KENTUCKY BANCSHARES INC /KY/ - FORM 10-Q

Attached files

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EX-32 - EX-32 - KENTUCKY BANCSHARES INC /KY/	ktyb_ex32.htm
EX-31.2 - EX-31.2 - KENTUCKY BANCSHARES INC /KY/	ktyb_ex312.htm
EX-31.1 - EX-31.1 - KENTUCKY BANCSHARES INC /KY/	ktyb_ex311.htm

Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period September 30, 2016

☐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

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 ☒ No ☐

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 (Section 232.405 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 ☒ No ☐

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 definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer ☐

Accelerated filer ☐

Non-accelerated filer ☒ (Do not check if a smaller reporting company)

Smaller reporting company ☐

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

Number of shares of Common Stock outstanding as of October 31, 2016: 2,982,952.

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KENTUCKY BANCSHARES, INC.

Table of Contents

Part I - Financial Information

Item 1. Financial Statements

	Consolidated Balance Sheets	3

	Consolidated Statements of Income and Comprehensive Income	4

	Consolidated Statement of Changes in Stockholders’ Equity	5

	Consolidated Statements of Cash Flows	6

	Notes to Consolidated Financial Statements	7

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	33

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	44

Item 4.	Controls and Procedures	45

Part II - Other Information		46

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	46

Item 6.	Exhibits	47

Signatures		48

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Item 1 – Financial Statements

KENTUCKY BANCSHARES, INC.

CONSOLIDATED BALANCE SHEETS (unaudited)

(in thousands, except per share amounts)


	9/30/2016		12/31/2015
ASSETS
Cash and due from banks	$	16,558	$	26,546
Federal funds sold		551		1,502
Cash and cash equivalents		17,109		28,048
Interest bearing time deposits		5,029		4,874
Securities available for sale		255,618		264,212
Trading Assets		5,696		5,531
Loans held for sale		2,899		624
Loans		659,970		624,121
Allowance for loan losses		(7,405)		(6,521)
Net loans		652,565		617,600
Federal Home Loan Bank stock		7,034		7,034
Real estate owned, net		1,838		2,347
Assets held for sale		969		—
Bank premises and equipment, net		15,295		16,597
Interest receivable		3,687		3,681
Mortgage servicing rights		1,206		1,277
Goodwill		14,001		14,001
Other intangible assets		572		773
Other assets		7,624		8,085
Total assets	$	991,142	$	974,684

LIABILITIES AND STOCKHOLDERS’ EQUITY
Deposits
Non-interest bearing	$	217,869	$	209,289
Time deposits, $250,000 and over		67,576		61,199
Other interest bearing		448,753		488,493
Total deposits		734,198		758,981
Repurchase agreements		23,551		18,514
Federal funds purchased		10,517		—
Short-term Federal Home Loan Bank advances		10,000		—
Long-term Federal Home Loan Bank advances		96,173		87,833
Note payable		4,194		4,794
Subordinated debentures		7,217		7,217
Interest payable		740		659
Other liabilities		8,168		7,273
Total liabilities		894,758		885,271

Stockholders’ equity
Preferred stock, 300,000 shares authorized and unissued		—		—
Common stock, no par value; 10,000,000 shares authorized; 2,985,952 and 2,989,205 shares issued and outstanding at September 30, 2016 and December 31, 2015		20,657		20,730
Retained earnings		72,125		68,324
Accumulated other comprehensive income		3,602		359
Total stockholders’ equity		96,384		89,413
Total liabilities and stockholders’ equity	$	991,142	$	974,684

See Accompanying Notes

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KENTUCKY BANCSHARES, INC.

CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (unaudited)

(in thousands, except per share amounts)


	Three Months Ended				Nine Months Ended
	9/30/2016		9/30/2015		9/30/2016		9/30/2015
INTEREST INCOME:
Loans, including fees	$	7,630	$	7,094	$	22,432	$	19,649
Securities
Taxable		782		755		2,555		2,180
Tax exempt		649		663		1,967		2,029
Trading assets		44		44		117		127
Other		101		85		319		222
Total interest income		9,206		8,641		27,390		24,207
INTEREST EXPENSE:
Deposits		555		520		1,667		1,499
Repurchase agreements		30		36		83		83
Federal Home Loan Bank advances		428		388		1,205		1,187
Note payable		57		39		177		39
Subordinated debentures		70		60		198		175
Total interest expense		1,140		1,043		3,330		2,983
Net interest income		8,066		7,598		24,060		21,224
Provision for loan losses		175		375		775		1,025
Net interest income after provision		7,891		7,223		23,285		20,199
NON-INTEREST INCOME:
Service charges		1,401		1,215		3,782		3,210
Loan service fee income, net		(26)		45		23		153
Trust department income		272		252		796		788
Gain on sale of available for sale securities, net		40		159		317		410
Gain (loss) on trading assets		(52)		37		48		(16)
Gain on sale of loans		533		404		1,289		1,172
Brokerage income		168		189		602		431
Debit card interchange income		699		649		2,053		1,813
Bargain purchase gain		—		141		—		141
Other		201		(101)		222		780
Total other income		3,236		2,990		9,132		8,882
NON-INTEREST EXPENSE:
Salaries and employee benefits		4,540		4,232		13,472		12,176
Occupancy expenses		974		1,101		2,831		2,887
Repossession expenses, net		79		61		222		343
FDIC Insurance		106		135		444		436
Legal and professional fees		423		212		1,314		790
Data processing		396		247		1,249		1,000
Debit card expenses		391		323		1,078		872
Amortization expense of intangible assets, excluding mortgage servicing right		45		85		201		146
Advertising and marketing		225		275		675		700
Taxes other than payroll, property and income		282		269		836		728
Telephone		77		85		262		230
Postage		88		95		278		266
Loan fees		64		67		155		264
Acquisition expense		—		858		—		858
Other		1,064		524		2,536		1,798
Total other expenses		8,754		8,569		25,553		23,494
Income before taxes		2,373		1,644		6,864		5,587
Income taxes		8		103		580		409
Net income	$	2,365	$	1,541	$	6,284	$	5,178
Other Comprehensive Income, net of tax:
Change in Unrealized Gains on Securities		(800)		1,989		3,243		766
Comprehensive Income	$	1,565	$	3,530	$	9,527	$	5,944
Earnings per share
Basic	$	0.79	$	0.52	$	2.10	$	1.85
Diluted		0.79		0.52		2.10		1.85
Dividends per share		0.27		0.26		0.81		0.78

See Accompanying Notes

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KENTUCKY BANCSHARES, INC.

CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (unaudited)

(in thousands, except share information)


						Accumulated
						Other		Total
	Common Stock			Retained		Comprehensive		Stockholders’
(Dollars in thousands)	Shares	Amount		Earnings		Income		Equity
Balances, January 1, 2016	2,989,205	$	20,730	$	68,324	$	359	$	89,413
Common stock issued (including employee stock grants of 6,170 shares and director stock awards of 1,352 shares), net of 999 shares forfeited	6,523		49		—		—		49
Stock compensation expense	—		117		—		—		117
Common stock purchased and retired	(9,776)		(239)		(57)		—		(296)
Other comprehensive income							3,243		3,243
Net income	—		—		6,284		—		6,284
Dividends declared - $0.81 per share	—		—		(2,426)		—		(2,426)
Balances, September 30, 2016	2,985,952	$	20,657	$	72,125	$	3,602	$	96,384

(1)

Common Stock has no par value; amount includes Additional Paid-in Capital

See Accompanying Notes

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KENTUCKY BANCSHARES, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)

(in thousands)
	Nine Months Ended
	9/30/2016		9/30/2015
Cash Flows From Operating Activities
Net Income	$	6,284	$	5,178
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		985		1,439
Securities amortization (accretion), net		854		741
Stock based compensation expense		117		99
Provision for loan losses		775		1,025
Securities available for sale gains, net		(317)		(410)
Net change in trading assets		(165)		(110)
Originations of loans held for sale		(43,331)		(38,991)
Proceeds from sale of loans		42,345		39,419
Losses (gains) on sale of bank premises and equipment		(4)		(4)
Losses (gains) on other real estate		(163)		(5)
Gain on sale of mortgage loans		(1,289)		(1,172)
Bargain purchase gain		—		(141)
Write-downs of other real estate, net		131		252
Changes in:
Interest receivable		(6)		(280)
Other assets		461		(1,379)
Interest payable		81		82
Other liabilities		(762)		(1,659)
Net cash from operating activities		5,996		4,084
Cash Flows From Investing Activities
Acquisition of Madison Financial Corporation, net		—		3,514
Net change in interest bearing time deposits		(155)		(615)
Purchases of securities available for sale		(61,876)		(20,310)
Proceeds from sales of securities		23,888		21,579
Proceeds from principal payments, maturities and calls of securities		50,987		34,360
Net change in loans		(35,688)		(585)
Purchases of bank premises and equipment		(667)		(705)
Proceeds from the sale of bank premises and equipment		4		7
Proceeds from the sale of other real estate		734		4,812
Net cash from investing activities		(22,773)		42,057
Cash Flows From Financing Activities:
Net change in deposits		(24,783)		(39,687)
Net change in repurchase agreements		5,037		5,516
Net change in federal funds purchased		10,517		—
Proceeds from short-term Federal Home Loan Bank advances		50,000		130,000
Repayment of short-term Federal Home Loan Bank advances		(40,000)		(140,000)
Proceeds from long-term Federal Home Loan Bank advances		15,000		14,709
Repayment of long-term Federal Home Loan Bank advances		(6,660)		(7,503)
Proceeds from note payable		—		5,000
Repayment of note payable		(600)		—
Redemption of acquired preferred shares and unpaid dividends and interest		—		(6,066)
Issuance costs paid for common shares issued		—		(176)
Proceeds from issuance of common stock		49		2
Purchase of common stock		(296)		(30)
Dividends paid		(2,426)		(2,194)
Net cash from financing activities		5,838		(40,429)
Net change in cash and cash equivalents		(10,939)		5,712
Cash and cash equivalents at beginning of period		28,048		17,169
Cash and cash equivalents at end of period	$	17,109	$	22,881
Supplemental disclosures of cash flow information Cash paid during the year for:
Interest expense	$	3,249	$	2,842
Supplemental disclosures of non-cash investing activities
Real estate acquired through foreclosure	$	235	$	3,394

See Accompanying Notes

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1.SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The financial information presented as of any date other than December 31 has been prepared from the Company’s books and records without audit. The accompanying consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Certain financial information that is normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America, but is not required for interim reporting purposes, has been condensed or omitted. There have been no significant changes to the Company’s accounting and reporting policies as disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015. In the opinion of management, all adjustments, consisting of normal recurring adjustments, necessary for a fair presentation of such financial statements, have been included. The results of operations for the interim periods are not necessarily indicative of the results to be expected for the full year.

For further information, refer to the consolidated financial statements and footnotes thereto included in the Company's Annual Report on Form 10-K for the year ended December 31, 2015.

Basis of Presentation: The consolidated financial statements include the accounts of Kentucky Bancshares, Inc. (the “Company”, “we”, “our” or “us”), its wholly-owned subsidiaries, Kentucky Bank (the “Bank”) and KBI Insurance Company, Inc., and the Bank’s wholly-owned subsidiary, KB Special Assets Unit, LLC. Intercompany transactions and balances have been eliminated in consolidation.

Nature of Operations: As a state bank, the Bank is subject to regulation by the Kentucky Department of Financial Institutions and the Federal Deposit Insurance Corporation (“FDIC”). The Company, a bank holding company, is regulated by the Federal Reserve.

KBI Insurance Company, Inc. is a subsidiary of Kentucky Bancshares, Inc. and is located in Las Vegas, Nevada. It is a captive insurance subsidiary which provides various liability and property damage insurance policies for Kentucky Bancshares, Inc. and its related subsidiaries. KBI Insurance Company, Inc. is regulated by the State of Nevada Division of Insurance.

Estimates in the Financial Statements: The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates and such differences could be material to the financial statements.

Trading Assets: The Company engages in trading activities for its own account. Securities that are held principally for resale in the near term are recorded at fair value with changes in fair value included in earnings. Interest and dividends are included in net interest income.

Loss Contingencies: Loss contingencies, including claims and legal actions arising in the ordinary course of business, are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated.

Reclassifications: Some items in the prior year financial statements were reclassified to conform to the current presentation. Reclassifications had no effect on prior period net income or stockholders’ equity.

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Adoption of New Accounting Standards

Accounting Standards Update (“ASU”) ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606)

In May 2014, FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606). This ASU creates a new topic, Topic 606, to provide guidance on revenue recognition for entities that enter into contracts with customers to transfer goods or services or enter into contracts for the transfer of nonfinancial assets. The core principle of the guidance encourages an entity to recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. Additional disclosures are required to provide quantitative and qualitative information regarding the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. The new guidance is effective for annual reporting periods, and interim reporting periods within those annual periods, beginning after December 15, 2016. Early adoption is not permitted. Management is currently evaluating the impact of the adoption of this guidance on the Company’s financial statements. The Company does not anticipate this update will have a material impact on its Consolidated Financial Statements because almost all revenue sources are outside the scope of ASU 2014-09.

