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EX-23 - EX-23 - KENTUCKY BANCSHARES INC /KY/a15-23402_1ex23.htm
EX-21 - EX-21 - KENTUCKY BANCSHARES INC /KY/a15-23402_1ex21.htm
EX-32.1 - EX-32.1 - KENTUCKY BANCSHARES INC /KY/a15-23402_1ex32d1.htm
EX-31.1 - EX-31.1 - KENTUCKY BANCSHARES INC /KY/a15-23402_1ex31d1.htm
EX-31.2 - EX-31.2 - KENTUCKY BANCSHARES INC /KY/a15-23402_1ex31d2.htm
EX-32.2 - EX-32.2 - KENTUCKY BANCSHARES INC /KY/a15-23402_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, 2015

 

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:  000-52598

 

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 QX

 

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 x 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.  x

 

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, 2015 was approximately $71.4 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 10, 2016:  2,996,727.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the Registrant’s definitive Proxy Statement for its Annual Meeting of Stockholders to be held on May 26, 2016 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, and one non-bank subsidiary KBI Insurance Company.

 

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), Lexington (Fayette), Morehead (Rowan County), Nicholasville (Jessamine County), Richmond (Madison 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”).  KBI Insurance Company is a captive insurance subsidiary and was incorporated in 2014.

 

The Company had total assets of $974.7 million, total deposits of $759.0 million and stockholders’ equity of $89.4 million as of December 31, 2015.  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 its product offerings and premier 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 83% of which are secured by real estate at December 31, 2015.  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.  We primarily conduct our business in the Commonwealth of Kentucky.  Our primary market areas consist of Bourbon, Clark, Elliott, Fayette, Harrison, Jessamine, Madison, Rowan, Scott, Woodford and surrounding counties in Kentucky.  Per capita personal income for Kentucky increased from $37,382 in 2014 to $38,989 in 2015, according to the Bureau of Economic Analysis. The Bureau of Labor Statistics reports that the unemployment rate in Kentucky has slightly increased. The unemployment rate in Kentucky is 5.7% for December of 2015, compared to 5.1% for December of 2014.

 

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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 bank 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.  The company also has a captive insurance subsidiary which is regulated by the State of Nevada Division of Insurance.

 

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.

 

Capital and Liquidity:  On July 2, 2013, the Federal Reserve approved final rules known as the “Basel III Capital Rules” substantially revising the risk-based capital and leverage capital requirements applicable to bank holding companies and depository institutions.  The Basel III Capital Rules address the components of capital and other issues affecting the numerator in banking institutions’ regulatory capital ratios. Certain of the Basel III Capital Rules came into effect for the Company and Kentucky Bank on January 1, 2015; these rules are subject to a phase-in period which began on January 1, 2015.

 

Under the current rules, which were effective January 1, 2015, the Company is subject to additional capital requirements that include: (i) creation of a new required ratio for common equity Tier 1 (“CET1”) capital, (ii) an increase to the minimum Tier 1 Risk-based Capital ratio, (iii) changes to risk-weightings of certain assets for purposes of the risk-based capital ratios, (iv) creation of an additional capital conservation buffer in excess of the required minimum capital ratios, and (v) changes to what qualifies as capital for purposes of meeting these capital requirements.

 

When fully phased-in on January 1, 2019, the Basel III Capital Rules will require banking organizations to maintain:

 

·                                                        a minimum ratio of CET1 to risk-weighted assets of at least 4.5%, plus a 2.5% “capital conservation buffer” (which is added to the 4.5% CET1 ratio as that buffer is phased-in, effectively resulting in a minimum ratio of CET1 to risk-weighted assets of at least 7.0% upon full implementation);

 

·                                                        a minimum ratio of Tier 1 capital to risk-weighted assets of at least 6.0%, plus the 2.5% capital conservation buffer (which is added to the 6.0% Tier 1 capital ratio as that buffer is phased-in, effectively resulting in a minimum Tier 1 capital ratio of 8.5% upon full implementation);

 

·                                                        a minimum ratio of total capital (that is, Tier 1 plus Tier 2 capital) to risk-weighted assets of at least 8.0%, plus the 2.5% capital conservation buffer (which is added to the 8.0% total capital ratio as that buffer is phased-in, effectively resulting in a minimum total capital ratio of 10.5% upon full implementation); and

 

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·                                                        a minimum leverage ratio of 4.0%, calculated as the ratio of Tier 1 capital to adjusted average consolidated assets.

 

The Basel III Capital Rules also provide for a “countercyclical capital buffer” that is applicable to only certain covered institutions and is not expected to have any current applicability to the Company or Kentucky Bank.

 

The aforementioned capital conservation buffer is designed to absorb losses during periods of economic stress. Banking institutions with a ratio of CET1 to risk-weighted assets above the minimum but below the conservation buffer will face limitations on the payment of dividends, common stock repurchases and discretionary cash payments to executive officers based on the amount of the shortfall.

 

The Basel III Capital Rules provides for a number of deductions from and adjustments to CET1. These include, for example, the requirement that mortgage servicing rights, deferred tax assets dependent upon future taxable income and significant investments in non-consolidated financial entities be deducted from CET1 to the extent that any one such category exceeds 10% of CET1 or all such categories in the aggregate exceed 15% of CET1.  Under the Basel III Capital Rules, the Company and Kentucky Bank were given a one-time election (“Opt-out Election”) to filter certain accumulated other comprehensive income (“AOCI”) components, comparable to the treatment under the current general risk-based capital rule. The Company and Kentucky Bank elected to choose the AOCI Opt-out Election.

 

Implementation of the deductions and other adjustments to CET1 began on January 1, 2015 and will be phased-in over a five-year period (20% per year). The implementation of the capital conservation buffer will begin on January 1, 2016 at the 0.625% level and be phased-in over a four-year period (increasing by that amount on each subsequent January 1, until it reaches 2.5% on January 1, 2019).

 

In addition, the Basel III Capital Rules revise the rules for calculating risk-weighted assets to enhance their risk sensitivity. They establish a new framework under which mortgage-backed securities and other securitization exposures will be subject to risk-weights ranging from 20% to 1,250%. The rules also establish adjusted risk-weights for credit exposures, including multi-family and commercial real estate exposures that are 90 days or more past due or on non-accrual, which will be subject to a 150% risk-weight, except in situations where qualifying collateral and/or guarantees are in place. The existing treatment of residential mortgage exposures will remain subject to either a 50% risk-weight (for prudently underwritten owner-occupied first liens that are current or less than 90 days past due) or a 100% risk-weight (for all other residential mortgage exposures including 90 days or more past due exposures).

 

As shown in Note 19, the Company and Kentucky Bank meet all capital adequacy requirements, and management does not anticipate any adverse impact from the implementation of the new capital ratio.

 

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.

 

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.

 

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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 $47 thousand in 2015, $44 thousand in 2014 and $41 thousand for 2013.  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.  Outstanding FICO bonds, which are 30-year noncallable bonds, mature in 2017 through 2019.

 

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;

·                  codification and expansion of 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 FDIC deposit insurance to $250,000;

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

·                  changes in the calculation of FDIC deposit insurance assessments;

·                  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;

·                  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.

