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FFKT > SEC Filings for FFKT > Form 10-K on 7-Mar-2014All Recent SEC Filings

Show all filings for FARMERS CAPITAL BANK CORP



Annual Report

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

Glossary of Financial Terms

Allowance for loan losses

A valuation allowance to offset credit losses specifically identified in the loan portfolio, as well as management's best estimate of probable incurred losses in the remainder of the portfolio at the balance sheet date. Management estimates the allowance balance required using past loan loss experience, an assessment of the financial condition of individual borrowers, a determination of the value and adequacy of underlying collateral, the condition of the local economy, an analysis of the levels and trends of the loan portfolio, and a review of delinquent and classified loans. Actual losses could differ significantly from the amounts estimated by management.

Dividend payout

Cash dividends paid on common shares, divided by net income.

Basis points

Each basis point is equal to one hundredth of one percent. Basis points are calculated by multiplying percentage points times 100. For example: 3.7 percentage points equals 370 basis points.

Interest rate sensitivity

The relationship between interest sensitive earning assets and interest bearing liabilities.

Net charge-offs

The amount of total loans charged off net of recoveries of loans that have been previously charged off.

Net interest income

Total interest income less total interest expense.

Net interest margin

Taxable equivalent net interest income expressed as a percentage of average earning assets.

Net interest spread

The difference between the taxable equivalent yield on earning assets and the rate paid on interest bearing funds.

Other real estate owned

Real estate not used for banking purposes. For example, real estate acquired through foreclosure.

Provision for loan losses

The charge against current income needed to maintain an adequate allowance for loan losses.

Return on average assets (ROA)

Net income (loss) divided by average total assets. Measures the relative profitability of the resources utilized by the Company.

Return on average equity (ROE)

Net income (loss) divided by average shareholders' equity. Measures the relative profitability of the shareholders' investment in the Company.

Tax equivalent basis (TE)

Income from tax-exempt loans and investment securities has been increased by an amount equivalent to the taxes that would have been paid if this income were taxable at statutory rates. In order to provide comparisons of yields and margins for all earning assets, the interest income earned on tax-exempt assets is increased to make them fully equivalent to other taxable interest income investments.

Weighted average number of common shares outstanding

The number of shares determined by relating (a) the portion of time within a reporting period that common shares have been outstanding to (b) the total time in that period.

Management's Discussion and Analysis of Financial Condition and Results of Operations

The following pages present management's discussion and analysis of the consolidated financial condition and results of operations of Farmers Capital Bank Corporation (the "Company" or "Parent Company"), a bank holding company, and its bank and nonbank subsidiaries. Bank subsidiaries include Farmers Bank & Capital Trust Company ("Farmers Bank") in Frankfort, KY, United Bank & Trust Company ("United Bank") in Versailles, KY, First Citizens Bank ("First Citizens") in Elizabethtown, KY, and Citizens Bank of Northern Kentucky, Inc. ("Citizens Northern") in Newport, KY.

At year-end 2013, Farmers Bank had three primary subsidiaries, which include EG Properties, Inc., Leasing One Corporation ("Leasing One"), and Farmers Capital Insurance Corporation ("Farmers Insurance"). EG Properties, Inc. is involved in real estate management and liquidation for certain repossessed properties of Farmers Bank. Leasing One is a commercial leasing company in Frankfort, KY, and Farmers Insurance is an insurance agency in Frankfort, KY. United Bank had one direct subsidiary at year-end 2013, EGT Properties, Inc. EGT Properties, Inc. is involved in real estate management and liquidation for certain repossessed properties of United Bank. First Citizens had one subsidiary at year-end 2013, HBJ Properties, LLC. HBJ Properties, LLC is involved in real estate management and liquidation for certain repossessed properties of First Citizens. Citizens Northern had one direct subsidiary at year-end 2013, ENKY Properties, Inc., which is involved in real estate management and liquidation for certain repossessed properties of Citizens Northern.