Accounting Standards Update (“ASU”) ASU No. 2016-1, Financial Instruments-Overall: Recognition and Measurement of Financial Assets and Financial Liabilities

In January 2016, the FASB issued an update (ASU 2016-1, Financial Instruments-Overall: Recognition and Measurement of Financial Assets and Financial Liabilities) which will require entities to measure many equity investments at fair value and recognize changes in fair value in net income. This update does not apply to equity investments that result in consolidation, those accounted for under the equity method and certain others, and will eliminate use of the available for sale classification for equity securities while providing a new measurement alternative for equity investments that do not have readily determinable fair values and do not qualify for the net asset value practical expedient. The guidance in this ASU will become effective for interim and annual reporting periods beginning after December 15, 2017, with early adoption permitted. The Company does not anticipate this update will have a material impact on its Consolidated Financial Statements.

Accounting Standards Update (“ASU”) ASU No. 2016-2, Leases (Topic 842)

This ASU is a standard that applies to all lease contracts. A lease contract is defined as a contract, or part of a contract, that conveys the right to control the use of an asset for a period in exchange for consideration. Most leases are considered operating leases, which are not accounted for on the lessees’ balance sheets. The significant change under this ASU is that those operating leases will be recorded on the balance sheet.

Under this ASU, after determining that a contract contains a lease, a lessee will need to evaluate whether the lease is a finance or an operating lease at the commencement of a new lease and upon change in the lease term or change in the lessee’s option to purchase the asset. The classification criteria for distinguishing between finance leases and operating leases under this ASU are substantially similar to the classification criteria for distinguishing between capital leases and operating leases under previous GAAP. All leases, whether finance or operating, will be on balance sheet unless they are subject to a short-term (12 months or less) lease accounting policy election. The lease term includes periods subject to an option to extend the lease if the lessee is reasonably certain to exercise that option. This means leases of 12 months or less with extension options that meet that criteria will be recorded on the balance sheet.

Finance leases under this ASU will recognize amortization expense on the asset separately from interest expense on the liability, similar to capital lease guidance under existing GAAP. Operating leases under this ASU will recognize lease expense that includes amortization expense on the leased asset and interest on the liability.

The amendments in this ASU are effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. The Company is a lessee for a material level of operating leases and is analyzing the impact of this ASU on its consolidated financial statements.

Accounting Standards Update (“ASU”) ASU No. 2016-09, Compensation-Stock Compensation (Topic 718)

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In March 2016, the FASB issued ASU No. 2016-09, Compensation – Stock Compensation (Topic 718): Improvements to Employee Shared-Based Payment Accounting. The amendments are intended to improve the accounting for employee shared-based payments and affects all organizations that issue share-based payment awards to their employees. Several aspects of the accounting for share-based payment award transactions are simplified, including the income tax consequences, the classification of awards as either equity or liabilities, and the classification on the statement of cash flows. The amendments in this update become effective for annual periods and interim periods within those annual periods beginning after December 15, 2016. We are currently evaluating the impact of adopting the new guidance on the consolidated financial statements, but the Company does not expect these amendments to have a material impact.

Accounting Standards Update (“ASU”) ASU No. 2016-13, Financial Instruments (Topic 326)

In June 2016, the FASB issued ASU No. 2016-13, . The final standard will change estimates for credit losses related to financial assets measured at amortized cost such as loans, held-to-maturity debt securities, and certain other contracts. For estimating credit losses, the FASB is replacing the incurred loss model with an expected loss model, which is referred to as the current expected credit loss (CECL) model. The largest impact will be on the allowance for loan and lease losses. The standard will become effective for fiscal years beginning after December 15, 2019 for public companies. We are currently evaluating the impact of adopting the new guidance on the consolidated financial statements.

Accounting Standards Update (“ASU”) ASU No. 2016-15, Statement of Cash Flows (Topic 230)

In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments. The primary purpose of the ASU is to reduce the diversity in practice that has resulted from the lack of consistent principles on this topic. The ASU’s amendments add or clarify guidance on eight cash flow issues. The guidance in the ASU is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. Early adoption is permitted. Entities must apply the guidance retrospectively to all periods presented but may apply it prospectively from the earliest date practicable if retrospective application would be impracticable. The Company does not anticipate this update will have a material impact on its Consolidated Financial Statements.

2.SECURITIES

SECURITIES AVAILABLE FOR SALE

Period-end securities are as follows:

(in thousands)


			Gross		Gross
	Amortized		Unrealized		Unrealized		Fair
	Cost		Gains		Losses		Value
Available for Sale
September 30, 2016
U. S. government agencies	$	29,801	$	503	$	(2)	$	30,302
States and political subdivisions		90,144		3,853		(8)		93,989
Mortgage-backed - residential		129,896		1,476		(393)		130,979
Equity securities		320		28		—		348
Total	$	250,161	$	5,860	$	(403)	$	255,618

December 31, 2015
U. S. government agencies	$	49,012	$	51	$	(200)	$	48,863
States and political subdivisions		89,501		2,644		(183)		91,962
Mortgage-backed - residential		124,834		210		(2,001)		123,043
Equity securities		320		24		—		344
Total	$	263,667	$	2,929	$	(2,384)	$	264,212

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The amortized cost and fair value of securities at September 30, 2016 by contractual maturity are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Securities not due at a single maturity are shown separately. Further discussion concerning Fair Value Measurements can be found in Note 9.


	Amortized		Fair
	Cost		Value

Due in one year or less	$	—	$	—
Due after one year through five years		21,462		22,150
Due after five years through ten years		54,326		55,834
Due after ten years		44,157		46,307
		119,945		124,291
Mortgage-backed - residential		129,896		130,979
Equity		320		348
Total	$	250,161	$	255,618

Proceeds from sales of securities during the first nine months of 2016 and 2015 were $23.9 million and $21.6 million. Gross gains of $317 thousand and $413 thousand and gross losses of $0 and $3 thousand were realized on those sales, respectively. The tax provision related to these realized net gains was $108 thousand and $139 thousand, respectively.

Proceeds from sales of securities during the three months ended September 30, 2016 and September 30, 2015 were $2.5 million and $12.5 million. Gross gains of $40 thousand and $162 thousand and gross losses of $0 thousand and $3 thousand were realized on those sales, respectively. The tax provision related to these realized net gains was $14 thousand and $54 thousand, respectively.

Securities with unrealized losses at September 30, 2016 and at December 31, 2015 not recognized in income are as follows:

September 30, 2016


	Less than 12 Months				12 Months or More				Total
	Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
Description of Securities	Value		Loss		Value		Loss		Value		Loss

U.S. Government agencies	$	4,018	$	(2)	$	—	$	—	$	4,018	$	(2)
States and municipals		1,685		(8)		—		—		1,685		(8)
Mortgage-backed - residential		30,099		(131)		14,586		(262)		44,685		(393)
Total temporarily impaired	$	35,802	$	(141)	$	14,586	$	(262)	$	50,388	$	(403)

December 31, 2015


	Less than 12 Months				12 Months or More				Total
	Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
Description of Securities	Value		Loss		Value		Loss		Value		Loss

U.S. Government agencies	$	15,243	$	(56)	$	30,293	$	(144)	$	45,536	$	(200)
States and municipals		10,938		(102)		4,065		(81)		15,003		(183)
Mortgage-backed - residential		77,898		(1,231)		23,488		(770)		101,386		(2,001)
Total temporarily impaired	$	104,079	$	(1,389)	$	57,846	$	(995)	$	161,925	$	(2,384)

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The Company evaluates securities for other than temporary impairment at least on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. In analyzing an issuer’s financial condition, we may consider many factors including, (1) whether the securities are issued by the federal government or its agencies, (2) whether downgrades by bond rating agencies have occurred, (3) the results of reviews of the issuer’s financial condition and near-term prospects, (4) the length of time and the extent to which the fair value has been less than cost, and (5) whether we intend to sell the investment security or more likely than not will be required to sell the investment security before its anticipated recovery.

Unrealized losses on securities included in the tables above have not been recognized into income because (1) all rated securities are investment grade and are of high credit quality, (2) management does not intend to sell and it is more likely than not that management would not be required to sell the securities prior to their anticipated recovery, (3) management believes the decline in fair value is largely due to changes in interest rates and (4) management believes the declines in fair value are temporary. The Company believes the fair value is expected to recover as the securities approach maturity.

TRADING ASSETS

The trading assets, which totaled $5.7 million at September 30, 2016 and $5.5 million at December 31, 2015, are primarily comprised of cash and cash equivalents and municipal securities which are generally held for 60 days or less.

3.LOANS

Loans at period-end are as follows:

(in thousands)


	9/30/2016		12/31/2015

Commercial	$	71,388	$	55,929
Real estate construction		29,536		29,320
Real estate mortgage:
1-4 family residential		246,365		230,721
Multi-family residential		40,671		38,281
Non-farm & non-residential		184,490		183,692
Agricultural		68,206		66,782
Consumer		19,149		18,880
Other		165		516
Total	$	659,970	$	624,121

The above loan balances include loans purchased in the Madison Financial Corporation acquisition. Loan balances acquired in the Madison Financial Corporation acquisition have no allocated allowance for loan losses. The composition of loans acquired as of September 30, 2016 is as follows:


	9/30/2016		12/31/2015
Commercial	$	1,141	$	1,505
Real estate construction		402		1,616
Real estate mortgage:
1-4 family residential		12,354		16,376
Multi-family residential		5,250		5,652
Non-farm & non-residential		20,911		29,029
Agricultural		1,722		2,194
Consumer		118		379
Total	$	41,898	$	56,751

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Activity in the allowance for loan losses for the nine month and three month periods indicated was as follows:


	Nine Months Ended September 30, 2016
	(in thousands)
	Beginning								Ending
	Balance		Charge-offs		Recoveries		Provision		Balance

Commercial	$	486	$	—	$	37	$	164	$	687
Real estate Construction		411		—		15		153		579
Real estate mortgage:
1-4 family residential		2,081		(90)		8		252		2,251
Multi-family residential		458		—		7		111		576
Non-farm & non-residential		1,213		—		355		(355)		1,213
Agricultural		678		(3)		35		118		828
Consumer		525		(210)		77		163		555
Other		60		(705)		583		124		62
Unallocated		609		—		—		45		654
	$	6,521	$	(1,008)	$	1,117	$	775	$	7,405


	Three Months Ended September 30, 2016
	(in thousands)
	Beginning								Ending
	Balance		Charge-offs		Recoveries		Provision		Balance

Commercial	$	666	$	—	$	3	$	18	$	687
Real estate construction		552		—		2		25		579
Real estate mortgage:
1-4 family residential		2,304		(26)		1		(28)		2,251
Multi-family residential		507		—		3		66		576
Non-farm & non-residential		1,158		—		82		(27)		1,213
Agricultural		801		(3)		12		18		828
Consumer		550		(47)		7		45		555
Other		50		(206)		143		75		62
Unallocated		671		—		—		(17)		654
	$	7,259	$	(282)	$	253	$	175	$	7,405


	Nine Months Ended September 30, 2015
	(in thousands)
	Beginning								Ending
	Balance		Charge-offs		Recoveries		Provision		Balance

Commercial	$	339	$	(30)	$	-	$	116	$	425
Real estate Construction		446		-		6		46		498
Real estate mortgage:
1-4 family residential		1,829		(241)		8		260		1,856
Multi-family residential		495		(94)		27		12		440
Non-farm & non-residential		813		-		8		221		1,042
Agricultural		998		(242)		20		(92)		684
Consumer		520		(195)		35		196		556
Other		32		(768)		571		231		66
Unallocated		540		-		-		35		575
	$	6,012	$	(1,570)	$	675	$	1,025	$	6,142

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	Three Months Ended September 30, 2015
	(in thousands)
	Beginning								Ending
	Balance		Charge-offs		Recoveries		Provision		Balance

Commercial	$	399	$	(5)	$	-	$	31	$	425
Real estate Construction		476		-		4		18		498
Real estate mortgage:
1-4 family residential		1,807		(89)		3		135		1,856
Multi-family residential		442		-		25		(27)		440
Non-farm & non-residential		1,074		-		8		(40)		1,042
Agricultural		578		0		8		98		684
Consumer		534		(32)		8		46		556
Other		55		(275)		162		124		66
Unallocated		585		-		-		(10)		575
	$	5,950	$	(401)	$	218	$	375	$	6,142

Purchased Credit Impaired Loans:

The Company has purchased loans, for which there was, at acquisition, evidence of deterioration of credit quality since origination and it was probable, at acquisition, that all contractually required payments would not be collected. The carrying amount of those loans is as follows:


	9/30/2016		12/31/2015

Commercial	$	—	$	4
Real estate mortgage:
Construction		—		8
1-4 family residential		1,449		2,039
Non-farm & non-residential		127		667
Agricultural		258		418
	$	1,834	$	3,136

There was no associated allowance for loan losses as of September 30, 2016 or December 31, 2015 for purchased credit impaired loans. The contractual principal balance of these loans was $2.8 million at September 30, 2016 and $4.2 million at December 31, 2015.

