Kentucky Bancshares (KTYB) 10-Q 2014 Q3 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

FORM 10-Q

(Mark One)

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

For the quarterly period September 30, 2014

or

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

For the transition period from                      to                     

Commission File Number:  000-52598

KENTUCKY BANCSHARES, INC.

(Exact name of registrant as specified in its charter)

Kentucky	61-0993464
(State or other jurisdiction of	(I.R.S. Employer Identification No.)
incorporation or organization)

P.O. Box 157, Paris, Kentucky	40362-0157
(Address of principal executive offices)	(Zip Code)

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

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o

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

Large accelerated filer o	Accelerated filer o
Non-accelerated filer x	Smaller reporting company o
(Do not check if a smaller reporting company)

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

Number of shares of Common Stock outstanding as of October 31, 2014:  2,720,842.

KENTUCKY BANCSHARES, INC.

Table of Contents

Part I - Financial Information
Item 1. Financial Statements
	Consolidated Balance Sheets	3
	Consolidated Statements of Income and Comprehensive Income (Loss)	4
	Consolidated Statement of Changes in Stockholders’ Equity	6
	Consolidated Statements of Cash Flows	7
	Notes to Consolidated Financial Statements	8
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	37
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	49
Item 4.	Controls and Procedures	51
Part II - Other Information		51
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	51
Item 6.	Exhibits	52
Signatures		53

2

Item 1 - Financial Statements

KENTUCKY BANCSHARES, INC.

CONSOLIDATED BALANCE SHEETS (unaudited)

(in thousands, except per share data)

	9/30/2014			12/31/2013
Assets
Cash and due from banks	$	17,102		$	22,650
Federal funds sold	140			510
Cash and cash equivalents	17,242			23,160
Securities available for sale	214,143			230,396
Trading Assets	5,325			—
Mortgage loans held for sale	754			223
Loans	510,994			468,655
Allowance for loan losses	(5,706		)	(5,441		)
Net loans	505,288			463,214
Federal Home Loan Bank stock	5,981			6,731
Real estate owned, net	3,348			3,379
Bank premises and equipment, net	16,644			16,709
Interest receivable	3,519			3,618
Mortgage servicing rights	1,238			1,344
Goodwill	13,117			13,117
Other intangible assets	209			317
Other assets	7,316			8,371
Total assets	$	794,124		$	770,579
Liabilities and Stockholders’ Equity
Deposits
Non-interest bearing	$	161,174		$	152,052
Time deposits, $100,000 and over	88,561			96,264
Other interest bearing	338,583			369,084
Total deposits	588,318			617,400
Repurchase agreements and other borrowings	11,289			12,867
Federal funds purchased	2,776			—
Short-term Federal Home Loan Bank advances	25,000			—
Long-term Federal Home Loan Bank advances	75,437			57,847
Subordinated debentures	7,217			7,217
Interest payable	657			736
Other liabilities	7,331			6,839
Total liabilities	718,025			702,906
Stockholders’ equity
Preferred stock, 300,000 shares authorized and unissued	—			—
Common stock, no par value; 10,000,000 shares authorized; 2,720,842 and 2,717,434 shares issued and outstanding on September 30, 2014 and December 31, 2013	12,636			12,570
Retained earnings	63,509			60,229
Accumulated other comprehensive loss	(46		)	(5,126		)
Total stockholders’ equity	76,099			67,673
Total liabilities & stockholders’ equity	$	794,124		$	770,579

See Accompanying Notes

3

KENTUCKY BANCSHARES, INC.

CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (LOSS) (unaudited)

(in thousands, except per share amounts)

	Nine Months Ending
	9/30/2014		9/30/2013
INTEREST INCOME:
Loans, including fees	$	17,757	$	17,094
Securities
Taxable	1,941		1,549
Tax exempt	2,133		2,022
Trading assets	129		—
Other	210		233
Total interest income	22,170		20,898
INTEREST EXPENSE:
Deposits	1,557		1,725
Repurchase agreements and other borrowings	72		56
Federal Home Loan Bank advances	1,003		543
Subordinated debentures	172		174
Total interest expense	2,804		2,498
Net interest income	19,366		18,400
Provision for loan losses	500		850
Net interest income after provision	18,866		17,550
NON-INTEREST INCOME:
Service charges	3,223		3,240
Loan service fee income, net	63		64
Trust department income	717		548
Gain on sale of available for sale securities, net	514		774
Gain on trading assets	196		—
Gain on sale of mortgage loans	715		1,431
Brokerage income	422		279
Debit card interchange income	1,543		1,444
Other	34		(8		)
Total other income	7,427		7,772
NON-INTEREST EXPENSE:
Salaries and employee benefits	11,013		10,438
Occupancy expenses	2,526		2,358
Repossession expenses, net	163		53
FDIC Insurance	403		385
Legal and professional fees	765		668
Data processing	1,005		1,021
Debit card expenses	698		718
Amortization	104		171
Advertising and marketing	653		650
Taxes other than payroll, property and income	647		670
Telephone	256		172
Postage	236		227
Loan fees	273		333
Other	1,452		1,485
Total other expenses	20,194		19,349
Income before taxes	6,099		5,973
Income taxes	704		1,112
Net income	$	5,395	$	4,861
Other Comprehensive Income (Loss), net of tax:
Change in Unrealized Gains (losses) on Securities	5,080		(7,531		)
Comprehensive Income (Loss)	$	10,475	$	(2,670	)
Earnings per share
Basic	$	1.99	$	1.80
Diluted	1.99		1.80
Dividends per share	0.75		0.72

See Accompanying Notes

4

KENTUCKY BANCSHARES, INC.

CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (LOSS) (unaudited)

(in thousands, except per share amounts)

	Three Months Ending
	9/30/2014			9/30/2013
INTEREST INCOME:
Loans, including fees	$	6,100		$	5,815
Securities
Taxable	586			543
Tax exempt	682			673
Trading assets	49			—
Other	65			74
Total interest income	7,482			7,105
INTEREST EXPENSE:
Deposits	483			563
Repurchase agreements and other borrowings	24			25
Federal Home Loan Bank advances	380			213
Subordinated debentures	57			59
Total interest expense	944			860
Net interest income	6,538			6,245
Provision for loan losses	300			250
Net interest income after provision	6,238			5,995
NON-INTEREST INCOME:
Service charges	1,150			1,132
Loan service fee income, net	29			100
Trust department income	256			188
Gain on sale of available for sale securities, net	81			—
Gain on trading assets	34			—
Gain on sale of mortgage loans	317			291
Brokerage income	132			102
Debit card interchange income	534			491
Other	(43		)	38
Total other income	2,490			2,342
NON-INTEREST EXPENSE:
Salaries and employee benefits	3,750			3,660
Occupancy expenses	848			811
Repossession expenses, net	140			18
FDIC Insurance	135			123
Legal and professional fees	307			278
Data processing	337			333
Debit card expenses	202			250
Amortization	30			57
Advertising and marketing	212			274
Taxes other than payroll, property and income	225			223
Telephone	80			62
Postage	79			80
Loan fees	113			87
Other	507			472
Total other expenses	6,965			6,728
Income before taxes	1,763			1,609
Income taxes	43			242
Net income	$	1,720		$	1,367
Other Comprehensive Income (Loss), net of tax:
Change in Unrealized Gains (losses) on Securities	99			(1,555		)
Comprehensive Income (Loss)	$	1,819		$	(188	)
Earnings per share
Basic	$	0.63		$	0.51
Diluted	0.63			0.51
Dividends per share	0.25			0.24

See Accompanying Notes

5

KENTUCKY BANCSHARES, INC.

CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY  (unaudited)

(in thousands, except share information)

									Accumulated
									Other			Total
	—Common Stock(1)—					Retained			Comprehensive			Stockholders’
	Shares		Amount			Earnings			Income/(Loss)			Equity
Balances, January 1, 2014	2,717,434		$	12,570		$	60,229		$	(5,126	)	$	67,673
Common stock issued, net of forfeitures	7,203		—			—			—			—
Stock based compensation expense	—		83			—			—			83
Common stock purchased and retired	(3,795	)	(17		)	(74		)	—			(91		)
Net change in unrealized gain (loss) on securities available for sale, net of tax and reclassifications	—		—			—			5,080			5,080
Net income	—		—			5,395			—			5,395
Dividends declared - $0.75 per share	—		—			(2,041		)	—			(2,041		)
Balances, September 30, 2014	2,720,842		$	12,636		$	63,509		$	(46	)	$	76,099

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

See Accompanying Notes

6

KENTUCKY BANCSHARES, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS  (unaudited)

(in thousands)

	Nine Months Ending
	9/30/2014			9/30/2013
Cash Flows From Operating Activities
Net Income	$	5,395		$	4,861
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization	1,357			1,331
Securities amortization (accretion), net	476			724
Stock based compensation expense	83			72
Provision for loan losses	500			850
Securities available for sale gains, net	(514		)	(774		)
Net change in trading assets	(5,325		)	—
Originations of loans held for sale	(26,655		)	(45,878		)
Proceeds from sale of loans	26,839			46,883
Losses (gains) on sale of fixed assets	—			100
Losses (gains) on other real estate	(134		)	(25		)
Gain on sale of mortgage loans	(715		)	(1,431		)
Changes in:
Interest receivable	99			191
Write-downs of other real estate, net	64			(79		)
Other assets	872			(1,092		)
Interest payable	(79		)	134
Other liabilities	(2,125		)	1,612
Net cash from operating activities	138			7,479
Cash Flows From Investing Activities
Purchases of securities available for sale	(41,495		)	(89,456		)
Proceeds from principal payments, sales, maturities and calls of securities	65,483			60,533
Net change in loans	(44,225		)	(36,759		)
Proceeds from redemption of Federal Home Loan Bank stock	750			—
Purchases of bank premises and equipment	(895		)	(1,366		)
Proceeds from sale of bank premises and equipment	—			258
Proceeds from the sale of other real estate	1,752			1,056
Net cash from investing activities	(18,630		)	(65,734		)
Cash Flows From Financing Activities:
Net change in deposits	(29,082		)	(16,939		)
Net change in repurchase agreements and other borrowings	1,198			13,563
Short-term advances from Federal Home Loan Bank	175,000			192,500
Payment on short-term Federal Home Loan Bank advance	(150,000		)	(177,500		)
Long-term advances from Federal Home Loan Bank	27,277			42,660
Payments on long-term Federal Home Loan Bank advances	(9,687		)	(6,530		)
Payments on note payable	—			(500		)
Purchase of common stock	(91		)	(135		)
Dividends paid	(2,041		)	(1,961		)
Net cash from financing activities	12,574			45,158
Net change in cash and cash equivalents	(5,918		)	(13,097		)
Cash and cash equivalents at beginning of period	23,160			31,764
Cash and cash equivalents at end of period	$	17,242		$	18,667
Supplemental disclosures of cash flow information
Cash paid during the year for:
Interest expense	$	2,883		$	2,364
Income taxes	1,000			1,275
Supplemental disclosures of non-cash investing activities
Real estate acquired through foreclosure	$	1,651		$	472

See Accompanying Notes

7

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1.SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The financial information presented as of any date other than December 31 has been prepared from the Company’s books and records without audit.  The accompanying consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X.  Certain financial information that is normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America, but is not required for interim reporting purposes, has been condensed or omitted.  There have been no significant changes to the Company’s accounting and reporting policies as disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013.  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, 2013.

