Attached files

file filename
EX-32 - EX-32 - KENTUCKY BANCSHARES INC /KY/ktyb-20200331xex32.htm
EX-31.2 - EX-31.2 - KENTUCKY BANCSHARES INC /KY/ktyb-20200331ex312758562.htm
EX-31.1 - EX-31.1 - KENTUCKY BANCSHARES INC /KY/ktyb-20200331ex3117955d0.htm

 

 

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 March 31, 2020

 

or

 

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

 

For the transition period from                         to                         

 

Commission File Number:  000-52598

 

KENTUCKY BANCSHARES, INC.

(Exact name of registrant as specified in its charter)

 

Kentucky

    

61-0993464

(State or other jurisdiction of

 

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

incorporation or organization)

 

 

 

 

P.O. Box 157, Paris, Kentucky

    

40362-0157

(Address of principal executive offices)

 

(Zip Code)

 

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

 

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

 

 

 

Title of each class

Trading Symbol(s)

Name of each exchange on which registered

Common Stock

KTYB

OTCQX

 

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 every Interactive Data File required to be submitted 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 such files). Yes ☒ No ☐

 

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

 

Large accelerated filer ☐

Accelerated filer

 

 

Non-accelerated filer   ☐

Smaller reporting company

 

 

 

Emerging growth company ☐

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

 

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 April 30, 2020:  5,946,998.

 

 

 

KENTUCKY BANCSHARES, INC.

 

Table of Contents

 

 

 

 

 

2

Item 1 – Financial Statements

KENTUCKY BANCSHARES, INC.

CONSOLIDATED BALANCE SHEETS (unaudited)

(Dollar amounts in thousands)

 

 

 

 

 

 

 

 

 

 

3/31/2020

    

12/31/2019

 

ASSETS

 

 

 

 

 

 

 

Cash and due from banks

 

$

37,474

 

$

21,922

 

Federal funds sold

 

 

292

 

 

260

 

Cash and cash equivalents

 

 

37,766

 

 

22,182

 

Interest bearing time deposits

 

 

2,375

 

 

2,375

 

Securities available for sale

 

 

247,187

 

 

265,330

 

Loans held for sale

 

 

4,990

 

 

2,144

 

Loans

 

 

778,327

 

 

744,313

 

Allowance for loan losses

 

 

(9,916)

 

 

(8,460)

 

Net loans

 

 

768,411

 

 

735,853

 

Federal Home Loan Bank stock

 

 

7,034

 

 

7,034

 

Real estate owned, net

 

 

2,110

 

 

2,148

 

Bank premises and equipment, net

 

 

19,999

 

 

19,429

 

Interest receivable

 

 

4,010

 

 

4,166

 

Mortgage servicing rights

 

 

1,504

 

 

1,573

 

Goodwill

 

 

14,001

 

 

14,001

 

Other intangible assets

 

 

114

 

 

136

 

  Bank owned life insurance

 

 

18,308

 

 

18,165

 

  Operating lease right of use asset

 

 

8,022

 

 

8,195

 

Other assets

 

 

7,547

 

 

8,059

 

Total assets

 

$

1,143,378

 

$

1,110,790

 

 

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

 

 

Deposits

 

 

 

 

 

 

 

Non-interest bearing

 

$

243,073

 

$

235,268

 

Time deposits, $250,000 and over

 

 

45,741

 

 

43,345

 

Other interest bearing

 

 

564,403

 

 

564,040

 

Total deposits

 

 

853,217

 

 

842,653

 

Repurchase agreements

 

 

5,410

 

 

5,994

 

Short-term Federal Home Loan Bank advances

 

 

54,000

 

 

25,000

 

Long-term Federal Home Loan Bank advances

 

 

84,925

 

 

91,418

 

Subordinated debentures

 

 

7,217

 

 

7,217

 

Interest payable

 

 

1,217

 

 

1,170

 

Operating lease liability

 

 

8,210

 

 

8,350

 

Other liabilities

 

 

11,395

 

 

9,725

 

Total liabilities

 

 

1,025,591

 

 

991,527

 

 

 

 

 

 

 

 

 

Stockholders’ equity

 

 

 

 

 

 

 

Preferred stock, 300,000 shares authorized and unissued

 

 

 —

 

 

 —

 

Common stock, no par value; 20,000,000 shares authorized; 5,946,998 and 5,913,922 shares issued and outstanding at March 31, 2020 and December 31, 2019

 

 

21,771

 

 

21,447

 

Retained earnings

 

 

97,584

 

 

96,903

 

Accumulated other comprehensive income (loss)

 

 

(1,568)

 

 

913

 

Total stockholders’ equity

 

 

117,787

 

 

119,263

 

Total liabilities and stockholders’ equity

 

$

1,143,378

 

$

1,110,790

 

 

See Accompanying Notes

3

KENTUCKY BANCSHARES, INC.

CONSOLIDATED STATEMENTS OF INCOME (unaudited)

(Dollar amounts in thousands except per share data)

 

 

 

 

 

 

 

 

Three Months Ended

 

 

3/31/2020

    

3/31/2019

 

INTEREST INCOME:

 

 

 

 

 

 

Loans, including fees

$

9,380

 

$

8,800

 

Securities

 

 

 

 

 

 

Taxable

 

1,469

 

 

1,829

 

Tax exempt

 

176

 

 

333

 

Other

 

110

 

 

217

 

Total interest income

 

11,135

 

 

11,179

 

INTEREST EXPENSE:

 

 

 

 

 

 

Deposits

 

1,468

 

 

1,537

 

Repurchase agreements and federal funds purchased

 

 8

 

 

24

 

Federal Home Loan Bank advances

 

582

 

 

543

 

Note payable

 

 —

 

 

34

 

Subordinated debentures

 

85

 

 

102

 

Total interest expense

 

2,143

 

 

2,240

 

Net interest income

 

8,992

 

 

8,939

 

Provision for loan losses

 

1,625

 

 

125

 

Net interest income after provision

 

7,367

 

 

8,814

 

NON-INTEREST INCOME:

 

 

 

 

 

 

Service charges

 

1,289

 

 

1,194

 

Loan service fee income (loss), net

 

(83)

 

 

73

 

Trust department income

 

370

 

 

328

 

Gain (loss) on sale of available for sale securities, net

 

112

 

 

94

 

Gain on sale of loans

 

683

 

 

207

 

Brokerage income

 

127

 

 

136

 

Debit card interchange income

 

812

 

 

790

 

Other

 

252

 

 

178

 

Total other income

 

3,562

 

 

3,000

 

NON-INTEREST EXPENSE:

 

 

 

 

 

 

Salaries and employee benefits

 

4,965

 

 

4,690

 

Occupancy expenses

 

1,094

 

 

981

 

Legal and professional fees

 

245

 

 

216

 

Data processing

 

579

 

 

601

 

Debit card expenses

 

507

 

 

530

 

Advertising and marketing

 

267

 

 

234

 

Taxes other than payroll, property and income

 

337

 

 

324

 

Loss on limited partnership

 

293

 

 

159

 

Other

 

943

 

 

1,030

 

Total other expenses

 

9,230

 

 

8,765

 

Income before income taxes

 

1,699

 

 

3,049

 

Provision for income taxes

 

(52)

 

 

238

 

Net income

$

1,751

 

$

2,811

 

Earnings per share

 

 

 

 

 

 

Basic

$

0.30

 

$

0.47

 

Diluted

 

0.30

 

 

0.47

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

See Accompanying Notes

4

KENTUCKY BANCSHARES, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (unaudited)

(Dollar amounts in thousands)

 

 

 

 

 

 

 

 

 

Three Months Ended

 

3/31/2020

    

3/31/2019

Net income

$

1,751

 

$

2,811

 

 

 

 

 

 

Other comprehensive income (loss)

 

 

 

 

 

Unrealized gains on securities arising during the period

 

354

 

 

3,599

Reclassification of realized amount

 

(112)

 

 

(94)

Net change in unrealized gain (loss) on securities

 

242

 

 

3,505

Less: Tax impact

 

(52)

 

 

(736)

  Net of tax

 

190

 

 

2,769

 

 

 

 

 

 

Unrealized gains (losses) on cashflow hedges

 

 

 

 

 

  Unrealized holding loss

 

(2,671)

 

 

 —

 

 

 

 

 

 

Total other comprehensive income (loss)

 

(2,481)

 

 

2,769

 

 

 

 

 

 

Comprehensive income (loss)

$

(730)

 

$

5,580

See Accompanying Notes

 

 

 

5

KENTUCKY BANCSHARES, INC.

CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (unaudited)

(Dollar amounts in thousands except per share data)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

    

    

 

 

 

    

Accumulated

    

 

 

 

 

 

 

 

 

 

 

 

 

Other

 

Total

 

 

 

Common Stock

 

Retained

 

Comprehensive

 

Stockholders’

 

 

 

Shares

 

Amount

 

Earnings

 

Income (Loss)

 

Equity

 

Balances, December 31, 2018

 

5,955,242

 

$

21,170

 

$

89,101

 

$

(3,478)

 

$

106,793

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Common stock issued (employee stock grants of 23,260 shares, net of 120 shares forfeited, and director stock grants of 2,824 shares)

 

26,084

 

 

295

 

 

 —

 

 

 —

 

 

295

 

Stock compensation expense

 

 —

 

 

56

 

 

 —

 

 

 —

 

 

56

 

Other comprehensive income

 

 —

 

 

 —

 

 

 —

 

 

2,769

 

 

2,769

 

Net income

 

 —

 

 

 —

 

 

2,811

 

 

 —

 

 

2,811

 

Dividends declared - $0.17 per share

 

 —

 

 

 —

 

 

(1,015)

 

 

 —

 

 

(1,015)

 

Balances, March 31, 2019

 

5,981,326

 

$

21,521

 

$

90,897

 

$

(709)

 

$

111,709

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balances, December 31, 2019

 

5,913,922

 

$

21,447

 

$

96,903

 

$

913

 

$

119,263

 

Common stock issued (employee stock grants of 29,242 shares, net of 788 shares for net settlement for income taxes and director stock grants of 3,834 shares)

 

33,076

 

 

263

 

 

 —

 

 

 —

 

 

263

 

Stock compensation expense

 

 —

 

 

61

 

 

 —

 

 

 —

 

 

61

 

Other comprehensive loss

 

 —

 

 

 —

 

 

 —

 

 

(2,481)

 

 

(2,481)

 

Net income

 

 —

 

 

 —

 

 

1,751

 

 

 —

 

 

1,751

 

Dividends declared - $0.18 per share

 

 —

 

 

 —

 

 

(1,070)

 

 

 —

 

 

(1,070)

 

Balances, March 31, 2020

 

5,946,998

 

$

21,771

 

$

97,584

 

$

(1,568)

 

$

117,787

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 


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

 

See Accompanying Notes

 

6

KENTUCKY BANCSHARES, INC.

CONSOLIDATED STATEMENT OF CASH FLOWS (unaudited)

(Dollar amounts in thousands)

 

 

 

 

 

 

 

 

    

Three Months Ended

 

 

3/31/2020

    

3/31/2019

Cash Flows From Operating Activities

 

 

 

 

 

 

Net Income

 

$

1,751

 

$

2,811

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

 

Depreciation

 

 

334

 

 

300

Amortization (accretion), net

 

 

91

 

 

(31)

Securities amortization (accretion), net

 

 

247

 

 

174

Stock based compensation expense

 

 

61

 

 

56

Provision for loan losses

 

 

1,625

 

 

125

Securities losses (gains) available for sale gains, net

 

 

(112)

 

 

(94)

Net increase in cash surrender value of bank-owned life insurance

 

 

(143)

 

 

(84)

Originations of loans held for sale

 

 

(23,496)

 

 

(8,435)

Proceeds from sale of loans

 

 

21,333

 

 

8,563

Gain on sale of loans

 

 

(683)

 

 

(207)

Write-downs of other real estate, net

 

 

38

 

 

38

Changes in:

 

 

 

 

 

 

Interest receivable

 

 

156

 

 

(27)

Other assets

 

 

1,017

 

 

664

Interest payable

 

 

47

 

 

 9

Deferred taxes

 

 

(523)

 

 

 5

Other liabilities

 

 

(1,296)

 

 

(3,618)

Net cash from operating activities

 

 

447

 

 

249

Cash Flows From Investing Activities

 

 

 

 

 

 

Purchases of securities available for sale

 

 

(448)

 

 

(8,022)

Proceeds from sales of securities available for sale

 

 

2,094

 

 

16,318

Proceeds from principal payments, maturities and calls securities available for sale

 

 

16,898

 

 

12,529

Net change in loans

 

 

(34,183)

 

 

(1,670)

Purchases of bank premises and equipment

 

 

(904)

 

 

(283)

Proceeds from the sale of other real estate

 

 

 —

 

 

12

Net cash from (used in) investing activities

 

 

(16,543)

 

 

18,884

Cash Flows From Financing Activities:

 

 

 

 

 

 

Net change in deposits

 

 

10,564

 

 

(6,304)

Net change in repurchase agreements

 

 

(584)

 

 

(1,473)

Net change in short-term Federal Home Loan Bank advances

 

 

29,000

 

 

(200)

Proceeds from long-term Federal Home Loan Bank advances

 

 

 —

 

 

5,000

Repayment of long-term Federal Home Loan Bank advances

 

 

(6,493)

 

 

(3,505)

Repayment of note payable

 

 

 —

 

 

(126)

Proceeds from issuance of common stock

 

 

263

 

 

295

Dividends paid

 

 

(1,070)

 

 

(1,015)

Net cash used in financing activities

 

 

31,680

 

 

(7,328)

Net change in cash and cash equivalents

 

 

15,584

 

 

11,805

Cash and cash equivalents at beginning of period

 

 

22,182

 

 

26,101

Cash and cash equivalents at end of period

 

$

37,766

 

$

37,906

Supplemental disclosures of cash flow information Cash paid during the year for:

 

 

 

 

 

 

     Interest expense

 

$

2,096

 

$

2,231

Supplemental disclosures of non-cash investing activities

 

 

 

 

 

 

     Securities transactions in process, payable

 

 

294

 

 

 —

     Real estate acquired through foreclosure

    

 

 —

 

 

72

 

 

 

 

 

 

 

See Accompanying Notes

7

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

 

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, 2019. 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, 2019.

 

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

 

Nature of Operations:  The Bank operates under a state bank charter and provides full banking services, including trust services, to customers located in Bourbon, Clark, Elliot, Fayette, Harrison, Jessamine, Madison, Rowan, Scott, Woodford and adjoining counties in Kentucky.  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., a captive insurance subsidiary, 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.

 

In December 2019, a novel strain of coronavirus, COVID-19, was reported in Wuhan, China. The COVID-19 virus continues to aggressively spread globally and has spread to over 185 countries, including all 50 states in the United States. A prolonged COVID-19 outbreak, or any other epidemic that harms the global economy, U.S. economy, or the economies in which we operate could adversely affect our operations. While the spread of the COVID-19 virus has minimally impacted our operations as of March 31, 2020, it has caused significant economic disruption throughout the United States as state and local governments issued “shelter at home” orders along with the closing of non-essential businesses. The potential financial impact is unknown at this time. However, if these actions are sustained, it may adversely impact several industries within our geographic footprint and impair the ability of our customers to fulfill their contractual obligations to the Company. This could cause Kentucky Bancshares to experience a material adverse effect on our business operations, asset valuations, financial condition, and results of operations. Material adverse impacts may include all or a combination of valuation impairments on Kentucky Bancshares’s intangible assets, investments, loans, loan servicing rights, deferred tax assets, or counter-party risk derivatives.

 

Cash Flows:  For purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks, federal funds sold, and certain short-term investments with maturities of less than three months.  Generally, federal funds are sold for one-day periods.  Net cash flows are reported for loan, deposit and short-term borrowing transactions.

 

Interest Bearing Time Deposits: Interest bearing time deposits in other financial institutions have original maturities between one and three years and are carried at cost.

 

8

Securities:  The Company is required to classify its securities portfolio into one of three categories:  trading securities, securities available for sale and securities held to maturity.  Fair value adjustments are made to the securities based on their classification with the exception of the held to maturity category.  The Company has no investments classified as trading securities or held to maturity.  Securities available for sale are carried at fair value. Unrealized holding gains and losses for securities which are classified as available for sale are reported in other comprehensive income, net of deferred tax. 