Accretable yield, or income expected to be collected, is as follows. There was no accretion recorded in income related to purchased credit impaired loans for the three months or nine months ended September 30, 2015.


	Three Months Ended		Nine Months Ended
	9/30/2016		9/30/2016

Balance, beginning of period	$	228	$	408
New loans purchased		—		—
Accretion of income		107		287
Balance, end of period	$	121	$	121

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The following tables present the balance in the allowance for loan losses and the recorded investment (excluding accrued interest receivable amounting to $2.5 million as of September 30, 2016 and $2.3 million at December 31, 2015) in loans by portfolio segment and based on impairment method as of September 30, 2016 and December 31, 2015:


	Individually		Collectively		Purchased
As of September 30, 2016	Evaluated for		Evaluated for		Credit
(in thousands)	Impairment		Impairment		Impaired		Total
Allowance for Loan Losses:
Commercial	$	—	$	687	$	—	$	687
Real estate construction		—		579		—		579
Real estate mortgage:
1-4 family residential		104		2,147		—		2,251
Multi-family residential		—		576		—		576
Non-farm & non-residential		25		1,188		—		1,213
Agricultural		462		366		—		828
Consumer		—		555		—		555
Other		—		62		—		62
Unallocated		—		654		—		654
	$	591	$	6,814	$	—	$	7,405
Loans:
Commercial	$	—	$	71,388	$	—	$	71,388
Real estate construction		153		29,383		—		29,536
Real estate mortgage:
1-4 family residential		835		244,081		1,449		246,365
Multi-family residential		—		40,671		—		40,671
Non-farm & non-residential		2,046		182,317		127		184,490
Agricultural		4,344		63,604		258		68,206
Consumer		—		19,149		—		19,149
Other		—		165		—		165
	$	7,378	$	650,758	$	1,834	$	659,970

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	Individually		Collectively		Purchased
As of December 31, 2015	Evaluated for		Evaluated for		Credit
(in thousands)	Impairment		Impairment		Impaired		Total
Allowance for Loan Losses:
Commercial	$	—	$	486	$	—	$	486
Real estate construction		—		411		—		411
Real estate mortgage:
1-4 family residential		128		1,953		—		2,081
Multi-family residential		—		458		—		458
Non-farm & non-residential		181		1,032		—		1,213
Agricultural		339		339		—		678
Consumer		—		525		—		525
Other		—		60		—		60
Unallocated		—		609		—		609
	$	648	$	5,873	$	—	$	6,521
Loans:
Commercial	$	—	$	55,924	$	4		55,929
Real estate construction		835		28,474		8		29,320
Real estate mortgage:
1-4 family residential		1,454		226,523		2,039		230,721
Multi-family residential		—		38,281		—		38,281
Non-farm & non-residential		2,882		179,913		667		183,692
Agricultural		4,298		61,921		418		66,782
Consumer		—		18,880		—		18,880
Other		—		516		—		516
Total	$	9,469	$	610,432	$	3,136	$	624,121

The following table presents loans individually evaluated for impairment by class of loans as of and for the nine months ended September 30, 2016 (in thousands):


	Unpaid				Allowance for		Average		Interest		Cash Basis
	Principal		Recorded		Loan Losses		Recorded		Income		Interest
	Balance		Investment		Allocated		Investment		Recognized		Recognized

With no related allowance recorded:
Real estate mortgage:
Construction	$	153	$	153	$	—	$	171	$	37	$	37
Agricultural		654		654		—		436		21		21

With an allowance recorded:
Real estate mortgage:
1-4 family residential		835		835		104		989		47		47
Non-farm & non-residential		2,046		2,046		25		1,983		70		70
Agricultural		3,690		3,690		462		3,868		—		—
Total	$	7,378	$	7,378	$	591	$	7,447	$	175	$	175

The recorded investment in loans excludes accrued interest receivable and loan origination fees, net due to immateriality.

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The following table presents loans individually evaluated for impairment by class of loans for the nine months ended September 30, 2015:


			Year to Date		Year to Date
	Average		Interest		Cash Basis
	Recorded		Income		Interest
(in thousands):	Investment		Recognized		Recognized

With no related allowance recorded:
Real estate mortgage:
1-4 family residential	$	1,867	$	90	$	90
Non-farm & non-residential		91
Agricultural		291		25		25

With an allowance recorded:
Real estate mortgage:
1-4 family residential		1,512		15		15
Multi-family residential		31		—		—
Non-farm & non-residential		2,795		89		89
Agricultural		4,242		7		7

Total	$	10,829	$	226	$	226

The recorded investment in loans excludes accrued interest receivable and loan origination fees, net due to immateriality.

The following table presents loans individually evaluated for impairment by class of loans as of and for the year ended December 31, 2015 (in thousands):


	Unpaid				Allowance for		Average		Interest		Cash Basis
	Principal		Recorded		Loan Losses		Recorded		Income		Interest
	Balance		Investment		Allocated		Investment		Recognized		Recognized

With no related allowance recorded:
Real estate construction	$	835	$	835	$	—	$	820	$	29	$	29
Real estate mortgage:
1-4 family residential		370		370		—		1,493		15		15
Non-farm & non-residential		—		—		—		68		—		—
Agricultural		469		469		—		335		14		14

With an allowance recorded:
Real estate mortgage
1-4 family residential		1,083		1,083		128		1,916		6		6
Multi-family residential		—		—		—		24		—		—
Non-farm & non-residential		2,882		2,882		181		2,885		29		29
Agricultural		3,830		3,830		339		4,379		—		—

Total	$	9,469	$	9,469	$	648	$	11,920	$	93	$	93

The recorded investment in loans excludes accrued interest receivable and loan origination fees, net due to immateriality.

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The following tables present loans individually evaluated for impairment by class of loans for the three months ended September 30, 2016 and September 30, 2015:


	Three Months Ending September 30, 2016
	Average		Interest		Cash Basis
	Recorded		Income		Interest
(in thousands):	Investment		Recognized		Recognized

With no related allowance recorded:


Real estate mortgage:	$
Construction		167		10		10
Agricultural		654		—		—

With an allowance recorded:
Real estate mortgage:
1-4 family residential		949		17		17
Non-farm & non-residential		2,094		21		21
Agricultural		3,824		—		—
Total	$	7,688	$	48	$	48


	Three Months Ending September 30, 2015
	Average		Interest		Cash Basis
	Recorded		Income		Interest
	Investment		Recognized		Recognized

With no related allowance recorded:

Real estate mortgage:
1-4 family residential	$	1,997	$	28	$	28
Agricultural		217		3		3
Non-farm & non-residential		137

With an allowance recorded:
Real estate mortgage:
1-4 family residential		1,225		5		5
Multi-family residential		—		—		—
Non-farm & non-residential		2,722		30		30
Agricultural		4,149		2		2
Total	$	10,447	$	68	$	68

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The following tables present the recorded investment in nonaccrual, loans past due over 90 days still on accrual and accruing troubled debt restructurings by class of loans as of September 30, 2016 and December 31, 2015:


			Loans Past Due
			Over 90 Days
As of September 30, 2016			Still		Troubled Debt
(in thousands)	Nonaccrual		Accruing		Restructurings

Commercial	$	4	$	33	$	—
Real estate construction		—		—		—
Real estate mortgage:
1-4 family residential		1,554		73		343
Multi-family residential		126		—		—
Non-farm & non-residential		78		—		1,738
Agricultural		3,980		—		—
Consumer		30		21		—

Total	$	5,772	$	127	$	2,081

Loans included in totals above acquired from Madison Financial Corporation	$	642	$	—	$	—


			Loans Past Due
			Over 90 Days
As of December 31, 2015			Still		Troubled Debt
(in thousands)	Nonaccrual		Accruing		Restructurings

Commercial	$	6	$	—	$	—
Real estate construction		145		365		—
Real estate mortgage:
1-4 family residential		1,531		471		468
Multi-family residential		—		—		—
Non-farm & non-residential		481		137		1,777
Agricultural		4,171		—		—
Consumer		17		27		—

Total	$	6,351	$	1,000	$	2,245

Loans included in totals above acquired from Madison Financial Corporation	$	1,107	$	446	$	—

Nonaccrual loans secured by real estate make up 97.0% of the total nonaccrual loan balances at September 30, 2016.

Nonaccrual loans and loans past due 90 days still on accrual include both smaller balance homogeneous loans that are collectively evaluated for impairment and individually classified impaired loans.

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.

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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. Other 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 but not in accordance with contractual terms.

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.

The following tables present the aging of the recorded investment in past due and non-accrual loans as of September 30, 2016 and December 31, 2015 by class of loans:


	30–59		60–89		Greater than				Total
As of September 30, 2016	Days		Days		90 Days				Past Due &		Loans Not
(in thousands)	Past Due		Past Due		Past Due		Non-accrual		Non-accrual		Past Due

Commercial	$	20	$	36	$	33	$	4	$	93	$	71,295
Real estate construction		461		—		—		—		461		29,075
Real estate mortgage:
1-4 family residential		1,460		296		73		1,554		3,383		242,982
Multi-family residential		—		—		—		126		126		40,545
Non-farm & non-residential		66		235		—		78		379		184,111
Agricultural		435		664		—		3,980		5,079		63,127
Consumer		110		27		21		30		188		18,961
Other		—		—		—		—		—		165

Total	$	2,552	$	1,258	$	127	$	5,772	$	9,709	$	650,261

Loans included in totals above acquired from Madison Financial Corp.	$	26	$	—	$	—	$	642	$	668	$	41,230


	30–59		60–89		Greater than				Total
As of December 31, 2015	Days		Days		90 Days				Past Due &		Loans Not
(in thousands)	Past Due		Past Due		Past Due		Non-accrual		Non-accrual		Past Due

Commercial	$	2,323	$	99	$	—	$	6	$	2,428	$	53,501
Real estate construction		—		—		365		145		510		28,810
Real estate mortgage:
1-4 family residential		1,508		264		471		1,531		3,774		226,947
Multi-family residential		—		—		—		—		—		38,281
Non-farm & non-residential		37		121		137		481		776		182,916
Agricultural		229		251		—		4,171		4,651		62,131
Consumer		50		45		27		17		139		18,741
Other		—		—		—		—		—		516

Total	$	4,147	$	780	$	1,000	$	6,351	$	12,278	$	611,843

Loans included in totals above acquired from Madison Financial Corp.	$	5	$	84	$	446	$	1,107	$	1,642	$	55,109

Troubled Debt Restructurings:

The Company has allocated $54 thousand in specific reserves to customers whose loan terms have been modified in troubled debt restructurings as of September 30, 2016. The Company allocated $101 thousand for specific reserves to customers whose loan terms had been modified in troubled debt restructuring as of December 31, 2015. The Company

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has not committed to lend additional amounts as of September 30, 2016 and December 31, 2015 to customers with outstanding loans that are classified as troubled debt restructurings.

During 2015, one loan which had a balance of $4 million and was classified as a troubled debt restructuring as of December 31, 2014, was placed on non-accrual and reported as such as of September 30, 2016 and December 31, 2015. No loans were modified as troubled debt restructurings during the first nine months ended of 2016 or 2015.

Credit Quality Indicators:

The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. The Company analyzes loans individually by classifying the loans as to credit risk. This analysis is performed on a quarterly basis. The Company uses the following definitions for risk ratings:

Special Mention. Loans classified as special mention have one or more potential weaknesses that deserve management's close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution's credit position at some future date.

Substandard. Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined and documented weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.

Doubtful. Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.

Loans not meeting the criteria above that are analyzed individually as part of the above described process are considered to be pass rated loans.

