Kentucky Bancshares (KTYB) 10-Q 2016 Q1 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

FORM 10-Q

(Mark One)

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

For the quarterly period March 31, 2016

or

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

For the transition period from                         to                         

Commission File Number:  000-52598

KENTUCKY BANCSHARES, INC.

(Exact name of registrant as specified in its charter)

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

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

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

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

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

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

Large accelerated filer ☐

Accelerated filer ☐

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

Smaller reporting company ☐

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

Number of shares of Common Stock outstanding as of April 30, 2016:  2,996,227.

KENTUCKY BANCSHARES, INC.

Table of Contents

Part I - Financial Information
Item 1. Financial Statements
	Consolidated Balance Sheets	3
	Consolidated Statements of Income and Comprehensive Income	4
	Consolidated Statement of Changes in Stockholders’ Equity	5
	Consolidated Statements of Cash Flows	6
	Notes to Consolidated Financial Statements	7
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	30
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	39
Item 4.	Controls and Procedures	41
Part II - Other Information		41
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	41
Item 6.	Exhibits	42
Signatures		43

2

Item 1 – Financial Statements

KENTUCKY BANCSHARES, INC.

CONSOLIDATED BALANCE SHEETS (unaudited)

(in thousands, except per share amounts)

	3/31/2016		12/31/2015
ASSETS
Cash and due from banks	$	25,387	$	26,546
Federal funds sold		1,667		1,502
Cash and cash equivalents		27,054		28,048
Interest bearing time deposits		4,629		4,874
Securities available for sale		270,393		264,212
Trading Assets		5,612		5,531
Mortgage loans held for sale		1,634		624
Loans		635,783		624,121
Allowance for loan losses		(7,147)		(6,521)
Net loans		628,636		617,600
Federal Home Loan Bank stock		7,034		7,034
Real estate owned, net		2,383		2,347
Bank premises and equipment, net		16,495		16,597
Interest receivable		3,702		3,681
Mortgage servicing rights		1,239		1,277
Goodwill		14,001		14,001
Other intangible assets		694		773
Other assets		7,328		8,085
Total assets	$	990,834	$	974,684
LIABILITIES AND STOCKHOLDERS’ EQUITY
Deposits
Non-interest bearing	$	208,715	$	209,289
Time deposits, $250,000 and over		74,531		61,199
Other interest bearing		482,696		488,493
Total deposits		765,942		758,981
Repurchase agreements		26,296		18,514
Long-term Federal Home Loan Bank advances		86,232		87,833
Note payable		4,794		4,794
Subordinated debentures		7,217		7,217
Interest payable		708		659
Other liabilities		6,752		7,273
Total liabilities		897,941		885,271
Stockholders’ equity
Preferred stock, 300,000 shares authorized and unissued		—		—
Common stock, no par value; 10,000,000 shares authorized; 2,996,227 and 2,989,205 shares issued and outstanding in March 2016 and December 2015		20,805		20,730
Retained earnings		69,342		68,324
Accumulated other comprehensive income		2,746		359
Total stockholders’ equity		92,893		89,413
Total liabilities and stockholders’ equity	$	990,834	$	974,684

See Accompanying Notes

3

KENTUCKY BANCSHARES, INC.

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

(in thousands, except per share amounts)

	Three Months Ended
	3/31/2016		3/31/2015
INTEREST INCOME:
Loans, including fees	$	7,379	$	6,209
Securities
Taxable		907		733
Tax exempt		657		676
Trading assets		42		44
Other		113		69
Total interest income		9,098		7,731
INTEREST EXPENSE:
Deposits		557		486
Repurchase agreements		26		23
Federal Home Loan Bank advances		384		402
Note payable		61		—
Subordinated debentures		61		57
Total interest expense		1,089		968
Net interest income		8,009		6,763
Provision for loan losses		375		300
Net interest income after provision		7,634		6,463
NON-INTEREST INCOME:
Service charges		1,117		904
Loan service fee income, net		51		53
Trust department income		263		277
Gain on sale of available for sale securities, net		126		8
Gain (loss) on trading assets		40		(5)
Gain on sale of mortgage loans		299		327
Brokerage income		184		106
Debit card interchange income		644		541
Other		23		59
Total other income		2,747		2,270
NON-INTEREST EXPENSE:
Salaries and employee benefits		4,370		3,794
Occupancy expenses		918		932
Repossession expenses, net		112		45
FDIC Insurance		174		156
Legal and professional fees		378		285
Data processing		426		367
Debit card expenses		319		256
Amortization		79		31
Advertising and marketing		225		213
Taxes other than payroll, property and income		275		230
Telephone		91		68
Postage		89		81
Loan fees		45		93
Other		827		666
Total other expenses		8,328		7,217
Income before taxes		2,053		1,516
Income taxes		216		1
Net income	$	1,837	$	1,515
Other Comprehensive Income, net of tax:
Change in Unrealized Gains on Securities		2,387		937
Comprehensive Income	$	4,224	$	2,452
Earnings per share
Basic	$	0.61	$	0.56
Diluted		0.61		0.56
Dividends per share		0.27		0.26

See Accompanying Notes

4

KENTUCKY BANCSHARES, INC.

CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (unaudited)

(in thousands, except share information)

						Accumulated
						Other		Total
	Common Stock			Retained		Comprehensive		Stockholders’
(Dollars in thousands)	Shares	Amount		Earnings		Income		Equity
Balances, January 1, 2016	2,989,205	$	20,730	$	68,324	$	359	$	89,413
Common stock issued including employee stock grants of  6,170 shares and director stock awards of 1,352 shares)	7,522		49		—		—		49
Stock compensation expense	—		39		—		—		39
Common stock purchased and retired	(500)		(13)		(10)		—		(23)
Other comprehensive income							2,387		2,387
Net income	—		—		1,837		—		1,837
Dividends declared - $0.27 per share	—		—		(809)		—		(809)
Balances, March 31, 2016	2,996,227	$	20,805	$	69,342	$	2,746	$	92,893

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

See Accompanying Notes

5

KENTUCKY BANCSHARES, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)

(in thousands)

