Kentucky Bancshares 10K 2015 Annual report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

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

For the fiscal year ended December 31, 2015

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

For the transition period from to

Commission File Number: 000-52598

KENTUCKY BANCSHARES, INC.

(Exact name of registrant as specified in its charter)


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

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

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

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

Title of each class		Name on each exchange on which registered
Common Stock, no par value per share		OTC QX

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

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

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

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

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

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

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

Large accelerated filer o		Accelerated filer o
Non-accelerated filer x		Smaller reporting company o

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

Aggregate market value of voting stock held by non-affiliates as of June 30, 2015 was approximately $71.4 million. For purposes of this calculation, it is assumed that the Bank’s Trust Department, directors, executive officers and beneficial owners of more than 5% of the registrant’s outstanding voting stock are affiliates.

Number of shares of Common Stock outstanding as of March 10, 2016: 2,996,727.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Registrant’s definitive Proxy Statement for its Annual Meeting of Stockholders to be held on May 26, 2016 are incorporated by reference into Items 10, 11, 12, 13 and 14 of Part III.

PART I

Item 1. Business

General

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

The Company conducts its business in the Commonwealth of Kentucky through one banking subsidiary, Kentucky Bank, and one non-bank subsidiary KBI Insurance Company.

Kentucky Bank is a commercial bank and trust company organized under the laws of Kentucky. Kentucky Bank has its main office in Paris (Bourbon County), with additional offices in Paris, Cynthiana (Harrison County), Georgetown (Scott County), Lexington (Fayette), Morehead (Rowan County), Nicholasville (Jessamine County), Richmond (Madison County), Sandy Hook (Elliott County), Versailles (Woodford County), Wilmore (Jessamine County) and Winchester (Clark County). The deposits of Kentucky Bank are insured up to prescribed limits by the Deposit Insurance Fund (“DIF”) of the Federal Deposit Insurance Corporation (“FDIC”). KBI Insurance Company is a captive insurance subsidiary and was incorporated in 2014.

The Company had total assets of $974.7 million, total deposits of $759.0 million and stockholders’ equity of $89.4 million as of December 31, 2015. The Company’s principal executive office is located at 339 Main Street, Paris, Kentucky 40361, and the telephone number at that address is (859) 987-1795.

Business Strategy

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

Lending

Kentucky Bank is engaged in general full-service commercial and consumer banking. A significant part of Kentucky Bank’s operating activities include originating loans, approximately 83% of which are secured by real estate at December 31, 2015. Kentucky Bank makes commercial, agricultural and real estate loans to its commercial customers, with emphasis on small-to-medium-sized industrial, service and agricultural businesses. It also makes residential mortgage, installment and other loans to its individual and other non-commercial customers.

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

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

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

Competition and Market Served

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

Market Served. We primarily conduct our business in the Commonwealth of Kentucky. Our primary market areas consist of Bourbon, Clark, Elliott, Fayette, Harrison, Jessamine, Madison, Rowan, Scott, Woodford and surrounding counties in Kentucky. Per capita personal income for Kentucky increased from $37,382 in 2014 to $38,989 in 2015, according to the Bureau of Economic Analysis. The Bureau of Labor Statistics reports that the unemployment rate in Kentucky has slightly increased. The unemployment rate in Kentucky is 5.7% for December of 2015, compared to 5.1% for December of 2014.

Supervision and Regulation

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

FDIC Assessments. The Company’s subsidiary bank is a member of the FDIC, and its deposits are insured by the FDIC’s Deposit Insurance Fund up to the amount permitted by law. The Company’s subsidiary bank is thus subject to FDIC deposit insurance assessments. The FDIC utilizes a risk-based assessment system that imposes insurance premiums based upon a risk matrix that takes into account a bank’s capital level and supervisory rating.

On February 7, 2011, the FDIC amended its regulations to implement revisions to the Federal Deposit Insurance Act made by the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”) by modifying the definition of an institution’s deposit insurance assessment base and to change the assessment rate adjustments.

Under Dodd-Frank, the assessment base must, with some possible exceptions, equal average consolidated total assets minus average tangible equity. Previously, the assessment base was based on deposits. Dodd-Frank also requires the FDIC to adopt a DIF restoration plan to ensure that the reserve ratio increases to 1.35% from 1.15% of insured deposits by 2020.

Financing Corporation (“FICO”) Assessments. FICO assessment costs were $47 thousand in 2015, $44 thousand in 2014 and $41 thousand for 2013. FICO is a mixed-ownership government corporation established by the Competitive Equality Banking Act of 1987 possessing assessment powers in addition to the FDIC. The FDIC acts as a collection agent for FICO, whose sole purpose is to function as a financing vehicle for the now defunct Federal Savings & Loan Insurance Corporation. Outstanding FICO bonds, which are 30-year noncallable bonds, mature in 2017 through 2019.

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

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

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

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

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

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

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

· a permanent increase of FDIC deposit insurance to $250,000;

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

· changes in the calculation of FDIC deposit insurance assessments;

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

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

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

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

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

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

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

Employees

At December 31, 2015, the number of full time equivalent employees of the Company was 243.

Nature of Company’s Business

The business of the Company is not seasonal. The Company’s business does not depend upon a single customer, or a few customers, the loss of any one or more of which would have material adverse effect on the Company.

No material portion of the Company’s business is subject to renegotiation of profits or termination of contracts or subcontracts at the election of any governmental entity.

Available Information

The Company files annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports with the Securities and Exchange Commission (“SEC”) pursuant to section 13(a) or 15(d) of the Securities Exchange Act of 1934.

The public may read and copy any material the Company files with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549 and may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC on its website at www.sec.gov. The Company’s website is located at www.kybank.com.

Item 1A. Risk Factors

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

Industry Risk

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

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

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

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

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

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

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

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

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

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

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

Financial Risk

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

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

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

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

Changes in market multiples may negatively affect the value of Goodwill. Goodwill resulting from business combinations prior to January 1, 2009 represents the excess of the purchase price over the fair value of the net assets of businesses acquired. Goodwill resulting from business combinations after January 1, 2009, is generally determined as the excess of the fair value of the consideration transferred, plus the fair value of any noncontrolling interests in the acquiree, over the fair value of the net assets acquired and liabilities assumed as of the acquisition date. Goodwill and intangible assets acquired in a purchase business combination and determined to have an indefinite useful life are not amortized, but tested for impairment at least annually. The Company has selected December 31 as the date to perform the annual impairment test. Intangible assets with definite useful lives are amortized over their estimated useful lives to their estimated residual values. Goodwill is the only intangible asset with an indefinite life on our balance sheet. At a minimum, management is required to assess goodwill and other intangible assets annually for impairment. This assessment involves estimating cash flows for future periods, preparing analyses of market multiples for similar operations, and estimating the fair value of the reporting unit to which the goodwill is allocated. If these variables change negatively, the Company would be required to take a charge against earnings to write down the asset to the lower fair value.

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

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

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

Business Risk

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

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

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

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

Operational Risk

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

Technology Risk

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

The business continuity of third-party providers may have a negative impact on our technology operations. Kentucky Bank outsources certain of its data processing to third-party providers. If third-party providers encounter difficulties, or if the Bank has difficulty communicating with them, Kentucky Bank’s ability to adequately process and account for customer transactions could be affected, and its business operations could be adversely impacted. Threats to information security also exist in the processing of customer information through various other vendors and their personnel.

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

Item 1B. Unresolved Staff Comments

None.

Item 2. Properties

The Company’s corporate headquarters is located at 339 Main Street, Paris, KY 40361, which it owns. The main banking office of Kentucky Bank is located at 401 Main Street, Paris, Kentucky 40361. In addition, Kentucky Bank serves customer needs at 16 other locations. All locations offer a full range of banking services. Kentucky Bank owns all of the properties at which it conducts its business with the exception of the Lexington and Richmond locations. The Company owns approximately 100,000 square feet of office space and leases approximately 9,800 square feet of office space.

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

Kentucky Bank Banking Offices

Owned

401 Main Street, Paris, KY 40361

2021 South Main Street, Paris, KY 40361

24 West Lexington Avenue, Winchester, KY 40391

1975 By Pass Road, Winchester, KY 40391

144 South KY 7, Sandy Hook, KY 41171

939 US Hwy 27 South, Cynthiana, KY 41031

920 North Main Street, Nicholasville, KY 40356

108 East Main Street, Wilmore, KY 40390

400 West First Street, Morehead, KY 40351

1500 Flemingsburg Road, Morehead, KY 40351

260 Blossom Park Drive, Georgetown, KY 40324

103 West Showalter Drive, Georgetown, KY 40324

520 Marsailles Road, Versailles, KY 40383

Leased

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

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

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

724 West Main Street, Richmond, KY 40475

Item 3. Legal Proceedings

None to report.

PART II

Item 5. Market for Common Equity and Related Stockholder Matters

Market Information

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

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

		High		Low		Dividend

2015	Quarter 4	$	30.19	$	29.54	$	0.26
	Quarter 3	33.00		30.05		0.26
	Quarter 2	32.35		27.75		0.26
	Quarter 1	28.15		27.00		0.26
2014	Quarter 4	$	28.85	$	27.15	$	0.25
	Quarter 3	28.85		26.10		0.25
	Quarter 2	27.50		23.75		0.25
	Quarter 1	24.80		23.90		0.25

Note 16 to the Company’s 2015 Consolidated Financial Statements and Notes included Item 8 contains additional information relating to amounts available to be paid as dividends.

Holders

As of December 31, 2015 the Company had 2,989,205 shares of Common Stock outstanding and approximately 564 holders of record of its Common Stock.

Dividends

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

Purchases of Equity Securities by the Issuer and Affiliates Purchasers

The table below lists issuer purchases of equity securities.

	(a)		(c) Total Number	(d) Maximum Number
	Total	(b)	of Shares (or Units)	(or Approximate Dollar
	Number of	Average	Purchased as Part	Value) of Shares (or
	Shares (or	Price Paid	of Publicly	Units) that May Yet Be
	Units)	Per Share	Announced Plans	Purchased Under the
Period	Purchased	(or Unit)	Or Programs	Plans or Programs

10/1/15 - 10/31/15	—	—	—	82,256 shares

11/1/15 - 11/30/15	—	—	—	82,256 shares

12/1/15 - 12/31/15	—	—	—	82,256 shares

Total	—	—	—	82,256 shares

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

Through December 31, 2015, 317,744 shares have been purchased, with the most recent share repurchase under the Board-approved stock repurchase program having occurred on July 2, 2015.

Securities Authorized for Issuance under Equity Compensation Plans

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

			No. of securities
			remaining available
	Number of securities		for future issuance
	to be issued	Weighted average	under equity
	upon exercise of	exercise price of	compensation plans
	outstanding options,	outstanding options	(excluding securities
Plan category	warrants and rights	warrants and rights	reflected in column 1)

*Plans Approved By Stockholders:*

1993 Nonemployee Directors Stock Ownership Incen- tive Plan	2,400	30.38	—

2009 Stock Award Plan	—	—	147,635

Performance Graph

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

The following graph compares the change in the cumulative total stockholder return on our common stock with the cumulative total return of listed NASDAQ banks and the Russell Microcap Index from 2010 through 2015. This comparison assumes $100 invested on December 31, 2010 in (a) our common stock,(b) NASDAQ Bank and (c) the Russell Microcap Index.

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

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

	At or For the Year Ended December 31
	2015			2014			2013			2012			2011
CONDENSED STATEMENT OF INCOME:
Total Interest Income	$	33,185		$	29,731		$	28,168		$	28,233		$	29,889
Total Interest Expense	4,050			3,756			3,456			3,716			5,565
Net Interest Income	29,135			25,975			24,712			24,517			24,324
Provision for Losses	1,450			950			1,050			2,050			2,450
Net Interest Income After Provision for Losses	27,685			25,025			23,662			22,467			21,874
Noninterest Income	11,484			10,158			10,222			11,870			9,347
Noninterest Expense	31,807			27,215			27,203			25,686			24,615
Income Before Income Tax Expense	7,362			7,968			6,681			8,651			6,606
Income Tax Expense	530			897			859			1,643			919
Net Income	6,832			7,071			5,822			7,008			5,687

SHARE DATA:
Basic Earnings per Share (EPS)	$	2.40		$	2.60		$	2.15		$	2.59		$	2.09
Diluted EPS	2.40			2.60			2.15			2.59			2.09
Cash Dividends Declared	1.04			1.00			0.96			0.92			0.88
Book Value	29.62			28.65			24.90			27.21			25.38
Average Common Shares-Basic	2,823			2,721			2,705			2,705			2,719
Average Common Shares-Diluted	2,823			2,721			2,709			2,708			2,720

SELECTED BALANCE SHEET DATA:
Loans, net	$	617,600		$	532,293		$	463,214		$	423,928		$	406,025
Investment Securities	264,212			246,861			230,396			192,780			180,419
Trading Assets	5,531			5,370			—			—			—
Total Assets	974,684			855,209			770,579			701,010			659,453
Deposits	758,981			654,869			617,400			590,425			542,924
Securities sold under agreements to repurchase	18,514			12,457			12,867			4,315			4,524
Federal Home Loan Bank advances	87,833			93,785			57,847			17,449			30,326
Note Payable	4,794			—			—			—			—
Subordinated Debentures	7,217			7,217			7,217			7,217			7,217
Stockholders’ Equity	89,413			77,942			67,672			74,009			68,953

PERFORMANCE RATIOS:
(Average Balances)
Return on Assets	0.76		%	0.89		%	0.80		%	1.03		%	0.87		%
Return on Stockholders’ Equity	8.20		%	9.50		%	8.12		%	9.70		%	8.74		%
Net Interest Margin (1)	3.63		%	3.69		%	3.85		%	4.19		%	4.35		%
Equity to Assets (annual average)	9.25		%	9.34		%	9.84		%	10.60		%	9.97		%

SELECTED STATISTICAL DATA:
Dividend Payout Ratio	43.2		%	38.48		%	41.53		%	35.71		%	42.24		%
Number of Employees (at period end)	243			215			208			193			194

ALLOWANCE COVERAGE RATIOS:
Allowance to Total Loans	1.04		%	1.12		%	1.16		%	1.41		%	1.42		%
Net Charge-offs as a Percentage of Average Loans	0.16		%	0.08		%	0.37		%	0.44		%	0.38		%

(1) Tax equivalent

Item 7. Management’s Discussion and Analysis

This section presents an analysis of the consolidated financial condition of the Company and its wholly-owned subsidiary, Kentucky Bank, at December 31, 2015, 2014 and 2013, and the consolidated results of operations for each of the years in the three year period ended December 31, 2015. The following discussion and analysis of financial condition and results of operations should be read in conjunction with the 2015 Consolidated Financial Statements and Notes included in Item 8. When necessary, reclassifications have been made to prior years’ data throughout the following discussion and analysis for purposes of comparability with 2015 data.

Critical Accounting Policies

Overview. The accounting and reporting policies of the Company and its subsidiary are in accordance with accounting principles generally accepted in the United States and conform to general practices within the banking industry. Significant accounting policies are listed in Note 1 of the Company’s 2015 Consolidated Financial Statements and Notes included in Item 8. Critical accounting and reporting policies include accounting for loans and the allowance for loan losses, goodwill and fair value. Different assumptions in the application of these policies could result in material changes in the consolidated financial position or consolidated results of operations.

Loan Values and Allowance for Loan Losses. Loans are stated at the amount of unpaid principal, reduced by an allowance for loan losses. Interest on loans is recognized on the accrual basis, except for those loans on the nonaccrual status. Interest income received on such loans is accounted for on the cash basis or cost recovery method. The allowance for loan losses is a valuation allowance for probable incurred credit losses. Management estimates the allowance balance required using past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions, and other factors. The accounting policies relating to the allowance for loan losses involve the use of estimates and require significant judgments to be made by management. The loan portfolio also represents the largest asset group on the consolidated balance sheets. Additional information related to the allowance for loan losses that describes the methodology and risk factors can be found under the captions “Asset Quality” and “Loan Losses” in this management’s discussion and analysis of financial condition and results of operation, as well as Notes 1 and 4 of the Company’s 2015 Consolidated Financial Statements and Notes.

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

Fair Values. Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed in the description of each asset and liability category in Note 17 of the Company’s 2015 Consolidated Financial Statements and Notes. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments, and other factors, especially in the absence of broad markets for particular items. Changes in assumptions or in market conditions could significantly affect the estimates.

Forward-Looking Statements

This discussion contains forward-looking statements under the Private Securities Litigation Reform Act of 1995 that involve risks and uncertainties. Although the Company believes that the assumptions underlying the forward-looking statements contained herein are reasonable, any of the assumptions could be inaccurate, and therefore, there can be no assurance that the forward-looking statements included herein will prove to be accurate. Factors that could cause actual results to differ from the results discussed in the forward-looking statements include, but are not limited to: economic conditions (both generally and more specifically in the markets, including the tobacco market, the thoroughbred horse industry and the automobile industry relating to Toyota vehicles, in which the Company and its bank operate); competition for the Company’s customers from other providers of financial and mortgage services; government legislation, regulation and monetary policy (which changes from time to time and over which the Company has no control); changes in interest rates (both generally and more specifically mortgage interest rates); material unforeseen changes in the liquidity, results of operations, or financial condition of the Company’s customers; and other risks detailed in the Company’s filings with the Securities and Exchange Commission, all of which are difficult to predict and many of which are beyond the control of the Company. The Company undertakes no obligation to republish revised forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.

Overview

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

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

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

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

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

RESULTS OF OPERATIONS

Net Interest Income

Net interest income, the Company’s largest source of revenue, on a tax equivalent basis increased from $26.3 million in 2013 to $27.6 million in 2014, and to $30.7 million in 2015. The taxable equivalent adjustment (nontaxable interest income on state and municipal obligations net of the related non-deductible portion of interest expense) is based on our Federal income tax rate of 34%.

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

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

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

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

The accompanying analysis of changes in net interest income in the following table shows the relationships of the volume and rate portions of these changes in 2015 vs. 2014 and 2014 vs. 2013. Changes in interest income and expenses due to both rate and volume are allocated on a pro rata basis.