As of September 30, 2016 and December 31, 2015, and based on the most recent analysis performed, the risk category of loans by class of loans is as follows:


As of September 30, 2016			Special
(in thousands)	Pass		Mention		Substandard		Doubtful

Commercial	$	70,039	$	1,343	$	6	$	—
Real estate construction		28,944		—		592		—
Real estate mortgage:
1-4 family residential		236,354		4,916		5,095		—
Multi-family residential		37,123		2,633		915		—
Non-farm & non-residential		179,183		4,508		799		—
Agricultural		59,357		3,867		4,982		—

Total	$	611,000	$	17,267	$	12,389	$	—

Loans included in totals above acquired from Madison Financial Corporation	$	38,789	$	489	$	2,620	$	—

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As of December 31, 2015			Special
(in thousands)	Pass		Mention		Substandard		Doubtful

Commercial	$	54,392	$	1,323	$	215	$	—
Real estate construction		26,835		1,402		1,083		—
Real estate mortgage:
1-4 family residential		216,661		6,155		7,903		—
Multi-family residential		35,221		2,916		143		—
Non-farm & non-residential		178,289		4,448		955		—
Agricultural		60,177		1,198		5,407		—

Total	$	571,575	$	17,442	$	15,706	$	—

Loans included in totals above acquired from Madison Financial Corporation	$	44,367	$	2,533	$	3,189	$	—

For consumer loans, the Company evaluates the credit quality based on the aging of the recorded investment in loans, which was previously presented. Non-performing consumer loans are loans which are greater than 90 days past due or on non-accrual status, and total $51 thousand at September 30, 2016 and $6 thousand at December 31, 2015.

4.REAL ESTATE OWNED

Activity in real estate owned, net was as follows:


	Nine Months Ended
	September 30,
	2016		2015

Beginning of year	$	2,347	$	4,603
Additions		193		3,394
Acquired with Madison Financial Corporation		—		445
Sales		(571)		(6,000)
(Additions) subtractions to valuation allowance, net		(131)		942

End of period	$	1,838	$	3,384

Activity in the valuation allowance was as follows:


	Nine Months Ended
	September 30,
	2016		2015

Beginning of year	$	616	$	1,583
Write-downs of other real estate, net		131		252
Reductions from sale		—		(1,194)

End of Period	$	747	$	641

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Expenses related to foreclosed assets include:


	Nine Months Ended
	September 30,
	2016		2015

Net (gain) loss on sales, included in other income on income statement	$	(163)	$	(5)
Additions to valuation allowance, net		131		252
Operating expenses, net of rental income		91		91
Repossession expense, net		222		343

Net expenses	$	59	$	338


	Three Months Ended
	September 30,
	2016		2015
		(in thousands)

Net (gain) loss on sales, included in other income on income statement	$	(163)	$	(64)

Additions to valuation allowance, net		46		25
Operating expenses, net of rental income		33		36

Repossession expenses, net		79		61
For the period	$	(84)	$	(3)

5.EARNINGS PER SHARE

Basic earnings per common share is net income divided by the weighted average number of common shares outstanding during the period. Diluted earnings per common share includes the dilutive effect of additional potential common shares issuable under stock based compensation agreements.

The factors used in the earnings per share computation follow:


	Nine Months Ended
	September 30,
	2016		2015
	(in thousands)

Basic Earnings Per Share
Net Income	$	6,284	$	5,178
Weighted average common shares outstanding		2,975		2,774
Basic earnings per share	$	2.10	$	1.85

Diluted Earnings Per Share
Net Income	$	6,284	$	5,178
Weighted average common shares outstanding		2,975		2,774
Weighted average common and dilutive potential common shares outstanding		2,975		2,774
Diluted earnings per share	$	2.10	$	1.85

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	Three Months Ended
	September 30,
	2016		2015
	(in thousands)

Basic Earnings Per Share
Net Income	$	2,365	$	1,541
Weighted average common shares outstanding		2,976		2,941
Basic earnings per share	$	0.79	$	0.52

Diluted Earnings Per Share
Net Income	$	2,365	$	1,541
Weighted average common shares outstanding		2,976		2,941
Weighted average common and dilutive potential common shares outstanding		2,976		2,941
Diluted earnings per share	$	0.79	$	0.52

Stock options for 1,200 shares of common stock for the nine and three months ended September 30, 2016 and 2,400 shares of common stock for the nine and three months ended September 30, 2015 were excluded from diluted earnings per share because their impact was antidilutive.

6.STOCK COMPENSATION

We have four stock based compensation plans as described below.

Two Stock Option Plans

Under its expired 1999 Employee Stock Option Plan, the Company has granted certain officers and key employees stock option awards which vest and become fully exercisable at the end of five years and provided for issuance of up to 100,000 options.

Under the expired 1993 Non-Employee Directors Stock Ownership Incentive Plan, the Company also granted certain directors stock option awards which vest and become fully exercisable immediately and provided for issuance of up to 20,000 options. For each Stock Option Plan, the exercise price of each option which has a ten year life, was equal to the market price of the Company’s stock on the date of grant.

Summary of activity in the stock option plan for the first nine months of 2016 follows:


				Weighted
		Weighted		Average
		Average		Remaining		Aggregate
		Exercise		Contractual		Intrinsic
	Shares	Price		Term		Value
Outstanding, beginning of year	2,400	$	30.37
Granted	—		—
Forfeited or expired	(1,200)		29.75
Exercised	—		—
Outstanding, end of year	1,200	$	31.00	11.0	months	$	—
Vested and expected to vest	1,200	$	31.00	11.0	months	$	—
Exercisable, end of period	1,200	$	31.00	11.0	months	$	—

As of September 30, 2016, there was $0 of total unrecognized compensation cost related to nonvested stock options granted under the Plan. Since both stock option plans have expired, neither plan allows for additional options to be issued.

2005 Restricted Stock Grant Plan

On May 10, 2005, the Company’s stockholders approved a restricted stock grant plan. Total shares issuable under the plan were 50,000. There were 0 shares issued during the first nine months of 2016 and 5,385 shares issued during the

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first nine months of 2015. The plan is now expired and no additional shares will be issued from the 2005 plan. There were 639 shares forfeited during the first nine months of 2016 and 153 shares were forfeited during the first nine month of 2015.

A summary of changes in the Company’s nonvested shares for the year follows:


		Weighted-Average		Fair
		Grant-Date		Value
Nonvested Shares	Shares	Fair Value		Per Share

Nonvested at January 1, 2016	12,696	$	271,365	$	21.37
Granted	—		—		—
Vested	(4,948)		(99,507)		20.11
Forfeited	(639)		(15,155)		23.72
Nonvested at September 30, 2016	7,109	$	156,703	$	22.04

As of September 30, 2016, there was $186 thousand of total unrecognized compensation cost related to nonvested shares granted under the restricted stock grant plan. The cost is expected to be recognized over a weighted-average period of 2.5 years. As September 30, 2016, no additional shares are available for issuance under the restricted stock grant plan.

2009 Stock Award Plan

On May 13, 2009, the Company’s stockholders approved a stock award plan that provides for the granting of both incentive and nonqualified stock options and other share based awards. Total shares issuable under the plan are 150,000. There were 6,170 shares issued during the first nine months of 2016 and 465 shares were issued during the first nine months of 2015. There were 360 shares forfeited during the first nine months of 2016 and 0 shares forfeited during the first nine months of 2015.

A summary of changes in the Company’s nonvested shares for the year follows:


		Weighted-Average		Fair
		Grant-Date		Value
Nonvested Shares	Shares	Fair Value		Per Share

Nonvested at January 1, 2016	6,800	$	186,808	$	27.47
Granted	6,170		182,941		29.65
Vested	(1,404)		(37,965)		27.04
Forfeited	(360)		(10,306)		28.63
Nonvested at September 30, 2016	11,206	$	321,477	$	28.69

As of September 30, 2016, there was $186 thousand of total unrecognized compensation cost related to nonvested shares granted under the restricted stock grant plan. The cost is expected to be recognized over a weighted-average period of 4.1 years. As of September 30, 2016, 140,313 shares are still available for issuance.

7.REPURCHASE AGREEMENTS

Repurchase agreements totaled $23.6 million as of September 30, 2016. Of this, $17.6 million were overnight obligations and $6.0 million had terms extending through May 2020 and a weighted remaining average life of 1.9 years. The Company pledged agency-backed securities with a carrying amount of $30.5 million to secure repurchase agreements as of September 30, 2016.

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8.OTHER BORROWINGS

On July 20, 2015, the Company borrowed $5 million which had an outstanding balance of $4.2 million at September 30, 2016. The term loan has a fixed interest rate of 5.02%, requires quarterly principal and interest payments, matures July 20, 2025 and is collateralized by Kentucky Bank stock. The maturity schedule for the term loan as of September 30, 2016 is as follows:


2016	$	107
2017		441
2018		463
2019		487
2020		512
Thereafter		2,184
	$	4,194

9.FAIR VALUE MEASUREMENTS

ASC Topic 820, “Fair Value Measurements and Disclosures”, defines fair value, establishes a framework for measuring fair value, and sets forth disclosures about fair value measurements. ASC Topic 825, “Financial Instruments”, allows entities to choose to measure certain financial assets and liabilities at fair value. The Company has not elected the fair value option for any financial assets or liabilities.

ASC Topic 820 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. It also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. This Topic describes three levels of inputs that may be used to measure fair value:

Level 1 – Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.

Level 2 – Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

Level 3 – Significant unobservable inputs that reflect a company’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

The Company used the following methods and significant assumptions to estimate the fair value:

Investment Securities and Trading Assets: The fair values for available for sale investment securities and trading assets are determined by quoted market prices, if available (Level 1). For securities where quoted prices are not available, fair values are calculated based on market prices of similar securities (Level 2). For securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows or other market indicators (Level 3).

Impaired Loans: The fair value of impaired loans with specific allocations of the allowance for loan losses is generally based on recent third party real estate appraisals. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available for similar loans and collateral underlying such loans.

No adjustments were made for the first nine months of 2016 and adjustments totaled $14 thousand for the first nine months of 2015, and $0 thousand for both the three months ended September 30, 2016 and September 30, 2015, and resulted in a Level 3 classification of the inputs for determining fair value.

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Non-real estate collateral may be valued using an appraisal, net book value per the borrower’s financial statements, or aging reports, adjusted or discounted based on management’s historical knowledge, changes in market conditions from the time of the valuation, and management’s expertise and knowledge of the client and client’s business, resulting in a Level 3 fair value classification. Impaired loans are evaluated on a quarterly basis for additional impairment and adjusted in accordance with the allowance policy.

Other Real Estate Owned: Assets acquired through or instead of loan foreclosure and classified as other real estate owned (OREO) are initially recorded at fair value less costs to sell when acquired, establishing a new cost basis. These assets are subsequently accounted for at lower of cost or fair value less estimated costs to sell. Fair value is commonly based on recent real estate appraisals which are updated no less frequently than annually. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach with data from comparable properties. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments were $131 thousand for the nine months ended September 30, 2016 and $372 thousand for the nine months ended September 30, 2015 and resulted in a Level 3 classification of the inputs for determining fair value. Such adjustments were $46 thousand for the three months ended September 30, 2016 and $25 thousand for the three months ended September 30, 2015 and resulted in a Level 3 classification of the inputs for determining fair value. Real estate owned properties are evaluated on a quarterly basis for additional impairment and adjusted accordingly.

Mortgage Servicing Rights: Fair value is based on market prices for comparable mortgage servicing contracts, when available, or alternatively based on a valuation model that calculates the present value of estimated future net servicing income, resulting in a Level 3 classification.

Assets and Liabilities Measured on a Recurring Basis

Available for sale investment securities and trading assets are the Company’s only balance sheet items that meet the disclosure requirements for instruments measured at fair value on a recurring basis. Disclosures are as follows in the tables below.

Fair Value Measurements at September 30, 2016 (in thousands):


			Quoted Prices
			In Active
			Markets for		Significant Other		Significant
			Identical		Observable		Unobservable
	Carrying		Assets		Inputs		Inputs
Description	Value		(Level 1)		(Level 2)		(Level 3)

U. S. government agencies	$	30,302	$	—	$	30,302	$	—
States and municipals		93,989		—		93,989		—
Mortgage-backed - residential		130,979		—		130,979		—
Equity securities		348		348		—		—
Trading Assets		5,696		5,696		—		—
Total	$	261,314	$	6,044	$	255,270	$	—

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Fair Value Measurements at December 31, 2015 (in thousands):


			Quoted Prices
			In Active
			Markets for		Significant Other		Significant
			Identical		Observable		Unobservable
	Carrying		Assets		Inputs		Inputs
Description	Value		(Level 1)		(Level 2)		(Level 3)

U. S. government agencies	$	48,863	$	—	$	48,863	$	—
States and municipals		91,962		—		91,962		—
Mortgage-backed - residential		123,043		—		123,043		—
Equity securities		344		344		—		—
Trading Assets		5,531		5,531		—		—
Total	$	269,743	$	5,875	$	263,868	$	—

There were no transfers between level 1 and level 2 during 2016 or 2015.

