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KTYB > SEC Filings for KTYB > Form 10-K on 28-Mar-2014All Recent SEC Filings

Show all filings for KENTUCKY BANCSHARES INC /KY/

Form 10-K for KENTUCKY BANCSHARES INC /KY/


28-Mar-2014

Annual Report


Item 7. Management's Discussion and Analysis

This section presents an analysis of the consolidated financial condition of the Company and its wholly-owned subsidiary, Kentucky Bank, at December 31, 2013, 2012 and 2011, and the consolidated results of operations for each of the years in the three year period ended December 31, 2013. The following discussion and analysis of financial condition and results of operations should be read in conjunction with the 2013 Consolidated Financial Statements and Notes included in Item 8. When necessary, reclassifications have been made to prior years' data throughout the following discussion and analysis for purposes of comparability with 2013 data.

Critical Accounting Policies

Overview. The accounting and reporting policies of the Company and its subsidiary are in accordance with accounting principles generally accepted in the United States and conform to general practices within the banking industry. Significant accounting policies are listed in Note 1 of the Company's 2013 Consolidated Financial Statements and Notes included in Item 8. Critical accounting and reporting policies include accounting for loans and the allowance for loan losses, goodwill and fair value. Different assumptions in the application of these policies could result in material changes in the consolidated financial position or consolidated results of operations.

Loan Values and Allowance for Loan Losses. Loans are stated at the amount of unpaid principal, reduced by an allowance for loan losses. Interest on loans is recognized on the accrual basis, except for those loans on the nonaccrual status. Interest income received on such loans is accounted for on the cash basis or cost recovery method. The allowance for loan losses is a valuation allowance for probable incurred credit losses. Management estimates the allowance balance required using past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions, and other factors. The accounting policies relating to the allowance for loan losses involve the use of estimates and require significant judgments to be made by management. 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 "Loan Losses" in this management's discussion and analysis of financial condition and results of operation, as well as Notes 1 and 4 of the Company's 2013 Consolidated Financial Statements and Notes.

Goodwill. Goodwill and intangible assets acquired in a purchase business combination and determined to have an indefinite useful life are not amortized, but tested for impairment at least annually. The Company has selected December 31 as the date to perform the annual impairment test. Intangible assets with definite useful lives are amortized over their estimated useful lives to their estimated residual values. Goodwill is the only intangible asset with an indefinite life on our balance sheet.


Fair Values. Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed in the description of each asset and liability category in Note 17 of the Company's 2013 Consolidated Financial Statements and Notes. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments, and other factors, especially in the absence of broad markets for particular items. Changes in assumptions or in market conditions could significantly affect the estimates.

Forward-Looking Statements

This discussion contains forward-looking statements under the Private Securities Litigation Reform Act of 1995 that involve risks and uncertainties. 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. 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, the thoroughbred horse industry and the automobile industry relating to Toyota vehicles, in which the Company and its bank operate); competition for the Company'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 the Company has 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 the Company's customers; and other risks 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 undertakes 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.

Overview

We conduct our business through our one bank subsidiary, Kentucky Bank. Kentucky Bank is engaged in general full-service commercial and consumer banking. A significant part of Kentucky Bank's operating activities include originating loans, approximately 86% of which are secured by real estate at December 31, 2013. Kentucky Bank makes commercial, agricultural and real estate loans to its commercial customers, with emphasis on small-to-medium-sized industrial, service and agricultural businesses. It also makes residential mortgages, installment and other loans to its individual and other non-commercial customers. Kentucky Bank's primary market is Bourbon, Clark, Elliott, Fayette, Harrison, Jessamine, Rowan, Scott, Woodford and surrounding counties in Kentucky.

Net income for the year ended December 31, 2013 was $5.8 million, or $2.15 per common share compared to $7.0 million, or $2.59 for 2012 and $5.7 million, or $2.09 for 2011. Earnings per share assuming dilution were $2.15, $2.59 and $2.09 for 2013, 2012 and 2011, respectively. For 2013, net income decreased $1.2 million, or 16.9%. Net interest income increased $195 thousand, the loan loss provision decreased $1.0 million, total other income decreased $1.6 million, while total other expenses increased $1.5 million and income tax expense decreased $785 thousand.