Changes in Interest Income and Expense

	(in thousands)
	2015 vs. 2014									2014 vs. 2013
	Increase			(Decrease)			Due to Change in			Increase			(Decrease)			Due to Change in
	Volume			Rate			Net Change			Volume			Rate			Net Change
INTEREST INCOME
Loans	$	3,742		$	(535	)	$	3,207		$	2,491		$	(1,569	)	$	922
Investment Securities	399			(182		)	217			350			123			473
Trading Assets	8			(6		)	2			168			—			168
Federal Funds Sold and Securities Purchased under Agreements to Resell	—			—			—			—			—			—
Deposits with Banks	(3		)	32			29			(10		)	10			—
Total Interest Income	4,146			(691		)	3,455			2,999			(1,436		)	1,563
INTEREST EXPENSE
Deposits
Demand	44			22			66			15			(65		)	(50		)
Savings	11			(16		)	(5		)	13			(19		)	(6		)
Negotiable Certificates of Deposit and Other Time Deposits	77			(152		)	(75		)	(54		)	(134		)	(188		)
Securities sold under agreements to repurchase and other borrowings	103			19			122			32			(17		)	15
Federal Home Loan Bank advances	295			(108		)	187			762			(233		)	529
Total Interest Expense	530			(235		)	295			768			(468		)	300
Net Interest Income	$	3,616		$	(456	)	$	3,160		$	2,231		$	(968	)	$	1,263

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

	2015							2014							2013
	Average					Average		Average					Average		Average					Average
	Balance			Interest		Rate		Balance			Interest		Rate		Balance			Interest		Rate
ASSETS
Interest-Earning Assets
Securities Available for Sale (1)
U.S. Treasury and Federal Agency Securities	$	157,285		$	2,840	1.81	%	$	142,426		$	2,583	1.81	%	$	131,538		$	2,145	1.63	%
State and Municipal obligations	87,147			2,783		3.19	%	85,772			2,835		3.31	%	81,471			2,771		3.40	%
Other Securities	6,968			271		3.89	%	6,364			259		3.89	%	7,001			288		4.11	%
Total Investment Securities	251,400			5,894		2.34	%	234,562			5,677		2.42	%	220,010			5,204		2.38	%
Tax Equivalent Adjustment				1,586		0.63	%				1,620		0.69	%				1,556		0.71	%
Tax Equivalent Total				7,480		2.98	%				7,297		3.11	%				6,760		3.07	%
Trading Assets	5,431			170		3.13	%	5,199			168		3.23	%				—		—
Federal Funds Sold and Agreements to Repurchase	1,042			—		—		327			—		—		290			—		—	%
Interest-Bearing Deposits with Banks	13,609			57		0.52	%	13,359			28		0.23	%	17,238			29		0.17	%
Loans, Net of Deferred Loan Fees (2)
Commercial	60,269			2,577		4.28	%	48,307			2,268		4.69	%	48,877			2,380		4.87	%
Real Estate Mortgage	496,965			23,147		4.66	%	429,773			20,249		4.71	%	378,468			19,191		5.07	%
Installment	16,907			1,340		7.93	%	16,886			1,340		7.94	%	17,244			1,364		7.91	%
Total Loans	574,141			27,064		4.71	%	494,966			23,857		4.82	%	444,589			22,935		5.16	%
Total Interest-Earning Assets	845,623			34,771		4.11	%	748,413			31,350		4.19	%	682,127			29,725		4.36	%
Allowance for Loan Losses	(6,068		)					(5,673		)					(5,838		)
Cash and Due From Banks	16,607							12,274							7,127
Premises and Equipment	16,571							16,700							16,922
Other Assets	28,910							26,414							28,871
Total Assets	$	901,643						$	797,148						$	729,209

LIABILITIES
Interest-Bearing Deposits
Negotiable Order of Withdrawal (“NOW”) and Money Market Investment Accounts	$	225,604		$	434	0.19	%	$	202,185		$	368	0.18	%	$	195,302		$	418	0.21	%
Savings	78,217			78		0.10	%	68,023			83		0.12	%	58,799			89		0.15	%
Certificates of Deposit and Other Deposits	196,409			1,512		0.77	%	187,012			1,587		0.85	%	193,038			1,775		0.92	%
Total Interest-Bearing Deposits	500,230			2,024		0.40	%	457,220			2,038		0.45	%	447,139			2,282		0.51	%
Securities sold under agreements to repurchase and other borrowings	26,418			447		1.69	%	20,264			325		1.60	%	18,340			311		1.70	%
Federal Home Loan Bank advances	90,534			1,579		1.74	%	73,947			1,392		1.88	%	35,435			863		2.44	%
Total Interest-Bearing Liabilities	617,182			4,050		0.66	%	551,431			3,755		0.68	%	500,914			3,456		0.69	%
Noninterest-Bearing Earning Demand Deposits	194,538							164,712							151,127
Other Liabilities	6,197							6,587							5,442
Total Liabilities	817,917							722,730							657,483
STOCKHOLDERS’ EQUITY	83,726							74,418							71,726
Total Liabilities and Stockholders’ Equity	$	901,643						$	797,148						$	729,209
Average Equity to Average Total Assets	9.25		%					9.34		%					9.84		%
Net Interest Income				29,135							25,795							24,713
Net Interest Income (tax equivalent) (3)				30,721							27,595							26,269
Net Interest Spread (tax equivalent) (3)						3.45	%						3.51	%						3.67	%
Net Interest Margin (tax equivalent) (3)						3.63	%						3.69	%						3.85	%

(1) Averages computed at amortized cost.

(2) Includes loans on a nonaccrual status and loans held for sale.

(3) Tax equivalent difference represents the nontaxable interest income on state and municipal securities net of the related non-deductible portion of interest expense.

Noninterest Income and Expenses

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

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

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

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

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

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

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

The largest component of occupancy expense, depreciation, increased $115 thousand to $1.4 million in 2015, and increased $90 thousand to $1.3 million in 2014. Building repairs and maintenance increased $74 thousand during 2015 to $440 thousand and building and equipment rents increased $119 thousand during 2015 to $348 thousand. The increase in rent expense is attributable to the acquisition of Madison Financial Corporation on July 24, 2015. The three branch buildings acquired through the acquisition are all leased. Other noninterest expenses increased from $8.7 million in 2013 to $9.1 million in 2014 and increased to $11.4 million in 2015. One-time expenses incurred during 2015 for the acquisition of Madison Financial Corporation totaled $858 thousand. Debit card & credit card interchange expense increased $282 thousand due to an increase in the number of transactions which also resulted in an increase in interchange income. Advertising and marketing expense increased $176 thousand due to the Company increasing its presence throughout central Kentucky and sponsoring multiple events such as the Breeders Cup and a professional tennis tournament. Losses on foreclosed properties increased $151 thousand in 2015 compared to 2014 due to the Bank recognizing $146 thousand in net gains on sales of other real estate properties during 2014. Committee and director fees increased $92 thousand during 2015 compared to 2014. Amortization of core deposits was $205 thousand in 2015, compared to $140 thousand in 2014. See Note 7 in the Company’s Consolidated Financial Statements and Notes included in Item 8 for more detail of the goodwill and intangible assets.

The following table is a summary of noninterest income and expense for the three-year period indicated.

	For the Year Ended Year Ended December 31
	(in thousands)
	2015			2014			2013
NON-INTEREST INCOME
Service Charges	$	4,408		$	4,240		$	4,325
Loan Service Fee Income (Loss), net	206			66			202
Trust Department Income	1,056			979			746
Investment Securities Gains (Losses),net	412			966			967
Gains on trading assets	(9		)	202			—
Gains on Sale of Mortgage Loans	1,488			951			1,658
Brokerage Income	597			554			351
Debit Card Interchange Income	2,477			2,119			1,947
Other	849			81			26
Total Non-interest Income	$	11,484		$	10,158		$	10,222

NON-INTEREST EXPENSE
Salaries and Employee Benefits	$	16,583		$	14,806		$	15,387
Occupancy Expense	3,781			3,308			3,130
Acquisition Expense	858			—			—
Other	10,585			9,101			8,686
Total Non-interest Expense	$	31,807		$	27,215		$	27,203

Net Non-interest Expense as a Percentage of Average Assets	2.25		%	2.14		%	2.33		%

Income Taxes

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

The Company had income tax expense of $530 thousand in 2015, $897 thousand in 2014 and $859 thousand in 2013. This represents an effective income tax rate of 7.1% in 2015, 11.3% in 2014 and 12.9% in 2013. The difference between the effective tax rate and the statutory federal rate of 34% is primarily due to tax exempt income on certain investment securities and loans. In addition, the Company had additional tax credits which also contributed to the lower effective income tax rate for those years. In 2015, the Company had tax credits totaling $611 thousand for investments made in low income housing projects which represented an increase of $56 thousand compared to similar tax credits in 2014.

Balance Sheet Review

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

Loans

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

As of December 31, 2015, the real estate mortgage portfolio comprised 73% of total loans in 2015 and 72% in 2014. Of this, 1-4 family residential property represented 37% in 2015 and 35% in 2014. Agricultural loans comprised 11% of the loan portfolio in 2015 and 13% in 2014. Approximately 87% of the agricultural loans are secured by real estate in both 2015 and 2014. The remainder of the agricultural portfolio is used to purchase livestock, equipment and other capital improvements and for general operation of the farm. Generally, a secured interest is obtained in the capital assets, equipment, livestock or crops.

Automobile loans account for 22%, both in 2015 and 2014, of the consumer loan portfolio, while the purpose of the remainder of this portfolio is used by customers for purchasing retail goods, home improvement or other personal reasons. The commercial loan portfolio is mainly for capital outlays and business operation.

Collateral is requested depending on the creditworthiness of the borrower. Unsecured loans are made to individuals or companies mainly based on the creditworthiness of the customer. Approximately 5% of the loan portfolio is unsecured. Management is not aware of any significant concentrations that may cause future material risks, which may result in significant problems with future income and capital requirements.

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

	December 31 (in thousands)
Loans Outstanding	2015		2014		2013		2012		2011
Commercial	$	55,929	$	47,185	$	34,654	$	33,137	$	28,892
Real Estate Construction	29,320		16,938		11,177		14,102		13,261
Real Estate Mortgage:
1-4 Family Residential	231,479		190,357		194,718		170,825		161,407
Multi-Family Residential	38,281		34,415		16,420		11,512		13,305
Non-Farm & Non-Residential	183,692		161,822		126,791		113,440		100,047
Agricultural	66,782		71,345		68,002		69,806		77,820
Installment	18,880		16,863		17,065		17,442		17,572
Other	516		279		158		337		324
Total Loans	624,879		539,204		468,985		430,601		412,628
Less Deferred Loan Fees	134		123		107		140		136
Total Loans, Net of Deferred Loan Fees	624,745		539,081		468,985		430,461		412,492
Less loans held for sale	624		776		223		486		625
Less Allowance for Loan Losses	6,521		6,012		5,441		6,047		5,842
Net Loans	$	617,600	$	532,293	$	463,214	$	423,928	$	406,025

The following table sets forth the maturity distribution and interest sensitivity of selected loan categories at December 31, 2015. Maturities are based upon contractual term. The total loans in this report represent loans net of deferred loan fees, including loans held for sale but excluding the allowance for loan losses. In addition, deferred loan fees on the above table are netted with real estate mortgage loans on the following table.

	December 31, 2015 (in thousands)
	One Year		One Through		Over		Total
Loan Maturities and Interest Sensitivity	or Less		Five Years		Five Years		Loans
Commercial	$	18,217	$	24,941	$	12,771	$	55,929
Real Estate Construction	10,658		9,605		9,057		29,320
Real Estate Mortgage:
1-4 Family Residential	90,544		97,519		42,658		230,721
Multi-Family Residential	7,455		17,064		13,762		38,281
Non-Farm & Non-Residential	27,047		89,792		66,853		183,692
Agricultural	20,596		43,158		3,028		66,782
Installment	8,501		10,334		45		18,880
Other	516		—		—		516
Total Loans, Net of Deferred Loan Fees	183,534		292,413		148,174		624,121
Fixed Rate Loans	22,516		74,429		140,211		237,156
Floating Rate Loans	161,018		217,984		7,963		386,965
Total Loans, Net of Deferred Loan Fees	$	183,534	$	292,413	$	148,174	$	624,121

Mortgage Banking

The Company has been in mortgage banking since the early 1980’s. The activity in origination and sale of these loans fluctuates, mainly due to changes in interest rates. Mortgage loan originations decreased from $54 million in 2013 to $37 million in 2014, and increased to $49 million in 2015. Proceeds from the sale of loans were $51 million, $37 million and $55 million for the years 2015, 2014 and 2013, respectively. Mortgage loans held for sale were $624 thousand at December 31, 2015 and $776 thousand at December 31, 2014. Fixed rate residential mortgage loans are generally sold when they are made. The volume of loan originations is inverse to rate changes. Historically low interest rates during 2013 resulted in higher loan originations during that year. During 2013, interest rates began to slightly increase resulting in a decrease in mortgage originations and continuing through 2014. During 2015, declining mortgage rates and an improvement in the housing market resulted in the Bank originating more mortgage loans when compared to 2014 but less than 2013. The effect of these changes was also reflected on the income statement. As a result, the gain on sale of mortgage loans was $1.5 million in 2015 compared to $951 thousand in 2014 and $1.7 million in 2013.

The Bank has sold various loans to the Federal Home Loan Mortgage Corporation (FHLMC) and the Federal Home Loan Bank (FHLB) while retaining the servicing rights. Gains and losses on loan sales are recorded at the time of the cash sale, which represents the premium or discount paid by the FHLMC and FHLB. The Bank receives a servicing fee from the FHLMC and FHLB on each loan sold. Servicing rights are carried using the amortized cost method and are capitalized based on the relative fair value of the rights and the expected life of the loan and are expensed in proportion to, and over the period of, estimated net servicing revenues.

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

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

Deposits

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

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

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

	At December 31, 2015
Maturity of Time Deposits of $100,000 or More	(in thousands)
Maturing 3 Months or Less	$	21,735
Maturing over 3 Months through 6 Months	48,799
Maturing over 6 Months through 12 Months	30,789
Maturing over 12 Months	11,882
Total	$	113,205

Borrowings

The Company utilizes both long and short term borrowings. Long term borrowing at the Bank is mainly from the Federal Home Loan Bank (FHLB). This borrowing is mainly used to fund longer term, fixed rate mortgages, as part of a leverage strategy and to assist in asset/liability management. Advances are either paid monthly or at maturity. As of December 31, 2015, $87.8 million was borrowed from FHLB, a decrease of $6.0 million from December 31, 2014. Throughout 2015, the Bank borrowed $135 million in short-term funds from the FHLB and repaid $145 million for short-term funds. As of December 31, 2015, no short-term borrowings from the FHLB were outstanding. Also, during 2015, the Bank borrowed $14.7 million in longer-term advances and paid down $10.7 million in long term advances from current and prior years. These advances each have an original maturity of more than 1 year.

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

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

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

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

	As of and for the year ended
	December 31 (in thousands)
Short Term Borrowings	2015			2014			2013
Federal Funds Purchased:
Balance at Year end	$	—		$	—		$	—
Average Balance During the Year	373			777			1,313
Maximum Month End Balance	4,300			7,952			12,530
Year end rate	—			—			—
Average annual rate	0.32		%	0.28		%	0.49		%
Repurchase Agreements:
Balance at Year end	$	18,514		$	12,457		$	12,867
Average Balance During the Year	16,596			12,270			9,646
Maximum Month End Balance	19,874			13,788			13,198
Year end rate	0.54		%	0.75		%	0.73		%
Average annual rate	0.59		%	0.76		%	0.68		%
Other Borrowed Funds:
Balance at Year end	$	—		$	10,000		$	—
Average Balance During the Year	—			—			164
Maximum Month End Balance	—			10,000			500
Year end rate	—			0.14		%	0.00		%
Average annual rate	—			0.14		%	3.25		%

Contractual Obligations

The Bank has required future payments for time deposits and long-term debt. The other required payments under such commitments at December 31, 2015 are as follows:

	Payments due by period (in thousands)
			Less						More
			than 1		1-3		3-5		than 5
Contractual Obligations	Total		year		years		years		years

Federal Home Loan Bank advances	$	87,833	$	10,159	$	29,907	$	25,824	$	21,943
Note payable	4,794		302		861		952		2,679
Subordinated debentures	7,217		—		—		—		7,217
Time deposits	201,829		122,188		59,376		20,126		139
Lease payments on premises	2,674		342		607		572		1,153

Asset Quality

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

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

The Company discontinues the accrual of interest on loans that become 90 days past due as to principal or interest unless reasons for delinquency are documented such as the loan being well collateralized and in the process of collection. A loan remains in a non-accrual status until factors indicating doubtful collection no longer exist. A loan is classified as a restructured loan when the interest rate is materially reduced or the term is extended beyond the original maturity date because of the inability of the borrower to service the interest payments at market rates. Other real estate is recorded at fair value less estimated costs to sell. The acquisition of Madison Financial Corporation did not have a material impact on the asset quality of the Company.

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

	At December 31 (in thousands)
Nonperforming Assets	2015			2014			2013			2012			2011
Non-accrual Loans	$	6,351		$	6,577		$	2,974		$	7,024		$	6,017
Accruing Loans which are Contractually past due 90 days or more	1,000			24			554			841			398
Restructured Loans	2,245			6,138			6,901			7,227			1,104
Total Nonperforming Loans	9,596			12,739			10,429			15,092			7,519
Other Real Estate	2,347			4,604			3,379			4,168			8,296
Total Nonperforming Assets	$	11,943		$	17,343		$	13,808		$	19,260		$	15,815
Total Nonperforming Loans as a Percentage of Loans (including loans held for sale) (1)	1.54		%	2.36		%	2.22		%	3.51		%	1.83		%
Total Nonperforming Assets as a Percentage of Total Assets	1.23		%	2.03		%	1.79		%	2.75		%	2.40		%
Allowance As a Percentage of nonperforming assets	55		%	35		%	39		%	31		%	37		%

(1) Net of deferred loan fees

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

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

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

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

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

The allowance for loan losses on impaired loans is determined using one of two methods. Either the present value of estimated future cash flows of the loan, discounted at the loan’s effective interest rate or the fair value of the underlying collateral. The entire change in present value of expected cash flows is reported as a provision for loan losses in the same manner in which impairment initially was recognized or as a reduction in the amount of provision for loan losses that otherwise would be reported. The total allowance for loan losses related to these loans was $648 thousand, $998 thousand and $712 thousand on December 31, 2015, 2014 and 2013, respectively.