Assets measured at fair value on a non-recurring basis are summarized below:


	Fair Value Measurements at September 30, 2016 Using :
			Quoted Prices
			In Active
			Markets for	Significant Other	Significant
			Identical	Observable	Unobservable
	Carrying		Assets	Inputs	Inputs
(In thousands)	Value		(Level 1)	(Level 2)	(Level 3)

Description
Impaired loans:
Real Estate Mortgage:
1-4 family Residential		417	—	—		417
Other real estate owned, net:
Residential		1,623	—	—		1,623
Loan servicing rights		1,093	—	—		1,093


	Fair Value Measurements at December 31, 2015 Using :
			Quoted Prices
			In Active
			Markets for	Significant Other	Significant
			Identical	Observable	Unobservable
	Carrying		Assets	Inputs	Inputs
(In thousands)	Value		(Level 1)	(Level 2)	(Level 3)

Description
Impaired loans:
Real Estate Mortgage:
Multi-family residential		540	—	—	$	540
Non-farm & non-residential		285	—	—		285
Agricultural		—	—	—		—
Other real estate owned, net:
Residential		1,504	—	—		1,504
Loan servicing rights		87	—	—		87

Impaired loans, which are measured for impairment using the fair value of the collateral for collateral dependent loans, had a carrying amount of $147 thousand, which includes a valuation allowance of $75 thousand at September 30, 2016. At September 30, 2016, no loans which became impaired during 2016, resulted in additional loan loss provision expense for the first nine months of 2016.

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Impaired loans had a carrying amount of $169 thousand at September 30, 2015, which included a valuation allowance of $34 thousand. During the first nine months of 2015, one new loan became impaired resulting in additional loan loss provision expense of $34 thousand. The total allowance for specific impaired loans decreased $57 thousand for the nine months ended September 30, 2016 and decreased $526 thousand for the nine months ended September 30, 2015.The total allowance for specific impaired loans decreased $25 thousand for the three months ended September 30, 2016 and decreased $226 thousand for the three months ended September 30, 2015.

Other real estate owned, which is measured at fair value less costs to sell, had a net carrying amount of $1.6 million, which is made up of the outstanding balance of $2.4 million, net of a valuation allowance of $747 thousand at September 30, 2016. The Company recorded $131 thousand in write-downs of other real estate owned properties for the nine months ended September 30, 2016. The Company recorded $252 thousand in net write-downs of other real estate owned properties during the nine months ended September 30, 2015. The Company recorded $46 thousand in write-downs of other real estate owned properties during the three months ended September 30, 2016 and $25 thousand in write-downs of other real-estate owned properties during the three months ended September 30, 2015.

Impaired loan servicing rights, which are carried at the lower of cost or fair value, were carried at their fair value of $1.1 million, which is made up of the outstanding balance of $1.2 million, net of a valuation allowance of $125 thousand at September 30, 2016. For the first nine months of 2016, the Company recorded net write-downs of $106 thousand and a net recovery of prior write-downs of $43 thousand for the nine months ended September 30, 2015. For the three months ended September 30, 2016, the Company recorded net write-downs of $64 thousand. For the three months ended September 30, 2015, the Company recorded a net recovery of $9 thousand. At December 31, 2015, impaired loan servicing rights were carried at their fair value of $87 thousand, which is made up of the outstanding balance of $106 thousand, net of a valuation allowance of $19 thousand.

The following table presents quantitative information about level 3 fair value measurements for financial instruments measured at fair value on a non-recurring basis at September 30, 2016 and December 31, 2015:


				Range
September 30, 2016	Fair	Valuation	Unobservable	(Weighted
(In thousands)	Value	Technique(s)	Input(s)	Average)
Impaired loans
Real estate mortgage:
1-4 family residential	417	sales comparison	adjustment for differences between the comparable sales	0%-12%	(6)%
Other real estate owned:
Residential	808	sales comparison	adjustment for differences between the comparable sales	1%-16%	(10)%
Residential	815	income approach	capitalization rate	10%-10%	(10)%

Loan Servicing Rights	1,093	discounted cash flow	discount rate	10%-26%	(13)%


				Range
December 31, 2015	Fair	Valuation	Unobservable	(Weighted
(In thousands)	Value	Technique(s)	Input(s)	Average)
Impaired loans
Real estate mortgage:
1-4 family residential	540	sales comparison	adjustment for differences between the comparable sales	1%-12%	(7)%
Non-farm & non-residential	285	sales comparison	adjustment for differences between the comparable sales	23%-31%	(27)%
Other real estate owned:
Residential	1,504	sales comparison	adjustment for differences between the comparable sales	10%-28%	(19)%
Loan Servicing Rights	87	discounted cash flow	discount rate	8%-21%	(11)%

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Fair Value of Financial Instruments

The carrying amounts and estimated fair values of financial instruments, at September 30, 2016 and December 31, 2015 are as follows:

September 30, 2016:


	Carrying
(in thousands)	Value		Level 1		Level 2		Level 3		Total

Financial assets
Cash and cash equivalents	$	17,109	$	17,109	$	—	$	—	$	17,109
Interest bearing deposits		5,029		5,029		—		—		5,029
Securities		255,618		348		255,270		—		255,618
Trading assets		5,696		5,696		—		—		5,696
Loans held for sale		2,899		—		2,946		—		2,946
Loans, net		652,565		—		—		651,760		651,760
FHLB Stock		7,034		—		—		—		N/A
Assets held for sale		969		2,270		—		—		2,270
Interest receivable		3,687		—		1,215		2,472		3,687
Financial liabilities
Deposits	$	734,198	$	540,274	$	194,605	$	—	$	734,879
Federal funds purchased		10,517		10,517		—		—		10,517
Securities sold under agreements to repurchase		23,551		—		23,684		—		23,684
Short-term Federal Home Loan Bank advances		10,000		—		10,000				10,000
Long-term Federal Home Loan Bank advances		96,173		—		94,688		—		94,688
Note payable		4,194				4,807				4,807
Subordinated debentures		7,217		—		—		7,210		7,210
Interest payable		740		—		670		70		740

December 31, 2015:


	Carrying
(in thousands)	Value		Level 1		Level 2		Level 3		Total

Financial assets
Cash and cash equivalents	$	28,048	$	28,048	$	—	$	—	$	28,048
Interest bearing deposits		4,874		4,874		—		—		4,874
Securities		264,212		344		263,868		—		264,212
Trading assets		5,531		5,531		—		—		5,531
Mortgage loans held for sale		624		—		633		—		633
Loans, net		617,600		—		—		616,206		616,206
FHLB Stock		7,034		—		—		—		N/A
Interest receivable		3,681		—		1,358		2,323		3,681
Financial liabilities
Deposits	$	758,981	$	557,146	$	203,192	$	—	$	760,338
Securities sold under agreements to repurchase		18,514		—		18,523		—		18,523
FHLB advances		87,833		—		82,349		—		82,349
Note payable		4,794		—		5,431		—		5,431
Subordinated debentures		7,217		—		—		7,206		7,206
Interest payable		659		—		649		10		659

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The methods and assumptions, not previously presented, used to estimate fair values are described as follows:

Cash and Cash Equivalents - The carrying amounts of cash and cash equivalents approximate fair values and are classified as Level 1.

Interest Bearing Deposits – The carrying amounts of interest bearing deposits approximate fair values and are classified as Level 1.

FHLB Stock - It is not practical to determine the fair value of FHLB stock due to restrictions placed on its transferability.

Loans - Fair values of loans, excluding loans held for sale, are estimated as follows: For variable rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values resulting in a Level 3 classification. Fair values for other loans are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality resulting in a Level 3 classification. Impaired loans are valued at the lower of cost or fair value as described previously. The methods used to estimate the fair value of loans do not necessarily represent an exit price.

The fair value of mortgage loans held for sale is estimated based upon binding contracts and quotes from third party investors resulting in a Level 2 classification.

Deposits - The fair values disclosed for demand deposits (e.g., interest and non-interest checking, passbook savings, and certain types of money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amount) resulting in a Level 1 classification. The carrying amounts of variable rate, fixed-term money market accounts and certificates of deposit approximate their fair values at the reporting date resulting in a Level 1 classification. Fair values for fixed rate certificates of deposit are estimated using a discounted cash flows calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits resulting in a Level 2 classification.

Securities Sold Under Agreements to Repurchase and Other Borrowings - The carrying amounts of borrowings under repurchase agreements approximate their fair values resulting in a Level 2 classification.

The carrying amount of the Company’s variable rate borrowings approximate their fair values resulting in a Level 2 classification.

Federal Funds Purchased - The carrying amounts of federal funds purchased approximate fair values and are classified as Level 1.

FHLB Advances, Borrowings and Subordinated Debentures - The fair values of the Company’s FHLB advances and other borrowings are estimated using discounted cash flow analyses based on the current borrowing rates for similar types of borrowing arrangements resulting in a Level 2 classification.

The fair values of the Company’s Subordinated Debentures are estimated using discounted cash flow analyses based on the current borrowing rates for similar types of borrowing arrangements resulting in a Level 3 classification.

Accrued Interest Receivable/Payable - The carrying amounts of accrued interest approximate fair value resulting in a Level 2 or Level 3 classification based on the level of the related asset/liability.

Off-balance Sheet Instruments - Fair values for off-balance sheet, credit-related financial instruments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing. The fair value of off-balance sheet instruments is not material.

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10.CHANGES IN ACCUMULATED OTHER COMPREHENSIVE INCOME BY COMPONENT

Changes in Accumulated Other Comprehensive Income by Component (unaudited)

(in thousands)


	Unrealized
	Gains and Losses on
	Available for Sale
	Securities
	For the Nine Months Ended September 30,
	2016		2015

Beginning Balance	$	359	$	791

Unrealized holding gains (losses) for the period, net of tax		3,452		1,037

Reclassification adjustment for:

Securities gains realized in income		317		410
Income taxes		(108)		(139)
		209		271

Net current period other comprehensive income		3,243		766

Ending balance	$	3,602	$	1,557


	Unrealized
	Gains and Losses on
	Available for Sale
	Securities
	For the Three Months Ended September 30,
	2016		2015

Beginning Balance	$	4,402	$	(432)

Unrealized holding gains (losses) for the period, net of tax		(774)		2,094

Reclassification adjustment for:

Securities gains realized in income, net		40		159
Income taxes		(14)		(54)
		26		105

Net current period other comprehensive income		(800)		1,989

Ending balance	$	3,602	$	1,557

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The following is significant amounts reclassified out of each component of accumulated other comprehensive Income (Loss) for the nine months ended September 30, 2016 and 2015:

September 30, 2016


Details about	Amount		Affected Line Item
Accumulated Other	Reclassified From		in the Statement
Comprehensive	Accumulated Other		Where Net
Income Components	Comprehensive Income		Income is Presented

Unrealized gains and losses on available-for-sale securities	$	317	Gain on sale of available for sale securities, net
		108	Income taxes
		209	Net income

September 30, 2015


Details about	Amount		Affected Line Item
Accumulated Other	Reclassified From		in the Statement
Comprehensive	Accumulated Other		Where Net
Income Components	Comprehensive Income		Income is Presented

Unrealized gains and losses on available-for-sale securities	$	410	Gain on sale of available for sale securities, net
		139	Income taxes
		271	Net income

The following is significant amounts reclassified out of each component of accumulated other comprehensive Income (Loss) for the three months ended September 30, 2016 and 2015:

September 30, 2016


Details about	Amount		Affected Line Item
Accumulated Other	Reclassified From		in the Statement
Comprehensive	Accumulated Other		Where Net
Income Components	Comprehensive Income		Income is Presented

Unrealized gains and losses on available-for-sale securities	$	40	Gain on sale of available for sale securities, net
		14	Provision for income taxes
		26	Net of tax

September 30, 2015


Details about	Amount		Affected Line Item
Accumulated Other	Reclassified From		in the Statement
Comprehensive	Accumulated Other		Where Net
Income Components	Comprehensive Income		Income is Presented

Unrealized gains and losses on available-for-sale securities	$	159	Gain on sale of available for sale securities, net
		54	Provision for income taxes
		105	Net of tax

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Item 2 - MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Forward-Looking Statements

The following discussion provides information about the financial condition and results of operations of the Company and its subsidiaries as of the dates and periods indicated. This discussion and analysis should be read in conjunction with the unaudited consolidated financial statements and Notes thereto appearing elsewhere in this report and the Management’s Discussion and Analysis in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015.

This discussion contains forward-looking statements under the Private Securities Litigation Reform Act of 1995 that involve risks and uncertainties. We intend such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the federal securities laws. These statements are not historical facts, but rather statements based on our current expectations regarding our business strategies and their intended results and our future performance. Forward-looking statements are preceded by terms such as “expects,” “believes,” “anticipates,” “intends,” “estimates,” “potential,” “may,” and similar expressions.

