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SYBT > SEC Filings for SYBT > Form 10-Q on 7-Aug-2014All Recent SEC Filings

Show all filings for STOCK YARDS BANCORP, INC.

Form 10-Q for STOCK YARDS BANCORP, INC.


7-Aug-2014

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations

This item discusses the results of operations for Stock Yards Bancorp, Inc. ("Bancorp" or "Company"), and its subsidiary, Stock Yards Bank & Trust Company ("Bank") for the three and six months ended June 30, 2014 and compares these periods with the same periods of the previous year. Unless otherwise indicated, all references in this discussion to the Bank include Bancorp. In addition, the discussion describes the significant changes in the financial condition of Bancorp and the Bank that have occurred during the first six months of 2014 compared to the year ended December 31, 2013. This discussion should be read in conjunction with the consolidated financial statements and accompanying notes presented in Part 1, Item 1 of this report.

This report contains forward-looking statements under the Private Securities Litigation Reform Act that involve risks and uncertainties. Although Bancorp believes the assumptions underlying the forward-looking statements contained herein are reasonable, any of these assumptions could be inaccurate. Factors that could cause actual results to differ from results discussed in forward-looking statements include, but are not limited to the following:
economic conditions both generally and more specifically in the markets in which Bancorp and the Bank operate; competition for Bancorp's customers from other providers of financial services; government legislation and regulation which change from time to time and over which Bancorp has no control; changes in interest rates; material unforeseen changes in liquidity, results of operations, or financial condition of Bancorp's customers; and other risks detailed in Bancorp's filings with the Securities and Exchange Commission, all of which are difficult to predict and many of which are beyond the control of Bancorp.

Overview of 2014 through June 30

Bancorp completed the first six months of 2014 with record net income of $16.2 million or 23% more than the comparable period of 2013. The increase is due primarily to higher net interest income and a lower provision for loan losses, somewhat offset by higher non-interest expenses and higher income tax expense. Diluted earnings per share for the first six months of 2014 were $1.10, compared to the first six months of 2013 at $0.94.

As is the case with most banks, the primary source of Bancorp's revenue is net interest income and fees from various financial services provided to customers. Net interest income is the difference between interest income earned on loans, investment securities and other interest earning assets less interest expense on deposit accounts and other interest bearing liabilities. Loan volume and the interest rates earned on those loans are critical to overall profitability. Similarly, deposit volume is crucial to funding loans and rates paid on deposits directly impact profitability. Business volumes are influenced by overall economic factors including market interest rates, business spending, consumer confidence and competitive conditions within the marketplace.

Net interest income increased $3,445,000, or 9.2%, for the first six months of 2014, compared to the same period in 2013. The net interest margin was 3.77% for the first six months of 2014, compared to 3.78% for the same period in 2013. Strong loan growth was the primary driver of increased interest income, and was partially offset by the effect of declining interest rates earned. In the fourth quarter of 2013, Bancorp redeemed $30 million of subordinated debentures which carried a rate of 10.00%; this accounted for the majority of the interest expense savings, and contributed approximately 14 basis points to the net interest margin. To a lesser extent, interest expense declined due to lower costs on deposits and FHLB borrowings arising from lower interest rates and a more favorable deposit mix.

Also favorably impacting 2014 results, Bancorp's provision for loan losses was $1.7 million for the first six months of 2014, compared to $3.7 million in the first six months of 2013. The provision for loan losses is calculated after considering credit quality factors, and ultimately relies on an overall internal analysis of the risk in the loan portfolio. Bancorp's allowance for loan losses was 1.65% of total loans at June 30, 2014, compared to 1.66% of total loans at December 31, 2013, and 1.92% at June 30, 2013.


Table of Contents

Total non-interest income in the first six months of 2014 was virtually flat compared to the same period in 2013, and remained consistent at 32% of total revenues. Decreases in mortgage banking revenue and brokerage commissions were largely offset by increases in investment management and bankcard transaction revenue. Results for the first six months of 2013 included a $449,000 gain on acquisition.