	Three Months Ended
	3/31/2016		3/31/2015
Cash Flows From Operating Activities
Net Income	$	1,837	$	1,515
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		365		423
Securities amortization (accretion), net		241		240
Stock based compensation expense		39		33
Provision for loan losses		375		300
Securities available for sale gains, net		(126)		(8)
Net change in trading assets		(81)		(39)
Originations of loans held for sale		(7,302)		(8,988)
Proceeds from sale of loans		6,591		9,151
Losses (gains) on other real estate		—		39
Gain on sale of mortgage loans		(299)		(327)
Write-downs of other real estate, net		85		26
Changes in:
Interest receivable		(21)		(271)
Other assets		124		(745)
Interest payable		49		(40)
Other liabilities		(1,090)		(1,869)
Net cash from operating activities		787		(560)
Cash Flows From Investing Activities
Net change in interest bearing time deposits		245		—
Purchases of securities available for sale		(23,679)		(11,797)
Proceeds from sales of securities		9,250		—
Proceeds from principal payments, maturities and calls of securities		11,764		10,368
Net change in loans		(11,483)		(3,477)
Purchases of bank premises and equipment		(237)		(190)
Proceeds from the sale of other real estate		—		3,349
Net cash from investing activities		(14,140)		(1,747)
Cash Flows From Financing Activities:
Net change in deposits		6,961		5,945
Net change in repurchase agreements and other borrowings		7,782		1,812
Payment on short-term Federal Home Loan Bank advances		—		(10,000)
Long-term advances from Federal Home Loan Bank		—		4,682
Payments on long-term Federal Home Loan Bank advances		(1,601)		(1,517)
Proceeds from issuance of common stock		49		—
Purchase of common stock		(23)		(9)
Dividends paid		(809)		(709)
Net cash from financing activities		12,359		204
Net change in cash and cash equivalents		(994)		(2,103)
Cash and cash equivalents at beginning of period		28,048		17,169
Cash and cash equivalents at end of period	$	27,054	$	15,066
Supplemental disclosures of cash flow information Cash paid during the year for:
Interest expense	$	1,040	$	1,008
Supplemental disclosures of non-cash investing activities
Real estate acquired through foreclosure	$	163	$	2,746

See Accompanying Notes

6

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1.SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

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

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

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

Nature of Operations:  Management continues to consider opportunities for branch expansion and will also consider acquisition opportunities that help advance its strategic objectives.  As a state bank, the Bank is subject to regulation by the Kentucky Department of Financial Institutions and the Federal Deposit Insurance Corporation (“FDIC”).  The Company, a bank holding company, is regulated by the Federal Reserve. 

On July 9, 2014, a new subsidiary of the Company was incorporated under the name KBI Insurance Company, Inc.  KBI Insurance Company, Inc. is a subsidiary of Kentucky Bancshares, Inc. and is located in Las Vegas, Nevada.  It is a captive insurance subsidiary which provides various liability and property damage insurance policies for Kentucky Bancshares, Inc. and its related subsidiaries.  KBI Insurance Company, Inc. is regulated by the State of Nevada Division of Insurance. 

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

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

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

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

7

Adoption of New Accounting Standards

Accounting Standards Update (“ASU”) ASU No. 2016-1

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

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

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

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

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

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

8

2.SECURITIES

SECURITIES AVAILABLE FOR SALE

Period-end securities are as follows:

(in thousands)

			Gross		Gross
	Amortized		Unrealized		Unrealized		Fair
	Cost		Gains		Losses		Value
Available for Sale
March 31, 2016
U. S. government agencies	$	49,610	$	242	$	(19)	$	49,833
States and political subdivisions		90,743		3,633		(48)		94,328
Mortgage-backed - residential		125,560		1,020		(696)		125,884
Equity securities		320		28		—		348
Total	$	266,233	$	4,923	$	(763)	$	270,393	—
December 31, 2015
U. S. government agencies	$	49,012	$	51	$	(200)	$	48,863
States and political subdivisions		89,501		2,644		(183)		91,962
Mortgage-backed - residential		124,834		210		(2,001)		123,043
Equity securities		320		24		—		344
Total	$	263,667	$	2,929	$	(2,384)	$	264,212

The amortized cost and fair value of securities at March 31, 2016 by contractual maturity are shown below.  Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.  Securities not due at a single maturity are shown separately.  Further discussion concerning Fair Value Measurements can be found in Note 8.

	Amortized		Fair
	Cost		Value
Due in one year or less	$	166	$	166
Due after one year through five years		31,853		32,357
Due after five years through ten years		61,731		63,286
Due after ten years		46,603		48,352
		140,353		144,161
Mortgage-backed - residential		125,560		125,884
Equity		320		348
Total	$	266,233	$	270,393

Proceeds from sales of securities during the first three months of 2016 and 2015 were $9.3 million and $0 million.  Gross gains of $126 thousand and $8 thousand and gross losses of $0 and $0 were realized on those sales, respectively.  The tax provision related to these realized net gains was $43 thousand and $0 thousand, respectively.

9

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

March 31, 2016

	Less than 12 Months				12 Months or More				Total
	Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
Description of Securities	Value		Loss		Value		Loss		Value		Loss
U.S. Government agencies	$	3,995	$	(5)	$	6,487	$	(14)	$	10,482	$	(19)
States and municipals		3,193		(34)		1,836		(14)		5,029		(48)
Mortgage-backed - residential		23,131		(296)		27,818		(400)		50,949		(696)
Total temporarily impaired	$	30,319	$	(335)	$	36,141	$	(428)	$	66,460	$	(763)

December 31, 2015

	Less than 12 Months				12 Months or More				Total
	Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
Description of Securities	Value		Loss		Value		Loss		Value		Loss
U.S. Government agencies	$	15,243	$	(56)	$	30,293	$	(144)	$	45,536	$	(200)
States and municipals		10,938		(102)		4,065		(81)		15,003		(183)
Mortgage-backed - residential		77,898		(1,231)		23,488		(770)		101,386		(2,001)
Total temporarily impaired	$	104,079	$	(1,389)	$	57,846	$	(995)	$	161,925	$	(2,384)

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

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

TRADING ASSETS

The trading assets of $5.6 million are primarily comprised of cash and cash equivalents and municipal securities which are generally held for 60 days or less.

10

3.LOANS

Loans at period-end are as follows:

(in thousands)

	3/31/2016		12/31/2015
Commercial	$	59,665	$	55,929
Real estate construction		31,734		29,320
Real estate mortgage:
1-4 family residential		237,567		230,721
Multi-family residential		36,564		38,281
Non-farm & non-residential		183,809		183,692
Agricultural		67,459		66,782
Consumer		18,483		18,880
Other		502		516
Total	$	635,783	$	624,121

The above loan balances include loans purchased in the Madison Financial Corporation acquisition. Loan balances acquired in the Madison Financial Corporation acquisition have a $350 thousand allocated allowance for loan losses.  The composition of loans acquired as of March 31, 2016 is as follows:

	3/31/2016		12/31/2015
Commercial	$	1,447	$	1,505
Real estate construction		1,504		1,616
Real estate mortgage:
1-4 family residential		14,722		16,376
Multi-family residential		5,587		5,652
Non-farm & non-residential		23,603		29,029
Agricultural		2,085		2,194
Consumer		340		379
Total	$	49,288	$	56,751