Although we believe that the assumptions underlying the forward-looking statements contained herein are reasonable, any of the assumptions could be inaccurate, and therefore, there can be no assurance that the forward-looking statements included herein will prove to be accurate. Factors that could cause actual results to differ from the results discussed in the forward-looking statements include, but are not limited to: economic conditions (both generally and more specifically in the markets, including the tobacco market and the thoroughbred horse industry, in which we and our Bank operate); competition for our subsidiary’s customers from other providers of financial and mortgage services; government legislation, regulation and monetary policy (which changes from time to time and over which we have no control); changes in interest rates (both generally and more specifically mortgage interest rates); material unforeseen changes in the liquidity, results of operations, or financial condition of our subsidiary’s customers;

adequacy of the allowance for losses on loans and the level of future provisions for losses on loans; and other risks detailed in our filings with the Securities and Exchange Commission, all of which are difficult to predict and many of which are beyond our control.

As a result of the uncertainties and the assumptions on which this discussion and the forward-looking statements are based, actual future operations and results in the future may differ materially from those indicated herein.

You should not place undue reliance on any forward-looking statements made by us or on our behalf. Our forward-looking statements are made as of the date of the report, and we undertake no obligation to republish revised forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.

Summary

The Company recorded net income of $6.3 million, or $2.10 basic earnings and diluted earnings per share for the first nine months ended September 30, 2016 compared to $5.2 million or $1.85 basic earnings and diluted earnings per share for the nine month period ended September 30, 2015. The first nine months net earnings reflect an increase of $1.1 million, or 21.4%, compared to the same time period in 2015. The increase in net earnings is mostly attributed to an increase of $2.8 million, or 13.4%, in net interest income, an increase of $250 thousand, or 2.8%, in non-interest income and a decrease of $250 thousand, or 24.4%, for the provision for loan losses. These positive variances were partially offset by an increase of $2.1 million, or 8.8%, in non-interest expense. Increases in both income and expense are largely attributed to the Company acquiring Madison Financial Corportion on July 24, 2015.

The earnings for the three months ended September 30, 2016 were $2.4 million or $0.79 basic and diluted earnings per share compared to $1.5 million or $0.52 basic and diluted earnings per share for the three month period ended September 30, 2015. The earnings for the three month period in 2016 reflect an increase of 53.5% compared to the same time period in 2015.

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For the nine months ended September 30, 2016 and compared to the nine months ended September 30, 2015, service charges increased $572 thousand, brokerage fee income increased $171 thousand, debit card interchange income increased $240 thousand and gains on the sale of loans increased $117 thousand. Other income decreased $558 thousand due to the Company receiving restitution for a legal settlement in 2015.

For the nine months ended September 30, 2016 and compared to the the nine months ended September 30, 2015, salaries and benefits expense increased $1.3 million, legal and professional fees increased $524 thousand, data processing expense increased $249 thousand, debit card expense increased $206 thousand and other expenses increased $738 thousand. For the same nine month comparision, repossession expense decreased $121 thousand.

For the three months ended September 30, 2016 and compared to the three months ended September 30, 2015, service charges increased $186 thousand, gains on the sale of loans increased $129 thousand, and other income increased $302 thousand. For the three months ended September 30, 2016 and compared to the three months ended September 30, 2015, salaries and benefits expense increased $308 thousand, data processing expense increased $149 thousand, legal and professional fees increased $211 thousand and other expense increased $540 thousand. During the third quarter of 2015, the Company had additional acquisition expense of $858 for the acquision of Madison Financial Corporation on July 24, 2015.

Return on average assets was 0.84% for the nine months ended September 30, 2016 and 0.78% for the nine months ended September 30, 2015. Return on average assets was 0.94% for the three months ended September 30, 2016 and 0.66% for the three months ended September 30, 2015. Return on average equity was 8.94% for the nine month period ended September 30, 2016 and 8.47% for the nine month period ended September 30, 2015. Return on average equity was 9.83% for the three month period ended September 30, 2016 and 7.14% for the three month period ended September 30, 2015.

Securities available for sale decreased $8.6 million from $264.2 million at December 31, 2015 to $255.6 million at September 30, 2016. Trading assets totaled $5.7 million at September 30, 2016 compared to $5.5 million at December 31, 2015 and includes income on the investment totaling $165 thousand during the first nine months of 2016 compared to $111 thousand for the nine months ended September 30, 2015. Income (loss) on the trading account totaled $(8) thousand for the three months ended September 30, 2016 compared to $81 thousand thousand for the three months ended September 30, 2015.

Gross Loans increased $35.9 million from $624.1 million on December 31, 2015 to $660.0 million at September 30, 2016. Loans acquired with Madison Financial Corporation had outstanding loan balances of $41.9 million at September 30, 2016 compared to $56.8 million at December 31, 2015.

The overall increase in loan balances from December 31, 2015 to September 30, 2016 is comprised of the following: an increase of $15.6 million in 1-4 family residential loans, an increase of $15.5 million in commercial loans, an increase of $2.4 million in multi-family residential loans, an increase of $1.4 million in agricultural loans, an increase of $798 thousand in non-farm and non-residential loans, an increase of $269 thousand in consumer loans and an increase of $216 thousand in real-estate construction loans. Other loan balances decreased $351 thousand from December 31, 2015 to September 30, 2016.

Assets held for sale increased from $0 at December 31, 2015 to $969 thousand at September 30, 2016. The assets held for sale balance represents assets associated with one of our existing branches expected to be sold during the fourth quarter of 2016. These assets were included in bank premeises and equipment, net on the balance sheet at December 31, 2015.

Total deposits decreased from $759.0 million on December 31, 2015 to $734.2 million on September 30, 2016, a decrease of $24.8 million. Non-interest bearing demand deposit accounts increased $8.6 million from December 31, 2015 to September 30, 2016 while time deposits $250 thousand and over increased $6.4 million and other interest bearing deposit accounts decreased $39.7 million from December 31, 2015 to September 30, 2016.

Public fund account balances decreased $38.1 million from December 31, 2015 to September 30, 2016. Public fund accounts typically decrease during the first three quarters of the year and increase during the last quarter of the year due to tax payments collected during the fourth quarter and then withdrawn from the Bank during the following months.

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Borrowings from the Federal Home Loan Bank increased $18.3 million from December 31, 2015 to September 30, 2016, of which $10.0 million were short-term borrowings, repurchase agreements increased $5.0 million and federal funds purchased increased $10.5 million.

Net Interest Income

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

Net interest income was $24.1 million for the nine months ended September 30, 2016 compared to $21.2 million for the nine months ended September 30, 2015, an increase of 13.4%. Net interest income was $8.1 million for the three months ended September 30, 2016 compared to $7.6 million for the three months ended September 30, 2015, an increase of 6.2%.

The interest spread, excluding tax equivalent adjustments, was 3.37% for the first nine months of 2016 compared to 3.38% for the first nine months of 2015. For the first nine months in 2016, the yield on assets increased from 3.85% in 2015 to 3.86% in 2016, excluding tax equivalent adjustments. The yield on loans increased two basis points compared to the nine months ended September 30, 2015 from 4.72% to 4.74% for the nine months ended September 30, 2016. The yield on securities, excluding tax equivalent adjustments, decreased one basis point during the first nine months of 2016 compared to 2015 from 2.31% in 2015 to 2.30% in 2016. The cost of liabilities was 0.49% for the first nine months in 2016 compared to 0.50% in 2015. The acquisition of Madison Financial on July 24, 2015 resulted in significant larger average balances for our interest bearing assets.

Year to date average loans, excluding overdrafts, increased $82.3 million, or 14.7% for the nine months ended September 30, 2016 compared to the nine months ended September 30, 2015. Loan interest income increased $2.8 million during the first nine months of 2016 compared to the first nine months of 2015. Year to date average total deposits increased from September 30, 2015 to September 30, 2016 by $86.2 million or 12.6%. Year to date average interest bearing deposits increased $62.1 million, or 126%, from September 30, 2015 to September 30, 2016. Deposit interest expense increased $347 thousand for the first nine months of 2016 compared to the same period in 2015. Year to date average borrowings, including repurchase agreements, increased $13.2 million, or 11.5% from September 30, 2015 to September 30, 2016. Interest expense on borrowed funds, including repurchase agreements, increased $62 thousand for the first nine months of 2016 compared to the same period in 2015.

The volume rate analysis for the nine months ended September 30, 2016 indicates that $2.9 million of the increase in loan interest income is attributable to an increase in loan volume and $254 thousand of the increase in securities interest income is attributable to an increase in the volume of our security portfolio. Further, a decrease in loan rates caused a decrease of $155 thousand in interest income and an increase in rates in our security portfolio contributed an increase of $49 thousand in securities interest income. The net effect to interest income was an increase of $3.2 million for the first nine months of 2016 compared to the same time period in 2015.

Also based on the following volume rate analysis for the nine months ended September 30, 2016, an increase in demand deposit interest rates resulted in $341 thousand additional interest expense while decreases in interest rates paid for time deposits resulted in a reduction of $335 thousand in interest expense. The change in volume in deposits and borrowings was responsible for a $325 thousand increase in interest expense, of which an increase in time deposits resulted in an increase of $131 thousand in interest expense and an increase in repurchase agreements and other borrowings resulted in an increase of $154 thousand in interest expense. The net effect to interest expense was an increase of $345 thousand. As a result, the increase in net interest income for the first nine months in 2016 is mostly attributed to growth in the Company’s loan and security portfolios.

The volume rate analysis for the three months ended September 30, 2016 indicates that $726 thousand of the increase in net interest income is attributable to growth in the Company’s balance sheet. However, higher rates primarily with demand deposits, resulted in a $256 thousand decrease in net interest income. The net change to net interest income for the three months ended September 30, 2016 was an increase of $470 thousand.

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Changes in Interest Income and Expense


	Nine Months Ended
	2016 vs. 2015
	Increase (Decrease) Due to Change in
(in thousands)	Volume		Rate		Net Change

INTEREST INCOME
Loans	$	2,938	$	(155)	$	2,783
Investment Securities		254		49		303
Other		73		24		97
Total Interest Income		3,265		(82)		3,183
INTEREST EXPENSE
Deposits
Demand		26		341		367
Savings		—		5		5
Negotiable Certificates of Deposit and Other Time Deposits		131		(335)		(204)
Securities sold under agreements to repurchase and other borrowings		154		5		159
Federal Home Loan						—
Bank advances		14		4		18
Total Interest Expense		325		20		345
Net Interest Income	$	2,940	$	(102)	$	2,838


	Three Months Ended
	2016 vs. 2015
	Increase (Decrease) Due to Change in
	Volume		Rate		Net Change

INTEREST INCOME
Loans	$	694	$	(158)	$	536
Investment Securities		(11)		24		13
Other		(11)		27		16
Total Interest Income		672		(107)		565
INTEREST EXPENSE
Deposits
Demand		(17)		249		232
Savings		—		1		1
Negotiable Certificates of Deposit and Other Time Deposits		(40)		(158)		(198)
Securities sold under agreements to repurchase and other borrowings		24		(4)		20
Federal Home Loan		—		—		—
Bank advances		(21)		61		40
Total Interest Expense		(54)		149		95
Net Interest Income	$	726	$	(256)	$	470

Non-Interest Income

Non-interest income increased $250 thousand for the nine months ended September 30, 2016, compared to the same period in 2015, to $9.1 million. Non-interest income increased $246 thousand for the three months ended September 30, 2016, compared to the thee months ended September 30 2015, to $3.3 million.

As previously noted, non-interest income increased $250 thousand for the nine months ended September 30, 2016 in comparison to the nine months ended September 30, 2015. Decreases to non-interest income for the nine month period

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ended September 30, 2016 compared to the nine months ended September 30, 2015 include a decrease of $558 thousand in other income. Other income was higher in 2015 due to the Company receiving $747 thousand in June 2015 for restitution related to the settlement of the pension dispute disclosed in prior filings.

Favorable variances to non-interest income for the first nine months of 2016 include an increase of $572 thousand in service charges, an increase of $171 thousand in brokerage fee income, an increase of $240 thousand in debit card interchange income and an increase of $117 thousand in gains on the sale of loans. Decreases to non-interest income for the three months ended September 30, 2016 compared to the three months ended September 30, 2015 include a decrease of $119 thousand in gains on the sale of securities and a decrease of $141 thousand in bargain purchase gains. Favorable variances in non-interest income for the three month period ended September 30, 2016 compared to the same time period in 2015 includes a gain of $186 thousand in service charge income, an increase of $129 thousand in gains on the sale of mortgage loans and an increase of $302 thousand in other income.

The gain on the sale of loans increased from $1.2 million during the first nine months of 2015 to $1.3 million during the first nine months of 2016, an increase of $117 thousand. For the three months ended September 30, the gain on the sale of mortgage loans increased from $404 thousand in 2015 to $533 thousand in 2016.

The volume of loans originated to sell during the first nine months of 2016 increased $4.3 million compared to the same time period in 2015. The volume of loans originated to sell the during the three months ended September 30, 2016 compared to the three months ended September 30, 2015 increased $5.0 million. The volume of mortgage loan originations and sales is generally inverse to rate changes. A change in the mortgage loan rate environment can have a significant impact on the related gain on sale of mortgage loans. Loan service fee income, net of amortization and impairment expense, was $23 thousand for the nine months ended September 30, 2016 compared to $153 thousand for the nine months ended September 30, 2015, a decrease of $130 thousand.