For 2012, net income increased $1.3 million, or 23.2%. Net interest income increased $193 thousand, the loan loss provision decreased $400 thousand, total other income increased $2.5 million, while total other expenses increased $1.1 million and income tax expense increased $724 thousand.

Return on average equity was 8.1% in 2013 compared to 9.7% in 2012 and 8.7% in 2011. Return on average assets was 0.80% in 2013 compared to 1.03% in 2012 and 0.87% in 2011.

Non-performing loans as a percentage of loans (including held for sale) were 2.22%, 3.51% and 1.83% as of December 31, 2013, 2012 and 2011, respectively.

RESULTS OF OPERATIONS

Net Interest Income

Net interest income, the Company's largest source of revenue, on a tax equivalent basis increased from $25.9 million in 2011 to $26.2 million in 2012, and to $26.3 million in 2013. The taxable equivalent adjustment (nontaxable interest income on state and municipal obligations net of the related non-deductible portion of interest expense) is based on our Federal income tax rate of 34%.

Average earning assets and interest bearing liabilities both increased from 2012 to 2013. Average earning assets increased $57.4 million, or 9.2%. Average investment securities increased $32.4 million primarily due to increased deposits. Average loans increased $26.5 million as a result of improved economic conditions and increased demand over 2012. Average interest bearing liabilities increased $39.5 million, or 8.6% during this same period. This change was primarily from an increase of $18.7 million in "NOW" and money market accounts, an increase of $11.2 million in savings deposits and an increase of $5.7 million in Federal Home Loan Bank advances. The Company continues to actively pursue quality loans and fund these primarily with deposits and Federal Home Loan Bank advances.

The bank prime rates have declined since 2006. Bank prime rates decreased 100 basis points in 2007, and another 400 basis points in 2008, and have remained unchanged since then. The tax equivalent yield on earning assets decreased from 4.78% in 2012 to 4.36% in 2013.

The volume rate analysis for 2013 that follows indicates that $2.3 million of the decrease in interest income is attributable to the decrease in rates, while the change in volume contributed to an increase of $2.2 million in interest income. Further, decreases in rates caused a decrease in the cost of interest bearing liabilities. The average rate of these liabilities decreased from 0.81% in 2012 to 0.69% in 2013. Based on the volume rate analysis that follows, the lower level of interest rates contributed to a decrease of $577 thousand in interest expense and a change in volume contributed to a $317 thousand increase in interest expense. In summary, the increase in the Company's 2013 net interest income is attributed mostly to an increase in volume in the loan and security portfolios and decreases in rates in time deposits and Federal Home Loan Bank advances.


The volume rate analysis for 2012 that follows indicates that $2.6 million of the decrease in interest income is attributable to the decrease in rates, while the change in rates volume contributed to an increase of $960 thousand in interest income. Further, decreases in rates and volume caused a decrease in the cost of interest bearing liabilities. The average rate of these liabilities decreased from 1.22% in 2011 to 0.81 in 2012. Based on the volume rate analysis that follows, the lower level of interest rates contributed to a decrease of $1.4 million in interest expense and a change in volume contributed to a $439 thousand decrease in interest expense. As a result, the increase in the Company's 2012 net interest income is attributed mostly to decreases in rates in time deposits and increases in non-interest bearing deposit accounts.

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 vs. 2012 and 2012 vs. 2011. 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



                                                                  (in thousands)
                                           2013 vs. 2012                                   2012 vs. 2011
                               Increase (Decrease) Due to Change in            Increase (Decrease) Due to Change in
                              Volume            Rate         Net Change       Volume            Rate         Net Change