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

	Three Months Ended March 31, 2016
	(in thousands)
	Beginning								Ending
	Balance		Charge-offs		Recoveries		Provision		Balance
Commercial	$	486	$	—	$	31	$	(9)	$	508
Real estate construction		411		—		6		459		876
Real estate mortgage:										—
1-4 family residential		2,081		(12)		5		102		2,176
Multi-family residential		458		—		3		11		472
Non-farm & non-residential		1,213		—		266		(298)		1,181
Agricultural		678		—		11		38		727
Consumer		525		(110)		57		59		531
Other		60		(303)		297		6		60
Unallocated		609		—		—		7		616
	$	6,521	$	(425)	$	676	$	375	$	7,147

11

	Three Months Ended March 31, 2015
	(in thousands)
	Beginning								Ending
	Balance		Charge-offs		Recoveries		Provision		Balance
Commercial	$	339	$	(25)	$	-	$	26	$	340
Real estate Construction		446		-		2		(10)		438
Real estate mortgage:
1-4 family residential		1,829		(32)		3		25		1,825
Multi-family residential		495		-		-		4		499
Non-farm & non-residential		813		-		-		217		1,030
Agricultural		998		(242)		1		(34)		723
Consumer		520		(81)		15		43		497
Other		32		(242)		209		35		34
Unallocated		540		-		-		(6)		534
	$	6,012	$	(622)	$	230	$	300	$	5,920

Purchased Credit Impaired Loans:

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

	3/31/2016		12/31/2015
Commercial	$	—	$	5
Real estate mortgage:
Construction		—		11
1-4 family residential		1,918		2,744
Non-farm & non-residential		658		897
Agricultural		406		563
	$	2,982	$	4,220

There was no associated allowance for loan losses as of March 31, 2016 or December 31, 2015 for purchased credit impaired loans.  The contractual principal balance of these loans was $4.1 million at March 31, 2016 and $4.2 million at December 31, 2015.

Accretable yield, or income expected to be collected, is as follows:

	Three Months Ended
	3/31/2016
Balance, beginning of period	$	408
New loans purchased		—
Accretion of income		69
Balance, end of period	$	339

12

The following tables present the balance in the allowance for loan losses and the recorded investment (excluding accrued interest receivable amounting to $2.4 million as of March 31, 2016 and $2.3 million at December 31, 2015) in loans by portfolio segment and based on impairment method as of March 31, 2016 and December 31, 2015:

	Individually		Collectively		Purchased
As of March 31, 2016	Evaluated for		Evaluated for		Credit
(in thousands)	Impairment		Impairment		Impaired		Total
Allowance for Loan Losses:
Commercial	$	—	$	508	$	—	$	508
Real estate construction		366		510		—		876
Real estate mortgage:
1-4 family residential		127		2,049		—		2,176
Multi-family residential		—		472		—		472
Non-farm & non-residential		132		1,049		—		1,181
Agricultural		390		337		—		727
Consumer		—		531		—		531
Other		—		60		—		60
Unallocated		—		616		—		616
	$	1,015	$	6,132	$	—	$	7,147
Loans:
Commercial	$	—	$	59,665	$	—	$	59,665
Real estate construction		2,394		29,340		—		31,734
Real estate mortgage:				—				—
1-4 family residential		1,440		234,209		1,918		237,567
Multi-family residential		—		36,564		—		36,564
Non-farm & non-residential		1,999		181,152		658		183,809
Agricultural		4,179		62,874		406		67,459
Consumer		—		18,483		—		18,483
Other		—		502		—		502
	$	10,012	$	622,789	$	2,982	$	635,783

13

	Individually		Collectively		Purchased
As of December 31, 2015	Evaluated for		Evaluated for		Credit
(in thousands)	Impairment		Impairment		Impaired		Total
Allowance for Loan Losses:
Commercial	$	—	$	486	$	—	$	486
Real estate construction		—		411		—		411
Real estate mortgage:
1-4 family residential		128		1,953		—		2,081
Multi-family residential		—		458		—		458
Non-farm & non-residential		181		1,032		—		1,213
Agricultural		339		339		—		678
Consumer		—		525		—		525
Other		—		60		—		60
Unallocated		—		609		—		609
	$	648	$	5,873	$	—	$	6,521
Loans:
Commercial	$	—	$	55,924	$	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

The following table presents loans individually evaluated for impairment by class of loans as of and for the three months ended March 31, 2016 (in thousands):

	Unpaid				Allowance for		Average		Interest		Cash Basis
	Principal		Recorded		Loan Losses		Recorded		Income		Interest
	Balance		Investment		Allocated		Investment		Recognized		Recognized
With no related allowance recorded:
Real estate mortgage:
1-4 family residential		370		370		—		370		2		2
Agricultural		222		222		—		346		3		3
With an allowance recorded:
Real estate mortgage:
Construction		2,394		2,394		366		1,197		32		32
1-4 family residential		1,070		1,070		127		1,077		5		5
Non-farm & non-residential		1,999		1,999		132		2,441		18		18
Agricultural		3,957		3,957		390		3,420		—		—
Total	$	10,012	$	10,012	$	1,015	$	8,851	$	60	$	60

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

14

The following table presents loans individually evaluated for impairment by class of loans for the three months ended March 31, 2015:

			Year to Date		Year to Date
	Average		Interest		Cash Basis
	Recorded		Income		Interest
(in thousands):	Investment		Recognized		Recognized
With no related allowance recorded:
Real estate mortgage:
1-4 family residential		1,613		13		13
Agricultural		440		10		10
With an allowance recorded:
Real estate mortgage:
1-4 family residential		420		5		5
Multi-family residential		179		—		—
Non-farm & non-residential		2,949		30		30
Agricultural		5,793		—		—
Total	$	11,394	$	58	$	58

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

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

	Unpaid				Allowance for			Average		Interest		Cash Basis
	Principal		Recorded		Loan Losses			Recorded		Income		Interest
	Balance		Investment		Allocated			Investment		Recognized		Recognized
With no related allowance recorded:
Real estate construction	$	835	$	835	$	—	��	$	820	$	29	$	29
Real estate mortgage:
1-4 family residential		370		370		—			1,493		15		15
Non-farm & non-residential		—		—		—			68		—		—
Agricultural		469		469		—			335		14		14
With an allowance recorded:
Real estate mortgage
1-4 family residential		1,083		1,083		128			1,916		6		6
Multi-family residential		—		—		—			24		—		—
Non-farm & non-residential		2,882		2,882		181			2,885		29		29
Agricultural		3,830		3,830		339			4,379		—		—
Total	$	9,469	$	9,469	$	648		$	11,920	$	93	$	93