 

Interest income includes amortization of purchase premium or discount.  Premiums and discounts on securities are amortized on the level-yield method without anticipating prepayments, except for mortgage backed securities where prepayments are anticipated.  Premiums on purchased callable debt securities are amortized to the earliest call date.  Gains and losses on sales are recorded on the settlement date and determined using the specific identification method.

 

Equity investments are included in other assets with changes in fair value recorded in other income. 

 

Management evaluates securities for other-than-temporary impairment (“OTTI”) at least on a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation.  For securities in an unrealized loss position, management considers the extent and duration of the unrealized loss, and the financial condition and near-term prospects of the issuer.  Management also assesses whether it intends to sell, or it is more likely than not that it will be required to sell, a security in an unrealized loss position before recovery of its amortized cost basis.  If either of the criteria regarding intent or requirement to sell is met, the entire difference between amortized cost and fair value is recognized as impairment through earnings.

 

For debt securities that do not meet the aforementioned criteria, the amount of impairment is split into two components as follows: 1) OTTI related to credit loss, which must be recognized in the income statement and 2) OTTI related to other factors, which is recognized in other comprehensive income.  The credit loss is defined as the difference between the present value of the cash flows expected to be collected and the amortized cost basis. 

 

Loans Held for Sale:  Loans held for sale are carried at the lower of cost or fair value as determined by outstanding commitments from investors or current secondary market prices, calculated on the aggregate loan basis.  The Company also provides for any losses on uncovered commitments to lend or sell.  The Company sells loans with servicing rights retained.

 

Loans:  Loans that management has the intent and ability to hold for the foreseeable future or until maturity are stated at the amount of unpaid principal, net of deferred loan origination fees and costs and acquired purchase premiums and discounts, reduced by an allowance for loan losses.  Interest income on loans is recognized  on the accrual basis except for those loans on a nonaccrual status.  Interest income on real estate mortgage (1-4 family residential and multi-family residential) and consumer loans is discontinued at the time the loan is 90 days delinquent, and interest income on real estate construction, non-farm and non-residential mortgage, agricultural and commercial loans is discontinued at the time the loan is 120 days delinquent, unless the loan is well-secured and in process of collection.  Past due status is based on the contractual terms of the loan.  In all cases, loans are placed on nonaccrual or charged-off at an earlier date if collection of principal or interest is considered doubtful.  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.  Loan origination fees and certain direct origination costs are capitalized and recognized as an adjustment of the yield on the related loan.  Recorded investment is the outstanding loan balance, excluding accrued interest receivable.

 

When interest accrual is discontinued, interest income received on such loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual.  Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.  Typically, the Company seeks to establish a payment history of at least six consecutive payments made on a timely basis before returning a loan to accrual status.  Consumer and credit card loans are typically charged off no later than 120 days past due.  Loans are placed on nonaccrual or charged-off at an earlier date if collection of principal or interest is considered doubtful.

 

9

Concentration of Credit Risk:  Most of the Company’s business activity is with customers located within Bourbon, Clark, Elliott, Fayette, Harrison, Jessamine, Madison, Rowan, Scott, Woodford and surrounding counties located in Kentucky.  Therefore, the Company’s exposure to credit risk is significantly affected by changes in the economy in these counties.

 

Allowance for Loan Losses:  The allowance for loan losses is a valuation allowance for probable incurred credit losses.  Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed.  Subsequent recoveries, if any, are credited to the allowance.

 

Adjustments are made to the historical loss experience ratios based on the qualitative factors as outlined in the regulatory Interagency Policy Statement on the Allowance for Loan and Lease Losses.  These qualitative factors include the nature and volume of portfolio, economic and business conditions, classification, past due and non-accrual trends.

 

Management estimates the allowance balance required using past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions, and other factors.  Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management’s judgment, should be charged off.

 

The allowance for loan losses is evaluated at the portfolio segment level using the same methodology for each segment.  The recent historical actual net losses is the basis for the general reserve for each segment which is then adjusted for qualitative factors as outlined above (i.e., nature and volume of portfolio, economic and business conditions, classification, past due and non-accrual trends) specifically evaluated at individual segment levels.

 

The allowance consists of specific and general components.  The specific component relates to loans that are individually classified as impaired.  The general component covers non-classified loans and is based on historical loss experience adjusted for current factors for non-classified loans and a migration analysis for classified loans.

 

A loan is impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement.  Loans, for which the terms have been modified, and for which the borrower is experiencing financial difficulties and has been granted a concession, are considered troubled debt restructurings and classified as impaired.

 

Loans are charged off when available information confirms that loans, or portions thereof, are uncollectible.  While management considers the number of days a loan is past due in its evaluation process, we also consider a variety of other factors.

 

Factors considered by management in evaluating the charge-off decision include collateral value, availability of current financial information for both borrower and guarantor (if any), and the probability of collecting contractual principal and interest payments.  These considerations may result in loans being charged off before they are 90 days or more past due.  This evaluation framework for determining charge-offs is consistently applied to each segment. 

 

From time to time, the Company will charge-off a portion of impaired and non-performing loans.  Loans that meet the criteria under ASC 310 are evaluated individually for impairment.  Management considers payment status, collateral value, availability of current financial information for the borrower and guarantor, actual and expected cash flows, and probability of collecting amounts due.  If a loan’s collection status is deemed to be collateral dependent or foreclosure is imminent, the loan is charged down to the fair value of the collateral, less selling costs.  In circumstances where the loan is not deemed to be collateral dependent, but we believe, after completing our evaluation process, that probable loss has been incurred, we will provide a specific allocation on that loan.

 

The impact of recording partial charge-offs is a reduction of gross loans and a reduction of the loan loss reserve.  The net loan balance is unchanged in instances where the loan had a specific allocation as a component of the allowance for loan losses.  The allowance as a percentage of total loans may be lower as the allowance no longer needs to include a component for the loss, which has now been recorded, and net charge-off amounts are increased as partial charge-offs are recorded.

 

10

Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due.  Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired.  Management determines the significance of payment delays and payment shortfalls on case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed.

 

Commercial and real estate construction and real estate mortgage loans (multi-family residential, and non-farm and non-residential mortgage) over $200 thousand are individually evaluated for impairment.  If a loan is impaired, a portion of the allowance is allocated so that the loan is reported, net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral.  Large groups of smaller balance homogeneous loans, such as consumer and 1-4 family residential real estate loans, are collectively evaluated for impairment, and accordingly, they are not separately identified for impairment disclosures. 

Troubled debt restructurings are separately identified for impairment disclosures and are measured at the present value of estimated future cash flows using the loan’s effective rate at inception.

 

If a troubled debt restructuring is considered to be a collateral dependent loan, the loan is reported, net, at the fair value of the collateral. For troubled debt restructurings that subsequently default, the Company determines the amount of reserve in accordance with the accounting policy for the allowance for loan losses.

 

The general component covers non-impaired loans and is based on historical loss experience adjusted for current factors.  The historical loss experience is determined by portfolio segment and is based on the actual loss history experienced by the Company over the most recent 5 years.  This actual loss experience is supplemented with other economic factors based on the risks present for each portfolio segment.  These economic factors include consideration of the following:  levels of and trends in delinquencies and impaired loans; levels of and trends in charge-offs and recoveries; trends in volume and terms of loans; effects of any changes in risk selection and underwriting standards; other changes in lending policies, procedures, and practices; experience, ability, and depth of lending management and other relevant staff; national and local economic trends and conditions; industry conditions; and effects of changes in credit concentrations.

 

A “portfolio segment” is defined as the level at which an entity develops and documents a systematic methodology to determine its allowance for loan losses.  The Company has identified the following portfolio segments:  commercial, real estate construction, real estate mortgage, agricultural, consumer (credit cards and other consumer) and other (overdrafts).

 

Commercial:  These loans to businesses do not have real estate as the underlying collateral.  Instead of real estate, collateral could be business assets such as equipment or accounts receivable or the personal guarantee of one or more guarantors.  These loans generally present a higher level of risk than loans secured by commercial real estate because in the event of default by the borrower, the business assets must be liquidated and/or guarantors pursued for deficit funds.  Business assets are worth more while they are in use to produce income for the business and worth significantly less if the business is no longer in operation.  Within the commercial portfolio, risk analysis is performed primarily based on the individual loan type.

 

Real estate construction:  Real estate construction consists of loans secured by real estate for additions or alterations to existing structures, as well as constructing new structures.  They include fixed and floating rate loans.  Real estate construction loans generally present a higher level of risk than loans secured by 1-4 family residential real estate primarily because of the length of the construction period, potential change in prices of construction, the incomplete status of the collateral and economic cycles.  Because of these factors, real estate construction loans generally have higher qualitative adjustments.

 

Real Estate Mortgage:

 

1-4 family residential:  Loans secured by 1-4 family residential real estate represent the lowest risk of loans for the Company.  They include fixed and floating rate loans as well as loans for commercial purposes or consumer purposes.  The Company generally does not hold subprime residential mortgages. Borrowers with loans in this category, whether for commercial or consumer purposes, tend to make their payments timely as they do not want to risk foreclosure and loss of property.

11

 

Multifamily residential:  Loans secured by multifamily residential real estate consist primarily of loans secured by apartment buildings and can be either fixed or floating rate loans.  Multi-family residential real estate loans generally present a higher level of risk than loans secured by 1-4 family residential real estate because the borrower’s repayment ability typically comes from rents from tenants.  Local economic and employment fluctuations impact rent rolls and potentially the borrower’s repayment ability.

 

Non-farm & non-residential:  Loans secured by non-farm non-residential real estate consist of loans secured by commercial real estate that is not owner occupied.  These loans generally consist of loans collateralized by property whereby rents received from commercial tenants of the borrower are the source of repayment.   These loans generally present a higher level of risk than loans secured by owner occupied commercial real estate because repayment risk is expanded to be dependent on the success of multiple businesses which are paying rent to the borrower. 

If multiple businesses fail due to deteriorating economic conditions or poor business management skills, the borrower may not have enough rents to cover their monthly payment.  Repayment risk is also increased depending on the level of surplus available commercial lease space in the local market area.

 

Agricultural:  These loans to agricultural businesses do not have real estate as the underlying collateral.  Instead of real estate, collateral could be assets such as equipment or accounts receivable or the personal guarantee of one or more guarantors.  These loans generally present a higher level of risk than loans secured by real estate because in the event of default by the borrower, the assets must be liquidated and/or guarantors pursued for deficit funds.  Farm assets are worth more while they are in use to produce income and worth significantly less if the farm is no longer in operation.

Consumer:  Consumer loans are generally loans to borrowers for non-business purposes.  They can be either secured or unsecured.  Consumer loans are generally small in the individual amount of principal outstanding and are repaid from the borrower’s private funds earned from employment.  Consumer lending risk is very susceptible to local economic trends.

 

If there is a consumer loan default, any collateral that may be repossessed is generally not well maintained and has a diminished value.  For this reason, consumer loans tend to have higher overall interest rates to cover the higher cost of repossession and charge-offs.  However, due to their smaller average balance per borrower, consumer loans are collectively evaluated for impairment in determining the appropriate allowance for loan losses.

 

Other:  All other loan types are aggregated together for credit risk evaluation due to the varying nature but small number of the remaining types of loans in the Company’s loan portfolio.  Loans in this segment include but are not limited to overdrafts.  Due to their smaller balance, other loans are collectively evaluated for impairment in determining the appropriate allowance for loan losses.

 

Due to the overall high level of real estate mortgage loans within the loan portfolio as a whole, as compared to other portfolio segments, for risk assessment and allowance purposes this segment was segregated into more granular pools by collateral property type. 

 

The non-farm non-residential and the multi-family real estate mortgage loan portfolio segments had the next highest level of qualitative adjustments due to the effects of local markets and economies on the underlying collateral property values, as well as for industry concentrations and risks related to the this type of property. 

 

Derivatives:  At the inception of a derivative contract, the Company designates the derivative as one of three types based on the Company’s intentions and belief as to likely effectiveness as a hedge.  These three types are (1) a hedge of the fair value of a recognized asset or liability or of an unrecognized firm commitment (“fair value hedge”), (2) a hedge of a forecasted transaction or the variability of cash flows to be received or paid related to a recognized asset or liability (“cash flow hedge”), or (3) an instrument with no hedging designation (“stand-alone derivative”).  For a fair value hedge, the gain or loss on the derivative, as well as the offsetting loss or gain on the hedged item, are recognized in current earnings as fair value changes.  For a cashflow hedge, the gain or loss on the derivative is reported in other comprehensive income and is reclassified into earnings in the same periods during which the hedged transaction affects earnings.  Changes in the fair value of derivatives that do not qualify for hedge accounting are reported currently in earnings, as non-interest income. 

 

12

Net cash settlements on derivatives that qualify for hedge accounting are recorded in interest income or interest expense, based on the item being hedged.  Net cash settlements on derivatives that do not qualify for hedge accounting are reported in non-interest income.  Cash flows on hedges are classified in the cash flow statement the same as the cash flows of the items being hedged. 

 

The Company formally documents the relationship between derivatives and hedged items, as well as the risk-management objective and the strategy for undertaking hedge transactions at the inception of the hedging relationship.  This documentation includes linking both fair value hedges and cash flow hedges to specific assets and liabilities on the balance sheet or to specific firm commitments or forecasted transactions. 

 

The Company also formally assesses, both at the hedge’s inception and on an ongoing basis, whether the derivative instruments that are used are highly effective in offsetting changes in fair values or cash flows of the hedged items.  The Company discontinues hedge accounting when it determines that the derivative is no longer effective in offsetting changes in the fair value or cash flows of the hedged item, the derivative is settled or terminates, a hedged forecasted transaction is no longer probable, a hedged firm commitment is no longer firm, or treatment of the derivative as a hedge is no longer appropriate or intended.

 

When hedge accounting is discontinued, subsequent changes in fair value of the derivative are recorded as non-interest income.  When a fair value hedge is discontinued, the hedged asset or liability is no longer adjusted for changes in fair value and the existing basis adjustment is amortized or accreted over the remaining life of the asset or liability.  When a cash flow hedge is discontinued but the hedged cash flows or forecasted transactions are still expected to occur, gains or losses that were accumulated in other comprehensive income are amortized into earnings over the same periods which the hedged transactions will affect earnings.

 

Mortgage Banking Derivatives:  Commitments to fund mortgage loans (interest rate locks) to be sold into the secondary market and forward commitments for the future delivery of these mortgage loans are accounted for as free standing derivatives.  The fair value of the interest rate lock is recorded at the time the commitment to fund the mortgage loan is executed and is adjusted for the expected exercise of the commitment before the loan is funded.  In order to hedge the change in interest rates resulting from its commitments to fund the loans, the Company enters into forward commitments for the future delivery of the mortgage loans when interest rate locks are entered into.  Fair values of these mortgage derivatives are estimated based on changes in mortgage interest rates from the date the interest on the loan is locked.  Changes in the fair values of these derivatives are included in net gains on the sales of loans.

 

Mortgage Servicing Rights:  The Bank has sold certain residential mortgage loans to the Federal Home Loan Mortgage Corporation (FHLMC) while retaining the servicing rights.  Servicing rights are recognized separately when they are acquired through sales of loans.  When mortgage loans are sold, servicing rights are initially recorded at fair value with the income statement effect recorded in gain on sale of mortgage loans.  Fair value is based on market prices for comparable mortgage servicing contracts, when available, or alternatively, is based on a valuation model that calculates the present value of estimated future net servicing income. 

 

The valuation model incorporates assumptions that market participants would use in estimating future net servicing income, such as the cost to service, the discount rate, the custodial earnings rate, an inflation rate, ancillary income, prepayment speeds and default rates and losses.  All classes of servicing assets are subsequently measured using the amortization method which requires servicing rights to be amortized into loan service fee income, net, included in non-interest income in proportion to, and over the period of, the estimated future net servicing income of the underlying loans. 

