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EX-21 - EX-21 - KENTUCKY BANCSHARES INC /KY/a11-2356_1ex21.htm
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EX-31.1 - EX-31.1 - KENTUCKY BANCSHARES INC /KY/a11-2356_1ex31d1.htm
EX-31.2 - EX-31.2 - KENTUCKY BANCSHARES INC /KY/a11-2356_1ex31d2.htm
EX-32.1 - EX-32.1 - KENTUCKY BANCSHARES INC /KY/a11-2356_1ex32d1.htm
EX-32.2 - EX-32.2 - KENTUCKY BANCSHARES INC /KY/a11-2356_1ex32d2.htm

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 

FORM 10-K

 

(Mark One)

 

x      ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the fiscal year ended December 31, 2010

 

or

 

o         TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                         to                       

 

Commission File Number:  33-96358

 

KENTUCKY BANCSHARES, INC.

(Exact name of registrant as specified in its charter)

 

Kentucky

 

61-0993464

(State or other jurisdiction of

 

(I.R.S. Employer Identification No.)

incorporation or organization)

 

 

 

 

 

P.O. Box 157, Paris, Kentucky

 

40362-0157

(Address of principal executive offices)

 

(Zip Code)

 

Registrant’s telephone number, including area code:  (859)987-1795

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class

 

Name on each exchange on which registered

Common Stock, no par value per share

 

OTC Bulletin Board

 

Securities registered pursuant to Section 12(g) of the Act:  None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o  No x

 

Indicate by check mark if the registrant is not required to file reports to Section 13 or Section 15(d) of the Exchange Act. Yes o No x

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x  No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (229.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o  No o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer o

 

Accelerated filer o

 

 

 

Non-accelerated filer x

 

Smaller reporting company o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o  No x

 

Aggregate market value of voting stock held by non-affiliates as of June 30, 2010 was approximately $35.1 million.  For purposes of this calculation, it is assumed that the Bank’s Trust Department, directors, executive officers and beneficial owners of more than 5% of the registrant’s outstanding voting stock are affiliates.

 

Number of shares of Common Stock outstanding as of March 18, 2011:  2,743,929.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the Registrant’s definitive Proxy Statement for its Annual Meeting of Stockholders to be held on May 18, 2011 are incorporated by reference into Items 10, 11, 12, 13 and 14 of Part III.

 

 

 



 

PART I

 

Item 1.  Business

 

General

 

Kentucky Bancshares, Inc. (“Company,” “Kentucky,” “we,” “our” and “us”) is a bank holding company headquartered in Paris, Kentucky.  The Company was organized in 1981 and is registered under the Bank Holding Company Act of 1956, as amended (“BHCA”).

 

The Company conducts its business in the Commonwealth of Kentucky through one banking subsidiary, Kentucky Bank.

 

Kentucky Bank is a commercial bank and trust company organized under the laws of Kentucky.  Kentucky Bank has its main office in Paris (Bourbon County), with additional offices in Paris, Cynthiana (Harrison County), Georgetown (Scott County), Morehead (Rowan County), Nicholasville (Jessamine County), Sandy Hook (Elliott County), Versailles (Woodford County), Wilmore (Jessamine County) and Winchester (Clark County).  The deposits of Kentucky Bank are insured up to prescribed limits by the Deposit Insurance Fund (“DIF”) of the Federal Deposit Insurance Corporation (“FDIC”).

 

The Company had total assets of $658.9 million, total deposits of $537.4 million and stockholders’ equity of $61.0 million as of December 31, 2010.  The Company’s principal executive office is located at 339 Main Street, Paris, Kentucky  40361, and the telephone number at that address is (859) 987-1795.

 

Business Strategy

 

The Company’s current business strategy is to operate a well-capitalized, profitable and independent community bank with a significant presence in Central and Eastern Kentucky.  Management believes the optimum way to grow the Company is by attracting new loan and deposit customers within its existing markets through it product offerings and customer service.  Management continues to consider opportunities for branch expansion and will also consider acquisition opportunities that help advance its strategic objectives.

 

Lending

 

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 85% of which are secured by real estate at December 31, 2010.  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 mortgage, installment and other loans to its individual and other non-commercial customers.

 

Loan Rates:  Kentucky Bank offers variable and fixed rate loans.  Loan rates on variable rate loans generally adjust upward or downward based on changes in the loan’s index.  Rate adjustments on variable rate loans are made from 1 day to 5 years.  Variable rate loans may contain provisions that cap the amount of interest rate increases or decreases over the life of the loan.  In addition to the lifetime caps and floors on rate adjustments, loans secured by residential real estate may contain provisions that limit annual increases at a maximum of 200 basis points.  There is usually no annual limit applied to loans secured by commercial real estate.

 

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Credit Risk:  Commercial lending and real estate construction lending, generally include a higher degree of credit risk than other loans, such as residential mortgage loans.  Commercial loans, like other loans, are evaluated at the time of approval to determine the adequacy of repayment sources and collateral requirements. Collateral requirements vary to some degree among borrowers and depend on the borrower’s financial strength, the terms and amount of the loan, and collateral available to secure the loan.  Credit risk results from the decreased ability or willingness to pay by a borrower.  Credit risk also results when a liquidation of collateral occurs and there is a shortfall in collateral value as compared to a loan’s outstanding balance.  For construction loans, inaccurate initial estimates of a project’s costs and the property’s completed value could weaken the Company’s position and lead to the property having a value that is insufficient to satisfy full payment of the amount of funds advanced for the property.  Secured and unsecured consumer loans generally are made for automobiles, boats, and other motor vehicles.  In most cases, loans are restricted to Kentucky Bank’s general market area.

 

Other Products:  Kentucky Bank offers its customers a variety of other services, including checking, savings, money market accounts, certificates of deposits, safe deposit facilities, credit cards and other consumer-oriented financial services.  Kentucky Bank has Internet banking, including bill payment available to its customers at www.kybank.com.  Through its Wealth Management Department, Kentucky Bank provides brokerage services, annuities, life and long term care insurance, personal trust and agency services (including management agency services).

 

Competition and Market Served

 

Competition:  The banking business is highly competitive.  Competition arises from a number of sources, including other bank holding companies and commercial banks, consumer finance companies, thrift institutions, other financial institutions and financial intermediaries.  In addition to commercial banks, savings and loan associations, savings banks and credit unions actively compete to provide a wide variety of banking services.  Mortgage banking firms, finance companies, insurance companies, brokerage companies, financial affiliates of industrial companies and government agencies provide additional competition for loans and for many other financial services.  Kentucky Bank also currently competes for interest-bearing funds with a number of other financial intermediaries, including brokerage firms and mutual funds, which offer a diverse range of investment alternatives.  Some of the Company’s competitors are not subject to the same degree of regulatory review and restrictions that apply to the Company and its subsidiary bank.  In addition, the Company must compete with much larger financial institutions that have greater financial resources than the Company.

 

Market Served.  The Company’s primary market areas consist of Bourbon, Clark, Elliott, Harrison, Jessamine, Rowan, Scott, Woodford and surrounding counties in Kentucky.

 

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Supervision and Regulation

 

Governing Regulatory Institutions:  As a bank holding company, the Company is subject to the regulation and supervision of the Federal Reserve Board.  The Company’s subsidiary is subject to supervision and regulation by applicable state and federal banking agencies, including the Federal Reserve Board, the Federal Deposit Insurance Corporation and the Kentucky Department of Financial Institutions.  Kentucky Bank is also subject to various requirements and restrictions under federal and state law, including requirements to maintain reserves against deposits, restrictions on the types and amounts of loans that may be granted and the interest that may be charged thereon, and limitations on the types of investments that may be made and the types of services that may be offered.  In addition to the impact of regulation, Kentucky Bank is affected significantly by the actions of the Federal Reserve Board as it attempts to control the money supply and credit availability in order to influence the economy.

 

Laws Protecting Deposits:  There are a number of obligations and restrictions imposed on bank holding companies and their depository institution subsidiaries by federal law and regulatory policy.  These obligations and restrictions are designed to reduce potential loss exposure to the depositors of such depository institutions and to the FDIC insured funds in the event the depository institution becomes in danger of default or is in default.  For example, under a policy of the Federal Reserve Board with respect to bank holding company operations, a bank holding company is required to serve as a source of financial strength to its subsidiary depository institutions and commit resources to support such institutions in circumstances where it might not do so absent such policy.  In addition, the “cross-guarantee” provisions of federal law require insured depository institutions under common control to reimburse the FDIC for any loss suffered or reasonably anticipated as a result of the default of a commonly controlled insured depository institution or for any assistance provided by the FDIC to a commonly controlled insured depository institution in danger of default.

 

The federal banking agencies also have broad powers under current federal law to take prompt corrective action to resolve problems of insured depository institutions.  The extent of these powers depends upon whether the institutions in question are “well capitalized”, “adequately capitalized”, “undercapitalized”, “significantly undercapitalized” or “critically undercapitalized”, as such terms are defined under uniform regulation defining such capital levels issued by each of the federal banking agencies.

 

Deposit Insurance:  The Company is subject to several deposit insurance assessments, which are described below:

 

FDIC Assessments.  The Company’s subsidiary bank is a member of the FDIC, and its deposits are insured by the FDIC’s Deposit Insurance Fund up to the amount permitted by law.  The Company’s subsidiary bank is thus subject to FDIC deposit insurance assessments.  The FDIC utilizes a risk-based assessment system that imposes insurance premiums based upon a risk matrix that takes into account a bank’s capital level and supervisory rating.  Under the Federal Deposit Insurance Reform Act of 2005, which became law in 2006, the Company received a one-time assessment credit of $434 thousand that can be applied against future premiums, subject to certain limitations.  Based on the one-time assessment credit, the Company was not required to pay any deposit insurance premiums in 2006 and unused credits from 2006 resulted in the amount of deposit insurance premiums being zero in 2007.  Lower credits remained to offset assessments for 2008, which was the primary factor in higher deposit insurance net assessments of $175 thousand in 2008.

 

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In February 2009, the FDIC adopted a long-term DIF restoration plan as well as an additional emergency assessment for 2009.  The restoration plan increased base assessment rates for banks in all risk categories in order to raise the DIF reserve ratio from its then current 0.40% to 1.15% within a certain of years.  Beginning April 1, 2009, the FDIC established an initial base assessment rate for each bank ranging from 12 to 45 basis points, depending upon a particular bank’s risk category.  Banks in the best risk category, which include the Company’s subsidiary bank, were assessed initial base rates ranging from 12 to 16 basis points of assessable deposits.  The FDIC then adjusted the initial base rate assessment higher or lower to obtain the total base assessment rate based upon a bank’s level of unsecured debt, secured liabilities, and brokered deposits.  The total base assessment rate ranges between 7 and 77.5 basis points and is applied to a bank’s assessable deposits when computing the FDIC insurance assessment amount.