 

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Volcker Rule:  On December 10, 2013, in implementing section 619 of the Dodd-Frank Act, the final Volcker Rule was approved by the OCC, the Federal Reserve, the FDIC, the SEC, and the Commodities Futures Trading Commission (“CFTC”).  The Volcker Rule attempts to reduce risk and banking system instability by restricting U.S. banks from investing in or engaging in proprietary trading and speculation and imposing a strict framework to justify exemptions for underwriting, market making and hedging activities.  U.S. banks will be restricted from investing in funds with collateral comprised of less than 100% loans that are not registered with the SEC and from engaging in hedging activities that do not hedge a specific identified risk.  The Company does not believe the Volcker Rule will have a significant effect on operations.

 

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.

 

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, 2015, the number of full time equivalent employees of the Company was 243.

 

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.

 

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The public may read and copy any material the Company files with the SEC at the SEC’s Public Reference Room at 100 F 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 internal audit plan, our 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.  While economic conditions have improved slightly in recent months, business activity remains low, particularly in real estate.  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, supervision and examination by federal and state banking authorities.  Any change in applicable regulations or federal or state legislation could have a substantial impact on our operations.

 

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Additional legislation and regulations may be enacted or adopted in the future that could significantly affect our powers, authority and operations, which 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.  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.

 

Enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), and the promulgation of regulations thereunder could significantly increase our compliance and operating costs or otherwise have a material and adverse effect on the Company’s financial position, results of operations, or cash flows.

 

The Dodd-Frank Act has resulted in comprehensive overhaul of the financial services industry within the United States.  Changes imposed by Dodd-Frank affecting our business include, among others: (i) new requirements on banking, derivative and investment activities, including modified capital requirements, the repeal of the prohibition on the payment of interest on business demand accounts, and debit card interchange fee requirements; (ii) enhanced financial institution safety and soundness regulations, including increases in assessment fees and deposit insurance coverage; and (iii) the establishment of new regulatory bodies, such as the Consumer Financial Protection Bureau.  Many of the requirements of Dodd-Frank are still being implemented and will not become fully effective for several years.  At this time, it is difficult to predict the extent to which the Dodd-Frank Act or the resulting regulations will impact the Company’s business.   However, compliance with these new laws and regulations will result in additional costs, which may adversely impact the Company’s results of operations, financial condition or liquidity, any of which may impact the market price of the Company’s common stock.  See previous discussion under “Regulation and Supervision” for more information on the Dodd-Frank Act.

 

Deposit insurance premiums levied against the Company may increase if the number of bank failures increase or the cost of resolving failed banks increases.

 

The FDIC maintains a DIF to protect insured depositors in the event of bank failures. The DIF is funded by fees assessed on insured depository institutions including Kentucky Bank.  Future deposit premiums paid by Kentucky Bank depend on the level of the DIF and the magnitude and cost of future bank failures. Kentucky Bank may be required to pay significantly higher FDIC premiums if market developments change such that the DIF balance is reduced.

 

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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.

 

Changes in consumer use of banks and changes in consumer spending and saving habits could adversely affect our financial results.  Technology and other changes now allow many consumers to complete financial transactions without using banks. For example, consumers can pay bills and transfer funds directly without going through a bank and can access loans through lending groups and other non-regulated entities. This “disintermediation” could result in the loss of fee and interest income, as well as the loss of customer deposits and income generated from those deposits. In addition, changes in consumer spending and saving habits could adversely affect our operations, and we may be unable to timely develop competitive new products and services in response to these changes that are accepted by new and existing customers.

 

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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.

 

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., 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.

 

11



 

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

 

Our results of operations and financial condition may be negatively affected if we are unable to meet a debt covenant and, correspondingly, unable to obtain a waiver regarding the debt covenant from the lender.  From time to time we may obtain financing from other lenders.  The loan documents reflecting the financing often require us to meet various debt covenants.  If we are unable to meet one or more of our debt covenants, then we will typically attempt to obtain a waiver from the lender.  If the lender does not agree to a waiver, then we will be in default under our borrowing obligation.  This default could affect our ability to fund various strategies that we may have implemented resulting in a negative impact in our results of operations and financial condition.

 

Business Risk

 

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

 

12



 

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

 

Because the nature of the financial services business involves a high volume of transactions, we face significant operational risks.  Operational risk is the risk of loss resulting from our operations, including, but not limited to, the risk of fraud by employees or persons outside of the Company, the execution of unauthorized transactions by employees, errors relating to transaction processing and technology, breaches of the internal control system and compliance requirements and business continuation and disaster recovery. This risk of loss also includes the potential legal actions that could arise as a result of an operational deficiency or as a result of noncompliance with applicable regulatory standards, adverse business decisions or their implementation, and customer attrition due to potential negative publicity. In the event of a breakdown in the internal control system, improper operation of systems or improper employee actions, we could suffer financial loss, face regulatory action and suffer damage to its reputation.

 

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 Kentucky Bank’s business, as such systems are used to manage customer relationships, deposits, loans, general ledger accounts, financial reporting and regulatory compliance.  While Kentucky 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 Kentucky Bank’s information security systems could deter customers from using Kentucky Bank’s web site and its internet banking service, both of which involve the transmission of confidential information.  Although Kentucky 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.  Kentucky Bank outsources certain of its data processing to third-party providers.  If third-party providers encounter difficulties, or if the Bank has difficulty communicating with them, Kentucky Bank’s ability to adequately process and account for customer transactions could be affected, and its 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.

 

13



 

We and our subsidiary bank have 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, we obtain and review 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 40361, 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 16 other locations.  All locations offer a full range of banking services.  Kentucky Bank owns all of the properties at which it conducts its business with the exception of the Lexington and Richmond locations.  The Company owns approximately 100,000 square feet of office space and leases approximately 9,800 square feet of office space.

 

Note 6 to the Company’s audited and consolidated financial statements included in Item 8 (“2015 Consolidated Financial Statements and Notes”) contains additional information relating to amounts invested in premises and equipment.

 

Kentucky Bank Banking Offices

 

Owned

 

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

144 South KY 7, 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

 

Leased

 

360 East Vine Street, Suite 100, Lexington, KY 40507

1001 Gibson Bay Drive, Suite 101, Richmond, KY 40475

680 Dwight Drive Richmond, KY 40475, Richmond, KY 40475

724 West Main Street, Richmond, KY 40475

 

14



 

Item 3.  Legal Proceedings

 

None to report.

 

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 OTC QX under the symbol “KTYB”.  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 as follows:

 

 

 

 

High

 

Low

 

Dividend

 

 

 

 

 

 

 

 

 

 

2015

Quarter 4

 

$

30.19

 

$

29.54

 

$

0.26

 

 

Quarter 3

 

33.00

 

30.05

 

0.26

 

 

Quarter 2

 

32.35

 

27.75

 

0.26

 

 

Quarter 1

 

28.15

 

27.00

 

0.26

 

2014

Quarter 4

 

$

28.85

 

$

27.15

 

$

0.25

 

 

Quarter 3

 

28.85

 

26.10

 

0.25

 

 

Quarter 2

 

27.50

 

23.75

 

0.25

 

 

Quarter 1

 

24.80

 

23.90

 

0.25

 

 

Note 16 to the Company’s 2015 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, 2015 the Company had 2,989,205 shares of Common Stock outstanding and approximately 564 holders of record of its Common Stock.

 

Dividends

 

During 2015 and 2014, the Corporation declared quarterly cash dividends aggregating $1.04 and $1.00 per share, respectively.