 

Servicing assets are evaluated for impairment based upon the fair value of the rights as compared to carrying amount.  Impairment is determined by stratifying rights into groupings based on predominant risk characteristics, such as interest rate, loan type and investor type.  Impairment is recognized through a valuation allowance for an individual grouping, to the extent that fair value is less than the carrying amount.  If the Company later determines that all or a portion of the impairment no longer exists for a particular grouping, a reduction of the allowance may be recorded as an increase to income.  The fair values of servicing rights are subject to significant fluctuations as a result of changes in estimated and actual prepayment speeds and default rates and losses.

 

13

Servicing fee income, which is reported on the income statement as loan service income, net, is recorded for fees earned for servicing loans.  The fees are based on a contractual percentage of the outstanding principal or a fixed amount per loan and are recorded as income when earned.  The amortization of mortgage servicing rights and valuation allowance are netted against loan servicing fee income.  Servicing fees totaled $145 thousand for the three months ended March 31, 2020 compared to $134 thousand for the three months ended March 31, 2019 and are included in loan service fee income, net in the income statement.  Late fees and ancillary fees related to loan servicing are not material. 

 

Federal Home Loan Bank (FHLB) Stock:  The Bank is a member of the FHLB system. Members are required to own a certain amount of stock based on the level of borrowings and other factors, and may invest in additional amounts.  FHLB stock is carried at cost, classified as a restricted security, and periodically evaluated for impairment based on ultimate recovery of par value.  Both cash and stock dividends are reported as income.

 

Bank-Owned Life Insurance:  The Company has purchased life insurance policies on certain key employees.  Bank- owned life insurance is recorded at the amount that can be realized under the insurance contract at the balance sheet date, which is the cash surrender value adjusted for other charges or other amounts due that are probable at settlement.

 

Bank Premises and Equipment:  Land is carried at cost.  Bank premises and equipment are stated at cost less accumulated depreciation.  Buildings and related components are depreciated using the straight-line method with useful lives ranging from 5 to 40 years.  Furniture, fixtures and equipment are depreciated using the straight-line (or accelerated) method with useful lives ranging from 3 to 10 years.

 

Real Estate Owned:  Physical possession of residential real estate property collateralizing a consumer mortgage loan occurs when legal title is obtained upon completion of foreclosure or when the borrower conveys all interest in the property to satisfy the loan through completion of a deed in lieu of foreclosure or similar legal agreement.  Real estate acquired through foreclosure is initially recorded at fair value less costs to sell when acquired, establishing a new cost basis.  These assets are subsequently accounted for at the lower of cost or fair value less estimated costs to sell.  The value of the underlying loan is written down to the fair value of the real estate to be acquired by a charge to the allowance for loan losses, if necessary.  Any subsequent write-downs are charged to operating expenses.  Operating expenses of such properties, net of related income, and gains and losses on their disposition are included in other expenses

 

Investments in Limited Partnerships:  Investments in limited partnerships represent the Company’s investments in affordable housing projects for the primary purpose of available tax benefits.  The Company is a limited partner in these investments and as such, the Company is not involved in the management or operation of such investments.  These investments are amortized over the period that the Company expects to receive the tax benefits.  These investments are evaluated for impairment when events indicate the carrying amount may not be recoverable. 

 

The investment recorded at March 31, 2020 was $3.9 million and $4.0 million at March 31, 2019, respectively, and is included with other assets in the balance sheet.  During the quarters ended March 31, 2020 and 2019, the Company

recognized amortization expense of $293 thousand and $159 thousand, respectively, which was included within

other noninterest expense on the consolidated statements of income.    

 

Leases:  Lessees are required to recognize assets and liabilities on the balance sheet for leases with lease terms greater than 12 months. The Company recorded an operating lease right of use asset of $8.0 million and an operating lease liability of $8.2 million, as of March 31, 2020, as a result of recording operating lease contracts where the Company is lessee. 

 

Repurchase Agreements:  Substantially all repurchase agreement liabilities represent amounts advanced by various customers.  Securities are pledged to cover these liabilities, which are not covered by federal deposit insurance.

 

Stock-Based Compensation:  Compensation cost is recognized for stock options and restricted stock awards issued to employees, based on the fair value of these awards at the date of grant.  A Black-Scholes model is utilized to estimate the fair value of stock options, while the market price of the Company’s common stock at the date of grant is used for restricted stock awards.  Compensation cost is recognized over the required service period, generally defined as the

14

vesting period.  For awards with graded vesting, compensation cost is recognized on a straight-line basis over the requisite service period for the entire award.

 

Revenue Recognition:  The Company’s services that fall within the scope of ASC 606 are presented within Non-Interest Income and are recognized as revenue as the Company satisfies its obligation to the customer.  Services within the scope of ASC 606 include trust department income, service charges, debit card interchange income and brokerage income.

 

Income Taxes:  Income tax expense is the total of the current year income tax due or refundable and the change in deferred tax assets and liabilities.  Deferred tax assets and liabilities are the expected future tax amounts for the temporary differences between carrying amounts and tax bases of assets and liabilities, computed using enacted tax rates.  A valuation allowance, if needed, reduces deferred tax assets to the amount expected to be realized.

 

A tax position is recognized as a benefit only if it is “more likely than not” that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur.  The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being realized on examination.  For tax positions not meeting the “more likely than not” test, no tax benefit is recorded.

 

The Company recognizes interest related to income tax matters as interest expense and penalties related to income tax matters as other expense.

 

Retirement Plans:  Employee 401(k) and profit sharing plan expense is the amount of matching contributions.

 

Goodwill and Intangible Assets:  Goodwill and intangible assets acquired in a purchase business combination and determined to have an indefinite useful life are not amortized, but tested for impairment at least annually.  The Company has selected December 31 as the date to perform the annual impairment test.  Intangible assets with definite useful lives are amortized over their estimated useful lives to their estimated residual values.  Goodwill is the only intangible asset with an indefinite life on our balance sheet.  Management believes no impairment exists to Goodwill as of March 31, 2020 due to the recent economic downturn associated with the COVID-19 pandemic.

 

Intangible assets consist of core deposit intangible assets arising from whole bank and branch acquisitions.  They are initially measured at fair value and then are amortized on either an accelerated or straight-line basis, over ten or fifteen years.

 

Loan Commitments and Related Financial Instruments:  Financial instruments include off-balance sheet credit instruments, such as commitments to make loans and commercial letters of credit, issued to meet customer financing needs.  The face amount for these items represents the exposure to loss, before considering customer collateral or ability to repay.  Such financial instruments are recorded when they are funded.

 

Earnings Per Common 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 include the dilutive effect of additional potential common shares issuable under stock options.  Earnings and dividends per share have been adjusted in all periods presented to give effect to all stock splits and dividends through the date of issuance of the financial statements.

 

Comprehensive Income (Loss):  Comprehensive income consists of net income and other comprehensive income.  Other comprehensive income (loss) includes unrealized gains and losses on securities available for sale, and unrealized gains and losses on cash flow hedges, which are also recognized as a separate component of equity.

 

Fair Value of Financial Instruments:  Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed in a separate note.  Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments, and other factors, especially in the absence of broad markets for particular items.  Changes in assumptions or in market conditions could significantly affect the estimates.

 

15

Operating Segments:  While the Company’s chief decision makers monitor the revenue streams of the various Company products and services, operations are managed and financial performance is evaluated on a Company-wide basis.  Accordingly, all of the Company’s operations are considered by management to be aggregated into one reportable operating segment: banking.

 

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

 

Adoption of New Accounting Standards

 

FASB ASC 326, 815, and 825 – In April 2019, the FASB issued ASU No. 2019-04, Codification Improvements to Topic 326, Financial Instruments—Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments. The amendments related to Topic 326 address accrued interest, transfers between classifications or categories for loans and debt securities, recoveries, vintage disclosures, and contractual extensions and renewal options and became effective for annual periods and interim periods within those annual periods beginning after December 15, 2019. The improvements and clarifications related to Topic 815 address partial-term fair value hedges of interest-rate risk, amortization, and disclosure of fair value hedge basis adjustments and consideration of hedged contractually specified interest rate under the hypothetical method and became effective for the annual reporting period beginning January 1, 2020. The amendments related to Topic 825 contain various improvements to ASU 2016-01, including scope; held-to-maturity debt securities fair value disclosures; and remeasurement of equity securities at historical exchange rates and became effective for fiscal years and interim periods beginning after December 15, 2019. The amendments in this update did not have a material impact on the financial statements

 

FASB ASC 350 – In January 2017, the FASB issued ASU No. 2017-04, Intangibles: Goodwill and Other: Simplifying the Test for Goodwill Impairment. To simplify the subsequent measurement of goodwill, the amendments eliminate Step 2 from the goodwill impairment test. The annual, or interim, goodwill impairment test is performed by comparing the fair value of a reporting unit with its carrying amount. An impairment charge should be recognized for the amount by which the carrying amount exceeds the reporting unit’s fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. In addition, the income tax effects of tax deductible goodwill on the carrying amount of the reporting unit should be considered when measuring the goodwill impairment loss, if applicable. The amendments also eliminate the requirements for any reporting unit with a zero or negative carrying amount to perform Step 2 of the goodwill impairment test. An entity still has the option to perform the qualitative assessment for a reporting unit to determine if the quantitative impairment test is necessary. The amendments should be applied on a prospective basis. The nature of and reason for the change in accounting principle should be disclosed upon transition. The amendments in this update became effective for annual or any interim goodwill impairment tests in fiscal years beginning after December 15, 2019 and did not have a material impact on the financial statements. 

 

FASB ASC 820 – In August 2018, the FASB issued ASU No. 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework – Changes to the Disclosure Requirements for Fair Value Measurement. The updated guidance improves the disclosure requirements on fair value measurements. The ASU removes certain disclosures required by Topic 820 related to transfers between Level 1 and Level 2 of the fair value hierarchy; the policy for timing of transfers between levels; the valuation processes for Level 3 fair value measurements; and for nonpublic entities, the changes in unrealized gains and losses for the period included in earnings for recurring Level 3 fair value measurements held at the end of the reporting period. The ASU modifies certain disclosures required by Topic 820 related to disclosure of transfers into and out of Level 3 of the fair value hierarchy and purchases and issues of Level 3 assets and liabilities for nonpublic entities; the requirement to disclose the timing of liquidation of an investee’s assets and the date when restrictions from redemption might lapse only if the investee has communicated the timing to the entity or announced the timing publicly for investments in certain entities that calculate net asset value; and clarification that the measurement uncertainty disclosure is to communicate information about the uncertainty in measurement as of the reporting date. The ASU adds certain disclosure requirements related to changes in unrealized gains and losses for the period included in other comprehensive income for recurring Level 3 fair value measurements held at the end of the reporting period and the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements. For certain unobservable inputs, an entity may disclose other quantitative information in lieu of the weighted average if the entity determines that other quantitative information would be a more reasonable and rational method to reflect the distribution of unobservable inputs used to develop Level 3 fair value measurements. The amendments in this update

16

became effective for fiscal years, and interim periods within those fiscal years beginning after December 15, 2019 and did not have a material impact on the financial statements.

 

On March 22, 2020, the federal banking agencies issued an “Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus”.  This guidance encourages financial institutions to work prudently with borrowers that may be unable to meet their contractual obligations because of the effects of COVID-19.  The guidance goes on to explain that in consultation with the FASB staff that the federal banking agencies conclude that short-term modifications (e.g. six months) made on a good faith basis to borrowers who were current as of the implementation date of a relief program are not Troubled Debt Restructurings (“TDRs”).  The Coronavirus Aid, Relief and Economic Security (“CARES”) Act was passed by Congress on March 27, 2020.  Section 4013 of the CARES Act also addressed COVID-19 related modifications and specified that COVID-19 related modifications on loans that were current as of December 31, 2019 are not TDRs. Modifications are likely to be executed in the second quarter of 2020.  The majority of these modifications will involve three to six month forbearance payments which will be added to the end of the note. As of April 30, 2020,  we had approved modifications on $105.4 million of loans.

 

Accounting Standards Issued But Not Yet Adopted

 

ASU 2016-13, “Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.” Issued in June 2016, ASU 2016-13 added Financial Accounting Standards Board “FASB” ASC Topic 326, “Financial Instruments-Credit Losses” and finalized amendments to FASB ASC Subtopic 825-15, “Financial Instruments-Credit Losses.” The amendments of ASU 2016-13 are intended to provide financial statement users with more decision-useful information related to expected credit losses on financial instruments and other commitments to extend credit by replacing the current incurred loss impairment methodology with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to determine credit loss estimates.

 

The amendment requires the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts.  Financial institutions and other organizations will now use forward-looking information to enhance their credit loss estimates.  The amendment requires enhanced disclosures to help investors and other financial statement users better understand significant estimates and judgments used in estimating credit losses, as well as the credit quality and underwriting standards of an organization’s portfolio.  In addition, the ASU amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. 

 

As previously disclosed, the Company formed a steering committee to oversee the adoption of the ASU at the effective date.  Appropriate members of Senior Management have developed a plan focused on understanding the ASU, researching issues, identifying data needs for modeling inputs, technology requirements, and modeling considerations.  The Company is focused on the completion of its model, refining assumptions, and continued review of the model.  Concurrent with this, the Company is also focused on researching and resolving interpretive accounting issues in the ASU, contemplating various related accounting policies, developing processes and related controls, and considering various reporting disclosures.

 

As of the beginning of the first reporting period in which the new standard is effective, the Company expects to recognize a one-time cumulative effect adjustment increasing the allowance for loan losses, if any, since the ASU covers credit losses over the expected life of a loan as well as considering future changes in macroeconomic conditions. The magnitude of any such one-time adjustment or the overall impact of the new guidance on the consolidated financial statements cannot yet be reasonably estimated, however, we expect to run multiple parallel models before finalizing the adjustment amount by December 31, 2022.

 

In December 2018, the OCC, the Board of Governors of the Federal Reserve System, and the FDIC approved a final rule to address changes to credit loss accounting under GAAP, including banking organizations’ implementation of CECL.  The final rule provides banking organizations the option to phase in over a three-year period the day-one adverse effects on regulatory capital that may result from the adoption of the new accounting standard.  In 2019, the Financial Accounting Standards Board approved a delay for the implementation of the current expected credit loss standard until

17

January 2023 for certain companies. The delay would apply to smaller reporting companies (as defined by the SEC), non-SEC public companies and private companies.  The delayed implementation date of January 2023 will apply to Kentucky Bancshares and the Company does not intend to early adopt. 

 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

March 31, 2020

 

 

 

 

 

 

 

 

 

 

 

 

 

    U.S. treasury notes

 

$

9,142

 

$

194

 

$

 —

 

$

9,336

 

U.S. government agencies

 

 

17,732

 

 

202

 

 

(14)

 

 

17,920

 

States and political subdivisions

 

 

28,286

 

 

602

 

 

(12)

 

 

28,876

 

Mortgage-backed - residential

 

 

106,857

 

 

3,133

 

 

 —

 

 

109,990

 

Mortgage-backed - commercial

 

 

48,436

 

 

320

 

 

(513)

 

 

48,243

 

Asset-backed

 

 

35,396

 

 

37

 

 

(2,611)

 

 

32,822

 

Total

 

$

245,849

 

$

4,488

 

$

(3,150)

 

$

247,187

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2019

 

 

 

 

 

 

 

 

 

 

 

 

 

    U.S. treasury notes

 

$

9,165

 

$

 3

 

$

 —

 

$

9,168

 

U.S. government agencies

 

 

23,716

 

 

60

 

 

(41)

 

 

23,735

 

States and political subdivisions

 

 

31,950

 

 

661

 

 

(22)

 

 

32,589

 

Mortgage-backed - residential

 

 

113,629

 

 

634

 

 

(272)

 

 

113,991

 

Mortgage-backed - commercial

 

 

50,092

 

 

406

 

 

(147)

 

 

50,351

 

Asset-backed

 

 

35,682

 

 

55

 

 

(241)

 

 

35,496

 

Total

 

$

264,234

 

$

1,819

 

$

(723)

 

$

265,330

 

 

The amortized cost and fair value of securities as of March 31, 2020 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 7.