 

Additionally, the FDIC approved an interim rule imposing a special emergency assessment to all financial institutions of five basis points on a bank’s total assets less Tier I capital as of June 30, 2009.  Our special assessment amounted to $296 thousand and was paid on September 30, 2009.  On November 12, 2009, the FDIC adopted a final rule requiring insured depository institutions to prepay their estimated quarterly risk-based assessments for the fourth quarter of 2009, and for all of 2010, 2011, and 2012, on December 30, 2009, along with each institution’s risk-based deposit insurance assessment for the third quarter of 2009.  The prepayment was based on a bank’s regular assessment base as of September 30, 2009, with a quarterly increase of an estimated 5% annual growth rate through the end of 2012.  The prepaid amount will be amortized over the prepayment period.  The Company’s initial prepayment was $3.1 million.  An institution’s quarterly risk-based deposit insurance assessment thereafter is offset by the amount prepaid until that amount is exhausted or until June 30, 2013 when any remaining amount will be returned to the institution.  Prepaid FDIC insurance assessments are included in other assets on the Company’s balance sheet.

 

On February 7, 2011, the FDIC amended its regulations to implement revisions to the Federal Deposit Insurance Act made by the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”) by modifying the definition of an institution’s deposit insurance assessment base and to change the assessment rate adjustments.  Under Dodd-Frank, the assessment base must, with some possible exceptions, equal average consolidated total assets minus average tangible equity.  Previously, the assessment base was based on deposits.  Dodd-Frank also requires the FDIC to adopt a DIF restoration plan to ensure that the reserve ratio increases to 1.35% from 1.15% of insured deposits by 2020.

 

Financing Corporation (“FICO”) Assessments.  FICO assessment costs were $58 thousand in 2010, $53 thousand in 2009 and $54 thousand for 2008.  FICO is a mixed-ownership government corporation established by the Competitive Equality Banking Act of 1987 possessing assessment powers in addition to the FDIC.  The FDIC acts as a collection agent for FICO, whose sole purpose is to function as a financing vehicle for the now defunct Federal Savings & Loan Insurance Corporation.

 

Temporary Liquidity Guarantee Program (“TLGP”).  The Company’s participation in the FDIC’s Transaction Account Guarantee Program initiated during the fourth quarter of 2008 also contributed to an increase in deposit insurance premiums.  The TLGP consists of two separate programs implemented by the FDIC in October 2008.  This includes the Debt Guarantee Program (“DGP”) and the Transaction Account Guarantee Program (“TAGP”).  These programs were initially provided at no cost to participants during the first 30 days.

 

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Eligible institutions that do not “opt out” of either of these programs become participants by default and will incur the fees assessed for taking part.

 

Under the DGP, the FDIC will guarantee senior unsecured debt issued on or after October 14, 2008 through June 30, 2009 up to certain limits by participating entities.  The FDIC will provide guarantee coverage for debt issued between those dates until the earlier of the maturity date of the debt or June 30, 2012.  The Company chose to opt out of the DGP.

 

Under the TAGP, the FDIC guarantees 100% of certain noninterest bearing transaction accounts up to any amount to participating FDIC insured institutions.  The unlimited coverage was initially applicable until December 31, 2009, but was later extended to December 31, 2012.  The Company opted to participate in the TAGP; as such, it will incur an additional quarterly-assessed fee on balances in noninterest bearing transaction accounts exceeding the recently increased $250 thousand deposit limit that became effective on November 13, 2008.  The previous deposit insurance limit amount was $100 thousand.

 

Dodd-Frank Wall Street Reform and Consumer Protection Act:  Dodd-Frank was signed into law by the President on July 21, 2010, and represents a significant change in the American financial regulatory environment affecting all Federal financial regulatory agencies and affecting almost every aspect of the nation’s financial services industry.  Dodd-Frank includes, among others, the following:

 

·                  the creation of a Financial Stability Oversight Counsel to identify emerging systemic risks and improve interagency cooperation;

·                  the establishment of the same or strengthened capital and liquidity requirements for bank holding companies that apply to insured depository institutions;

·                  restrictions in proprietary trading and investing in or sponsoring of any hedge fund or private equity fund;

·                  the establishment of minimum credit risk retention requirements relating to securitizations;

·                  the establishment of detailed asset-level and data-level disclosure requirements relating to loan brokers and originators;

·                  Codify and expand the “source of strength” doctrine as a statutory requirement.  The source of strength doctrine represents the long held policy view by the Federal Reserve that a bank holding company should serve as a source of financial strength for its subsidiary banks;

·                  a permanent increase of the previously implemented temporary increase of FDIC deposit insurance to $250,000 and an extension of federal deposit coverage until January 1, 2013 for the full net amount held by depositors in non-interest bearing transaction accounts;

·                  authorization for financial institutions to pay interest on business checking accounts;

·                  changes in the calculation of FDIC deposit insurance assessments, such that the assessment base will no longer be the institution’s deposit base, but instead, will be its average consolidated total assets less its average tangible equity;

·                  expanded restrictions on transactions with affiliates and insiders under Section 23A and 23B of the Federal Reserve Act and lending limits for derivative transactions, repurchase agreements and securities lending and borrowing transactions;

·                  provisions for new disclosure and other requirements regarding corporate governance and executive compensation;

 

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·                  the creation of a Consumer Financial Protection Bureau, which is authorized to promulgate consumer protection regulations relating to bank and non-bank financial products and examine and enforce these regulations on institutions with more than $10 billion in assets.

 

Many of the requirements of Dodd-Frank will be implemented over time and most will be subject to regulations to be implemented or which will not become fully effective for several years.

 

Emergency Economic Stabilization Act of 2008 (“EESA”):  EESA was signed into law by the President on October 3, 2008 as a measure to stabilize and provide liquidity to the U.S. financial markets.  Under EESA, the Troubled Asset Relief Program (“TARP”) was created.  TARP granted the Treasury authority to, among other things, invest in financial institutions and purchase troubled assets in an aggregate amount up to $700 billion.

 

Consumer Regulations:  In addition to the laws and regulations discussed above, Kentucky Bank is also subject to certain consumer laws and regulations that are designed to protect consumers in transactions with banks.  While the list set forth herein is not exhaustive, these laws and regulations include the Truth in Lending Act, the Truth in Savings Act, the Electronic Funds Transfer Act, the Expedited Funds Availability Act, the Equal Credit Opportunity Act, the Real Estate Settlement Procedures Act, the Fair Housing Act and the Fair and Accurate Transactions Act, among others.  These laws and regulations mandate certain disclosure requirements and regulate the manner in which financial institutions must deal with clients when taking deposits or making loans. These laws also limit Kentucky Bank’s ability to share information with affiliated and unaffiliated entities.  The bank must comply with the applicable provisions of these consumer protection laws and regulations as part of its ongoing business operations.

 

Dividend Restrictions:  There are various legal and regulatory limits on the extent to which the Company’s subsidiary bank may pay dividends or otherwise supply funds to the Company.  In addition, federal and state regulatory agencies also have the authority to prevent a bank or bank holding company from paying a dividend or engaging in any other activity that, in the opinion of the agency, would constitute an unsafe or unsound practice.  Dividends paid by the subsidiary bank have provided substantially all of the Company’s operating funds, and this may reasonably be expected to continue for the foreseeable future.

 

Employees

 

At December 31, 2010, the number of full time equivalent employees of the Company was 184.

 

Nature of Company’s Business

 

The business of the Company is not seasonal.  The Company’s business does not depend upon a single customer, or a few customers, the loss of any one or more of which would have material adverse effect on the Company.  No material portion of the Company’s business is subject to renegotiation of profits or termination of contracts or subcontracts at the election of any governmental entity.

 

Available Information

 

The Company files annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports with the Securities and Exchange Commission (“SEC”) pursuant to section 13(a) or 15(d) of the Securities Exchange Act of 1934.  The public may read and copy any material the Company files with the SEC at the SEC’s Public Reference Room at 100 F

 

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Street, NE, Washington, DC  20549 and may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330.  The SEC maintains an internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC on its website at www.sec.gov.  The Company’s website is located at www.kybank.com.

 

Item 1A.  Risk Factors

 

There are factors, many beyond our control, which may significantly affect the Company’s financial position and results of operations.  Some of these factors are described below in the sections titled financial risk, business risk and operational risk.  These risks are not totally independent of each other; some factors affect more than one type of risk.  These include regulatory, economic, and competitive environments.  As part of the annual audit plan, our internal risk management department meets with management to assess these risks throughout the Company.  Many risks are further addressed in other sections of this Form 10-K document.  Additional risks and uncertainties that management is not aware of or focused on or that management currently deems immaterial may also impair the Company’s business operations.  This report is qualified in its entirety by these risk factors.

 

Industry Risk

 

Industry risk includes risks that affect the entire banking service industry.

 

Significant decline in general economic conditions will negatively affect the financial results of our banking operations.  Our success depends on general economic conditions both locally, nationally, and to a lesser extent, internationally.  Economic conditions in the United States and abroad deteriorated significantly in the latter part of 2008 and such weakened conditions continued in 2009 and in 2010.  While economic conditions have improved in some areas, business activity remains low, particularly in real estate.  Further, the recent natural disasters and resulting devastation in Japan may affect the ability of our customers, who work for or contract with the Toyota car manufacturing facility located in Georgetown, Kentucky, to repay mortgage or commercial business loans.  Many businesses are still in serious difficulty due to reduced consumer spending and continued liquidity challenges in the market.  The housing market is still depressed as reflected by a high level of foreclosures and continued unemployment.  These factors have affected the performance of mortgage loans and resulted in financial institutions, including government-sponsored entities, in making significant write-downs of asset values of mortgage-backed securities, credit default swaps and other derivative and cash securities.  Some financial institutions have failed.  Many financial institutions and institutional investors have tightened the availability of credit to borrowers and other financial institutions, which, in turn, results in more loan defaults and decreased business activity.  Consumer confidence regarding the economy is low and the financial markets reflect this lack of confidence.  Most of our customers are in the Central Kentucky area, and have been directly affected by this recession.  Local economic conditions have affected the demand of customers for loans, the ability of some borrowers to repay these loans and the value of the collateral securing these loans.  Loan growth is critical to our profitability.  We do not expect significant improvement in the economy in the near future, and future declines in the economy will likely make the credit market crisis worse.