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

15

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

			Loans Past Due
			Over 90 Days
As of March 31, 2016			Still		Troubled Debt
(in thousands)	Nonaccrual		Accruing		Restructurings
Commercial	$	6	$	—	$	—
Real estate construction		145		—		—
Real estate mortgage:
1-4 family residential		1,476		200		464
Multi-family residential		—		—		—
Non-farm & non-residential		249		120		1,765
Agricultural		4,222		14		—
Consumer		3		10		—
Total	$	6,101	$	344	$	2,229
Loans included in totals above acquired from Madison Financial Corporation	$	702	$	8	$	—

			Loans Past Due
			Over 90 Days
As of December 31, 2015			Still		Troubled Debt
(in thousands)	Nonaccrual		Accruing		Restructurings
Commercial	$	6	$	—	$	—
Real estate construction		145		365		—
Real estate mortgage:
1-4 family residential		1,531		471		468
Multi-family residential		—		—		—
Non-farm & non-residential		481		137		1,777
Agricultural		4,171		—		—
Consumer		17		27		—
Other		—		—		—
Total	$	6,351	$	1,000	$	2,245
Loans included in totals above acquired from Madison Financial Corporation	$	1,107	$	446	$	—

Nonaccrual loans secured by real estate make up 98.9% of the total nonaccruals at March 31, 2016.

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

A loan is considered impaired when, based on current information and events, it is probable that a creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement.  All amounts due according to the contractual terms means that both the contractual interest payments and the contractual principal payments of a loan will be collected as scheduled in the loan agreement.  Nonaccrual loans are loans for which payments in full of principal or interest is not expected or which principal or interest has been in default for a period of 90 days or more unless the asset is both well secured and in the process of collection.  Other impaired loans may be loans showing signs of weakness or interruptions in cash flow, but ultimately are current or less than 90 days past due with respect to principal and interest and for which we anticipate full payment of principal and interest but not in accordance with contractual terms.

16

Additional factors considered by management in determining impairment and non-accrual status include payment status, collateral value, availability of current financial information, and the probability of collecting all contractual principal and interest payments.

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

	30–59		60–89		Greater than				Total
As of March 31, 2016	Days		Days		90 Days				Past Due &		Loans Not
(in thousands)	Past Due		Past Due		Past Due		Non-accrual		Non-accrual		Past Due
Commercial	$	47	$	5	$	—	$	6	$	58	$	59,607
Real estate construction		2,214		—		—		145		2,359		29,375
Real estate mortgage:						—		—		—
1-4 family residential		1,710		396		200		1,476		3,782		233,785
Multi-family residential		126		—		—		—		126		36,438
Non-farm & non-residential		436		194		120		249		999		182,810
Agricultural		258		102		14		4,222		4,596		62,863
Consumer		57		10		10		3		80		18,403
Other		—		—		—		—		—		502
Total	$	4,848	$	707	$	344	$	6,101	$	12,000	$	623,783
Loans included in totals above acquired from Madison Financial Corp.	$	2,390	$	194	$	8	$	702	$	3,294	$	52,315

	30–59		60–89		Greater than				Total
As of December 31, 2015	Days		Days		90 Days				Past Due &		Loans Not
(in thousands)	Past Due		Past Due		Past Due		Non-accrual		Non-accrual		Past Due
Commercial	$	2,323	$	99	$	—	$	6	$	2,428	$	53,501
Real estate construction		—		—		365		145		510		28,810
Real estate mortgage:
1-4 family residential		1,508		264		471		1,531		3,774		226,947
Multi-family residential		—		—		—		—		—		38,281
Non-farm & non-residential		37		121		137		481		776		182,916
Agricultural		229		251		—		4,171		4,651		62,131
Consumer		50		45		27		17		139		18,741
Other		—		—		—		—		—		516
Total	$	4,147	$	780	$	1,000	$	6,351	$	12,278	$	611,843
Loans included in totals above acquired from Madison Financial Corp.	$	5	$	84	$	446	$	1,107	$	1,642	$	55,109

Troubled Debt Restructurings:

The Company has allocated $93 thousand in specific reserves to customers whose loan terms have been modified in troubled debt restructurings as of March 31, 2016.  The Company allocated $101 thousand for specific reserves to customers whose loan terms had been modified in troubled debt restructuring as of December 31, 2015.  The Company has not committed to lend additional amounts as of March 31, 2016 and December 31, 2015 to customers with outstanding loans that are classified as troubled debt restructurings.

17

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

Credit Quality Indicators:

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

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

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

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

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

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

As of March 31, 2016			Special
(in thousands)	Pass		Mention		Substandard		Doubtful
Commercial	$	58,243	$	1,209	$	213	$	—
Real estate construction		28,635		—		3,099		—
Real estate mortgage:
1-4 family residential		223,851		6,074		7,625		17
Multi-family residential		33,529		2,897		138		—
Non-farm & non-residential		178,615		4,353		841		—
Agricultural		58,456		3,663		5,340		—
Total	$	581,329	$	18,196	$	17,256	$	17
Loans included in totals above acquired from Madison Financial Corporation	$	49,154	$	1,151	$	5,303	$	1

18

As of December 31, 2015			Special
(in thousands)	Pass		Mention		Substandard		Doubtful
Commercial	$	54,392	$	1,323	$	215	$	—
Real estate construction		26,835		1,402		1,083		—
Real estate mortgage:
1-4 family residential		216,661		6,155		7,903		—
Multi-family residential		35,221		2,916		143		—
Non-farm & non-residential		178,289		4,448		955		—
Agricultural		60,177		1,198		5,407		—
Total	$	571,575	$	17,442	$	15,706	$	—
Loans included in totals above acquired from Madison Financial Corporation	$	44,367	$	2,533	$	3,189	$	—

For consumer loans, the Company evaluates the credit quality based on the aging of the recorded investment in loans, which was previously presented.  Non-performing consumer loans are loans which are greater than 90 days past due or on non-accrual status, and total $3 thousand at March 31, 2016 and $6 thousand at December 31, 2015.

