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KTYB > SEC Filings for KTYB > Form 10-Q on 13-May-2014All Recent SEC Filings

Show all filings for KENTUCKY BANCSHARES INC /KY/

Form 10-Q for KENTUCKY BANCSHARES INC /KY/


13-May-2014

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, 2013.

This discussion contains forward-looking statements under the Private Securities Litigation Reform Act of 1995 that involve risks and uncertainties. We intend such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the federal securities laws. 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 should not place undue reliance on any forward-looking statements made by us or on our behalf. Our forward-looking statements are made as of the date of this report, and 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.


Table of Contents

Summary

The Company recorded net income of $1.77 million, or $0.66 basic earnings and diluted earnings per share for the first three months ending March 31, 2014 compared to $1.70 million or $0.63 basic earnings and diluted earnings per share for the three month period ended March 31, 2013. The first three months earnings reflect an increase of 3.6% compared to the same time period in 2013. The increase in earnings is mostly attributed to a decrease of $350 thousand in the provision for loan losses, an increase of $215 thousand in net interest income, a decrease of $109 thousand in income tax expense, an increase of $81 thousand in loan service fee income, an increase of $71 thousand in the gains on securities held for trading and a decrease of $69 thousand in net repossession expense. These positive changes to net income during 2014 were partially offset by a decrease of $469 thousand in the gains on the sale of mortgage loans, a decrease of $101 thousand in the gains on the sale of securities, an increase of $312 thousand in salaries & benefits expense and an increase of $130 thousand in occupancy expense.

Return on average assets was 0.91% for the three months ending March 31, 2014 and 0.96% for the three months ending March 31, 2013. Return on average equity was 10.0% for the three month period ending March 31, 2014 and 9.2% for the three month period ending March 31, 2013.

In January 2014, the Bank invested $5.0 million in trading securities which are shown as trading assets on the balance sheet. This is the first quarter in which the Bank has held trading assets. The decision was made to invest in these assets after much due diligence and consideration to the fact that management believed the Company could earn a higher return on this investment, compared to other investments, with minimized additional risk due to the short-term attributes of the assets. The assets are primarily comprised of municipal securities which are held for a very short period of time and generate additional profits primarily by taking gains on short-term differences in price. At March 31, 2014, trading assets totaled $5.1 million, which represents income on the investment of $108 thousand during the first quarter of 2014.

Gross Loans increased $5.3 million from $468.7 million on December 31, 2013 to $474.0 million on March 31, 2014. The overall increase in loans is attributed to an increase of $1.6 million in 1-4 family residential properties, an increase of $3.2 million in non-farm and non-residential properties, an increase of $2.6 million in multi-family residential properties, an increase of $660 thousand in real estate construction loans and an increase of $474 thousand in agricultural loans. Commercial loan balances decreased $2.9 million and consumer loan balances decreased $277 thousand.

Total deposits increased from $617.4 million on December 31, 2013 to $628.0 million on March 31, 2014, an increase of $10.6 million. Non-interest bearing demand deposit accounts increased $13.6 million from December 31, 2013 to March 31, 2014. Time deposits $100 thousand and over increased $289 thousand and other interest bearing deposit accounts decreased $3.3 million from December 31, 2013 to March 31, 2014. Public fund accounts decreased $9.4 million from December 31, 2013 to March 31, 2014. 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 decreased $467 thousand from December 31, 2013 to March 31, 2014.


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Net Interest Income

Net interest income is the difference between interest income earned on interest-earning assets and the interest expense paid on interest-bearing liabilities.

Net interest income was $6.3 million for the three months ending March 31, 2014 compared to $6.1 million for the three months ending March 31, 2013, an increase of 3.5%. The interest spread, excluding tax equivalent adjustments was 3.41% for the first three months of 2014 and down from 3.97% reported for the same period in 2013, a decrease of 56 basis points. Rates have remained fairly low in the past year. For the first three months ending March 31, 2014, the cost of total deposits was 0.35% compared to 0.40% for the same time period in 2013. Increasing non-interest bearing deposit accounts and lower rates on certificates of deposit accounts have helped to lower the cost of deposits.