The Company has three active nonbank subsidiaries, FCB Services, Inc. ("FCB Services"), FFKT Insurance Services, Inc. ("FFKT Insurance"), and EKT Properties, Inc. ("EKT"). FCB Services is a data processing subsidiary located in Frankfort, KY that provides services to the Company's banks as well as unaffiliated entities. FFKT Insurance is a captive property and casualty insurance company insuring primarily deductible exposures and uncovered liability related to properties of the Company. EKT was formed to manage and liquidate certain real estate properties repossessed by the Company. In addition, the Company has three subsidiaries organized as Delaware statutory trusts that are not consolidated into its financial statements. These trusts were formed for the purpose of issuing trust preferred securities. All significant intercompany transactions and balances are eliminated in consolidation.

For a complete list of the Company's subsidiaries, please refer to the discussion under the heading "Organization" included in Part 1, Item 1 of this Form 10-K. The following discussion should be read in conjunction with the audited consolidated financial statements and related footnotes that follow.

Forward-Looking Statements

This report contains forward-looking statements with the meaning of Section 27A of the Securities Act of 1933, as amended (the "Securities Act") and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), under the Private Securities Litigation Reform Act of 1995 that involve risks and uncertainties. Statements in this report that are not statements of historical fact are forward-looking statements. In general, forward-looking statements relate to a discussion of future financial results or projections, future economic performance, future operational plans and objectives, and statements regarding the underlying assumptions of such statements. Although the Company believes 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.

Various risks and uncertainties may cause actual results to differ materially from those indicated by the Company's forward-looking statements. In addition to the risks described under Part 1, Item 1A "Risk Factors" in this report, 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 in which the Company and its subsidiaries operate) and lower interest margins; competition for the Company's customers from other providers of financial services; deposit outflows or reduced demand for financial services and loan products; government legislation, regulation, and changes in monetary and fiscal policies (which changes from time to time and over which the Company has no control); changes in interest rates; changes in prepayment speeds of loans or investment securities; inflation; material unforeseen changes in the liquidity, results of operations, or financial condition of the Company's customers; changes in the level of non-performing assets and charge-offs; changes in the number of common shares outstanding; the capability of the Company to successfully enter into a definitive agreement for and close anticipated transactions;

unexpected claims or litigation against the Company; technological or operational difficulties; the impact of new accounting pronouncements and changes in policies and practices that may be adopted by regulatory agencies; acts of war or terrorism; the ability of the parent company to receive dividends from its subsidiaries; the impact of larger or similar financial institutions encountering difficulties, which may adversely affect the banking industry or the Company; the Company or its subsidiary banks' ability to maintain required capital levels and adequate funding sources and liquidity; and other risks or uncertainties detailed in the Company's filings with the Securities and Exchange Commission, all of which are difficult to predict and many of which are beyond the control of the Company.

The Company's forward-looking statements are based on information available at the time such statements are made. The Company expressly disclaims any intent or obligation to update any forward-looking statements to reflect changes in underlying assumptions or factors, new information, future events, or other changes.

Application of Critical Accounting Policies

The Company's audited consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America and follow general practices applicable to the banking industry. Application of these principles requires management to make estimates, assumptions, and judgments that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reported period. These estimates, assumptions, and judgments are based on information available as of the date of the financial statements. Certain policies inherently have a greater reliance on the use of estimates, assumptions, and judgments and as such have a greater possibility of producing results that could be materially different than originally reported. Estimates, assumptions, and judgments are necessary when assets and liabilities are required to be recorded at fair value, when a decline in the value of an asset warrants an impairment write-down or valuation reserve to be established, or when an asset or liability needs to be recorded contingent upon a future event. Carrying assets and liabilities at fair value inherently results in more financial statement volatility between reporting periods. The fair values and the information used to record valuation adjustments for certain assets and liabilities are based either on quoted market prices or are provided by third-party sources, when available. When third-party information is not available, valuation adjustments are estimated in good faith by management primarily through the use of internal cash flow modeling techniques.

