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KTYB > SEC Filings for KTYB > Form 10-Q on 13-Nov-2013All Recent SEC Filings

Show all filings for KENTUCKY BANCSHARES INC /KY/

Form 10-Q for KENTUCKY BANCSHARES INC /KY/


13-Nov-2013

Quarterly Report


Item 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Forward-Looking Statements

The following discussion provides information about the financial condition and results of operations of the Company and its subsidiaries as of the dates and periods indicated. This discussion and analysis should be read in conjunction with the unaudited consolidated financial statements and Notes thereto appearing elsewhere in this report and the Management's Discussion and Analysis in the Company's Annual Report on Form 10-K for the year ended December 31, 2012.

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," "estimates," "potential," "may," 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.

As a result of the uncertainties and the assumptions on which this discussion and the forward-looking statements are based, actual future operations and results in the future may differ materially from those indicated herein.

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.


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Summary

The Company recorded net income of $4.9 million, or $1.80 basic earnings and diluted earnings per share for the first nine months ending September 30, 2013 compared to $5.1 million or $1.88 basic earnings and diluted earnings per share for the nine month period ended September 30, 2012. The first nine months earnings reflect a decrease of 4.6% compared to the same time period in 2012. The decrease in earnings is largely due to a decrease of $147 thousand in net interest income, a decrease of $241 thousand in service charge income, a decrease of $113 thousand in gains on sold securities, a loss of $100 thousand on the sale of fixed assets, an increase of $1.2 million in salaries and benefits, an increase of $169 thousand in legal and professional fees, an increase of $134 thousand in data processing and an increase of $121 thousand in marketing and advertising expenses. These adverse changes to net income during 2013 were partially offset by a decrease of $750 thousand in the loan loss provision, an increase of $110 thousand in brokerage income, a decrease of $967 thousand in repossession expense and a decrease of $178 thousand in losses on foreclosed properties. The earnings for the three months ending September 30, 2013 were $1.4 million, or $0.51 basic and diluted earnings per share compared to $1.7 million or $0.63 basic and diluted earnings per share for the three month period ending September 30, 2012. The earnings for the three month period in 2013 reflect a 19.5% decrease compared to the same time period in 2012. During the second quarter of 2013, the Bank opened a new branch in Lexington, KY. As expected, additional expenses were incurred with the opening of the new location which did affect short-term earnings. However, management believes this expansion will increase long-term earnings and shareholder equity.

Return on average assets was 0.90% for the nine months ending September 30, 2013 and 1.00% for the nine months ending September 30, 2012. Return on average assets was 0.75% for the three months ended September 30, 2013 and 1.00% for the three months ending September 30, 2012. Return on average equity was 9.0% for the nine month period ending September 30, 2013 and 9.5% for the nine month period ending September 30, 2012. Return on average equity was 8.0% for the three months ending September 30, 2013 and 9.3% for the same time period in 2012.

Gross Loans increased $34.9 million from $430.0 million on December 31, 2012 to $464.9 million on September 30, 2013. The overall increase is mostly attributed to an increase of $24.3 million in 1-4 family residential properties, an increase of $11.4 million in non-farm and non-residential properties, an increase of $2.9 million in multi-family residential properties and an increase of $3.5 million in commercial loans. Real estate construction loan balances decreased $4.0 million and agricultural loan balances decreased $2.7 million. Included in the decrease in agricultural loans is a decrease of $2.2 million in loans associated with the tobacco buyout program which 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 September 30, 2013. The decrease in this loan balance is attributed to receiving payments of approximately $2.5 million and charging off $578 thousand which was reserved for at December 31, 2012.


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Total deposits decreased from $590.4 million on December 31, 2012 to $573.5 million on September 30 2013, a decrease of $16.9 million. Non-interest bearing demand deposit accounts increased $8.2 million from December 31, 2012 to September 30, 2013. Time deposits $100 thousand and over increased $2.0 million and other interest bearing deposit accounts decreased $27.2 million from December 31, 2012 to September 30, 2013. Public fund accounts decreased $31.3 million from December 31, 2012 to September 30, 2013. Public fund accounts typically decrease during the first three quarters of the year and increase during the last quarter of the year due to tax monies collected during the fourth quarter and then withdrawn from the Bank in the following months.

Borrowings from the Federal Home Loan Bank increased $51.1 million from December 31, 2012 to September 30, 2013. The increase includes an increase of $15.0 million in short-term advances and an increase of $36.1 million in long-term advances. The $15 million in short-term advances outstanding at September 30, 2013 had an original maturity of 28 days. The increase of $36.1 million in long-term advances is attributed to funding the growth in the Banks' loan portfolio and strategically locking in long-term funding with historically low interest rates.

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 $18.4 million for the nine months ending September 30, 2013 compared to $18.5 million for the nine months ending September 30, 2012, a decrease of 0.8%. The interest spread, excluding tax equivalent adjustments was 3.64% for the first nine months of 2013 and down from 3.97% reported for the same period in 2012, a decrease of 33 basis points. Rates have remained fairly low in the past year. For the first nine months ending September 30, 2013, the cost of total deposits was 0.39% compared to 0.46% 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. Net interest income was $6.2 million for the three months ending September 30, 2013 compared to $6.1 million for the three months ending September 30, 2012, an increase of 2.8%. The interest spread, excluding tax equivalent adjustments, was 3.60% for the three month period ending September 30, 2013 compared to 3.91% for the three month period in 2012, a decrease of 39 basis points.