INTEREST INCOME
Loans                      $      1,431    $       (1,857 )  $      (426 ) $        574    $       (1,258 )  $      (684 )
Investment Securities               790              (429 )          361            369            (1,356 )         (987 )
Federal Funds Sold and
Securities Purchased
under Agreements to
Resell                                -                 -              -             (3 )              (2 )           (5 )
Deposits with Banks                  (3 )               3              -             19                 -             19
Total Interest Income             2,218            (2,283 )          (65 )          959            (2,616 )       (1,657 )
INTEREST EXPENSE
Deposits
Demand                               45               (82 )          (37 )          111              (301 )         (190 )
Savings                              17                (5 )           12             14               (12 )            2
Negotiable Certificates
of Deposit and Other
Time Deposits                       (22 )            (175 )         (197 )         (311 )            (921 )       (1,232 )
Securities sold under
agreements to repurchase
and other borrowings                118               (96 )           22            (40 )              14            (26 )
Federal Home Loan Bank
advances                            159              (219 )          (60 )         (213 )            (191 )         (404 )
Total Interest Expense              317              (577 )         (260 )         (439 )          (1,411 )       (1,850 )
Net Interest Income        $      1,901    $       (1,706 )  $       195   $      1,398    $       (1,205 )  $       193


Average Consolidated Balance Sheets and Net Interest Analysis ($ in thousands)



                                                  2013                                2012                                2011
                                     Average                 Average     Average                  Average    Average                  Average
                                     Balance     Interest     Rate       Balance      Interest     Rate      Balance      Interest     Rate
ASSETS
Interest-Earning Assets
Securities Available for Sale (1)
U.S. Treasury and Federal Agency
Securities                          $  131,538   $  2,145      1.63  % $   100,359   $    1,527      1.52 % $   86,706   $    2,254      2.60 %
State and Municipal obligations         81,471       2,771      3.40 %      80,219        3,007      3.75 %     82,137        3,279      3.99 %
Other Securities                         7,001         288      4.11 %       7,001          308      4.40 %      7,000          296      4.23 %
Total Investment Securities            220,010       5,204      2.37 %     187,579        4,842      2.58 %    175,843        5,829      3.31 %
Tax Equivalent Adjustment                            1,556      0.71 %                    1,640      0.87 %                   1,596      0.91 %
Tax Equivalent Total                                 6,760      3.07 %                    6,482      3.46 %                   7,425      4.22 %
Federal Funds Sold and Agreements
to Repurchase                              290           -         -           389            -         -        4,783            5      0.10 %
Interest-Bearing Deposits with
Banks                                   17,238          29      0.17 %      18,749           30      0.16 %      6,753           11      0.16 %
Loans, Net of Deferred Loan Fees
(2)
Commercial                              48,877       2,380      4.87 %      48,006        2,550      5.31 %     46,852        2,567      5.48 %
Real Estate Mortgage                   378,468      19,191      5.07 %     352,674       19,407      5.50 %    342,979       20,007      5.83 %
Installment                             17,244       1,364      7.91 %      17,369        1,403      8.08 %     18,304        1,470      8.03 %
Total Loans                            444,589      22,935      5.16 %     418,049       23,360      5.59 %    408,135       24,044      5.89 %
Total Interest-Earning Assets          682,127      29,725      4.36 %     624,766       29,872      4.78 %    595,514       31,485      5.29 %
Allowance for Loan Losses               (5,838 )                            (5,949 )                            (5,483 )
Cash and Due From Banks                  7,127                               6,898                              10,479
Premises and Equipment                  16,922                              16,667                              16,992
Other Assets                            28,871                              39,261                              35,198
Total Assets                        $  729,209                         $   681,643                          $  652,700
LIABILITIES
Interest-Bearing Deposits
Negotiable Order of Withdrawal
("NOW") and Money Market
Investment Accounts                 $  195,302   $     418      0.21 % $  176,654    $      455      0.26 % $  147,484   $      645      0.44 %
Savings                                 58,799          89      0.15 %      47,577           77      0.16 %     39,456           75      0.19 %
Certificates of Deposit and Other
Deposits                               193,038       1,775      0.92 %     195,207        1,972      1.01 %    218,199        3,204      1.47 %
Total Interest-Bearing Deposits        447,139       2,282      0.51 %     419,438        2,504      0.60 %    405,139        3,924      0.97 %
Securities sold under agreements
to repurchase and other
borrowings                              18,340         311      1.70 %      12,218          288      2.36 %     13,950          314      2.25 %
Federal Home Loan Bank advances         35,435         863      2.44 %      29,728          923      3.10 %     36,052        1,327      3.68 %
Total Interest-Bearing
Liabilities                            500,914       3,456      0.69 %     461,384        3,715      0.81 %    455,141        5,565      1.22 %
Noninterest-Bearing Earning
Demand Deposits                        151,127                             141,448                             128,643
Other Liabilities                        5,442                               6,552                               3,830
Total Liabilities                      657,483                             609,384                             587,614
STOCKHOLDERS' EQUITY                    71,726                              72,259                              65,086
Total Liabilities and
Stockholders' Equity                $  729,209                         $   681,643                          $  652,700
Average Equity to Average Total
Assets                                    9.84 %                             10.60 %                              9.97 %
Net Interest Income                                 24,713                               24,517                              24,324
Net Interest Income (tax
equivalent) (3)                                     26,269                               26,157                              25,920
Net Interest Spread (tax
equivalent) (3)                                                 3.67 %                               3.97 %                              4.07 %
Net Interest Margin (tax
equivalent) (3)                                                 3.85 %                               4.19 %                              4.35 %