The most significant accounting policies followed by the Company are presented in Note 1 of the Company's 2013 audited consolidated financial statements. These policies, along with the disclosures presented in other financial statement notes and in this Management's Discussion and Analysis of Financial Condition and Results of Operations, provide information on how significant assets and liabilities are valued in the financial statements and how those values are determined. Based on the valuation techniques used and the sensitivity of financial statement amounts to the methods, assumptions, and estimates underlying those amounts, management has identified the determination of the allowance for loan losses and fair value measurements to be the accounting areas that require the most subjective or complex judgments, and as such could be most subject to revision as new information becomes available.

Allowance for Loan Losses

The allowance for loan losses represents credit losses specifically identified in the loan portfolio, as well as management's estimate of probable incurred credit losses in the loan portfolio at the balance sheet date. Determining the amount of the allowance for loan losses and the related provision for loan losses is considered a critical accounting estimate because it requires significant judgment and the use of estimates related to the amount and timing of expected future cash flows on impaired loans, estimated losses on pools of homogeneous loans based on historical loss experience, and consideration of current economic trends and conditions, all of which may be susceptible to significant changes. The loan portfolio also represents the largest asset group on the consolidated balance sheets. Additional information related to the allowance for loan losses that describes the methodology and risk factors can be found under the captions "Asset Quality" and "Nonperforming Assets" in this Management's Discussion and Analysis of Financial Condition and Results of Operations, as well as Notes 1 and 3 of the Company's 2013 audited consolidated financial statements.

Fair Value Measurements

The carrying value of certain financial assets and liabilities of the Company is impacted by the application of fair value measurements, either directly or indirectly. Fair value is the price that would be received to sell an asset or paid to transfer a liability

(exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. In certain cases, an asset or liability is measured and reported at fair value on a recurring basis, such as investment securities classified as available for sale. In other cases, management must rely on estimates or judgments to determine if an asset or liability not measured at fair value warrants an impairment write-down or whether a valuation reserve should be established.

The Company estimates the fair value of a financial instrument using a variety of valuation methods. Where financial instruments are actively traded and have quoted market prices, quoted market prices are used for fair value. Active markets are those where transaction volumes are sufficient to provide objective pricing information with reasonably narrow bid/ask spreads and where quoted prices do not vary widely. When the financial instruments are not actively traded, other observable market inputs such as quoted prices of securities with similar characteristics may be used, if available, to determine fair value. Inactive markets are characterized by low transaction volumes, price quotations that vary substantially among market participants, or in which minimal information is released publicly.

When observable market prices do not exist, the Company estimates fair value primarily by using cash flow and other financial modeling methods. The valuation methods may also consider factors such as liquidity and concentration concerns. Other factors such as model assumptions, market dislocations, and unexpected correlations can affect estimates of fair value. Changes in these underlying factors, assumptions, or estimates in any of these areas could materially impact the amount of revenue or loss recorded.

Additional information regarding fair value measurements can be found in Notes 1 and 18 of the Company's 2013 audited consolidated financial statements. The following is a summary of the Company's more significant assets that may be affected by fair value measurements, as well as a brief description of the current accounting practices and valuation methodologies employed by the Company:

Available For Sale Investment Securities

Investment securities classified as available for sale are measured and reported at fair value on a recurring basis. Available for sale investment securities are valued primarily by independent third party pricing services under the market valuation approach that include, but are not limited to, the following inputs:

? Mutual funds and equity securities are priced utilizing real-time data feeds from active market exchanges for identical securities; and

? Government-sponsored agency debt securities, obligations of states and political subdivisions, mortgage-backed securities, corporate bonds, and other similar investment securities are priced with available market information through processes using benchmark yields, matrix pricing, prepayment speeds, cash flows, live trading data, and market spreads sourced from new issues, dealer quotes, and trade prices, among others sources.

