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

Show all filings for KENTUCKY BANCSHARES INC /KY/

Form 10-Q for KENTUCKY BANCSHARES INC /KY/


13-Aug-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 the 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.


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Summary

The Company recorded net income of $3.7 million, or $1.36 basic earnings and diluted earnings per share for the first six months ending June 30, 2014 compared to $3.5 million or $1.29 basic earnings and diluted earnings per share for the six month period ended June 30, 2013. The first six months earnings reflect an increase of 5.2% compared to the same time period in 2013. The increase in earnings is mostly attributed to an increase of $673 thousand in net interest income, a decrease of $400 thousand in the provision for loan losses, a decrease of $209 thousand in income tax expense, an increase of $162 thousand in gains on trading assets, an increase of $113 thousand in brokerage fee income and an increase of $101 thousand in trust department income. These positive changes to net income during 2014 were partially offset by a decrease of $742 thousand in the gains on the sale of mortgage loans, a decrease of $341 thousand in the gains on the sale of securities, an increase of $485 thousand in salaries & benefits expense and an increase of $131 thousand in occupancy expense. The earnings for the three months ending June 30, 2014 were $1.9 million or $0.70 basic and diluted earnings per share compared to $1.8 million or $0.66 basic and diluted earnings per share for the three month period ending June 30, 2013. The earnings for the three month period in 2014 reflect a 6.7% increase compared to the same time period in 2013. During the second quarter of 2013, the Bank opened a new branch in Lexington, KY and during the first quarter of 2014, the Bank opened a new branch in Richmond, KY. As expected, additional expenses were incurred with the opening of the two new locations which did affect short-term earnings. However, management believes this expansion will increase long-term earnings and shareholder equity.

Return on average assets was 0.94% for the six months ending June 30, 2014 and 0.98% for the six months ending June 30, 2013. Return on average assets was 0.97% for the three months ending June 30, 2014 and 1.00% for the three months ending June 30, 2013. Return on average equity was 10.18% for the six month period ending June 30, 2014 and 9.43% for the three month period ending June 30, 2013. Return on average equity was 10.33% for the three months ending June 30, 2014 and 9.63% for the same time period in 2013.

In January 2014, the Bank invested $5.0 million in trading securities which are shown as trading assets on the balance sheet. Management made the decision to invest in these assets after much due diligence because it 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 June 30, 2014, trading assets totaled $5.2 million, which represents income on the investment totaling $242 thousand during the first six months of 2014 and $134 thousand for the three months ending June 30, 2014.

Gross Loans increased $27.4 million from $468.7 million on December 31, 2013 to $496.1 million on June 30, 2014. The overall increase in loans is attributed to an increase of $14.2 million in 1-4 family residential properties, an increase of $5.0 million in non-farm and non-residential properties, an increase of $4.6 million in agricultural loans, an increase of $2.4 million in multi-family residential properties and an increase of $2.2 million in real estate construction loans. Commercial loan balances decreased $927 thousand and consumer loan balances decreased $118 thousand.


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Total deposits decreased from $617.4 million on December 31, 2013 to $597.4 million on June 30, 2014, a decrease of $20.0 million. Non-interest bearing demand deposit accounts increased $5.9 million from December 31, 2013 to June 30, 2014. Time deposits $100 thousand and over decreased $4.2 million and other interest bearing deposit accounts decreased $21.7 million from December 31, 2013 to June 30, 2014. Public fund accounts decreased $29.0 million from December 31, 2013 to June 30, 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 increased $23.6 million from December 31, 2013 to June 30, 2014.

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 $12.8 million for the six months ending June 30, 2014 compared to $12.2 million for the six months ending June 30, 2013, an increase of 5.5%. The interest spread, excluding tax equivalent adjustments was 3.44% for the first six months of 2014 and down from 3.67% reported for the same period in 2013, a decrease of 23 basis points. Rates have remained fairly low in the past year. For the first six months ending June 30, 2014, the cost of total deposits was 0.35% compared to 0.39% 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. Net interest income was $6.5 million for the three months ending June 30, 2014 compared to $6.0 million for the three months ending June 30, 2013, an increase of 7.6%. The interest spread, excluding tax equivalent adjustments, was 3.47% for the three month period ending June 30, 2014 compared to 3.67% for the three month period in 2013, a decrease of 20 basis points.