 

The exercise of regulatory power may have negative impact on our results of operations and financial condition.  We are subject to extensive regulation, The exercise of regulatory power may have negative impact on our results of operations and financial condition.  We are subject to extensive regulation, supervision and examination by federal and state banking authorities.  Any change in

 

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applicable regulations or federal or state legislation could have a substantial impact on our operations.  Additional legislation and regulations may be enacted or adopted in the future that could significantly affect our powers, authority and operations, which could have a material adverse effect on the financial condition and results of operations.  For example, in response to the economic downturn and financial crisis, the U.S. government has enacted legislation by passing the Emergency Economic Stabilization Act of 2008 (“EESA”) followed by the American Recovery and Reinvestment Act of 2009 (the “Recovery Act”), and Dodd-Frank in 2010.  These Acts have enabled, and will enable the U.S. Treasury, the FDIC and the Federal Reserve Board to develop programs, such as the Capital Purchase Program, the Financial Stability Plan and the foreclosure prevention program, to improve funding to consumers, increase interbank lending and reduce home foreclosures.  The U.S. government continues to closely evaluate the economy, the effect of its legislation and resulting programs and initiatives on the economy.  We expect that the U.S. government will continue to refine these programs and develop new programs.  We do not know whether these Acts and programs will positively affect the economy, help stabilize the financial markets and increase the availability of credit.  Our business, financial condition, results of operations, liquidity and access to capital and credit will likely be negatively affected if the economy worsens or the financial markets do not stabilize.

 

Higher FDIC Deposit Insurance Premiums and Assessments Could Adversely Affect Our Financial Condition.  FDIC insurance premiums have increased substantially in 2009 and 2010, and the Company may have to continue to pay significantly higher FDIC premiums in the future.  Market developments have significantly depleted the insurance fund of the FDIC and reduced the ratio of reserves to insured deposits.  Under the Federal Deposit Insurance Act, as amended by Dodd-Frank, the FDIC must establish and implement a plan to restore the Deposit Insurance Fund’s designated reserve ratio to 1.35% of insured deposits by 2020.  Dodd-Frank removed the previously established upper limit reserve ratio of 1.15%.  The FDIC must continue to assess and consider the appropriate level of the designated reserve ratio annually by considering each of the following:  risk of loss to the insurance fund; economic conditions affecting the banking industry; the prevention of sharp swings in the assessment rates; and any other factors the FDIC deems important. In December 2010 the FDIC announced that it had established the long-term reserve ratio at 2.0%.

 

The FDIC previously implemented a restoration plan that changed both its risk-based assessment system and its base assessment rates.  As part of this plan, during the second quarter of 2009 it increased deposit insurance assessment rates generally and imposed a special assessment of five basis points on each insured institution’s total assets less Tier 1 capital.  The special assessment in 2009 was in addition to the regular quarterly risk-based assessment.  The Company paid $296 thousand related to this special assessment.

 

In the wake of a rapid depletion of the FDIC’s Deposit Insurance Fund resulting from a high number of bank failures, the FDIC required that all (with limited exceptions) insured institutions pay in the fourth quarter of 2009 its following estimated three years’ quarterly deposit assessments in advance.  This resulted in an aggregate payment by the Company’s bank totaling $3.1 million in the fourth quarter of 2009.  The three years’ advance payment was recorded as a prepaid asset that is being expensed in approximately equal amounts over the prepayment period and, thus, only impact earnings in the normal course.  However, the advance payment reduced the liquid assets of the Company’s bank at the time of payment.

 

As a result of Dodd-Frank, the FDIC has revised its DIF restoration plan by changing the calculation of FDIC deposit insurance assessments; the assessment base will no longer be the institution’s deposit base, but instead, will be its average consolidated total assets less its average tangible equity.  These changes may result in higher insurance premiums and could significantly increase the

 

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Company’s non-interest expense in future periods.  Any increase in assessments could adversely impact the Company’s future earnings and liquidity.

 

The effect of changes to banking capital standards could negatively impact the Company’s regulatory capital and liquidity.  In December 2010, the Basel Committee on Banking Supervision issued final rules related to global regulatory standards on bank capital adequacy and liquidity.  The new rules present details of the Basel III framework, which includes increased capital requirements and limits the types of instruments that can be included in Tier 1 capital.  Basel III implementation in the U.S. will require that regulations and guidelines be issued by U.S. banking regulators, which may significantly differ from the recommendations published by the Basel Committee.

 

The Company cannot predict at this time the precise content of capital and liquidity guidelines or regulations that may be adopted by regulatory agencies having authority over us and our subsidiary, or the impact that any changes in regulation would have on the Company.  However, we expect that the new standards will generally require the Company or our banking subsidiary to maintain more capital, with common equity as a more predominant component, or manage the configuration of our assets and liabilities in order to comply with new liquidity requirements, which could significantly impact our return on equity, financial condition, operations, capital position and ability to pursue business opportunities.

 

Increased competition from other providers may adversely affect our financial condition and results of operations.  We face vigorous competition from banks and other financial institutions.  This competition may reduce or limit our margins on banking services, reduce market share and adversely affect results of operations and financial condition.

 

Many other banks and financial institutions have substantially greater resources and lending limits, larger branch systems and a wider array of banking services.  Additionally, we encounter competition from both de novo and smaller community banks entering the markets we are currently in.  We also compete with other providers of financial services, such as money market mutual funds, brokerage firms, consumer finance companies and insurance companies.

 

Financial Risk

 

Financial risk components include, but are not limited to, credit risk, interest rate risk, goodwill impairment, market risk and liquidity risk.  We have adopted various policies to minimize potential adverse effects of interest rate, market and liquidity risks.  However, even with these policies in place, a change in interest rates could negatively impact our results of operations or financial position.

 

Defaults in the repayment of loans may negatively impact our business.  Credit risk is most closely associated with lending activities at financial institutions.  Credit risk is the risk to earnings and capital when a customer fails to meet the terms of any contract or otherwise fails to perform as agreed.  Credit risk arises from all activities where the Company is dependent on issuer, borrower, or counterparty performance, not just traditional lending activities.  For example, the investment security portfolio has inherent credit risk as do counterparties in derivative contracts.  Credit risk encompasses a broad range of financial institution activities and includes items reflected both on and off the balance sheet.

 

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Management makes various assumptions and judgments about the collectability of our loan portfolio, including the creditworthiness of its borrowers and the value of real estate and other assets serving as collateral for repayment of many of the loans.  In determining the size of the allowance for loan losses, management considers, among other factors, the Company’s loan loss experience and an evaluation of economic conditions.  If these assumptions prove to be incorrect, the current allowance may not be sufficient to cover future loan losses and adjustments may be necessary to allow for different economic conditions or adverse developments in the loan portfolio.  Material additions to the Company’s allowance would materially decrease our net income.

 

Fluctuations in interest rates may negatively impact our banking business.  Interest rate risk focuses on the impact to earnings and capital arising from movements in interest rates.  Interest rate risk focuses on the value implications for accrual portfolios (e.g., held-to-maturity and available-for-sale portfolios) and includes the potential impact to the Company’s accrual earnings as well as the economic perspective of the market value of portfolio equity.  The interest rate risk is comprised of repricing risk, basis risk, yield curve risk and options risk.  Repricing risk represents the risk associated with the differences in timing of cash flows and rate changes with our products.  Basis risk represents the risk associated with changing rate relationships among varying yield curves.  Yield curve risk is associated with changing rate relationships over the maturity structure.  Options risk is associated with interest-related options, which are embedded in our products.

 

Changes in market multiples may negatively affect the value of Goodwill.  Goodwill resulting from business combinations prior to January 1, 2009 represents the excess of the purchase price over the fair value of the net assets of businesses acquired.  Goodwill resulting from business combinations after January 1, 2009, is generally determined as the excess of the fair value of the consideration transferred, plus the fair value of any noncontrolling interests in the acquiree, over the fair value of the net assets acquired and liabilities assumed as of the acquisition date.  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.  At a minimum, management is required to assess goodwill and other intangible assets annually for impairment.  This assessment involves estimating cash flows for future periods, preparing analyses of market multiples for similar operations, and estimating the fair value of the reporting unit to which the goodwill is allocated.  If these variables change negatively, the Company would be required to take a charge against earnings to write down the asset to the lower fair value.

 

Changes in market factors may negatively affect the value of our investment assetsMarket risk focuses on the impact to earnings and capital arising from changes in market factors (e.g., interest rates, market liquidity, volatilities, etc.) that affect the value of traded instruments.  Market risk includes items reflected both on and off the balance sheet.  Market risk focuses primarily on mark-to-market portfolios (e.g., accounts revalued for financial statement presentation).

 

Our inability to maintain appropriate levels of liquidity may have a negative impact on our results of operations and financial condition.  Liquidity risk focuses on the impact to earnings and capital resulting from our inability to meet our obligations as they become due in the normal course of business without incurring significant losses.  It also includes the management of unplanned decreases or changes in funding sources as well as managing changes in market conditions, which could affect the ability to liquidate

 

11



 

assets in the normal course of business without incurring significant losses.  Liquidity risk includes items both on and off the balance sheet.

 

Business Risk

 

Business risk is composed mainly of legal (compliance) risk, strategic risk and reputation risk.

 

Our results of operations and financial condition are susceptible to legal or compliance risks.  Legal or compliance risk is the risk to earnings or capital arising from the impact of unenforceable contracts, lawsuits, adverse judgments, violations or nonconformance with laws, rules, regulations, prescribed practices, or ethical standards.  The risk also arises in situations where laws or rules governing certain products or activities of our customers may be ambiguous or untested.  This risk is not limited to the traditional thinking that legal/compliance risk is only associated with consumer protection laws.  It includes the exposure to litigation from all aspects of both traditional and nontraditional financial institution activities.

 

Incorrect strategic decisions may have a negative impact on our results of operations and financial condition.

 

Adverse publicity may have a negative impact on our business.  Reputation risk is the risk to earnings and capital arising from negative public opinion.  This affects the ability to establish new relationships or services or to continue servicing existing relationships.  Examiners will assess reputation risk by recognizing the potential effect the public’s opinion could have on our franchise value.

 

Operational Risk

 

An inability to process transactions may have a negative impact on our business.  Operational risk is present on a daily basis through our processing of transactions and is pervasive in all products and services provided to our customers.  It can be defined as the impact to earnings and capital from problems encountered in processing transactions.  Operational risk is a function of internal controls, operating processes, management information systems, and employee integrity.