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

Nature of Operations:  The Bank operates under a state bank charter and provides full banking services, including trust services, to customers located in Bourbon, Clark, Elliott, Fayette, Harrison, Jessamine, Madison, Rowan, Scott, Woodford and adjoining counties in Kentucky.  Management continues to consider opportunities for branch expansion and will also consider acquisition opportunities that help advance its strategic objectives.  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.  On July 9, 2014, a new subsidiary of the Company was incorporated under the name KBI Insurance Company, Inc.  KBI Insurance Company, Inc. is a subsidiary of Kentucky Bancshares, Inc. and is located in Las Vegas, Nevada.  It is a captive insurance subsidiary which insures various liability and property damage policies for Kentucky Bancshares, Inc. and its related subsidiaries.  KBI Insurance Company, Inc. is regulated by the State of Nevada Division of Insurance.  Our transfer, registrar and dividend agent, Registrar and Transfer Company, was recently acquired by Computershare.  The migration to Computershare occurred October 31, 2014.

Estimates in the Financial Statements:  The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  Actual results could differ from those estimates and such differences could be material to the financial statements.  The allowance for loan losses, loss contingencies, mortgage servicing rights, real estate owned, goodwill and fair value of financial instruments are particularly subject to change.

8

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

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

Pension Matter:  The Company terminated the Kentucky Bancshares, Inc. Retirement Plan and Trust (the “Plan”) in a standard termination, with a termination date of December 31, 2008.  Prior to such termination, the Pension Protection Act of 2006 (“PPA”) had amended Internal Revenue Code (“IRC”) Section 417(e)(3) in part by changing the definition of “applicable interest rate” in a manner that in most cases (when combined with other changes to IRC Section 417(e)(3)) would result in a decrease in the value of a participant’s or beneficiary’s plan benefits under pension plans such as the Company’s Plan with the new definition applicable (for most plans, including the Plan) to lump sums with annuity starting dates in or after the 2008 plan year.  The Plan had determined in mid-2008 to comply with IRC Section 417(e)(3), as amended by PPA, by using the assumptions governing minimum lump sums, rather than by using the pre-PPA minimum lump sum assumptions, and operated the Plan in compliance with that decision.  As permitted by the IRC, the Plan was amended on February 24, 2009 (after the termination of the Plan on December 31, 2008) to formalize that decision in accordance with Section 1107 of PPA.

The Internal Revenue Service issued a favorable determination as to the Plan termination in July 2010.  Subsequent to Plan termination and distributions to Plan participants, the Plan was selected for audit by the Pension Benefit Guaranty Corporation (“PBGC”).  The PBGC asserted that the February, 2009 amendment to the Plan violated PBGC Regulation Section 4041.8(a) because the amendment served to lower benefits to Plan beneficiaries.  The PBGC filed a Complaint in May 2013 in United States District Court (Eastern District of Kentucky) to require the Company to make additional distributions to Plan beneficiaries.  On March 17, 2014, the United States District Court (Eastern District of Kentucky) issued an Opinion and Order entering judgment in favor of the PBGC and ruling that the Company must comply with the PBGC’s determination respecting the Plan.  The Company has appealed the decision and the appeal is pending.  However, in light of the court’s opinion, the Company accrued approximately $1.6 million as of December 31, 2013 for this matter.  The accrued balance for this matter remains $1.6 million at September 30, 2014.  Moreover, in the event the subject court decision is not overturned, the Company believes it has claims for further contribution towards payment of this liability from professionals who assisted the Company in the termination of the Plan.

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

9

Adoption of New Accounting Standards

ASU 2014-14 — Receivables — Troubled Debt Restructurings by Creditors (Subtopic 310-40): Classification of Certain Government-Guaranteed Mortgage Loans upon Foreclosure.

The amendments in this ASU require that a mortgage loan be derecognized and that a separate other receivable be recognized upon foreclosure if: a) the loan has a government guarantee that is not separable from the loan before foreclosure; b) at the time of foreclosure, the creditor has the intent to convey the real estate property to the guarantor and make a claim on the guarantee, and the creditor has the ability to recover under that claim; and c) at the time of foreclosure, any amount of the claim that is determined on the basis of the fair value of the real estate is fixed. The separate other receivable recognized upon foreclosure should be measured based on the amount of the loan balance (principal and interest) expected to be received from the guarantor. The amendments in this ASU are effective for the Company beginning January 1, 2015 and are not expected to have a material impact on the Company’s financial statements.

10

2.SECURITIES

SECURITIES AVAILABLE FOR SALE

Period-end securities are as follows:

(in thousands)

			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
Available for Sale	Cost		Gains		Losses			Value
September 30, 2014
U.S. government agencies	$	68,139	$	46	$	(1,713	)	$	66,472
States and political subdivisions	80,886		3,019		(528		)	83,377
Mortgage-backed - residential	64,918		118		(1,035		)	64,001
Equity securities	270		23		—			293
Total	$	214,213	$	3,206	$	(3,276	)	$	214,143
December 31, 2013
U.S. government agencies	$	73,930	$	51	$	(4,695	)	$	69,286
States and political subdivisions	91,043		1,614		(2,474		)	90,183
Mortgage-backed - residential	72,920		44		(2,326		)	70,638
Equity securities	270		19		—			289
Total	$	238,163	$	1,728	$	(9,495	)	$	230,396

The amortized cost and fair value of securities at September 30, 2014 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 8.

	Amortized		Fair
(in thousands)	Cost		Value
Due in one year or less	$	617	$	617
Due after one year through five years	9,125		9,074
Due after five years through ten years	77,983		77,403
Due after ten years	61,300		62,755
	149,025		149,849
Mortgage-backed - residential	64,918		64,001
Equity	270		293
Total	$	214,213	$	214,143

Proceeds from sales of securities during the first nine months of 2014 and 2013 were $53.6 million and $27.2 million.  Gross gains of $914 thousand and $774 thousand and gross losses of $400 thousand and $0 were realized on those sales, respectively.  The tax provision related to these realized net gains was $175 thousand and $263 thousand, respectively.

Proceeds from sales of securities during the three months ending September 30, 2014 and September 30, 2013 were $13.5 million and $0.  Gross gains of $129 thousand and $0 and gross losses of $48 thousand and $0 were realized on those sales, respectively.  The tax provision related to these realized gains and losses was $28 thousand and $0, respectively.

11

Securities with unrealized losses September 30, 2014 and at December 31, 2013 not recognized in income are as follows:

September 30, 2014

	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	$	9,541	$	(157	)	$	51,060	$	(1,556	)	$	60,601	$	(1,713	)
States and municipals	5,577		(73		)	10,922		(455		)	16,499		(528		)
Mortgage-backed - residential	26,598		(332		)	21,554		(703		)	48,152		(1,035		)
Total temporarily impaired	$	41,716	$	(562	)	$	83,536	$	(2,714	)	$	125,252	$	(3,276	)

December 31, 2013

	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	$	57,203	$	(3,812	)	$	8,117	$	(883	)	$	65,320	$	(4,695	)
States and municipals	32,289		(2,106		)	2,879		(368		)	35,168		(2,474		)
Mortgage-backed - residential	62,126		(2,326		)	—		—			62,126		(2,326		)
Total temporarily impaired	$	151,618	$	(8,244	)	$	10,996	$	(1,251	)	$	162,614	$	(9,495	)

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

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

TRADING ASSETS

The trading assets of $5.3 million are primarily comprised of municipal securities which are held for a very short period of time.

12

3. LOANS

Loans at period-end are as follows:

(in thousands)

	9/30/14		12/31/13
Commercial	$	34,457	$	34,654
Real estate construction	14,366		11,177
Real estate mortgage:
1-4 family residential	196,175		194,388
Multi-family residential	28,808		16,420
Non-farm & non-residential	144,888		126,791
Agricultural	75,163		68,002
Consumer	16,925		17,065
Other	212		158
Total	$	510,994	$	468,655

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

	Nine Months Ended September 30, 2014
	(in thousands)
	Beginning									Ending
	Balance		Charge-offs		Recoveries		Provision			Balance
Commercial	$	230	$	200	$	—	$	213		$	243
Real estate Construction	358		—		11		18			387
Real estate mortgage:
1-4 family residential	2,169		179		55		(27		)	2,018
Multi-family residential	427		42		—		86			471
Non-farm & non-residential	564		—		367		(167		)	764
Agricultural	578		18		27		103			690
Consumer	548		201		58		139			544
Other	51		398		285		139			77
Unallocated	516		—		—		(4		)	512
	$	5,441	$	1,038	$	803	$	500		$	5,706

	Three Months Ended September,30 2014
	(in thousands)
	Beginning									Ending
	Balance		Charge-offs		Recoveries		Provision			Balance
Commercial	$	231	$	—	$	—	$	12		$	243
Real estate Construction	359		—		3		25			387
Real estate mortgage:
1-4 family residential	2,324		91		39		(254		)	2,018
Multi-family residential	327		42		—		186			471
Non-farm & non-residential	734		—		—		30			764
Agricultural	546		18		2		160			690
Consumer	543		48		17		32			544
Other	33		196		126		114			77
Unallocated	517		—		—		(5		)	512
	$	5,614	$	395	$	187	$	300		$	5,706

13

	Nine Months Ended September 30, 2013
	(in thousands)
	Beginning									Ending
	Balance		Charge-offs		Recoveries		Provision			Balance
Commercial	$	150	$	12	$	28	$	(14	)	$	152
Real estate Construction	918		578		21		55			416
Real estate mortgage:
1-4 family residential	1,989		186		58		210			2,071
Multi-family residential	414		161		103		89			445
Non-farm & non-residential	628		99		18		37			584
Agricultural	845		109		22		(135		)	623
Consumer	517		298		9		306			534
Other	54		513		301		284			126
Unallocated	532		—		—		18			550
	$	6,047	$	1,956	$	560	$	850		$	5,501