For the first six months, the yield on assets decreased from 4.19% in 2013 to 3.97% in 2014, excluding tax equivalent adjustments. The yield on loans decreased 42 basis points in the first three months of 2014 compared to 2013 from 5.31% to 4.89%. The yield on securities increased 10 basis points in the first six months of 2014 compared to 2013 from 2.31% in 2013 to 2.41% in 2014. The cost of liabilities was 0.53% for the first six months in 2014 compared to 0.52% in 2013. Year to date average loans, excluding overdrafts, increased $51.9 million, or 12.2% from June 30, 2013 to June 30, 2014. Loan interest income increased $378 thousand for the first six months of 2014 compared to the first six months of 2013. Year to date average total deposits increased from June 30, 2013 to June 30, 2014, up $28.5 million or 4.8%. Year to date average interest bearing deposits increased $16.9 million, or 3.8%, from June 30, 2013 to June 30, 2014. Deposit interest expense decreased $88 thousand for the first six months of 2014 compared to the same period in 2013. Year to date average borrowings increased $46.5 million, or 31.8% from June 30, 2013 to June 30, 2014. Interest expense on borrowed funds increased $310 thousand for the first six months of 2014 compared to the same period in 2013.


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The volume rate analysis for the six months ending June 30, 2014 indicates that $2.4 million of the increase in interest income is attributable to an increase in loan volume and $356 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 $2.0 million to interest income while an increase in rates in our security portfolio contributed an increase of $177 thousand to interest income. The net effect to interest income was an increase of $895 thousand for the first six months of 2014 compared to the same time period in 2013. The average rate of the Company's total outstanding deposits and borrowings decreased from 0.68% in 2013 to 0.53% in 2014. Based on the following volume rate analysis, the lower level of interest rates contributed to a decrease of $596 thousand in interest expense, while the change in volume was responsible for a $818 thousand increase in interest expense. As a result, the increase in net interest income for the first six 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.

Changes in Interest Income and Expense



(in thousands)



                                                               Six Months Ending
                                                                 2014 vs. 2013
                                                      Increase (Decrease) Due to Change in
                                                   Volume             Rate           Net Change
INTEREST INCOME
Loans                                           $       2,382    $        (2,004 )  $        378
Investment Securities                                     356                177             533
Other                                                     (14 )               (2 )           (16 )
Total Interest Income                                   2,724             (1,829 )           895
INTEREST EXPENSE
Deposits
Demand                                                     26                (57 )           (31 )
Savings                                                    29                (23 )             6
Negotiable Certificates of
Deposit and Other
Time Deposits                                             (13 )              (50 )           (63 )
Securities sold under agreements to
repurchase and other borrowings                            48                (31 )            17
Federal Home Loan
Bank advances                                             728               (435 )           293
Total Interest Expense                                    818               (596 )           222
Net Interest Income                             $       1,906    $        (1,233 )  $        673


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Non-Interest Income

Non-interest income decreased $493 thousand for the six months ending June 30, 2014, compared to the same period in 2013, to $4.9 million. . For the three month period ending June 30, 2014 compared to the three months ending June 30, 2013, total non-interest income decreased $159 thousand.

The decrease for the six month period ending June 30, 2014 was primarily due to a decrease of $742 thousand in gains on the sale of mortgage loans and a decrease of $341 thousand in gains on the sale of securities. Favorable variances to non-interest income included an increase of $162 thousand in gains on trading assets, an increase of $113 thousand in brokerage fee income and an increase of $101 thousand in fee income generated by the trust department.

