investment securities. Average interest bearing liabilities increased $76.5 million, or 5.2%, to $1.56 billion for the first nine months of 2013 compared to 2012 primarily due to increases in interest bearing demand, savings and money market deposits, partially offset by decreases in certificates of deposits, securities sold under agreements to repurchase and FHLB advances. Growth in overall deposits supports loan growth, while decreasing time deposit balances and FHLB advances contribute to lower interest expense.

In the third quarter of 2013, Bancorp announced that it intends to redeem $30.0 million, or the entire outstanding amount, of its 10% fixed-rate cumulative trust preferred securities resulting in $3.0 million savings of interest expense in 2014 and forward. The redemption price will be equal to 100% of the aggregate liquidation amount of the trust preferred securities plus any accumulated and unpaid distributions thereon to the date of redemption.

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 September 30, 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,


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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           (4.79 )%
Increase 100bp           (3.48 )
Decrease 100bp           (2.68 )
Decrease 200bp             N/A

Loans indexed to the prime rate, with floors of 4% or higher, comprise approximately 19% 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. In a declining rate environment, the current level of rates on deposits allows little opportunity to further lower 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 14 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 $1.3 million and $2.5 million for the third quarter of 2013 and 2012, respectively, and $5.0 million and $9.0 million for the first nine months of 2013 and 2012, respectively. 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. Management continues to see favorable trends in credit quality metrics and believes Bancorp remains adequately reserved based on its current assessment of overall risk in the loan portfolio. 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 impaired loans. For all loans graded, but not individually reviewed for specific allowance allocations, 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, 2013.

Prior to the third quarter of 2013, management measured the appropriateness of the allowance for loan losses in its entirety using (a) quantitative (historical . . .

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