	Three Months Ended September 30, 2013
	(in thousands)
	Beginning										Ending
	Balance		Charge-offs		Recoveries			Provision			Balance
Commercial	$	150	$	—	$	—		$	2		$	152
Real estate Construction	373		—		—			43			416
Real estate mortgage:
1-4 family residential	1,984		45		2			130			2,071
Multi-family residential	481		—		64			(100		)	445
Non-farm & non-residential	677		99		—			6			584
Agricultural	661		23		19			(34		)	623
Consumer	548		46		(9		)	41			534
Other	92		204		95			143			126
Unallocated	531		—		—			19			550
	$	5,497	$	417	$	171		$	250		$	5,501

14

The following tables present the balance in the allowance for loan losses and the recorded investment (excluding accrued interest receivable amounting to $2.2 million as of September 30, 2014 and $2.3 million at December 31, 2013) in loans by portfolio segment and based on impairment method as of September 30, 2014 and December 31, 2013:

As of September 30, 2014

    (in thousands)

	Individually		Collectively
	Evaluated for		Evaluated for
	Impairment		Impairment		Total
Allowance for Loan Losses:
Commercial	$	—	$	243	$	243
Real estate construction	—		387		387
Real estate mortgage
1-4 family residential	137		1,881		2,018
Multi-family residential	91		380		471
Non-farm & non-residential	164		600		764
Agricultural	391		299		690
Consumer	—		544		544
Other	—		77		77
Unallocated	—		512		512
	$	783	$	4,923	$	5,706
Loans:
Commercial	$	—	$	34,457	$	34,457
Real estate construction	—		14,366		14,366
Real estate mortgage:
1-4 family residential	2,364		193,811		196,175
Multi-family residential	260		28,548		28,808
Non-farm & non-residential	5,844		139,044		144,888
Agricultural	9,740		65,423		75,163
Consumer	—		16,925		16,925
Other	—		212		212
	$	18,208	$	492,786	$	510,994

As of December 31, 2013

    (in thousands)

	Individually		Collectively
	Evaluated for		Evaluated for
	Impairment		Impairment		Total
Allowance for Loan Losses:
Commercial	$	—	$	230	$	230
Real estate construction	—		358		358
Real estate mortgage:
1-4 family residential	228		1,941		2,169
Multi-family residential	76		351		427
Non-farm & non-residential	110		454		564
Agricultural	298		280		578
Consumer	—		548		548
Other	—		51		51
Unallocated	—		516		516
	$	712	$	4,729	$	5,441
Loans:
Commercial	$	—	$	34,654	$	34,654
Real estate construction	—		11,177		11,177
Real estate mortgage:
1-4 family residential	2,873		191,515		194,388
Multi-family residential	274		16,146		16,420
Non-farm & non-residential	2,716		124,075		126,791
Agricultural	7,673		60,329		68,002
Consumer	—		17,065		17,065
Other	—		158		158
	$	13,536	$	455,119	$	468,655

15

The following table presents loans individually evaluated for impairment by class of loans as of and for the nine months ended September 30, 2014 (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:
Commercial	$	—	$	—	$	—	$	—	$	—	$	—
Real estate construction	—		—		—		—		—		—
Real estate mortgage:
1-4 family residential	1,113		1,113		—		1,109		43		43
Multi-family residential	—		—		—		—		—		—
Non-farm & non-residential	1,960		1,960		—		653		68		68
Agricultural	4,985		4,985		—		3,404		96		96
Consumer	—		—		—		—		—		—
Other	—		—		—		—		—		—
With an allowance recorded:
Commercial	—		—		—		—		—		—
Real estate construction	—		—		—		—		—		—
Real estate mortgage:
1-4 family residential	1,251		1,251		137		1,442		26		26
Multi-family residential	260		260		91		289		5		5
Non-farm & non-residential	3,884		3,884		164		3,263		100		100
Agricultural	4,755		4,755		391		4,633		—		—
Consumer	—		—		—		—		—		—
Other	—		—		—		—				—
Total	$	18,208	$	18,208	$	783	$	14,793	$	338	$	338

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

16

The following table presents loans individually evaluated for impairment by class of loans as of and for the year ended December 31, 2013 (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:
Commercial	$	—	$	—	$	—	$	—	$	—	$	—
Real estate construction	—		—		—		—		—		—
Real estate mortgage:
1-4 family residential	824		793		—		1,217		28		28
Multi-family residential	—		—		—		—		—		—
Non-farm & non-residential	1,650		803		—		1,471		81		81
Agricultural	2,912		2,826		—		2,802		123		123
Consumer	—		—		—		—		—		—
Other	—		—		—		—		—		—
With an allowance recorded:
Commercial	—		—		—		—		—		—
Real estate construction	—		—		—		607		—		—
Real estate mortgage
1-4 family residential	2,080		2,080		228		1,349		96		96
Multi-family residential	274		274		76		443		3		3
Non-farm & non-residential	1,913		1,913		110		1,938		79		79
Agricultural	4,847		4,847		298		4,864		287		287
Consumer	—		—		—		—		—		—
Other	—		—		—		—				—
Total	$	14,501	$	13,536	$	712	$	14,691	$	697	$	697

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

17

The following table presents loans individually evaluated for impairment by class of loans as of and for the nine months ended September 30, 2013 (in thousands):

	Average		Interest		Cash Basis
	Recorded		Income		Interest
	Investment		Recognized		Recognized
With no related allowance recorded:
Commercial	$	—	$	—	$	—
Real estate construction	—		—		—
Real estate mortgage:
1-4 family residential	1,323		38		38
Multi-family residential	—		—		—
Non-farm & non-residential	1,432		61		61
Agricultural	2,796		12		12
Consumer	—		—		—
Other	—		—		—
With an allowance recorded:
Commercial	—		—		—
Real estate construction	759		—
Real estate mortgage:
1-4 family residential	1,167		43		43
Multi-family residential	485		3		3
Non-farm & non-residential	2,150		59		59
Agricultural	4,868		122		122
Consumer	—		—		—
Other	—				—
Total	$	14,980	$	338	$	338

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

18

The following tables present loans individually evaluated for impairment by class of loans for the three months ending September 30, 2014 and September 30, 2013

(in thousands):

	Three Months Ending September 30, 2014
	Average		Interest		Cash Basis
	Recorded		Income		Interest
	Investment		Recognized		Recognized
With no related allowance recorded:
Commercial	$	—	$	—	$	—
Real estate construction	—		—		—
Real estate mortgage:
1-4 family residential	1,208		13		13
Multi-family residential	—		—		—
Non-farm & non-residential	980		19		19
Agricultural	4,883		37		37
Consumer	—		—		—
Other	—		—		—
With an allowance recorded:
Commercial	—		—		—
Real estate construction	—		—		—
Real estate mortgage:
1-4 family residential	1,572		5		5
Multi-family residential	303		—		—
Non-farm & non-residential	3,910		34		34
Agricultural	4,755		—		—
Consumer	—		—		—
Other	—		—		—
Total	$	17,611	$	108	$	108

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

	Three Months Ending September 30, 2013
	Average		Interest		Cash Basis
	Recorded		Income		Interest
	Investment		Recognized		Recognized
With no related allowance recorded:
Commercial	$	—	$	—	$	—
Real estate construction	—		—		—
Real estate mortgage:
1-4 family residential	1,017		17		17
Multi-family residential	—		—		—
Non-farm & non-residential	808		20		20
Agricultural	2,761		3		3
Consumer	—		—		—
Other	—		—		—
With an allowance recorded:
Commercial	—		—		—
Real estate construction	—		—		—
Real estate mortgage:
1-4 family residential	1,129		22		22
Multi-family residential	400		2		2
Non-farm & non-residential	2,508		20		20
Agricultural	4,697		65		65
Consumer	—		—		—
Other	—		—		—
Total	$	13,320	$	149	$	149

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

19

The following tables present the recorded investment in nonaccrual, loans past due over 90 days still on accrual and accruing troubled debt restructurings by class of loans as of September 30, 2014 and December 31, 2013:

As of September 30, 2014

   (in thousands)

			Loans Past Due
			Over 90 Days		Accruing
			Still		Troubled Debt
	Nonaccrual		Accruing		Restructurings
Commercial	$	382	$	—	$	—
Real estate construction	—		—		—
Real estate mortgage:
1-4 family residential	1,548		532		484
Multi-family residential	260		—		—
Non-farm & non-residential	988		69		1,841
Agricultural	147		232		4,530
Consumer	5		2		—
Total	$	3,330	$	835	$	6,855

As of December 31, 2013

   (in thousands)

			Loans Past Due
			Over 90 Days		Accruing
			Still		Troubled Debt
	Nonaccrual		Accruing		Restructurings
Commercial	$	—	$	—	$	—
Real estate construction	—		—		—
Real estate mortgage:
1-4 family residential	1,171		314		493
Multi-family residential	275		—		—
Non-farm & non-residential	803		—		1,878
Agricultural	717		232		4,530
Consumer	8		8		—
Total	$	2,974	$	554	$	6,901

Nonaccrual loans secured by real estate make up 88.4% of the total nonaccruals at September 30, 2014.

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.

20

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 of September 30, 2014 and December 31, 2013 by class of loans:

As of September 30, 2014

       (in thousands)

	30–59		60–89		Loans Past Due				Total
	Days		Days		Over 90 Days				Past Due &		Loans Not
	Past Due		Past Due		Still Accruing		Non-accrual		Non-accrual		Past Due
Commercial	$	73	$	—	$	—	$	382	$	455	$	34,002
Real estate construction	372		144		—		—		516		13,850
Real estate mortgage:
1-4 family residential	1,145		359		532		1,548		3,584		192,591
Multi-family residential	—		—		—		260		260		28,548
Non-farm & non-residential	—		70		69		988		1,127		143,761
Agricultural	111		—		232		147		490		74,673
Consumer	54		8		2		5		69		16,856
Other	—		—		—		—		—		212
Total	$	1,755	$	581	$	835	$	3,330	$	6,501	$	504,493

As of December 31, 2013

   (in thousands)

	30–59		60–89		Greater than				Total
	Days		Days		90 Days				Past Due &		Loans Not
	Past Due		Past Due		Past Due		Non-accrual		Non-accrual		Past Due
Commercial	$	49	$	—	$	—	$	—	$	49	$	34,605
Real estate construction	175		—		—		—		175		11,002
Real estate mortgage:
1-4 family residential	1,981		1,285		314		1,171		4,751		189,637
Multi-family residential	—		—		—		275		275		16,145
Non-farm & non-residential	503		—		—		803		1,306		125,485
Agricultural	155		—		232		717		1,104		66,898
Consumer	102		27		8		8		145		16,920
Other	—		—		—		—		—		158
Total	$	2,965	$	1,312	$	554	$	2,974	$	7,805	$	460,850

21

Troubled Debt Restructurings:

The Company has allocated $383 thousand in specific reserves to customers whose loan terms have been modified in troubled debt restructurings as of September 30, 2014.  The Company allocated $428 thousand for specific reserves to customers whose loan terms had been modified in troubled debt restructuring as of December 31, 2013.  The Company has not committed to lend additional amounts as of September 30, 2014 and December 31, 2013 to customers with outstanding loans that are classified as troubled debt restructurings.  There were no troubled debt restructurings for which there was a payment default within twelve months following the modification during the periods ending September 30, 2014 and 2013.