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For the first nine months, the yield on assets decreased from 4.60% in 2012 to 4.17% in 2013, excluding tax equivalent adjustments. The yield on loans decreased 42 basis points in the first nine months of 2013 compared to 2012 from 5.64% to 5.22%. The yield on securities decreased 35 basis points in the first nine months of 2013 compared to 2012 from 2.68% in 2012 to 2.33% in 2013. The cost of liabilities decreased from 0.62% in 2012 to 0.52% in 2013. Year to date average loans, excluding overdrafts, increased $21.5 million, or 5.2% from September 30, 2012 to September 30, 2013. Loan interest income decreased $553 thousand for the first nine months of 2013 compared to the first nine months of 2012. Year to date average total deposits increased from September 30, 2012 to September 30, 2013, up $38.4 million or 7.1%. Year to date average interest bearing deposits increased $29.2 million, or 6.9%, from September 30, 2012 to September 30, 2013. Deposit interest expense decreased $188 thousand for the first nine months of 2013 compared to the same period in 2012. Year to date average borrowings increased $1.2 million, or 2.8% from September 30, 2012 to September 30, 2013. Interest expense on borrowed funds decreased $188 thousand for the first nine months of 2013 compared to the same period in 2012.

The volume rate analysis for the nine months ending September 30, 2013 which follows indicates that $2.5 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 $2.0 million in interest income. The average rate of the Company's total outstanding deposits and borrowing liabilities decreased from 0.62% in 2012 to 0.52% in 2013. Based on the volume rate analysis that follows, the lower level of interest rates contributed to a decrease of $431 thousand in interest expense, while the change in volume was responsible for a $55 thousand increase in interest expense. As a result, the decrease in net interest income for the first nine months in 2013 is mostly attributed to lower rates earned in the Company's loan and security portfolios.

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.


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Changes in Interest Income and Expense



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

INTEREST INCOME
Loans                                          $      1,250    $       (1,804 )  $       (554 )
Investment Securities                                   728              (688 )            40
Other                                                   (10 )               1              (9 )
Total Interest Income                                 1,968            (2,491 )          (523 )
INTEREST EXPENSE
Deposits
Demand                                                   54               (72 )           (18 )
Savings                                                  16                (7 )             9
Negotiable Certificates of Deposit and
Other Time Deposits                                     (26 )            (153 )          (179 )
Securities sold under agreements to
repurchase and other borrowings                         117              (110 )             7
Federal Home Loan Bank advances                        (106 )             (89 )          (195 )
Total Interest Expense                                   55              (431 )          (376 )
Net Interest Income                            $      1,913    $       (2,060 )  $       (147 )

Non-Interest Income

Non-interest income decreased $294 thousand for the nine months ending September 30, 2013, compared to the same period in 2012, to $7.8 million. For the three month period ending September 30, 2013 compared to the three months ending September 30, 2012, total non-interest income decreased $746 thousand. The decrease for the nine month period ending September 30, 2013 was primarily due to a decrease of $188 thousand in overdraft income, a decrease of $113 thousand in gains on sold securities and a decrease of $114 thousand in gains on the sale of fixed assets. In 2013, the Bank sold a former branch building and incurred a loss of $100 thousand which is netted in gains on the sale of fixed assets and included in income. Increases to non-interest income for the first nine months of 2013 compared to the first nine months of 2012 included an increase of $110 thousand in brokerage income.


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The gain on the sale of mortgage loans decreased from $1.5 million in the first nine months of 2012 to $1.4 million during the first nine months of 2013, a decrease of $42 thousand. For the three months ending September 30, 2013 compared to the same time period in 2012, the gain on the sale of mortgage loans decreased $334 thousand. The volume of loans originated to sell during the first nine months of 2013 decreased $1.3 million compared to the same time period in 2012. For the three months ending September 30, 2013, the volume of loans originated for sale decreased $7.1 million compared to the same three months 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 $64 thousand for the nine months ending September 30, 2013 compared to $29 thousand for the nine months ending September 30, 2012 an increase of $35 thousand. For the three month period ending September 30, 2013, loan service fee income, net of amortization and impairment expense, was $100 thousand compared to a loss of $54 thousand for the same time period one year ago. During the first nine months of 2013, the adjustment to the carrying value of the mortgage servicing right was a positive net amount of $24 thousand, as the fair value of this asset increased. Of this, a negative valuation adjustment of $73 thousand was recorded in the first quarter of 2013, a positive valuation adjustment of $8 thousand was recorded during the second quarter of 2013 and a positive valuation adjustment of $89 thousand was recorded during the third quarter of 2013. For the nine months ending September 30, 2012, the carrying value of the mortgage servicing right had a negative valuation adjustment in the amount of $29 thousand with a $63 thousand positive valuation adjustment recorded during the first quarter of 2012, a $23 thousand negative valuation adjustment recorded during the second quarter of 2012 and a $69 thousand negative valuation adjustment recorded during the third quarter of 2012.