4.REAL ESTATE OWNED

Activity in real estate owned, net was as follows:

	Three Months Ended
	March 31,
	2016		2015
Beginning of year	$	2,347	$	4,603
Additions		121		3,029
Sales		—		(3,413)
(Additions) subtractions to valuation allowance, net		(85)		—
End of period	$	2,383	$	4,219

Activity in the valuation allowance was as follows:

	Three Months Ended
	March 31,
	2016		2015
Beginning of year	$	616	$	1,583
Write-downs of other real estate, net		85		26
Reductions from sale		—		(26)
End of Period	$	701	$	1,583

19

Expenses related to foreclosed assets include:

	Three Months Ended
	March 31,
	2016		2015
Net loss (gain) on sales	$	—	$	39
Additions to valuation allowance, net		85		26
Operating expenses (receipts), net of rental income		27		19
Repossession expense, net		112		45
Net expenses	$	112	$	84

5.EARNINGS PER SHARE

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

The factors used in the earnings per share computation follow:

	Three Months Ended
	March 31,
	2016		2015
	(in thousands)
Basic Earnings Per Share
Net Income	$	1,837	$	1,515
Weighted average common shares outstanding		2,977		2,708
Basic earnings per share	$	0.61	$	0.56
Diluted Earnings Per Share
Net Income	$	1,837	$	1,515
Weighted average common shares outstanding		2,977		2,708
Weighted average common and dilutive potential common shares outstanding		2,977		2,708
Diluted earnings per share	$	0.61	$	0.56

Stock options for 1,200 shares of common stock for the three months ended March 31, 2016 and 2,400 shares of common stock for three months ended March 31, 2015 were excluded from diluted earnings per share because their impact was antidilutive.

6.STOCK COMPENSATION

We have four stock based compensation plans as described below.

Two Stock Option Plans

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

20

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

Summary of activity in the stock option plan for the first three months of 2015 follows:

				Weighted
		Weighted		Average
		Average		Remaining		Aggregate
		Exercise		Contractual		Intrinsic
	Shares	Price		Term		Value
Outstanding, beginning of year	2,400	$	30.37
Granted	—		—
Forfeited or expired	(1,200)		29.75
Exercised	—		—
Outstanding, end of year	1,200	$	31.00	17.0	months	$	—
Vested and expected to vest	1,200	$	31.00	17.0	months	$	—
Exercisable, end of period	1,200	$	31.00	17.0	months	$	—

As of March 31, 2016, there was $0 of total unrecognized compensation cost related to nonvested stock options granted under the Plan.  Since both stock option plans have expired, neither plan allows for additional options to be issued.

2005 Restricted Stock Grant Plan

On May 10, 2005, the Company’s stockholders approved a restricted stock grant plan.  Total shares issuable under the plan were 50,000. There were 0 shares issued during the first three months of 2016 and 5,385 shares issued during the first three months of 2015.  The plan is now expired and no additional shares will be issued from the 2005 plan.  There were 0 shares forfeited during the first three months of both 2016 and 2015. 

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

		Weighted-Average		Fair
		Grant-Date		Value
Nonvested Shares	Shares	Fair Value		Per Share
Nonvested at January 1, 2016	12,696	$	271,365	$	21.37
Granted	—		—		—
Vested	(5,599)		(120,239)		21.48
Forfeited	—		—		—
Nonvested at March 31, 2016	7,097	$	151,126	$	21.29

As of March 31, 2016, there was $178,053 of total unrecognized compensation cost related to nonvested shares granted under the restricted stock grant plan.  The cost is expected to be recognized over a weighted-average period of 3.4 years. As of March 31, 2016, no additional shares are available for issue under the restricted stock grant plan.

2009 Stock Award Plan

On May 13, 2009, the Company’s stockholders approved a stock award plan that provides for the granting of both incentive and nonqualified stock options and other share based awards.  Total shares issuable under the plan are 150,000.  There were 6,170 shares issued during the first three months of 2016 and 465 shares were issued in 2015. There were no shares forfeited during the first three months of 2016 or 2015.

21

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

		Weighted-Average		Fair
		Grant-Date		Value
Nonvested Shares	Shares	Fair Value		Per Share
Nonvested at January 1, 2016	6,800	$	170,263	$	27.47
Granted	6,170		182,941		29.65
Vested	(253)		(6,784)		26.81
Forfeited	—		—		—
Nonvested at March 31, 2016	12,717	$	346,420	$	27.24

As of March 31, 2016, there was $181,483 of total unrecognized compensation cost related to nonvested shares granted under the restricted stock grant plan.  The cost is expected to be recognized over a weighted-average period of  4.9 years. As of March 31, 2016, 140,013 shares are still available for issuance.

7.REPURCHASE AGREEMENTS

Repurchase agreements totaled $26.3 million as of March 31, 2016. Of this, $20.3 million were overnight obligations and $6.0 million had terms extending through May 2019 and a weighted average life of 1.5 years. The Company pledged agency-backed securities with a carrying amount of $30.8 million to secure repurchase agreements as of March 31, 2016.

8.OTHER BORROWINGS

On July 20, 2015, the Company borrowed $5 million which was outstanding at March 31, 2016. The term loan has a fixed interest rate of 5.02 %, requires quarterly principal and interest payments, matures July 20, 2025 and is collateralized by the Company’s stock.  The maturity schedule for the term loan as of March 31, 2016 is as follows:

2016	$	302
2017		420
2018		441
2019		464
2020		488
Thereafter		2,679
	$	4,794

9.FAIR VALUE MEASUREMENTS

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

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

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

22

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

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

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

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

Impaired Loans:  The fair value of impaired loans with specific allocations of the allowance for loan losses is generally based on recent third party real estate appraisals.  These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available for similar loans and collateral underlying such loans.  Such adjustments were $366 thousand for 2016 and $34 for 2015 and resulted in a Level 3 classification of the inputs for determining fair value.  Non-real estate collateral may be valued using an appraisal, net book value per the borrower’s financial statements, or aging reports, adjusted or discounted based on management’s historical knowledge, changes in market conditions from the time of the valuation, and management’s expertise and knowledge of the client and client’s business, resulting in a Level 3 fair value classification.  Impaired loans are evaluated on a quarterly basis for additional impairment and adjusted in accordance with the allowance policy.  

Other Real Estate Owned:  Assets acquired through or instead of loan foreclosure and classified as other real estate owned (OREO) are initially recorded at fair value less costs to sell when acquired, establishing a new cost basis.  These assets are subsequently accounted for at lower of cost or fair value less estimated costs to sell.  Fair value is commonly based on recent real estate appraisals which are updated no less frequently than annually.  These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach with data from comparable properties.  Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments were $85 thousand as of March 31, 2016 and $0 as of March 31, 2015 and resulted in a Level 3 classification of the inputs for determining fair value.  Real estate owned properties are evaluated on a quarterly basis for additional impairment and adjusted accordingly.