No loans were modified as troubled debt restructurings during the nine months ending September 30, 2014 and 2013.

Credit Quality Indicators:

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

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

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

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

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

22

As of September 30, 2014 and December 31, 2013, and based on the most recent analysis performed, the risk category of loans by class of loans is as follows:

As of September 30, 2014

   (in thousands)

			Special
	Pass		Mention		Substandard		Doubtful
Commercial	$	32,758	$	1,364	$	277	$	58
Real estate construction	12,448		1,774		144		—
Real estate mortgage:
1-4 family residential	182,462		5,998		7,663		52
Multi-family residential	28,383		—		425		—
Non-farm & non-residential	136,662		4,831		3,395		—
Agricultural	60,415		8,666		6,029		53
Total	$	453,128	$	22,633	$	17,933	$	163

As of December 31, 2013

   (in thousands)

			Special
	Pass		Mention		Substandard		Doubtful
Commercial	$	32,771	$	1,587	$	296	$	—
Real estate construction	9,660		1,517		—		—
Real estate mortgage:
1-4 family residential	176,553		10,346		7,489		—
Multi-family residential	14,392		1,579		449		—
Non-farm & non-residential	120,195		5,327		1,269		—
Agricultural	56,713		7,297		3,992		—
Total	$	410,284	$	27,653	$	13,495	$	—

For consumer loans, the Company evaluates the credit quality based on the aging of the recorded investment in loans, which was previously presented.  Non-performing consumer loans are loans which are greater than 90 days past due or on non-accrual status, and total $7 at September 30, 2014 and $16 thousand at December 31, 2013.

23

4.             REAL ESTATE OWNED

Activity in real estate owned, net was as follows:

	Nine Months Ended
	2014			2013
	(in thousands)
Beginning of year	$	3,379		$	4,168
Additions	1,651			542
Sales	(1,676		)	(1,238		)
(Additions) subtractions to valuation allowance, net	(64		)	79
Recovery from sale in valuation allowance	58			207
End of period	$	3,348		$	3,758

Activity in the valuation allowance was as follows:

	Nine Months Ended
	2014			2013
	(in thousands)
Beginning of year	$	1,524		$	1,668
Additions (subtractions) to valuation allowance, net	64			(79		)
Recovery from sale	(58		)	(207		)
End of period	$	1,530		$	1,382

Expenses related to foreclosed assets include:

	Nine Months Ended
	2014			2013
	(in thousands)
Net loss (gain) on sales	$	(134	)	$	(25	)
Additions (subtractions) to valuation allowance, net	64			(79		)
Operating expenses (receipts), net of rental income	99			132
Repossession expenses, net	163			53
For the period	$	29		$	28

24

5.             EARNINGS PER SHARE

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

The factors used in the earnings per share computation follow:

	Nine Months Ended
	September 30
	2014		2013
	(in thousands)
Basic Earnings Per Share
Net Income	$	5,395	$	4,861
Weighted average common shares outstanding	2,708		2,705
Basic earnings per share	$	1.99	$	1.80
Diluted Earnings Per Share
Net Income	$	5,395	$	4,861
Weighted average common shares outstanding	2,708		2,705
Add dilutive effects of assumed vesting of stock grants	—		4
Weighted average common and dilutive potential common shares outstanding	2,708		2,709
Diluted earnings per share	$	1.99	$	1.80
	Three Months Ended
	September 30
	2014		2013
	(in thousands)
Basic Earnings Per Share
Net Income	$	1,720	$	1,367
Weighted average common shares outstanding	2,708		2,705
Basic earnings per share	$	0.63	$	0.51
Diluted Earnings Per Share
Net Income	$	1,720	$	1,367
Weighted average common shares outstanding	2,708		2,705
Add dilutive effects of assumed vesting of stock grants	—		4
Weighted average common and dilutive potential common shares outstanding	2,708		2,709
Diluted earnings per share	$	0.63	$	0.51

Stock options for 12,725 shares of common stock for the nine and three months ended September 30, 2014 and 19,100 shares of common stock for the nine and three months ended September 30, 2013 were excluded from diluted earnings per share because their impact was antidilutive.

25

6.  STOCK COMPENSATION

We have four stock based compensation plans as described below.

Two Stock Option Plans

Under our now expired 1999 Employee Stock Option Plan (the “1999 Plan”), we granted certain officers and key employees stock option awards which vest and become fully exercisable at the end of five years and provide for issuance of up to 100,000 options.  Under the now expired 1993 Non-Employee Directors Stock Ownership Incentive Plan (together with the 1999 Plan, the “Stock Option Plans”), we also granted certain directors stock option awards which vest and become fully exercisable immediately and provide for issuance of up to 20,000 options.  For each Stock Option Plan, the exercise price of each option, which has a ten year life, was equal to the market price of our stock on the date of grant.

The combined summary of activity for 2014 in the expired Stock Option Plans follows:

					Weighted
			Weighted		Average
			Average		Remaining	Aggregate
			Exercise		Contractual	Intrinsic
	Shares		Price		Term	Value
Outstanding, beginning of year	19,100		$	31.50
Granted	—		—
Forfeited or expired	(6,375	)	33.56
Exercised	—		—
Outstanding, end of period	12,725		$	30.46	7.9 months	$	—
Vested and expected to vest	12,725		$	30.46	7.9 months	$	—
Exercisable, end of period	12,725		$	30.46	7.9 months	$	—

As of September 30, 2014, there was no unrecognized compensation cost related to nonvested stock options granted under either Stock Option Plan.  Since both Stock Option Plans have expired, no additional options can be granted under either of these plans.

2005 Restricted Stock Grant Plan

On May 10, 2005, our stockholders approved a restricted stock grant plan.  Total shares issuable under the plan are 50,000.  We issued 7,475 shares during 2014 and 6,065 shares during 2013.  There were 300 shares forfeited during the first nine months of 2014 and 65 shares forfeited during the first nine months of 2013.  As of September 30, 2014, the restricted stock grant plan allows for additional restricted stock share awards of up to 5,295 shares.

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

			Weighted-Average			Fair
			Grant-Date			Value
Nonvested Shares	Shares		Fair Value			Per Share
Nonvested at January 1, 2014	15,565		$	280,016		$	17.99
Granted	7,475		181,194			24.24
Vested	(4,956	)	(87,768		)	17.71
Forfeited	(300	)	(5,419		)	18.06
Nonvested at September 30, 2014	17,784		$	368,023		$	20.69

As of September 30, 2014, there was $294,867 of total unrecognized compensation cost related to nonvested shares granted under the restricted stock grant plan.  The cost is expected to be recognized over a weighted-average period of 5 years.

2009 Stock Award Plan

On May 13, 2009, our stockholders approved a stock award plan that provides for the granting of both incentive and nonqualified stock options and other share based awards.  Total shares issuable under the plan are 150,000.  We issued no stock grants during the first nine months of 2014 and 900 shares during the first nine months of 2013.  As of September 30, 2014, 149,100 shares are still available for issuance.

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

			Weighted-Average			Fair
			Grant-Date			Value
Nonvested Shares	Shares		Fair Value			Per Share
Nonvested at January 1, 2014	900		$	20,880		$	23.20
Granted	—		—			—
Vested	(180	)	(4,176		)	23.20
Forfeited	—		—			—
Nonvested at September 30, 2014	720		$	16,704		$	23.20

As of September 30, 2014, there was $14,268 of total unrecognized compensation cost related to nonvested shares granted under the restricted stock grant plan.  The cost is expected to be recognized over a weighted-average period of 5 years.

7.  OTHER BORROWINGS

At December 31, 2013 the Company had a $5 million revolving promissory note which matured July 27, 2014.  The Company renewed this note with similar terms as the original note with a maturity date of July 26, 2015.  The Company has no outstanding balances related to this promissory note at September 30, 2014.

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8.  FAIR VALUE MEASUREMENTS

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

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

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

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

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

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

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

Impaired Loans:  The fair value of impaired loans with specific allocations of the allowance for loan losses is generally based on recent third party real estate appraisals.  These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available.  Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value.

Other Real Estate Owned:  The fair value of certain commercial and residential real estate properties classified as other real estate owned (OREO) are generally based on third party appraisals of the property, resulting in a Level 3 classification.   In cases where the carrying amount exceeds the fair value, less costs to sell, an impairment loss is recognized.

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

Assets and Liabilities Measured on a Recurring Basis

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

Fair Value Measurements at September 30, 2014 Using (In thousands):

			Quoted Prices
			In Active
			Markets for		Significant Other		Significant
			Identical		Observable		Unobservable
	Fair		Assets		Inputs		Inputs
Description	Value		(Level 1)		(Level 2)		(Level 3)
U. S. government agencies	$	66,472	$	—	$	66,472	$	—
States and municipals	83,377		—		83,377		—
Mortgage-backed - residential	64,001		—		64,001		—
Equity securities	293		293		—		—
Trading Assets	5,325		5,325		—		—
Total	$	219,468	$	5,618	$	213,850	$	—

Available for Sale Investment Securities Fair Value Measurements at December 31, 2013 Using (In thousands):

			Quoted Prices
			In Active
			Markets for		Significant Other		Significant
			Identical		Observable		Unobservable
	Fair		Assets		Inputs		Inputs
Description	Value		(Level 1)		(Level 2)		(Level 3)
U. S. government agencies	$	69,286	$	—	$	69,286	$	—
States and municipals	90,183		—		90,183		—
Mortgage-backed - residential	70,638		—		70,638		—
Equity securities	289		289		—		—
Total	$	230,396	$	289	$	230,107	$	—

The Company held no trading assets at December 31, 2013.  Also, there were no transfers between level 1 and level 2 during 2014 or 2013.