 

15



 

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

 

 

 

 

 

 

 

 

 

10/1/15 - 10/31/15

 

 

 

 

82,256 shares

 

 

 

 

 

 

 

 

 

11/1/15 - 11/30/15

 

 

 

 

82,256 shares

 

 

 

 

 

 

 

 

 

12/1/15 - 12/31/15

 

 

 

 

82,256 shares

 

 

 

 

 

 

 

 

 

Total

 

 

 

 

82,256 shares

 

On October 25, 2000, the Company announced that its Board of Directors approved a stock repurchase program.  The Company was 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.  On May 17, 2011, the Board of Directors approved and authorized the Company’s repurchase 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, 2015, 317,744 shares have been purchased, with the most recent share repurchase under the Board-approved stock repurchase program having occurred on July 2, 2015.

 

16



 

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 Incen- tive Plan

 

2,400

 

30.38

 

 

 

 

 

 

 

 

 

 

2009 Stock Award Plan

 

 

 

147,635

 

 

17



 

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 listed NASDAQ banks and the Russell Microcap Index from 2010 through 2015.  This comparison assumes $100 invested on December 31, 2010 in (a) our common stock,(b) NASDAQ Bank and (c) the Russell Microcap Index.

 

18



 

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

 

 

 

2015

 

2014

 

2013

 

2012

 

2011

 

CONDENSED STATEMENT OF INCOME:

 

 

 

 

 

 

 

 

 

 

 

Total Interest Income

 

$

33,185

 

$

29,731

 

$

28,168

 

$

28,233

 

$

29,889

 

Total Interest Expense

 

4,050

 

3,756

 

3,456

 

3,716

 

5,565

 

Net Interest Income

 

29,135

 

25,975

 

24,712

 

24,517

 

24,324

 

Provision for Losses

 

1,450

 

950

 

1,050

 

2,050

 

2,450

 

Net Interest Income After Provision for Losses

 

27,685

 

25,025

 

23,662

 

22,467

 

21,874

 

Noninterest Income

 

11,484

 

10,158

 

10,222

 

11,870

 

9,347

 

Noninterest Expense

 

31,807

 

27,215

 

27,203

 

25,686

 

24,615

 

Income Before Income Tax Expense

 

7,362

 

7,968

 

6,681

 

8,651

 

6,606

 

Income Tax Expense

 

530

 

897

 

859

 

1,643

 

919

 

Net Income

 

6,832

 

7,071

 

5,822

 

7,008

 

5,687

 

 

 

 

 

 

 

 

 

 

 

 

 

SHARE DATA:

 

 

 

 

 

 

 

 

 

 

 

Basic Earnings per Share (EPS)

 

$

2.40

 

$

2.60

 

$

2.15

 

$

2.59

 

$

2.09

 

Diluted EPS

 

2.40

 

2.60

 

2.15

 

2.59

 

2.09

 

Cash Dividends Declared

 

1.04

 

1.00

 

0.96

 

0.92

 

0.88

 

Book Value

 

29.62

 

28.65

 

24.90

 

27.21

 

25.38

 

Average Common Shares-Basic

 

2,823

 

2,721

 

2,705

 

2,705

 

2,719

 

Average Common Shares-Diluted

 

2,823

 

2,721

 

2,709

 

2,708

 

2,720

 

 

 

 

 

 

 

 

 

 

 

 

 

SELECTED BALANCE SHEET DATA:

 

 

 

 

 

 

 

 

 

 

 

Loans, net

 

$

617,600

 

$

532,293

 

$

463,214

 

$

423,928

 

$

406,025

 

Investment Securities

 

264,212

 

246,861

 

230,396

 

192,780

 

180,419

 

Trading Assets

 

5,531

 

5,370

 

 

 

 

Total Assets

 

974,684

 

855,209

 

770,579

 

701,010

 

659,453

 

Deposits

 

758,981

 

654,869

 

617,400

 

590,425

 

542,924

 

Securities sold under agreements to repurchase

 

18,514

 

12,457

 

12,867

 

4,315

 

4,524

 

Federal Home Loan Bank advances

 

87,833

 

93,785

 

57,847

 

17,449

 

30,326

 

Note Payable

 

4,794

 

 

 

 

 

Subordinated Debentures

 

7,217

 

7,217

 

7,217

 

7,217

 

7,217

 

Stockholders’ Equity

 

89,413

 

77,942

 

67,672

 

74,009

 

68,953

 

 

 

 

 

 

 

 

 

 

 

 

 

PERFORMANCE RATIOS:

 

 

 

 

 

 

 

 

 

 

 

(Average Balances)

 

 

 

 

 

 

 

 

 

 

 

Return on Assets

 

0.76

%

0.89

%

0.80

%

1.03

%

0.87

%

Return on Stockholders’ Equity

 

8.20

%

9.50

%

8.12

%

9.70

%

8.74

%

Net Interest Margin (1) 

 

3.63

%

3.69

%

3.85

%

4.19

%

4.35

%

Equity to Assets (annual average)

 

9.25

%

9.34

%

9.84

%

10.60

%

9.97

%

 

 

 

 

 

 

 

 

 

 

 

 

SELECTED STATISTICAL DATA:

 

 

 

 

 

 

 

 

 

 

 

Dividend Payout Ratio

 

43.2

%

38.48

%

41.53

%

35.71

%

42.24

%

Number of Employees (at period end)

 

243

 

215

 

208

 

193

 

194

 

 

 

 

 

 

 

 

 

 

 

 

 

ALLOWANCE COVERAGE RATIOS:

 

 

 

 

 

 

 

 

 

 

 

Allowance to Total Loans

 

1.04

%

1.12

%

1.16

%

1.41

%

1.42

%

Net Charge-offs as a Percentage of Average Loans

 

0.16

%

0.08

%

0.37

%

0.44

%

0.38

%

 


(1)         Tax equivalent

 

19



 

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, 2015, 2014 and 2013, and the consolidated results of operations for each of the years in the three year period ended December 31, 2015.  The following discussion and analysis of financial condition and results of operations should be read in conjunction with the 2015 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 2015 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 2015 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 2015 Consolidated Financial Statements and Notes.

 

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

 

Fair Values.  Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed in the description of each asset and liability category in Note 17 of the Company’s 2015 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.

 

20



 

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, and our one non-bank subsidiary KBI Insurance Company.  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 83% of which are secured by real estate at December 31, 2015.  Kentucky Bank makes commercial, agricultural and real estate loans to its commercial customers, with emphasis on small-to-medium-sized industrial, service and agricultural businesses.  It also makes residential mortgages, installment and other loans to its individual and other non-commercial customers.  Kentucky Bank’s primary market is Bourbon, Clark, Elliott, Fayette, Harrison, Jessamine, Madison, Rowan, Scott, Woodford and surrounding counties in Kentucky.  KBI Insurance Company is a captive insurance subsidiary and was incorporated in 2014.

 

Net income for the year ended December 31, 2015 was $6.8 million, or $2.40 per common share compared to $7.1 million, or $2.60 for 2014 and $5.8 million, or $2.15 for 2013.  Earnings per share assuming dilution were $2.40, $2.60 and $2.15 for 2015, 2014 and 2013, respectively.  For 2015, net income decreased $239 thousand, or 3.4%.  Net interest income increased $3.2 million, the loan loss provision increased $500 thousand, total other income increased $1.4 million, while total other expenses increased $4.6 million and income tax expense decreased $367 thousand.