Loan service fee income, net of amortization and impairment expense, was $(26) thousand for the three months ended September 30, 2016 compared to $45 thousand for the three months ended September 30, 2015, a decrease of $71 thousand. During the first nine months of 2016, the market value adjustment to the carrying value of the mortgage servicing right was a net write-down of $106 thousand, as the fair value of this asset decreased. During the first nine months of 2015, the market value adjustment to the carrying value of the mortgage servicing right asset was a positive valuation adjustment of $43 thousand as the fair value of the mortgage servicing asset increased. For the three months ended September 30, 2016, the market value adjustment to the carrying value of the mortgage serving right asset was a net write-down of $64 thousand compared to a positive valuation adjustment of $9 thousand during the third quarter of 2015.

Non-Interest Expense

Total non-interest expense increased $2.1 million for the nine month period ended September 30, 2016 compared to the same period in 2015. Total non-interest expense increased $185 thousand for the three month period ended September 30, 2016 compared to the three months ended September 30, 2015. Management continues to consider opportunities for branch expansion, and will also consider acquisition opportunities that help advance its strategic objectives, which would result in additional future non-interest expense.

For the comparable nine month periods, salaries and employees benefits expense increased $1.3 million, an increase of 10.6%. The number of full-time employee equivalent employees increased from 228 at June 30, 2015 to 247 at September 30, 2016, an increase of 19 full-time employee equivalent employees. The increase in the number of employees is largely attributed to the Company acquiring Madison Financial Corporation on July 24, 2015. For the three months ended September 30, 2016 compared to the three months ended September 30, 2015, salaries and employee benefits expense increased $308 thousand, or 7.3%.

Occupancy expense decreased $56 thousand to $2.8 million for the first nine months of 2016 compared to the same time period in 2015. Building rent expense increased $37 thousand due to acquiring Madison Financial Corporation on July 24, 2015. The acquisition provided the Company three additional branches in Richmond, KY, all of which are leased. Depreciation expense decreased $104 thousand for the nine months ended September 30, 2016 compared to September 30, 2015. Expenses incurred for assets not depreciated decreased $79 thousand during the first nine months of 2016 compared to the first nine months of 2015. This decrease is attributed to purchasing additional equipment during the first

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quarter of 2015 which resulted in additional expense. Occupancy expense decreased $127 thousand to $974 thousand for the three months ended September 30, 2016 compared to the comparable three months in 2015.

Legal and professional fees increased $524 thousand for the nine months ended September 30, 2016 compared to the first nine months in 2015 and increased $211 thousand for the three months ended September 30, 2016 compared to the three months ended September 30, 2015.

Debit card expenses increased $206 thousand for the nine months ended September 30, 2016 compared to the first nine months of 2015 due to increased volume and increased $68 thousand for the three months ended September 30, 2016 compared to the three months ended September 30, 2015. The increase in debit card expense is attributed to an increase in debit card interchange activity which also resulted in increases in debit card interchange income as shown on the income statement.

Repossession expense decreased $121 thousand for the first nine months ended September 30, 2016 compared to the same time period in 2015 and increased $18 thousand for the three month period ended September 30, 2016 compared to the three months ended September 30, 2015. Repossession expenses are reported net of rental income earned on repossessed properties. Net repossession expenses were lower during the first nine months of 2016 when compared to 2015 due to net write-downs totaling $131 thousand in 2016 compared to net write-downs of $252 thousand in 2015.

Income Taxes

The effective tax rate for the nine months ended September 30, 2016 was 8.5% compared to 7.3% in 2015. The effective tax rate for the three months ended September 30, 2016 was 0.3% compared to 6.3% in 2015. These effective tax rates are less than the statutory rate as a result of the Company investing in tax-free securities, loans and other investments which generate tax credits for the Company.

The Company also has a captive insurance subsidiary which contributes to reducing taxable income. Income tax expense increased $171 thousand for the nine months ended September 30, 2016 compared to the first nine months in 2015. Tax-exempt interest income increased $280 thousand for the first nine months of 2016 compared to the first nine months of 2015. Further, for the first nine months of 2016, the Company had tax credits totaling $836 thousand for investments made in low income housing projects which represented an increase of $378 thousand compared to similar tax credits for the first nine months of 2015.

As part of normal business, the Bank typically makes tax free loans to select municipalities in our market and invests in selected tax free securities, primarily in the Commonwealth of Kentucky. In making these investments, the Company considers the overall impact to managing our net interest margin, credit worthiness of the underlying issuer and the favorable impact on our tax position. For the nine months ended September 30, 2016, the Company averaged $90.4 million in tax free securities and $37.7 million in tax free loans. As of September 30, 2016, the weighted average remaining maturity for the tax free securities is 100 months, while the weighted average remaining maturity for the tax free loans is 150 months.

Liquidity and Funding

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

Liquidity risk is the possibility that we may not be able to meet our cash requirements in an orderly manner. Management of liquidity risk includes maintenance of adequate cash and sources of cash to fund operations and to meet the needs of borrowers, depositors and creditors. Excess liquidity has a negative impact on earnings as a result of the lower yields on short-term assets.

Cash and cash equivalents were $17.1 million as of September 30, 2016 compared to $28.0 million at December 31, 2015. The decrease in cash and cash equivalents is attributed to a decrease of $10.0 million in cash and due from banks and a decrease of $951 thousand in federal funds sold.

In addition to cash and cash equivalents, the securities portfolio provides an important source of liquidity. Securities available for sale totaled $255.6 million at September 30, 2016 compared to $264.2 million at December 31, 2015.

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Securities classified as trading assets totaled $5.7 million at September 30, 2016 compared to $5.5 million at December 31, 2015.

The securities available for sale and trading assets are available to meet liquidity needs on a continuing basis. However, we expect our customers’ deposits to be adequate to meet our funding demands.

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

For the first nine months of 2016, deposits decreased $24.8 million compared to December 31, 2015. The Company’s borrowed funds from the Federal Home Loan Bank increased $18.3 million from December 31, 2015 to September 30, 2016, federal funds purchased increased $10.5 million and total repurchase agreements increased $5.0 million from December 31, 2015 to September 30, 2016.

Management is aware of the challenge of funding sustained loan growth. Therefore, in addition to deposits, other sources of funds, such as Federal Home Loan Bank advances, may be used. We rely on Federal Home Loan Bank advances for both liquidity and asset/liability management purposes. These advances are used primarily to fund long-term fixed rate residential mortgage loans. As of September 30, 2016, we have sufficient collateral to borrow an additional $73 million from the Federal Home Loan Bank.

In addition, as of September 30, 2016, $50 million is available in overnight borrowing through various correspondent banks and the Company has access to an additional $276 million in brokered deposits. In light of this, management believes there is sufficient liquidity to meet all reasonable borrower, depositor and creditor needs in the present economic environment.

Capital Requirements

The Company and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possible additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s financial statements.

Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of the Company’s and the Bank’s assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Company and Bank capital amounts and classifications are also subject to qualitative judgments by regulators about components, risk weightings, and other factors.

Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (set forth in the following table) of Total and Tier I capital, including Common Equity Tier 1 Capital, (as defined in the applicable banking regulations) to risk-weighted assets (as defined), and of Tier I capital to average assets (as defined). Management believes, as of September 30, 2016 and December 31, 2015, that the Company and the Bank meet all capital adequacy requirements to which they are subject.

The most recent notification from the FDIC categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Bank must maintain minimum Total risk-based, Tier I risk-based, Common Equity Tier 1 risk based and Tier I leverage ratios as set forth in the following table. There are no conditions or events since that notification that management believes have changed the institution’s category.

In July 2013, the FDIC and the other federal bank regulatory agencies issued a final rule that revised their leverage and risk-based capital requirements and the method of calculating risk-weighted assets to make them consistent with agreements that were reached by the Basel Committee on Banking Supervision and certain provisions of the Dodd-Frank Act.

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Among other things, the rule establishes a new common equity Tier 1 minimum capital requirement (4.5% of risk-weighted assets), increases the minimum Tier 1 capital to risk-based assets requirement (from 4% to 6% of risk-weighted assets) and assigns a higher risk weight (150%) to exposures that are more than 90 days past due or are on nonaccrual status and to certain commercial real estate facilities that finance the acquisition, development or construction of real property. The final rule also requires unrealized gains and losses on certain “available-for-sale” securities holdings to be included for purposes of calculating regulatory capital requirement unless a one-time opt-in or opt-out is exercised, which the Company did opt-out of.

The rule limits a banking organization’s capital distributions and certain discretionary bonus payments if the banking organization does not hold a “capital conservation buffer” consisting of 2.5% of common equity Tier 1 capital to risk-weighted assets in addition to the amount necessary to meet its minimum risk-based capital requirements.

The capital conservation buffer was 0.625% at September 30, 2016 and the Company is in compliance with the capital conservation buffer. The final rule became effective for the Bank on January 1, 2016. In accordance with the final rule, the capital conservation buffer requirement is being phased in beginning January 1, 2016 and will continue through January 1, 2019, when the full capital conservation buffer requirement will be effective. The Company’s and the Bank’s actual amounts and ratios are presented in the table below:


									To Be Well
									Capitalized
									Under Prompt
					For Capital				Corrective
	Actual				Adequacy Purposes				Action Provisions
	Amount		Ratio		Amount		Ratio		Amount		Ratio
	(Dollars in Thousands)
September 30, 2016
Consolidated
Total Capital (to Risk-Weighted Assets)	$	93,047	13.7	%	$	N/A	N/A	%		N/A	N/A
Tier I Capital (to Risk-Weighted Assets)		85,554	12.6			40,733	6.0			N/A	N/A
Common Equity Tier 1 Capital (to Risk-Weighted Assets)		78,554	11.6			30,550	4.5			N/A	N/A
Tier I Capital (to Average Assets)		85,554	8.8			39,118	4.0			N/A	N/A

Bank Only
Total Capital (to Risk-Weighted Assets)	$	94,264	13.9	%	$	54,273	8.0	%	$	67,841	10.0	%
Tier I Capital (to Risk-Weighted Assets)		86,771	12.8			40,705	6.0			54,273	8.0
Common Equity Tier 1 Capital (to Risk-Weighted Assets)		86,771	12.8			30,528	4.5			44,097	6.5
Tier I Capital (to Average Assets)		86,771	8.9			39,015	4.0			48,769	5.0

December 31, 2015
Consolidated
Total Capital (to Risk-Weighted Assets)	$	88,456	13.3	%	$	N/A	N/A	%		N/A	N/A
Tier I Capital (to Risk-Weighted Assets)		81,849	12.4			39,769	6.0			N/A	N/A
Common Equity Tier 1 Capital (to Risk-Weighted Assets)		74,849	11.3			29,827	4.5			N/A	N/A
Tier I Capital (to Average Assets)		81,849	8.6			38,232	4.0			N/A	N/A

Bank Only
Total Capital (to Risk-Weighted Assets)	$	90,855	13.7	%	$	52,981	8.0	%	$	66,227	10.0	%
Tier I Capital (to Risk-Weighted Assets)		84,248	12.7			39,736	6.0			52,981	8.0
Common Equity Tier 1 Capital (to Risk-Weighted Assets)		84,248	12.7			29,802	4.5			43,047	6.5
Tier I Capital (to Average Assets)		84,248	8.9			38,124	4.0			47,654	5.0

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Non-Performing Assets

As of September 30, 2016, our non-performing assets totaled $9.8 million or 0.99% of assets compared to $11.9 million or 1.23% of assets at December 31, 2015 (See table below.) The Company experienced a decrease of $579 thousand in non-accrual loans from December 31, 2015 to September 30, 2016. As of September 30, 2016, non-accrual loans include $3.9 million in loans secured by farmland, $1.6 million in loans secured by 1-4 family properties, $78 thousand in loans secured by non-farm and non-residential properties, $126 thousand in loans secured by multi-family residential loans, $138 thousand in agricultural production loans, $4 thousand in commercial loans and $30 thousand in consumer loans.

Loans secured by real estate composed 97.0% of the non-performing loans as of September 30, 2016 and 96.5% as of December 31, 2015. Forgone interest income on non-accrual loans totaled $65 thousand for the first nine months of 2016 compared to forgone interest of $47 thousand for the same time period in 2015. Accruing loans that are contractually 90 days or more past due as of September 30, 2016 totaled $127 thousand compared to $1.0 million at December 31, 2015, a decrease of $873 thousand.

Total nonperforming and restructured loans decreased $1.6 million from December 31, 2015 to September 30, 2016. The decrease in non-performing loan balances contributed to the decrease in the ratio of nonperforming and restructured loans to loans which decreased 33 basis points to 1.21% from December 31, 2015 to September 30, 2016.