At December 31, 2013, all of the Company's available for sale investment securities were measured using observable market data.

Other Real Estate Owned

Other real estate owned ("OREO") includes properties acquired by the Company through, or in lieu of, actual loan foreclosures and is initially carried at fair value less estimated costs to sell. Fair value is generally based on third party appraisals of the property that includes comparable sales data. The carrying value of each OREO property is updated at least annually and more frequently when market conditions significantly impact the value of the property. If the carrying amount exceeds fair value less estimated costs to sell, an impairment loss is recorded through expense. OREO is subsequently accounted for at the lower of carrying amount or fair value less estimated costs to sell. At December 31, 2013, OREO was $37.8 million compared to $52.6 million at year-end 2012.

Impaired Loans

Loans are considered impaired when it is probable that the Company will be unable to collect all amounts due under the contractual terms of the loan agreement. Impaired loans are measured at the present value of expected future cash flows, discounted at the

loan's effective interest rate, at the loan's observable market price, or at the fair value of the collateral based on recent appraisals if the loan is collateral dependent. If the value of an impaired loan is less than the unpaid balance, the difference is credited to the allowance for loan losses with a corresponding charge to provision for loan losses. Loan losses are charged against the allowance for loan losses when management believes the uncollectibility of a loan is confirmed.

Appraisals used in connection with valuing collateral-dependent loans may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Appraisers take absorption rates into consideration and adjustments are routinely made in the appraisal process to identify differences between the comparable sales and income data available. Such adjustments consist mainly of estimated costs to sell that are not included in certain appraisals or to update appraised collateral values as a result of market declines of similar properties for which a newer appraisal is available. These adjustments can be significant. Impaired loans were $58.3 million and $63.9 million at year-end 2013 and 2012, respectively.


The Company offers a variety of financial products and services at its 36 banking locations in 23 communities throughout Central and Northern Kentucky. The Company has four separately chartered commercial banks that operate under a community banking philosophy. This philosophy focuses primarily on understanding the banking needs of those in our local and surrounding communities and providing them with competitively priced products and a high level of personalized service. The most significant products and services the Company offers include consumer and business lending, checking, savings, and other deposit accounts, automated teller machines, electronic bill payments, and providing trust services and other traditional banking products and services. The primary goals of the Company are to continually improve profitability and shareholder value, increase and maintain a strong capital position, provide excellent service to our customers through our community banking structure, and to provide a challenging and rewarding work environment for our employees.

The Company generates a significant amount of its revenue, cash flows, and net income from interest income and net interest income. The ability to properly manage net interest income under changing market environments is crucial to the success of the Company. Managing credit risk also has a significant influence on the operating results of the Company. Although the overall economy showed moderate growth during the year, the overall decline experienced from the early years of the recent economic downturn continue to weigh on the Company primarily in the form of still-elevated nonperforming assets. Unemployment rates remain high and federal fiscal policy is constraining economic growth.

The most significant issues to impact the Company's operating results for 2013 continue to include elevated amounts of nonperforming assets and the lack of high quality loan demand. The Company remained focused on reducing nonperforming assets, which fell $18.1 million or 17.0% during the year to the lowest balance since the third quarter of 2009. The overall credit quality of the loan portfolio also improved, as historical loss rates and other measures showed widespread improvement. While certain measures of the economy are showing incremental improvements, economic growth is slow and quality loan demand remains soft.

For 2014, the Company intends to add to the improvements made over the last few years. Reducing nonperforming assets will continue to be a focal point. Seeking out and funding high quality loan demand and improving profitability is also an important goal. The Company plans to repay a portion of its outstanding preferred stock, although this is subject to approval by its banking regulators. United Bank, a subsidiary of the Company, in early 2014 received notice that the formal Consent Order it entered into with its regulators during 2011 had been terminated and replaced with a stepped-down enforcement action in the form of an informal Memorandum. Removal of formal enforcement actions by regulators, such as the Consent Order, is an important step toward being able to repay a portion of the preferred stock. The Company is diligently working to improve its overall financial condition and for the removal of all enforcement actions with its banking regulators.