Kentucky Bank has a “Problem Loan Committee” that meets at least monthly to review problem loans, including past dues and non-performing loans, and other real estate. When analyzing the problem loans and the loan quality as of December 31, 2015, the following factors have been considered:

·		Changes in lending policies and procedures, including changes in underwriting standards and collection, charge-off and recovery practices not considered elsewhere in estimating credit losses.
·		Change in international, national, regional and local economic and business conditions and developments that affect the collectability of the portfolio, including the condition of various market segments.

·		Changes in the nature and volume of the portfolio and in the terms of loans.
·		Changes in the experience, ability and depth of lending management and other relevant staff.
·		Changes in the volume and severity of past due loans; the volume of non-accrual loans, and the volume and severity of adversely classified or graded loans.
·		Changes in the quality of the Bank’s loan review system.
		Changes in the value of underlying collateral for collateral-dependent loans.
·		The existence and effect of any concentrations of credit, and changes in the level of such concentrations.
·		The effect of other external factors such as competition and legal and regulatory requirements on the level of estimated credit losses in the Bank’s existing portfolio.

Loan Losses

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

	For the Year Ended December 31 (in thousands)
	2015			2014			2013			2012			2011
Balance at Beginning of Year	$	6,012		$	5,441		$	6,047		$	5,842		$	4,925
Amounts Charged-off:
Commercial	30			258			12			21			36
Real Estate Construction	—			—			578			74			143
Real Estate Mortgage:
1-4 Family Residential	284			274			262			1,090			659
Multi-Family Residential	94			42			161			88			178
Non-Farm & Non-Residential	—			—			99			126			333
Agricultural	242			8			109			15			27
Consumer	1,300			758			1,083			921			1,170
Total Charged-off Loans	1,950			1,340			2,304			2,335			2,546
Recoveries on Amounts Previously Charged-off:
Commercial	—			—			28			24			74
Real Estate Construction	11			14			23			19			—
Real Estate Mortgage
1-4 Family Residential	33			59			63			38			15
Multi-Family Residential	30			57			113			1			144
Non-Farm & Non-Residential	86			368			18			1			14
Agricultural	23			27			27			9			15
Consumer	826			436			379			398			751
Total Recoveries	1,009			961			648			490			1,013
Net Charge-offs	941			379			1,656			1,845			1,533
Provision for Loan Losses	1,450			950			1,050			2,050			2,450
Balance at End of Year	6,521			6,012			5,441			6,047			5,842
Total Loans (1)
Average	574,141			494,966			444,589			418,049			408,135
At December 31	624,745			539,081			468,878			429,975			411,866
As a Percentage of Average Loans (1):
Net Charge-offs	0.16		%	0.08		%	0.37		%	0.44		%	0.38		%
Provision for Loan Losses	0.25		%	0.19		%	0.24		%	0.49		%	0.60		%
Allowance as a Percentage of Year-end Loans (1)	1.04		%	1.12		%	1.16		%	1.41		%	1.42		%
Beginning Allowance as a Multiple of Net Charge-offs	6.4			14.4			3.7			3.2			3.2
Ending Allowance as a Multiple of Nonperforming Assets	0.55			0.35			0.39			0.31			0.37

(1) Net of deferred loan fees and includes loans held for sale

Loans are typically charged-off when the collection of principal is considered doubtful, and would be well documented and approved by the appropriate responsible party or committee. The provision for loan losses for 2015 was $1.5 million compared to $950 thousand in 2014 and $1.1 million in 2013. Net charge-offs were $941 thousand in 2015, $379 thousand in 2014 and $1.7 million in 2013. Net charge-offs to average loans were 0.16%, 0.08% and 0.37% in 2015, 2014 and 2013, respectively. The loan loss provision increased $500 thousand from 2014 to 2015 and decreased $100 thousand from 2013 to 2014. The provision for loan losses for 2015 is higher than 2014 and 2013 primarily due to growth in the Banks’ loan portfolio. The allowance for loan losses increased $509 thousand from December 31, 2014 to December 31, 2015.

In evaluating the allowance for loan losses, management considers the composition of the loan portfolio, the historical loan loss experience, the overall quality of the loans and an assessment of current economic conditions. At December 31, 2015, the allowance for loan losses was 1.04% of loans outstanding compared to 1.12% at year-end 2014 and 1.16% at year-end 2013. Management believes the allowance for loan losses at the end of 2015 is adequate to cover probable incurred credit losses within the portfolio.

The following tables set forth an allocation for the allowance for loan losses and loans by category. In making the allocation, management evaluates the risk in each category, current economic conditions and charge-off experience. An allocation for the allowance for loan losses is an estimate of the portion of the allowance that will be used to cover future charge-offs in each loan category, but it does not preclude any portion of the allowance allocated to one type of loan being used to absorb losses of another loan type.

Allowance for Loan Losses (in thousands)	2015		2014		2013		2012		2011

Commercial	$	536	$	410	$	280	$	250	$	342
Real Estate Construction	453		400		358		918		1,008
Real Estate Mortgage:
1-4 Family Residential	2,296		2,145		2,535		2,421		2,258
Multi-family Residential	505		562		327		414		336
Non-farm & Non-residential 1,338	800		664		628		604
Agricultural	748		1,125		678		845		720
Consumer	645		570		599		571		574
Total	6,521		6,012		5,441		6,047		5,842

	2015				2014				2013				2012				2011
Loans (in thousands)	Dollars		Percentage		Dollars		Percentage		Dollars		Percentage		Dollars		Percentage		Dollars		Percentage

Commercial	$	55,929	8.96	%	$	47,185	8.77	%	$	34,654	7.39	%	$	33,137	7.71	%	$	28.892	7.01	%
Real Estate Construction	29,320		4.70	%	16,938		3.15	%	11,177		2.38	%	14,102		3.28	%	13,261		3.22	%
Real Estate Mortgage:
1-4 Family Residential	230,721		36.97	%	189,458		35.20	%	194,388		41.50	%	170,199		39.58	%	160,645		39.01	%
Multi-family Residential	38,281		6.13	%	34,415		6.39	%	16,420		3.50	%	11,512		2.68	%	13,305		3.23	%
Non-farm & Non-residential	183,692		29.43	%	161,822		30.06	%	126,791		27.05	%	113,440		26.38	%	100,047		24.29	%
Agricultural	66,782		10.70	%	71,345		13.25	%	68,002		14.51	%	69,806		16.23	%	77,820		18.89	%
Consumer	18,880		3.03	%	16,863		3.13	%	17,065		3.64	%	17,442		4.06	%	17,572		4.27	%
Other	516		0.08	%	279		0.05	%	158		0.03	%	337		0.08	%	324		0.08	%
Total, Net (1)	624,121		100.00	%	538,305		100.00	%	468,655		100.00	%	429,975		100.00	%	411,866		100.00	%

(1) Net of deferred loan fees

Off-balance Sheet Arrangements

Some financial instruments, such as loan commitments, credit lines, letters of credit, and overdraft protection, are issued to meet customer financing needs. These are agreements to provide credit or to support the credit of others, as long as conditions established in the contract are met, and usually have expiration dates. Commitments may expire without being used. Off-balance sheet risk to credit loss exists up to the face amount of these instruments, although material losses are not anticipated. The same credit policies are used to make such commitments as are used for loans, including obtaining collateral at exercise of the commitment.

Financial instruments with off-balance sheet risk were as follows at year-end (in thousands):

	2015		2014

Unused lines of credit	$	96,581	$	88,741
Commitments to make loans	9,854		6,178
Letters of credit	805		441

Unused lines of credit are substantially all at variable rates. Commitments to make loans are generally made for a period of 60 days or less and are primarily fixed at current market rates ranging from 3.00% to 5.01% with maturities ranging from 2 to 30 years.

Capital

As displayed by the following table, the Company’s Tier I capital (as defined by the Federal Reserve Board under the Board’s risk-based guidelines) at December 31, 2015 increased $10.9 million to $81.8 million from December 31, 2014. Stockholders’ equity, excluding accumulated other comprehensive income, was $89.1 million at December 31, 2015 compared to $77.2 million at December 31, 2014. Increases in stockholders’ equity and Tier I capital during 2015 were mostly a result of acquiring Madison Financial Corporation on July 24, 2015. The Company issued 263,361 shares which increased outstanding stock by $7.9 million, net of issuance costs. Included in Tier I capital is $7 million of trust preferred securities issued in August 2003. The disallowed amount of stockholders’ equity is mainly attributable to the goodwill and core deposit intangible, resulting from the Peoples acquisition in 2006, the Kentucky First acquisition in 2003 and the Madison Financial Corporation acquisition in 2015. The Company’s risk-based capital and leverage ratios, as shown in the following table, exceeded the levels required to be considered “well capitalized”. The leverage ratio compares Tier I capital to total average assets less disallowed amounts of goodwill.

	At December 31 (in thousands)
	2015			2014			Change
Stockholders’ Equity (1)	$	89,054		$	77,151		$	11,903
Trust Preferred Securities	7,000			7,000			—
Less Disallowed Amount	14,205			13,234			971
Tier I Capital	81,849			70,917			10,932
Allowance for Loan Losses	6,596			6,087			509
Other	11			12			(1		)
Tier II Capital	6,607			6,099			508
Total Capital	88,456			77,016			11,440
Total Risk Weighted Assets	$	662,816		$	590,098		$	72,718
Ratios:
Common Equity Tier I Capital to Risk-weighted Assets	11.3		%	n/a			n/a
Tier I Capital to Risk-weighted Assets	12.4		%	12.0		%	0.4		%
Total Capital to Risk-weighted Assets	13.4		%	13.1		%	0.3		%
Leverage	8.6		%	8.7		%	(0.1		)%

(1) Excluding accumulated other comprehensive income/loss.

The Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”) established five capital categories for insured depository institutions under its Prompt Corrective Action Provisions. The bank regulatory agencies adopted regulations, which became effective in 1992, defining these five capital categories for banks they regulate. The categories vary from “well capitalized” to “critically undercapitalized”. A “well capitalized” bank is defined as one with a total risk-based capital ratio of 10% or more, a Tier I risk-based capital ratio of 8% or more, a leverage ratio of 5% or more, and one not subject to any order, written agreement, capital directive, or prompt corrective action directive to meet or maintain a specific capital level. At December 31, 2015, the bank had ratios that exceeded the minimum requirements established for the “well capitalized” 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 became effective for the Bank on January 1, 2015. 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.

In management’s opinion, there are no other known trends, events or uncertainties that will have or that are reasonably likely to have a material effect on the Company’s liquidity, capital resources or operations.

Securities and Federal Funds Sold

Securities, classified as available for sale, increased from $246.9 million at December 31, 2014 to $264.2 million at December 31, 2015. Federal funds sold totaled $1.5 million at December 31, 2015 and $398 thousand at December 31, 2014.

Per Company policy, fixed rate asset backed securities will not have an average life exceeding seven years, but final maturity may be longer. Adjustable rate securities shall adjust within three years per Company policy. As of December 31, 2015 and 2014, the Company held no adjustable rate mortgage backed securities. Unrealized gains (losses) on investment securities are temporary and change inversely with movements in interest rates. In addition, some prepayment risk exists on mortgage-backed securities and prepayments are likely to increase with decreases in interest rates. The following tables present the investment securities for each of the past three years and the maturity and yield characteristics of securities as of December 31, 2015.

Securities Available for Sale and Trading Assets at Fair Value

	At December 31 (in thousands)
Investment Securities (at fair value)	2015		2014		2013

Available for Sale
U.S. government agencies	$	48,863	$	60,586	$	69,286
States and political subdivisions	91,962		89,281		90,183
Mortgage-backed
Fixed -
GNMA, FNMA, FHLMC Passthroughs	42,731		43,072		55,299
GNMA, FNMA, FHLMC CMO’s	80,312		53,626		15,339
Total mortgage backed	123,043		96,698		70,638
Equity Securities	344		296		289
Total	$	264,212	$	246,861	$	230,396

Trading Assets	$	5,531	5,370		—

Maturity Distribution of Securities Available for Sale

	December 31, 2015 (in thousands)
				Over One			Over Five						Asset
				Year			Years			Over			Backed
	One Year			Through			Through			Fifteen			& Equity
	or Less			Five Years			Fifteen Years			Years			Securities			Total

Available for Sale
U.S. government agencies	$	—		$	29,431		$	19,432		$	—		$	—		$	48,863
States and political subdivisions	167			3,820			82,586			5,389			—			91,962
Mortgage-backed	—			—			—			—			123,043			123,043
Equity Securities	—			—			—			—			344			344
Total	167			33,251			102,018			5,389			123,387			264,212
Percent of Total	0.1		%	12.6		%	38.6		%	2.0		%	46.7		%	100.0		%
Weighted Average Yield (1)	2.00		%	1.65		%	3.16		%	4.10		%	2.74		%	2.79		%

(1) Tax Equivalent yield

Trading assets totaling $5.5 million are generally held for a short period of time before being sold.

Impact of Inflation and Changing Prices

The majority of the Company’s assets and liabilities are monetary in nature. Therefore, the Company differs greatly from most commercial and industrial companies that have significant investments in nonmonetary assets and inventories. However, inflation does have an important impact on the growth of assets in the banking industry and the resulting need to increase equity capital at higher than normal rates in order to maintain an appropriate equity to assets ratio. Inflation also affects other expenses, which tend to rise during periods of inflation.

Item 7A. Quantitative and Qualitative Disclosures about Market Risk

Market risk is the risk of loss arising from adverse changes in market prices and rates. Management considers interest rate risk and liquidity risk to be significant market risks to the Company, but considers interest risk to be the most significant.

Kentucky Bank’s Asset/Liability Committee oversees the Company’s interest rate risk and liquidity risks. The Bank has developed procedures designed to ensure safety and soundness, maintain liquidity and regulatory capital standards, and achieve acceptable net interest income. The exposure to market risk is reviewed on a regular basis by the Asset/Liability Committee.

Interest Rate Risk. 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 tool used by management is an interest rate shock simulation model.

Certain assumptions, such as prepayment risks, are included in the model. However, actual prepayments may differ from those assumptions. In addition, immediate withdrawal of interest checking and other savings accounts may have an effect on the results of the model. The Bank has no market risk sensitive instruments held for trading purposes.

The following table depicts the change in net interest income resulting from 100 and 300 basis point changes in rates. The projections are based on balance sheet growth assumptions and repricing opportunities for new, maturing and adjustable rate amounts. In addition, the projected percentage changes from level rates are outlined below along with the Board of Directors approved limits. As of December 31, 2015 the projected net interest income percentages are within the Board of Directors limits. Please note that at in the current low interest rate environment, many rates cannot decline 100 basis points. Therefore, the projected net interest income changes below as of December 31, 2015 for a declining rate environment are not as relevant. The projected net interest income report summarizing the Company’s interest rate sensitivity as of December 31, 2015 and 2014 is as follows:

Projected Net Interest Income (December 31, 2015)

				Level
Rate Change:	—100			Rates		+100			+300

Year One (1/16 - 12/16)
Net interest income	$	31,475		$	32,056	$	31,944		$	31,906

Net interest income dollar change	$	(581	)	$	—	$	(31	)	$	(150	)

Net interest income percentage change	—1.8		%	N/A		—0.1		%	—0.5		%

Limitation on % Change	>-6.0		%	N/A		>-4.0		%	>-10.0		%

Projected Net Interest Income (December 31, 2014)

				Level
Rate Change:	—100			Rates		+100			+300

Year One (1/15 - 12/15)
Net interest income	$	26,674		$	27,318	$	27,386		$	27,336

Net interest income dollar change	$	(643	)	$	—	$	69		$	18

Net interest income percentage change	—2.4		%	N/A		0.3		%	0.7		%

Limitation on % Change	>-6.0		%	N/A		>-4.0		%	>-10.0		%

The numbers in 2015 are comparable to 2014. In 2015, year one reflected a decrease in projected net interest income of 0.1% compared to a 0.3% projected increase from 2014 with a 100 basis point increase. The 300 basis point increase in rates reflected a 0.5% decrease in net interest income in 2015 compared to a 0.7% increase in 2014. The 100 point decrease in rates reflected a 1.8% decrease in net interest income in 2015 compared to a 2.4% decrease in 2014.

Management measures the Company’s interest rate risk by computing estimated changes in net interest income in the event of a range of assumed changes in market interest rates. The Company’s exposure to interest rates is reviewed on a monthly basis by senior management and quarterly with the Board of Directors.

Exposure to interest rate risk is measured with the use of interest rate sensitivity analysis to determine the change in net interest income in the event of hypothetical changes in interest rates, while interest rate sensitivity gap analysis is used to determine the repricing characteristics of the Company’s assets and liabilities. If estimated changes to net interest income are not within the limits established by the Board, the Board may direct management to adjust the Company’s asset and liability mix to bring interest rate risk within Board approved limits.

Liquidity Risk. Liquidity risk is the possibility that the Company may not be able to meet its cash requirements. Management of liquidity risk includes maintenance of adequate cash and sources of cash to fund operations and meet the needs of borrowers, depositors and creditors. Excess liquidity generally has a negative impact on earnings resulting from the lower yields on short-term assets.

In addition to cash and cash equivalents, the securities portfolio provides an important source of liquidity. Total securities maturing within one year along with cash and cash equivalents totaled $30.9 million at December 31, 2015. Additionally, securities available-for-sale with maturities greater than one year totaled $261.4 million at December 31, 2015. The available for sale securities are available to meet liquidity needs on a continuing basis. In addition, trading assets totaled $5.5 million at December 31, 2015.

The Company maintains a relatively stable base of customer deposits and its steady growth is expected to be adequate to meet its funding demands. In addition, management believes the majority of its $100,000 or more certificates of deposit are no more volatile than its core deposits. At December 31, 2015 these balances totaled $113.2 million, approximately 15% of total deposits.