 

For 2014, net income increased $1.2 million, or 21.5%.  Net interest income increased $1.2 million, the loan loss provision decreased $100 thousand, total other income decreased $64 thousand, while total other expenses increased $12 thousand and income tax expense increased $38 thousand.

 

Return on average equity was 8.2% in 2015 compared to 9.5% in 2014 and 8.1% in 2013.  Return on average assets was 0.76% in 2015 compared to 0.89% in 2014 and 0.80% in 2013.

 

21



 

Non-performing loans as a percentage of loans (including held for sale) were 1.54%, 2.36% and 2.22% as of December 31, 2015, 2014 and 2013, respectively.

 

RESULTS OF OPERATIONS

 

Net Interest Income

 

Net interest income, the Company’s largest source of revenue, on a tax equivalent basis increased from $26.3 million in 2013 to $27.6 million in 2014, and to $30.7 million in 2015.  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 2014 to 2015.  Average earning assets increased $97.2 million, or 13.0%.  Average investment securities increased $16.8 million primarily due to increased deposits and securities obtained through the acquisition of Madison Financial Corporation on July 24, 2015.  Average loans increased $79.2 million, mostly due to the acquisition of Madison Financial Corporation.  Average interest bearing liabilities increased $65.8 million, or 11.9% during this same period.  This change was mostly attributed to an increase of $43.0 million, or 9.4%, in interest bearing deposits, which is mostly attributed to the acquisition of Madison Financial Corporation.  Average borrowings from the Federal Home Loan Bank increased $16.6 million, or 22.4%.  The Company continues to actively pursue quality loans and fund these primarily with deposits and Federal Home Loan Bank advances.

 

The bank prime rates remained unchanged from 2008 until December 2015 at which time they increased twenty-five basis points.  The tax equivalent yield on earning assets decreased from 4.19% in 2014 to 4.11% in 2015.

 

The volume rate analysis for 2015 that follows indicates that $4.1 million of the increase in interest income is attributable to an increase in volume, while the change in rates contributed to a decrease of $692 thousand in interest income.  Further, decreases in rates caused a decrease in the cost of interest bearing liabilities.  The average rate of these liabilities decreased from 0.68% in 2014 to 0.66% in 2015.  Based on the volume rate analysis that follows, the lower level of interest rates contributed to a decrease of $236 thousand in interest expense and a change in volume contributed to a $530 thousand increase in interest expense.  In summary, the increase in the Company’s 2015 net interest income is attributed mostly to an increase in volume in the loan and security portfolios and decreases in rates in time deposits and Federal Home Loan Bank advances.

 

The volume rate analysis for 2014 that follows indicates that $3.0 million of the increase in interest income is attributable to an increase in volume, while the change in rates contributed to a decrease of $1.4 million in interest income.  Further, decreases in rates caused a decrease in the cost of interest bearing liabilities.  The average rate of these liabilities decreased from 0.69% in 2013 to 0.68% in 2014.  Based on the volume rate analysis that follows, the lower level of interest rates contributed to a decrease of $468 thousand in interest expense and a change in volume contributed to a $768 thousand increase in interest expense.  In summary, the increase in the Company’s 2014 net interest income is attributed mostly to an increase in volume in the loan and security portfolios and decreases in rates in time deposits and Federal Home Loan Bank advances.

 

22



 

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 2015 vs. 2014 and 2014 vs. 2013.  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)

 

 

 

2015 vs. 2014

 

2014 vs. 2013

 

 

 

Increase

 

(Decrease)

 

Due to Change in

 

Increase

 

(Decrease)

 

Due to Change in

 

 

 

Volume

 

Rate

 

Net Change

 

Volume

 

Rate

 

Net Change

 

INTEREST INCOME

 

 

 

 

 

 

 

 

 

 

 

 

 

Loans

 

$

3,742

 

$

(535

)

$

3,207

 

$

2,491

 

$

(1,569

)

$

922

 

Investment Securities

 

399

 

(182

)

217

 

350

 

123

 

473

 

Trading Assets

 

8

 

(6

)

2

 

168

 

 

168

 

Federal Funds Sold and Securities Purchased under Agreements to Resell

 

 

 

 

 

 

 

Deposits with Banks

 

(3

)

32

 

29

 

(10

)

10

 

 

Total Interest Income

 

4,146

 

(691

)

3,455

 

2,999

 

(1,436

)

1,563

 

INTEREST EXPENSE

 

 

 

 

 

 

 

 

 

 

 

 

 

Deposits

 

 

 

 

 

 

 

 

 

 

 

 

 

Demand

 

44

 

22

 

66

 

15

 

(65

)

(50

)

Savings

 

11

 

(16

)

(5

)

13

 

(19

)

(6

)

Negotiable Certificates of Deposit and Other Time Deposits

 

77

 

(152

)

(75

)

(54

)

(134

)

(188

)

Securities sold under agreements to repurchase and other borrowings

 

103

 

19

 

122

 

32

 

(17

)

15

 

Federal Home Loan Bank advances

 

295

 

(108

)

187

 

762

 

(233

)

529

 

Total Interest Expense

 

530

 

(235

)

295

 

768

 

(468

)

300

 

Net Interest Income

 

$

3,616

 

$

(456

)

$

3,160

 

$

2,231

 

$

(968

)

$

1,263

 

 

23



 

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

 

 

 

2015

 

2014

 

2013

 

 

 

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

 

$

157,285

 

$

2,840

 

1.81

%

$

142,426

 

$

2,583

 

1.81

%

$

131,538

 

$

2,145

 

1.63

%

State and Municipal obligations

 

87,147

 

2,783

 

3.19

%

85,772

 

2,835

 

3.31

%

81,471

 

2,771

 

3.40

%

Other Securities

 

6,968

 

271

 

3.89

%

6,364

 

259

 

3.89

%

7,001

 

288

 

4.11

%

Total Investment Securities

 

251,400

 

5,894

 

2.34

%

234,562

 

5,677

 

2.42

%

220,010

 

5,204

 

2.38

%

Tax Equivalent Adjustment

 

 

 

1,586

 

0.63

%

 

 

1,620

 

0.69

%

 

 

1,556

 

0.71

%

Tax Equivalent Total

 

 

 

7,480

 

2.98

%

 

 

7,297

 

3.11

%

 

 

6,760

 

3.07

%

Trading Assets

 

5,431

 

170

 

3.13

%

5,199

 

168

 

3.23

%

 

 

 

 

Federal Funds Sold and Agreements to Repurchase

 

1,042

 

 

 

327

 

 

 

290

 

 

%

Interest-Bearing Deposits with Banks

 

13,609

 

57

 

0.52

%

13,359

 

28

 

0.23

%

17,238

 

29

 

0.17

%

Loans, Net of Deferred Loan Fees (2)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial

 

60,269

 

2,577

 

4.28

%

48,307

 

2,268

 

4.69

%

48,877

 

2,380

 

4.87

%

Real Estate Mortgage

 

496,965

 

23,147

 

4.66

%

429,773

 

20,249

 

4.71

%

378,468

 

19,191

 

5.07

%

Installment

 

16,907

 

1,340

 

7.93

%

16,886

 

1,340

 

7.94

%

17,244

 

1,364

 

7.91

%

Total Loans

 

574,141

 

27,064

 

4.71

%

494,966

 

23,857

 

4.82

%

444,589

 

22,935

 

5.16

%

Total Interest-Earning Assets

 

845,623

 

34,771

 