For the first three months, the yield on assets decreased from 4.24% in 2013 to 3.94% in 2014, excluding tax equivalent adjustments. The yield on loans decreased 52 basis points in the first three months of 2014 compared to 2013 from 5.44% to 4.92%. The yield on securities increased 11 basis points in the first three months of 2014 compared to 2013 from 2.29% in 2013 to 2.40% in 2014. The cost of liabilities was 0.53% both in 2013 and 2014. Year to date average loans, excluding overdrafts, increased $48.0 million, or 11.3% from March 31, 2013 to March 31, 2014. Loan interest income increased $35 thousand for the first three months of 2014 compared to the first three months of 2013. Year to date average total deposits increased from March 31, 2013 to March 31, 2014, up $27.2 million or 4.5%. Year to date average interest bearing deposits increased $14.9 million, or 3.3%, from March 31, 2013 to March 31, 2014. Deposit interest expense decreased $51 thousand for the first three months of 2014 compared to the same period in 2013. Year to date average borrowings increased $48.7 million, or 63.8% from March 31, 2013 to March 31, 2014. Interest expense on borrowed funds increased $162 thousand for the first three months of 2014 compared to the same period in 2013.

The volume rate analysis for the three months ending March 31, 2014 which follows indicates that $2.4 million of the increase in interest income is attributable to an increase in loan volume and $203 thousand of the increase in interest income is attributable to an increase in the volume of our security portfolio. Further, a decrease in loan rates caused a decrease of $2.4 million to interest income while an increase in rates in our security portfolio contributed an increase of $95 thousand to interest income. The net effect to interest income was an increase of $326 thousand for the first three months of 2014 compared to the same time period in 2013. The average rate of the Company's total outstanding deposits and borrowing liabilities decreased from 0.68% in 2013 to 0.35% in 2014. Based on the volume rate analysis that follows, the lower level of interest rates contributed to a decrease of $670 thousand in interest expense, while the change in volume was responsible for a $781 thousand increase in interest expense. As a result, the increase in net interest income for the first three months in 2014 is mostly attributed to growth 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 2014. 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



(in thousands)



                                                              Three Months Ending
                                                                 2014 vs. 2013
                                                      Increase (Decrease) Due to Change in
                                                   Volume             Rate           Net Change
INTEREST INCOME
Loans                                           $       2,396    $        (2,361 )  $         35
Investment Securities                                     203                 95             298
Other                                                      (4 )               (3 )            (7 )
Total Interest Income                                   2,595             (2,269 )           326
INTEREST EXPENSE
Deposits
Demand                                                     26                (46 )           (20 )
Savings                                                    28                (25 )             3
Negotiable Certificates of
Deposit and Other
Time Deposits                                              (7 )              (27 )           (34 )
Securities sold under agreements to
repurchase and other borrowings                            82                (68 )            14
Federal Home Loan
Bank advances                                             652               (504 )           148
Total Interest Expense                                    781               (670 )           111
Net Interest Income                             $       1,814    $        (1,599 )  $        215

Non-Interest Income

Non-interest income decreased $334 thousand for the three months ending March 31, 2014, compared to the same period in 2013, to $2.3 million. The decrease for the three month period ending March 31, 2014 was primarily due to a decrease of $469 thousand in gains on the sale of mortgage loans and a decrease of $101 thousand in gains on the sale of securities. Favorable variances to non-interest income included an increase of $81 thousand in loan service fee income and an increase of $71 thousand in gains on trading assets.