 

Technology Risk

 

Systems failure, interruption or breach of security may have a negative impact on our business.  Communications and information systems are essential to the conduct of the Bank’s business, as such systems are used to manage customer relationships, deposits, loans, general ledger accounts, financial reporting and regulatory compliance.  While the Bank has established policies and procedures to prevent or limit the impact of systems failures, interruptions, and security breaches, there can be no assurance that such events will not occur or that they will be adequately addressed if they do.  In addition, any compromise of the Bank’s information security systems could deter customers from using the Bank’s web site and its internet banking service, both of which involve the transmission of confidential information.  Although the Bank relies on commonly used security and processing systems to provide the security and authentication necessary to ensure the secure transmission and processing of data, these precautions may not protect our systems from all compromises or breaches of security.

 

The business continuity of third-party providers may have a negative impact on our technology operations.  The Bank outsources certain of its data processing to third-party providers.  If third-party providers encounter difficulties, or if the Bank has difficulty

 

12



 

communicating with them, the Bank’s ability to adequately process and account for customer transactions could be affected, and the Bank’s business operations could be adversely impacted.  Threats to information security also exist in the processing of customer information through various other vendors and their personnel.

 

The Bank has addressed technology risks through the use of logon and user access controls, transaction limits, firewalls, antivirus software, intrusion protection monitoring and third party vulnerability scans.  Systems failure or interruption has been addressed by adopting a disaster recovery and contingency plan.  In addition, for all third-party providers of data processing services, the Bank obtains and reviews audit reports prepared by independent registered public accounting firms regarding their financial condition and the effectiveness of their internal controls.

 

Item 1B.  Unresolved Staff Comments

 

None.

 

Item 2.  Properties

 

The Company’s corporate headquarters is located at 339 Main Street, Paris, KY 40631, which it owns.  The main banking office of Kentucky Bank is located at 401 Main Street, Paris, Kentucky 40361.  In addition, Kentucky Bank serves customer needs at 12 other locations.  All locations offer a full range of banking services.  Kentucky Bank owns all of the properties at which it conducts its business.  The Company owns approximately 119,000 square feet of office space.

 

Note 6 to the Company’s audited and consolidated financial statements included in Item 8 (“2010 Consolidated Financial Statements and Notes”) contains additional information relating to amounts invested in premises and equipment.

 

Kentucky Bank Banking Offices

 

401 Main Street, Paris, KY 40361

2021 South Main Street, Paris, KY 40361

24 West Lexington Avenue, Winchester, KY 40391

1975 By Pass Road, Winchester, KY 40391

Main and Jane Street, Sandy Hook, KY 41171

939 US Hwy 27 South, Cynthiana, KY 41031

920 North Main Street, Nicholasville, KY 40356

108 East Main Street, Wilmore, KY 40390

400 West First Street, Morehead, KY 40351

1500 Flemingsburg Road, Morehead, KY 40351

260 Blossom Park Drive, Georgetown, KY 40324

103 West Showalter Drive, Georgetown, KY 40324

520 Marsailles Road, Versailles, KY 40383

 

13



 

Item 3.  Legal Proceedings

 

The Company and its subsidiary are from time to time involved in routine legal proceedings occurring in the ordinary course of business that, in the aggregate, management believes will not have a material impact on the Company’s financial condition and results of operation.  Further, we maintain liability insurance to cover some, but not all, of the potential liabilities normally incident to the ordinary course of our businesses as well as other insurance coverage’s customary in our business, with coverage limits as we deem prudent.

 

PART II

 

Item 5.  Market for Common Equity and Related Stockholder Matters

 

Market Information

 

There is no established public trading market for the Company’s Common Stock.  The Company’s Common Stock is not listed on any national securities exchange.  However, it is traded on the OTC Bulletin Board under the symbol “KTYB.OB”.  Trading in the Common Stock has been infrequent, with retail brokerage firms making the market.

 

The following table sets forth the high and low closing sales prices of the Common Stock from the OTC Bulletin Board and the dividends declared thereon, for the periods indicated below:

 

 

 

 

High

 

Low

 

Dividend

 

 

 

 

 

 

 

 

 

 

2010

Quarter 4

 

$

17.45

 

$

16.25

 

$

.21

 

 

Quarter 3

 

17.50

 

15.00

 

.21

 

 

Quarter 2

 

18.00

 

15.75

 

.21

 

 

Quarter 1

 

18.00

 

16.00

 

.21

 

2009

Quarter 4

 

$

17.90

 

$

15.50

 

$

.20

 

 

Quarter 3

 

18.00

 

15.20

 

.20

 

 

Quarter 2

 

17.95

 

15.50

 

.20

 

 

Quarter 1

 

19.50

 

16.50

 

.20

 

 

Note 16 to the Company’s 2010 Consolidated Financial Statements and Notes included Item 8 contains additional information relating to amounts available to be paid as dividends.

 

Holders

 

As of December 31, 2010 the Company had 2,738,039 shares of Common Stock outstanding and approximately 519 holders of record of its Common Stock.

 

Dividends

 

During 2010 and 2009, the Corporation declared quarterly cash dividends aggregating $0.84 and $0.80 per share, respectively.

 

14



 

Purchases of Equity Securities by the Issuer and Affiliates Purchasers

 

The table below lists issuer purchases of equity securities.

 

 

 

(a)

 

 

 

(c) Total Number

 

(d) Maximum Number

 

 

 

Total

 

(b)

 

of Shares (or Units)

 

(or Approximate Dollar

 

 

 

Number of

 

Average

 

Purchased as Part

 

Value) of Shares (or

 

 

 

Shares (or

 

Price Paid

 

of Publicly

 

Units) that May Yet Be

 

 

 

Units)

 

Per Share

 

Announced Plans

 

Purchased Under the

 

Period

 

Purchased

 

(or Unit)

 

Or Programs

 

Plans or Programs

 

 

 

 

 

 

 

 

 

 

 

10/1/10 - 10/31/10

 

1,150

 

$

17.00

 

1,150

 

30,398 shares

 

 

 

 

 

 

 

 

 

 

 

11/1/10 - 11/30/10

 

2,537

 

16.98

 

2,537

 

27,861 shares

 

 

 

 

 

 

 

 

 

 

 

12/1/10 - 12/31/10

 

500

 

16.25

 

500

 

27,361 shares

 

 

 

 

 

 

 

 

 

 

 

Total

 

4,187

 

 

 

4,187

 

27,361 shares

 

 

On October 25, 2000, the Company announced that its Board of Directors approved a stock repurchase program.  The Company is authorized to purchase up to 100,000 shares of its outstanding common stock.  On November 11, 2002, the Board of Directors approved and authorized the Company’s repurchase of an additional 100,000 shares.  On May 20, 2008, the Board of Directors approved and authorized the purchase of an additional 100,000 shares.  Shares will be purchased from time to time in the open market depending on market prices and other considerations.  Through December 31, 2010, 272,639 shares have been purchased, with the most recent share repurchase under the Board-approved stock repurchase program having occurred on December 1, 2010.

 

15



 

Securities Authorized for Issuance under Equity Compensation Plans

 

The following table sets forth certain information regarding Company compensations plans under which equity securities of the company are authorized for issuance.

 

 

 

 

 

 

 

No. of securities

 

 

 

 

 

 

 

remaining available

 

 

 

Number of securities

 

 

 

for future issuance

 

 

 

to be issued

 

Weighted average

 

under equity

 

 

 

upon exercise of

 

exercise price of

 

compensation plans

 

 

 

outstanding options,

 

outstanding options

 

(excluding securities

 

Plan category

 

warrants and rights

 

warrants and rights

 

reflected in column 1)

 

 

 

 

 

 

 

 

 

Plans Approved By Stockholders:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

1993 Nonemployee Directors Stock Ownership Incentive Plan

 

6,100

 

$

29.96

 

 

 

 

 

 

 

 

 

 

1999 Employee Stock Option Plan

 

26,540

 

29.37

 

 

 

 

 

 

 

 

 

 

2005 Restricted Stock Grant Plan

 

 

 

30,501

 

 

 

 

 

 

 

 

 

2009 Stock Award Plan

 

 

 

150,000

 

 

16



 

Performance Graph

 

The information included under the caption “Performance Graph” in this Item 5 of this Form 10-K is not deemed to be “soliciting material” or to be “filed” with the SEC or subject to Regulation 14A or 14C under the Securities Exchange Act of 1934 or to the liabilities of Section 18 of the Securities Exchange Act of 1934, and will not be deemed to be incorporated by reference into any filings we make under the Securities Act of 1933 or the Securities Exchange Act of 1934, except to the extent we specifically incorporate it by reference into such a filing.

 

The following graph compares the change in the cumulative total stockholder return on our common stock with the cumulative total return of the SIC Code 6022 State Commercial Banks less than $100 million and the Russell Microcap Index from 2005 through 2010.  This comparison assumes $100 invested on December 31, 2005 in (a) our common stock, (b) SIC Code 6022 State Commercial Banks <$100 million, and (c) the Russell Microcap Index.

 

 

17



 

Item 6.  Selected Financial Data (in thousands except per share data)

 

The following selected financial data should be read in conjunction with the Company’s Consolidated Financial Statements and the accompanying notes presented in Item 8.