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

Assets and Liabilities Measured on a Recurring Basis

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

23

Fair Value Measurements at March 31, 2016 Using (In thousands):

			Quoted Prices
			In Active
			Markets for		Significant Other		Significant
			Identical		Observable		Unobservable
	Carrying		Assets		Inputs		Inputs
Description	Value		(Level 1)		(Level 2)		(Level 3)
U. S. government agencies	$	49,833	$	—	$	49,833	$	—
States and municipals		94,328		—		94,328		—
Mortgage-backed - residential		125,884		—		125,884		—
Equity securities		348		348		—		—
Trading Assets		5,612		5,612		—		—
Total	$	276,005	$	5,960	$	270,045	$	—

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

			Quoted Prices
			In Active
			Markets for		Significant Other		Significant
			Identical		Observable		Unobservable
	Carrying		Assets		Inputs		Inputs
Description	Value		(Level 1)		(Level 2)		(Level 3)
U. S. government agencies	$	48,863	$	—	$	48,863	$	—
States and municipals		91,962		—		91,962		—
Mortgage-backed - residential		123,043		—		123,043		—
Equity securities		344		344		—		—
Trading Assets		5,531		5,531		—		—
Total	$	269,743	$	5,875	$	263,868	$	—

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

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

	Fair Value Measurements at March 31, 2016 Using :
			Quoted Prices
			In Active
			Markets for	Significant Other	Significant
			Identical	Observable	Unobservable
	Carrying		Assets	Inputs	Inputs
(In thousands)	Value		(Level 1)	(Level 2)	(Level 3)
Description
Impaired loans:
Real Estate Mortgage:
Construction	$	2,028	—	—	$	2,028
1-4 family Residential		531	—	—		531
Non-farm & non-residential		143	—	—		143
Other real estate owned, net:
Residential		1,419	—	—		1,419
Loan servicing rights		72	—	—		72

24

	Fair Value Measurements at December 31, 2015 Using :
			Quoted Prices
			In Active
			Markets for	Significant Other	Significant
			Identical	Observable	Unobservable
	Carrying		Assets	Inputs	Inputs
(In thousands)	Value		(Level 1)	(Level 2)	(Level 3)
Description
Impaired loans:
Real Estate Mortgage:
Multi-family residential		540	—	—	$	540
Non-farm & non-residential		285	—	—		285
Agricultural		—	—	—		—
Other real estate owned, net:
Residential		1,504	—	—		1,504
Loan servicing rights		87	—	—		87

Impaired loans, which are measured for impairment using the fair value of the collateral for collateral dependent loans, had a carrying amount of $2.7 million, which includes a valuation allowance of $532 thousand at March 31, 2016.  During the first three months of 2016, two new loans became impaired resulting in additional loan loss provision expense of $366 thousand. The total allowance for specific impaired loans increased $368 thousand for the three months ending March 31, 2016 and increased $199 thousand for the three months ending March 31, 2015.

Other real estate owned, which is measured at fair value less costs to sell, had a net carrying amount of $1.4 million, which is made up of the outstanding balance of $2.1 million, net of a valuation allowance of $701 thousand at March 31, 2016.  The Company recorded $85 thousand in write-downs of other real estate owned properties for the three months ending March 31, 2016. The Company recorded $26 thousand in net write-downs of other real estate owned properties for the three months  ending March 31, 2015. 

Loan servicing rights, which are carried at the lower of cost or fair value, were carried at their fair value of $72 thousand, which is made up of the outstanding balance of $88 thousand, net of a valuation allowance of $16 thousand at March 31, 2016. For the first three months of 2015, the Company recorded net write-downs of $14 thousand and  a net recovery of prior write-downs of $3 thousand for the three months ending March 31, 2016.  At December 31, 2015, loan servicing rights were carried at their fair value of $87 thousand, which is made up of the outstanding balance of $106 thousand, net of a valuation allowance of $19 thousand.

25

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 March 31, 2016 and December 31, 2015:

				Range
March 31, 2016	Fair	Valuation	Unobservable	(Weighted
(In thousands)	Value	Technique(s)	Input(s)	Average)
Impaired loans
Construction	2,028	sales comparison	adjustment for differences between the comparable sales	1%-4%	3%
1-4 family	531	sales comparison	adjustment for differences between the comparable sales	0%-12%	7%
Non-farm & non-residential	143	sales comparison	adjustment for differences between the comparable sales	23%-31%	27%
Other real estate owned:
Residential	808	sales comparison	adjustment for differences between the comparable sales	10%-28%	19%
	611	income approach	capitalization rate	10%-10%	10%
Loan Servicing Rights	72	discounted cash	discount rate	9%-20%	11%

				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 flow	discount rate	8%-21%	(11)%

26

Fair Value of Financial Instruments

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

March 31, 2016:

	Carrying
(in thousands)	Value		Level 1		Level 2		Level 3		Total
Financial assets
Cash and cash equivalents	$	27,054	$	27,054	$	—	$	—	$	27,054
Interest bearing deposits		4,629		4,629		—		—		4,629
Securities		270,393		348		270,045		—		270,393
Trading assets		5,612		5,612		—		—		5,612
Mortgage loans held for sale		1,634		—		1,687		—		1,687
Loans, net		628,636		—		—		626,713		626,713
FHLB Stock		7,034		—		—		—		N/A
Interest receivable		3,702		—		1,329		2,373		3,702
Financial liabilities
Deposits	$	765,942	$	562,360	$	204,834	$	—	$	767,194
Securities sold under agreements to repurchase		26,296		—		26,351		—		26,351
FHLB advances		86,232		—		83,313		—		83,313
Note payable		4,794				5,419				5,419
Subordinated debentures		7,217		—		—		7,206		7,206
Interest payable		708		—		638		70		708

27

December 31, 2015:

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

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

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

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

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

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

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

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

28

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

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

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

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

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

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

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

10.CHANGES IN ACCUMULATED OTHER COMPREHENSIVE INCOME BY COMPONENT

Changes in Accumulated Other Comprehensive Income by Component (unaudited)

(in thousands)

	Unrealized
	Gains and Losses on
	Available for Sale
	Securities
	For the Three Months Ended March 31,
	2016		2015
Beginning Balance	$	359	$	791
Unrealized holding gains (losses) for the period, net of tax		2,470		942
Reclassification adjustment for:
Securities gains realized in income		126		8
Income taxes		(43)		(3)
		83		5
Net current period other comprehensive income		2,387		937
Ending balance	$	2,746	$	1,728

29

The following is significant amounts reclassified out of each component of accumulated other comprehensive Income (Loss) for the three months ending March 31, 2016 and 2015:

March 31, 2016

Details about	Amount		Affected Line Item
Accumulated Other	Reclassified From		in the Statement
Comprehensive	Accumulated Other		Where Net
Income Components	Comprehensive Income		Income is Presented
Unrealized gains and losses on available-for-sale securities	$	126	Gain on sale of available for sale securities, net
		43	Income taxes
		83	Net income

March 31, 2015

Details about	Amount		Affected Line Item
Accumulated Other	Reclassified From		in the Statement
Comprehensive	Accumulated Other		Where Net
Income Components	Comprehensive Income		Income is Presented
Unrealized gains and losses on available- for-sale securities	$	8	Gain on sale of available for sale securities, net
		3	Income taxes
		5	Net income

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

Forward-Looking Statements

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

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

30

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

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

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

Summary

The Company recorded net income of $1.8 million, or $0.61 basic earnings and diluted earnings per share for the first three months ended March 31, 2016 compared to $1.5 million or $0.56 basic earnings and diluted earnings per share for the three month period ended March 31, 2015.  The first three months net earnings reflect an increase of 21.3% compared to the same time period in 2015.  The increase in net earnings is attributed to an increase of $1.2 million, or 18.4%, in net interest income and an increase of $477 thousand, or 21.0%, in non-interest income.  These positive variances to net earnings were partially offset by an increase of $1.1 million, or 15.4%, in non-interest expense.  Increases in both income and expenses are largely attributed to the Company acquiring Madison Financial Corportion on July 24, 2015. 