The gain on the sale of mortgage loans decreased from $626 thousand in the first three months of 2013 to $157 thousand during the first three months of 2014, a decrease of $469 thousand. The volume of loans originated to sell during the first three months of 2014 decreased $10.4 million compared to the same time period in 2013. 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 $29 thousand for the three months ending March 31, 2014 compared to $(52) thousand for the three months ending March 31, 2013, an increase of $81 thousand. During the first three months of 2014, the adjustment to the carrying value of the mortgage servicing right was a positive net amount of $5 thousand, as the fair value of this asset increased. For the three months ending March 31, 2013, the carrying value of the mortgage servicing right was written down a net amount of $73 thousand, as the fair value of this asset decreased.


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Non-Interest Expense

Total non-interest expenses increased $278 thousand for the three month period ending March 31, 2014 compared to the same period in 2013.

For the comparable three month periods, salaries and benefits increased $312 thousand, an increase of 9.5%. The increase is attributed to additional personnel hired during 2013 for expanding into two new markets and normal pay increases at the beginning of 2014. The number of full time equivalent employees at March 31, 2014 was 207 compared to 205 one year ago.

Occupancy expenses increased $130 thousand to $848 million for the first three months of 2014 compared to the same time period in 2013. Rent expense increased $46 thousand due to entering two new markets within the past year and leasing branch facilities in both markets. Depreciation expense increased $37 thousand during the first three months ending March 31, 2014 compared to the same time period one year ago. In addition, computer maintenance expense increased $24 thousand and building maintenance expense increased $21 thousand for the first three months ending March 31, 2014 compared to the same time period in 2013.

Legal and professional fees decreased $17 thousand for the first three months ending March 31, 2014 compared to the same time period in 2013. Repossession expenses decreased $69 thousand for the first three months ending March 31, 2014 compared to the same time period in 2013. Repossession expenses are reported net of rental income earned on repossessed properties. Repossession expenses were lower in the first three months of 2014 when compared to the same time period in 2013 due to the Company selling many of the properties included in other real estate owned. FDIC insurance expense decreased $4 thousand for the three months ending March 31, 2014 compared to the same time period in 2013.

Income Taxes

The effective tax rate for the three months ending March 31, 2014 was 14.2% compared to 19.0% in 2013. These effective tax rates are less than the statutory rate as a result of the Company investing in tax-free securities, loans and other investments which generate tax credits for the Company. Tax-exempt interest income increased $28 thousand for the first three months of 2014 compared to the first three months of 2013. Also, for the first three months of 2014, the Company had tax credits totaling $139 thousand for investments made in low income housing projects which represented an increase of $94 thousand compared to similar tax credits for the first three months of 2013.

As part of normal business, the Bank typically makes tax free loans to select municipalities in our market and invests in selected tax free securities, primarily in the Commonwealth of Kentucky. In making these investments, the Company considers the overall impact to managing our net interest margin, credit worthiness of the underlying issuer and the favorable impact on our tax position. For the three months ending March 31, 2014, the Company averaged $89.0 million in tax free securities and $16.5 million in tax free loans. As of March 31, 2014, the weighted average remaining maturity for the tax free securities is 132 months, while the weighted average remaining maturity for the tax free loans is 175 months.


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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.

Cash and cash equivalents were $21.9 million as of March 31, 2014 compared to $23.2 million at December 31, 2013. The decrease in cash and cash equivalents is attributed to a decrease of $1.1 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 $236.4 million at March 31, 2014 compared to $230.4 million at December 31, 2013. Securities classified as trading assets totaled $5.1 million at March 31, 2014 and $0 at December 31,2013. The securities available for sale and those which are considered to be trading assets are available to meet liquidity needs on a continuing basis. However, we expect our customers' deposits to be adequate to meet our funding demands.

Generally, we rely upon net cash inflows from financing activities, supplemented by net cash inflows from operating activities, to provide cash used in our investing activities. As is typical of many financial institutions, significant financing activities include deposit gathering and the use of short-term borrowings, such as federal funds purchased and securities sold under repurchase agreements along with long-term debt. Our primary investing activities include purchasing investment securities and loan originations.