Non-Interest Expense

Total non-interest expenses increased $566 thousand for the nine month period ending September 30, 2013 compared to the same period in 2012. For the three month period ending September 30, 2013 compared to the three months ending September 30, 2012, total non-interest expense increased $238 thousand.

For the comparable nine month periods, salaries and benefits increased $1.2 million, an increase of 12.6%. The increase is attributed largely to additional personnel and normal pay increases at the beginning of 2013. The number of full time equivalent employees at September 30, 2013 was 218 compared to 202 one year ago. Salaries and employee benefits increased $546 thousand for the three month period ending September 30, 2013 compared to the same time period in 2012.

Occupancy expenses increased $129 thousand to $2.4 million for the first nine months of 2013 compared to the same time period in 2012. Occupancy expenses increased $68 thousand for the three month period ending September 30, 2013 compared to the same time period in 2012.


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Legal and professional fees increased $169 thousand for the first nine months ending September 30, 2013 compared to the same time period in 2012. Legal and professional fees increased $151 thousand for the three month period ending September 30, 2013 compared to the same time period in 2012. Legal and professional fees increased during 2013 mostly due to additional professional services obtained by the Company during the year and early cancellation of a contract the Company had. Repossession expenses decreased $967 thousand for the first nine months ending September 30, 2013 compared to the same time period in 2012 and decreased $482 thousand for the three months ending September 30, 2013 compared to the same time period one year ago. Repossession expenses are reported net of rental income earned on repossessed properties. Repossession expenses were lower in the first nine 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. FDIC insurance expense decreased $48 thousand for the nine months ending September 30, 2013 compared to the same time period in 2012 and $24 thousand for the three months ending September 30, 2013 compared to the same time period one year ago.

Income Taxes

The effective tax rate for the nine months ended September 30, 2013 was 18.6% compared to 18.2% in 2012. The effective tax rate for the three months ending September 30, 2013 was 15.0% compared to 18.2% for the three months ending September 30, 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 effective tax rate for the nine months ending September 30, 2013 is slightly higher due to a decrease in tax-exempt income. Tax-exempt interest income decreased $189 thousand for the first nine months of 2013 compared to the first nine months of 2012.

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 ending September 30, 2013, the Company averaged $80.3 million in tax free securities and $17.6 million in tax free loans. As of September 30, 2013, the weighted average remaining maturity for the tax free securities is 135 months, while the weighted average remaining maturity for the tax free loans is 168 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 in an orderly manner. 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 $18.7 million as of September 30, 2013 compared to $31.8 million at December 31, 2012. The decrease in cash and cash equivalents is attributed to a decrease of $13.1 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 $210.3 million at September 30, 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 nine months of 2013, deposits decreased $16.9 million. The Company's investment portfolio increased $17.6 million and the Company's loan portfolio increased $34.9 million. The borrowed funds the Company has with the Federal Home Loan Bank increased $51.1 million and federal funds purchased increased $7.4 million from December 31, 2012 to September 30, 2013.

Management is aware of the challenge of funding sustained loan growth. Therefore, in addition to deposits, other sources of funds, such as Federal Home Loan Bank advances, may be used. We rely on Federal Home Loan Bank 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, 2013, we have sufficient collateral to borrow an additional $60 million from the Federal Home Loan Bank. In addition, as of September 30, 2013, $12 million is available in overnight borrowing through various correspondent banks and the Company has access to $246 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.


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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 applicable banking regulations) to risk-weighted assets (as defined), and of Tier I capital to average assets (as defined). Management believes, as of September 30, 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.

In July 2013, the FDIC and the other federal bank regulatory agencies issued a final rule that will revise their leverage and risk-based capital requirements and the method of calculating risk-weighted assets to make them consistent with agreements that were reached by the Basel Committee on Banking Supervision and certain provisions of the Dodd-Frank Act. Among other things, the rule establishes a new common equity Tier 1 minimum capital requirement (4.5% of risk-weighted assets), increases the minimum Tier 1 capital to risk-based assets requirement (from 4% to 6% of risk-weighted assets) and assigns a higher risk weight (150%) to exposures that are more than 90 days past due or are on nonaccrual status and to certain commercial real estate facilities that finance the acquisition, development or construction of real property. The final rule also requires unrealized gains and losses on certain "available-for-sale" securities holdings to be included for purposes of calculating regulatory capital requirement unless a one-time opt-in or opt-out is exercised. The rule limits a banking organization's capital distributions and certain discretionary bonus payments if the banking organization does not hold a "capital conservation buffer" consisting of 2.5% of common equity Tier 1 capital to risk-weighted assets in addition to the amount necessary to meet its minimum risk-based capital requirements. The final rule becomes effective for the Bank on January 1, 2015. The capital conservation buffer requirement will be phased in beginning January 1, 2016 and ending January 1, 2019, when the full capital conservation buffer requirement will be effective.


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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
. . .
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