4.11

%

748,413

 

31,350

 

4.19

%

682,127

 

29,725

 

4.36

%

Allowance for Loan Losses

 

(6,068

)

 

 

 

 

(5,673

)

 

 

 

 

(5,838

)

 

 

 

 

Cash and Due From Banks

 

16,607

 

 

 

 

 

12,274

 

 

 

 

 

7,127

 

 

 

 

 

Premises and Equipment

 

16,571

 

 

 

 

 

16,700

 

 

 

 

 

16,922

 

 

 

 

 

Other Assets

 

28,910

 

 

 

 

 

26,414

 

 

 

 

 

28,871

 

 

 

 

 

Total Assets

 

$

901,643

 

 

 

 

 

$

797,148

 

 

 

 

 

$

729,209

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

LIABILITIES

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-Bearing Deposits

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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

 

$

225,604

 

$

434

 

0.19

%

$

202,185

 

$

368

 

0.18

%

$

195,302

 

$

418

 

0.21

%

Savings

 

78,217

 

78

 

0.10

%

68,023

 

83

 

0.12

%

58,799

 

89

 

0.15

%

Certificates of Deposit and Other Deposits

 

196,409

 

1,512

 

0.77

%

187,012

 

1,587

 

0.85

%

193,038

 

1,775

 

0.92

%

Total Interest-Bearing Deposits

 

500,230

 

2,024

 

0.40

%

457,220

 

2,038

 

0.45

%

447,139

 

2,282

 

0.51

%

Securities sold under agreements to repurchase and other borrowings

 

26,418

 

447

 

1.69

%

20,264

 

325

 

1.60

%

18,340

 

311

 

1.70

%

Federal Home Loan Bank advances

 

90,534

 

1,579

 

1.74

%

73,947

 

1,392

 

1.88

%

35,435

 

863

 

2.44

%

Total Interest-Bearing Liabilities

 

617,182

 

4,050

 

0.66

%

551,431

 

3,755

 

0.68

%

500,914

 

3,456

 

0.69

%

Noninterest-Bearing Earning Demand Deposits

 

194,538

 

 

 

 

 

164,712

 

 

 

 

 

151,127

 

 

 

 

 

Other Liabilities

 

6,197

 

 

 

 

 

6,587

 

 

 

 

 

5,442

 

 

 

 

 

Total Liabilities

 

817,917

 

 

 

 

 

722,730

 

 

 

 

 

657,483

 

 

 

 

 

STOCKHOLDERS’ EQUITY

 

83,726

 

 

 

 

 

74,418

 

 

 

 

 

71,726

 

 

 

 

 

Total Liabilities and Stockholders’ Equity

 

$

901,643

 

 

 

 

 

$

797,148

 

 

 

 

 

$

729,209

 

 

 

 

 

Average Equity to Average Total Assets

 

9.25

%

 

 

 

 

9.34

%

 

 

 

 

9.84

%

 

 

 

 

Net Interest Income

 

 

 

29,135

 

 

 

 

 

25,795

 

 

 

 

 

24,713

 

 

 

Net Interest Income (tax equivalent) (3) 

 

 

 

30,721

 

 

 

 

 

27,595

 

 

 

 

 

26,269

 

 

 

Net Interest Spread (tax equivalent) (3) 

 

 

 

 

 

3.45

%

 

 

 

 

3.51

%

 

 

 

 

3.67

%

Net Interest Margin (tax equivalent) (3) 

 

 

 

 

 

3.63

%

 

 

 

 

3.69

%

 

 

 

 

3.85

%

 


(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.

 

24



 

Noninterest Income and Expenses

 

Noninterest income was $11.5 million in 2015, $10.2 million in 2014 and $10.2 million in 2013.  In 2015, reductions in gains on securities available for sale and gains on the trading account were offset by increases in gains on sold mortgage loans, debit card interchange income, service charges and loan servicing fee income.  In 2014, decreases in gains on sold mortgage loans, net loan servicing fees and overdraft income were offset by increases in fees generated within our wealth management department, gains on trading assets and debit card interchange income.

 

Securities gains were $412 thousand in 2015, $1.0 million in 2014 and $1.0 million in 2013.  These gains are primarily attributed to selling securities which had gains in market value due to declining interest rates and the related inverse relationship of interest rates and market values

 

Gains on loans sold were $1.5 million, $951 thousand and $1.7 million in 2015, 2014 and 2013, respectively.  Loans held for sale are generally sold after closing to the Federal Home Loan Mortgage Corporation or other government agencies.  During 2015, the loan servicing fee income, net of amortization expense for the mortgage servicing right asset, increased $140 thousand, compared to a decrease of $136 thousand in 2014.  In 2015, the mortgage servicing right asset had a net valuation recovery of prior year write-downs of $59 thousand compared to a net write-down of $20 thousand in the valuation allowance in 2014.  Proceeds from the sale of loans were $51 million, $37 million and $55 million in 2015, 2014 and 2013, respectively.  The volume of loan originations is inverse to rate changes with historic low rates spurring activity.  The volume of loan originations during 2015 was $49 million, $37 million in 2014, and $54 million in 2013.

 

Other noninterest income, excluding security net gains and gains on the sale of mortgage loans, was $9.6 million in 2015, $8.2 million in 2014 and $7.6 million in 2013.  Service charge income, and more particularly overdraft income, is the largest contributor to these numbers.  Overdraft income was $2.6 million in 2015, $2.6 million in 2014 and $2.8 million in 2013.  Debit card interchange income was the second largest contributor to noninterest income, excluding security gains and gains on the sale of mortgage loans.  Debit card interchange income was $2.5 million in 2015, $2.1 million in 2014 and $1.9 million in 2013.  Other income was $849 thousand in 2015, $81 thousand in 2014 and $25 thousand in 2013.  Other income increased $768 thousand in 2015 due to $747 received for restitution of a legal dispute.  Other income was lower in 2013 due to the bank recording a loss of $100 thousand for the sale of a former branch building.

 

Noninterest expense increased $4.6 million in 2015 to $31.8 million, and increased $12 thousand in 2014 to $27.2 million from $27.2 million in 2013.

 

The increase in salaries and benefits from $14.8 million in 2014 to $16.6 million in 2015 is attributed to increasing the number of personnel and normal pay increases.  The number of full-time equivalent employees increased from 215 at December 31, 2014 to 243 at December 31, 2015.  The increase in the number of employees during 2015 is attributed mostly to the acquisition of Madison Financial Corporation on July 24, 2015.

 

Incentive compensation expense increased $394 thousand in 2015 compared to 2014 due to the increased number of employees and the Bank achieving many of the goals as stated in the incentive compensation plan.