In addition, the amount the Company has recorded as other real estate owned decreased $509 thousand from December 31, 2015 to September 30, 2016. As of September 30, 2016, the amount recorded as other real estate owned totaled $1.8 million compared to $2.3 million at December 31, 2015. During the first nine months of 2016, $235 thousand in loan balances were foreclosed upon and added to other real estate properties while $571 thousand in other real estate properties were sold. The allowance as a percentage of non-performing and restructured loans and other real estate owned increased from 55% at December 31, 2015 to 75% at September 30, 2016.

Nonperforming and Restructured Assets


	9/30/2016			12/31/2015
	(in thousands)

Non-accrual Loans	$	5,772		$	6,351
Accruing Loans which are Contractually past due 90 days or more		127			1,000
Accruing Troubled Debt Restructurings		2,081			2,245
Total Nonperforming and Restructured Loans		7,980			9,596
Other Real Estate		1,838			2,347
Total Nonperforming and Restructured Loans and Other Real Estate	$	9,818		$	11,943
Nonperforming and Restructured Loans as a Percentage of Loans		1.21	%		1.54	%
Nonperforming and Restructured Loans and Other Real Estate as a Percentage of Total Assets		0.99	%		1.23	%
Allowance as a Percentage of Period-end Loans		1.12	%		1.04	%
Allowance as a Percentage of Non-performing and Restructured Loans and Other Real Estate		75	%		55	%

We maintain a “watch list” of agricultural, commercial, real estate mortgage, and real estate construction loans and review those loans on a regular basis. Generally, assets are designated as “watch list” loans to ensure more frequent monitoring. If we determine that there is serious doubt as to performance in accordance with original terms of the contract, then the loan is generally downgraded and often placed on non-accrual status.

We review and evaluate nonaccrual loans, past due loans, and loans graded substandard or worse on a regular basis to determine if the loan should be evaluated for impairment and whether specific allocations are needed.

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Provision for Loan Losses

The loan loss provision for the first nine months of 2016 was $775 thousand compared to $1.0 million for the first nine months of 2015. The loan loss provision for the three month period ended September 30, 2016 was $175 thousand compared to $375 thousand for the three month period ended September 30, 2015. The decrease in the total loan loss provision during the first nine months of 2016 compared to the same time period in 2015 is attributed to improved loan quality in our loan portfolio and, during the first quarter of 2016, the Company recovered $259 thousand for a loan that was charged off in a prior year. This recovery of a prior charge-off resulted in increasing the allowance for loan losses by $259 thousand with no additional provision for loan loss expense.

Management evaluates the loan portfolio by reviewing the historical loss rate for each respective loan type and assigns risk multiples to certain categories to account for qualitative factors including current economic conditions. The average loss rates are reviewed for trends in the analysis, as well as comparisons to peer group loss rates. Management makes allocations within the allowance for loan losses for specifically classified loans regardless of loan amount, collateral or loan type. Loan categories are evaluated utilizing subjective factors in addition to the historical loss calculations to determine a loss allocation for each of those types.

As this analysis, or any similar analysis, is an imprecise measure of loss, the allowance is subject to ongoing adjustments. Therefore, management will often take into account other significant factors that may be necessary or prudent in order to reflect probable incurred losses in the total loan portfolio.

Nonperforming loans and restructured loans decreased $1.6 million from December 31, 2015 to $8.0 million at September 30, 2016. The Company recorded net recoveries of $109 thousand for the nine months ended September 30, 2016 compared to net charge-offs of $895 thousand for the nine months ended September 30, 2015. During the first quarter of 2016, the Company recorded a recovery of $259 for one loan which was charged-off in a prior year. Future levels of charge-offs will be determined by the particular facts and circumstances surrounding individual loans.

Based on the above information, management believes the current loan loss allowance is sufficient to meet probable incurred loan losses.

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Loan Losses


	Nine Months Ended September 30,
	(in thousands)
		2016			2015

Balance at Beginning of Period Amounts Charged-off:	$	6,521		$	6,012
Commercial		—			30
1-4 family residential		90			241
Multi-family residential		—			94
Agricultural		3			242
Consumer and other		915			963
Total Charged-off Loans		1,008			1,570
Recoveries on Amounts Previously Charged-off:
Commercial		37			—
Real Estate Construction		15			6
1-4 family residential		8			8
Multi-family residential		7			27
Non-farm & non-residential		355			8
Agricultural		35			20
Consumer and other		660			606
Total Recoveries		1,117			675
Net Charge-offs (Recoveries)		(109)			895
Provision for Loan Losses		775			1,025
Balance at End of Period		7,405			6,142
Loans
Average		642,998			560,394
At September 30,		659,970			612,504
As a Percentage of Average Loans:
Net Charge-offs for the period		(0.02)	%		0.16	%
Provision for Loan Losses for the period		0.12	%		0.18	%
Allowance as a Multiple of Net Charge-offs annualized		(51.0)			5.1

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	Three Months Ended September 30,
	(in thousands)
	2016			2015

Balance at Beginning of Period Amounts Charged-off:	$	7,259		$	5,950
Commercial		—			5
1-4 family residential		26			89
Multi-family residential		—
Agricultural		3			—
Consumer and other		253			307
Total Charged-off Loans		282			401
Recoveries on Amounts Previously Charged-off:
Commercial		3			—
Real Estate Construction		2			4
1-4 family residential		1			3
Multi-family residential		3			25
Non-farm & non-residential		82			8
Agricultural		12			8
Consumer and other		150			170
Total Recoveries		253			218
Net Charge-offs		29			183
Provision for Loan Losses		175			375
Balance at End of Period		7,405			6,142
Loans
Average		657,336			600,550
At September 30,		659,970			612,504
As a Percentage of Average Loans:
Net Charge-offs (Recoveries) for the period		0.00	%		0.03	%
Provision for Loan Losses for the period		0.03	%		0.06	%
Allowance as a Multiple of Net Charge-offs annualized		63.8			8.4

Item 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Asset/Liability management control is designed to ensure safety and soundness, maintain liquidity and regulatory capital standards, and achieve acceptable net interest income. Management considers interest rate risk to be the most significant market risk since a bank’s net income is largely dependent on net interest income. Our exposure to market risk is reviewed on a regular basis by the Asset/Liability Committee. Interest rate risk is the potential of economic losses due to future interest rate changes.

These economic losses can be reflected as a loss of future net interest income and/or a loss of current fair market values. The objective is to measure the effect on net interest income and to adjust the balance sheet to minimize the inherent risk, while at the same time, maximize income.

Management realizes certain risks are inherent and that the goal is to identify and minimize the risks. The primary tools used by management are interest rate shock and economic value of equity (EVE) simulations. The Company has $5.7 million in market risk sensitive instruments which are held for trading purposes. These assets are held for a minimal period of time and are used to generate profits on short-term differences in price while earning interest for the time they are held.

Using interest rate shock simulations, the following table depicts the change in net interest income resulting from 100 and 300 basis point changes in rates on the Company’s interest earning assets and interest bearing liabilities.

The projections are based on balance sheet growth assumptions and repricing opportunities for new, maturing and adjustable rate amounts. As of September 30, 2016, the projected percentage changes are within limits approved by our Board of Directors (“Board”).

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Although management does analyze and monitor the projected percentage change in a declining interest rate environment, due to the current rate environment many of the current deposit rates cannot decline an additional 100 basis points. Therefore, management places more emphasis in the rising rate environment scenarios. Similar to prior periods, this period’s volatility is slightly lower in each rate shock simulation when compared to the same period a year ago. The projected net interest income report summarizing our interest rate sensitivity as of September 30, 2016 is as follows:

PROJECTED NET INTEREST INCOME

(dollars in thousands)


	Level
Change in basis points:	- 100			Rates		+ 100			+ 300

Year One (10/16 - 9/17)
Net interest income	$	31,479		$	32,176	$	32,120		$	32,038
Net interest income dollar change		(697)			N/A		(56)			(138)
Net interest income percentage change		(2.2)	%		N/A		(0.2)	%		(0.4)	%
Board approved limit		>(4.0)	%		N/A		>(4.0)	%		>(10.0)	%

The projected net interest income report summarizing the Company’s interest rate sensitivity as of September 30, 2015 is as follows:

PROJECTED NET INTEREST INCOME

(dollars in thousands)


	Level
Change in basis points:	- 100			Rates		+ 100			+ 300

Year One (10/15 - 9/16)
Net interest income	$	29,903		$	30,751	$	30,754		$	30,646
Net interest income dollar change		(848)			N/A		3			(106)
Net interest income percentage change		(2.8)	%		N/A		—	%		(0.3)	%
Board approved limit		>(4.0)	%		N/A		>(4.0)	%		>(10.0)	%

Projections from September 30, 2016 and September 30, 2015, year one reflected declines of 2.2% and 2.8% in net interest income. The 100 basis point increase in rates reflected a 0.2% decrease in net interest income in 2016 compared to an increase of 0.0% in 2015.

EVE applies discounting techniques to future cash flows to determine the present value of assets, liabilities, and therefore equity. Based upon applying these techniques to the September 30, 2016, balance sheet, a 100 basis point increase in rates results in a 11.5% decrease in EVE. A 100 basis point decrease in rates results in a 1.2% increase in EVE. These are within the Board approved limits.

Item 4 - CONTROLS AND PROCEDURES

As of the end of the period covered by this report, and pursuant to Rule 13a-15(b) of the Securities Exchange Act of 1934 (“Exchange Act”), our management, including the Chief Executive Officer and the Chief Financial Officer, carried out an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures (as that term is defined in Rule 13a-15(e) of the Exchange Act). Based on the foregoing, our Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective, in all material respects, to ensure that information required to be disclosed in the reports the Company files and submits under the Exchange Act is recorded, processed, summarized and reported as and when required.

We also conducted an evaluation of internal control over financial reporting to determine whether any changes occurred during the quarter covered by this report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. Based on this evaluation, there has been no such change during the quarter covered by this report.

Our management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives.

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Part II - Other Information

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

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

7/1/16-7/30/16	—	$	—	—	79,380	shares

8/1/16-8/31/16	1,900		29.80	1,900	77,480	shares

9/1/16-9/30/16	5,000		30.63	5,000	72,480	shares

Total	6,900	$	30.40	6,900	72,480	shares

On October 25, 2000, we announced that our Board approved a stock repurchase program and authorized the Company to purchase up to 100,000 shares of its outstanding common stock. On November 11, 2002, the Board 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 Company to purchase an additional 100,000 shares. On May 17, 2011, the Board 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 September 30, 2016, 327,520 shares have been purchased.

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Item 6. Exhibits

Ay
2.1		Agreement and Plan of Merger with Peoples Bancorp of Sandy Hook is incorporated by reference to Exhibit 2.1 of the Registrant’s Current Report on Form 8-K dated and filed February 24, 2006.

2.2		Agreement and Plan of Share Exchange with Madison Financial Corporation is incorporated by reference to Exhibit 2.1 of the Registrant’s Current Report on Form 8-K dated and filed January 21, 2015.

3.1		Amended and Restated Articles of Incorporation of the Registrant are incorporated by reference to Exhibit 3.1 of the Registrant’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2000 and filed May 15, 2000.

3.2		Bylaws of the Registrant are incorporated by reference to Exhibit 3.1 of the Registrant’s Current Report on Form 8-K dated and filed November 21, 2007.

3.3		Articles of Amendment to Amended and Restated Articles of Incorporation of the Registrant are incorporated by reference to Exhibit 3.3 of the Registrant’s Annual Report of Form 10-K for the period ended December 31, 2005 and filed March 29, 2006.

31.1		Certifications of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2		Certifications of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32		Certifications of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

101		The following financial information from Kentucky Bancshares, Inc. Quarterly Report on Form 10-Q for the period ended September 30, 2016, filed with the SEC November 11, 2016, formatted in Extensible Business Reporting Language (XBRL): (i) Consolidated Balance Sheets at September 30, 2016,and December 31, 2015, (ii) Consolidated Statements of Income and Comprehensive Income (Loss) for the nine months and three months ended September 30, 2016 and September 30, 2015, (iii) Consolidated Statement of Stockholders’ Equity for the nine months ended September 30, 2016, (iv) Consolidated Statements of Cash Flows for the nine months ended September 30, 2016 and September 30, 2015 and (v) Notes to Consolidated Financial Statements.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

		KENTUCKY BANCSHARES, INC.

Date	11/14/16	/s/Louis Prichard
		Louis Prichard, President and C.E.O.

Date	11/14/16	/s/Gregory J. Dawson
		Gregory J. Dawson, Chief Financial Officer

KENTUCKY BANCSHARES INC /KY/ - FORM 10-Q - November 14, 2016

Attached files

KENTUCKY BANCSHARES INC /KY/ Reports