 

 

 

At or For the Year Ended December 31

 

 

 

2010

 

2009

 

2008

 

2007

 

2006

 

CONDENSED STATEMENT OF INCOME:

 

 

 

 

 

 

 

 

 

 

 

Total Interest Income

 

$

30,276

 

$

31,929

 

$

35,129

 

$

39,219

 

$

35,593

 

Total Interest Expense

 

10,067

 

12,509

 

15,359

 

19,034

 

16,718

 

Net Interest Income

 

20,209

 

19,420

 

19,770

 

20,185

 

18,875

 

Provision for Losses

 

3,250

 

3,450

 

3,700

 

1,000

 

475

 

Net Interest Income After Provision for Losses

 

16,959

 

15,970

 

16,070

 

19,185

 

18,400

 

Noninterest Income

 

10,566

 

10,214

 

8,354

 

7,936

 

7,236

 

Noninterest Expense

 

22,021

 

21,152

 

20,027

 

18,131

 

16,682

 

Income Before Income Tax Expense

 

5,504

 

5,032

 

4,397

 

8,990

 

8,954

 

Income Tax Expense

 

565

 

184

 

684

 

2,404

 

2,468

 

Net Income

 

4,939

 

4,848

 

3,713

 

6,586

 

6,486

 

 

 

 

 

 

 

 

 

 

 

 

 

SHARE DATA:

 

 

 

 

 

 

 

 

 

 

 

Basic Earnings per Share (EPS)

 

$

1.81

 

$

1.77

 

$

1.34

 

$

2.31

 

$

2.35

 

Diluted EPS

 

1.81

 

1.77

 

1.33

 

2.30

 

2.34

 

Cash Dividends Declared

 

0.84

 

0.80

 

1.12

 

1.08

 

1.00

 

Book Value

 

22.29

 

22.25

 

20.77

 

20.65

 

19.59

 

Average Common Shares-Basic

 

2,732

 

2,737

 

2,778

 

2,852

 

2,762

 

Average Common Shares-Diluted

 

2,732

 

2,737

 

2,782

 

2,862

 

2,774

 

 

 

 

 

 

 

 

 

 

 

 

 

SELECTED BALANCE SHEET DATA:

 

 

 

 

 

 

 

 

 

 

 

Loans, including loans held for sale

 

$

406,905

 

$

417,818

 

$

418,812

 

$

412,509

 

$

439,159

 

Investment Securities

 

176,867

 

168,411

 

172,834

 

147,750

 

127,891

 

Total Assets

 

658,943

 

675,231

 

678,775

 

630,939

 

629,542

 

Deposits

 

537,401

 

536,446

 

520,808

 

486,005

 

468,808

 

Securities sold under agreements to repurchase and other borrowings

 

7,179

 

8,226

 

10,717

 

6,735

 

11,327

 

Federal Home Loan Bank advances

 

43,206

 

56,096

 

77,301

 

63,993

 

80,030

 

Stockholders’ Equity

 

61,043

 

60,966

 

57,041

 

58,844

 

55,281

 

 

 

 

 

 

 

 

 

 

 

 

 

PERFORMANCE RATIOS:

 

 

 

 

 

 

 

 

 

 

 

(Average Balances)

 

 

 

 

 

 

 

 

 

 

 

Return on Assets

 

0.71

%

0.72

%

0.58

%

1.04

%

1.09

%

Return on Stockholders’ Equity

 

7.84

%

8.10

%

6.45

%

11.59

%

12.82

%

Net Interest Margin (1) 

 

3.43

%

3.36

%

3.49

%

3.56

%

3.48

%

Equity to Assets (annual average)

 

9.07

%

8.92

%

8.96

%

8.97

%

8.48

%

 

 

 

 

 

 

 

 

 

 

 

 

SELECTED STATISTICAL DATA:

 

 

 

 

 

 

 

 

 

 

 

Dividend Payout Ratio

 

46.62

%

45.28

%

84.05

%

46.89

%

42.68

%

Number of Employees (at period end)

 

184

 

182

 

214

 

204

 

203

 

 

 

 

 

 

 

 

 

 

 

 

 

ALLOWANCE COVERAGE RATIOS:

 

 

 

 

 

 

 

 

 

 

 

Allowance to Total Loans

 

1.20

%

1.79

%

1.29

%

1.17

%

1.12

%

Net Charge-offs as a Percentage of Average Loans

 

1.42

%

0.31

%

0.75

%

0.26

%

0.14

%

 


(1)          Tax equivalent

 

18



 

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, 2010, 2009 and 2008, and the consolidated results of operations for each of the years in the three year period ended December 31, 2010.  The following discussion and analysis of financial condition and results of operations should be read in conjunction with the 2010 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 2010 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 2010 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 2010 Consolidated Financial Statements and Notes.

 

Goodwill.  Goodwill resulting from business combinations prior to January 1, 2009 represents the excess of the purchase price over the fair value of the net assets of businesses acquired.  Goodwill resulting from business combinations after January 1, 2009, is generally determined as the excess of the fair value of the consideration transferred, plus the fair value of any noncontrolling interests in the acquiree, over the fair value of the net assets acquired and liabilities assumed as of the acquisition date.  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

 

19



 

fully disclosed in the description of each asset and liability category in Note 1 of the Company’s 2010 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 85% of which are secured by real estate at December 31, 2010.  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 mortgage, installment and other loans to its individual and other non-commercial customers.  Kentucky Bank’s primary market is Bourbon, Clark, Elliott, Harrison, Jessamine, Rowan, Scott, Woodford and surrounding counties in Kentucky.

 

Net income for the year ended December 31, 2010 was $4.9 million, or $1.81 per common share compared to $4.8 million, or $1.77 for 2009 and $3.7 million, or $1.34 for 2008.  Earnings per share assuming dilution were $1.81, $1.77 and $1.33 for 2010, 2009 and 2008, respectively.  For 2010, net income increased $92 thousand, or 1.9%.  Net interest income increased $789 thousand, the loan loss provision decreased $200 thousand, total other income increased $352 thousand, while total other expenses increased $869 thousand and income tax expense increased $381 thousand.

 

For 2009, net income increased $1.1 million, or 30.6%.  Net interest income decreased $350 thousand, the loan loss provision decreased $250 thousand, total other income increased $1.9 million, while total other expenses increased $1.1 million.

 

20



 

Return on average equity was 7.8% in 2010 compared to 8.1% in 2009 and 6.5% in 2008.  Return on average assets was 0.71% in 2010 compared to 0.72% in 2009 and 0.58% in 2008.

 

Non-performing loans as a percentage of loans (including held for sale) were 3.20%, 3.42% and 1.73% as of December 31, 2010, 2009 and 2008, respectively.

 

RESULTS OF OPERATIONS

 

Net Interest Income

 

Net interest income, the Company’s largest source of revenue, on a tax equivalent basis increased from $20.7 million in 2008 and 2009 to $21.8 million in 2010.  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 2009 to 2010.  Average earning assets increased $19 million, or 3.1%.  Investment securities increased $3.0 million primarily due to lower level of loan demand.  Loans decreased $2.1 million as a result of the economy and slower demand during 2010.  Average interest bearing liabilities increased $9.7 million, or 1.9% during this same period.  This change was primarily from the increase in time deposits and “NOW” and money market accounts, offset by a decrease in borrowings.  The Company continues to actively pursue quality loans and fund these primarily with deposits and FHLB advances.

 

After peaking in 2006, bank prime rates began to decrease.  Bank prime rates decreased 100 basis points in 2007, and another 400 basis points in 2008, and have remain unchanged since then.  The tax equivalent yield on earning assets decreased from 5.38% in 2009 to 5.01% in 2010.

 

The volume rate analysis for 2010 that follows indicates that $1.7 million of the decrease in interest income is attributable to the decrease in rates, while the change in volume contributed to an increase of $9 thousand in interest income.  The rate decrease also caused a decrease in the cost of interest bearing liabilities.  The average rate of these liabilities decreased from 2.46% in 2009 to 1.94% in 2010.  Based on the volume rate analysis that follows, the lower level of interest rates contributed to a decrease of $2.1 million to interest expense, while the change in volume was responsible for a $332 thousand decrease in interest expense.  As a result, the 2010 net interest income increase is attributed mostly to decreases in rates and a decrease in average borrowings.

 

The volume rate analysis for 2009 that follows indicates that $4.5 million of the decrease in interest income is attributable to the decrease in rates, while the change in volume contributed to an increase of $1.3 million in interest income.  The rate decrease also caused a decrease in the cost of interest bearing liabilities.  The average rate of these liabilities decreased from 3.15% in 2008 to 2.46% in 2009.  Based on the volume rate analysis that follows, the lower level of interest rates contributed to a decrease of $3.5 million to interest expense, while the change in volume was responsible for a $602 thousand increase in interest expense.  As a result, the 2009 net interest income increase is attributed to decreases in rates.

 

21



 

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 2010 vs. 2009 and 2009 vs. 2008.  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)

 

 

 

2010 vs. 2009

 

2009 vs. 2008

 

 

 

Increase (Decrease) Due to Change in

 

Increase (Decrease) Due to Change in

 

 

 

Volume

 

Rate

 

Net Change

 

Volume

 

Rate

 

Net Change

 

INTEREST INCOME

 

 

 

 

 

 

 

 

 

 

 

 

 

Loans

 

$

(128

)

$

(889

)

$

(1,017

)

$

265

 

$

(2,796

)

$

(2,531

)

Investment Securities

 

111

 

(765

)

(654

)

1,185

 

(1,515

)

(330

)

Federal Funds Sold and Securities Purchased under Agreements to Resell

 

24

 

(1

)

23

 

(121

)

(213

)

(334

)

Deposits with Banks

 

2

 

(7

)

(5

)

1

 

(6

)

(5

)

Total Interest Income

 

9

 

(1,662

)

(1,653

)

1,330

 

(4,530

)

(3,200

)

INTEREST EXPENSE

 

 

 

 

 

 

 

 

 

 

 

 

 

Deposits

 

 

 

 

 

 

 

 

 

 

 

 

 

Demand

 

108

 

201

 

309

 

40

 

(830

)

(790

)

Savings

 

(25

)

(206

)

(231

)

9

 

(85

)

(76

)

Negotiable Certificates of Deposit and Other Time Deposits

 

364

 

(1,818

)

(1,454

)

986

 

(2,267

)

(1,281

)

Securities sold under agreements to repurchase and other borrowings

 

(184

)

(35

)

(219

)

 

(302

)

(302

)

Federal Home Loan Bank advances

 

(595

)

(252

)

(847

)

(433

)

32

 

(401

)

Total Interest Expense

 

(332

)

(2,110

)

(2,442

)

602

 

(3,452

)

(2,850

)

Net Interest Income

 

$

341

 

$

448

 

$

789

 

$

728

 

$

(1,078

)

$

(350

)

 

22



 

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

 

 

 

2010

 

2009

 

2008

 

 

 

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

 

99,178

 

2,605

 

2.63

%

107,658

 

3,641

 

3.38

%

88,272

 

4,348

 

4.93

%

State and Municipal obligations

 

83,833

 

3,393

 

4.05

%

72,307

 

2,994

 

4.14

%

63,463

 

2,581

 

4.07

%

Other Securities

 

6,978

 

305

 

4.37

%

6,982

 

322

 

4.61

%

6,796

 

358

 

5.27

%

Total Securities Available for Sale

 

189,989

 

6,303

 

3.32

%

186,947

 

6,957

 

3.72

%

158,531

 

7,287

 

4.60

%

Total Investment Securities

 

189,989

 

6,303

 

3.32

%

186,947

 

6,957

 

3.72

%

158,531

 

7,287

 

4.60

%

Tax Equivalent Adjustment

 

 

 

1,626

 

0.86

%

 

 

1,307

 

0.70

%

 

 