 

 

 

 

 

 

 

 

 

 

    

Amortized

    

Fair

 

 

 

Cost

 

Value

 

Due in one year or less

 

$

8,314

 

$

8,391

 

Due after one year through five years

 

 

17,129

 

 

17,389

 

Due after five years through ten years

 

 

14,040

 

 

14,298

 

Due after ten years

 

 

15,677

 

 

16,054

 

 

 

 

55,160

 

 

56,132

 

Mortgage-backed - residential

 

 

106,857

 

 

109,990

 

Mortgage-backed - commercial

 

 

48,436

 

 

48,243

 

Asset-backed

 

 

35,396

 

 

32,822

 

Total

 

$

245,849

 

$

247,187

 

 

Proceeds from the sale of available for sale securities for the first three months of 2020 and 2019 were $2.1 million and $16.3 million.  Gross gains of $118 thousand and $109 thousand and gross losses of $6 thousand and $15 were realized on those sales, respectively.  The tax provision related to these realized net gains was $23 thousand and $20 thousand, respectively. 

 

18

Securities with unrealized losses at March 31, 2020 and at December 31, 2019 not recognized in income are as follows:

 

March 31, 2020

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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

 

$

 —

 

$

 —

 

$

1,295

 

$

(14)

 

$

1,295

 

$

(14)

 

States and political subdivisions

 

 

1,208

 

 

(12)

 

 

 —

 

 

 —

 

 

1,208

 

 

(12)

 

Mortgage-backed - commercial

 

 

23,420

 

 

(463)

 

 

6,237

 

 

(50)

 

 

29,657

 

 

(513)

 

Asset-backed

 

 

23,785

 

 

(1,895)

 

 

6,336

 

 

(716)

 

 

30,121

 

 

(2,611)

 

Total temporarily impaired

 

$

48,413

 

$

(2,370)

 

$

13,868

 

$

(780)

 

$

62,281

 

$

(3,150)

 

 

December 31, 2019

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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

 

$

6,171

 

$

(18)

 

$

4,396

 

$

(23)

 

$

10,567

 

$

(41)

 

States and political subdivisions

 

 

859

 

 

(3)

 

 

1,199

 

 

(19)

 

 

2,058

 

 

(22)

 

Mortgage-backed - residential

 

 

32,718

 

 

(129)

 

 

14,583

 

 

(143)

 

 

47,301

 

 

(272)

 

Mortgage-backed - commercial

 

 

5,760

 

 

(25)

 

 

10,625

 

 

(122)

 

 

16,385

 

 

(147)

 

Asset-backed

 

 

21,786

 

 

(150)

 

 

6,962

 

 

(91)

 

 

28,748

 

 

(241)

 

Total temporarily impaired

 

$

67,294

 

$

(325)

 

$

37,765

 

$

(398)

 

$

105,059

 

$

(723)

 

 

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 will recover as the securities approach maturity.

 

3.LOANS

 

Loans at period-end are as follows:

(in thousands)

 

 

 

 

 

 

 

 

 

 

    

3/31/2020

    

12/31/2019

 

Commercial

 

$

82,793

 

$

86,552

 

Real estate construction

 

 

34,180

 

 

32,219

 

Real estate mortgage:

 

 

 

 

 

 

 

1-4 family residential

 

 

299,873

 

 

291,419

 

Multi-family residential

 

 

55,511

 

 

48,622

 

Non-farm & non-residential

 

 

223,208

 

 

204,908

 

Agricultural

 

 

60,013

 

 

57,166

 

Consumer

 

 

22,598

 

 

23,122

 

Other

 

 

151

 

 

305

 

Total

 

$

778,327

 

$

744,313

 

 

19

Activity in the allowance for loan losses for the three month period indicated was as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended March 31, 2020

 

 

 

(in thousands)

 

 

 

Beginning

 

 

 

 

 

 

 

 

 

 

Ending

 

 

    

Balance

    

Charge-offs 

    

Recoveries 

    

Provision

    

Balance

 

Commercial

 

$

920

 

$

(25)

 

$

 6

 

$

102

 

$

1,003

 

Real estate Construction

 

 

551

 

 

 —

 

 

 —

 

 

80

 

 

631

 

Real estate mortgage:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

1-4 family residential

 

 

2,901

 

 

(35)

 

 

15

 

 

540

 

 

3,421

 

Multi-family residential

 

 

807

 

 

 —

 

 

 —

 

 

217

 

 

1,024

 

Non-farm & non-residential

 

 

1,643

 

 

 —

 

 

 —

 

 

461

 

 

2,104

 

Agricultural

 

 

389

 

 

 —

 

 

 2

 

 

72

 

 

463

 

Consumer

 

 

506

 

 

(110)

 

 

 9

 

 

128

 

 

533

 

Other

 

 

43

 

 

(237)

 

 

206

 

 

19

 

 

31

 

Unallocated

 

 

700

 

 

 —

 

 

 —

 

 

 6

 

 

706

 

 

 

$

8,460

 

$

(407)

 

$

238

 

$

1,625

 

$

9,916

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended March 31, 2019

 

 

 

(in thousands)

 

 

 

Beginning

 

 

 

 

 

 

 

 

 

 

Ending

 

 

    

Balance

    

Charge-offs 

    

Recoveries 

    

Provision

    

Balance

 

Commercial

 

$

1,159

 

$

(191)

 

$

 7

 

$

(32)

 

$

943

 

Real estate Construction

 

 

414

 

 

 —

 

 

 —

 

 

(63)

 

 

351

 

Real estate mortgage:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

1-4 family residential

 

 

2,605

 

 

(99)

 

 

 8

 

 

146

 

 

2,660

 

Multi-family residential

 

 

733

 

 

 —

 

 

 —

 

 

(10)

 

 

723

 

Non-farm & non-residential

 

 

1,649

 

 

(17)

 

 

 —

 

 

(23)

 

 

1,609

 

Agricultural

 

 

420

 

 

 —

 

 

 1

 

 

(15)

 

 

406

 

Consumer

 

 

410

 

 

(61)

 

 

14

 

 

26

 

 

389

 

Other

 

 

58

 

 

(241)

 

 

209

 

 

44

 

 

70

 

Unallocated

 

 

679

 

 

 —

 

 

 —

 

 

52

 

 

731

 

 

 

$

8,127

 

$

(609)

 

$

239

 

$

125

 

$

7,882

 

 

20

 

 

 

 

 

 

 

 

 

 

 

 

    

Individually

    

Collectively

    

 

 

As of March 31, 2020

 

Evaluated for

 

Evaluated for

 

 

 

 

(in thousands)

 

Impairment

 

Impairment

 

Total

 

Allowance for Loan Losses:

 

 

 

 

 

 

 

 

 

 

Commercial

 

$

 —

 

$

1,003

 

$

1,003

 

Real estate construction

 

 

 —

 

 

631

 

 

631

 

Real estate mortgage:

 

 

 

 

 

 

 

 

 

 

1-4 family residential

 

 

 —

 

 

3,421

 

 

3,421

 

Multi-family residential

 

 

75

 

 

949

 

 

1,024

 

Non-farm & non-residential

 

 

 —

 

 

2,104

 

 

2,104

 

Agricultural

 

 

 —

 

 

463

 

 

463

 

Consumer

 

 

 —

 

 

533

 

 

533

 

Other

 

 

 —

 

 

31

 

 

31

 

Unallocated

 

 

 —

 

 

706

 

 

706

 

 

 

$

75

 

$

9,841

 

$

9,916

 

Loans:

 

 

 

 

 

 

 

 

 

 

Commercial

 

$

 —

 

$

82,793

 

$

82,793

 

Real estate construction

 

 

374

 

 

33,806

 

 

34,180

 

Real estate mortgage:

 

 

 

 

 

 

 

 

 

 

1-4 family residential

 

 

519

 

 

299,354

 

 

299,873

 

Multi-family residential

 

 

1,292

 

 

54,219

 

 

55,511

 

Non-farm & non-residential

 

 

1,799

 

 

221,409

 

 

223,208

 

Agricultural

 

 

1,532

 

 

58,481

 

 

60,013

 

Consumer

 

 

 —

 

 

22,598

 

 

22,598

 

Other

 

 

 —

 

 

151

 

 

151

 

        Total

 

$

5,516

 

$

772,811

 

$

778,327

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

Individually

    

Collectively

    

 

 

As of December 31, 2019

 

Evaluated for

 

Evaluated for

 

 

 

(in thousands)

 

Impairment

 

Impairment

 

Total

 

Allowance for Loan Losses:

 

 

 

 

 

 

 

 

 

 

Commercial

 

$

 —

 

$

920

 

$

920

 

Real estate construction

 

 

 —

 

 

551

 

 

551

 

Real estate mortgage:

 

 

 

 

 

 

 

 

 

 

1-4 family residential

 

 

 2

 

 

2,899

 

 

2,901

 

Multi-family residential

 

 

50

 

 

757

 

 

807

 

Non-farm & non-residential

 

 

 —

 

 

1,643

 

 

1,643

 

Agricultural

 

 

 —

 

 

389

 

 

389

 

Consumer

 

 

 —

 

 

506

 

 

506

 

Other

 

 

 —

 

 

43

 

 

43

 

Unallocated

 

 

 —

 

 

700

 

 

700

 

 

 

$

52

 

$

8,408

 

$

8,460

 

Loans:

 

 

 

 

 

 

 

 

 

 

Commercial

 

$

 —

 

$

86,552

 

$

86,552

 

Real estate construction

 

 

374

 

 

31,845

 

 

32,219

 

Real estate mortgage:

 

 

 

 

 

 

 

 

 

 

1-4 family residential

 

 

202

 

 

291,217

 

 

291,419

 

Multi-family residential

 

 

1,292

 

 

47,330

 

 

48,622

 

Non-farm & non-residential

 

 

1,799

 

 

203,109

 

 

204,908

 

Agricultural

 

 

842

 

 

56,324

 

 

57,166

 

Consumer

 

 

 —

 

 

23,122

 

 

23,122

 

Other

 

 

 —

 

 

305

 

 

305

 

        Total

 

$

4,509

 

$

739,804

 

$

744,313

 

21

The following table presents loans individually evaluated for impairment by class of loans as of and for the three months ended March 31, 2020 (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

 

$

374

 

$

374

 

$

 -

 

 

$

374

 

$

 -

 

$

 -

 

    Real estate mortgage:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

1-4 family residential

 

 

519

 

 

519

 

 

 -

 

 

 

361

 

 

 6

 

 

 6

 

Non-farm and non-residential

 

 

1,799

 

 

1,799

 

 

 -

 

 

 

1,799

 

 

 -

 

 

 -

 

Agricultural

 

 

1,532

 

 

1,532

 

 

 -

 

 

 

1,187

 

 

11

 

 

11

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

With an allowance recorded:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Real estate mortgage:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

        Multi-family residential

 

$

1,292

 

$

1,292

 

$

75

 

 

$

1,292

 

$

 -

 

$

 -

 

Total

 

$

5,516

 

$

5,516

 

$

75

 

 

$

5,013

 

$

17

 

$

17

 

 

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, 2019 (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

 

$

374

 

$

374

 

$

 —

 

 

$

374

 

$

 —

 

$

 —

 

Real-estate mortgage:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Non-farm & non-residential

 

 

1,799

 

 

1,799

 

 

 —

 

 

 

1,013

 

 

17

 

 

17

 

Agricultural

 

 

842

 

 

842

 

 

 —

 

 

 

1,003

 

 

18

 

 

18

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

With an allowance recorded:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Real estate mortgage

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

1-4 family residential

 

$

202

 

$

202

 

$

 2

 

 

$

603

 

$

35

 

$

35

 

Multi-family residential

 

 

1,292

 

 

1,292

 

 

50

 

 

 

646

 

 

54

 

 

54

 

Total

 

$

4,509

 

$

4,509

 

$

52

 

 

$

3,639

 

$

124

 

$

124

 

 

The following tables present the recorded investment in nonaccrual, loans past due over 89 days still on accrual and accruing troubled debt restructurings by class of loans as of March 31, 2020 and December 31, 2019:

 

 

 

 

 

 

 

 

 

 

 

 

 

    

 

    

Loans Past Due

    

 

 

 

 

 

 

 

Over 89 Days

 

 

 

 

As of March 31, 2020

 

 

 

 

Still

 

Troubled Debt

 

(in thousands)

 

Nonaccrual

 

Accruing

 

Restructurings

 

Commercial

 

$

 —

 

$

267

 

$

 —

 

Real estate construction

 

 

374

 

 

 —

 

 

 —

 

Real estate mortgage:

 

 

 

 

 

 

 

 

 

 

1-4 family residential

 

 

744

 

 

126

 

 

 —

 

Multi-family residential

 

 

1,292

 

 

 —

 

 

 —

 

Non-farm & non-residential

 

 

1,799

 

 

 —

 

 

 —

 

Agricultural

 

 

 —

 

 

75

 

 

 —

 

Consumer

 

 

27

 

 

 6

 

 

 —

 

Total

 

$

4,236

 

$

474

 

$

 —

 

 

22

 

 

 

 

 

 

 

 

 

 

 

 

    

 

    

Loans Past Due

    

 

 

 

 

 

 

 

Over 89 Days

 

 

 

 

As of December 31, 2019

 

 

 

 

Still

 

Troubled Debt

 

(in thousands)

 

Nonaccrual

 

Accruing

 

Restructurings

 

Real estate construction

 

$

374

 

$

 —

 

$

 —

 

Real estate mortgage:

 

 

 

 

 

 

 

 

 

 

1-4 family residential

 

 

845

 

 

47

 

 

 —

 

Multi-family residential

 

 

 —

 

 

1,292

 

 

 —

 

Non-farm & non-residential

 

 

1,799

 

 

121

 

 

 —

 

Agricultural

 

 

 —

 

 

 7

 

 

 —

 

Consumer

 

 

63

 

 

32

 

 

 —

 

Total

 

$

3,081

 

$

1,499

 

$

 —

 

 

Nonaccrual loans secured by real estate make up 98.0% of the total nonaccrual loan balances at March 31, 2020.

 

Nonaccrual loans and loans past due over 89 days and still accruing 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.

 

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 March 31, 2020 and December 31, 2019 by class of loans:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

30–59

    

60–89

    

Greater than

    

 

    

Total

    

 

 

As of March 31, 2020

 

Days

 

Days

 

89 Days

 

 

 

  Past Due &  

 

Loans Not

 

(in thousands)

 

Past Due

 

Past Due

 

Past Due

 

Non-accrual

 

Non-accrual

 

Past Due

 

Commercial

 

$

655

 

$

260

 

$

267

 

$

 —

 

$

1,182

 

$ 

81,611

 

Real estate construction

 

 

31

 

 

 —

 

 

 —

 

 

374

 

 

405

 

 

33,775

 

Real estate mortgage:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

1-4 family residential

 

 

1,374

 

 

346

 

 

126

 

 

744

 

 

2,590

 

 

297,283

 

Multi-family residential

 

 

 —

 

 

 —

 

 

 —

 

 

1,292

 

 

1,292

 

 

54,219

 

Non-farm & non-residential

 

 

1,380

 

 

 —

 

 

 —

 

 

1,799

 

 

3,179

 

 

220,029

 

Agricultural

 

 

52

 

 

82

 

 

75

 

 

 —

 

 

209

 

 

59,804

 

Consumer

 

 

170

 

 

112

 

 

 6

 

 

27

 

 

315

 

 

22,283

 

Other

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

151

 

Total

 

$

3,662

 

$

800

 

$

474

 

$

4,236

 

$

9,172

 

$

769,155

 

 

23

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

30–59

    

60–89

    

Greater than

    

 

    

Total

    

    

 

 

As of December 31, 2019

 

Days

 

Days

 

89 Days

 

 

 

  Past Due &  

 

Loans Not

 

(in thousands)

 

Past Due

 

Past Due

 

Past Due

 

Non-accrual

 

Non-accrual

 

Past Due

 

Commercial

 

$

326

 

$

25

 

$

 —

 

$

 —

 

$

351

 

$ 

86,201

 

Real estate construction

 

 

 —

 

 

 —

 

 

 —

 

 

374

 

 

374

 

 

31,845

 

Real estate mortgage:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

1-4 family residential

 

 

2,734

 

 

274

 

 

47

 

 

845

 

 

3,900

 

 

287,519

 

Multi-family residential

 

 

 —

 

 

 —

 

 

1,292

 

 

 —

 

 

1,292

 

 

47,330

 

Non-farm & non-residential

 

 

302

 

 

19

 

 

121

 

 

1,799

 

 

2,241

 

 

202,667

 

Agricultural

 

 

704

 

 

 —

 

 

 7

 

 

 —

 

 

711

 

 

56,455

 

Consumer

 

 

158

 

 

17

 

 

32

 

 

63

 

 

270

 

 

22,852

 

Other

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

305

 

Total

 

$

4,224

 

$

335

 

$

1,499

 

$

3,081

 

$

9,139

 

$

735,174

 

Troubled Debt Restructurings:

 

Management periodically reviews renewals and modifications of previously identified troubled debt restructurings (TDR), for which there was no principal forgiveness, to consider if it is appropriate to remove the TDR classification. If the borrower is no longer experiencing financial difficulty and the renewal/modification did not contain a concessionary interest rate or other concessionary terms, management considers the potential removal of the TDR classification. If deemed appropriate based upon current underwriting, the TDR classification is removed as the borrower has complied with the terms of the loan at the date of renewal/modification and there was a reasonable expectation that the borrower will continue to comply with the terms of the loan after the date of the renewal/modification.