The Company also relies 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. We have sufficient collateral to borrow an additional $72 million from the Federal Home Loan Bank at December 31, 2015. In addition, as of December 31, 2015, $36 million is available in overnight borrowing through various correspondent banks and the Company has access to an additional $317 million in brokered deposits.

Generally, the Company relies upon net cash inflows from financing activities, supplemented by net cash inflows from operating activities, to provide cash used in its 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. The Company’s primary investing activities include purchasing investment securities and loan originations. Management believes there is sufficient cash flow from operations to meet investing and liquidity needs related to reasonable borrower, depositor and creditor needs in the present economic environment.

The cash flow statements for the periods presented provide an indication of the Company’s sources and uses of cash as well as an indication of the ability of the Company to maintain an adequate level of liquidity.

A number of other techniques are used to measure the liquidity position, including the ratios presented below. These ratios are calculated based on annual averages for each year.

	December 31
Liquidity Ratios	2015		2014		2013
Average Loans (including loans held for sale)/Average Deposits	82.6	%	79.6	%	74.3	%
Average Securities sold under agreements to repurchase and other borrowings/Average Assets	2.9	%	2.5	%	2.5	%

The above table shows that the loan to deposit ratio increased both in 2015 and 2014. The increase in the ratio for both 2015 and 2014 is attributed to loan growth exceeding deposit growth.

Item 8. Financial Statements

The management of the Company has the responsibility for preparing the accompanying consolidated financial statements and for their integrity and objectivity. The statements were prepared in accordance with generally accepted accounting principles in the United States of America. The consolidated financial statements include amounts that are based on management’s best estimates and judgments. Management also prepared other information in the annual report and is responsible for its accuracy and consistency with the financial statements.

The Company’s 2015 consolidated financial statements have been audited by Crowe Horwath LLP, an independent registered public accounting firm. Management has made available to Crowe Horwath LLP all financial records and related data, as well as the minutes of Boards of Directors’ meetings. Management believes that all representations made to Crowe Horwath LLP during the audit were valid and appropriate.

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Audit Committee

Kentucky Bancshares, Inc.

Paris, Kentucky

We have audited the accompanying consolidated balance sheets of Kentucky Bancshares, Inc. as of December 31, 2015 and 2014, and the related consolidated statements of income, comprehensive income (loss), changes in stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2015. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2015 and 2014, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2015, in conformity with U.S. generally accepted accounting principles.

	/s/Crowe Horwath LLP
	Crowe Horwath LLP

Louisville, Kentucky
March 30, 2016

KENTUCKY BANCSHARES, INC.

Paris, Kentucky

CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2015, 2014 and 2013

CONSOLIDATED BALANCE SHEETS

December 31

(Dollars in thousands)	2015			2014
ASSETS
Cash and due from banks	$	26,546		$	16,771
Federal funds sold	1,502			398
Cash and cash equivalents	28,048			17,169
Interest bearing time deposits	4,874			1,280
Securities available for sale	264,212			246,861
Trading Assets	5,531			5,370
Mortgage loans held for sale	624			776
Loans	624,121			538,305
Allowance for loan losses	(6,521		)	(6,012		)
Net loans	617,600			532,293

Federal Home Loan Bank stock	7,034			5,981
Real estate owned, net	2,347			4,603
Bank premises and equipment, net	16,597			16,479
Interest receivable	3,681			3,299
Mortgage servicing rights	1,277			1,209
Goodwill	14,001			13,117
Other intangible assets	773			177
Other assets	8,085			6,595

Total assets	$	974,684		$	855,209

LIABILITIES AND STOCKHOLDERS’ EQUITY
Deposits
Non-interest bearing	$	209,289		$	176,743
Time deposits, $250,000 and over	61,199			52,913
Other interest bearing	488,493			425,213
Total deposits	758,981			654,869
Repurchase agreements	18,514			12,457
Short-term Federal Home Loan Bank advances	—			10,000
Long-term Federal Home Loan Bank advances	87,833			83,785
Note payable	4,794			—
Subordinated debentures	7,217			7,217
Interest payable	659			642
Other liabilities	7,273			8,297
Total liabilities	885,271			777,267

Commitments and contingent liabilities	—			—

Stockholders’ equity
Preferred stock, 300,000 shares authorized and unissued	—			—
Common stock, no par value; 10,000,000 shares authorized; 2,989,205 and 2,720,098 shares issued and outstanding in 2015 and 2014	20,730			12,662
Retained earnings	68,324			64,489
Accumulated other comprehensive income	359			791
Total stockholders’ equity	89,413			77,942

Total liabilities and stockholders’ equity	$	974,684		$	855,209

See accompanying notes.

CONSOLIDATED STATEMENTS OF INCOME

Years Ended December 31

(in thousands, except per share data)	2015			2014		2013

Interest income
Loans, including fees	$	27,064		$	23,857	$	22,935
Securities
Taxable	2,951			2,612		2,180
Tax exempt	2,680			2,812		2,742
Trading Assets	170			168		—
Other	320			282		311
	33,185			29,731		28,168
Interest expense
Deposits	2,024			2,038		2,282
Repurchase agreements and other borrowings	100			96		79
Federal Home Loan Bank advances	1,579			1,392		863
Note payable	109			—		—
Subordinated debentures	238			230		232
	4,050			3,756		3,456
Net interest income	29,135			25,975		24,712
Provision for loan losses	1,450			950		1,050
Net interest income after provision for loan losses	27,685			25,025		23,662

Other income
Service charges	4,408			4,240		4,325
Loan service fee income, net	206			66		202
Trust department income	1,056			979		746
Securities gains, net	412			966		968
Gain (loss) on trading assets, net	(9		)	202		—
Gain on sale of mortgage loans	1,488			951		1,658
Brokerage income	597			554		351
Debit card interchange income	2,477			2,119		1,947
Other	849			81		25
	11,484			10,158		10,222
Other expenses
Salaries and employee benefits	16,583			14,806		15,387
Occupancy expense	3,781			3,308		3,130
Repossession expense, net	416			371		267
FDIC insurance	576			535		486
Legal and professional fees	1,050			1,067		840
Data processing	1,427			1,351		1,346
Debit card expenses	1,287			1,005		955
Amortization	205			140		215
Advertising and marketing	1,003			827		825
Taxes other than payroll, property and income	904			851		875
Telephone	317			341		268
Postage	379			321		303
Loan fees	334			346		399
Acquisition expense	858			—		—
Other	2,687			1,946		1,907
	31,807			27,215		27,203
Income before income taxes	7,362			7,968		6,681
Provision for income taxes	530			897		859

Net income	$	6,832		$	7,071	$	5,822
Earnings per share:
Basic	$	2.40		$	2.60	$	2.15
Diluted	2.40			2.60		2.15

See accompanying notes.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Loss)

Years Ended December 31

	2015			2014			2013

Net income	$	6,832		$	7,071		$	5,822

Other comprehensive income (loss)
Unrealized gains (losses) on securities arising during the period	(242		)	9,931			(13,289		)
Reclassification of realized amount	(412		)	(966		)	(967		)
Net change in unrealized gain (loss) on securities	(654		)	8,965			(14,256		)
Less: Tax impact	(222		)	3,048			(4,847		)

Other comprehensive income (loss)	(432		)	5,917			(9,409		)

Comprehensive income (loss)	$	6,400		$	12,988		$	(3,587	)

See accompanying notes.

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

Years Ended December 31, 2015, 2014 and 2013

														Accumulated
														Other			Total
	Common Stock					Preferred Stock					Retained			Comprehensive			Stockholders’
(Dollars in thousands)	Shares		Amount			Shares		Amount			Earnings			Income (Loss)			Equity
Balances, January 1, 2013	2,719,694		$	12,529		—		$	—		$	57,197		$	4,283		$	74,009
Common stock issued including tax benefit, net (including stock grants of 5,615 shares and employee gifts of 49 shares)	6,758		—			—		—			—			—			—
Stock compensation expense	—		82			—		—			—			—			82
Common stock purchased and retired	(9,018	)	(41		)	—		—			(177		)	—			(218		)
Other comprehensive loss	—		—			—		—			—			(9,409		)	(9,409		)
Net income	—		—			—		—			5,822			—			5,822
Dividends declared - $0.96 per share	—		—			—		—			(2,613		)	—			(2,613		)
Balances, December 31, 2013	2,717,434		$	12,570		—		—			$	60,229		$	(5,126	)	$	67,673
Common stock issued including tax benefit, net (including stock grants of 7,475 shares and employee gifts of 74 shares)	7,159		2			—		—			—			—			2
Stock compensation expense	—		111			—		—			—			—			111
Common stock purchased and retired	(4,495	)	(21		)	—		—			(90		)	—			(111		)
Other comprehensive income	—		—			—		—			—			5,917			5,917
Net income	—		—			—		—			7,071			—			7,071
Dividends declared - $1.00 per share	—		—			—		—			(2,721		)	—			(2,721		)
Balances, December 31, 2014	2,720,098		$	12,662		—		—			$	64,489		$	791		$	77,942
Assumption of Madison Financial Corporation preferred stock	—		—			12,047		4,390
Redemption of Madison Financial Corporation preferred stock	—		—			(12,047	)	(4,390		)
Common stock issued including tax benefit, net (including stock grants of 6,955 shares and employee gifts of 34 shares)	6,719		2			—		—			—			—			2
Shares issued to acquire Madison Financial Corporation, net of issuance costs	263,361		7,939			—		—			—			—			7,939
Stock compensation expense	—		133			—		—			—			—			133
Common stock purchased and retired	(973	)	(6		)	—		—			(25		)	—			(31		)
Other comprehensive loss	—		—								—			(432		)	(432		)
Net income	—		—			—		—			6,832			—			6,832
Dividends declared - $1.04 per share	—		—			—		—			(2,972		)	—			(2,972		)
Balances, December 31, 2015	2,989,205		$	20,730		—		$	—		$	68,324		$	359		$	89,413

See accompanying notes.

CONSOLIDATED STATEMENTS OF CASH FLOWS

Years Ended December 31

(in thousands)	2015			2014			2013
Cash flows from operating activities
Net income	$	6,832		$	7,071		$	5,822
Adjustments to reconcile net income to net cash from operating activities:
Depreciation and amortization	1,326			1,830			1,665
Provision for loan losses	1,450			950			1,050
Securities amortization, net	975			638			845
Securities (gains) losses, net	(412		)	(966		)	(968		)
Net change in trading assets	(161		)	(5,370		)	—
Originations of loans held for sale	(48,953		)	(37,043		)	(53,578		)
Proceeds from sale of loans	50,593			37,441			55,499
Gain on sale of mortgage loans	(1,488		)	(951		)	(1,658		)
Stock based compensation expense	133			111			82
Losses (gain) on disposal of fixed assets	(4		)	(2		)	100
Losses (gain) on other real estate	(5		)	(146		)	(43		)
Changes in:
Interest receivable	(73		)	319			329
Write-downs of other real estate, net	252			144			63
Other assets	(1,163		)	1,506			(3,250		)
Interest payable	(42		)	(94		)	126
Deferred taxes	(17		)	3,048			(4,847		)
Other liabilities	(1,186		)	(4,637		)	9,547
Net cash from operating activities	8,057			3,849			10,784
Cash flows from investing activities
Acquisition of Madison Financial Corp.,net	3,514			—			—
Net change in interest bearing time deposits	(615		)	(980		)	—
Purchases of securities, available for sale	(84,479		)	(127,326		)	(141,135		)
Proceeds from sales of securities, available for sale	21,627			73,985			38,089
Proceeds from principal payments and maturities of securities	71,988			46,170			51,296
Net change in loans	(12,211		)	(73,304		)	(40,808		)
Proceeds from redemption of Federal Home Loan Bank Stock	—			749			—
Purchases of bank premises and equipment	(733		)	(1,056		)	(1,494		)
Proceeds from sale of other real estate	5,848			2,053			1,312
Proceeds from sale of bank premises and equipment	7			2			258
Net cash from investing activities	4,946			(79,707		)	(92,482		)
Cash flows from financing activities
Net change in deposits	8,289			37,468			26,976
Net change in repurchase agreements and other borrowings	(188		)	(410		)	9,052
Net change in short-term advances from Federal Home Loan Bank	(10,000		)	10,000			—
Long-term FHLB advances	14,709			38,666			47,660
Payments on long-term FHLB advances	(10,661		)	(12,728		)	(7,262		)
Proceeds from note payable	5,000			—			—
Payments on note payable	(206		)	—			(500		)
Redemption of acquired preferred shares and unpaid dividends and interest	(6,066		)	—			—

Proceeds from issuance of common stock, including options and grants, including tax benefits	2			2			—
Purchase of common stock	(31		)	(111		)	(218		)
Dividends paid	(2,972		)	(2,721		)	(2,613		)
Net cash from financing activities	(2,124		)	70,166			73,095

CONSOLIDATED STATEMENTS OF CASH FLOWS

Years Ended December 31

	2015		2014			2013

Net change in cash and cash equivalents	$	10,879	$	(5,692	)	$	(8,603	)
Cash and cash equivalents at beginning of year	17,169		22,861			31,464

Cash and cash equivalents at end of year	$	28,048	$	17,169		$	22,861

Supplemental disclosures of cash flow information
Cash paid during the year for:
Interest expense	$	4,033	$	3,850		$	3,330
Income taxes	200		1,200			1,475

Supplemental schedules of non-cash investing activities
Real estate acquired through foreclosure	$	3,394	$	3,275		$	472
Issuance of common stock in exchange for net assets in acquisition, net of issuance costs	7,939		—			—

See accompanying notes.

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

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

Nature of Operations: The Bank operates under a state bank charter and provides full banking services, including trust services, to customers located in Bourbon, Clark, Elliot, Fayette, Harrison, Jessamine, Madison, Rowan, Scott, Woodford and adjoining counties in Kentucky. As a state bank, the Bank is subject to regulation by the Kentucky Department of Financial Institutions and the Federal Deposit Insurance Corporation (FDIC). The Company, a bank holding company, is regulated by the Federal Reserve. KBI Insurance Company, Inc., a captive insurance subsidiary, is regulated by the State of Nevada Division of Insurance.

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

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

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

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

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

Management evaluates securities for other-than-temporary impairment (“OTTI”) at least on a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. For securities in an unrealized loss position, management considers the extent and duration of the unrealized loss, and the financial condition and near-term prospects of the issuer. Management also assesses whether it intends to sell, or it is more likely than not that it will be required to sell, a security in an unrealized loss position before recovery of its amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the entire difference between amortized cost and fair value is recognized as impairment through earnings. For debt securities that do not meet the aforementioned criteria, the amount of impairment is split into two components as follows: 1) OTTI related to credit loss, which must be recognized in the income statement and 2) other-than-temporary impairment (OTTI) related to other factors, which is recognized in other comprehensive income. The credit loss is defined as the difference between the present value of the cash flows expected to be collected and the amortized cost basis. For equity securities, the entire amount of impairment is recognized through earnings.

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

Loans: Loans that management has the intent and ability to hold for the foreseeable future or until maturity are stated at the amount of unpaid principal, reduced by an allowance for loan losses. Interest income on loans is recognized on the accrual basis except for those loans on a nonaccrual status. The accrual of interest on impaired loans is discontinued when management believes, after consideration of economic and business conditions and collection efforts, that the borrowers’ financial condition is such that collection of interest is doubtful. Interest income on real estate mortgage (1-4 family residential and multi-family residential) and consumer loans is discontinued at the time the loan is 90 days delinquent, and interest income on real estate construction, non-farm and non-residential mortgage, agricultural and commercial loans is discontinued at the time the loan is 120 days delinquent, unless the loan is well-secured and in process of collection. Past due status is based on the contractual terms of the loan. In all cases, loans are placed on nonaccrual or charged-off at an earlier date if collection of principal or interest is considered doubtful. Nonaccrual loans and loans past due 90 days still on accrual include both smaller balance homogeneous loans that are collectively evaluated for impairment and individually classified impaired loans. Recorded investment is the outstanding loan balance, excluding accrued interest receivable.

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

Loan origination fees and certain direct origination costs are capitalized and recognized as an adjustment of the yield on the related loan.

Loans are charged off when available information confirms that loans, or portions thereof, are uncollectible. While management considers the number of days a loan is past due in its evaluation process, we also consider a variety of other factors. Factors considered by management in evaluating the charge-off decision include collateral value, availability of current financial information for both borrower and guarantor, and the probability of collecting contractual principal and interest payments. These considerations may result in loans being charged off before they are 90 days or more past due. This evaluation framework for determining charge-offs is consistently applied to each segment. Consumer loans are typically charged off no later than 120 days past due. Other types of loans do not have a defined number of days delinquent before they are charged off.

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

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

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

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

Adjustments are made to the historical loss experience ratios based on the qualitative factors as outlined in the regulatory Interagency Policy Statement on the Allowance for Loan and Lease Losses. These qualitative factors include the nature and volume of portfolio, economic and business conditions, classification, past due and non-accrual trends. Management estimates the allowance balance required using past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions, and other factors. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management’s judgment, should be charged off.

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

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

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

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

Commercial and real estate construction and real estate mortgage loans (multi-family residential, and non-farm and non-residential mortgage) over $200 thousand are individually evaluated for impairment. If a loan is impaired, a portion of the allowance is allocated so that the loan is reported, net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral. Large groups of smaller balance homogeneous loans, such as consumer and 1-4 family residential real estate loans, are collectively evaluated for impairment, and accordingly, they are not separately identified for impairment disclosures. Troubled debt restructurings are separately identified for impairment disclosures and are measured at the present value of estimated future cash flows using the loan’s effective rate at inception. If a troubled debt restructuring is considered to be a collateral dependent loan, the loan is reported, net, at the fair value of the collateral. For troubled debt restructurings that subsequently default, the Company determines the amount of reserve in accordance with the accounting policy for the allowance for loan losses.

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

As of December 31, 2015, the allowance for loan losses related to loans collectively evaluated for impairment is $5.9 million. The amount attributable to the recent historical actual net average, adjusted for qualitative factors, is $5.3 million, leaving $609 thousand unallocated attributable to additional qualitative factors. As of December 31, 2014, the allowance for loan losses related to loans collectively evaluated for impairment is $5.0 million. The amount attributable to the recent historical actual net loss average, adjusted for qualitative fatcors, is $4.5 million, leaving $540 thousand unallocated attributable to additional qualitative factors. The unallocated amount related to qualitative factors increased $69 thousand from December 31, 2014 to December 31, 2015.