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

(In thousands)

	Fair Value Measurements at September 30, 2014 Using:
			Quoted Prices
			In Active		Other
			Markets for	Significant	Significant
			Identical	Observable	Unobservable
	Carrying		Assets	Inputs	Inputs
Description	Value		(Level 1)	(Level 2)	(Level 3)
Impaired loans:
Real Estate Mortgage:
1-4 family residential	$	683	—	—	$	683
Multi-family residential	169		—	—	169
Non-farm & non-residential	1,241		—	—	1,241
Agricultural	89		89
Other real estate owned:
Residential	1,126		—	—	1,126
Loan servicing rights	325		—	—	325

(In thousands)

	Fair Value Measurements at December 31, 2013 Using:
			Quoted Prices
			In Active		Other
			Markets for	Significant	Significant
			Identical	Observable	Unobservable
	Carrying		Assets	Inputs	Inputs
Description	Value		(Level 1)	(Level 2)	(Level 3)
Impaired loans:
Real Estate Mortgage:
1-4 family residential	$	1,420	—	—	$	1,420
Multi-family residential	199		—	—	199
Non-farm & non-residential	36		—	—	36
Agricultural	275		—	—	275
Other real estate owned:
Residential	1,361		—	—	1,361
Loan servicing rights	201		—	—	201

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Impaired loans, which are measured for impairment using the fair value of the collateral for collateral dependent loans, had a carrying amount of $2.2 million, which includes a valuation allowance of $357 thousand at September 30, 2014.  During the first nine months of 2014, six new loans became impaired resulting in an additional provision for loan losses of $265 thousand.  The allowance associated with these six loans which became impaired during 2014 decreased $36 thousand for the three months ending September 30, 2014.  The total allowance for specific impaired loans increased $71 thousand for the nine months ending September 30, 2014 and decreased $35 thousand for the three months ending September 30, 2014. During the first nine months of 2013, three new loans became impaired resulting in an additional provision for loan losses of $160 thousand. For the three months ending September 30, 2013, two new loans became impaired resulting in an additional provision for loan losses of $84 thousand.

Other real estate owned, which is measured at fair value less costs to sell, had a net carrying amount of $1.1 million, which is made up of the outstanding balance of $2.6 million, net of a valuation allowance of $1.5 million at September 30, 2014.  The Company recorded $64 thousand in write-downs of other real estate owned properties for the nine months ending September 30, 2014 and $54 thousand for the three month period ending September 30, 2014.  The Company recorded a net recovery of prior write-downs totaling $79 thousand for the nine months ending September 30, 2013 and a net recovery of $69 thousand for the three months ending September 30, 2013.

Loan servicing rights, which are carried at the lower of cost or fair value, were carried at their fair value of $325 thousand, which is made up of the outstanding balance of $387 thousand, net of a valuation allowance of $62 thousand at September 30, 2014.  The Bank recorded net write-downs of $3 thousand for the nine months ending September 30, 2014 and a recovery of prior write-downs totaling $9 thousand for the three months ending September 30, 2014.  At December 31, 2013, loan servicing rights were carried at their fair value of $201 thousand, which is made up of the outstanding balance of $260 thousand, net of a valuation allowance of $59 thousand.

The following table presents quantitative information about level 3 fair value measurements for financial instruments measured at fair value on a non-recurring basis at September 30, 2014 and December 31, 2013:

September 30, 2014

				Range
	Fair	Valuation	Unobservable	(Weighted
(In thousands)	Value	Technique(s)	Input(s)	Average)
Impaired loans
Real estate mortgage:
1-4 family residential	683	sales comparison	adjustment for differences between the comparable sales	1%-24% (10%)
Multi-family residential	169	income approach	capitalization rate	10%-10% (10%)
Non-farm & non-residential	1,241	income approach		10%-10% (10%)
Agricultural:	89	sales comparison	adjustment for differences between the comparable sales	5%-44% (40%)
Other real estate owned:
Residential	1,126	sales comparison	adjustment for differences between the comparable sales	0%-32% (7%)
		income approach	capitalization rate	8%-8% (8%)
Loan Servicing Rights	325	discounted cash flow	constant prepayment rates	8%-21% (11%)

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December 31, 2013

				Range
	Fair	Valuation	Unobservable	(Weighted
(In thousands)	Value	Technique(s)	Input(s)	Average)
Impaired loans
Real estate mortgage:
1-4 family residential	1,420	sales comparison	adjustment for differences between the comparable sales	0%-99% (14%)
Multi-family residential	199	sales comparison	adjustment for differences between the comparable sales	12%-32% (22%)
Non-farm & non-residential	36	sales comparison	adjustment for differences between the comparable sales	0%-61% (31%)
Agricultural	275	sales comparison	adjustment for differences between the comparable sales	5%-44% (20%)
Other real estate owned:
Residential	1,361	sales comparison	adjustment for differences between the comparable sales	0%-33% (4%)
		income approach	capitalization rate	8%-8%
				(8%)
Loan Servicing Rights	201	discounted cash flow	constant prepayment rates	7%-23% (10%)

Fair Value of Financial Instruments

The carrying amounts and estimated fair values of financial instruments, at September 30, 2014 and December 31, 2013 are as follows:

September 30, 2014:

	Carrying
(in thousands)	Value		Level 1		Level 2		Level 3		Total
Financial assets
Cash and cash equivalents	$	17,242	$	17,242	$	—	$	—	$	17,242
Securities	214,143		293		213,850		—		214,143
Trading Assets	5,325		5,325		—				5,325
Mortgage loans held for sale	754		—		759		—		759
Loans, net	505,288		—		—		504,962		504,962
FHLB Stock	5,981		—		—		—		N/A
Interest receivable	3,519		—		1,280		2,239		3,519
Financial liabilities
Deposits	$	588,318	$	412,662	$	178,130	$	—	$	590,792
Securities sold under agreements to repurchase and other borrowings	11,289		—		11,454		—		11,454
Federal Funds Purchased	2,776		2,776		—		—		2,776
FHLB advances	100,437		—		94,584		—		94,584
Subordinated Debentures	7,217		—		—		7,211		7,211
Interest payable	657		—		648		9		657

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December 31, 2013:

	Carrying
(in thousands)	Value		Level 1		Level 2		Level 3		Total
Financial assets
Cash and cash equivalents	$	23,160	$	23,160	$	—	$	—	$	23,160
Securities	230,396		289		230,107		—		230,396
Mortgage loans held for sale	223		—		229		—		229
Loans, net	463,214		—		—		459,796		459,796
FHLB Stock	6,731		—		—		—		N/A
Interest receivable	3,618		—		1,315		2,303		3,618
Financial liabilities
Deposits	$	617,400	$	428,239	$	191,523	$	—	$	619,762
Securities sold under agreements to repurchase and other borrowings	12,867		—		13,013		—		13,013
FHLB advances	57,847		—		52,220		—		52,220
Subordinated Debentures	7,217		—		—		7,217		7,217
Interest Payable	736				727		9		736

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

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

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

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

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

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

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

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

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

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

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

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

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

9.  CHANGES IN ACCUMULATED OTHER COMPREHENSIVE INCOME BY COMPONENT

Changes in Accumulated Other Comprehensive Income by Component (1)  (unaudited) (in thousands)

	Unrealized
	Gains and Losses on
	Available for Sale
	Securities
	For the Nine Months Ending September 30
	2014			2013
Beginning Balance	$	(5,126	)	$	4,283
Unrealized holding gains (losses) for the period, net of tax	5,419			(7,020		)
Reclassification adjustment for:
Securities gains realized in income	(514		)	(774		)
Income taxes	(175		)	(263		)
Securities gains realized in income, net	(339		)	(511		)
Net current period other comprehensive income	5,080			(7,531		)
Ending balance	$	(46	)	$	(3,248	)

34

	Unrealized
	Gains and Losses on
	Available for Sale
	Securities
	For the Three Months Ending September 30
	2014			2013
Beginning Balance	$	(145	)	$	(1,693	)
Unrealized holding gains (losses) for the period, net of tax	152			(1,555		)
Reclassification adjustment for:
Securities gains realized in income	(81		)	—
Income taxes	(28		)	—
Securities gains realized in income, net	(53		)	—
Net current period other comprehensive income	99			(1,555		)
Ending balance	$	(46	)	$	(3,248	)

The following is significant amounts reclassified out of each component of accumulated other comprehensive Income (Loss) for the nine months ending September 30, 2014 and 2013:

September 30, 2014

Details about	Amount			Affected Line Item
Accumulated Other	Reclassified From			in the Statement
Comprehensive	Accumulated Other			Where Net
Income Components	Comprehensive Income			Income is Presented
Unrealized gains and losses on available-for-sale securities	$	(514	)	Securities gains, net
	175			Provision for income taxes
	(339		)	Net of tax
September 30, 2013
Details about	Amount			Affected Line Item
Accumulated Other	Reclassified From			in the Statement
Comprehensive	Accumulated Other			Where Net
Income Components	Comprehensive Income			Income is Presented
Unrealized gains and losses on available-for-sale securities	$	(774	)	Securities gains, net
	263			Provision for income taxes
	(511		)	Net of tax

35

The following is significant amounts reclassified out of each component of accumulated other comprehensive Income (Loss) for the three months ending September 30, 2014 and 2013:

September 30, 2014

Details about	Amount			Affected Line Item
Accumulated Other	Reclassified From			in the Statement
Comprehensive	Accumulated Other			Where Net
Income Components	Comprehensive Income			Income is Presented
Unrealized gains and losses on available-for-sale securities	$	(81	)	Securities gains, net
	28			Provision for income taxes
	(53		)	Net of tax
September 30, 2013
Details about	Amount			Affected Line Item
Accumulated Other	Reclassified From			in the Statement
Comprehensive	Accumulated Other			Where Net
Income Components	Comprehensive Income			Income is Presented
Unrealized gains and losses on available-for-sale securities	$	—		Securities gains, net
	—			Provision for income taxes
	—			Net of tax

36

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

Forward-Looking Statements

The following discussion provides information about the financial condition and results of operations of the Company and its subsidiaries as of the dates and periods indicated.  This discussion and analysis should be read in conjunction with the unaudited consolidated financial statements and Notes thereto appearing elsewhere in this report and the Management’s Discussion and Analysis in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013.