 

Additionally, TDR classification can be removed in circumstances in which the Company performs a non-concessionary re-modification of the loan at terms considered to be at market for loans with comparable risk and management expects the borrower will continue to perform under the re-modified terms based on the borrower's past history of performance.

 

On March 22, 2020, federal banking regulators issued an interagency statement, which was subsequently clarified and revised by an interagency statement issued on April 7, 2020, that included guidance on their approach for the accounting of loan modifications in light of the economic impact of the Coronavirus Disease 2019 (COVID-19) pandemic. The guidance interprets current accounting standards and indicates that a lender can conclude that a borrower is not experiencing financial difficulty if short-term modifications are made in response to COVID-19, such as payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are insignificant related to the loans in which the borrower is less than 30 days past due on its contractual payments at the time a modification program is implemented. The agencies confirmed in working with the staff of the FASB that short-term modifications made on a good faith basis in response to COVID-19 to borrowers who were current prior to any relief are not TDRs.   The majority of these modifications will involve three to six month forbearance payments which will be added to the end of the note. As of April 30, 2020 we had approved modifications on $105.4 million of loans.

 

The Company had no loans classified as troubled debt restructurings as of March 31, 2020 or December 31, 2019.

 

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

24

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 March 31, 2020 and December 31, 2019, and based on the most recent analysis performed, the risk category of loans by class of loans is as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As of March 31, 2020

    

 

    

Special

    

 

    

 

 

(in thousands)

 

Pass

 

Mention

 

Substandard

 

Doubtful

 

Commercial

 

$

79,839

 

$

2,860

 

$

94

 

$

 —

 

Real estate construction

 

 

32,285

 

 

1,501

 

 

394

 

 

 —

 

Real estate mortgage:

 

 

 

 

 

 

 

 

 

 

 

 

 

1-4 family residential

 

 

291,414

 

 

3,037

 

 

5,422

 

 

 —

 

Multi-family residential

 

 

53,605

 

 

614

 

 

1,292

 

 

 —

 

Non-farm & non-residential

 

 

214,304

 

 

7,086

 

 

1,818

 

 

 —

 

Agricultural

 

 

54,213

 

 

3,774

 

 

2,026

 

 

 —

 

Total

 

$

725,660

 

$

18,872

 

$

11,046

 

$

 —

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As of December 31, 2019

    

 

    

Special

    

 

    

 

 

(in thousands)

 

Pass

 

Mention

 

Substandard

 

Doubtful

 

Commercial

 

$

83,515

 

$

2,785

 

$

252

 

$

 —

 

Real estate construction

 

 

30,462

 

 

1,363

 

 

394

 

 

 —

 

Real estate mortgage:

 

 

 

 

 

 

 

 

 

 

 

 

 

1-4 family residential

 

 

283,048

 

 

3,435

 

 

4,932

 

 

 4

 

Multi-family residential

 

 

43,193

 

 

4,137

 

 

1,292

 

 

 —

 

Non-farm & non-residential

 

 

195,800

 

 

7,169

 

 

1,939

 

 

 —

 

Agricultural

 

 

51,352

 

 

4,459

 

 

1,355

 

 

 —

 

Total

 

$

687,370

 

$

23,348

 

$

10,164

 

$

 4

 

 

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 89 days past due or on non-accrual status, and total $33 thousand at March 31, 2020 and $95 thousand at December 31, 2019.

 

Non-consumer loans with an outstanding balance less than $200 thousand are evaluated similarly to consumer loans. Loan performance is evaluated based on delinquency status. Both are reviewed at least quarterly and credit quality grades are updated as needed.    

 

25

4.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:

 

 

 

 

 

 

 

 

 

Three Months Ended

 

 

March 31,

 

    

2020

    

2019

 

 

(in thousands)

Basic and Diluted Earnings Per Share

 

 

 

 

 

 

Net Income

 

$

1,751

 

$

2,811

Weighted average common shares outstanding

 

 

5,880

 

 

5,929

Basic and diluted earnings per share

 

$

0.30

 

$

0.47

 

Restricted stock grants were excluded in shares outstanding for purposes of computing basic and diluted earnings per share for the both the three months ended March 31, 2020 and March 31, 2019.

 

5.STOCK COMPENSATION

 

We have three stock based compensation plans as described below.

 

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 100,000. There were no shares issued during 2020 or 2019.  The plan is now expired and no additional shares will be issued from the 2005 plan.  There were 0 shares forfeited during the three months ended March 31, 2020 and 12 shares were forfeited during the three months ended March 31, 2019. 

 

A summary of changes in the Company’s nonvested shares for the year follows (in thousands, except per share data):

 

 

 

 

 

 

 

 

    

    

    

 

Grant-Date

 

 

Shares

 

 

Fair Value

Nonvested at January 1, 2020

 

1,580

 

$

13.67

Vested

 

(1,580)

 

 

13.67

Nonvested at March 31, 2020

 

 —

 

$

 —

 

As of March 31, 2020,  there was no unrecognized compensation cost related to nonvested shares granted under the 2005 Restricted Stock Grant due to their being no nonvested shares outstanding. 

 

26

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 were 300,000.  There were 0 shares issued during the three months ended March 31, 2020 and 23,380 shares were issued during the three months ended March 31, 2019.  The plan is now expired and no additional shares will be issued from the 2009 plan.  There were 0 shares forfeited during the three months ended March 31, 2020 and 108 shares were forfeited during the three months ended March 31, 2019.

 

A summary of changes in the Company’s nonvested shares for the year follows (in thousands, except per share data):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted-Average

 

    

    

 

 

Grant-Date

 

 

Shares

 

 

Fair Value

Nonvested at January 1, 2020

 

38,482

 

$

21.46

Vested

 

(12,855)

 

 

20.98

Nonvested at March 31, 2020

 

25,627

 

$

21.70

 

2019 Stock Award Plan

 

On May 21, 2019, 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 300,000.  There were 30,030 shares issued during the three months ended March 31, 2020 and 0 shares were issued during the three months ended March 31, 2019.  There were 0 shares forfeited during both the three months ended March 31, 2020 and March 31, 2019.

 

 

 

 

 

 

 

 

    

    

    

Weighted-Average

 

 

 

 

Grant-Date

Nonvested Shares

 

Shares

 

   Fair Value   

Nonvested at January 1, 2020

 

 —

 

$

 —

Granted

 

30,030

 

 

23.11

Nonvested at March 31, 2020

 

30,030

 

$

23.11

 

 

 

6.   REPURCHASE AGREEMENTS

 

Repurchase agreements totaled $5.4 million as of March 31, 2020. Of this, $3.4 million of balances were overnight obligations and $2.0 million of balances had terms extending through May 2021 with a weighted remaining average life of 0.6 years. The Company pledged both U.S. treasury securities and U.S. government agency securities with a combined total carrying amount of $11.9 million to secure repurchase agreements as of March 31, 2020.

 

 

7.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.

 

27

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:  The fair values for available for sale investment securities 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.

 

Net adjustments totaled $23 thousand the first three months of 2020 and $(182) thousand for the first three months of 2019 and resulted in a Level 3 classification of the inputs for determining fair value.

 

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.  

 

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. 

 

Derivatives and Financial Instruments:  The fair values of derivative financial instruments are based on derivative valuation models using market data inputs as of the valuation date (Level 2).

 

28

Assets and Liabilities Measured on a Recurring Basis: 

 

Available for sale investment securities, derivatives and other financial instrument assets and equity securities included in other 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 March 31, 2020 (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)

 

Financial Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. treasury notes

 

$

9,336

 

$

 —

 

$

9,336

 

$

 —

 

U. S. government agencies

 

 

17,920

 

 

 —

 

 

17,920

 

 

 —

 

States and political subdivisions

 

 

28,876

 

 

 —

 

 

28,876

 

 

 —

 

Mortgage-backed - residential

 

 

109,990

 

 

 —

 

 

109,990

 

 

 —

 

Mortgage-backed-commercial

 

 

48,243

 

 

 —

 

 

48,243

 

 

 —

 

Asset-backed

 

 

32,822

 

 

 —

 

 

32,822

 

 

 —

 

Derivatives and financial instrument assets

 

 

237

 

 

 —

 

 

237

 

 

 —

 

Other Assets

 

 

296

 

 

296

 

 

 —

 

 

 —

 

Total

 

$

247,720

 

$

296

 

$

247,424

 

$

 —

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Financial Liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

Derivatives and financial instrument liabilities

 

$

3,525

 

$

 —

 

$

3,525

 

$

 —

 

 

Fair Value Measurements at December 31, 2019 (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. treasury notes

 

$

9,168

 

$

 —

 

$

9,168

 

$

 —

 

U. S. government agencies

 

 

23,735

 

 

 —

 

 

23,735

 

 

 —

 

States and political subdivisions

 

 

32,589

 

 

 —

 

 

32,589

 

 

 —

 

Mortgage-backed - residential

 

 

113,991

 

 

 —

 

 

113,991

 

 

 —

 

Mortgage-backed - commercial

 

 

50,351

 

 

 —

 

 

50,351

 

 

 —

 

Asset-backed

 

 

35,496

 

 

 —

 

 

35,496

 

 

 —

 

Derivatives and financial instrument assets

 

 

94

 

 

 

 

 

94

 

 

 

 

Other Assets

 

 

292

 

 

292

 

 

 —

 

 

 —

 

Total

 

$

265,716

 

$

292

 

$

265,424

 

$

 —

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Financial Liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

Derivatives and financial instrument liabilities

 

$

212

 

$

 —

 

$

212

 

$

 —

 

 

There were no transfers between level 1 and level 2 during 2020 or 2019.

 

29

Assets measured at fair value on a non-recurring basis are summarized below (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fair Value Measurements at March 31, 2020 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

 

$

1,217

$

 —

$

 —

$

 

1,217

 

  Other real estate owned, net:

 

 

 

 

 

 

 

 

 

 

 

     Real estate mortgage:

 

 

 

 

 

 

 

 

 

 

 

              1-4 family residential

 

 

132

 

 —

 

 —

 

 

132

 

Commercial

 

 

246

 

 —

 

 —

 

 

246

 

Agricultural

 

 

233

 

 —

 

 —

 

 

233

 

  Mortgage servicing rights

 

 

1,023

 

 —

 

 —

 

 

1,023

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fair Value Measurements at December 31, 2019 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

 

$

200

$

 —

$

 —

 

$

200

 

Multi-family residential

 

 

1,242

 

 —

 

 —

 

 

1,242

 

Other real estate owned, net:

 

 

 

 

 

 

 

 

 

 

 

Real Estate Mortgage:

 

 

 

 

 

 

 

 

 

 

 

1-4 family residential

 

 

40

 

 —

 

 —

 

 

40

 

Commercial

 

 

246

 

 —

 

 —

 

 

246

 

Agriculturual

 

 

233

 

 —

 

 —

 

 

233

 

Mortgage servicing rights

 

 

1,107

 

 —

 

 —

 

 

1,107

 

 

Impaired loans measured for impairment using the fair value of the collateral for collateral dependent loans had a net carrying amount of $1.2 million, which includes a valuation allowance of $75 thousand as of March 31, 2020.  Impaired loans measured for impairment using the fair value of the collateral for collateral dependent loans had a net carrying amount of $1.4 million, with a valuation allowance of $52 thousand at December 31, 2019. 

 

No additional loans were impaired at March 31, 2020 when compared to December 31, 2019.  One loan relationship which was impaired at December 31, 2019 required additional provision for loan loss expense of $25 thousand for the three months ended March 31, 2020. 

 

Other real estate owned measured at fair value less costs to sell had a net carrying amount of $611 thousand, which is made up of the outstanding balance of $1.1 million, net of a valuation allowance of $500 thousand as of March 31, 2020. Other real estate owned which was measured at fair value less costs to sell, had a net carrying amount of $519 thousand, which was made up of the outstanding balance of $980 thousand, net of a valuation allowance of $461 thousand at December 31, 2019.   The Company recorded $38 thousand in write-downs of other real estate owned properties for the three months ended both March 31, 2020 and March 31, 2019.

 

Impaired mortgage servicing rights are carried at the lower of cost or fair value.  At March 31 2020, impaired mortgage servicing rights totaled $1.3 million, less a valuation allowance of $252 thousand, resulting in a net carrying value of $1.0 million. 

30

At December 31, 2019, impaired mortgage servicing rights totaled $1.2 million, less a valuation allowance of $110 thousand, resulting in a carrying value of $1.1 million.  For the three months ended March 31, 2020, the Company recorded net writedowns of $142 thousand.  For the three months ended March 31,019, the Company recorded net write-downs of $6 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 as of March 31, 2020 and December 31, 2019:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Range

 

March 31, 2020

    

Fair

    

Valuation

    

Unobservable

    

(Weighted

 

(In thousands)

 

Value

 

Technique(s)

 

Input(s)

 

Average)

 

Impaired loans

 

 

 

 

 

 

 

 

 

 

Real estate mortgage:

 

 

 

 

 

 

 

 

 

 

Multi-family residential

$

1,217

 

income approach

 

capitalization rate

 

7% - 7%

(7)%

 

Other real estate owned:

 

 

 

 

 

 

 

 

 

 

Real estate mortgage:

 

 

 

 

 

 

 

 

 

 

1-4 family residential

 

132

 

sales comparison

 

adjustment for differences between the comparable sales

 

(23)% - (28)%

(30)%

 

Commercial

 

246

 

income approach

 

capitalization rate

 

(6)% - 8%

(62)%

 

Agricultural

 

233

 

sales comparison

 

adjustment for differences between the comparable sales

 

(0)% - 26%

(14)%

 

Mortgage servicing rights

 

1,023

 

discounted cash flow

 

constant prepayment rates

 

(8)% - (23)%

(13)%

 

 

 

 

 

 

 

 

 

 

 

 

 

    

    

    

    

    

    

    

Range

December 31, 2018

 

Fair

 

Valuation

 

Unobservable

 

(Weighted

(In thousands)

 

Value

 

Technique(s)

 

Input(s)

 

Average)

 

 

 

 

 

 

 

 

 

 

Impaired loans

 

 

 

 

 

 

 

 

 

Real estate mortgage:

 

 

 

 

 

 

 

 

 

1-4 family residential

$

200

 

sales comparison

 

adjustment for differences between the comparable sales

 

(1)% - 21%

(1)%

Multi-family residential

 

1,242

 

income approach

 

capitalization rate

 

7% - 7%

(7)%

Other real estate owned:

 

 

 

 

 

 

 

 

 

1-4 family residential

 

40

 

sales comparison

 

adjustment for differences between the comparable sales

 

(4%) - 11%

(29%)

Commercial

 

246

 

sales comparison

 

capitalization rate

 

(6%) - 8%

(62)%

Agriculturual

 

233

 

sales comparison

 

adjustment for differences between the comparable sales

 

0% - 26%

(14)%

Mortgage servicing rights

 

1,107

 

discounted cash flow

 

constant prepayment rates

 

9% - 20%

(12)%

 

31

Fair Value of Financial Instruments

 

The carrying amounts and estimated fair values of financial instruments, as of March 31, 2020 and December 31, 2019 are as follows:

 