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

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

Real estate construction: Real estate construction consist of loans secured by real estate for additions or alterations to existing structures, as well as constructing new structures. They include fixed and floating rate loans. Real estate construction loans generally present a higher level of risk than loans secured by 1-4 family residential real estate primarily because of the length of the construction period and the potential change in prices of construction materials.

Real Estate Mortgage:

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

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

Non-farm & non-residential: Loans secured by non-farm non-residential real estate consist of loans secured by commercial real estate that is not owner occupied. These loans generally consist of loans collateralized by property whereby rents received from commercial tenants of the borrower are the source of repayment. These loans generally present a higher level of risk than loans secured by owner occupied commercial real estate because repayment risk is expanded to be dependent on the success of multiple businesses which are paying rent to the borrower. If multiple businesses fail due to deteriorating economic conditions or poor business management skills, the borrower may not have enough rents to cover their monthly payment. Repayment risk is also increased depending on the level of surplus available commercial lease space in the local market area.

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

Consumer: Consumer loans are generally loans to borrowers for non-business purposes. They can be either secured or unsecured. Consumer loans are generally small in the individual amount of principal outstanding and are repaid from the borrower’s private funds earned from employment. Consumer lending risk is very susceptible to local economic trends. If there is a consumer loan default, any collateral that may be repossessed is generally not well maintained and has a diminished value. For this reason, consumer loans tend to have higher overall interest rates to cover the higher cost of repossession and charge-offs. However, due to their smaller average balance per borrower, consumer loans are collectively evaluated for impairment in determining the appropriate allowance for loan losses.

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

Due to the overall high level of real estate mortgage loans within the loan portfolio as a whole, as compared to other portfolio segments, for risk assessment and allowance purposes this segment was segregated into more granular pools by collateral property type. Real estate construction loans have the highest qualitative adjustments for economic and other credit risk factors, such as the incomplete status of the collateral and the effect of the recent economic downturn on these types of properties. The non-farm non-residential and the multi-family real estate mortgage loan portfolio segments had the next highest level of qualitative adjustments due to the effects of local markets and economies on the underlying collateral property values, as well as for industry concentrations and risks related to the this type of property. Within the commercial portfolio, risk analysis is performed primarily based on the individual loan type.

Mortgage Servicing Rights: The Bank has sold certain residential mortgage loans to the Federal Home Loan Mortgage Corporation (FHLMC) while retaining the servicing rights.

Servicing rights are recognized separately when they are acquired through sales of loans. When mortgage loans are sold, servicing rights are initially recorded at fair value with the income statement effect recorded in gain on sale of mortgage loans. Fair value is based on market prices for comparable mortgage servicing contracts, when available, or alternatively, is based on a valuation model that calculates the present value of estimated future net servicing income. The valuation model incorporates assumptions that market participants would use in estimating future net servicing income, such as the cost to service, the discount rate, the custodial earnings rate, an inflation rate, ancillary income, prepayment speeds and default rates and losses. All classes of servicing assets are subsequently measured using the amortization method which requires servicing rights to be amortized into loan service fee income, net, included in non-interest income in proportion to, and over the period of, the estimated future net servicing income of the underlying loans.

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

Servicing fee income, which is reported on the income statement as loan service income, net, is recorded for fees earned for servicing loans. The fees are based on a contractual percentage of the outstanding principal or a fixed amount per loan and are recorded as income when earned. The amortization of mortgage servicing rights and valuation allowance are netted against loan servicing fee income. Servicing fees totaled $470 thousand, $471 thousand, and $456 thousand for the years ended December 31, 2015, 2014 and 2013 and are included in loan service fee income in the income statement. Late fees and ancillary fees related to loan servicing are not material.

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

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

Real Estate Owned: Real estate acquired through foreclosure is initially recorded at fair value less costs to sell when acquired, establishing a new cost basis. These assets are subsequently accounted for at the lower of cost or fair value less estimated costs to sell. The value of the underlying loan is written down to the fair value of the real estate to be acquired by a charge to the allowance for loan losses, if necessary.

Any subsequent write-downs are charged to operating expenses. Operating expenses of such properties, net of related income, and gains and losses on their disposition are included in other expenses.

Investments in Limited Partnerships: Investments in limited partnerships represent the Company’s investments in affordable housing projects for the primary purpose of available tax benefits. The Company is a limited partner in these investments and as such, the Company is not involved in the management or operation of such investments. These investments are accounted for using the equity method of accounting. Under the equity method of accounting, the Company records its share of the partnership’s earnings or losses in its income statement and adjusts the carrying amount of the investments on the balance sheet. These investments are evaluated for impairment when events indicate the carrying amount may not be recoverable. The investment recorded at December 31, 2015 was $4.0 million and $4.2 million at December 31, 2014, respectively, and is included with other assets in the balance sheet.

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

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

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

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

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

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

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

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

Purchased Credit Impaired Loans: As part of the Madison Financial Corporation acquisition, the Company purchased loans, some of which have shown evidence of credit deterioration since origination. These purchased credit impaired loans are recorded at the amount paid, such that there is no carryover of the seller’s allowance for loan losses. After acquisition, losses are recognized by an increase in the allowance for loan losses. Such purchased credit impaired loans are accounted for individually or aggregated into pools of loans based on common risk characteristics such as, credit score, loan type, and date of origination. The Company estimated the amount and timing of expected cash flows for each loan or pool, and the expected cash flows in excess of amount paid is recorded as interest income over the remaining life of the loan or pool (accretable yield). The excess of the loan’s or pool’s contractual principal and interest over expected cash flows is not recorded (non-accretable difference).

Over the life of the loan or pool, expected cash flows continue to be estimated. If the present value of expected cash flows is less than the carrying amount, a loss is recorded as a provision for loan losses. If the present value of expected cash flows is greater than the carrying amount, it is recognized as part of future interest income.

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

Earnings Per Common Share: Basic earnings per common share is net income divided by the weighted average number of common shares outstanding during the period. Diluted earnings per common share include the dilutive effect of additional potential common shares issuable under stock options. Earnings and dividends per share are restated for all stock splits and dividends through the date of issuance of the financial statements.

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

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

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

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

Adoption of New Accounting Standards

In January 2014, FASB issued Accounting Standards Update 2014-04, Receivables—Troubled Debt Restructurings by Creditors (Subtopic 310-40): Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure (a consensus of the FASB Emerging Issues Task Force). The ASU clarifies when an insubstance repossession or foreclosure occurs and a creditor is considered to have received physical possession of real estate property collateralizing a consumer mortgage loan. Specifically, the new ASU requires a creditor to reclassify a collateralized consumer mortgage loan to real estate property upon obtaining legal title to the real estate collateral, or the borrower voluntarily conveying all interest in the real estate property to the lender to satisfy the loan through a deed in lieu of foreclosure or similar legal agreement. Additional disclosures are required detailing the amount of foreclosed residential real estate property held by the creditor and the recorded investment in consumer mortgages collateralized by real estate property that are in the process of foreclosure. The new guidance is effective for annual periods, and interim reporting periods within those annual periods, beginning after December 15, 2014. The adoption of this guidance did not have a material impact on the Company’s consolidated financial statements, but will result in additional disclosures.

In May 2014, FASB issued Accounting Standards Update 2014-09, Revenue from Contracts with Customers (Topic 606). The ASU creates a new topic, Topic 606, to provide guidance on revenue recognition for entities that enter into contracts with customers to transfer goods or services or enter into contracts for the transfer of nonfinancial assets. The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. Additional disclosures are required to provide quantitative and qualitative information regarding the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. The new guidance is effective for annual reporting periods, and interim reporting periods within those annual periods, beginning after December 15, 2016. Early adoption is not permitted. Management is currently evaluating the impact of the adoption of this guidance on the Company’s financial statements. However, in April 2015, the FASB voted to defer the effective date of ASU 2014-09 by one year making the amendments effective for public entities for annual reporting periods beginning after December 15, 2017, including interim periods within those reporting periods. Companies have the option to apply ASU 2014-09 as of the original effective date.

In June 2014, FASB issued Accounting Standards Update 2014-11, Transfers and Servicing (Topic 860): Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures. The amendments in this update require two accounting changes. First, the amendments in this update change the accounting for repurchase-to-maturity transactions to secured borrowing accounting. Second, for repurchase financing arrangements, the amendments require separate accounting for a transfer of a financial asset executed contemporaneously with a repurchase agreement with the same counter-party, which will result in secured borrowing accounting for the repurchase agreement. This update also requires certain disclosures for these types of transactions. This ASU became effective for the Company on January 1, 2015.

The adoption of ASU 2014-11 did not have a material impact on the Company’s financial statements.

2. ACQUISITION OF MADISON FINANCIAL CORPORATION

On July 24, 2015, the Company acquired Madison Financial Corporation and its wholly-owned subsidiary, Madison Bank, both of which were headquartered in Richmond, Kentucky. As a result of the acquisition the Company expanded its presence into central Kentucky with minimal overlap of its existing market footprint and generated long-term value for the Company shareholders. Madison Bank had $116.1 million in total assets and operated three financial centers.

The total purchase price for Madison Financial Corporation was $7.9 million net of capital stock issuance costs, consisting of $3 thousand cash for fractional shares and the issuance of 263,361 shares of the Company’s common stock valued at $7.9 million net of capital stock issuance costs. The acquisition was accounted for under the acquisition method of accounting. Accordingly, the Company recognized amounts for identifiable assets acquired and liabilities assumed at their estimated acquisition date fair values, while approximately $858 thousand of transaction and integration costs associated with the acquisition were expensed as incurred. Of the total purchase price, $884 thousand was allocated to goodwill which is not considered deductible for tax purposes.

Based on management’s preliminary valuation of the fair value of tangible and intangible assets acquired and liabilities assumed, which are based on assumptions that are subject to change, the purchase price for the Madison Financial Corporation acquisition is allocated as follows (in thousands):

Cash and cash equivalents	$	3,517
Interest-bearing deposits in other financial institutions	2,979
Securities available for sale	27,704
Loans	77,729
Federal Home Loan Bank Stock	1,053
Accrued interest receivable	309
Premises and equipment	789
Other real estate	445
Deferred tax assets	624
Core deposit intangible asset	800
Other assets	116

Total assets acquired	$	116,065

Deposits	$	95,823
Other borrowings	6,245
Accrued interest payable	59
Other liabilities	817
Total liabilities assumed	$	102,944

Liquidation amount of preferred stock including unpaid dividends and interest	6,066

Total identifiable net assets	$	7,055

Goodwill	884

	$	7,939

The fair value of net assets acquired includes fair value adjustments to certain loan receivables that were not considered impaired as of the acquisition date. The fair value adjustments were determined using discounted contractual cash flows. However, the Company believes that all contractual cash flows related to these loans will be collected. As such, these loan receivables were not considered impaired at the acquisition date and were not subject to the guidance relating to purchase credit impaired loans, which have shown evidence of credit deterioration since origination. Loan receivables acquired that were not subject to these requirements include non-impaired loans with a fair value and gross contractual amounts receivable of $73.6 million and $74.7 million as of the date of acquisition. The company is still in process of gathering information about the day one fair value of loans acquired and liabilities assumed which are subject to change during the measurement period. Subsequent to the acquisition date, the Company made adjustments to the fair value of loans, deferred tax assets and consideration transferred.

NOTE 3 - RESTRICTIONS ON CASH AND DUE FROM BANKS

Included in cash and due from banks are certain interest bearing deposits that are held at the Federal Reserve or maintained in vault cash in accordance with average balance requirements specified by the Federal Reserve Board of Governors. The reserve requirement was $0 at both December 31, 2015 and 2014.

NOTE 4 - SECURITIES AVAILABLE FOR SALE

The following table summarizes the amortized cost and fair value of the securities at December 31, 2015 and 2014 and the corresponding amounts of gross unrealized gains and losses recognized in accumulated other comprehensive income (loss) were as follows:

			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Losses			Value
2015
U. S. government agencies	$	49,012	$	51	$	(200	)	$	48,863
States and municipals	89,501		2,644		(183		)	91,962
Mortgage-backed - residential	124,834		210		(2,001		)	123,043
Equity securities	320		24		—			344
Total	$	263,667	$	2,929	$	(2,384	)	$	264,212

2014
U. S. government agencies	$	61,721	$	1	$	(1,136	)	$	60,586
States and municipals	86,322		3,234		(275		)	89,281
Mortgage-backed - residential	97,349		267		(918		)	96,698
Equity securities	270		26		—			296
Total	$	245,662	$	3,528	$	(2,329	)	$	246,861

The amortized cost and fair value of securities at December 31, 2015, 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.

	Amortized		Fair
	Cost		Value

Due in one year or less	$	167	$	167
Due after one year through five years	33,435		33,251
Due after five years through ten years	56,908		57,562
Due after ten years	48,003		49,845
	138,513		140,825
Mortgage-backed - residential	124,834		123,043
Equity	320		344

Total	$	263,667	$	264,212

Trading assets totaling $5.5 million are excluded from securities available for sale and consist primarily of municipal securities which are generally held for a minimal period of time.

Proceeds from sales of securities during 2015, 2014 and 2013 were $21.7 million, $74.0 million and $38.1 million. Gross gains of $425 thousand, $1.4 million, $967 thousand and gross losses of $13 thousand, $400 thousand and $0, were realized on those sales, respectively. The tax provision related to these realized gains and losses was $140 thousand, $328 thousand and $329 thousand, respectively.

Securities with an approximate carrying value of $246.2 million and $231.5 million at December 31, 2015 and 2014, were pledged to secure public deposits, trust funds, securities sold under agreements to repurchase and for other purposes as required or permitted by law.

Securities with unrealized losses at year end 2015 and 2014 not recognized in income are as follows:

2015

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

U.S. Government agencies	$	15,243	$	(56	)	$	30,293	$	(144	)	$	45,536	$	(200	)
States and municipals	10,938		(102		)	4,065		(81		)	15,003		(183		)
Mortgage-backed - residential	77,898		(1,231		)	23,488		(770		)	101,386		(2,001		)

Total temporarily impaired	$	104,079	$	(1,389	)	$	57,846	$	(995	)	$	161,925	$	(2,384	)

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	$	12,527	$	(176	)	$	45,067	$	(960	)	$	57,594	$	(1,136	)
States and municipals	5,012		(27		)	9,737		(248		)	14,749		(275		)
Mortgage-backed - residential	46,685		(572		)	18,747		(346		)	65,432		(918		)

Total temporarily impaired	$	64,224	$	(775	)	$	73,551	$	(1,554	)	$	137,775	$	(2,329	)

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, the Company may consider whether the securities are issued by the federal government or its agencies, whether downgrades by bond rating agencies have occurred, and the results of reviews of the issuer’s financial condition.

Unrealized losses on securities have not been recognized into income because the issues are of high credit quality, management does not intend to sell and it is more likely than not that management would be required to sell the securities prior to their anticipated recovery, and the decline in fair value is largely due to changes in interest rates. The fair value is expected to recover as the securities approach maturity.

At December 31, 2015, twenty-one U.S. government agency securities have unrealized losses with aggregate depreciation of 0.4% from their amortized cost, fifty-four mortgage-backed securities have an unrealized loss with depreciation of 1.9% from their amortized cost basis, and twenty four states and municipals have unrealized losses with aggregate depreciation of 1.2% from their amortized cost basis. Management believes the declines in fair value from these and other securities are largely due to changes in interest rates. The Company believes there is no other than temporary impairment and does not have the intent to sell these securities and it is likely that it will not be required to sell the securities before their anticipated recovery.

NOTE 5 - LOANS

Loans at year-end were as follows:

	2015		2014

Commercial	$	55,929	$	47,185
Real estate construction	29,320		16,938
Real estate mortgage:
1-4 family residential	230,721		189,458
Multi-family residential	38,281		34,415
Non-farm & non-residential	183,692		161,822
Agricultural	66,782		71,345
Consumer	18,880		16,863
Other	516		279

	$	624,121	$	538,305

As discussed under Footnote 2 “Acquisition”, the above loan balances include loans purchased in the acquisition of Madison Financial Corporation. All loan balances acquired in the Madison Financial Corporation acquisition have no allocated allowance for loan losses. The composition of loans acquired, as of December 31, 2015, is as follows:

	12/31/2015

Commercial	$	1,505
Real estate construction	1,616
Real estate mortgage:
1-4 family residential	16,376
Multi-family residential	5,652
Non-farm & non-residential	29,029
Agricultural	2,194
Consumer	379
	$	56,751

The following table presents the activity in the allowance for loan losses by portfolio segment for the years ending December 31, 2015, 2014 and 2013 (in thousands):

	Beginning									Ending
December 31, 2015	Balance		Charge-offs		Recoveries		Provision			Balance

Commercial	$	339	$	30	$	—	$	177		$	486
Real estate Construction	446		—		11		(46		)	411
Real estate mortgage:
1-4 family residential	1,829		284		33		503			2,081
Multi-family residential	495		94		30		27			458
Non-farm & non-residential	813		—		86		314			1,213
Agricultural	998		242		23		(101		)	678
Consumer	520		283		66		222			525
Other	32		1,017		760		285			60
Unallocated	540		—		—		69			609
	$	6,012	$	1,950	$	1,009	$	1,450		$	6,521

	Beginning									Ending
December 31, 2014	Balance		Charge-offs		Recoveries		Provision			Balance

Commercial	$	230	$	258	$	—	$	367		$	339
Real estate Construction	358		—		14		74			446
Real estate mortgage:
1-4 family residential	2,169		274		59		(125		)	1,829
Multi-family residential	427		42		57		53			495
Non-farm & non-residential	564		—		368		(119		)	813
Agricultural	578		8		27		401			998
Consumer	548		239		67		144			520
Other	51		519		369		131			32
Unallocated	516		—		—		24			540
	$	5,441	$	1,340	$	961	$	950		$	6,012

	Beginning									Ending
December 31, 2013	Balance		Charge-offs		Recoveries		Provision			Balance

Commercial	$	150	$	12	$	28	$	64		$	230
Real estate Construction	918		578		23		(5		)	358
Real estate mortgage:
1-4 family residential	1,989		262		63		379			2,169
Multi-family residential	414		161		113		61			427
Non-farm & non-residential	628		99		18		17			564
Agricultural	845		109		24		(182		)	578
Consumer	517		460		35		456			548
Other	54		623		344		276			51
Unallocated	532		—		—		(16		)	516
	$	6,047	$	2,304	$	648	$	1,050		$	5,441

Purchased Credit Impaired Loans:

The Company has purchased loans, for which there was, at acquisition, evidence of deterioration of credit quality since origination and it was probable, at acquisition, that all contractually required payments would not be collected. The carrying amount of those loans totaled $3.5 million at December 31, 2015 and $0 at December 31, 2014.