(1) Averages computed at amortized cost.

(2) Includes loans on a nonaccrual status and loans held for sale.

(3) Tax equivalent difference represents the nontaxable interest income on state and municipal securities net of the related non-deductible portion of interest expense.


Noninterest Income and Expenses

Noninterest income was $10.2 million in 2013 compared to $11.9 million in 2012 and $9.3 million in 2011. In 2013, decreases in gains on sold mortgage loans, gains on sold securities and service charges account for the majority of the decrease. In 2012, increases in gains on sold mortgage loans and gains on sold securities account for the majority of the increase.

Securities gains were $1.0 million in 2013, $1.8 million in 2012 and $1.2 million in 2011. These gains are primarily attributed to selling securities which had gains in market value due to declining interest rates and the related inverse relationship of interest rates and market values. Some securities gains were taken in 2013, 2012 and 2011 and used to offset additions to the loan loss reserve and write-downs of other real estate properties owned.

Gains on loans sold were $1.7 million, $2.3 million and $982 thousand in 2013, 2012 and 2011, respectively. Loans held for sale are generally sold after closing to the Federal Home Loan Mortgage Corporation. During 2013, the loan servicing fee income, net of amortization expense for the mortgage servicing right asset, increased $97 thousand, compared to an increase of $172 thousand in 2012. In 2013, the mortgage servicing right asset had a net valuation recovery of prior write-downs of $155 thousand compared to a net recovery of prior write-downs of $36 thousand in the valuation allowance in 2012. Proceeds from the sale of loans were $55 million, $67 million and $33 million in 2013, 2012 and 2011, respectively. The volume of loan originations is inverse to rate changes with historic low rates spurring activity. The volume of loan originations during 2013 was $54 million, $64 million in 2012, and $32 million in 2011.

Other noninterest income, excluding security net gains and gains on the sale of mortgage loans, was $7.6 million in 2013, $7.7 million in 2012 and $7.2 million in 2011. Service charge income, and more particularly overdraft income, is the largest contributor to these numbers. Overdraft income was $2.8 million in 2013, $3.4 million in 2012 and $3.7 million in 2011. The decreases in 2013 and 2012 are primarily attributable to the slower economy, increased consumer awareness and regulatory pressures. Debit card interchange income was the second largest contributor to noninterest income, excluding security gains and gains on the sale of mortgage loans. Debit card interchange income was $1.9 million in 2013, $1.9 million in 2012 and $1.7 million in 2011. Other income was $25 thousand in 2013, $93 thousand in 2012 and $190 thousand in 2011. The decrease in other income during 2013 was attributable to the bank recording a loss of $100 thousand for the sale of a former branch building. Likewise, other income was higher in 2011 due to the bank recording a gain of $55 thousand for the sale of a former branch building.