For the three months ended March 31, 2016 and compared to the three months ended March 31, 2015, service charge income increased $213 thousand, gains on the sale of securities increased $118 thousand and debit card interchange income increased $103 thousand.    Salaries and benefits expense increased $576 thousand, legal and professional fees increased $93 thousand and debit card expenses increased $63 thousand.  

Return on average assets was 0.74% for the three months ended March 31, 2016 and 0.70% for the three months ended March 31, 2015. Return on average equity was 8.07% for the three month period ended March 31, 2016 and 7.64% for the three month period ended March 31, 2015.

Securities available for sale increased $6.2 million from $264.2 million at December 31, 2015 to $270.4 million at March 31, 2016.  Trading assets totaled $5.6 million at March 31, 2016 compared to $5.5 million at December 31, 2015 and includes income on the investment totaling $82 thousand during the first three months of 2016 compared to $39 thousand for the three months ended March 31, 2015. 

Gross Loans increased $11.7 million from $624.1 million on December 31, 2015 to $635.8  million at March 31, 2016.  Loans acquired with Madison Financial Corporation had outstanding loan balances of $57.2 million at March 31, 2016.

The overall increase in loan balances from December 31, 2015 to March 31, 2016 is comprised of the following: an increase of $6.8 million in 1-4 family residential loans, an increase of $3.7 million in commercial loans, an increase of $2.4 million in real-estate construction loans, an increase of $677 thousand in agricultural loans, an increase of $117 thousand in non-farm and non-residential loans, a decrease of $1.7 million in multi-family residential loans and a decrease of $411 thousand in consumer and other loans.

31

Total deposits increased from $759.0 million on December 31, 2015 to $765.9 million on March 31, 2016, an increase of $6.9 million.  Non-interest bearing demand deposit accounts decreased $574 thousand from December 31, 2015 to March 31, 2016 while time deposits $250 thousand and over increased $13.3 million and other interest bearing deposit accounts decreased 5.8 million from December 31, 2015 to March 31, 2016.

Public fund account balances decreased $8.3 million from December 31, 2015 to March 31, 2016.  Public fund accounts typically decrease during the first quarter of the year and increase during the last quarter of the year due to tax payments collected during the fourth quarter and then withdrawn from the Bank during the following months.

Borrowings from the Federal Home Loan Bank decreased $1.6 million from December 31, 2015 to March 31, 2016 and  repurchase agreements increased $7.8 million from December 31, 2015 to March 31, 2016.   

Net Interest Income

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

Net interest income was $8.0 million for the three months ended March 31, 2016 compared to $6.8 million for the three months ended March 31, 2015, an increase of 18.4%.  The interest spread, excluding tax equivalent adjustments, was 3.34% for the first three months of both 2016 and 2015.

For the first three months, the yield on assets increased from 3.84% in 2015 to 3.88% in 2016, excluding tax equivalent adjustments.  The yield on loans decreased 2 basis points compared to the three months ended March 31, 2015 from 4.70% to 4.68% at March 31, 2016.  The yield on securities increased 8 basis points in the first three months of 2016 compared to 2015 from 2.31% in 2015 to 2.39% in 2016.  The cost of liabilities was 0.49% for the first three months in 2016 compared to 0.51% in 2015.  Year to date average loans, excluding overdrafts, increased $92.0 million, or 17.2% from March 31, 2015 to March 31, 2016.  Loan interest income increased $1.2 million for the first three months of 2016 compared to the first three months of 2015.  Year to date average total deposits increased from March 31, 2015 to March 31, 2016, up $105.4 million or 15.8%.  Year to date average interest bearing deposits increased $58.5 million, or 11.6%, from March 31, 2015 to March 31, 2016.  Deposit interest expense increased $71 thousand for the first three months of 2016 compared to the same period in 2015.  Year to date average borrowings, including repurchase agreements, increased $11.2 million, or 10.4% from March 31, 2015 to March 31, 2016.  Interest expense on borrowed funds, including repurchase agreements, increased $65 thousand for the first three months of 2016 compared to the same period in 2015.

The volume rate analysis for the three months ending March 31, 2016 indicates that $1.1 million of the increase in interest income is attributable to an increase in loan volume and $107 thousand of the increase in interest income is attributable to an increase in the volume of our security portfolio.  Further, an increase in loan rates caused an increase of $91 thousand in interest income and an increase in rates in our security portfolio contributed an increase of $48 thousand in interest income.  The net effect to interest income was an increase of $1.4 million for the first three months of 2016 compared to the same time period in 2015.

Also based on the following volume rate analysis, an increase interest rates contributed to a slight increase of $48 thousand in interest expense for the comparable three months, while the change in volume in deposits and borrowings was responsible for a $73 thousand increase in interest expense.  The net effect to interest expense was an increase of $121 thousand.  As a result, the increase in net interest income for the first three months in 2016 is mostly attributed to growth in the Company’s loan and security portfolios.

32

Changes in Interest Income and Expense

	Three Months Ended
	2016 vs. 2015
	Increase (Decrease) Due to Change in
(in thousands)	Volume		Rate		Net Change
INTEREST INCOME
Loans	$	1,079	$	91	$	1,170
Investment Securities		107		48		155
Other		73		(31)		42
Total Interest Income		1,259		108		1,367
INTEREST EXPENSE
Deposits
Demand		22		49		71
Savings		—		3		3
Negotiable Certificates of Deposit and Other Time Deposits		2		(5)		(3)
Securities sold under agreements to repurchase and other borrowings		56		12		68
Federal Home Loan						—
Bank advances		(7)		(11)		(18)
Total Interest Expense		73		48		121
Net Interest Income	$	1,186	$	60	$	1,246

Non-Interest Income

Non-interest income increased $477 thousand for the three months ending March 31, 2016, compared to the same period in 2015, to $2.7 million

Decreases to non-interest income for the three month period ended March 31, 2016 compared to the three months ended March 31, 2015 include a decrease of $28 thousand in gains on the sale of mortgage loans and a decrease of $36 thousand in other income.  Favorable variances to non-interest income for the first three months of 2016 include, an increase of $213 thousand in service charge income, an increase of $118 thousand in gains on the sale of securities, an increase of $103 thousand in debit card interchange income and an increase of $78 thousand in brokerage income. 