There was no associated allowance for loan losses as of December 31, 2015 or December 31, 2014 for purchased credit impaired loans. The contractual value of these loans was $4.6 million at December 31, 2015.

Accretable yield, or income expected to be collected, is as follows (in thousands):

	Twelve months ended
	12/31/15		12/31/14
Balance, beginning Of period	$	—	$	—
New loans purchased	505		—
Accretion of income	97		—
Balance, end of period	$	408	$	—

The following tables present the balance in the allowance for loan losses and the recorded investment (excluding accrued interest receivable amounting to $2.3 million and $2.0 million) in loans by portfolio segment and based on impairment method as of December 31, 2015 and December 31, 2014 (in thousands):

As of December 31, 2015	Individually Evaluated for Impairment		Collectively Evaluated for Impairment		Purchased Credit Impaired		Total
Allowance for Loan Losses:
Commercial	$	—	$	486	$	—	$	486
Real estate construction	—		411		—		411
Real estate mortgage:
1-4 family residential	128		1,953		—		2,081
Multi-family residential	—		458		—		458
Non-farm & non-residential	181		1,032		—		1,213
Agricultural	339		339				678
Consumer	—		525		—		525
Other	—		60		—		60
Unallocated	—		609		—		609
	$	648	$	5,873	$	—	$	6,521
Loans:
Commercial	$	—	$	55,924	$	5	$	55,929
Real estate construction	835		28,474		11		29,320
Real estate mortgage:
1-4 family residential	1,454		226,523		2,744		230,721
Multi-family residential	—		38,281		—		38,281
Non-farm & non-residential	2,882		179,913		897		183,692
Agricultural	4,298		61,921		563		66,782
Consumer	—		18,880		—		18,880
Other	—		516		—		516
	$	9,469	$	610,432	$	4,220	$	624,121

As of December 31, 2014	Individually Evaluated for Impairment		Collectively Evaluated for Impairment		Total
Allowance for Loan Losses:
Commercial	$	—	$	339	$	339
Real estate construction	—		446		446
Real estate mortgage:
1-4 family residential	56		1,773		1,829
Multi-family residential	94		401		495
Non-farm & non-residential	136		677		813
Agricultural	712		286		998
Consumer	—		520		520
Other	—		32		32
Unallocated	—		540		540
	$	998	$	5,014	$	6,012
Loans:
Commercial	$	—	$	47,185	$	47,185
Real estate construction	—		16,938		16,938
Real estate mortgage:
1-4 family residential	2,098		187,360		189,458
Multi-family residential	264		34,151		34,415
Non-farm & non-residential	2,958		158,864		161,822
Agricultural	8,479		62,866		71,345
Consumer	—		16,863		16,863
Other	—		279		279
	$	13,799	$	524,506	$	538,305

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

	Unpaid Principal Balance		Recorded Investment		Allowance for Loan Losses Allocated		Average Recorded Investment		Interest Income Recognized		Cash Basis Interest Recognized
With no related allowance recorded:
Commercial	$	—	$	—	$	—	$	—	$	—	$	—
Real estate construction	835		835		—		820		29		29
Real estate mortgage:
1-4 family residential	370		370		—		1,493		15		15
Multi-family residential	—		—		—		—		—		—
Non-farm & non-residential	—		—		—		68		—		—
Agricultural	469		469		—		335		14		14
Consumer	—		—		—		—		—		—
Other	—		—		—		—		—		—
With an allowance recorded:
Commercial	—		—		—		—		—		—
Real estate construction	—		—		—		—		—		—
Real estate mortgage
1-4 family residential	1,083		1,083		128		1,916		6		6
Multi-family residential	—		—		—		24		—		—
Non-farm & non-residential	2,882		2,882		181		2,885		29		29
Agricultural	3,957		3,957		339		4,379		—		—
Consumer	—		—		—		—		—		—
Other	—		—		—		—		—		—
Total	$	9,596	$	9,596	$	648	$	11,920	$	93	$	93

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

The following table presents loans individually evaluated for impairment by class of loans as of December 31, 2014 (in thousands):

	Unpaid Principal Balance		Recorded Investment		Allowance for Loan Losses Allocated		Average Recorded Investment		Interest Income Recognized		Cash Basis Interest Recognized
With no related allowance recorded:
Commercial	$	—	$	—	$	—	$	—	$	—	$	—
Real estate construction	—		—		—		—		—		—
Real estate mortgage:
1-4 family residential	1,618		1,618		—		1,147		25		25
Multi-family residential	—		—		—		—		—		—
Non-farm & non-residential	—		—		—		552		—		—
Agricultural	442		442		—		2,696		29		29
Consumer	—		—		—		—		—		—
Other	—		—		—		—		—		—
With an allowance recorded:
Commercial	—		—		—		—		—		—
Real estate construction	—		—		—		—		—		—
Real estate mortgage
1-4 family residential	480		480		56		990		18		18
Multi-family residential	264		264		94		284		5		5
Non-farm & non-residential	2,958		2,958		136		3,173		115		115
Agricultural	8,037		8,037		712		5,341		116		116
Consumer	—		—		—		—		—		—
Other	—		—		—		—		—		—
Total	$	13,799	$	13,799	$	998	$	14,183	$	308	$	308

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

The following table presents loans individually evaluated for impairment by class of loans as of 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	$	14,500	$	13,536	$	712	$	14,691	$	697	$	697

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

Nonperforming loans include impaired loans and smaller balance homogeneous loans, such as residential mortgage and consumer loans, that are collectively evaluated for impairment.

Nonaccrual loans secured by real estate make up 96.5% of the total nonaccrual loans.

The following tables present the recorded investment in nonaccrual and loans past due over 90 days still on accrual, excluding purchase credit impaired loans, by class of loans as of December 31, 2015 and 2014 (in thousands):

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

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

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

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

			Loans Past Due
			Over 90 Days
			Still		Troubled Debt
As of December 31, 2014	Nonaccrual		Accruing		Restructurings

Commercial	$	25	$	—	$	—
Real estate construction	142		—		—
Real estate mortgage:
1-4 family residential	1,390		23		480
Multi-family residential	264		—		—
Non-farm & non-residential	380		—		1,829
Agricultural	4,371		—		3,829
Consumer	5		1		—
Other	—		—		—

Total	$	6,577	$	24	$	6,138

The following tables present the aging of the recorded investment in past due and non-accrual loans as of December 31, 2015 and 2014 by class of loans (in thousands):



	30-59		60-89		Greater than				Total
	Days		Days		90 Days				Past Due &		Loans Not
2015	Past Due		Past Due		Past Due		Non-accrual		Non-accrual		Past Due

Commercial	$	2,323	$	99	$	—	$	6	$	2,428	$	53,501
Real estate construction	—		—		365		145		510		28,810
Real estate mortgage:
1-4 family residential	1,508		264		471		1,531		3,774		226,947
Multi-family residential	—		—		—		—		—		38,281
Non-farm & non-residential	37		121		137		481		776		182,916
Agricultural	229		251		—		4,171		4,651		62,131
Consumer	50		45		27		17		139		18,741
Other	—		—		—		—		—		516
Total	$	4,147	$	780	$	1,000	$	6,351	$	12,278	$	611,843

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



	30-59		60-89		Greater than				Total
	Days		Days		90 Days				Past Due &		Loans Not
2014	Past Due		Past Due		Past Due		Non-accrual		Non-accrual		Past Due

Commercial	$	92	$	—	$	—	$	25	$	117	$	47,068
Real estate construction	—		—		—		142		142		16,796
Real estate mortgage:
1-4 family residential	1,531		232		23		1,390		3,176		186,282
Multi-family residential	—		131		—		264		395		34,020
Non-farm & non-residential	67		—		—		380		447		161,375
Agricultural	7		11		—		4,371		4,389		66,956
Consumer	130		25		1		5		161		16,702
Other	—		—		—		—		—		279

Total	$	1,827	$	399	$	24	$	6,577	$	8,827	$	529,478

Troubled Debt Restructurings:

At December 31, 2015 and 2014, the Company had a recorded investment in troubled debt restructurings of $2.2 million and $6.1 million. The Company has allocated $101 thousand and $428 thousand in reserves to customers whose loan terms have been modified in troubled debt restructurings as of December 31, 2015 and 2014. The Company has not committed to lend additional amounts as of December 31, 2015 and 2014 to customers with outstanding loans that are classified as troubled debt restructurings.

During the years ending December 31, 2015 and 2014, no loans were modified that met the definition of troubled debt restructuring. However, one loan which had a balance of $4.0 million at December 31, 2015 was placed on non-accrual during 2015 and thus reported as a non-accrual loan.

Loans classified as troubled debt restructurings increased the allowance for loan losses by $101 thousand and $428 thousand and resulted in no charge offs during the periods ending December 31, 2015 and 2014. For the years ending December 31, 2015, 2014 and 2013, no loans modified as troubled debt restructurings had defaulted on payment.

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 includes primarily non-homogeneous loans with an outstanding balance greater than $200 thousand such as commercial and commercial real estate loans. 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 a potential weakness that deserves 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 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. The following tables present the risk category of loans by class of loans, based on the most recent analysis performed, as of December 31, 2015 and 2014 (in thousands):



			Special
2015	Pass		Mention		Substandard		Doubtful
Commercial	$	54,392	$	1,323	$	215	$	—
Real estate construction	26,835		1,402		1,083		—
Real estate mortgage:
1-4 family residential	216,661		6,155		7,903		—
Multi-family residential	35,221		2,916		143		—
Non-farm & non-residential	178,289		4,448		955		—
Agricultural	60,177		1,198		5,407		—
Total	$	571,575	$	17,442	$	15,706	$	—
Loans included in totals above acquired from Madison Financial Corp.	$	44,367	$	2,553	$	3,189	$	—



			Special
2014	Pass		Mention		Substandard		Doubtful

Commercial	$	45,602	$	1,307	$	275	$	—
Real estate construction	15,529		1,267		142		—
Real estate mortgage:
1-4 family residential	176,791		5,439		7,068		160
Multi-family residential	33,990		—		425		—
Non-farm & non-residential	154,857		5,178		1,787		—
Agricultural	58,110		7,653		5,581		—

Total	$	484,879	$	20,844	$	15,278	$	160

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 $44 thousand at December 31, 2015 and $16 thousand at December 31, 2014.

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

Certain directors and executive officers of the Company and companies in which they have beneficial ownership were loan customers of the Bank during 2015 and 2014. An analysis of the activity with respect to all director and executive officer loans is as follows (in thousands):

	2015			2014

Balance, beginning of year	$	1,706		$	1,288
New loans	—			977
Effect of changes in composition of related parties	—			—
Repayments	(33		)	(559		)

Balance, end of year	$	1,673		$	1,706

Loan Servicing

Mortgage loans serviced for others are not included in the accompanying consolidated balance sheets. The unpaid principal balances of mortgage loans serviced for others were approximately $196.2 million and $188.3 million at December 31, 2015 and 2014. Custodial escrow balances maintained in connection with the foregoing loan servicing, and included in demand deposits, were approximately $890 thousand and $763 thousand at December 31, 2015 and 2014.

Activity for mortgage servicing rights and the related valuation allowance follows (in thousands):

	2015			2014			2013

Servicing Rights:
Beginning balance	$	1,209		$	1,344		$	1,152
Additions	348			270			446
Amortization	(339		)	(385		)	(409		)
Change in valuation allowance	59			(20		)	155

Ending balance	$	1,277		$	1,209		$	1,344

Valuation Allowance:
Beginning balance	$	79		$	59		$	214
Additions expensed	—			34			73
Reductions credited to operations	59			14			228

Ending balance	$	20		$	79		$	59

The fair value of servicing rights was $1.7 million and $1.6 million at year-end 2015 and 2014. Fair value at year-end 2015 was determined using a discount rate of 12.0%, prepayment speeds ranging from 8.1% to 21.0%, depending on the stratification of the specific right, and default rates ranging from 0.1% to 0.9%. Fair value at year-end 2014 was determined using a discount rate of 12.0%, prepayment speeds ranging from 7.9% to 35.0%, depending on the stratification of the specific right, and default rates ranging from 0.1% to 0.9%.

The weighted average amortization period is 12.0 years. Estimated amortization expense for each of the next five years is (in thousands):

2016	$	260
2017	198
2018	148
2019	112
2020	88

NOTE 6 - REAL ESTATE OWNED

Activity in real estate owned was as follows (in thousands):

	Twelve Months Ended
	2015			2014

Beginning of year	$	4,603		$	3,379
Additions	3,394			3,275
Acquired with Madison Financial Corporation	445			—
Sales	(7,062		)	(1,992		)
(Additions) subtractions to valuation allowance, net	967			(59		)
End of period	$	2,347		$	4,603

Activity in the valuation allowance was as follows (in thousands):

	2015			2014			2013

Beginning of year	$	1,583		$	1,524		$	1,668
Write-downs of other real estate, net	252			144			63
Reductions from sale of other real estate	(1,219		)	(85		)	(207		)
End of year	$	616		$	1,583		$	1,524

Expenses related to foreclosed assets include (in thousands):

	2015			2014			2013

Net loss (gain) on sales	$	(5	)	$	(146	)	$	(43	)
Additions to valuation allowance, net	252			144			63
Operating expenses (receipts), net of rental income	164			227			204
Repossession expense, net	416			371			267

Net expenses	$	411		$	225		$	224

NOTE 7 - PREMISES AND EQUIPMENT

Year-end premises and equipment were as follows (in thousands):

	2015			2014

Land and buildings	$	20,755		$	20,236
Furniture and equipment	17,773			16,791
	38,528			37,027
Less accumulated depreciation	(21,931		)	(20,548		)

	$	16,597		$	16,479

Depreciation expense was $1.4 million, $1.3 million and $1.2 million in 2015, 2014, and 2013.

Certain premises, not included in premises and equipment above, are leased under operating leases. Minimum rental payments are as follows (in thousands):

2016	$	342
2017	304
2018	303
2019	303
2020	269
Thereafter	1,153
	$	2,674

NOTE 8 — GOODWILL AND INTANGIBLE ASSETS

The change in balance for goodwill during the year is as follows (in thousands):

	2015		2014		2013

Beginning of year	$	13,117	$	13,117	$	13,117
Acquired goodwill	884		—		—
Impairment	—		—		—

End of year	$	14,001	$	13,117	$	13,117

Goodwill is not amortized but instead evaluated periodically for impairment.

Impairment exists when a reporting unit’s carrying value of goodwill exceeds its fair value, which is determined through a two-step impairment test. Step 1 includes the determination of the carrying value of our single reporting unit, including the existing goodwill and intangible assets, and estimating the fair value of the reporting unit. We determined the fair value of our reporting unit and compared it to its carrying amount. If the carrying amount of a reporting unit exceeds its fair value, we are required to perform a second step to the impairment test.

Our annual impairment analysis as of December 31, 2015 and 2014 indicated that the Step 2 analysis was not necessary. If needed, Step 2 of the goodwill impairment test is performed to measure the impairment loss. Step 2 requires that the implied fair value of the reporting unit goodwill be compared to the carrying amount of that goodwill. If the carrying amount of the reporting unit goodwill exceeds the implied fair value of that goodwill, an impairment loss shall be recognized in an amount equal to that excess.

Acquired intangible assets were as follows at year-end (in thousands):

2015

2014

Gross

Carrying

Accumulated

Carrying

Accumulated

Amount

Amortization

Amount

Amortization

Amortized intangible assets:

Core deposit intangibles

3,330

2,557

2,530

2,353

Aggregate amortization expense was $205 thousand, $140 thousand and $215 thousand for 2015, 2014 and 2013.

Estimated amortization expense for each of the next five years (in thousands):

2016	$	244
2017	160
2018	131
2019	102
2020	74

NOTE 9 - DEPOSITS

Time deposits of $250 thousand or more were $61.2 million and $52.9 million at year-end 2015 and 2014, respectively.

At December 31, 2015, the scheduled maturities of time deposits for the next five years are as follows (in thousands):

2016	$	122,188
2017	39,373
2018	20,003
2019	8,511
2020	11,615

Certain directors and executive officers of the Company and companies in whom they have beneficial ownership are deposit customers of the Bank. The amount of these deposits was approximately $7.3 million and $6.7 million at December 31, 2015 and 2014.

NOTE 10 - REPURCHASE AGREEMENTS AND OTHER BORROWINGS

Securities sold under agreements to repurchase are secured by U.S. Government securities with a carrying amount of $18.5 million and $12.5 million at year-end 2015 and 2014.

Repurchase agreements range in maturities from 1 day to 72 months. The securities underlying the agreements are maintained in a third-party custodian’s account under a written custodial agreement. Information concerning repurchase agreements for 2015, 2014 and 2013 is summarized as follows (in thousands):

	2015			2014			2013
Average daily balance during the year	$	16,596		$	12,270		$	9,646
Average interest rate during the year	0.59		%	0.76		%	0.68		%
Maximum month-end balance during the year	$	19,874		$	13,788		$	13,198
Weighted average interest rate at year end	0.54		%	0.75		%	0.73		%

On July 20, 2015, the Company borrowed $5 million which had an outstanding balance of $4.8 million at December 31, 2015. The term loan has a fixed interest rate of 5.02%, requires quarterly principal and interest payments, matures July 20, 2025 and is collateralized by the Company’s stock. The maturity schedule for the term loan as of December 31, 2015 is as follows:

Due in one year or less	$	302
Due in one through three years	861
Due in three through five years	952
Due after five years	2,679
	$	4,794

At December 31, 2014 the Company had a $5 million revolving promissory note with a maturity date of July 26, 2015. Upon maturity, the Company renewed the revolving promissory note. The new note has similar terms as the original note and matures July 19, 2016. The Company had no outstanding balances related to this promissory note at December 31, 2015 or 2014.