 

25



 

The largest component of occupancy expense, depreciation, increased $115 thousand to $1.4 million in 2015, and increased $90 thousand to $1.3 million in 2014.  Building repairs and maintenance increased $74 thousand during 2015 to $440 thousand and building and equipment rents increased $119 thousand during 2015 to $348 thousand.  The increase in rent expense is attributable to the acquisition of Madison Financial Corporation on July 24, 2015.  The three branch buildings acquired through the acquisition are all leased.  Other noninterest expenses increased from $8.7 million in 2013 to $9.1 million in 2014 and increased to $11.4 million in 2015.  One-time expenses incurred during 2015 for the acquisition of Madison Financial Corporation totaled $858 thousand.  Debit card & credit card interchange expense increased $282 thousand due to an increase in the number of transactions which also resulted in an increase in interchange income.  Advertising and marketing expense increased $176 thousand due to the Company increasing its presence throughout central Kentucky and sponsoring multiple events such as the Breeders Cup and a professional tennis tournament.  Losses on foreclosed properties increased $151 thousand in 2015 compared to 2014 due to the Bank recognizing $146 thousand in net gains on sales of other real estate properties during 2014.  Committee and director fees increased $92 thousand during 2015 compared to 2014.  Amortization of core deposits was $205 thousand in 2015, compared to $140 thousand in 2014.  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)

 

 

 

2015

 

2014

 

2013

 

NON-INTEREST INCOME

 

 

 

 

 

 

 

Service Charges

 

$

4,408

 

$

4,240

 

$

4,325

 

Loan Service Fee Income (Loss), net

 

206

 

66

 

202

 

Trust Department Income

 

1,056

 

979

 

746

 

Investment Securities Gains (Losses),net

 

412

 

966

 

967

 

Gains on trading assets

 

(9

)

202

 

 

Gains on Sale of Mortgage Loans

 

1,488

 

951

 

1,658

 

Brokerage Income

 

597

 

554

 

351

 

Debit Card Interchange Income

 

2,477

 

2,119

 

1,947

 

Other

 

849

 

81

 

26

 

Total Non-interest Income

 

$

11,484

 

$

10,158

 

$

10,222

 

 

 

 

 

 

 

 

 

NON-INTEREST EXPENSE

 

 

 

 

 

 

 

Salaries and Employee Benefits

 

$

16,583

 

$

14,806

 

$

15,387

 

Occupancy Expense

 

3,781

 

3,308

 

3,130

 

Acquisition Expense

 

858

 

 

 

Other

 

10,585

 

9,101

 

8,686

 

Total Non-interest Expense

 

$

31,807

 

$

27,215

 

$

27,203

 

 

 

 

 

 

 

 

 

Net Non-interest Expense as a Percentage of Average Assets

 

2.25

%

2.14

%

2.33

%

 

26



 

Income Taxes

 

As part of normal business, Kentucky Bank typically makes tax free loans to select municipalities in our market and invests in selected tax free securities, primarily in the Commonwealth of Kentucky.  In making these investments, the Company considers the overall impact to managing our net interest margin, credit worthiness of the underlying issuer and the favorable impact on our tax position.  For the year ended December 31, 2015, the Company averaged $83.3 million in tax free securities, $5.4 million in tax free trading assets and $31.5 million in tax free loans.  For the year ended December 31, 2014, the Company averaged $84.5 million in tax free securities, $5.2 million in tax free trading assets and $18.5 million in tax free loans.  As of December 31, 2015, the weighted average remaining maturity for the tax free securities is 118 months, while the weighted average remaining maturity for the tax free loans is 152 months.

 

The Company had income tax expense of $530 thousand in 2015, $897 thousand in 2014 and $859 thousand in 2013.  This represents an effective income tax rate of 7.1% in 2015, 11.3% in 2014 and 12.9% in 2013.  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, the Company had additional tax credits which also contributed to the lower effective income tax rate for those years.  In 2015, the Company had tax credits totaling $611 thousand for investments made in low income housing projects which represented an increase of $56 thousand compared to similar tax credits in 2014.

 

Balance Sheet Review

 

Assets increased from $855 million at December 31, 2014 to $974 million at December 31, 2015.  Securities available for sale increased $17 million, outstanding loan balances increased $86 million during 2015 and deposits increased $104 million.  On July 24, 2015, the Company acquired Madison Financial Corporation, and its wholly owned subsidiary Madison Bank.  At the acquisition date, acquired securities available for sale totaled $28 million, acquired loan balances totaled $78 million and acquired deposit balances totaled $96 million.  Total acquired assets totaled $116 million at the acquisition date.  Assets at year-end 2014 totaled $855 million compared to $771 million in 2013.  Loan balances increased $70 million in 2014.  Deposits grew $38 million and Federal Home Loan Bank borrowings increased $36 million during 2014.

 

Loans

 

Total loans (including loans held for sale) were $625 million at December 31, 2015 compared to $539 million at December 31, 2014 and $469 million at December 31, 2013.  The increases in the loan portfolio during 2015 and 2014 are attributed to improved economic conditions, an increase in demand and entering into two new markets.  As of December 31, 2015 and compared to the prior year-end, commercial loans increased $8.7 million, real estate construction loans increased $12.4 million, 1-4 family residential property loans increased $41.3 million, multi-family residential property loans increased $3.9 million, non-farm & non-residential property loans increased $21.9 million, agricultural loans decreased $4.6 million and installment loans increased $2.0 million.  As of December 31, 2014 and compared to the prior year-end, commercial loans increased $12.5 million, real estate construction loans increased $5.8 million, 1-4 family residential property loans decreased $4.4 million, multi-family residential property loans increased $18.0 million, non-farm & non-residential property loans increased $35.0 million, agricultural loans increased $3.3 million and installment loans decreased $202 thousand.

 

27



 

As of December 31, 2015, the real estate mortgage portfolio comprised 73% of total loans in 2015 and 72% in 2014.  Of this, 1-4 family residential property represented 37% in 2015 and 35% in 2014.  Agricultural loans comprised 11% of the loan portfolio in 2015 and 13% in 2014. Approximately 87% of the agricultural loans are secured by real estate in both 2015 and 2014.  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 22%, both in 2015 and 2014, 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 5% 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.

 

 

 

 

 

December 31 (in thousands)

 

Loans Outstanding

 

2015

 

2014

 

2013

 

2012

 

2011

 

Commercial

 

$

55,929

 

$

47,185

 

$

34,654

 

$

33,137

 

$

28,892

 

Real Estate Construction

 

29,320

 

16,938

 

11,177

 

14,102

 

13,261

 

Real Estate Mortgage:

 

 

 

 

 

 

 

 

 

 

 

1-4 Family Residential

 

231,479

 

190,357

 

194,718

 

170,825

 

161,407

 

Multi-Family Residential

 

38,281

 

34,415

 

16,420

 

11,512

 

13,305

 

Non-Farm & Non-Residential

 

183,692

 

161,822

 

126,791

 

113,440

 

100,047

 

Agricultural

 

66,782

 

71,345

 

68,002

 

69,806

 

77,820

 

Installment

 

18,880

 

16,863

 

17,065

 

17,442

 

17,572

 

Other

 

516

 

279

 

158

 

337

 

324

 

Total Loans

 

624,879

 

539,204

 

468,985

 

430,601

 

412,628

 

Less Deferred Loan Fees

 

134

 

123

 

107

 

140

 

136

 

Total Loans, Net of Deferred Loan Fees

 

624,745

 

539,081

 

468,985

 

430,461

 

412,492

 

Less loans held for sale

 

624

 

776

 

223

 

486

 

625

 

Less Allowance for Loan Losses

 

6,521

 

6,012

 

5,441

 

6,047

 

5,842

 

Net Loans

 

$

617,600

 

$

532,293

 

$

463,214

 

$

423,928

 

$

406,025

 

 

28



 

The following table sets forth the maturity distribution and interest sensitivity of selected loan categories at December 31, 2015.  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.