March 31, 2020

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

Carrying

    

 

 

    

 

 

    

 

 

    

 

 

 

(in thousands)

 

Value

 

Level 1

 

Level 2

 

Level 3

 

Total

 

Financial assets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

37,766

 

$

37,766

 

$

 —

 

$

 —

 

$

37,766

 

Interest bearing time deposits

 

 

2,375

 

 

2,375

 

 

 —

 

 

 —

 

 

2,375

 

Securities available for sale

 

 

247,187

 

 

 —

 

 

247,187

 

 

 —

 

 

247,187

 

Loans held for sale

 

 

4,990

 

 

 —

 

 

5,065

 

 

 —

 

 

5,065

 

Net Loans

 

 

768,411

 

 

 —

 

 

 —

 

 

742,213

 

 

742,213

 

Federal Home Loan Bank stock

 

 

7,034

 

 

 —

 

 

 —

 

 

 —

 

 

N/A

 

Interest receivable

 

 

4,010

 

 

 —

 

 

894

 

 

3,116

 

 

4,010

 

Derivative and financial instruments

 

 

237

 

 

 —

 

 

237

 

 

 —

 

 

237

 

Other assets

 

 

296

 

 

296

 

 

 —

 

 

 —

 

 

296

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Financial liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total deposits

 

$

853,217

 

$

637,199

 

$

217,638

 

$

 —

 

$

854,837

 

Repurchase agreements

 

 

5,410

 

 

 —

 

 

5,410

 

 

 —

 

 

5,410

 

Short-term Federal Home Loan Bank advances

 

 

54,000

 

 

 —

 

 

54,000

 

 

 —

 

 

54,000

 

Long-term Federal Home Loan Bank advances

 

 

84,925

 

 

 —

 

 

87,678

 

 

 —

 

 

87,678

 

Subordinated debentures

 

 

7,217

 

 

 —

 

 

 —

 

 

6,785

 

 

6,785

 

Interest payable

 

 

1,217

 

 

 —

 

 

1,205

 

 

12

 

 

1,217

 

   Derivative and financial instruments

 

 

3,525

 

 

 —

 

 

3,525

 

 

 —

 

 

3,525

 

 

December 31, 2019

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

Carrying

    

 

 

    

 

 

    

 

 

    

 

 

 

(in thousands)

 

Value

 

Level 1

 

Level 2

 

Level 3

 

Total

 

Financial assets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

22,182

 

$

22,182

 

$

 —

 

$

 —

 

$

22,182

 

Interest bearing time deposits

 

 

2,375

 

 

2,375

 

 

 —

 

 

 —

 

 

2,375

 

Securities available for sale

 

 

265,330

 

 

 —

 

 

265,330

 

 

 —

 

 

265,330

 

Loans held for sale

 

 

2,144

 

 

 —

 

 

2,171

 

 

 —

 

 

2,171

 

Net Loans

 

 

735,853

 

 

 —

 

 

 —

 

 

735,060

 

 

735,060

 

Federal Home Loan Bank stock

 

 

7,034

 

 

 —

 

 

 —

 

 

 —

 

 

N/A

 

Interest receivable

 

 

4,166

 

 

 —

 

 

1,035

 

 

3,131

 

 

4,166

 

Derivatives and financial instruments

 

 

94

 

 

 —

 

 

94

 

 

 —

 

 

94

 

Other assets

 

 

292

 

 

292

 

 

 —

 

 

 —

 

 

292

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Financial liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total deposits

 

$

842,653

 

$

630,948

 

$

210,892

 

$

 —

 

$

841,840

 

Repurchase agreements

 

 

5,994

 

 

 —

 

 

5,993

 

 

 —

 

 

5,993

 

Short-term Federal Home Loan Bank advances

 

 

25,000

 

 

 —

 

 

25,000

 

 

 —

 

 

25,000

 

Long-term Federal Home Loan Bank advances

 

 

91,418

 

 

 —

 

 

91,397

 

 

 —

 

 

91,397

 

Subordinated debentures

 

 

7,217

 

 

 —

 

 

 —

 

 

7,213

 

 

7,213

 

Interest payable

 

 

1,170

 

 

 —

 

 

1,156

 

 

14

 

 

1,170

 

Derivatives and financial instruments

 

 

212

 

 

 —

 

 

212

 

 

 —

 

 

212

 

 

 

32

8.LEASES

 

 

 

 

 

 

 

 

 

 

 

Statement of

 

 

 

 

Financial Condition

 

 

 

 

Location

 

 

 

3/31/2020

 

12/31/2019

 

 

 

 

 

 

(in thousands)

Operating Lease Right of Use Asset:

 

 

 

 

 

 

 

 

Gross Carrying Amount

 

 

 

$

 

8,824

$

8,857

Accumulated Amortization

 

 

 

 

 

(802)

 

(662)

Net Book Value

 

Operating lease right of use asset

 

$

 

8,022

$

8,195

 

 

 

 

 

 

 

 

 

Operating Lease Liabilities

 

 

 

 

 

 

 

 

Right of use lease obligations

 

Operating lease liability

 

$

 

8,210

$

8,350

 

As of March 31, 2020, the weighted-average remaining lease term for operating leases was 35.2 years and the weighted- average discount rate used in the measurement of operating lease liabilities was 4.13%. The Company utilized the FHLB fixed rate advance rate as of December 31, 2018 for the term most closely aligning with the remaining lease term for lease obligations in existence as of December 31, 2018.  The Company utilized the FHLB fixed rate advance rate as of April 30, 2019 as a basis for determining the discount rate for one contract which was entered into during April 2019.

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

 

 

 

 

 

3/31/2020

 

3/31/2019

 

 

 

 

 

 

(in thousands)

Lease Cost:

 

 

 

 

 

 

 

 

Operating lease cost

 

 

 

$

 

140

$

111

Total lease cost

 

 

 

$

 

140

$

111

 

 

 

 

 

 

 

 

 

Other information

 

 

 

 

 

 

 

 

 Cash paid for amounts included in the measurement of lease liabilities:

 

 

 

 

 

 

 

 

  Operating cash flows from operating leases

 

 

 

$

 

102

$

130

 

 Maturity analysis of liabilities under operating leases with terms longer than 12 months, are as follows at March 31, 2020:

 

 

 

 

 

 

 

 

 

 

 

As of March 31, 2020

 

 

 

 

 

 

(in thousands)

Twelve months ended March 31,

 

 

 

 

 

 

2020

 

 

 

$

 

533

2021

 

 

 

 

 

521

2022

 

 

 

 

 

527

2023

 

 

 

 

 

531

2024

 

 

 

 

 

545

Thereafter

 

 

 

 

 

18,847

Total undiscounted lease payments

 

 

 

$

 

21,504

Amounts representing interest

 

 

 

 

 

(13,294)

Lease liability

 

 

 

$

 

8,210

 

 

33

9.    REVENUE FROM CONTRACTS WITH CUSTOMERS

 

The Company’s revenue from contracts with customers in the scope of Topic 606 is recognized within noninterest income.  The consolidated statements of income include all categories of noninterest income.  There are no significant individual items included in other non-interest income within the scope of Topic 606.  The following table reflects only the categories of noninterest income that are within the scope of Topic 606:

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

 

 

3/31/2020

 

3/31/2019

Service charges

 

 

$

1,289

 

$

1,194

Trust department income

 

 

 

370

 

 

328

Brokerage income

 

 

 

127

 

 

136

Debit card interchange income

 

 

 

812

 

 

790

Total

 

 

$

2,598

 

$

2,448

 

Trust department income: We earn wealth management fees based upon asset custody, investment management, trust, and estate services provided to customers. Most of these customers receive monthly billings for services rendered based upon the market value of assets and/or income generated. Fees that are transaction based are recognized at the point in time that the transaction is executed

 

Service charges: We earn fees from our deposit customers for transaction-based, account maintenance, and overdraft services. Transaction-based fees and overdraft fees are recognized at a point in time, since the customer generally has a right to cancel the depository arrangement at any time. The arrangement is considered a day-to-day contract with ongoing renewals and optional purchases, so the duration of the contract does not extend beyond the services already performed. Account maintenance fees, which relate primarily to monthly maintenance, are earned over the course of a month representing the period over which we satisfy our performance obligation. 

 

Debit card interchange income: As with the transaction-based fees on deposit accounts, debit card interchange income is recognized at the point in time that we fulfill the customer’s request. We earn interchange fees from cardholder transactions processed through card association networks. Interchange rates are generally set by the card associations based upon purchase volumes and other factors. Interchange fees represent a percentage of the underlying transaction value and are recognized daily, concurrently with the transaction processing services provided to the cardholder

 

Brokerage income: Brokerage income fees are the commissions and fees received from a registered broker/dealer and investment adviser that provide those services to our customers. We act as an agent in arranging the relationship between the customer and the third-party service provider. These fees are recognized monthly from the third-party broker based upon services already performed. 

 

NOTE 10 – DERIVATIVES AND FINANCIAL INSTRUMENTS

As part of our overall interest rate risk management, the Company uses derivative instruments, including interest rate swaps.  The notional amount does not represent amounts exchanged by the parties.  The amount exchanged is determined by reference to the notional amount and the other terms of the individual agreements.

Cash Flow Hedges:  Interest rate swaps with notional amounts totaling $23 million and $10 million as of March 31, 2020 and December 31, 2019, were designated as cash flow hedges of certain rolling three month term FHLB advances and were determined to be effective during all periods presented. The Company expects the hedges to remain effective during the remaining terms of the swaps.  The carrying value of the cash flow hedge was a liability of $2.6 million as of March 31, 2020 and an asset of $46 thousand as of December 31, 2019.

Fair Value Hedges: Interest rate swaps with notional amounts totaling $7 million and $7 million as of March 31, 2020 and December 31, 2019 were designated as fair value last of layer hedges of certain fixed rate prepayable loans.  The hedges were determined to be effective during all periods presented. The Company expects the hedges to remain effective during the remaining terms of the swaps. The carrying value of the fair value hedge liability was $664 thousand and $164 thousand as of March 31, 2020 and December 31, 2019 and was included in other liabilities on the Company’s balance sheet.

34

Derivatives Not Designated as Hedges:  The Company also enters into interest rates swaps with its loan customers.  The notional amounts of interest rate swaps with its loan customer as of March 31, 2020 and December 31, 2019 were $26.7 million and $7.4 million.  The Company enters into corresponding offsetting derivatives with third parties.  While these derivatives represent economic hedges, they do not qualify as hedges for accounting purposes.  The carrying value of the fair value asset and liability was $237 thousand and $48 thousand as of March 31, 2020 and December 31, 2019 and was included in other assets and other liabilities on the Company’s balance sheet.

 

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, 2019.

 

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 “future”, “expects,” “believes,” “anticipates,” “intends,” “estimates,” “potential,” “may,” and similar expressions.

 

Forward looking statements are neither historical facts nor assurances of future performance.  Instead, they are based on only our current beliefs, expectations and assumptions regarding the future of our business, future plans and strategies, projections, anticipated events and trends, the economy and other future conditions.  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 in which we operate); negative impacts of current COVID-19 pandemic, current or future volatility in market conditions; 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); ability to successfully gain regulatory approval when required; 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; future acquisitions, changes in technology, information security breaches or cyber security attacks involving the Company, its subsidiaries, or third-party service providers; 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

 

Policy and Regulatory Developments. Federal, state and local governments and regulatory authorities have enacted and issued a range of policy responses to the COVID-19 pandemic, including the following:

 

·

The Federal Reserve decreased the range for the federal funds target rate by 50 basis points on March 3, 2020, and by another 100 basis points on March 16, 2020, reaching a current range of 0.0% - 0.25 %.

 

35

·

On March 27, 2020, President Trump signed the Coronavirus Aid, Relief and Economic Security Act (CARES Act), which established a $2 trillion economic stimulus package, including cash payments to individuals, supplemental unemployment insurance benefits and a $349 billion loan program administered through the U.S. Small Business Administration (SBA), referred to as the paycheck protection program (PPP). Under the PPP, small businesses, sole proprietorships, independent contractors and self-employed individuals may apply for loans from existing SBA lenders and other approved regulated lenders that enroll in the program, subject to numerous limitations and eligibility criteria. The Bank is participating as a lender in the PPP. In addition, the CARES Act provides financial institutions the option to temporarily suspend certain requirements under GAAP related to TDRs for a limited period of time to account for the effects of COVID-19.

 

·

On April 7, 2020, federal banking regulators issued a revised Interagency Statement on Loan Modifications and Reporting for Financial Institutions, which, among other things, encouraged financial institutions to work prudently with borrowers who are or may be unable to meet their contractual payment obligations because of the effects of COVID-19, and stated that institutions generally do not need to categorize COVID-19-related modifications as TDRs and that the agencies will not direct supervised institutions to automatically categorize all COVID-19 related loan modifications as TDRs.

 

·

On April 9, 2020, the Federal Reserve announced additional measures aimed at supporting small and mid-sized businesses, as well as state and local governments impacted by COVID-19. The Federal Reserve announced the Main Street Business Lending Program, which establishes two new loan facilities intended to facilitate lending to small and mid-sized businesses: (1) the Main Street New Loan Facility, or MSNLF, and (2) the Main Street Expanded Loan Facility, or MSELF. MSNLF loans are unsecured term loans originated on or after April 8, 2020, while MSELF loans are provided as upsized tranches of existing loans originated before April 8, 2020. The combined size of the program will be up to $600 billion. The program is designed for businesses with up to 10,000 employees or $2.5 billion in 2019 revenues. To obtain a loan, borrowers must confirm that they are seeking financial support because of COVID-19 and that they will not use proceeds from the loan to pay off debt. The Federal Reserve also stated that it would provide additional funding to banks offering PPP loans to struggling small businesses. Lenders participating in the PPP will be able to exclude loans financed by the facility from their leverage ratio. In addition, the Federal Reserve created a Municipal Liquidity Facility to support state and local governments with up to $500 billion in lending, with the Treasury Department backing $35 billion for the facility using funds appropriated by the CARES Act. The facility will make short-term financing available to cities with a population of more than one million or counties with a population of greater than two million. The Federal Reserve expanded both the size and scope its Primary and Secondary Market Corporate Credit Facilities to support up to $750 billion in credit to corporate debt issuers. This will allow companies that were investment grade before the onset of COVID-19 but then subsequently downgraded after March 22, 2020 to gain access to the facility. Finally, the Federal Reserve announced that its Term Asset-Backed Securities Loan Facility will be scaled up in scope to include the triple A-rated tranche of commercial mortgage-backed securities and newly issued collateralized loan obligations. The size of the facility is $100 billion.

 

Effects on Our Business. We currently expect that the COVID-19 pandemic and the specific developments referred to above could have a significant impact on our business. In particular, we anticipate that a significant portion of the Bank’s borrowers in various segments will continue to endure significant economic distress, which has caused, and may continue to cause, them to draw on their existing lines of credit and adversely affect their ability to repay existing indebtedness, and is expected to adversely impact the value of collateral.

 

These developments, together with economic conditions generally, are also expected to impact our commercial real estate portfolio, particularly with respect to real estate with exposure to these industries, and the value of certain collateral securing our loans. As a result, we anticipate that our financial condition, capital levels and results of operations could be adversely affected, as described in further detail below.

 

Our Response. We have taken numerous steps in response to the COVID-19 pandemic, including the following:

 

·

We are actively working with loan customers to evaluate prudent loan modification terms.

 

36

·

We continue to promote our digital banking options through our website. Customers are encouraged to utilize online and mobile banking tools, and our customer service and retail departments are fully staffed and available to assist customers remotely.

 

·

We are a participating lender in the PPP. We believe it is our responsibility as a community bank to assist the SBA in the distribution of funds authorized under the CARES Act to our customers and communities, which we are carrying out in a prudent and responsible manner.

 

·

We have limited all branches to drive-up and appointment only services. We continue to pay all employees according to their normal work schedule, even if their work has been reduced. No employees have been furloughed. Employees whose job responsibilities can be effectively carried out remotely are working from home. Employees whose critical duties require their continued presence on-site are observing social distancing and cleaning protocols.