944

 

0.60

%

Tax Equivalent Total

 

 

 

7,929

 

4.17

%

 

 

8,264

 

4.42

%

 

 

8,231

 

5.19

%

Federal Funds Sold and Agreements to Repurchase

 

27,049

 

35

 

0.13

%

8,678

 

12

 

0.14

%

18,324

 

346

 

1.89

%

Interest-Bearing Deposits with Banks

 

1,056

 

4

 

0.38

%

882

 

9

 

1.02

%

799

 

14

 

1.75

%

Loans, Net of Deferred Loan Fees (2)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial

 

45,817

 

2,584

 

5.64

%

47,395

 

2,696

 

5.69

%

45,309

 

2,852

 

6.29

%

Real Estate Mortgage

 

357,382

 

20,088

 

5.62

%

360,752

 

21,220

 

5.88

%

358,067

 

23,442

 

6.55

%

Installment

 

15,332

 

1,262

 

8.23

%

12,563

 

1,035

 

8.24

%

13,292

 

1,187

 

8.93

%

Total Loans

 

418,531

 

23,934

 

5.72

%

420,710

 

24,951

 

5.93

%

416,668

 

27,481

 

6.60

%

Total Interest-Earning Assets

 

636,625

 

31,902

 

5.01

%

617,217

 

33,236

 

5.38

%

594,322

 

36,072

 

6.07

%

Allowance for Loan Losses

 

(6,742

)

 

 

 

 

(6,064

)

 

 

 

 

(5,123

)

 

 

 

 

Cash and Due From Banks

 

12,891

 

 

 

 

 

12,585

 

 

 

 

 

13,387

 

 

 

 

 

Premises and Equipment

 

17,699

 

 

 

 

 

17,754

 

 

 

 

 

17,196

 

 

 

 

 

Other Assets

 

34,279

 

 

 

 

 

29,374

 

 

 

 

 

22,729

 

 

 

 

 

Total Assets

 

694,752

 

 

 

 

 

670,866

 

 

 

 

 

642,511

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

LIABILITIES

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-Bearing Deposits

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Negotiable Order of Withdrawal (“NOW”) and Money Market Investment Accounts

 

136,870

 

773

 

0.56

%

113,576

 

464

 

0.41

%

110,022

 

1,254

 

1.14

%

Savings

 

36,544

 

91

 

0.25

%

39,888

 

322

 

0.81

%

38,962

 

398

 

1.02

%

Certificates of Deposit and Other Deposits

 

281,493

 

6,994

 

2.48

%

269,435

 

8,448

 

3.14

%

242,884

 

9,729

 

4.01

%

Total Interest-Bearing Deposits

 

454,907

 

7,858

 

1.73

%

422,899

 

9,234

 

2.18

%

391,868

 

11,381

 

2.90

%

Securities sold under agreements to repurchase and other borrowings

 

14,401

 

377

 

2.62

%

21,354

 

596

 

2.79

%

21,346

 

898

 

4.21

%

Federal Home Loan Bank advances

 

48,803

 

1,832

 

3.75

%

64,142

 

2,679

 

4.18

%

74,508

 

3,080

 

4.13

%

Total Interest-Bearing Liabilities

 

518,111

 

10,067

 

1.94

%

508,395

 

12,509

 

2.46

%

487,722

 

15,359

 

3.15

%

Noninterest-Bearing Earning Demand Deposits

 

108,426

 

 

 

 

 

96,171

 

 

 

 

 

91,244

 

 

 

 

 

Other Liabilities

 

5,192

 

 

 

 

 

6,438

 

 

 

 

 

5,983

 

 

 

 

 

Total Liabilities

 

631,729

 

 

 

 

 

611,004

 

 

 

 

 

584,949

 

 

 

 

 

STOCKHOLDERS’ EQUITY

 

63,023

 

 

 

 

 

59,862

 

 

 

 

 

57,562

 

 

 

 

 

Total Liabilities and Stockholders’ Equity

 

694,752

 

 

 

 

 

670,866

 

 

 

 

 

642,511

 

 

 

 

 

Average Equity to Average Total Assets

 

9.07

%

 

 

 

 

8.92

%

 

 

 

 

8.96

%

 

 

 

 

Net Interest Income

 

 

 

20,209

 

 

 

 

 

19,420

 

 

 

 

 

19,769

 

 

 

Net Interest Income (tax equivalent) (3) 

 

 

 

21,835

 

 

 

 

 

20,727

 

 

 

 

 

20,713

 

 

 

Net Interest Spread (tax equivalent) (3) 

 

 

 

 

 

3.07

%

 

 

 

 

2.92

%

 

 

 

 

2.92

%

Net Interest Margin (tax equivalent) (3) 

 

 

 

 

 

3.43

%

 

 

 

 

3.36

%

 

 

 

 

3.49

%

 


(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.

 

23



 

Noninterest Income and Expenses

 

Noninterest income was $10.6 million in 2010 compared to $10.2 million in 2009 and $8.4 million in 2008.  In 2010, increases in securities gains and gains on sold mortgage loans account for the majority of the increase.  In 2009, increases in securities gains also account for the majority of the increase.  However, for both 2009 and 2010 these increases were offset by decreases in service charges.

 

Securities gains were $2.1 million in 2010, $1.6 million in 2009 and $658 thousand in 2008.  These are primarily attributable to declining interest rates and the related inverse relationship of interest rates and market values.  Some securities gains were taken in 2010, 2009 and 2008 and used to offset additions to the loan loss reserve and costs related to the pension plan termination in 2009 and 2008.

 

Gains on loans sold were $1.1 million, $1.2 million and $411 thousand in 2010, 2009 and 2008, respectively.  Loans held for sale are generally sold after closing to the Federal Home Loan Mortgage Corporation.  During 2010, the loan service fee income decreased $41 thousand, compared to an increase of $290 thousand in 2009, which was largely due to recovering some of the write downs of mortgage servicing rights in 2008 which totaled $213 thousand.  Proceeds from the sale of loans were $38 million, $53 million and $19 million in 2010, 2009 and 2008, respectively.  The volume of loan originations is inverse to rate changes with historic low rates in 2010 and 2009 spurring activity.  The volume of loan originations during 2010 was $37 million, $52 million in 2009, and $19 million in 2008.

 

Other noninterest income excluding security net gains and gains on the sale of mortgage loans was $7.4 million in 2010, $7.4 million in 2009 and $7.3 million in 2008.  Service charge income, and more particularly overdraft income, is the largest contributor to these numbers.  Overdraft income was $3.9 million in 2010, $4.2 million in 2009 and $4.3 million in 2008.  The decreases in 2010 and 2009 are primarily attributable to the slower economy.  Debit card interchange income was the second largest contributor to noninterest income, excluding security net gains and gains on the sale of mortgage loans.  Debit card interchange income was $1.5 million in 2010, $1.3 million in 2009 and $1.2 million in 2008.  Other income was $157 thousand in 2008, $79 thousand in 2009 and $148 thousand in 2010.  The increase in other income during 2010 was mainly the result of an increase of $113 thousand in trust fees.

 

Noninterest expense increased $869 thousand in 2010 to $22.0 million, and increased $1.1 million in 2009 to $21.2 million from $20.0 million in 2008.  The increases in salaries and benefits from $11.1 million in 2008 to $11.3 million in 2009 are attributable to normal salary and benefit increases.  The decrease in salaries and benefits of $1.0 million in 2010 to $10.2 million was mostly the result of having no pension expense in 2010.  Costs associated with terminating the pension plan as of December 31, 2008 that were incurred and expensed in 2009 were $874 thousand. Additional pension plan costs due to its December 31, 2008 termination were $563 thousand in 2008.  There were also fewer employees during the first half of the year in 2010 due to certain employees being offered and accepting voluntary separation offers during the fourth quarter of 2009.  The reduction in staff also contributed to a decrease in salary expense.  Bonus compensation was $25 thousand less in 2010 compared to 2009 and $381 thousand higher in 2009 compared to 2008.  The 2009 increase was mainly a result of a successful bank wide incentive program that incorporated individual goals.  The 2010 bonus compensation plan was similar to the plan offered in 2009.  Occupancy expense increased $283 thousand in 2010 to $2.9 million and decreased $92 thousand, or 3.3% in 2009 to $2.6 million.  The largest expense, depreciation, increased $193 thousand to $1.2 million in 2010, and decreased $128 thousand to $1.0 million in 2009.  Other noninterest expenses increased from $6.2 million in 2008 to $7.2 million in 2009 and increased to $8.8 million in 2010.  Repossession expenses increased $993 thousand in 2010 compared to 2009 to $1.3 million.  Of this, $560 thousand was due to write-downs and adjustments to properties classified as “Other

 

24



 

Real Estate” the Company had on its books during 2010.  FDIC insurance decreased $117 thousand in 2010 compared to 2009.  Legal and professional fees increased $279 thousand from 2009 to 2010, mainly from additional loan collection efforts.  Advertising and marketing expenses incurred increased $141 thousand during 2010 compared to 2009.  Taxes other than payroll, property and income increased $204 thousand in 2010 from 2009 to $795 thousand.  The increase was mostly due to a one-time tax credit the Company received in 2009 in the amount of $171 thousand.  Amortization of core deposits related to the Peoples acquisition was $158 thousand in 2010, compared to $164 thousand in 2009.  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)

 

 

 

2010

 

2009

 

2008

 

NON-INTEREST INCOME

 

 

 

 

 

 

 

Service Charges

 

$

4,920

 

$

5,212

 

$

5,332

 

Loan Service Fee Income (Loss), net

 

119

 

160

 

(130

)

Trust Department Income

 

633

 

520

 

478

 

Investment Securities Gains (Losses),net

 

2,082

 

1,619

 

658

 

Gains on Sale of Mortgage Loans

 

1,054

 

1,205

 

411

 

Brokerage Income

 

156

 

149

 

249

 

Debit Card Interchange Income

 

1,454

 

1,270

 

1,199

 

Other

 

148

 

79

 

157

 

Total Non-interest Income

 

10,566

 

10,214

 

8,354

 

 

 

 

 

 

 

 

 

NON-INTEREST EXPENSE

 

 

 

 

 

 

 

Salaries and Employee Benefits

 

10,245

 

11,289

 

11,082

 

Occupancy Expenses

 

2,929

 

2,646

 

2,738

 

Other

 

8,847

 

7,217

 

6,207

 

Total Non-interest Expense

 

22,021

 

21,152

 

20,027

 

 

 

 

 

 

 

 

 

Net Non-interest Expense as a Percentage of Average Assets

 

1.71

%

1.63

%

1.82

%

 

Income Taxes

 

The Company had income tax expense of $565 thousand in 2010 and $185 thousand in 2009 and $684 thousand in 2008.  This represents an effective income tax rate of 10.3% in 2010, 3.7% in 2009 and 15.6% in 2008.  The difference between the effective tax rate and the statutory federal rate of 34% is primarily due to tax exempt income on certain investment securities and loans.  In addition, in 2009 and 2010, the Company had additional tax credits which also contributed to the lower effective income tax rate for those years.