NOTE 11 - FEDERAL HOME LOAN BANK ADVANCES

At year-end, advances from the Federal Home Loan Bank were as follows (in thousands):

	2015		2014
Long Term Advances
Maturities range from March 2016 through March 2030, fixed rates from 1.00% to 7.00%, averaging 1.77% in 2015 and 1.87% in 2015	$	87,833	$	83,785

Short Term Advances
One advance which matures in January 2015 and has a fixed rate of 0.14%	$	—	10,000

Advances are paid either on a monthly basis or at maturity. All advances require a prepayment penalty, and are secured by the FHLB stock and substantially all first mortgage residential, multi-family and farm real estate loans.

Scheduled principal payments due on advances during the years subsequent to December 31, 2015 are as follows (in thousands):

2016	$	10,159
2017	13,633
2018	16,274
2019	11,021
2020	17,803
Thereafter	18,943

	$	87,833

NOTE 12 - SUBORDINATED DEBENTURES

In August 2003, the Company formed Kentucky Bancshares, Statutory Trust I (“Trust”). The Trust issued $217 thousand of common securities to the Company and $7 million of trust preferred securities as part of a pooled offering of such securities. The Company issued $7.2 million subordinated debentures to the Trust in exchange for the proceeds of the offering, which debentures represent the sole asset of the Trust. The debentures paid interest quarterly at 7.06% for the first 5 years. Starting September 2008, the rate converted to three-month LIBOR plus 3.00% adjusted quarterly, which was 3.53% at year-end 2015. The Company is not considered the primary beneficiary of this Trust (variable interest entity), therefore the trust is not consolidated in the Company’s financial statements, but rather the subordinated debentures are shown as a liability.

The Company may redeem the subordinated debentures, in whole or in part, beginning September 2008 at a price of 100% of face value. The subordinated debentures must be redeemed no later than 2033. The Company has the option to defer interest payments on the subordinated debentures from time to time for a period not to exceed five consecutive years.

The subordinated debentures may be included in Tier I capital (with certain limitations applicable) under current regulatory guidelines and interpretations.

NOTE 13 - INCOME TAXES

Income tax expense was as follows (in thousands):

	2015			2014		2013

Current	$	629		$	853	$	900
Deferred	(99		)	44		(41		)

	$	530		$	897	$	859

Year-end deferred tax assets and liabilities were due to the following (in thousands). No valuation allowance for the realization of deferred tax assets is considered necessary.

	2015			2014
Deferred tax assets
Allowance for loan losses	$	2,233		$	2,070
Other real estate owned	295			538
Nonaccrual loan interest	36			30
Accrued pension	—			319
Accrued expenses	189			161
Acquisition market value adjustments	814			—
AMT tax credit	200			—
General business tax carryforward	244			—
Net operating loss carryforward	116			—
Unrealized loss on securities	—			—
Other	82			76

Deferred tax liabilities
Unrealized gain on securities	(185		)	(407		)
Bank premises and equipment	(1,109		)	(1,190		)
FHLB stock	(1,308		)	(1,194		)
Prepaid expenses	(263		)	(282		)
Mortgage servicing rights	(434		)	(411		)
Core deposit intangibles	(262		)	(60		)
Low income housing investments	(69		)	(167		)
Acquisition loan loss recapture	(193		)	—
Other	(178		)	(138		)
Net deferred tax asset (liability)	$	208		$	(655	)

Effective tax rates differ from federal statutory rates applied to financial statement income due to the following:

	2015		2014		2013
U. S. federal income tax rate	34.0	%	34.0	%	34.0	%
Changes from the statutory rate
Tax-exempt interest income	(16.3	)	(14.7	)	(16.8	)
Historic and low income tax credits	(8.2	)	(7.0	)	(5.4	)
Insurance captive	(3.7	)	(1.8	)	—
Non-deductible interest expense related to carrying tax-exempt investments	0.4		0.4		0.5
Non-deductible merger expenses	0.9		—		—
Other	0.1		0.4		0.6
	7.2	%	11.3	%	12.9	%

Federal income tax laws provided the First Federal Savings Bank, acquired by the Company in 2003, with additional bad debt deductions through 1987, totaling $1.3 million. Accounting standards do not require a deferred tax liability to be recorded on this amount, which otherwise would total a $441 thousand liability at December 31, 2015. The Company’s acquisition of First Federal Savings Bank did not require the recapture of the bad debt reserve. However, if Kentucky Bank was liquidated or otherwise ceased to be a bank, or if tax laws were to change, the $441 thousand would be recorded as expense.

Unrecognized Tax Benefits

The Company does not have any beginning and ending unrecognized tax benefits. The Company does not expect the total amount of unrecognized tax benefits to significantly increase or decrease in the next twelve months.

There were no interest and penalties recorded in the income statement or accrued for the years ended December 31, 2015 and 2014.

The Company and its subsidiaries file a consolidated U.S. Corporation income tax return and a corporate income tax return in the state of Kentucky. The Company is no longer subject to examination by taxing authorities for years before 2012.

NOTE 14 - EARNINGS PER SHARE

The factors used in the earnings per share computation follow (in thousands):

	2015		2014		2013
Basic Earnings Per Share
Net income	$	6,832	$	7,071	$	5,822
Weighted average common shares outstanding	2,842		2,721		2,705
Basic earnings per share	$	2.40	$	2.60	$	2.15

Diluted Earnings Per Share
Net income	$	6,832	$	7,071	$	5,822
Weighted average common shares outstanding	2,842		2,721		2,705
Add effect of dilutive shares	—		—		4
Weighted average common shares outstanding including dilutive shares	2,842		2,721		2,709
Diluted earnings per share	$	2.40	$	2.60	$	2.15

Stock options of 2,400 shares common stock from 2015, 12,625 shares common stock from 2014 and 19,100 shares common stock from 2013 were excluded from diluted earnings per share because their impact was antidilutive. No stock grants for 2015, 2014 and 2013 were excluded from diluted earnings per share because their impact was antidilutive.

NOTE 15 - RETIREMENT PLAN

The Company has a qualified profit sharing plan which covers substantially all employees and includes a 401(k) provision. Profit sharing contributions, excluding the 401(k) provision, are at the discretion of the Company’s Board of Directors. Expense recognized in connection with the plan was $815 thousand, $729 thousand and $777 thousand in 2015, 2014 and 2013.

NOTE 16 - STOCK BASED COMPENSATION

The Company has four share based compensation plans as described below. Total compensation cost that has been charged against income for those plans was $133 thousand, $111 thousand, and $82 thousand for 2015, 2014 and 2013. The total income tax benefit was $0, $0, and $0.

Two Stock Option Plans

Under its expired 1999 Employee Stock Option Plan, the Company has granted certain officers and key employees stock option awards which vest and become fully exercisable at the end of five years and provided for issuance of up to 100,000 options. Under the expired 1993 Non-Employee Directors Stock Ownership Incentive Plan, the Company had also granted certain directors stock option awards which vest and become fully exercisable immediately and provided for issuance of up to 20,000 options. The exercise price of each option, which has a ten year life, was equal to the market price of the Company’s stock on the date of grant.

The fair value of each option award is estimated on the date of grant using a closed form option valuation (Black-Scholes) model that uses various assumptions. Expected volatilities are based on historical volatilities of the Company’s common stock. The Company uses historical data to estimate option exercise and post-vesting termination behavior. The expected term of options granted is based on historical data and represents the period of time that options granted are expected to be outstanding, which takes into account that the options are not transferable. The risk-free interest rate for the expected term of the option is based on the U.S. Treasury yield curve in effect at the time of the grant. No options were granted in 2015, 2014 or 2013.

Summary of activity in the two expired stock option plans for 2015 follows:

					Weighted
			Weighted		Average
			Average		Remaining	Aggregate
			Exercise		Contractual	Intrinsic
	Shares		Price		Term	Value

Outstanding, beginning of year	12,625		$	30.46
Granted	—		—
Forfeited or expired	(10,225	)	30.48
Exercised	—		—
Outstanding, end of year	2,400		$	30.37	12.5 months	$	—
Vested and expected to vest	2,400		$	30.37	12.5 months	$	—
Exercisable, end of year	2,400		$	30.37	12.5 months	$	—

Options outstanding at year-end 2015 were as follows:

	Outstanding			Exercisable
		Weighted
		Average	Weighted		Weighted
		Remaining	Average		Average
		Contractual	Exercise		Exercise
Range of Exercise Prices	Options	Life	Price	Options	Price

From $29.50 to $31.00 per share	2,400	12.5	30.37	2,400	30.37

As of December 31, 2015, there was $0 of total unrecognized compensation cost related to nonvested stock options granted under the Plan. Since both stock option plans have expired, as of December 31, 2015, neither plan allows for additional options to be issued.

2005 Restricted Stock Grant Plan

Under its expired 2005 Restricted Stock Grant Plan, total shares issuable under the plan were 50,000. There were 465 shares issued during 2015 and 7,475 shares issued during 2014. There were 88 shares forfeited during 2015 and 390 shares forfeited during 2014.

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, 2015	17,694		$	365,586		$	20.66
Granted	465		12,718			27.35
Vested	(5,375	)	(105,017		)	19.54
Forfeited	(88	)	(1,922		)	21.84
Nonvested at December 31, 2015	12,696		$	271,365		$	21.37

As of December 31, 2015, there was $178 thousand of total unrecognized compensation cost related to nonvested shares granted under the Plan. The cost is expected to be recognized over a weighted-average period of 2.6 years. The total grant-date fair value of shares vested during the years ended December 31, 2015, 2014 and 2013 was $105 thousand, $88 thousand and $88 thousand. The vesting-date fair value of shares vested during 2015, 2014 and 2013 is immaterially different when compared to the grant-date fair value. Since the plan has expired, as of December 31, 2015, no additional restricted stock share awards will be issued.

2009 Stock Award Plan

On May 13, 2009, the Company’s stockholders approved a stock award plan that provides for the granting of both incentive and nonqualified stock options and other share based awards. Total shares issuable under the plan are 150,000. There were 6,385 shares issued during 2015 and 900 shares issued during 2014. There were 65 shares forfeited during 2015 and none during 2014.

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, 2015	720		$	16,704		$	23.20
Granted	6,385		160,703			27.79
Vested	(240	)	(5,568		)	23.20
Forfeited	(65	)	(1,576		)	27.35
Nonvested at December 31, 2015	6,800		$	170,263		$	27.47

As of December 31, 2015 there was $154 thousand of total unrecognized compensation cost related to nonvested shares granted under the Plan. The cost is expected to be recognized over a weighted-average period of 4.0 years. The total grant-date fair value of shares vested during the years ended December 31, 2015, 2014 and 2013 was $6 thousand, $4 thousand and $0. The vesting-date fair value of shares vested during 2015, 2014 and 2013 is immaterially different when compared to the grant-date fair value.

As of December 31, 2015, the restricted stock grant plan allows for additional restricted stock share awards of up to 148 thousand shares.

NOTE 17 - LIMITATION ON BANK DIVIDENDS

The Company’s principal source of funds is dividends received from the Bank. Banking regulations limit the amount of dividends that may be paid by the Bank without prior approval of regulatory agencies. Under these regulations, the amount of dividends that may be paid in any calendar year is limited to the current year’s net profits, as defined, combined with the retained net profits of the preceding two years. During 2016 the Bank could, without prior approval, declare dividends on any 2016 net profits retained to the date of the dividend declaration plus $5.6 million.

NOTE 18 - FAIR VALUE

Fair value is the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. There are three levels of inputs that may be used to measure fair values:

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:

Securities Available for Sale and Trading Assets: The fair values for 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 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.

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

Other Real Estate Owned: Assets acquired through, or instead of, loan foreclosure are initially recorded at fair value less costs to sell when acquired, establishing a new cost basis. These assets are subsequently accounted for at lower of cost or fair value less estimated costs to sell. Fair value is commonly based on recent real estate appraisals which are updated no less frequently than annually. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value. Real estate owned properties are evaluated on a quarterly basis for additional impairment and adjusted accordingly.

Loan 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 are the Company’s only balance sheet item that meet the disclosure requirements for instruments measured at fair value on a recurring basis. Disclosures are as follows in the tables below.

(In thousands)

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

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

Total	$	269,743	$	5,875	$	263,868	$	—

(In thousands)

	Fair Value Measurements at December 31, 2014 Using:
			Quoted Prices
			In Active
			Markets for		Significant Other		Significant
			Identical		Observable		Unobservable
	Carrying		Assets		Inputs		Inputs
Description	Value		(Level 1)		(Level 2)		(Level 3)

U.S. government agencies	$	60,586	$	—	$	60,586	$	—
States and municipals	89,281		—		89,281		—
Mortgage-backed - residential	96,698		—		96,698		—
Equity securities	296		296		—		—
Trading Assets	5,370		5,370		—		—

Total	$	252,231	$	5,666	$	246,565	$	—

There were no transfers between level 1 and level 2 during 2015 or 2014.

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

(In thousands)

	Fair Value Measurements at December 31, 2015 Using:
			Quoted Prices
			In Active
			Markets for	Significant Other	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	$	540	—	—	$	540
Non-farm & non-residential	285		—	—	285

Other real estate owned, net:
Residential	1,504		—	—	1,504
Loan servicing rights	87		—	—	87

(In thousands)

	Fair Value Measurements at December 31, 2014 Using:
		Quoted Prices
		In Active
		Markets for	Significant Other	Significant
		Identical	Observable	Unobservable
	Carrying	Assets	Inputs	Inputs
Description	Value	(Level 1)	(Level 2)	(Level 3)

Impaired loans:
Real Estate Mortgage:
Multi-family residential	169	—	—	169
Non-farm & non-residential	366	—	—	366
Agricultural	3,729	—	—	3,729

Other real estate owned, net:
Residential	1,670	—	—	1,670
Loan servicing rights	516	—	—	516

Impaired loans, which are measured for impairment using the fair value of the collateral for collateral dependent loans, had a net carrying amount of $825 thousand, with a valuation allowance of $170 thousand at December 31, 2015. During 2015, two new loans became impaired resulting in an additional provision for loan losses of $170 thousand. The total allowance for specific impaired loans decreased $351 thousand for the year ending December 31, 2015.

At December 31, 2014, impaired loans had a net carrying amount of $4.3 million, with a valuation allowance of $587 thousand, resulting in an additional provision for loan losses of $427 thousand for the year ending December 31, 2014.

Other real estate owned which is measured at fair value less costs to sell, had a net carrying amount of $1.5 million, which is made up of the outstanding balance of $2.1 million, net of a valuation allowance of $616 thousand at December 31, 2015. Write-downs of other real estate totaled $252 thousand for the year ending December 31, 2015. At December 31, 2014, other real estate owned had a net carrying amount of $1.7 million, which is made up of the outstanding balance of $3.3 million, net of a valuation allowance of $1.6 million at December 31, 2014. Write-downs of other real estate netted to a recovery of $144 thousand for the year ending December 31, 2014.

Certain impaired loan servicing rights, which are carried at lower of cost or fair value, were carried at their fair value of $87 thousand, which is made up of the outstanding balance of $106 thousand, net of a valuation allowance of $19 thousand at December 31, 2015. Net recoveries of prior year write-downs for the loan servicing rights totaled $59 thousand for the year ending December 31, 2015. At December 31, 2014, impaired loan servicing rights were carried at their fair value of $516 thousand, which is made up of the outstanding balance of $595 thousand, net of a valuation allowance of $79 thousand at December 31, 2014. Net Recoveries for prior write-downs were recorded in the amount of $20 thousand for the year ending December 31, 2014.

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 December 31, 2015 and 2014:

				Range
December 31, 2015	Fair	Valuation	Unobservable	(Weighted
(In thousands)	Value	Technique(s)	Input(s)	Average)

Impaired loans

Real estate mortgage:

1-4 family residential	540	sales comparison	adjustment for differences between the comparable sales	1%-12%
				(7%)



Non-farm & non-residential	285	sales comparison	adjustment for differences between the comparable sales	23%-31%
				(27%)



Other real estate owned:

Residential	1,504	sales comparison	adjustment for differences between the comparable sales	10%-28%
				(19%)


		income approach	capitalization rate	10%-10%
				(10%)

Loan Servicing Rights	87	discounted cash	constant prepayment rates	8%-21%
		flow	constant prepayment rates	(11%)

				Range
December 31, 2014	Fair	Valuation	Unobservable	(Weighted
(In thousands)	Value	Technique(s)	Input(s)	Average)
Impaired loans

Real estate mortgage:
Multi-family residential	169	sales comparison	adjustment for differences between the comparable sales	10%-10% (10%)

Non-farm & non-residential	366	sales comparison	adjustment for differences between the comparable sales	0%-0% (0%)

Agricultural	3,729	sales comparison	adjustment for differences between the comparable sales	5%-53% (43%)

Other real estate owned:
Residential	1,670	sales comparison	adjustment for differences between the comparable sales	0%-48% (11%)
		income approach	capitalization rate	8%-10% (9%)

Loan Servicing Rights	516	discounted cash flow	constant prepayment rates	8%-35% (11%)

Fair Value of Financial Instruments

The carrying amounts and estimated fair values of financial instruments, at December 31, 2015 and December 31, 2014 are as follows:

December 31, 2015:

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

December 31, 2014:

(in thousands)	Carrying Value		Level 1		Level 2		Level 3		Total
Financial assets									��
Cash and cash equivalents	$	17,169	$	17,169	$	—	$	—	$	17,169
Interest bearing deposits	1,280		1,280		—		—		1,280
Securities	246,861		296		246,565		—		246,861
Trading assets	5,370		5,370		—		—		5,370
Mortgage loans held for sale	776		—		782		—		782
Loans, net	532,293		—		—		535,213		535,213
FHLB Stock	5,981		—		—		—		N/A
Interest receivable	3,299		—		1,274		2,025		3,299
Financial liabilities
Deposits	$	654,869	$	470,912	$	185,429	$	—	$	656,341
Securities sold under agreements to repurchase	12,457		—		12,620		—		12,620
FHLB advances	93,785		—		88,373		—		88,373
Subordinated debentures	7,217		—		—		7,209		7,209
Interest payable	642		—		633		9		642

The methods and assumptions, not previously presented, used to estimate fair value are described as follows: Carrying amount is the estimated fair value for cash and cash equivalents, interest bearing deposits, accrued interest receivable and payable, demand deposits, short-term debt, and variable rate loans or deposits that reprice frequently and fully. The methods for determining the fair values for securities were described previously. For fixed rate loans or deposits and for variable rate loans or deposits with infrequent repricing or repricing limits, fair value is based on discounted cash flows using current market rates applied to the estimated life and credit risk (including consideration of widening credit spreads).