The gain on the sale of mortgage loans decreased from $1.1 million in the first six months of 2013 to $400 thousand during the first six months of 2014, a decrease of $742 thousand. For the three months ending June 30, 2014 compared to the same time period in 2013, the gain on the sale of mortgage loans decreased $273 thousand. The volume of loans originated to sell during the first six months of 2014 decreased $20.6 million compared to the same time period in 2013. For the three months ending June 30, 2014, the volume of loans originated for sale decreased $10.2 million compared to the same three months 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 $34 thousand for the six months ending June 30, 2014 compared to $(36) thousand for the six months ending June 30, 2013, an increase of $70 thousand. For the three month period ending June 30, 2014, loan service fee income, net of amortization and impairment expense, was $5 thousand compared to $16 thousand for the same time period one year ago. During the first six months of 2014, the adjustment to the carrying value of the mortgage servicing right was a negative net amount of $12 thousand, as the fair value of this asset decreased. Of this, a positive valuation adjustment of $5 thousand was recorded in the first quarter of 2014 and a negative valuation adjustment of $17 thousand was recorded during the second quarter of 2014. During the first six months of 2013, the carrying value of the mortgage servicing right was written down a net amount of $65 thousand, as the fair value of this asset decreased. Of this, a negative valuation adjustment of $73 thousand was recorded in the first quarter of 2013 and a positive valuation adjustment of $8 thousand was recorded during the second quarter of 2013.

Non-Interest Expense

Total non-interest expenses increased $608 thousand for the six month period ending June 30, 2014 compared to the same period in 2013. For the three month period ending June 30, 2014 compared to the three months ending June 30, 2013, total non-interest expense increased $330 thousand

For the comparable six month periods, salaries and benefits increased $485 thousand, an increase of 7.2%. 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 June 30, 2014 was 219 compared to 215 one year ago. Salaries and employee benefits increased $173 thousand, or 5.0%, for the three month period ending June 30, 2014 compared to the same time period in 2013.


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Occupancy expenses increased $131 thousand to $1.7 million for the first six months of 2014 compared to the same time period in 2013. Rent expense increased $58 thousand due to entering two new markets within the past year and leasing branch facilities in both markets. Depreciation expense increased $60 thousand during the first six months ending June 30, 2014 compared to the same time period one year ago. In addition, computer maintenance expense increased $72 thousand. Occupancy expenses increased $1 thousand for the three month period ending June 30, 2014 compared to the same time period in 2013.

Legal and professional fees increased $68 thousand for the first six months ending June 30, 2014 compared to the same time period in 2013. Legal and professional fees increased $85 thousand for the three month period ending June 30, 2014 compared to the same time period in 2013. Repossession expenses decreased $12 thousand for the first six months ending June 30, 2014 compared to the same time period in 2013 and increased $57 thousand for the three months ending June 30, 2014 compared to the same three months one year ago. Repossession expenses are reported net of rental income earned on repossessed properties. Repossession expenses were lower in the first six 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 increased $7 thousand for the six months ending June 30, 2014 compared to the same time period in 2013 and $10 thousand for the three months ending June 30, 2014 compared to the three months ending June 30, 2013.

Income Taxes

The effective tax rate for the six months ending June 30, 2014 was 15.2% compared to 19.9% in 2013. The effective tax rate for the three months ending June 30, 2014 was 16.2% compared to 20.8% for the three months ending June 30, 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 $40 thousand for the first six months of 2014 compared to the first six months of 2013. Also, for the first six months of 2014, the Company had tax credits totaling $488 thousand for investments made in low income housing projects which represented an increase of $67 thousand compared to similar tax credits for the first six 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 six months ending June 30, 2014, the Company averaged $87.5 million in tax free securities and $17.0 million in tax free loans. As of June 30, 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 169 months.

Liquidity and Funding

Liquidity is the ability to meet current and future financial obligations. The Company's primary sources of funds consist of deposit inflows, loan repayments, maturities and sales of investment securities and Federal Home Loan Bank borrowings.


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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 $15.0 million as of June 30, 2014 compared to $23.2 million at December 31, 2013. The decrease in cash and cash equivalents is attributed to a decrease of $7.7 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 $224.2 million at June 30, 2014 compared to $230.4 million at December 31, 2013. Securities classified as trading assets totaled $5.2 million at June 30, 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 six months of 2014, deposits decreased $20.0 million. The Company's investment portfolio decreased $1.0 million and the Company's loan portfolio increased $27.4 million. The borrowed funds the Company have with the Federal Home Loan Bank increased $23.6 million from December 31, 2013 to June 30, 2014. The Company had outstanding federal funds purchased totaling $4.6 million at June 30, 2014 and $0 at 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 June 30, 2014, we have sufficient collateral to borrow an additional $66 million from the Federal Home Loan Bank. In addition, as of June 30, 2014, $26 million is available in overnight borrowing through various correspondent banks and the Company has access to $258 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.


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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 June 30, 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.


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

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