 

Balance Sheet Review

 

Assets declined from $675 million at December 31, 2009 to $659 million at December 31, 2010.  Securities increased $8 million and loans decreased $11 million in 2010.  Deposits grew $1 million and FHLB borrowings decreased $13 million.  Assets at year-end 2009 totaled $675 million compared to $679 million in 2008.  Loans increased $1 million in 2009.  Deposits grew $16 million and FHLB borrowings decreased $21 million.  The gain in deposits of 3% is primarily from normal growth and the addition of public money.

 

25



 

Loans

 

Total loans (including loans held for sale) were $412 million at December 31, 2010 compared to $425 million at the end of 2009 and $424 million in 2008.  The decrease in 2010 is mainly attributable to decreased loan demand and the Company charging off non-performing loans or repossessing the collateral associated with certain non-performing loans and those loans balances being moved to “Other Real Estate” on the balance sheet.  Loans increased $1 million in 2009, and the increase in 2009 was primarily attributable to normal loan demand.  As of the end of 2010 and compared to the prior year-end, commercial loans increased $907 thousand, real estate construction loans decreased $3.3 million, 1-4 family residential property loans decreased $5.2 million, multi-family residential property loans decreased $168 thousand, non-farm & non-residential property loans decreased $4.1 million, agricultural loans decreased $2.2 million and installment loans increased $552 thousand.  As of the end of 2009 and compared to the prior year-end, commercial loans increased $428 thousand, real estate construction loans were flat, 1-4 family residential property loans decreased $7.4 million, multi-family residential property loans decreased $2.1 million, non-farm & non-residential property loans decreased $4.5 million and installment loans increased $600 thousand.

 

As of December 31, 2010, the real estate mortgage portfolio comprised 68% of total loans similar to 68% in 2009.  Of this, 1-4 family residential property represented 57% in 2010 and 57% in 2009.  Agricultural loans comprised 19% in 2010 and 19% in 2009 of the loan portfolio.  Approximately 77% of the agricultural loans are secured by real estate in 2010 compared to 75% in 2009.  The remainder of the agricultural portfolio is used to purchase livestock, equipment and other capital improvements and for general operation of the farm.  Generally, a secured interest is obtained in the capital assets, equipment, livestock or crops.  Automobile loans account for 27% in 2010 and 30% in 2009 of the consumer loan portfolio, while the purpose of the remainder of this portfolio is used by customers for purchasing retail goods, home improvement or other personal reasons.  The commercial loan portfolio is mainly for capital outlays and business operation.  Collateral is requested depending on the creditworthiness of the borrower.  Unsecured loans are made to individuals or companies mainly based on the creditworthiness of the customer.  Approximately 6% of the loan portfolio is unsecured.  Management is not aware of any significant concentrations that may cause future material risks, which may result in significant problems with future income and capital requirements.

 

The following table represents a summary of the Company’s loan portfolio by category for each of the last five years.  There is no concentration of loans (greater than 5% of the loan portfolio) in any industry.  The Company has no foreign loans or highly leveraged transactions in its loan portfolio.

 

Loans Outstanding

 

 

 

December 31 (in thousands)

 

 

 

2010

 

2009

 

2008

 

2007

 

2006

 

Commercial

 

$

22,840

 

$

21,933

 

$

21,505

 

$

22,924

 

$

29,335

 

Real Estate Construction

 

13,518

 

16,865

 

16,819

 

26,172

 

29,034

 

Real Estate Mortgage:

 

 

 

 

 

 

 

 

 

 

 

1-4 Family Residential

 

158,997

 

164,445

 

157,081

 

168,087

 

177,378

 

Multi-Family Residential

 

13,519

 

13,687

 

15,749

 

17,805

 

21,004

 

Non-Farm & Non-Residential

 

105,580

 

109,665

 

114,202

 

84,857

 

91,942

 

Agricultural

 

78,375

 

80,619

 

80,779

 

80,774

 

79,627

 

Installment

 

18,830

 

18,277

 

17,643

 

15,421

 

15,684

 

Other

 

291

 

280

 

685

 

1,603

 

402

 

Total Loans

 

411,950

 

425,771

 

424,463

 

417,643

 

444,406

 

Less Deferred Loan Fees

 

120

 

161

 

186

 

255

 

256

 

Total Loans, Net of Deferred Loan Fees

 

411,830

 

425,610

 

424,277

 

417,388

 

444,150

 

Less loans held for sale

 

 

191

 

 

 

 

Less Allowance for Loan Losses

 

4,925

 

7,601

 

5,465

 

4,879

 

4,991

 

Net Loans

 

406,905

 

417,818

 

418,812

 

412,509

 

439,159

 

 

26



 

The following table sets forth the maturity distribution and interest sensitivity of selected loan categories at December 31, 2010.  Maturities are based upon contractual term.  The total loans in this report represent loans net of deferred loan fees, including loans held for sale but excluding the allowance for loan losses.  In addition, deferred loan fees on the above table are netted with real estate mortgage loans on the following table.

 

Loan Maturities and Interest Sensitivity

 

 

 

December 31, 2010 (in thousands)

 

 

 

One Year

 

One Through

 

Over

 

Total

 

 

 

or Less

 

Five Years

 

Five Years

 

Loans

 

Commercial

 

$

14,622

 

$

6,943

 

$

1,275

 

$

22,840

 

Real Estate Construction

 

7,286

 

6,232

 

 

 

13,518

 

Real Estate Mortgage:

 

 

 

 

 

 

 

 

 

1-4 Family Residential

 

11,765

 

26,510

 

120,602

 

158,877

 

Multi-Family Residential

 

815

 

4,729

 

7,975

 

13,519

 

Non-Farm & Non-Residential

 

16,089

 

30,038

 

59,453

 

105,580

 

Agricultural

 

14,551

 

30,325

 

33,499

 

78,375

 

Installment

 

5,148

 

9,838

 

3,844

 

18,830

 

Other

 

291

 

 

 

291

 

Total Loans, Net of Deferred Loan Fees

 

70,567

 

114,615

 

226,648

 

411,830

 

Fixed Rate Loans

 

25,751

 

68,491

 

33,733

 

127,975

 

Floating Rate Loans

 

44,816

 

46,124

 

192,915

 

283,855

 

Total Loans, Net of Deferred Loan Fees

 

70,567

 

114,615

 

226,648

 

411,830

 

 

Mortgage Banking

 

The Company has been in mortgage banking since the early 1980’s.  The activity in origination and sale of these loans fluctuates, mainly due to changes in interest rates.  Mortgage loan originations increased from $19 million in 2008 to $52 million in 2009, and decreased to $37 million in 2010.  Proceeds from the sale of loans were $38 million, $53 million and $19 million for the years 2010, 2009 and 2008, respectively.  Mortgage loans held for sale were zero at December 31, 2010 and $191 thousand at December 31, 2009.  Loans are generally sold when they are made.  The volume of loan originations is inverse to rate changes.  Declining rates toward the end of 2007 and continued low rates into 2009, along with consumer tax incentives, resulted in higher loan originations starting in the latter portion of 2007 and continued into 2009.  During 2010, leveling of interest rates primarily resulted in a decline in mortgage originations.  Better pricing resulted in a slight decrease in the gain on sale of mortgage loans from 2009 to 2010.  The effect of these changes was also reflected on the income statement.  As a result, the gain on sale of mortgage loans was $1.1 million in 2010 compared to $1.2 million in 2009 and $411 thousand in 2008.

 

The Bank has sold various loans to the Federal Home Loan Mortgage Corporation (FHLMC) while retaining the servicing rights.  Gains and losses on loan sales are recorded at the time of the cash sale, which represents the premium or discount paid by the FHLMC.  The Bank receives a servicing fee from the FHLMC on each loan sold.  Servicing rights are capitalized based on the relative fair value of the rights and the expected life of the loan and are included in intangible assets on the balance sheet and expensed in proportion to, and over the period of, estimated net servicing revenues.  Mortgage servicing rights were $958 thousand at December 31, 2010, $822 thousand at December 31, 2009 and $465 thousand at December 31, 2008.  Amortization of mortgage servicing rights was $224 thousand (including $36 thousand in recovery of 2009 write downs), $161 thousand (including $75 thousand in recovery of 2008 write downs) and $417 thousand (including $213 thousand in write downs) for the years ended

 

27



 

December 31, 2010, 2009 and 2008, respectively.  See Note 4 in the Company’s 2010 Consolidated Financial Statements and Notes included in Item 8 for additional information.

 

Deposits

 

For 2010, total deposits increased $1 million to $537 million.  Noninterest bearing deposits increased $9 million, time deposits of $100 thousand and over increased   $6 million, and other interest bearing deposits decreased $14 million.  Public funds totaled $106 million at the end of 2010 ($100 million were interest bearing).

 

Total deposits increased to $536 million in 2009, up $16 million from 2008.  Noninterest bearing deposits increased $7 million, time deposits of $100 thousand and over decreased $3 million, and other interest bearing deposits increased $13 million.  Public funds totaled $101 million at the end of 2009 ($95 million were interest bearing), an increase of $46 million from the end of 2008.

 

The table below provides information on the maturities of time deposits of $100,000 or more at December 31, 2010:

 

Maturity of Time Deposits of $100,000 of More

 

 

 

At December 31, 2010

 

 

 

(in thousands)

 

Maturing 3 Months or Less

 

$

41,385

 

Maturing over 3 Months through 6 Months

 

7,083

 

Maturing over 6 Months through 12 Months

 

34,734

 

Maturing over 12 Months

 

28,037

 

Total

 

$

111,239

 

 

Borrowings

 

The Company utilizes both long and short term borrowings.  Long term borrowing at the Bank is mainly from the Federal Home Loan Bank (FHLB).  This borrowing is mainly used to fund longer term, fixed rate mortgages, as part of a leverage strategy and to assist in asset/liability management.  Advances are either paid monthly or at maturity.  As of December 31, 2010, $43 million was borrowed from FHLB, a decrease of $13 million from 2009.  During 2010, $13 million of FHLB borrowing was paid, and no new advances were made.  The decrease in advances in 2010 is primarily a result of an increase in deposits and the slower loan growth.  In 2009, $32 million of FHLB advances were paid and advances were made for an additional $11 million.  The following table depicts relevant information concerning our short term borrowings.