Total non-interest expense in the first six months of 2014 increased $844 thousand, or 2.5%, compared to the same period in 2013 due to increases in salaries and benefits, net occupancy, data processing and other non-interest expenses. These increases were somewhat offset by gains on sale of foreclosed assets. Results for the first six months of 2013 included $1,548,000 of acquisition costs related to the Oldham transaction. Bancorp's second quarter 2014 efficiency ratio was 57.18% compared with 63.72% in the second quarter last year. For the first six months of 2014, the efficiency ratio was 57.87%, compared to 59.85% for the same period in 2013.

Tangible common equity (TCE), a non-GAAP measure, is a measure of a company's capital which is useful in evaluating the quality and adequacy of capital. The ratio of tangible common equity to total tangible assets was 10.00% as of June 30, 2014, compared to 9.50% at December 31, 2013. See the Non-GAAP Financial Measures section for details on reconcilement to US GAAP measures.

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

a) Results Of Operations

Net income of $8,034,000 for the three months ended June 30, 2014 increased $1,627,000, or 25.4%, from $6,407,000 for the comparable 2013 period. Basic and diluted net income per share was $0.55 for the second quarter of 2014, an increase of 22.2% from the $0.45 for the second quarter of 2013.

Reflecting increased net income, annualized return on average assets and annualized return on average stockholders' equity were 1.37% and 13.35%, respectively, for the second quarter of 2014, compared to 1.16% and 11.69%, respectively, for the same period in 2013.

Record net income of $16,211,000 for the six months ended June 30, 2014 increased $3,036,000, or 23.0%, from $13,175,000 for the comparable 2013 period. Basic net income per share was $1.12 for the first six months of 2014, an increase of 19.1% from the $0.94 for the first six months of 2013. Net income per share on a diluted basis was $1.10 for the first six months of 2014, an increase of 17.0% from the $0.94 for the first six months of 2013.

Reflecting increased net income, annualized return on average assets and annualized return on average stockholders' equity were 1.39% and 13.74%, respectively, for the first six months of 2014, compared to 1.23% and 12.41%, respectively, for the same period in 2013.

Basic and diluted net income per share did not increase at the same rate as net income due to the issuance of 531,288 shares in the second quarter of 2013 for the Oldham transaction. Also, Bancorp's higher average stock price for the second quarter and first six months of 2014, as compared to the same periods in 2013, is the primary factor for more dilutive shares. See Note 12 for additional information related to net income per share.

Net Interest Income

The following tables present the average balance sheets for the three and six month periods ended June 30, 2014 and 2013 along with the related calculation of tax-equivalent net interest income, net interest margin and net interest spread for the related periods. See the notes following the tables for further explanation.


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Average Balances and Interest Rates - Taxable Equivalent Basis



                                               Three months ended June 30
                                        2014                                2013
                            Average                 Average     Average                 Average
(Dollars in thousands)     Balances     Interest     Rate      Balances     Interest     Rate

Earning assets:
Federal funds sold        $    77,386   $      63      0.33 % $    95,029   $      72      0.30 %
Mortgage loans held for
sale                            4,438          43      3.89 %       6,471          56      3.47 %
Securities:
Taxable                       322,208       1,760      2.19 %     275,727       1,328      1.93 %
Tax-exempt                     59,968         424      2.84 %      55,521         419      3.03 %
FHLB stock and other
securities                      6,995          63      3.61 %       6,772          64      3.79 %
Loans, net of unearned
income                      1,750,487      19,905      4.56 %   1,633,895      19,608      4.81 %

Total earning assets        2,221,482      22,258      4.02 %   2,073,415      21,547      4.17 %

Less allowance for loan
losses                         29,089                              33,248
                            2,192,393                           2,040,167
Non-earning assets:
Cash and due from banks        35,896                              33,876
Premises and equipment         39,321                              38,383
Accrued interest
receivable and other
assets                         90,087                              94,051

Total assets              $ 2,357,697                         $ 2,206,477

Interest bearing
liabilities:
Deposits:
Interest bearing demand
deposits                  $   473,628   $     124      0.11 % $   385,426   $     101      0.11 %
Savings deposits              108,360          10      0.04 %      97,437           9      0.04 %
Money market deposits         629,844         324      0.21 %     572,249         299      0.21 %
Time deposits                 338,531         656      0.78 %     372,357         876      0.94 %
Securities sold under
agreements to
repurchase                     52,396          29      0.22 %      54,576          33      0.24 %
Fed funds purchased and
other short term
borrowings                     22,109           9      0.16 %      21,839           9      0.17 %
FHLB advances                  34,886         206      2.37 %      31,864         219      2.76 %
Long-term debt                      -           -         -        30,900         772     10.02 %