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

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

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

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

37

Summary

The Company recorded net income of $5.4 million, or $1.99 basic earnings and diluted earnings per share for the first nine months ending September 30, 2014 compared to $4.9 million or $1.80 basic earnings and diluted earnings per share for the nine month period ended September 30, 2013.  The first nine months earnings reflect an increase of 11.0% compared to the same time period in 2013.  The increase in earnings is mostly attributed to an increase of $966 thousand in net interest income, a decrease of $350 thousand in the provision for loan losses, a decrease of $408 thousand in income tax expense, an increase of $196 thousand in gains on trading assets, an increase of $143 thousand in brokerage fee income and an increase of $169 thousand in trust department income. These positive changes to net income during 2014 were partially offset by a decrease of $716 thousand in gains on the sale of mortgage loans, a decrease of $260 thousand in gains on the sale of securities, an increase of $575 thousand in salaries & benefits expense, an increase of $168 thousand in occupancy expense and an increase of $110 thousand in repossession expense.  The earnings for the three months ending September 30, 2014 were $1.7 million or $0.63 basic and diluted earnings per share compared to $1.4 million or $0.51 basic and diluted earnings per share for the three month period ending September 30, 2013.  The earnings for the three month period in 2014 reflect a 25.8% increase compared to the same time period in 2013.  During the second quarter of 2013, the Bank opened a new branch in Lexington, KY.  Additionally, during the first quarter of 2014, the Bank opened a new branch in Richmond, KY.  As expected, additional expenses were incurred with the opening of the two new locations which did affect short-term earnings.  However, management believes these expansions will increase long-term earnings and shareholder equity.

Return on average assets was 0.91% for the nine months ending September 30, 2014 and 0.90% for the nine months ending September 30, 2013.  Return on average assets was 0.85% for the three months ending September 30, 2014 and 0.75% for the three months ending September 30, 2013.  Return on average equity was 9.81% for the nine month period ending September 30, 2014 and 8.96% for the nine month period ending September 30, 2013.  Return on average equity was 9.06% for the three months ending September 30, 2014 and 8.02% for the same time period in 2013.

In January 2014, the Bank invested $5.0 million in trading securities which are shown as trading assets on the balance sheet.  Management made the decision to invest in these assets after much due diligence because it believed the Company could earn a higher return on this investment, compared to other investments, with minimized additional risk due to the short-term attributes of the assets.  The assets are primarily comprised of municipal securities which are held for a very short period of time and generate additional profits primarily by taking gains on short-term differences in price.  At September 30, 2014, trading assets totaled $5.3 million, which represents income on the investment totaling $325 thousand during the first nine months of 2014 and $83 thousand for the three months ending September 30, 2014.

Gross Loans increased $42.3 million from $468.7 million on December 31, 2013 to $511.0 million on September 30, 2014.  The overall increase in loans is attributed to an increase of $1.8 million in 1-4 family residential properties, an increase of $18.1 million in non-farm and non-residential properties, an increase of $7.2 million in agricultural loans, an increase of $12.4 million in multi-family residential properties and an increase of $3.2 million in real estate construction loans.  Commercial loan balances decreased $200 thousand and consumer loan balances decreased $86 thousand.

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Total deposits decreased from $617.4 million on December 31, 2013 to $588.3 million on September 30, 2014, a decrease of $29.1 million.  Non-interest bearing demand deposit accounts increased $9.1 million from December 31, 2013 to September 30, 2014.  Time deposits $100 thousand and over decreased $7.7 million and other interest bearing deposit accounts decreased $30.5 million from December 31, 2013 to September 30, 2014.  Public fund accounts decreased $38.6 million from December 31, 2013 to September 30, 2014.  Public fund accounts typically decrease during the first three quarters of the year and increase during the last quarter of the year due to tax monies collected during the fourth quarter and then withdrawn from the Bank in the following months.

Borrowings from the Federal Home Loan Bank increased $42.6 million from December 31, 2013 to September 30, 2014.

Net Interest Income

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

Net interest income was $19.4 million for the nine months ending September 30, 2014 compared to $18.4 million for the nine months ending September 30, 2013, an increase of 5.3%.  The interest spread, excluding tax equivalent adjustments was 3.44% for the first nine months of 2014 and down from 3.64% reported for the same period in 2013, a decrease of 20 basis points.  Rates have remained fairly low in the past year.  For the first nine months ending September 30, 2014, the cost of total deposits was 0.34% compared to 0.39% for the same time period in 2013.  Increasing non-interest bearing deposit accounts and lowering rates on certificates of deposit accounts have helped to lower the cost of deposits.  Net interest income was $6.5 million for the three months ending September 30, 2014 compared to $6.2 million for the three months ending September 30, 2013, an increase of 4.7%.  The interest spread, excluding tax equivalent adjustments, was 3.48% for the three month period ending September 30, 2014 compared to 3.60% for the three month period in 2013, a decrease of 12 basis points.

For the first nine months, the yield on assets decreased from 4.17% in 2013 to 3.98% in 2014, excluding tax equivalent adjustments.  The yield on loans decreased 35 basis points in the first nine months of 2014 compared to 2013 from 5.22% to 4.87%.  The yield on securities increased 6 basis points in the first nine months of 2014 compared to 2013 from 2.33% in 2013 to 2.39% in 2014.  The cost of liabilities was 0.53% for the first nine months in 2014 compared to 0.52% in 2013.  Year to date average loans, excluding overdrafts, increased $49.0 million, or 11.2% from September 30, 2013 to September 30, 2014.  Loan interest income increased $663 thousand for the first nine months of 2014 compared to the first nine months of 2013.  Year to date average total deposits increased from September 30, 2013 to September 30, 2014, up $23.2 million or 3.9%.  Year to date average interest bearing deposits increased $9.9 million, or 2.2%, from September 30, 2013 to September 30, 2014.  Deposit interest expense decreased $168 thousand for the first nine months of 2014 compared to the same period in 2013.  Year to date average borrowings increased $45.3 million, or 102.3% from September 30, 2013 to September 30, 2014.  Interest expense on borrowed funds increased $474 thousand for the first nine months of 2014 compared to the same period in 2013.

39

The volume rate analysis for the nine months ending September 30, 2014 indicates that $2.3 million of the increase in interest income is attributable to an increase in loan volume and $429 thousand of the increase in interest income is attributable to an increase in the volume of our security portfolio.  Further, a decrease in loan rates caused a decrease of $1.6 million to interest income while an increase in rates in our security portfolio contributed an increase of $203 thousand to interest income.  The net effect to interest income was an increase of $1.3 million for the first nine months of 2014 compared to the same time period in 2013.  The average rate of the Company’s total outstanding deposits and borrowings slightly increased from 0.52% in 2013 to 0.53% in 2014.  Based on the following volume rate analysis, the lower level of interest rates contributed to a decrease of $484 thousand in interest expense, while the change in volume in deposits and borrowings was responsible for a $790 thousand increase in interest expense.  As a result, the increase in net interest income for the first nine months in 2014 is mostly attributed to growth in the Company’s loan and security portfolios.

The accompanying analysis of changes in net interest income in the following table shows the relationships of the volume and rate portions of these changes in 2014.  Changes in interest income and expenses due to both rate and volume are allocated on a pro rata basis.

Changes in Interest Income and Expense

(in thousands)

	Nine Months Ending
	2014 vs. 2013
	Increase (Decrease) Due to Change in
	Volume			Rate			Net Change
INTEREST INCOME
Loans	$	2,306		$	(1,643	)	$	663
Investment Securities	429			203			632
Other	(23		)	—			(23		)
Total Interest Income	2,712			(1,440		)	1,272
INTEREST EXPENSE
Deposits
Demand	15			(60		)	(45		)
Savings	25			(25		)	—
Negotiable Certificates of
Deposit and Other
Time Deposits	(40		)	(83		)	(123		)
Securities sold under agreements to repurchase and other borrowings	34			(20		)	14
Federal Home Loan
Bank advances	756			(296		)	460
Total Interest Expense	790			(484		)	306
Net Interest Income	$	1,922		$	(956	)	$	966

40

Non-Interest Income

Non-interest income decreased $345 thousand for the nine months ending September 30, 2014, compared to the same period in 2013, to $7.4 million.  For the three month period ending September 30, 2014 compared to the three months ending September 30, 2013, total non-interest income increased $148 thousand.

The decrease for the nine month period ending September 30, 2014 was primarily due to a decrease of $716 thousand in gains on the sale of mortgage loans and a decrease of $260 thousand in gains on the sale of securities.  Favorable variances to non-interest income included an increase of $196 thousand in gains on trading assets, an increase of $143 thousand in brokerage fee income and an increase of $169 thousand in fee income generated by the trust department.

The gain on the sale of mortgage loans decreased from $1.4 million in the first nine months of 2013 to $715 thousand during the first nine months of 2014, a decrease of $716 thousand.  For the three months ending September 30, 2014 compared to the same time period in 2013, the gain on the sale of mortgage loans increased $26 thousand.  The volume of loans originated to sell during the first nine months of 2014 decreased $19.2 million compared to the same time period in 2013.  For the three months ending September 30, 2014, the volume of loans originated for sale increased $863 thousand compared to the same three months in 2013.  The volume of mortgage loan originations and sales is generally inverse to rate changes.  A change in the mortgage loan rate environment can have a significant impact on the related gain on sale of mortgage loans.  Loan service fee income, net of amortization expense, was $63 thousand for the nine months ending September 30, 2014 compared to $64 thousand for the nine months ending September 30, 2013, a decrease of $1 thousand.  For the three month period ending September 30, 2014, loan service fee income, net of amortization and impairment expense, was $29 thousand compared to $100 thousand for the same time period one year ago.  During the first nine months of 2014, the adjustment to the carrying value of the mortgage servicing right was a negative net amount of $3 thousand, as the fair value of this asset decreased.  Of this, a positive valuation adjustment of $5 thousand was recorded in the first quarter of 2014, a negative valuation adjustment of $17 thousand was recorded during the second quarter of 2014 and a $9 thousand positive adjustment was recorded during the third quarter of 2014.  During the first nine months of 2013, the adjustment to the carrying value of the mortgage servicing right was a positive net amount of $24 thousand, as the fair value of this asset increased.  Of this, a negative valuation adjustment of $73 thousand was recorded in the first quarter of 2013, a positive valuation adjustment of $8 thousand was recorded during the second quarter of 2013 and a positive valuation adjustment of $89 thousand was recorded during the third quarter of 2013.

Non-Interest Expense

Total non-interest expenses increased $845 thousand for the nine month period ending September 30, 2014 compared to the same period in 2013.  For the three month period ending September 30, 2014 compared to the three months ending September 30, 2013, total non-interest expense increased $237 thousand

41

For the comparable nine month periods, salaries and benefits increased $575 thousand, an increase of 5.5%.  The increase is attributed to hiring additional personnel during 2013 and 2014 for expanding into two new markets and normal pay increases at the beginning of 2014.  The number of full time equivalent employees at September 30, 2014 was 215 compared to 218 one year ago.  Although the number of full time equivalent employees decreased as of September 30, 2014 when compared to September 30, 2013, the year to date average number of full time equivalent employees increased in 2014.  Salaries and employee benefits increased $90 thousand, or 2.5%, for the three month period ending September 30, 2014 compared to the same time period in 2013.