 

The Company recorded net income of $1.8 million, or $0.30 basic earnings and diluted earnings per share for the first three months ended March 31, 2020 compared to $2.8 million or $0.47 basic earnings and diluted earnings per share for the three month period ended March 31, 2019. The first three months net earnings reflect a decrease when compared to the same time period in 2019 although net interest income increased. Net interest income increased $53 thousand, or 0.6%, and the provision for loan losses increased $1.5 million. Non-interest income increased $562 thousand, or 18.7%, for the three months ended March 31, 2020 compared to the same three month period in 2019.  The increase in non-interest income is mostly attributed to an increase in gain on sale of loans.

 

For the three months ended March 31, 2020 and compared to the three months ended March 31, 2019, service charges increased $95 thousand, gain on the sale of loans increased $476 thousand, gain on the sale of available for sale securities increased $18 thousand and salaries and benefits expense increased $275 thousand.  Data processing fees decreased $22 thousand and debit card expenses decreased $23 thousand.

 

Return on average assets was 0.62% for the three months ended March 31, 2020 and 1.04% for the three months ended March 31, 2019. Return on average equity was 5.77% for the three month period ended March 31, 2020 and 10.39% for the three month period ended March 31, 2019.

 

Securities available for sale decreased $18.1 million from $265.3 million at December 31, 2019 to $247.2 million at March 31, 2020.

 

Gross Loans increased $34.0 million from $744.3 million on December 31, 2019 to $778.3 million at March 31, 2020.

 

The overall increase in loan balances from December 31, 2019 to March 31, 2020 is comprised of the following: an increase of $8.5 million in 1-4 family residential loans, a decrease of $3.8 million in commercial loans, an increase of $6.9 million in multi-family residential loans, an increase of $2.8 million in agricultural loans, an increase of $18.3 million in non-farm and non-residential loans, a decrease of $524 thousand in consumer loans, and an increase of $2.0 million in real-estate construction loans. Other loan balances decreased $154 thousand from December 31, 2019 to March 31, 2020.

 

Total deposits increased from $842.7 million on December 31, 2019 to $853.2 million on March 31, 2020, an increase of $10.6 million. Time deposits $250 thousand and over increased $2.4 million from December 31, 2019 to March 31, 2020 while non-interest bearing demand deposit accounts increased $7.8 million and other interest bearing deposit accounts increased $363 thousand from December 31, 2019 to March 31, 2020.

 

Public fund account balances decreased $3.6 million from December 31, 2019 to March 31, 2020. 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 subsequent months.

 

Borrowings from the Federal Home Loan Bank increased $22.5 million from December 31, 2019 to March 31, 2020 and repurchase agreements decreased $584 thousand.

 

37

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 $9.0 million for the three months ended March 31, 2020 compared to $8.9 million for the three months ended March 31, 2019, an increase of 0.6%.

 

The interest spread, excluding tax equivalent adjustments, was 3.10% for the first three months of 2020 compared to 3.27% for the first three months of 2019. For the first three months in 2020, the yield on interest earning assets decreased from 4.49% in 2019 to 4.24% in 2020, excluding tax equivalent adjustments.

 

The yield on loans, excluding tax equivalent adjustments, decreased twenty basis points for the three months ended March 31, 2020 compared to the three months ended March 31, 2019 from 5.15% to 4.95%. The yield on securities, excluding tax equivalent adjustments, decreased thirty-seven basis points during the first three months of 2020 compared to 2019 from 2.91% in 2019 to 2.54% in 2020. The cost of liabilities was 1.14% for the first three months in 2020 compared to 1.22% in 2019.

 

Year to date average loans, excluding overdrafts, increased $76.5 million, or 11.2% for the three months ended March 31, 2020 compared to the three months ended March 31, 2019.  Loan interest income increased $580 thousand during the first three months of 2020 compared to the first three months of 2019.

 

Year to date average total deposits increased from March 31, 2019 to March 31, 2020 by $17.2 million or 2.0%. Year to date average interest bearing deposits increased $11.8 million, or 1.9%, from March 31, 2019 to March 31, 2020. Deposit interest expense decreased $69 thousand for the first three months of 2020 compared to the same period in 2019. Year to date average borrowings, including repurchase agreements, increased $11.3 million, or 10.1%, from March 31, 2019 to March 31, 2020. Interest expense on borrowed funds, including repurchase agreements, decreased $28 thousand for the first three months of 2020 compared to the same period in 2019.  This decrease is mostly attributed to the Bank paying the note payable in full in 2019.

 

The volume rate analysis for the three months ended March 31, 2020 indicates loan interest income increased $580 thousand when compared to the same time period in 2019.  An increase of $2.4 million attributed to increased loan volume was offset by a decrease of $1.8 million in loan interest income attributed to a decrease in loan rates.  Much of the decrease in loan income is attributed to variable rate loans repricing at lower rates.  The decrease of $515 thousand in securities interest income is attributable to both decreases in rates and volume of our security portfolio. 

 

Also based on the following volume rate analysis for the three months ended March 31, 2020, a decrease in demand deposit interest rates resulted in a $243 thousand reduction to interest expense, interest paid for savings deposits remained fairly flat, and increases in interest rates paid for time deposits resulted in additional interest expense of $82 thousand.

The change in volume in deposits and borrowings was responsible for a $265 thousand increase in interest expense, of which a decrease in demand deposits resulted in a decrease of $55 thousand in interest expense, an increase in time deposits resulted in an increase of $149 thousand in interest expense, a decrease in repurchase agreements resulted in a decrease of $43 thousand in interest expense, and an increase in other borrowings resulted in an increase of $214 thousand in interest expense. The net effect to interest expense was a decrease of $97 thousand. As a result, the increase in net interest income for the first three months in 2020 is mostly attributed to decreasing rates paid on deposits.

 

38

Changes in Interest Income and Expense

 

 

 

 

 

 

 

 

 

 

 

 

 

    

Three Months Ended

 

 

 

2020 vs. 2019

 

 

 

Increase (Decrease) Due to Change in

 

(in thousands)

 

Volume

    

Rate

    

Net Change

 

INTEREST INCOME

 

 

 

 

 

 

 

 

 

 

Loans

 

$

2,427

 

$

(1,847)

 

$

580

 

Investment Securities

 

 

(257)

 

 

(258)

 

 

(515)

 

Other

 

 

146

 

 

(255)

 

 

(109)

 

Total Interest Income

 

 

2,316

 

 

(2,360)

 

 

(44)

 

INTEREST EXPENSE

 

 

 

 

 

 

 

 

 

 

Deposits

 

 

 

 

 

 

 

 

 

 

Demand

 

 

(55)

 

 

(243)

 

 

(298)

 

Savings

 

 

 —

 

 

(2)

 

 

(2)

 

Negotiable Certificates of Deposit and Other Time Deposits

 

 

149

 

 

82

 

 

231

 

Securities sold under agreements to repurchase and other borrowings

 

 

(43)

 

 

(24)

 

 

(67)

 

Federal Home Loan Bank advances

 

 

214

 

 

(175)

 

 

39

 

Total Interest Expense

 

 

265

 

 

(362)

 

 

(97)

 

Net Interest Income

 

$

2,051

 

$

(1,998)

 

$

53

 

 

 

 

 

 

 

 

 

 

 

 

Non-Interest Income

 

Non-interest income increased $562 thousand for the three months ended March 31, 2020, compared to the same period in 2019, to $3.6 million.

 

Favorable variances to non-interest income for the first three months of 2020 include an increase of $18 thousand in gain on sale of available for sale securities, an increase of $42 thousand in trust department income, an increase of $95 thousand in service charges, an increase of $476 thousand in gains on the sale of loans, an increase of $22 thousand in debit card interchange income and an increase of $74 thousand in other income. Decreases to non-interest income for the three months ended March 31, 2020 compared to the three months ended March 31, 2019 include a decrease of $156 thousand in net loan service fee income  and a decrease of $9 thousand in brokerage income.

 

The gain on the sale of loans increased from $207 thousand during the first three months of 2019 to $683 thousand during the first three months of 2020, an increase of $476 thousand.

 

The volume of loans originated to sell during the first three months of 2020 increased $15.1 million compared to the same time period in 2019.  The increase in the volume of loans originated to sell during 2019 is largely attributed to an increase in customers choosing to refinance existing mortgages due to the decrease in mortgage rates.  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 $(83) thousand for the three months ended March 31, 2020 compared to $73 thousand for the three months ended March 31, 2019, a decrease of $156 thousand.  During the first three months of 2020, the market value adjustment to the carrying value of the mortgage servicing right was a net writedown of $142 thousand, as the fair value of this asset decreased. During the first three months of 2019, the market value adjustment to the carrying value of the mortgage servicing right asset was a net writedown of $6 thousand, as the fair value of the asset decreased.

 

Non-Interest Expense

 

Total non-interest expense increased $465 thousand, or 5.3%, for the three month period ended March 31, 2020 compared to the same period in 2019. 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. Our most recent expansion involves constructing a new branch in Lexington, KY in Tates Creek Centre.  We anticipate the new branch to be open by the end of the second quarter or early third quarter of 2020.

39

For the comparable three month periods, salaries and employees benefits expense increased $275 thousand, an increase of 5.9%. The number of full-time employee equivalent employees increased from 230 at March 31, 2019 to 235 at March 31, 2020, an increase of five full-time equivalent employees.

 

Occupancy expense increased $113 thousand to $1.1 million for the first three months of 2020 compared to the same time period in 2019.

 

Loss on limited partnership expense increased $134 thousand for the first three months ended March 31, 2020 compared to the same time period in 2019. The increase is attributed to accelerating the amortization of one our tax credit investments.  However, this was offset through reduced income tax expense.

 

Income Taxes

 

The effective tax rate for the three months ended March 31, 2020 was (3.1)% compared to 7.8% in 2019.  These effective tax rates are less than the statutory rate of 21% 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.  The effective tax rate was lower for the three months ended March 31, 2020 when compared to the three months ended March 31, 2019 due to tax credits associated with low income housing investments increasing from $138 thousand for the three months ended March 31, 2019 to $304 thousand for the three months ended March 31, 2020; an increase of $165 thousand.  Tax- exempt interest income increased $127 thousand for the first three months of 2020 compared to the first three months of 2019. Further, income before income taxes for the three months ended March 31, 2020 decreased $1.4 million when compared to the three months ended March 31, 2019. 

 

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 three months ended March 31, 2020, the Company averaged $24.8 million in tax free securities and $56.1 million in tax free loans. As of March 31, 2020, the weighted average remaining maturity for the tax free securities is 41 months, while the weighted average remaining maturity for the tax free loans is 170 months.

 

For the year ended December 31, 2019, the Company averaged $36.3 million in tax free securities, and $42.8 million in tax free loans.  As of December 31, 2019, the weighted average remaining maturity for the tax free securities was 103 months, while the weighted average remaining maturity for the tax free loans was 131 months.

 

On March 26, 2019, Governor Bevin signed House Bill 354 into law which, among other things, repealed the bank franchise tax structure in Kentucky. The capital based franchise tax structure will be replaced with the state-wide corporate income tax structure starting in 2021. Kentucky Bancshares, Inc. has historically filed a separate return in Kentucky, and has generated a Kentucky net operating loss (“NOL”) carryforward, given the nature of its operations. Given House Bill 354, Kentucky Bancshares, Inc. will file a combined return in 2021, unless the Company decides to timely elect to file on a consolidated basis.

 

On April 9, 2019, Governor Bevin signed House Bill 458 into law which, among other things, allows a taxpayer to utilize certain net operating loss (“NOL”) carryforwards to offset other members in the combined filing group starting in 2021.

 

As a result of these tax law changes, the Company had a deferred tax asset of $563 thousand as of March 31, 2020 and $606 thousand as of December 31, 2019.

 

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.

 

40

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 $37.8 million as of March 31, 2020 compared to $22.2 million at December 31, 2019. The increase in cash and cash equivalents is attributed to an increase of $15.6 million in cash and due from banks.

 

In addition to cash and cash equivalents, the securities portfolio provides an important source of liquidity. Securities available for sale totaled $247.2 million at March 31, 2020 compared to $265.3 million at December 31, 2019. The securities available for sale 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 three months of 2020, deposits increased $10.6 million compared to December 31, 2019. The Company’s borrowed funds from the Federal Home Loan Bank increased $22.5 million from December 31, 2019 to March 31, 2020, federal funds purchased remained at zero, and total repurchase agreements decreased $584 thousand from December 31, 2019 to March 31, 2020.

 

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 March 31, 2020, we have sufficient collateral to borrow an additional $75.6 million from the Federal Home Loan Bank.  In addition, as of March 31, 2020, $33 million is available in overnight borrowing through various correspondent banks and $273 million is available 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.  In addition, the Federal Reserve has implemented a liquidity facility available to financial institutions participating in the PPP.  As such, the Bank believes it has sufficient liquidity sources to fund all pending PPP loans and to continue to provide this important service to local businesses.

 

Capital Requirements

 

In August 2018, the Federal Reserve Board issued an interim final ruling that holding companies with assets less than $3 billion are not subject to minimum capital requirements. As a result, only Bank capital data and capital ratios are presented as of March 31, 2020 and December 31, 2019.

 

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

 

The final rules implementing the Basel Committee on Banking Supervision’s capital guidelines for US banks (Basel III rules) became effective for the Company on January 1, 2015 with full compliance with all of the requirements being phased in over a multi-year schedule, and was fully phased in on January 1, 2019. The net unrealized gain or loss on available for sale securities and holding gains or losses on cash flow hedges are not included in computing regulatory capital.

 

41

The federal banking agencies jointly issued a final rule that provides for an optional, simplified measure of capital adequacy, the community bank leverage ratio framework, for qualifying community banking organizations, consistent with Section 201 of the Economic Growth, Regulatory Relief, and Consumer Protection Act. The final rule became effective on January 1, 2020.  This final rule is applicable to all non-advanced approaches FDIC-supervised institutions with less than $10 billion in total consolidated assets.  Highlights of the Community Bank Leverage Ratio Framework follow:

 

·

The community bank leverage ratio (CBLR) final rule will be effective on January 1, 2020, and will allow qualifying community banking organizations to calculate a leverage ratio to measure capital adequacy. Banks opting into the CBLR framework (CBLR banks) will not be required to calculate or report risk-based capital.

·

A qualifying community banking organization is defined as having less than $10 billion in total consolidated assets, a leverage ratio greater than 9%, off-balance sheet exposures of 25% or less of total consolidated assets, and trading assets and liabilities of 5% or less of total consolidated assets. It also cannot be an advanced approaches institution.

·

The final rule adopts tier 1 capital and the existing leverage ratio into the community bank leverage ratio framework. The tier 1 numerator takes into account the modifications made in relation to the capital simplifications and current expected credit losses methodology (CECL) transitions rules as of the compliance dates of those rules.

·

A CBLR bank will not be subject to other capital and leverage requirements. It will be deemed to have met the "well capitalized" ratio requirements and be in compliance with the generally applicable capital rule.

·

A CBLR bank that ceases to meet any qualifying criteria in a future period and that has a leverage ratio greater than 8% will be allowed a grace period of two reporting periods to satisfy the CBLR qualifying criteria or comply with the generally applicable capital requirements.

·

A CBLR may opt out of the framework at any time, without restriction, by reverting to the generally applicable risk-based capital rule.

 

Management believes as of March 31, 2020, the Bank meets all capital adequacy requirements to which it is subject. Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the following table) and Tier I capital (as defined in the regulations) to average assets (as defined).

 

Prompt corrective action regulations provide five classifications: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized, although these terms are not used to represent overall financial condition. If adequately capitalized, regulatory approval is required to accept brokered deposits. If undercapitalized, capital distributions are limited, as is asset growth and expansion, and capital restoration plans are required.

 

At March 31, 2020 and at December 31, 2019, the most recent regulatory notifications 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 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.