Total interest bearing
liabilities                 1,659,754       1,358      0.33 %   1,566,648       2,318      0.59 %

Non-interest bearing
liabilities:
Non-interest bearing
demand deposits               431,817                             394,202
Accrued interest
payable and other
liabilities                    24,750                              25,756
Total liabilities           2,116,321                           1,986,606

Stockholders' equity          241,376                             219,871

Total liabilities and
stockholders' equity      $ 2,357,697                         $ 2,206,477
Net interest income                     $  20,900                           $  19,229
Net interest spread                                    3.69 %                              3.58 %
Net interest margin                                    3.77 %                              3.72 %


Table of Contents

                                                Six months ended June 30
                                        2014                                2013
                            Average                 Average     Average                 Average
(Dollars in thousands)     Balances     Interest     Rate      Balances     Interest     Rate

Earning assets:
Federal funds sold        $    87,024   $     142      0.33 % $   102,707   $     152      0.30 %
Mortgage loans held for
sale                            3,615          74      4.13 %       7,157         120      3.38 %
Securities:
Taxable                       323,045       3,531      2.20 %     252,959       2,639      2.10 %
Tax-exempt                     59,607         851      2.88 %      51,430         808      3.17 %
FHLB stock and other
securities                      7,170         130      3.66 %       6,478         123      3.83 %
Loans, net of unearned
income                      1,733,924      39,383      4.58 %   1,605,811      38,788      4.87 %

Total earning assets        2,214,385      44,111      4.02 %   2,026,542      42,630      4.24 %

Less allowance for loan
losses                         29,085                              33,834
                            2,185,300                           1,992,708
Non-earning assets:
Cash and due from banks        35,664                              32,787
Premises and equipment         39,447                              37,414
Accrued interest
receivable and other
assets                         91,626                              93,605

Total assets              $ 2,352,037                         $ 2,156,514

Interest bearing
liabilities:
Deposits:
Interest bearing demand
deposits                  $   477,449   $     255      0.11 % $   361,766   $     186      0.10 %
Savings deposits              106,011          20      0.04 %      91,897          18      0.04 %
Money market deposits         623,819         631      0.20 %     566,907         598      0.21 %
Time deposits                 344,051       1,348      0.79 %     374,021       1,822      0.98 %
Securities sold under
agreements to
repurchase                     56,622          63      0.22 %      55,948          68      0.25 %
Fed funds purchased and
other short term
borrowings                     19,397          15      0.16 %      20,747          17      0.17 %
FHLB advances                  34,596         402      2.34 %      31,870         436      2.76 %
Long-term debt                      -           -         -        30,900       1,545     10.08 %

Total interest bearing
liabilities                 1,661,945       2,734      0.33 %   1,534,056       4,690      0.62 %

Non-interest bearing
liabilities:
Non-interest bearing
demand deposits               426,695                             382,963
Accrued interest
payable and other
liabilities                    25,397                              25,426
Total liabilities           2,114,037                           1,942,445

Stockholders' equity          238,000                             214,069

Total liabilities and
stockholders' equity      $ 2,352,037                         $ 2,156,514
Net interest income                     $  41,377                           $  37,940
Net interest spread                                    3.69 %                              3.62 %
Net interest margin                                    3.77 %                              3.78 %


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Notes to the average balance and interest rate tables:

Net interest income, the most significant component of the Bank's earnings is total interest income less total interest expense. The level of net interest income is determined by the mix and volume of interest earning assets, interest bearing deposits and borrowed funds, and changes in interest rates.

Net interest spread is the difference between the taxable equivalent rate earned on interest earning assets less the rate expensed on interest bearing liabilities.

Net interest margin represents net interest income on a taxable equivalent basis as a percentage of average interest earning assets. Net interest margin is affected by both the interest rate spread and the level of non-interest bearing sources of funds, primarily consisting of demand deposits and stockholders' equity.