 

 

 

December 31, 2015 (in thousands)

 

 

 

One Year

 

One Through

 

Over

 

Total

 

Loan Maturities and Interest Sensitivity

 

or Less

 

Five Years

 

Five Years

 

Loans

 

Commercial

 

$

18,217

 

$

24,941

 

$

12,771

 

$

55,929

 

Real Estate Construction

 

10,658

 

9,605

 

9,057

 

29,320

 

Real Estate Mortgage:

 

 

 

 

 

 

 

 

 

1-4 Family Residential

 

90,544

 

97,519

 

42,658

 

230,721

 

Multi-Family Residential

 

7,455

 

17,064

 

13,762

 

38,281

 

Non-Farm & Non-Residential

 

27,047

 

89,792

 

66,853

 

183,692

 

Agricultural

 

20,596

 

43,158

 

3,028

 

66,782

 

Installment

 

8,501

 

10,334

 

45

 

18,880

 

Other

 

516

 

 

 

516

 

Total Loans, Net of Deferred Loan Fees

 

183,534

 

292,413

 

148,174

 

624,121

 

Fixed Rate Loans

 

22,516

 

74,429

 

140,211

 

237,156

 

Floating Rate Loans

 

161,018

 

217,984

 

7,963

 

386,965

 

Total Loans, Net of Deferred Loan Fees

 

$

183,534

 

$

292,413

 

$

148,174

 

$

624,121

 

 

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 decreased from $54 million in 2013 to $37 million in 2014, and increased to $49 million in 2015.  Proceeds from the sale of loans were $51 million, $37 million and $55 million for the years 2015, 2014 and 2013, respectively.  Mortgage loans held for sale were $624 thousand at December 31, 2015 and $776 thousand at December 31, 2014.  Fixed rate residential mortgage loans are generally sold when they are made.  The volume of loan originations is inverse to rate changes.  Historically low interest rates during 2013 resulted in higher loan originations during that year. During 2013, interest rates began to slightly increase resulting in a decrease in mortgage originations and continuing through 2014.  During 2015, declining mortgage rates and an improvement in the housing market resulted in the Bank originating more mortgage loans when compared to 2014 but less than 2013.  The effect of these changes was also reflected on the income statement.  As a result, the gain on sale of mortgage loans was $1.5 million in 2015 compared to $951 thousand in 2014 and $1.7 million in 2013.

 

The Bank has sold various loans to the Federal Home Loan Mortgage Corporation (FHLMC) and the Federal Home Loan Bank (FHLB) 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 and FHLB.  The Bank receives a servicing fee from the FHLMC and FHLB on each loan sold.  Servicing rights are carried using the amortized cost method and are capitalized based on the relative fair value of the rights and the expected life of the loan and are expensed in proportion to, and over the period of, estimated net servicing revenues.

 

29



 

Mortgage servicing rights were $1.3 million at December 31, 2015, $1.2 million at December 31, 2014 and $1.3 million at December 31, 2013.

 

Amortization of mortgage servicing rights was $280 thousand (including $59 thousand in recoveries of prior year write-downs), $405 thousand (including $20 thousand in valuation write-downs) and $254 thousand (including $155 thousand in net recoveries of prior valuation write-downs) for the years ended December 31, 2015, 2014 and 2013, respectively.  See Note 4 in the Company’s 2015 Consolidated Financial Statements and Notes included in Item 8 for additional information.

 

Deposits

 

For 2015, total deposits increased $104 million to $759 million.  Noninterest bearing deposits increased $33 million, time deposits of $250 thousand and over increased $8 million, and other interest bearing deposits increased $63 million.  Public fund balances totaled $168 million at December 31, 2015, of which $157 million was interest bearing.  On July 24, 2015, the Company acquired Madison Financial Corporation, and its wholly owned subsidiary, Madison Bank which resulted in additional deposit balances of $96 million at the acquisition date.

 

For 2014, total deposits increased $37 million to $655 million.  Noninterest bearing deposits increased $25 million, time deposits of $250 thousand and over increased $2.4 million, and other interest bearing deposits increased $12 million.  Public fund balances totaled $171 million at December 31, 2014, of which $168 million was interest bearing).

 

The table below provides information on the maturities of time deposits of $100,000 or more at December 31, 2015:

 

 

 

At December 31, 2015

 

Maturity of Time Deposits of $100,000 or More

 

(in thousands)

 

Maturing 3 Months or Less

 

$

21,735

 

Maturing over 3 Months through 6 Months

 

48,799

 

Maturing over 6 Months through 12 Months

 

30,789

 

Maturing over 12 Months

 

11,882

 

Total

 

$

113,205

 

 

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, 2015, $87.8 million was borrowed from FHLB, a decrease of $6.0 million from December 31, 2014.  Throughout 2015, the Bank borrowed $135 million in short-term funds from the FHLB and repaid $145 million for short-term funds.  As of December 31, 2015, no short-term borrowings from the FHLB were outstanding.  Also, during 2015, the Bank borrowed $14.7 million in longer-term advances and paid down $10.7 million in long term advances from current and prior years.  These advances each have an original maturity of more than 1 year.

 

In 2014, the Bank borrowed $38.7 million in long-term advances from the FHLB and paid down $12.7 million in long-term advances.  The Bank borrowed $225.0 million in short-term borrowings during 2014 and had $10 million in outstanding short-term advances as of December 31, 2014.

 

30



 

The increase in long-term advances is attributed to funding the growth in the Banks’ loan portfolio and strategically locking in historically low interest rates.

 

On July 20, 2015, the Company borrowed $5.0 million which had an outstanding balance of $4.8 million at December 31, 2015.  The term loan has a fixed interest rate of 5.0%, requires quarterly principal and interest payments, matures July 20, 2025 and is collateralized by the Company’s stock.  Additional information pertaining to the note payable may be found in note 10 of the financial statements.

 

The following table depicts relevant information concerning our short term borrowings.

 

 

 

As of and for the year ended

 

 

 

December 31 (in thousands)

 

Short Term Borrowings

 

2015

 

2014

 

2013

 

Federal Funds Purchased:

 

 

 

 

 

 

 

Balance at Year end

 

$

 

$

 

$

 

Average Balance During the Year

 

373

 

777

 

1,313

 

Maximum Month End Balance

 

4,300

 

7,952

 

12,530

 

Year end rate

 

 

 

 

Average annual rate

 

0.32

%

0.28

%

0.49

%

Repurchase Agreements:

 

 

 

 

 

 

 

Balance at Year end

 

$

18,514

 

$

12,457

 

$

12,867

 

Average Balance During the Year

 

16,596

 

12,270

 

9,646

 

Maximum Month End Balance

 

19,874

 

13,788

 

13,198

 

Year end rate

 

0.54

%

0.75

%

0.73

%

Average annual rate

 

0.59

%

0.76

%

0.68

%

Other Borrowed Funds:

 

 

 

 

 

 

 

Balance at Year end

 

$

 

$

10,000

 

$

 

Average Balance During the Year

 

 

 

164

 

Maximum Month End Balance

 

 

10,000

 

500

 

Year end rate

 

 

0.14

%

0.00

%

Average annual rate

 

 

0.14

%

3.25

%

 

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, 2015 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

 

 

 

 

 

 

 

 

 

 

 

 

 

Federal Home Loan Bank advances

 

$

87,833

 

$

10,159

 

$

29,907

 

$

25,824

 

$

21,943

 

Note payable

 

4,794

 

302

 

861

 

952

 

2,679

 

Subordinated debentures

 

7,217

 

 

 

 

7,217

 

Time deposits

 

201,829

 

122,188

 

59,376

 

20,126

 

139

 

Lease payments on premises

 

2,674

 

342

 

607

 

572

 

1,153

 

 

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.