The method used to determine the fair value of loans does not necessarily represent an exit price. Fair value of debt is based on current rates for similar financing. It was not practicable to determine the fair value of FHLB stock due to restrictions placed on its transferability. The fair value of off-balance sheet items is not considered material.

NOTE 19 — OFF-BALANCE SHEET ACTIVITIES AND COMMITMENTS

Financial instruments with off-balance sheet risk were as follows at year-end (in thousands):

	2015		2014
Unused lines of credit	$	96,581	$	88,741
Commitments to make loans	9,854		6,178
Letters of credit	805		441

NOTE 20 — 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 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.

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

Capital amounts and ratios for December 31, 2014 are calculated using Basel I rules. Management believes as of December 31, 2015, the Company and the Bank meet all capital adequacy requirements to which they are subject.

Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the following table) of Total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital to average assets (as defined). Management believes, as of December 31, 2015 and 2014, that the Bank meets all capital adequacy requirements to which they are subject.

The most recent notification from the Federal Deposit Insurance Corporation 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.

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

	Actual				For Capital Adequacy Purposes				To Be Well Capitalized Under Prompt Corrective Action Provisions
	Amount		Ratio		Amount		Ratio		Amount		Ratio
	(Dollars in Thousands)
2015
Consolidated
Total Capital (to Risk-Weighted Assets)	$	88,456	13.3	%	$	53,025	8.0	%	N/A		N/A
Tier I Capital (to Risk-Weighted Assets)	81,849		12.4		39,769		6.0		N/A		N/A
Common Equity Tier 1 Capital (to Risk-Weighted Assets)	74,849		11.3		29,827		4.5		N/A		N/A
Tier I Capital (to Average Assets)	81,849		8.6		38,232		4.0		N/A		N/A
Bank Only
Total Capital (to Risk-Weighted Assets)	$	90,855	13.7	%	$	52,981	8.0	%	$	66,227	10.0	%
Tier I Capital (to Risk-Weighted Assets)	84,248		12.7		39,736		6.0		52,981		8.0
Common Equity Tier 1 Capital (to Risk-Weighted Assets)	84,248		12.7		29,802		4.5		43,047		6.5
Tier I Capital (to Average Assets)	84,248		8.9		38,124		4.0		47,654		5.0
2014
Consolidated
Total Capital (to Risk-Weighted Assets)	$	77,016	13.1	%	$	47,208	8.0	%	N/A		N/A
Tier I Capital (to Risk-Weighted Assets)	70,917		12.0		23,604		4.0		N/A		N/A
Tier I Capital (to Average Assets)	70,917		8.7		32,497		4.0		N/A		N/A
Bank Only
Total Capital (to Risk-Weighted Assets)	$	74,575	12.6	%	$	47,184	8.0	%	$	58,980	10	%
Tier I Capital (to Risk-Weighted Assets)	68,476		11.6		23,592		4.0		35,388		6
Tier I Capital (to Average Assets)	68,476		8.4		32,442		4.0		40,553		5

Common Equity Tier 1 Capital is not applicable for 2014 and earlier periods.

NOTE 21 - PARENT COMPANY FINANCIAL STATEMENTS

Condensed Balance Sheets

December 31

	2015		2014
	(In Thousands)
ASSETS
Cash on deposit with subsidiaries	$	500	$	1,561
Investment in subsidiaries	100,495		83,379
Securities available for sale	70		20
Other assets	369		258

Total assets	$	101,434	$	85,218

LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities
Note payable	$	4,794	—
Subordinated debentures	7,217		$	7,217
Other Liabilities	10		59
Stockholders’ equity
Preferred stock	—		—
Common stock	20,730		12,662
Retained earnings	68,324		64,489
Accumulated other comprehensive income	359		791
Total liabilities and stockholders’ equity	$	101,434	$	85,218

Condensed Statements of Income and Comprehensive Income (Loss)

Years Ended December 31

	2015			2014			2013
	(In Thousands)
Income
Dividends from subsidiary	$	4,200		$	4,100		$	3,800
Interest income	—			—			—
Total income	4,200			4,100			3,800

Expenses
Interest expense	347			230			238
Other expenses	644			385			123
Total expenses	991			615			361

Income before income taxes and equity in undistributed income of subsidiary	3,209			3,485			3,439
Applicable income tax benefits	269			209			123

Income before equity in undistributed income of subsidiary	3,478			3,694			3,562
Equity in undistributed income of subsidiaries	3,354			3,377			2,260
Net income	6,832			7,071			5,822

Other comprehensive income (loss), net of tax:
Unrealized gains (losses) on securities arising during the period	(160		)	6,555			(8,770		)
Reclassification of realized amount	(272		)	(638		)	(639		)

Net change in unrealized gain (loss) on securities	(432		)	5,917			(9,409		)

Comprehensive income (loss)	$	6,400		$	12,988		$	(3,587	)

Condensed Statements of Cash Flows

Years Ended December 31

	2015			2014			2013
	(In Thousands)
Cash flows from operating activities
Net income	$	6,832		$	7,071		$	5,822
Adjustments to reconcile net income to net cash from operating activities
Equity in undistributed earnings of subsidiary	(3,354		)	(3,377		)	(2,260		)
Change in other assets	12			(109		)	11
Change in other liabilities	(49		)	50			—
Net cash from operating activities	3,441			3,635			3,573

Cash flows from investing activities
Acquisition of Madison Financial Corporation	(229		)	—			—
Investment in captive insurance subsidiary	—			(250		)	—
Net cash from investing activities	(229		)	(250		)	—

Cash flows from financing activities
Proceeds from issuance of long-term debt	5,000			—			—
Payments on note payable	(206		)	—			(500		)
Dividends paid	(2,972		)	(2,721		)	(2,613		)
Payment to repurchase preferred stock	(6,066		)	—			—
Proceeds from issuance of common stock	2			—			—
Purchase of common stock	(31		)	(111		)	(217		)
Net cash from financing activities	(4,273		)	(2,832		)	(3,330		)

Net change in cash	(1,061		)	553			243

Cash at beginning of year	1,561			1,008			765

Cash at end of year	$	500		$	1,561		$	1,008

NOTE 22 - QUARTERLY FINANCIAL DATA (UNAUDITED)

(in thousands, except per share data)

	Interest		Net Interest		Net		Earnings Per Share
	Income		Income		Income		Basic		Fully Diluted

2015
First quarter	$	7,731	$	6,763	$	1,515	$	0.56	$	0.56
Second quarter	7,835		6,863		2,122		0.77		0.77
Third quarter	8,641		7,598		1,541		0.52		0.52
Fourth quarter	8,978		7,911		1,654		0.55		0.55

2014
First quarter	$	7,283	$	6,349	$	1,772	$	0.66	$	0.66
Second quarter	7,405		6,479		1,904		0.70		0.70
Third quarter	7,483		6,538		1,720		0.63		0.63
Fourth quarter	7,560		6,609		1,675		0.61		0.61

The Company recorded an additional $747 in other income during the second quarter of 2015 for the settlement of a legal matter.

NOTE 23 - ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)

The following is changes in Accumulated Other Comprehensive Income (Loss) by component, net of tax, for the years ending December 31, 2015 and 2014 (in thousands):

	Unrealized
	Gains and Losses on
	Available for Sale
	Securities
	2015			2014
Beginning Balance	$	791		$	(5,126	)

Unrealized holding gains (losses) for the period, net of tax	(160		)	6,555

Reclassification adjustment for:

Securities gains realized in income	(412		)	(966		)
Income taxes	(140		)	(328		)
	(272		)	(638		)
Net current period other comprehensive income	(432		)	5,917

Ending balance	$	359		$	791

Item 9. Changes In and Disagreements with Accountants on Accounting and Financial Disclosure

None

Item 9A. Controls and Procedures

Evaluation of Disclosure Controls. Our Chief Executive Officer and Chief Financial Officer, with the participation of management, have evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) as of the end of the period covered by this annual report on Form 10-K. Based on their evaluation, they have concluded that our disclosure controls and procedures are effective as of the end of the period covered by this report to ensure that the Company is able to collect, process and disclose the information it is required to disclose in the reports it files with the SEC within the required time periods.

Management’s Report on Internal Control Over Financial Reporting.

General Overview of Internal Controls over Financial Reporting. Management of the Company is responsible for establishing and maintaining effective internal control over financial reporting as defined in Rules 13a-15(f) under the Securities Exchange Act of 1934.

The Company’s internal control over financial reporting is designed to provide reasonable assurance to the Company’s management and Board of Directors regarding the reliability of financial reporting and the preparation and fair presentation of published financial statements. All internal controls, however, have inherent limitations regardless of how well they have been designed.

General Description of Internal Control over Financial Reporting. Internal control over financial reporting refers to a process designed by, or under the supervision of, the Company’s Chief Executive Officer and Chief Financial Officer and effected by the Company’s Board of Directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles and includes those policies and procedures that:

(1) Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of Company assets;

(2) Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. generally accepted accounting principles, and that Company’s receipts and expenditures are being made only in accordance with the authorization of Company’s management and members of the Company’s Board of Directors; and

(3) Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisitions, uses or dispositions of Company assets that could have a material effect on the Company’s financial statements.

Inherent Limitations in Internal Control over Financial Reporting. Internal control over financial reporting cannot provide absolute assurance of achieving financial reporting objectives because of its inherent limitations. Internal control over financial reporting is a process that involves human diligence and compliance and is subject to lapses in judgment and breakdowns resulting from human failures. Internal control over financial reporting also can be circumvented or overridden by collusion or other improper activities. Because of such limitations, there is a risk that material misstatements may not be prevented or detected on a timely basis by internal control over financial reporting. However, these inherent limitations are known features of the financial reporting process, and it is possible to design into the process safeguards to reduce, though not eliminate, this risk.

Management’s Assessment of the Company’s Internal Control over Financial Reporting. Management, with participation of the Company’s Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Company’s disclosure controls and procedures as of December 31, 2015.

Based on the evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective to ensure that information required to be disclosed by the Company in reports that the Company files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in the 2013 Internal Control — Integrated Framework.

No Changes in Internal Controls over Financial Reporting During Most Recent Quarter. The Company’s Chief Executive Officer and Chief Financial Officer have also concluded that there were no changes in the Company’s internal control over financial reporting or in other factors that occurred during the Company’s most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting or any corrective actions with regard to significant deficiencies and material weaknesses in internal control over financial reporting.

Attestation Report of Registered Public Accounting Firm. This annual report does not include an attestation report of the Company’s registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s registered public accounting firm pursuant to rules of the Securities and Exchange Commission that permit the Company to provide only management’s report in this annual report.

Item 9B. Other Information

None

PART III

Item 10. Directors and Executive Officers and Corporate Governance

Set forth below is information about our executive officers who do not serve as Directors, including their business experience for at least the past five years and their ages as of March 20, 2016.

Name	Age	Position with the Company

James B. Braden	37	Senior Vice President, Chief Administrative
		Officer since 2013. Director of Risk Management
		from 2010 to 2012. Previously a Senior Manager
		at a national public accounting firm serving
		financial institutions.

Brenda S. Bragonier	59	Senior Vice President, Director of Marketing
		since 1999.

Carol Caskey	58	Senior Vice President, Director of Human Resources
		since 2011. Previously an Associate Relations
		Consultant at a national health insurance
		carrier.

Gregory J. Dawson	55	Senior Vice President, Chief Financial Officer
		since 1989.

James L. Elliott	69	Senior Vice President, Director of Wealth
		Management and Market President since 2013.
		Previously a Senior Vice President and Group
		Director of private financial services for a
		financial institution.

Norman J. Fryman	66	Executive Vice President, Chief Credit Officer
		since 2010. Director of Sales and Service
		from 2004 to 2009.

Christopher Gorley	45	Senior Vice President, Director of Operations
		since 2013. Previously a Vice President and
		Chief Operations Officer with a community bank.

William Hough	61	Senior Vice President, Director of Sales and
		Service since 2011. Previously a Market
		President from 2006 to 2010.

The remaining information required by Item 10 is hereby incorporated by reference under the headings “Corporate Governance”, “Section 16(a) Beneficial Ownership Reporting Compliance” and “Proposal No. 2 — Election of Directors” from the Company’s definitive proxy statement in connection with its annual meeting of stockholders scheduled for May 26, 2016, which will be filed with the Commission on or about April 15, 2016, pursuant to Regulation 14A (“2013 Proxy Statement”).

Item 11. Executive Compensation

The information required by Item 11 is hereby incorporated by reference under the headings “Executive Compensation,” “Report of Compensation Committee” and “Compensation of Named Executive Officers” in the 2015 Proxy Statement.

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

The information required by Item 12 is hereby incorporated by reference under the heading “Stock Ownership of Directors and Executive Officers” in the 2015 Proxy Statement. See Part II, Item 5, for information about securities authorized for issuance under the Company’s equity compensation plans.

Item 13. Certain Relationships and Related Transactions, and Director Independence

The information required by Item 13 is hereby incorporated by reference under the headings “Corporate Governance” and “Transactions with Related Persons” in the 2015 Proxy Statement.

Item 14. Principal Accountant Fees and Services

The information required by Item 14 is hereby incorporated by reference under the heading “Fees of Independent Registered Public Accounting Firm” in the 2015 Proxy Statement.

Part IV

Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K

(a)(1) Financial Statements

The following financial statements are included in Item 8 of this Form 10-K.

Report of Independent Registered Public Accounting Firm

Consolidated Balance Sheets

Consolidated Statements of Income

Consolidated Statements of Comprehensive Income (Loss)

Consolidated Statements of Changes in Stockholders’ Equity

Consolidated Statements of Cash Flow

Notes to Consolidated Financial Statements

(a)(2) Financial Statement Schedules.

All financial statement schedules have been omitted as the required information is inapplicable or the required information has been included in the Consolidated Financial statements or notes thereto.

(a)(3) Exhibits

Reference is made to the Exhibit Index beginning on Page E-1 hereof.

100

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) 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.
By:	/s/Louis Prichard
Louis Prichard, President and Chief Executive Officer, Director
March 30, 2016

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

/s/Louis Prichard		March 30, 2016
Louis Prichard, President and Chief Executive Officer, Director

/s/Gregory J. Dawson		March 30, 2016
Gregory J. Dawson, Chief Financial and Accounting Officer

/s/Buckner Woodford, IV		March 30, 2016
Buckner Woodford, IV, Chairman of the Board, Director

/s/B. Proctor Caudill, Jr.		March 30, 2016
B. Proctor Caudill, Jr., Director

/s/Henry Hinkle		March 30, 2016
Henry Hinkle, Director

/s/Betty J. Long		March 30, 2016
Betty J. Long, Director

/s/Ted McClain		March 30, 2016
Ted McClain, Director

/s/Jack W. Omohundro		March 30, 2016
Jack W. Omonhundro, Director

/s/Edwin S. Saunier		March 30, 2016
Edwin S. Saunier, Director

/s/Robert G. Thompson		March 30, 2016
Robert G. Thompson, Director

/s/Woodford Van Meter		March 30, 2016
Woodford Van Meter, Director

101

Kentucky Bancshares, Inc.

Exhibit Index

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

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

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

3.2 Bylaws 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 June 30, 2000.

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

10.1 Kentucky Bancshares, Inc. 1993 Non-Employee Directors Stock Ownership Incentive Plan is incorporated by reference to Exhibit 10.3 of the Registrant’s Registration Statement on Form S-4 (File No. 33-96358).

10.2 Kentucky Bancshares, Inc. 1999 Employee Stock Option Plan is incorporated by reference to Exhibit 99.1 of the Registrant’s Form 10-K for the fiscal year ended December 31, 1998.

10.3 Employment Agreement for Louis Prichard as incorporated by reference to the Registrant’s Current Report on Exhibit 10.1 of the Registrant’s Current Report on Form 8-K dated April 3, 2008.

10.4 2005 Restricted Stock Grant Plan, including form of Award Agreement, as incorporated by reference to Exhibit 10.1 of the Registrant’s Current Report on Form 8-K dated February 22, 2005.

10.5 2009 Stock Award Plan, as incorporated by reference to Exhibit 10.1 of the Registrant’s Quarterly Report on Form 10-Q for the quarterly period ending June 30, 2009.

10.6 Agreement and Plan of Share Exchange dated as of January 21, 2015 between (i) Madison Financial Corporation and (ii) Kentucky Bancshares, Inc. is incorporated by reference to Exhibit 2.1 of the Registrant’s Current Report on Form 8-K dated January 21, 2015

11 Computation of earnings per share - See Note 13 in the notes to the consolidated financial statements included in Item 8.

21 Subsidiaries of Registrant

23 Consent of Crowe Horwath LLP

102

31.1 Certification of Chief Executive Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, as amended.

31.2 Certification of Chief Financial Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, as amended.

32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2 Certification of 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. Annual Report on Form 10-K for the period ended December 31, 2015, filed with the SEC on March 30, 2016, formatted in Extensible Business Reporting Language (XBRL): (i) Consolidated Balance Sheets at December 31, 2015 and 2014, (ii) Consolidated Statements of Income and Comprehensive Income (Loss) for the years ended December 31, 2015, 2014 and 2013, (iii) Consolidated Statement of Changes in Stockholders’ Equity for the years ended December 31, 2014, 2013 and 2012, (iv) Consolidated Statements of Cash Flows for the years ended December 31, 2015, 2014 and 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 Annual Report on Form 10-K 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

103

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Kentucky Bancshares (KTYB) 10-K2015 FY Annual report

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