Interest income on a fully tax equivalent basis includes the additional amount of interest income that would have been earned if investments in certain tax-exempt interest earning assets had been made in assets subject to federal taxes yielding the same after-tax income. Interest income on municipal securities and loans have been calculated on a fully tax equivalent basis using a federal income tax rate of 35%. The approximate tax equivalent adjustments to interest income were $245,000 and $254,000, respectively, for the three month periods ended June 30, 2014 and 2013 and $494,000 and $502,000, respectively, for the six month periods ended June 30, 2014 and 2013.

Average balances for loans include the principal balance of non-accrual loans and exclude participation loans accounted for as secured borrowings.

Fully taxable equivalent net interest income of $20.9 million for the three months ended June 30, 2014 increased $1,671,000, or 8.7%, from $19.2 million when compared to the same period last year. Net interest spread and net interest margin were 3.69% and 3.77%, respectively, for the second quarter of 2014 and 3.58% and 3.72%, respectively, for the second quarter of 2013.

Fully taxable equivalent net interest income of $41.4 million for the six months ended June 30, 2014 increased $3,437,000, or 9.1%, from $37.9 million when compared to the same period last year. Net interest spread and net interest margin were 3.69% and 3.77%, respectively, for the first six months of 2014 and 3.62% and 3.78%, respectively, for the first six months of 2013.

Approximately $650 million, or 36%, of Bancorp's loans are variable rate; most of these loans are indexed to the prime rate and may reprice as that rate changes. However, approximately $335 million of variable rate loans have reached their contractual floor of 4% or higher. Approximately $147 million of variable rate loans have contractual floors below 4%. The remaining $168 million of variable rate loans have no contractual floor. Bancorp intends to establish floors whenever possible upon acquisition of new customers. Bancorp's variable rate loans are primarily comprised of commercial lines of credit and real estate loans. At inception, most of Bancorp's fixed rate loans are priced in relation to the five year Treasury bond.

Average earning assets increased $187.8 million or 9.3%, to $2.21 billion for the first six months of 2014 compared to 2013, reflecting growth in the loan portfolio and investment securities. Average interest bearing liabilities increased $127.9 million, or 8.3%, to $1.66 billion for the first six months of 2014 compared to 2013 primarily due to increases in interest bearing demand, savings and money market deposits, FHLB advances and securities sold under agreements to repurchase, partially offset by decreases in long-term debt, certificates of deposits and federal funds purchased.


Table of Contents

Asset/Liability Management and Interest Rate Risk

Managing interest rate risk is fundamental for the financial services industry. The primary objective of interest rate risk management is to neutralize effects of interest rate changes on net income. By considering both on and off-balance sheet financial instruments, management evaluates interest rate sensitivity while attempting to optimize net interest income within the constraints of prudent capital adequacy, liquidity needs, market opportunities and customer requirements.

Interest Rate Simulation Sensitivity Analysis

Bancorp uses an earnings simulation model to estimate and evaluate the impact of an immediate change in interest rates on earnings in a one year forecast. The simulation model is designed to reflect the dynamics of interest earning assets, interest bearing liabilities and off-balance sheet financial instruments. By estimating the effects of interest rate increases and decreases, the model can reveal approximate interest rate risk exposure. The simulation model is used by management to gauge approximate results given a specific change in interest rates at a given point in time. The model is therefore a tool to indicate earnings trends in given interest rate scenarios and does not indicate actual expected results.

The June 30, 2014 simulation analysis, which shows very little interest rate sensitivity, indicates that an increase in interest rates of 100 to 200 basis points would have a negative effect on net interest income, and a decrease of 100 basis points in interest rates would also have a negative impact. These estimates are summarized below.

Net interest
income change

Increase 200bp           (6.48 )%
Increase 100bp           (4.39 )
Decrease 100bp           (1.91 )
Decrease 200bp             N/A

Loans indexed to the prime rate, with floors of 4% or higher, comprise approximately 19% of total loans. Since the prime rate is currently 3.25%, rates would have to increase more than 75 bp before the rates on such loans will rise. This effect, captured in the simulation analysis above, negatively impacts the effect of rising rates.

The scenario of rates decreasing 200 bp is not reasonably possible given current low rates for short-term instruments and most deposits.