Occupancy expenses increased $168 thousand to $2.5 million for the first nine months of 2014 compared to the same time period in 2013.  Rent expense increased $75 thousand due to entering two new markets within the past year and leasing branch facilities in both markets.  Depreciation expense increased $76 thousand during the first nine months ending September 30, 2014 compared to the same time period one year ago.  In addition, computer maintenance expense increased $87 thousand.  Occupancy expenses increased $37 thousand for the three month period ending September 30, 2014 compared to the same time period in 2013.

Legal and professional fees increased $97 thousand for the first nine months ending September 30, 2014 compared to the same time period in 2013.  Legal and professional fees increased $29 thousand for the three month period ending September 30, 2014 compared to the same time period in 2013.  Repossession expenses increased $110 thousand for the first nine months ending September 30, 2014 compared to the same time period in 2013 and increased $122 thousand for the three months ending September 30, 2014 compared to the same three months one year ago.  Repossession expenses are reported net of rental income earned on repossessed properties.  Net repossession expenses were higher in the first nine months of 2014 when compared to the same time period in 2013 due to the Company selling many of the properties which earned income in the form of building rents.  Further, the Company added $1.7 million to other real estate owned properties during the year resulting in increased expenses.  FDIC insurance expense increased $18 thousand for the nine months ending September 30, 2014 compared to the same time period in 2013 and $12 thousand for the three months ending September 30, 2014 compared to the three months ending September 30, 2013.

Income Taxes

The effective tax rate for the nine months ending September 30, 2014 was 11.5% compared to 18.6% in 2013.  The effective tax rate for the three months ending September 30, 2014 was 2.4% compared to 15.0% for the three months ending September 30, 2013.  These effective tax rates are less than the statutory rate as a result of the Company investing in tax-free securities, loans and other investments which generate tax credits for the Company.  Tax-exempt interest income increased $147 thousand for the first nine months of 2014 compared to the first nine months of 2013.  Also, for the first nine months of 2014, the Company had tax credits totaling $416 thousand for investments made in low income housing projects which represented an increase of $282 thousand compared to similar tax credits for the first nine months of 2013.

42

As part of normal business, the Bank typically makes tax free loans to select municipalities in our market and invests in selected tax free securities, primarily in the Commonwealth of Kentucky.  In making these investments, the Company considers the overall impact to managing our net interest margin, credit worthiness of the underlying issuer and the favorable impact on our tax position.  For the nine months ending September 30, 2014, the Company averaged $90.8 million in tax free securities and $16.8 million in tax free loans.  As of September 30, 2014, the weighted average remaining maturity for the tax free securities is 132 months, while the weighted average remaining maturity for the tax free loans is 166 months.

Liquidity and Funding

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

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

Cash and cash equivalents were $17.2 million as of September 30, 2014 compared to $23.2 million at December 31, 2013.  The decrease in cash and cash equivalents is attributed to a decrease of $5.5 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 $214.1 million at September 30, 2014 compared to $230.4 million at December 31, 2013.  Securities classified as trading assets totaled $5.3 million at September 30, 2014 and $0 at December 31, 2013.

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

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

For the first nine months of 2014, deposits decreased $29.1 million. The Company’s investment portfolio decreased $16.3 million and the Company’s loan portfolio increased $42.3 million.  The Company’s borrowed funds from the Federal Home Loan Bank increased $42.6 million from December 31, 2013 to September 30, 2014.  The Company had outstanding federal funds purchased totaling $2.8 million at September 30, 2014 and $0 at December 31, 2013.

43

Management is aware of the challenge of funding sustained loan growth.  Therefore, in addition to deposits, other sources of funds, such as Federal Home Loan Bank advances, may be used.  We rely on Federal Home Loan Bank advances for both liquidity and asset/liability management purposes.  These advances are used primarily to fund long-term fixed rate residential mortgage loans.  As of September 30, 2014, we have sufficient collateral to borrow an additional $59 million from the Federal Home Loan Bank.  In addition, as of September 30, 2014, $28 million is available in overnight borrowing through various correspondent banks and the Company has access to $255 million in brokered deposits.  In light of this, management believes there is sufficient liquidity to meet all reasonable borrower, depositor and creditor needs in the present economic environment.

Capital Requirements

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

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

Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (set forth in the following table) of Total and Tier I capital (as defined in the applicable banking regulations) to risk-weighted assets (as defined), and of Tier I capital to average assets (as defined).  Management believes, as of September 30, 2014 and December 31, 2013, that the Company and the Bank meet all capital adequacy requirements to which they are subject.

44

The most recent notification from the FDIC categorized the Bank as well capitalized under the regulatory framework for prompt corrective action.  To be categorized as well capitalized, the Bank must maintain minimum Total risk-based, Tier I risk-based and Tier I leverage ratios as set forth in the following table.  There are no conditions or events since that notification that management believes have changed the institution’s category. In July 2013, the FDIC and the other federal bank regulatory agencies issued a final rule that will revise their leverage and risk-based capital requirements and the method of calculating risk-weighted assets to make them consistent with agreements that were reached by the Basel Committee on Banking Supervision and certain provisions of the Dodd-Frank Act. Among other things, the rule establishes a new common equity Tier 1 minimum capital requirement (4.5% of risk-weighted assets), increases the minimum Tier 1 capital to risk-based assets requirement (from 4% to 6% of risk-weighted assets) and assigns a higher risk weight (150%) to exposures that are more than 90 days past due or are on nonaccrual status and to certain commercial real estate facilities that finance the acquisition, development or construction of real property. The final rule also requires unrealized gains and losses on certain “available-for-sale” securities holdings to be included for purposes of calculating regulatory capital requirement unless a one-time opt-in or opt-out is exercised. The rule limits a banking organization’s capital distributions and certain discretionary bonus payments if the banking organization does not hold a “capital conservation buffer” consisting of 2.5% of common equity Tier 1 capital to risk-weighted assets in addition to the amount necessary to meet its minimum risk-based capital requirements. The final rule becomes effective for the Bank on January 1, 2015.  In accordance with the final rule, the capital conservation buffer requirement will be phased in beginning January 1, 2016 and ending January 1, 2019, when the full capital conservation buffer requirement will be effective.

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

									To Be Well
									Capitalized
									Under Prompt
					For Capital				Corrective
	Actual				Adequacy		Purposes		Action		Provisions
	Amount		Ratio		Amount		Ratio		Amount		Ratio
	(Dollars in Thousands)
September 30, 2014
Consolidated
Total Capital (to Risk-Weighted Assets)	$	75,681	13.9	%	$	43,693	8	%	$	N/A	N/A
Tier I Capital (to Risk-Weighted Assets)	69,890		12.8		21,846		4		N/A		N/A
Tier I Capital (to Average Assets)	69,890		9.0		31,086		4		N/A		N/A
Bank Only
Total Capital (to Risk-Weighted Assets)	$	73,630	13.5	%	$	43,681	8	%	$	54,602	10	%
Tier I Capital (to Risk-Weighted Assets)	67,839		12.4		21,841		4		32,761		6
Tier I Capital (to Average Assets)	67,839		8.8		31,043		4		38,803		5
December 31, 2013
Consolidated
Total Capital (to Risk-Weighted Assets)	$	71,993	14.1	%	$	40,872	8	%	N/A		N/A
Tier I Capital (to Risk-Weighted Assets)	66,468		13.0		20,436		4		N/A		N/A
Tier I Capital (to Average Assets)	66,468		8.8		30,079		4		N/A		N/A
Bank Only
Total Capital (to Risk-Weighted Assets)	$	70,827	13.9	%	$	40,859	8	%	$	51,073	10	%
Tier I Capital (to Risk-Weighted Assets)	65,302		12.8		20,429		4		30,644		6
Tier I Capital (to Average Assets)	65,302		8.7		30,070		4		37,588		5

45

Non-Performing Assets

As of September 30, 2014, our non-performing assets totaled $14.4 million or 1.81% of assets compared to $13.8 million or 1.79% of assets at December 31, 2013 (See table below.)  The Company experienced an increase of $356 thousand in non-accrual loans from December 31, 2013 to September 30, 2014.  As of September 30, 2014, non-accrual loans include $1.5 million in loans secured by 1-4 family properties, $988 thousand in loans secured by non-farm and non-residential properties, $382 thousand in commercial loans, $85 thousand in loans secured by multi-family residential properties and $260 thousand in loans secured by multi-family properties and $146 thousand in loans secured by farmland.  Real estate loans composed 88.4% of the non-performing loans as of September 30, 2014 and 99.8% as of December 31, 2013.  Forgone interest income on non-accrual loans totaled $108 thousand for the first nine months of 2014 compared to forgone interest of $214 thousand for the same time period in 2013.  Accruing loans that are contractually 90 days or more past due as of September 30, 2014 totaled $835 thousand compared to $554 thousand at December 31, 2013, an increase of $281 thousand.  The total nonperforming and restructured loans increased $591 thousand from December 31, 2013 to September 30, 2014.  However, due to the recent loan growth the Company has experienced, the ratio of nonperforming and restructured loans to loans decreased 6 basis points to 2.16%.  In addition, the amount the Company has recorded as other real estate owned decreased $31 thousand from December 31, 2013 to September 30, 2014.  As of September 30, 2014, the amount recorded as other real estate owned totaled $3.3 million compared to $3.4 million at December 31, 2013.  During the first nine months of 2014, $1.7 million was added to other real estate properties while $1.6 million in other real estate properties were sold.  The allowance as a percentage of non-performing and restructured loans and other real estate owned increased from 39% at December 31, 2013 to 40% at September 30, 2014.

Nonperforming and Restructured Assets

	9/30/14			12/31/13
	(in thousands)
Non-accrual Loans	$	3,330		$	2,974
Accruing Loans which are Contractually past due 90 days or more	835			554
Accruing Troubled Debt Restructurings	6,855			6,901
Total Nonperforming and Restructured Loans	11,020			10,429
Other Real Estate	3,348			3,379
Total Nonperforming and Restructured Loans and Other Real Estate	$	14,368		$	13,808
Nonperforming and Restructured Loans as a Percentage of Loans	2.16		%	2.22		%
Nonperforming and Restructured Loans and Other Real Estate as a Percentage of Total Assets	1.81		%	1.79		%
Allowance as a Percentage of Period-end Loans	1.12		%	1.16		%
Allowance as a Percentage of Non-performing and Restructured Loans and Other Real Estate	40		%	39		%

46

We maintain a “watch list” of agricultural, commercial, real estate mortgage, and real estate construction loans and review those loans on a regular basis.  Generally, assets are designated as “watch list” loans to ensure more frequent monitoring.  If we determine that there is serious doubt as to performance in accordance with original terms of the contract, then the loan is generally downgraded and often placed on non-accrual status.  We review and evaluate nonaccrual loans, past due loans, and loans graded substandard or worse on a regular basis to determine if the loan should be evaluated for impairment and whether specific allocations are needed.