 

31



 

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 value less estimated costs to sell.  The acquisition of Madison Financial Corporation did not have a material impact on the asset quality of the Company.

 

A summary of the components of nonperforming assets, including several ratios using period-end data, is shown as follows.

 

 

 

At December 31 (in thousands)

 

Nonperforming Assets

 

2015

 

2014

 

2013

 

2012

 

2011

 

Non-accrual Loans

 

$

6,351

 

$

6,577

 

$

2,974

 

$

7,024

 

$

6,017

 

Accruing Loans which are Contractually past due 90 days or more

 

1,000

 

24

 

554

 

841

 

398

 

Restructured Loans

 

2,245

 

6,138

 

6,901

 

7,227

 

1,104

 

Total Nonperforming Loans

 

9,596

 

12,739

 

10,429

 

15,092

 

7,519

 

Other Real Estate

 

2,347

 

4,604

 

3,379

 

4,168

 

8,296

 

Total Nonperforming Assets

 

$

11,943 

 

$

17,343

 

$

13,808

 

$

19,260

 

$

15,815

 

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

 

1.54

%

2.36

%

2.22

%

3.51

%

1.83

%

Total Nonperforming Assets as a Percentage of Total Assets

 

1.23

%

2.03

%

1.79

%

2.75

%

2.40

%

Allowance As a Percentage of nonperforming assets

 

55

%

35

%

39

%

31

%

37

%

 


(1)  Net of deferred loan fees

 

Total nonperforming assets at December 31, 2015 were $11.9 million compared to $17.3 million at December 31, 2014 and $13.8 million at December 31, 2013.  The decrease from 2014 to 2015 is credited to decreases in non-accrual loans, other real estate and restructured loans.  The increase from 2013 to 2014 is credited to increases in non-accrual loan balances and other real estate.  Total other real estate properties totaled $2.3 million at December 31, 2015, of which $109 thousand were income producing property.  Total nonperforming loans were $9.6 million, $12.7 million, and $10.4 million at December 31, 2015, 2014 and 2013, respectively.  The decrease in restructured loans during 2015 is attributed to one loan which had a balance of $3.8 million at December 31, 2014 and was placed on non-accrual in 2015.  The increase in non-accrual loan balances from December 31, 2013 to December 31, 2014 was mostly attributed to one customer who had total non-accrual balances of $4.0 million at December 31, 2014.  Total loan charge offs in 2015 were $2.0 million.  The amount of lost interest on our non-accrual loans was $45 thousand for 2015 and $271 thousand for 2014.  At December 31, 2015, loans currently performing but which management believes requires special attention were $17.4 million, with 35% being 1-4 family residential, 25% being non-farm & non-residential and 7% being agricultural.  The Company continues to follow its long-standing policy of not engaging in international lending and not concentrating lending activity in any one industry.

 

32



 

Impaired loans as of December 31, 2015 were $9.5 million compared to $13.8 million in 2014 and $13.5 million in 2013.  Purchased credit impaired loans totaled $3.5 million at December 31, 2015 and $0 at December 31, 2014.  These amounts are generally included in the total nonperforming and restructured loans presented in the table above.  See Note 5 in the Company’s 2015 Consolidated Financial Statements and Notes included in Item 8 herein.

 

A loan is considered impaired when, based on current information and events, it is probable that a creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement.  All amounts due according to the contractual terms means that both the contractual interest payments and the contractual principal payments of a loan will be collected as scheduled in the loan agreement.

 

Nonaccrual loans are loans for which payments in full of principal or interest is not expected or which principal or interest has been in default for a period of 90 days or more unless the asset is both well secured and in the process of collection.  Impaired loans may be loans showing signs of weakness or interruptions in cash flow, but ultimately are current or less than 90 days past due with respect to principal and interest and for which we anticipate full payment of principal and interest through collateral liquidation.

 

Additional factors considered by management in determining impairment and non-accrual status include payment status, collateral value, availability of current financial information, and the probability of collecting all contractual principal and interest payments.  At December 31, 2015, impaired loans totaling $7.8 million had specific impairment allocations of $648 thousand.  The remaining $1.7 million in impaired loans did not have a specific impairment allocation.  The purchased credit impaired loans the Company had at December 31, 2015 had no allocated reserves.   At December 31, 2014, impaired loans totaling $11.7 million had specific impairment allocations of $998 thousand.  The remaining $2.1 million in impaired loans did not have a specific impairment allocation.

 

The allowance for loan losses on impaired loans is determined using one of two methods.  Either 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 $648 thousand, $998 thousand and $712 thousand on December 31, 2015, 2014 and 2013, respectively.

 

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, 2015, the following factors have been considered:

 

·

 

Changes in lending policies and procedures, including changes in underwriting standards and collection, charge-off and recovery practices not considered elsewhere in estimating credit losses.

·

 

Change in international, national, regional and local economic and business conditions and developments that affect the collectability of the portfolio, including the condition of various market segments.

 

33



 

·

 

Changes in the nature and volume of the portfolio and in the terms of loans.

·

 

Changes in the experience, ability and depth of lending management and other relevant staff.

·

 

Changes in the volume and severity of past due loans; the volume of non-accrual loans, and the volume and severity of adversely classified or graded loans.

·

 

Changes in the quality of the Bank’s loan review system.

 

 

Changes in the value of underlying collateral for collateral-dependent loans.

·

 

The existence and effect of any concentrations of credit, and changes in the level of such concentrations.

·

 

The effect of other external factors such as competition and legal and regulatory requirements on the level of estimated credit losses in the Bank’s existing portfolio.

 

Loan Losses

 

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

 

 

 

For the Year Ended December 31 (in thousands)

 

 

 

2015

 

2014

 

2013

 

2012

 

2011

 

Balance at Beginning of Year

 

$

6,012

 

$

5,441

 

$

6,047

 

$

5,842

 

$

4,925

 

Amounts Charged-off:

 

 

 

 

 

 

 

 

 

 

 

Commercial

 

30

 

258

 

12

 

21

 

36

 

Real Estate Construction

 

 

 

578

 

74

 

143

 

Real Estate Mortgage:

 

 

 

 

 

 

 

 

 

 

 

1-4 Family Residential

 

284

 

274

 

262

 

1,090

 

659

 

Multi-Family Residential

 

94

 

42

 

161

 

88

 

178

 

Non-Farm & Non-Residential

 

 

 

99

 

126

 

333

 

Agricultural

 

242

 

8

 

109

 

15

 

27

 

Consumer

 

1,300

 

758

 

1,083

 

921

 

1,170

 

Total Charged-off Loans

 

1,950

 

1,340

 

2,304

 

2,335

 

2,546

 

Recoveries on Amounts Previously Charged-off:

 

 

 

 

 

 

 

 

 

 

 

Commercial

 

 

 

28

 

24

 

74

 

Real Estate Construction

 

11

 

14

 

23

 

19

 

 

Real Estate Mortgage

 

 

 

 

 

 

 

 

 

 

 

1-4 Family Residential

 

33

 

59

 

63

 

38

 

15

 

Multi-Family Residential

 

30

 

57

 

113

 

1

 

144

 

Non-Farm & Non-Residential

 

86

 

368

 

18

 

1

 

14