Undesignated derivative instruments described in Note 6 are recognized on the consolidated balance sheet at fair value, with changes in fair value, due to changes in prevailing interest rates, recorded in other non-interest income. Because of matching terms of offsetting contracts, in addition to collateral provisions which mitigate the impact of non-performance risk, changes in fair value subsequent to initial recognition have a minimal effect on earnings, and are therefore not included in the simulation analysis results above.

Derivatives designated as cash flow hedges described in Note 6 are recognized on the consolidated balance sheet at fair value, with changes in fair value, due to changes in prevailing interest rates, recorded net of tax in other comprehensive income.


Table of Contents

Provision for Loan Losses

The provision for loan losses was $1.4 million and $1.3 million for the second quarter of 2014 and 2013, respectively, and $1.7 million and $3.7 million for the first six months of 2014 and 2013, respectively. The allowance for loan losses is calculated after considering credit quality factors, and ultimately relies on an overall internal analysis of the risk in the loan portfolio. Based on this analysis, provisions for loan losses are determined and recorded. The provision reflects an allowance methodology that is driven by risk ratings, historical losses, and qualitative factors. The levels of non-performing loans continue to decrease and many key indicators of loan quality continue to show improvement. While overall credit metrics have continued to improve, the downgrade of a large commercial and industrial lending relationship during the second quarter caused management to pause what has been a steady reduction of the allowance coverage over the past year. Management believes that by year end there will be greater clarity regarding the ultimate risk presented by this loan. Bancorp intends to continue with its historically conservative stance toward credit quality, remaining cautious in assessing the potential risk in the loan portfolio.

Management utilizes loan grading procedures which result in specific allowance allocations for the estimated inherent risk of loss. For all loans graded, but not individually reviewed, a general allowance allocation is computed using factors typically developed over time based on actual loss experience. The specific and general allocations plus consideration of qualitative factors represent management's best estimate of probable losses contained in the loan portfolio at the evaluation date. Although the allowance for loan losses is comprised of specific and general allocations, the entire allowance is available to absorb any credit losses. Based on this detailed analysis of credit risk, management considers the allowance for loan losses adequate to cover probable losses inherent in the loan portfolio at June 30, 2014.

An analysis of the changes in the allowance for loan losses and selected ratios for the three and six month periods ended June 30, 2014 and 2013 follows:

                                    Three months ended June 30        Six months ended June 30
(Dollars in thousands)                 2014             2013             2014            2013

Balance at the beginning of
the period                        $        28,591    $    32,022    $       28,522    $    31,881
Provision for loan losses                   1,350          1,325             1,700          3,650
Loan charge-offs, net of
recoveries                                   (180 )       (1,367 )            (461 )       (3,551 )
Balance at the end of the
period                            $        29,761    $    31,980    $       29,761    $    31,980
Average loans, net of unearned
income                            $     1,759,695    $ 1,644,886    $    1,743,244    $ 1,615,280
Provision for loan losses to
average loans (1)                            0.08 %         0.08 %            0.10 %         0.23 %
Net loan charge-offs to
average loans (1)                            0.01 %         0.08 %            0.03 %         0.22 %
Allowance for loan losses to
average loans                                1.69 %         1.94 %            1.71 %         1.98 %
Allowance for loan losses to
period-end loans                             1.65 %         1.92 %            1.65 %         1.92 %



(1) Amounts not annualized

Loans are charged off when deemed uncollectible and a loss is identified or after underlying collateral has been liquidated; however, collection efforts may continue and future recoveries may occur. Periodically, loans are partially charged off to the net realizable value based upon collateral analysis.


Table of Contents

An analysis of net charge-offs by loan category for the three and six month periods ended June 30, 2014 and 2013 follows:

(in thousands)

                                             Three months                    Six months
                                            ended June 30                   ended June 30
Net loan charge-offs (recoveries)        2014            2013            2014           2013
Commercial and industrial            $          24    $       (13 )  $         15    $        16
Construction and development,
excluding undeveloped land                       -              -               -           (164 )
Undeveloped land                               (37 )            -             (37 )        2,000
Real estate mortgage - commercial
investment                                     112            850             149            835
Real estate mortgage - owner
occupied commercial                             (9 )          318              85            357
Real estate mortgage - 1-4 family
. . .
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