 

42

The Bank’s actual amounts and ratios are presented in the following table:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

To Be Well

 

 

 

 

 

 

 

 

 

 

 

 

 

Capitalized

 

 

 

 

 

 

 

 

 

 

 

 

 

Under Prompt

 

 

 

 

 

 

 

 

For Capital

 

Corrective

 

 

 

Actual

 

Adequacy Purposes

 

Action Provisions

 

 

    

Amount

    

Ratio

    

Amount

    

Ratio

    

Amount

    

Ratio

 

 

 

(Dollars in Thousands)

 

March 31, 2020

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Bank Only

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Tier I Capital (to Average Assets)

 

 

103,101

 

9.3

 

 

100,111

 

9.0

 

 

100,111

 

9.0

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2019

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Bank Only

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Tier I Capital (to Average Assets)

 

 

102,759

 

9.3

 

 

44,164

 

4.0

 

 

55,206

 

5.0

 

 

Non-Performing Assets

 

As of March 31, 2020, our non-performing assets, including other real estate, totaled $6.8 million or 0.60% of assets compared to $6.7 million or 0.61% of assets at December 31, 2019 (see the following table). The Company experienced an increase of $1.2 million in non-accrual loans from December 31, 2019 to March 31, 2020. As of March 31, 2020, non-accrual loans include $374 thousand in loans secured by construction real estate, $1.3 million in loans secured by multi-family residential property, $1.8 million in loans secured by non-farm non-residential property, $744 thousand in loans secured by 1-4 family properties and $27 thousand in consumer loans.

 

Loans secured by real estate composed 92.0% of the non-performing loans as of March 31, 2020 and 97.8% as of December 31, 2019. Forgone interest income on non-accrual loans totaled $101 thousand for the first three months of 2020 compared to forgone interest of $31 thousand for the same time period in 2019. Accruing loans that are contractually 90 days or more past due as of March 31, 2019 totaled $474 thousand compared to $1.5 million at December 31, 2019, a decrease of $1.0 million. Total nonperforming and restructured loans increased $130 thousand from December 31, 2019 to March 31, 2020. The ratio of nonperforming and restructured loans to loans remained the same at 0.61% from December 31, 2019 to March 31, 2020.

 

In addition, the amount the Company has recorded as other real estate owned decreased $38 thousand from December 31, 2019 to March 31, 2020. As of March 31, 2020 and December 31, 2019, the amount recorded as other real estate owned totaled $2.1 million. During the first three months of 2020, no new additions were added to other real estate properties and no sales occurred.  The allowance as a percentage of non-performing and restructured loans and other real estate owned increased from 126% at December 31, 2019 to 145% at March 31, 2020.

 

The economic downturn experienced as a result of the COVID-19 pandemic is expected to result in increased non-performing assets.  Loan modifications are likely to be executed in the second quarter of 2020.  The majority of these modifications will involve three to six month forbearance payments which will be added to the end of the note.  These modification and econcomic stimulus packages offered by the government will help loan customers meet debt obligations but it is unknown to what extent at this time.

43

Nonperforming and Restructured Assets

 

 

 

 

 

 

 

 

 

 

    

3/31/2020

    

12/31/2019

 

 

 

(in thousands)

 

Non-accrual Loans

 

$

4,236

 

$

3,081

 

Accruing Loans which are Contractually past due over 89 days

 

 

474

 

 

1,499

 

Accruing Troubled Debt Restructurings

 

 

 —

 

 

 —

 

Total Nonperforming and Restructured Loans

 

 

4,710

 

 

4,580

 

Other Real Estate

 

 

2,110

 

 

2,148

 

Total Nonperforming and Restructured Loans and Other Real Estate

 

$

6,820

 

$

6,728

 

Nonperforming and Restructured Loans as a Percentage of Loans

 

 

0.61

%  

 

0.61

%

Nonperforming and Restructured Loans and Other Real Estate as a Percentage of Total Assets

 

 

0.60

%  

 

0.61

%

Allowance as a Percentage of Period-end Loans

 

 

1.27

%  

 

1.14

%

Allowance as a Percentage of Non-performing and Restructured Loans and Other Real Estate

 

 

145

%  

 

126

%

 

We maintain a “watch list” of agricultural, commercial, real estate mortgage, and real estate construction loans and review those loans at least quarterly but more often if needed. 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.

 

Provision for Loan Losses

 

The loan loss provision for the first three months of 2020 was $1.6 million compared to $125 thousand for the first three months of 2019.  The increase in the total loan loss provision during the first three months of 2020 compared to the same time period in 2019 was attributed mostly to uncertainties surrounding the COVID-19 pandemic.  It is possible the Company will have additional provision for loan losses expense in future quarters as a result of the economic downturn associated with the COVID-19 pandemic.  Strong loan growth during the first quarter of 2020 also contributed to the increase in loan loss provision expense.  The allowance for loan losses as a percentage of loans was 1.27% at March 31, 2020 compared to 1.15% at March 31, 2019.

 

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 increased $130 thousand from December 31, 2019 to $4.7 million at March 31, 2020. The Company recorded net charge-offs of $169 thousand for the three months ended March 31, 2020 compared to net charge-offs of $370 thousand for the three months ended March 31, 2019.

 

Net charge-offs of $370 thousand recorded during the first three months of 2019 were mostly attributed to one loan which had a charged-off balance of $191 thousand during the first quarter of 2019.  This loan had a specific reserve of $191 thousand at December 31, 2018; thus, this charged-off balance did not result in additional loan loss provision expense for the three months ended March 31, 2019. Future levels of charge-offs will be determined by the particular facts and circumstances surrounding individual loans.

 

44

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

 

 

 

 

 

 

 

 

 

 

Three Months Ended March 31,

 

 

 

(in thousands)

 

 

    

 

2020

    

 

2019

 

Balance at Beginning of Period

 

$

8,460

 

$

8,127

 

Amounts Charged-Off:

 

 

 

 

 

 

 

Commercial

 

 

25

 

 

191

 

1-4 family residential

 

 

35

 

 

99

 

Non-farm & non-residential

 

 

 —

 

 

17

 

Consumer and other

 

 

347

 

 

302

 

Total Charged-off Loans

 

 

407

 

 

609

 

Recoveries on Amounts Previously Charged-off:

 

 

 

 

 

 

 

    Commercial

 

 

 6

 

 

 7

 

1-4 family residential

 

 

15

 

 

 8

 

Agricultural

 

 

 2

 

 

 1

 

Consumer and other

 

 

215

 

 

223

 

Total Recoveries

 

 

238

 

 

239

 

Net Charge-offs (Recoveries)

 

 

169

 

 

370

 

Provision for Loan Losses

 

 

1,625

 

 

125

 

Balance at End of Period

 

 

9,916

 

 

7,882

 

Loans

 

 

 

 

 

 

 

Average

 

 

762,389

 

 

685,928

 

At March 31,

 

 

778,327

 

 

687,484

 

As a Percentage of Average Loans:

 

 

 

 

 

 

 

Net Charge-offs for the period

 

 

0.02

%

 

0.05

%

Provision for Loan Losses for the period

 

 

0.21

%

 

0.02

%

Allowance as a Multiple of Net Charge-offs annualized

 

 

14.7

 

 

5.3

 

 

 

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.

 

45

Part II - Other Information

 

Item 1.  Legal Proceedings

 

In the ordinary course of operations, the Company and the Bank may be involved in various legal proceedings that the Company believes is of such types common to our industry.  There is no proceeding pending, or to the knowledge of management, threatened in which an adverse decision could result in a material adverse change in the business or consolidated financial position of the Company or the Bank.

 

Item 1 A.  Risk Factors

 

There are factors, many beyond our control, which may significantly affect the Company’s financial position and results of operations.  Some of these factors are described below in the sections titled financial risk, business risk and operational risk.  These risks are not totally independent of each other; some factors affect more than one type of risk.  These include regulatory, economic, and competitive environments.  

 

As part of the annual internal audit plan, our risk management department meets with management to assess these risks throughout the Company.  Many risks are further addressed in other sections of this Form 10-Q document.  Additional risks and uncertainties that management is not aware of or focused on or that management currently deems immaterial may also impair the Company’s business operations.  This report is qualified in its entirety by these risk factors.

 

The outbreak of Coronavirus Disease 2019 (“COVID-19”) has adversely impacted, and an outbreak of other highly infectious or contagious diseases could adversely impact, certain industries in which the Company’s customers operate and could impair their ability to fulfill their obligations to the Company. Further, the spread of the outbreak is expected to lead to an economic recession and other severe disruptions in the U.S. economy and may disrupt banking and other financial activity in the areas in which the Company operates and could potentially create widespread issues for the Company.

 

The spread of highly infectious or contagious diseases could cause, and the spread of COVID-19 has caused, severe disruptions in the U.S. economy at large, and for small businesses in particular, which could disrupt the Company’s operations. We are starting to see the impact from COVID-19 on our business, and we believe that it could be significant, adverse and potentially material. Currently, COVID-19 is spreading through the United States and the world. The resulting concerns on the part of the U.S. and global populations have created the threat of a recession, reduced economic activity and caused a significant correction in the global stock markets. We expect that we could experience significant disruptions across our business due to these effects, possibly leading to decreased earnings, significant slowdowns in our loan collections or increased loan defaults.  We also may experience financial losses due to increased cyber and payment fraud risk, as cybercriminals attempt to profit from the disruptions, given increased only and remote activity.

 

The Company relies upon its third-party vendors to conduct business and to process, record, and monitor transactions. If any of these vendors are unable to continue to provide the Company with these services, it could negatively impact the Company’s ability to serve its customers. Furthermore, the outbreak could negatively impact the ability of the Company’s employees and customers to engage in banking and other financial transactions in the geographic areas in which the Company operates and could create widespread issues for the Company.

 

The Company also could be adversely affected if key personnel or a significant number of employees were to become unavailable due to the effects and restrictions of a COVID-19 outbreak in our market areas. Although the Company has business continuity plans and other safeguards in place, there is no assurance that such plans and safeguards will be effective.  We believe that the economic impact from COVID-19 could have an adverse impact on our business and could result in losses in our loan portfolio, all of which would impact our earnings and capital.

 

COVID-19 may impact businesses’ and consumers’ desire or financial ability to borrow money, which would negatively impact loan volumes. In addition, certain of our borrowers are in or have exposure to the various industries impacted by COVID-19 and/or are located in areas that are quarantined or under stay-at-home orders, and COVID-19 may also have an adverse effect on our commercial real estate and consumer loan portfolios. A prolonged quarantine or stay-at-home

46

order would have a negative adverse impact on these borrowers and their revenue streams, which consequently impacts their ability to meet their financial obligations and could result in loan defaults.

 

The outbreak of COVID-19 or an outbreak of other highly infectious or contagious diseases has resulted in or may result in a decrease in our customers’ businesses, a decrease in consumer confidence and business generally, an increase in unemployment or a disruption in the services provided by the Company’s vendors. Disruptions to our customers could result in increased risk of delinquencies, defaults, foreclosures and losses on our loans, negatively impact regional economic conditions, result in declines in local loan demand, liquidity of loan guarantors, loan collateral (particularly in real estate), loan originations and deposit availability and negatively impact the implementation of our growth strategy.

 

As a participating lender in the U.S. Small Business Administration (“SBA”) Paycheck Protection Program (“PPP”), the Company and the Bank are subject to additional risks of litigation from the Bank’s customers or other parties regarding the Bank’s processing of loans for the PPP and risks that the SBA may not fund some or all PPP loan guaranties. 

 

On March 27, 2020, President Trump signed the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”), which included a $349 billion loan program administered through the SBA referred to as the PPP. Under the PPP, small businesses and other entities and individuals can apply for loans from existing SBA lenders and other approved regulated lenders that enroll in the program, subject to numerous limitations and eligibility criteria. The Bank is participating as a lender in the PPP. The PPP opened on April 3, 2020; however, because of the short timeframe between the passing of the CARES Act and the opening of the PPP, there is some ambiguity in the laws, rules and guidance regarding the operation of the PPP, which exposes the Company to risks relating to noncompliance with the PPP. On or about April 16, 2020, the SBA notified lenders that the $349 billion earmarked for the PPP was exhausted.  On our about April 23, 2020,  Congress approved an $310 billion in new funding for the PPP, including $30 billion that was reserved for lenders with less than $10 billion in assets such as the Company.

 

Since the opening of the PPP, several other larger banks have been subject to litigation regarding the process and procedures that such banks used in processing applications for the PPP. The Company and the Bank may be exposed to the risk of similar litigation, from both customers and non‑customers that approached the Bank regarding PPP loans, regarding its process and procedures used in processing applications for the PPP. If any such litigation is filed against the Company or the Bank and is not resolved in a manner favorable to the Company or the Bank, it may result in significant financial liability or adversely affect the Company’s reputation. In addition, litigation can be costly, regardless of outcome. Any financial liability, litigation costs or reputational damage caused by PPP related litigation could have a material adverse impact on our business, financial condition and results of operations.

 

The Bank also has credit risk on PPP loans if a determination is made by the SBA that there is a deficiency in the manner in which the loan was originated, funded, or serviced by the Bank, such as an issue with the eligibility of a borrower to receive a PPP loan, which may or may not be related to the ambiguity in the laws, rules and guidance regarding the operation of the PPP.

 

In the event of a loss resulting from a default on a PPP loan and a determination by the SBA that there was a deficiency in the manner in which the PPP loan was originated, funded, or serviced by the Company, the SBA may deny its liability under the guaranty, reduce the amount of the guaranty, or, if it has already paid under the guaranty, seek recovery of any loss related to the deficiency from the Company.

 

Even after the COVID-19 outbreak has subsided, we may continue to experience adverse impacts to our business as a result of the virus’s global economic impact, including the availability of credit, adverse impacts on our liquidity and any recession that has occurred or may occur in the future. There are no comparable recent events that provide guidance as to the effect the spread of COVID-19 as a global pandemic may have, and as a result, the ultimate impact of the outbreak is highly uncertain and subject to change.

 

To the extent the COVID-19 pandemic adversely affects our business, financial position, results of operations and/or cash flows, it may also have the effect of heightening many of the other risks we face, including the risks described in the section entitled “Risk Factors” in our 2019 Form 10-K and any subsequent Quarterly Report on Form 10-Q.

 

47

We continue to work with our management to assess, address and mitigate the impact of this global pandemic. However, we cannot predict the length and impact of the COVID-19 pandemic at this time.

 

The risks described in our 2019 Form 10-K are not the only risks that we encounter. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, results of operations, financial condition and/or liquidity.

 

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

 

1/1/20 - 1/31/20

 

 —

 

$

 —

 

 —

 

135,824

shares

 

 

 

 

 

 

 

 

 

 

 

2/1/20 - 2/29/20

 

 —

 

 

 —

 

 —

 

135,824

shares

 

 

 

 

 

 

 

 

 

 

 

3/1/20 - 3/31/20

 

 —

 

 

 —

 

 —

 

135,824

shares

 

 

 

 

 

 

 

 

 

 

 

Total

 

 —

 

$

 —

 

 —

 

135,824

shares

 

On October 25, 2000, we announced that our Board approved a stock repurchase program and authorized the Company to purchase up to 200,000 shares of its outstanding common stock.  On November 11, 2002, the Board approved and authorized the Company’s repurchase of an additional 200,000 shares.  On May 20, 2008, the Board of Directors approved and authorized the Company to purchase an additional 200,000 shares.  On May 17, 2011, the Board approved and authorized the Company’s repurchase of an additional 200,000 shares.  On November 18, 2016, the Board of Directors approved and authorized the Company’s repurchase of an additional 100,000 shares.  Shares will be purchased from time to time in the open market depending on market prices and other considerations.  Through March 31, 2020, 764,176 shares have been purchased.

48

Item 6.     Exhibits

Ay

 

 

 

 

 

3.1

 

Second Amended and Restated Articles of Incorporation of the Registrant are incorporated by reference to Annex A of the Registrant’s Schedule 14A Proxy Statement and filed April 15, 2019.

 

 

 

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.

 

 

 

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 INS XBRL Instance Document

 

       101 SCH XBRL Taxonomy Extension Scheme Document

 

       101 CAL XBRL Taxonomy Extension Calculation Linkbase Document

 

       101 DEF XBRL Taxonomy Extension Definition Linkbase Document

 

       101 LAB XBRL Taxonomy Extension Label Linkbase Document

 

       101 PRE XBRL Taxonomy Extension Presentation Linkbase Document   

 

 

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

5/11/20

 

 /s/Louis Prichard

 

 

 

 Louis Prichard, President and C.E.O.

 

 

 

 

Date

5/11/20

 

 /s/Gregory J. Dawson

 

 

 Gregory J. Dawson, Chief Financial Officer

 

49