Provision for Loan Losses

The loan loss provision for the first nine months of 2014 was $500 thousand compared to $850 thousand for the first nine months of 2013.  The loan loss provision was $300 thousand for the three months ending September 30, 2014 compared to $250 thousand for the three months ending September 30, 2013.  The decrease in the total loan loss provision during the first nine months of 2014 compared to the same time period in 2013 is attributed to improved quality of the Bank’s loan portfolio and having a significant recovery of $367 thousand during the first quarter of 2014 for a loan that was charged off in a prior year.

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 $591 thousand since December 31, 2013 to $11.0 million as of September 30, 2014.  Other real estate properties owned decreased $31 thousand over this same time period.  Additions to Other real estate properties totaled $1.7 million while sales totaled $1.6 million and negative valuation adjustments totaled $64 thousand.

The September 30, 2014 unallocated allowance of $512 was comparable to the December 31, 2013 balance of $516 thousand.

Net charge-offs were $235 thousand for the nine months ending September 30, 2014 and $1.4 million for the nine months ending September 30, 2013.  Net charge-offs were $208 thousand for the three months ending September 30, 2014 and $246 thousand for the three months ending September 30, 2013.  During the first quarter of 2014, the Company recorded a recovery of $367 for one loan which was previously charged-off.  Future levels of charge-offs will be determined by the particular facts and circumstances surrounding individual loans.  Further, the growth the Company has experienced in our loan portfolio is attributed to passing grade loans which require fewer reserves as of September 30, 2014.  Based on the above information, management believes the current loan loss allowance is sufficient to meet probable incurred loan losses.

47

Loan Losses

	Nine Months Ended September 30
	(in thousands)
	2014			2013
Balance at Beginning of Period	$	5,441		$	6,047
Amounts Charged-off:
Commercial	200			12
Real Estate Construction	—			578
1-4 family residential	179			186
Multi-family residential	42			161
Non-farm & non-residential	—			99
Agricultural	18			109
Consumer and other	599			811
Total Charged-off Loans	1,038			1,956
Recoveries on Amounts Previously Charged-off:
Commercial	—			28
Real Estate Construction	11			21
1-4 family residential	55			58
Multi-family residential	—			103
Non-farm & non-residential	367			18
Agricultural	27			22
Consumer and other	343			310
Total Recoveries	803			560
Net Charge-offs	235			1,396
Provision for Loan Losses	500			850
Balance at End of Period	5,706			5,501
Loans
Average	487,991			439,317
At September 30	510,994			465,128
As a Percentage of Average Loans:
Net Charge-offs for the period	0.05		%	0.32		%
Provision for Loan Losses for the period	0.10		%	0.19		%
Allowance as a Multiple of Net Charge-offs annualized	18.2			3.0

48

Loan Losses

	Three Months Ended September 30
	(in thousands)
	2014			2013
Balance at Beginning of Period	$	5,614		$	5,497
Amounts Charged-off:
Commercial	—			—
Real Estate Construction	—			—
1-4 family residential	91			45
Multi-family residential	42			—
Non-farm & non-residential	—			99
Agricultural	18			23
Consumer and other	244			250
Total Charged-off Loans	395			417
Recoveries on Amounts Previously Charged-off:
Commercial	—			—
Real Estate Construction	3			—
1-4 family residential	39			2
Multi-family residential	—			64
Non-farm & non-residential	—			—
Agricultural	2			19
Consumer and other	143			86
Total Recoveries	187			171
Net Charge-offs	208			246
Provision for Loan Losses	300			250
Balance at End of Period	5,706			5,501
Loans
Average	502,859			459,623
At September 30	510,994			465,128
As a Percentage of Average Loans:
Net Charge-offs for the period	0.04		%	0.05		%
Provision for Loan Losses for the period	0.06		%	0.05		%
Allowance as a Multiple of Net Charge-offs annualized	6.9			5.6

Item 3 — QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Asset/Liability management control is designed to ensure safety and  soundness, maintain liquidity and regulatory capital standards, and achieve acceptable net interest income. Management considers interest rate risk to be the most significant market risk since a bank’s net income is largely dependent on net interest income.  Our exposure to market risk is reviewed on a regular basis by the Asset/Liability Committee.  Interest rate risk is the potential of economic losses due to future interest rate changes.  These economic losses can be reflected as a loss of future net interest income and/or a loss of current fair market values.  The objective is to measure the effect on net interest income and to adjust the balance sheet to minimize the inherent risk, while at the same time, maximize income.

Management realizes certain risks are inherent and that the goal is to identify and minimize the risks.  The primary tools used by management are interest rate shock and economic value of equity (EVE) simulations.  The Company has $5.3 million in market risk sensitive instruments which are held for trading purposes.  These assets are held for a very short period of time and are used to generate profits on short-term differences in price.

49

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

The projections are based on balance sheet growth assumptions and repricing opportunities for new, maturing and adjustable rate amounts.  As of September 30, 2014, the projected percentage changes are within limits approved by our Board of Directors (“Board”).  Although management does analyze and monitor the projected percentage change in a declining interest rate environment, due to the current rate environment many of the current deposit rates cannot decline an additional 100 basis points.  Therefore, management places more emphasis in the rising rate environment scenarios.  Similar to prior periods, this period’s volatility is slightly lower in each rate shock simulation when compared to the same period a year ago.  The projected net interest income report summarizing our interest rate sensitivity as of September 30, 2014 is as follows:

PROJECTED NET INTEREST INCOME

(dollars in thousands)

	Level
Change in basis points:	– 100			Rates		+ 100			+ 300
Year One (10/14 – 9/15)
Net interest income	$	25,010		$	25,724	$	26,036		$	26,060
Net interest income dollar change	(715		)	N/A		311			336
Net interest income percentage change	–2.8		%	N/A		1.2		%	1.3		%
Board approved limit	>–4.0		%	N/A		>–4.0		%	>–10.0		%

The projected net interest income report summarizing the Company’s interest rate sensitivity as of September 30, 2013 is as follows:

PROJECTED NET INTEREST INCOME

(dollars in thousands)

	Level
Change in basis points:	– 100			Rates		+ 100			+ 300
Year One (10/13 – 9/14)
Net interest income	$	23,641		$	24,482	$	24,915		$	25,048
Net interest income dollar change	(842		)	N/A		432			566
Net interest income percentage change	–3.4		%	N/A		1.8		%	2.3		%
Board approved limit	>–4.0		%	N/A		>–4.0		%	>–10.0		%

Projections from September 30, 2014, year one reflected a decline in net interest income of 2.8% with a 100 basis point decline compared to the 3.4% decline in 2013.  The 100 basis point increase in rates reflected a 1.2% increase in net interest income in 2014 compared to an increase of 1.8% in 2013.

EVE applies discounting techniques to future cash flows to determine the present value of assets, liabilities, and therefore equity.  Based upon applying these techniques to the September 30, 2014 balance sheet, a 100 basis point increase in rates results in a 9.7% decrease in EVE.  A 100 basis point decrease in rates results in a 1.2% decrease in EVE.  These are within the Board approved limits.

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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.

Part II — Other Information

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

ISSUER PURCHASES OF EQUITY SECURITIES

	(a)			(c) Total Number	(d) Maximum Number
	Total	(b)		of Shares (or Units)	(or Approximate Dollar
	Number of	Average		Purchased as Part	Value) of Shares (or
	Shares (or	Price Paid		of Publicly	Units) that May Yet Be
	Units)	Per Share		Announced Plans	Purchased Under the
Period	Purchased	(or Unit)		Or Programs	Plans or Programs
7/1/14 – 7/31/14	—	$	—	—	83,929 shares
8/1/14 – 8/31/14	—	—		—	83,929 shares
9/1/14 – 9/30/14	—	—		—	83,929 shares
Total	—	$	—	—	83,929 shares

On October 25, 2000, we announced that our Board approved a stock repurchase program and authorized the Company to purchase up to 100,000 shares of its outstanding common stock.  On November 11, 2002, the Board approved and authorized the Company’s repurchase of an additional 100,000 shares.  On May 20, 2008, the Board of Directors approved and authorized the Company to purchase an additional 100,000 shares.  On May 17, 2011, the Board approved and authorized the Company’s repurchase of an additional 100,000 shares.  Shares will be purchased from time to time in the open market depending on market prices and other considerations.  Through September 30, 2014, 316,071 shares have been purchased.

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Item 6.Exhibits

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

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

3.2Bylaws of the Registrant are incorporated by reference to Exhibit 3.1 of the Registrant’s Quarterly Report of Form 10-Q for the quarterly period ending June 30, 2000 and filed August 14, 2000.

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

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

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

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

101*The following financial information from Kentucky Bancshares, Inc. Quarterly Report on Form 10-Q for the period ended September 30, 2014, filed with the SEC on November 13, 2014, formatted in Extensible Business Reporting Language (XBRL):  (i) Consolidated Balance Sheets at September 30, 2014 and December 31, 2013, (ii) Consolidated Statements of Income and Comprehensive Income (Loss) for the nine and three months ended September 30, 2014 and September 30, 2013, (iii) Consolidated Statement of Stockholders’ Equity for the nine months ended September 30, 2014, (iv) Consolidated Statements of Cash Flows for the nine months ended September 30, 2014 and September 30, 2013 and (v) Notes to Consolidated Financial Statements.

*Pursuant to Rule 406T of Regulation S-T, the XBRL related information in Exhibit 101 to this Quarterly Report on Form 10-Q shall not be deemed to be “filed” for purposes of Sections 11 and 12 of the Securities Act of 1933 and Section 18 of the Exchange Act of 1934, or otherwise subject to the liability of those sections, and shall not be deemed part of a registration statement, prospectus or other document filed under the Securities Act of 1933 or the Exchange Act of 1934, except as shall be expressly set forth by specific reference in such filings.

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SIGNATURES

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

		KENTUCKY BANCSHARES, INC.
Date	11/13/14	/s/ Louis Prichard
		Louis Prichard, President and C.E.O.
Date	11/13/14	/s/ Gregory J. Dawson
		Gregory J. Dawson, Chief Financial Officer

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