 

28



 

Short Term Borrowings

 

 

 

As of and for the year ended

 

 

 

December 31 (in thousands)

 

 

 

2010

 

2009

 

2008

 

Federal Funds Purchased:

 

 

 

 

 

 

 

Balance at Year end

 

$

 

$

 

$

 

Average Balance During the Year

 

452

 

2,094

 

1,643

 

Maximum Month End Balance

 

4,657

 

12,611

 

10,853

 

Year end rate

 

0.00

%

0.00

%

0.00

%

Average annual rate

 

0.38

%

0.45

%

2.25

%

Repurchase Agreements:

 

 

 

 

 

 

 

Balance at Year end

 

$

5,079

 

$

4,807

 

$

6,617

 

Average Balance During the Year

 

3,936

 

8,576

 

9,686

 

Maximum Month End Balance

 

5,079

 

11,935

 

13,125

 

Year end rate

 

0.41

%

1.33

%

3.09

%

Average annual rate

 

1.34

%

2.43

%

2.97

%

Other Borrowed Funds:

 

 

 

 

 

 

 

Balance at Year end

 

$

2,100

 

$

3,419

 

$

4,100

 

Average Balance During the Year

 

2,796

 

3,467

 

2,800

 

Maximum Month End Balance

 

3,714

 

3,901

 

4,500

 

Year end rate

 

3.25

%

2.76

%

2.46

%

Average annual rate

 

3.02

%

2.78

%

3.68

%

 

Contractual Obligations

 

The Bank has required future payments for time deposits and long-term debt.  The other required payments under such commitments at December 31, 2010 are as follows:

 

 

 

Payments due by period (in thousands)

 

 

 

 

 

Less

 

 

 

 

 

More

 

 

 

 

 

than 1

 

1-3

 

3-5

 

than 5

 

Contractual Obligations

 

Total

 

year

 

years

 

years

 

years

 

 

 

 

 

 

 

 

 

 

 

 

 

FHLB advances

 

$

43,206

 

$

11,252

 

$

19,021

 

$

7,378

 

$

5,555

 

Subordinated debentures

 

7,217

 

 

 

 

7,217

 

Time deposits

 

242,598

 

170,354

 

61,683

 

10,561

 

 

 

29



 

Asset Quality

 

With respect to asset quality, management considers three categories of assets to merit close scrutiny.  These categories include:  loans that are currently nonperforming, other real estate, and loans that are currently performing but which management believes require special attention.

 

During periods of economic slowdown, the Company may experience an increase in nonperforming loans.

 

The Company discontinues the accrual of interest on loans that become 90 days past due as to principal or interest unless reasons for delinquency are documented such as the loan being well collateralized and in the process of collection.  A loan remains in a non-accrual status until factors indicating doubtful collection no longer exist.  A loan is classified as a restructured loan when the interest rate is materially reduced or the term is extended beyond the original maturity date because of the inability of the borrower to service the interest payments at market rates.  Other real estate is recorded at fair market value less estimated costs to sell.  A summary of the components of nonperforming assets, including several ratios using period-end data, is shown below.

 

Nonperforming Assets

 

 

 

At December 31 (in thousands)

 

 

 

2010

 

2009

 

2008

 

2007

 

2006

 

Non-accrual Loans

 

$

12,479

 

$

12,038

 

$

6,562

 

$

6,358

 

$

2,379

 

Accruing Loans which are Contractually past due 90 days or more

 

706

 

2,526

 

779

 

195

 

253

 

Restructured Loans

 

 

 

 

 

 

Total Nonperforming Loans

 

13,185

 

14,564

 

7,341

 

6,553

 

2,632

 

Other Real Estate

 

8,424

 

4,542

 

1,840

 

768

 

411

 

Total Nonperforming Assets

 

21,609

 

19,106

 

9,181

 

7,321

 

3,043

 

Total Nonperforming Loans as a Percentage of Loans (including loans held for sale) (1) 

 

3.20

%

3.42

%

1.73

%

1.57

%

0.59

%

Total Nonperforming Assets as a Percentage of Total Assets

 

3.28

%

2.83

%

1.35

%

1.16

%

0.48

%

Allowance to nonperforming assets

 

0.23

 

0.40

 

0.60

 

0.67

 

1.64

 

 


(1)  Net of deferred loan fees

 

Total nonperforming assets at December 31, 2010 were $21.6 million compared to $19.1 million at December 31, 2009 and $9.2 million at December 31, 2008.  The increase from 2009 to 2010 is attributed primarily to additions to other real estate.  The increase from 2008 to 2009 is primarily attributable to the increase in various loans being put on non-accrual and additions to other real estate.  Of the $8.4 million of other real estate at December 31, 2010, $4.7 million is income producing property.  Total nonperforming loans were $13.2 million, $14.6 million, and $7.3 million at December 31, 2010, 2009 and 2008, respectively.  The non-accrual loan increase from 2009 to 2010 was mainly attributable to several smaller loans being placed on non-accrual.  No loans that were placed into non-accrual status during 2010 and still classified as non-accrual at December 31, 2010, were greater than $500 thousand.  Loans placed into non-accrual status during 2010 that were still listed as non-accrual at December 31, 2010 totaled $5.4 million.  The ending non-accrual loan balance did not increase accordingly due to loans being charged off in 2010 that were classified as non-accrual loans at December 31, 2009, and transfers to other real estate.  Total charge offs in 2010 was $6.8 million.   The non-accrual loan increase from 2008 to 2009 was mainly attributable to four loans ranging from $1.2 million to $3.4 million that total $7.8 million.  All other non-accrual loans were less than $500 thousand.  The decrease in past due loans greater than 90 days or more is mostly the result of

 

30



 

loans past due more than 90 days at December 31, 2009 being placed into non-accrual status during 2010.  In 2009, the increase in past due loans 90 days or more was primarily from one borrower of $1.4 million.  All other loans in this category were less than $300 thousand.  These loans were secured by real estate.  The amount of lost interest on our non-accrual loans was $620 thousand for 2010 and $600 thousand for 2009.  At December 31, 2010, loans currently performing but which management believes requires special attention were $21.7 million, with 51% being 1-4 family residential.  The Company continues to follow its long-standing policy of not engaging in international lending and not concentrating lending activity in any one industry.

 

Impaired loans as of December 31, 2010 were $19.8 million compared to $33.5 million in 2009 and $5.1 million in 2008.  These amounts are generally included in the total nonperforming and restructured loans presented in the table above.  See Note 4 in the Company’s 2010 Consolidated Financial Statements and Notes included in Item 8 herein.

 

A loan is considered impaired when it is probable that all principal and interest amounts will not be collected according to the loan contract.  The allowance for loan losses on impaired loans is determined using the present value of estimated future cash flows of the loan, discounted at the loan’s effective interest rate or the fair value of the underlying collateral.  The entire change in present value of expected cash flows is reported as a provision for loan losses in the same manner in which impairment initially was recognized or as a reduction in the amount of provision for loan losses that otherwise would be reported.  The total allowance for loan losses related to these loans was $799 thousand, $4.1 million and $320 thousand on December 31, 2010, 2009 and 2008, respectively.  The reduction in specific allocations is directly related to the reduction in impaired loans as we charged off large loans in 2010 that had been specifically reserved for in 2009.

 

Kentucky Bank has a “Problem Loan Committee” that meets at least monthly to review problem loans, including past dues and non-performing loans, and other real estate.  When analyzing the problem loans and the loan quality as of December 31, 2010, the following factors have been considered:

 

·                  The loan portfolio decreased $11 million from December 31, 2009 to December 31, 2010.

·                  Nonperforming loans decreased $1.4 million from December 31, 2009 to December 31, 2010.

·                  Impaired loans decreased $13.7 million from December 31, 2009 to December 31, 2010, and the related allowance for loan losses decreased $3.3 million.

·                  Forty five percent of the net charge-offs in 2010 were reserved for in 2009.

 

31



 

Loan Losses

 

The following table is a summary of the Company’s loan loss experience for each of the past five years.

 

Loan Losses

 

 

 

For the Year Ended December 31 (in thousands)

 

 

 

2010

 

2009

 

2008

 

2007

 

2006

 

Balance at Beginning of Year

 

$

7,600

 

$

5,465

 

$

4,879

 

$

4,991

 

$

4,310

 

Balance of Allowance for Loan Losses of Acquired Bank at Acquisition Date Amounts Charged-off:

 

 

 

 

 

 

 

 

 

775

 

Commercial

 

24

 

340

 

114

 

131

 

15

 

Real Estate Construction

 

1,236

 

39

 

637

 

374

 

28

 

Real Estate Mortgage:

 

 

 

 

 

 

 

 

 

 

 

1-4 Family Residential

 

2,009

 

807

 

787

 

289

 

232

 

Multi-Family Residential

 

1,336

 

 

 

 

 

Non-Farm & Non-Residential

 

1,498

 

 

1,194

 

 

 

Agricultural

 

83

 

22

 

101

 

25

 

3

 

Consumer

 

607

 

621

 

563

 

449

 

365

 

Total Charged-off Loans

 

6,793

 

1,829

 

3,396

 

1,268

 

643

 

Recoveries on Amounts Previously Charged-off:

 

 

 

 

 

 

 

 

 

 

 

Commercial

 

43

 

6

 

6

 

24

 

2

 

Real Estate Construction

 

 

35

 

27

 

19

 

 

Real Estate Mortgage:

 

 

 

 

 

 

 

 

 

 

 

1-4 Family Residential

 

35

 

71

 

15

 

10

 

 

Multi-Family Residential

 

 

 

 

 

 

Non-Farm & Non-Residential

 

706

 

337

 

150

 

 

 

2

 

Agricultural

 

17

 

0

 

30

 

64

 

21

 

Consumer

 

67

 

65

 

54

 

39

 

49

 

Total Recoveries

 

868

 

514

 

282

 

156

 

74

 

Net Charge-offs

 

5,925

 

1,315

 

3,114

 

1,112

 

569

 

Provision for Loan Losses

 

3,250

 

3,450

 

3,700

 

1,000

 

475

 

Balance at End of Year

 

4,925

 

7,600

 

5,465

 

4,879

 

4,991

 

Total Loans (1)

 

 

 

 

 

 

 

 

 

 

 

Average

 

418,531

 

420,710