Noninterest expense increased $1.5 million in 2013 to $27.2 million, and increased $1.1 million in 2012 to $25.7 million from $24.6 million in 2011. The increase in salaries and benefits from $12.6 million in 2012 to $15.4 million in 2013 is attributable to a non-recurring expense of $973 thousand related to additional pension expense for the 2008 termination of the defined benefit pension plan, normal salary and benefit increases, an increase in full-time equivalent employees and increased incentive compensation. The number of full-time equivalent employees increased from 193 at December 31, 2012 to 208 at December 31, 2013. The increase in the number of employees is largely due to the new branch opened in Lexington, KY during the year. Incentive compensation expense increased $527 thousand in 2013 compared to 2012 due to the increased number of employees and the Bank achieving many of the goals as stated in the incentive compensation plan. The increase in salaries and benefits from $12.0 million in 2011 to $12.6 million in 2012 are attributable to normal salary and benefit increases. Incentive compensation was $148 thousand greater in 2012 compared to 2011. Occupancy expense increased $97 thousand in 2013 to $3.1 million and increased $75 thousand in 2012 to $3.0 million.


The largest component of occupancy expense, depreciation, decreased $83 thousand to $1.2 million in 2013, and increased $89 thousand to $1.3 million in 2012. Building repairs and maintenance increased $96 thousand during 2013 to $414 thousand and building and equipment rents increased $101 thousand during 2013 to $158 thousand. The increase in building repairs and maintenance is generally related to additional maintenance work the Company performed during the year. The increase in rent expense is due to the branch expansion into the Lexington, KY market during the year. Other noninterest expenses increased from $9.7 million in 2011 to $10.1 million in 2012 and decreased to $8.7 million in 2013. Repossession expenses, net of rental income, decreased $1.5 million in 2013 compared to 2012 to $267 thousand. The decrease was mostly attributed to net write-downs of other real estate properties owned decreasing from $991 thousand in 2012 to $63 thousand in 2013. Further, other real estate properties owned by the Company decreased from $4.2 million at December 31, 2012 to $3.4 million at December 31, 2013 resulting in a decrease in general expenses incurred with maintaining the properties. FDIC insurance decreased $86 thousand in 2013 compared to 2012 due to changes provided by Dodd-Frank in the calculation the FDIC uses to assess premiums. Legal and professional fees increased $150 thousand from 2012 to 2013, mainly from additional professional services obtained by the Company during the year and early cancellation of a contract by the Bank. Advertising and marketing expenses incurred increased $81 thousand during 2013 compared to 2012 due to the branch expansion in 2013. Taxes other than payroll, property and income increased $32 thousand in 2013 from 2012 to $843 thousand. Data processing was $1.3 million in 2013 compared to $1.2 million in 2012, an increase of $160 thousand. The increase in data processing expense was mostly related to additional services the Company obtained throughout the year. Amortization of core deposits was $215 thousand in 2013, compared to $234 thousand in 2012. See Note 7 in the Company's Consolidated Financial Statements and Notes included in Item 8 for more detail of the goodwill and intangible assets.

The following table is a summary of noninterest income and expense for the three-year period indicated.

                                                    For the Year Ended Year Ended December 31
                                                                  (in thousands)
                                                     2013              2012              2011
NON-INTEREST INCOME
Service Charges                                 $        4,325    $        4,741    $        4,604
Loan Service Fee Income (Loss), net                        202               105               (66 )
Trust Department Income                                    746               663               637
Investment Securities Gains (Losses),net                   967             1,835             1,164
Gains on Sale of Mortgage Loans                          1,658             2,325               982
Brokerage Income                                           351               240               156
Debit Card Interchange Income                            1,947             1,868             1,680
Other                                                       26                93               190
Total Non-interest Income                       $       10,222    $       11,870    $        9,347

NON-INTEREST EXPENSE
Salaries and Employee Benefits                  $       15,387    $       12,584    $       11,953
Occupancy Expenses                                       3,129             3,033             2,958
Other                                                    8,687            10,069             9,704
Total Non-interest Expense                      $       27,203    $       25,686    $       24,615

Net Non-interest Expense as a Percentage of
Average Assets                                            2.33 %            2.02 %            2.34 %


Income Taxes

As part of normal business, Kentucky Bank typically makes tax free loans to select municipalities in our market and invests in selected tax free securities, . . .

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