For the first three months of 2014, deposits increased $10.6 million. The Company's investment portfolio increased $11.1 million and the Company's loan portfolio increased $5.4 million. The borrowed funds the Company have with the Federal Home Loan Bank decreased $467 thousand and the Company had no outstanding federal funds purchased at March 31, 2014 or December 31, 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 March 31, 2014, we have sufficient collateral to borrow an additional $79 million from the Federal Home Loan Bank. In addition, as of March 31, 2014, $31 million is available in overnight borrowing through various correspondent banks and the Company has access to $267 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.


Table of Contents

Capital Requirements

The Company and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possible additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of the Company's and the Bank's assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Company and Bank capital amounts and classifications are also subject to qualitative judgments by regulators about components, risk weightings, and other factors.

Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (set forth in the following table) of Total and Tier I capital (as defined in the applicable banking regulations) to risk-weighted assets (as defined), and of Tier I capital to average assets (as defined). Management believes, as of March 31, 2014 and December 31, 2013, 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. In accordance with the final rule, 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.


Table of Contents

The Company's and the Bank's actual amounts and ratios are presented in the table below:

                                                                               To Be Well
                                                                               Capitalized
                                                                              Under Prompt
                                                       For Capital             Corrective
                                   Actual           Adequacy Purposes       Action Provisions
                               Amount    Ratio      Amount       Ratio      Amount       Ratio
                                                   (Dollars in Thousands)
March 31, 2014
Consolidated

Total Capital (to
Risk-Weighted Assets)         $ 73,217     14.1 % $    41,584         8 % $       N/A       N/A
Tier I Capital (to
Risk-Weighted Assets)           67,520     13.0        20,792         4           N/A       N/A
Tier I Capital (to Average
Assets)                         67,520      8.7        31,012         4           N/A       N/A

Bank Only
Total Capital (to
Risk-Weighted Assets)         $ 72,083     13.9 % $    41,561         8 % $    51,951        10 %
Tier I Capital (to
Risk-Weighted Assets)           66,386     12.8        20,781         4        31,171         6
Tier I Capital (to Average
Assets)                         66,386      8.6        31,002         4        38,753         5

December 31, 2013
Consolidated
Total Capital (to
Risk-Weighted Assets)         $ 71,993     14.1 % $    40,872         8 %         N/A       N/A
Tier I Capital (to
Risk-Weighted Assets)           66,468     13.0        20,436         4           N/A       N/A
Tier I Capital (to Average
Assets)                         66,468      8.8        30,079         4           N/A       N/A

Bank Only
Total Capital (to
Risk-Weighted Assets)         $ 70,827     13.9 % $    40,859         8 % $    51,073        10 %
Tier I Capital (to
Risk-Weighted Assets)           65,302     12.8        20,429         4        30,644         6
Tier I Capital (to Average
Assets)                         65,302      8.7        30,070         4        37,588         5

Non-Performing Assets

As of March 31, 2014, our non-performing assets totaled $14.8 million or 1.89% of assets compared to $13.8 million or 1.79% of assets at December 31, 2013 (See table below.) The Company experienced an increase of $846 thousand in non-accrual loans from December 31, 2013 to March 31, 2014. As of March 31, 2014, non-accrual loans include $2.1 million in loans secured by 1-4 family properties, $970 thousand in loans secured by non-farm and non-residential properties, $299 thousand in commercial loans, $275 thousand in loans secured by multi-family residential properties, $217 thousand in loans secured by agricultural properties and $1 thousand in consumer loans. Real estate loans composed 92.3% of the non-performing loans as of March 31, 2014 and 99.8% as of December 31, 2013. Forgone interest income on non-accrual loans totaled $59 thousand for the first three months of 2014 compared to forgone interest of $273 thousand for the same time period in 2013. Accruing loans that are contractually 90 days or more past due as of March 31, 2014 totaled $867 thousand compared to $554 thousand at December 31, 2013, an increase of $313 thousand. The total nonperforming and restructured loans increased $1.1 million from December 31, 2013 to March 31, 2014, resulting in an increase in the ratio . . .

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