The Company reported net income of $13.4 million for 2013 an increase of $1.3 million or 10.7% compared to $12.1 million for 2012. On a per common share basis, net income was $1.54 and $1.37 for 2013 and 2012, respectively. Selected income statement amounts and related information is presented in the table below.

(In thousands, except per share data)                                            Increase
Twelve Months Ended December 31,                   2013              2012       (Decrease)
Interest income                           $      66,733     $      71,222     $       (4,489 )
Interest expense                                 11,995            18,258             (6,263 )
Net interest income                              54,738            52,964              1,774
Provision for loan losses                        (2,600 )           2,772             (5,372 )
Net interest income after provision for
loan losses                                      57,338            50,192              7,146
Noninterest income                               22,116            24,654             (2,538 )
Noninterest expenses                             61,573            59,787              1,786
Income before income taxes                       17,881            15,059              2,822
Income tax expense                                4,435             2,910              1,525
Net income                                $      13,446     $      12,149     $        1,297
Less preferred stock dividends and
discount accretion                                1,951             1,922                 29
Net income available to common
shareholders                              $      11,495     $      10,227     $        1,268

Basic and diluted net income per common
share                                     $        1.54     $        1.37     $          .17

Weighted average common shares
outstanding - basic and diluted                   7,474             7,457                 17
Return on average assets                            .74 %             .65 %             9 bp
Return on average equity                           7.97 %            7.38 %            59 bp

bp = basis points.

The more significant components related to the Company's results of operations are included below.

Interest Income

Interest income results from interest earned on earning assets, which primarily includes loans and investment securities. Interest income is affected by volume (average balance), the composition of earning assets, and the related rates earned on those assets. Total interest income for 2013 was $66.7 million, a decrease of $4.5 million or 6.3% compared to $71.2 million for 2012. With the exception of nontaxable investment securities, interest income decreased across all major earning asset categories. The decrease in interest income relates to lower interest on loans and investment securities, which decreased due to a combination of both rate and volume declines. Rate declines continue to be driven by a slow-growth economy and related competitive factors combined with the overall strategy by the Company of being more selective in pricing both its loans and deposits. While longer-term market interest rates began to climb toward the last half of 2013, actions by the Federal Reserve Board ("Federal Reserve") have kept the level of interest rates low, with the objective of holding short-term interest rates at exceptionally low levels until unemployment rates decline to a target of 6.5%. In general, the Company's variable and floating rate assets and liabilities resetting since the prior year, as well as activity related to new earning assets and funding sources, have repriced downward in the current interest rate environment. The Company's tax equivalent yield on earning assets was 4.1% for 2013, a decrease of 12 basis points compared to 4.2% for 2012.

Interest Expense

Interest expense results from incurring interest on interest bearing liabilities, which are made up of interest bearing deposits, federal funds purchased, securities sold under agreements to repurchase, and other borrowed funds. Interest expense is affected by volume, composition of interest bearing liabilities, and the related rates paid on those liabilities. Total interest expense was $12.0 million for 2013, a decrease of $6.3 million or 34.3% compared to $18.3 million for 2012. The decrease in interest expense is attributed to lower interest on deposits and long-term borrowings. Both rate declines and lower volume contributed to the decrease in interest

expense for each of these items. For deposits, substantially all of the decrease in interest expense was related to time deposits. The Company has continued to aggressively reprice higher-rate maturing time deposits downward to lower market rates or to allow them to mature without renewal. For long-term borrowings, the decrease in interest expense reflects two events that occurred during the fourth quarter of 2012: a $50.0 million principal repayment of borrowed funds which drove down the average balance for 2013 and the repricing of $23.2 million of . . .

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