The gain on the sale of mortgage loans decreased from $327 thousand during the first three months of 2015 to $299 thousand during the first three months of 2016, a decrease of $28 thousand.  The volume of loans originated to sell during the first three months of 2016 decreased $1.7 million compared to the same time period in 2015.

For the three months ending March 31, 2016, the volume of loans originated for sale decreased $1.7 million compared to the same three months in 2015.  The volume of mortgage loan originations and sales is generally inverse to rate changes.  A change in the mortgage loan rate environment can have a significant impact on the related gain on sale of mortgage loans.  Loan service fee income, net of amortization and impairment expense, was $51 thousand for the three months ended March 31, 2016 compared to $53 thousand for the three months ended March 31, 2015, a decrease of $2 thousand.  During the first three months of 2016, the market value adjustment to the carrying value of the mortgage servicing right was a positive net amount of $3 thousand, as the fair value of this asset increased.  During the first three months of 2015, the carrying value of the mortgage servicing had a favorable adjustment of $14 thousand, as the fair value of this asset increased. 

Non-Interest Expense

Total non-interest expense increased $1.1 million for the three month period ending March 31, 2016 compared to the same period in 2015. 

33

For the comparable three month periods, salaries and benefits increased $576 thousand, an increase of 15.2%.  The number of full time equivalent employees at March 31, 2016 was 247 compared to 229 one year ago.  The increase in the number of full time equivalents is largely attributed to acquiring Madison Financial Corporation on July 24, 2015.

Occupancy expenses decreased $14 thousand to $918 thousand for the first three months of 2016 compared to the same time period in 2015.  Building rent expense increased $21 thousand due to acquiring Madison Financial Corporation on July 24, 2015.  The acquisition provided the Company three additional branches in Richmond, KY, all of which are leased.  Depreciation expense increased $13 thousand for the three months ended March 31, 2016 compared to March 31, 2015.  Expenses incurred for assets with a cost of less than one thousand decreased $63 thousand during the first three months of 2016 compared to the first three months of 2015 which are not capitalized but are instead recorded to expense as incurred.  This decrease is attributed to purchasing additional equipment during the first quarter of 2015 which resulted in additional expense.

Legal and professional fees increased $93 thousand for the first three months ending March 31, 2016 compared to the same time period in 2015. Repossession expenses increased $67 thousand for the first three months ended March 31, 2016 compared to the same time period in 2015.  Repossession expenses are reported net of rental income earned on repossessed properties.  Net repossession expenses were higher during the first three months of 2016 when compared to 2015 due to net write-downs totaling $85 thousand in 2016 compared to net write-downs of $26 thousand in 2015.  Debit card expenses increased $63 thousand for the first three months of 2016 compared to the first three months of 2015 due to increased volume.

Income Taxes

The effective tax rate for the three months ended March 31, 2016 was 10.5% compared to 0.1% in 2015.  These effective tax rates are less than the statutory rate as a result of the Company investing in tax-free securities, loans and other investments which generate tax credits for the Company.  The Company also has a captive insurance subsidiary which contributes to reducing taxable income.  Income tax expense increased $215 thousand for the three months ending March 31, 2016 compared to the first three months in 2015.  Income tax expense increased largely due to an increase of $537 thousand in income before tax expense.  Tax-exempt interest income increased $123 thousand for the first three months of 2016 compared to the first three months of 2015.

Further, for the first three months of 2016, the Company had tax credits totaling $172 thousand for investments made in low income housing projects which represented an increase of $19 thousand compared to similar tax credits for the first three months of 2015.

As part of normal business, the Bank typically makes tax free loans to select municipalities in our market and invests in selected tax free securities, primarily in the Commonwealth of Kentucky.  In making these investments, the Company considers the overall impact to managing our net interest margin, credit worthiness of the underlying issuer and the favorable impact on our tax position.  For the three months ending March 31, 2016, the Company averaged $89.5 million in tax free securities and $36.6 million in tax free loans.  As of March 31, 2016, the weighted average remaining maturity for the tax free securities is 112 months, while the weighted average remaining maturity for the tax free loans is 155 months.

Liquidity and Funding

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

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

34

Cash and cash equivalents were $27.1 million as of March 31, 2016 compared to $28.0 million at December 31, 2015.  The decrease in cash and cash equivalents is attributed to a decrease of $1.1 million in cash and due from banks and a decrease of $200 thousand in federal funds sold.

In addition to cash and cash equivalents, the securities portfolio provides an important source of liquidity.  Securities available for sale totaled $270.4 million at March 31, 2016 compared to $264.2 million at December 31, 2015.  Securities classified as trading assets totaled $5.6 million at March 31, 2016 compared to $5.5 million at December 31, 2015.

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

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

For the first three months of 2016, deposits increased $7.0 million. The Company’s investment portfolio increased $6.2 million and the Company’s loan portfolio increased $11.7 million.  The Company’s borrowed funds from the Federal Home Loan Bank decreased $1.6 million from December 31, 2015 to March 31, 2016 and  total repurchase agreements increased $7.8 million from December 31, 2015 to March 31, 2016.

Management is aware of the challenge of funding sustained loan growth.  Therefore, in addition to deposits, other sources of funds, such as Federal Home Loan Bank advances, may be used.  We rely on Federal Home Loan Bank advances for both liquidity and asset/liability management purposes.  These advances are used primarily to fund long-term fixed rate residential mortgage loans.  As of March 31, 2016, we have sufficient collateral to borrow an additional $70 million from the Federal Home Loan Bank.  In addition, as of March 31, 2016, $36 million is available in overnight borrowing through various correspondent banks and the Company has access to an additional $321 million in brokered deposits.  In light of this, management believes there is sufficient liquidity to meet all reasonable borrower, depositor and creditor needs in the present economic environment.

Capital Requirements

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

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

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

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

35

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, which the Company did opt-out of.

The rule limits a banking organization’s capital distributions and certain discretionary bonus payments if the banking organization does not hold a “capital conservation buffer” consisting of 2.5% of common equity Tier 1 capital to risk-weighted assets in addition to the amount necessary to meet its minimum risk-based capital requirements.  The capital conservation buffer was 0.625% at March 31, 2016.  The final rule became effective for the Bank on January 1, 2016.  In accordance with the final rule, the capital conservation buffer requirement is being phased in beginning January 1, 2016 and will continue through January 1, 2019, when the full capital conservation buffer requirement will be effective.he Company’s and the Bank’s actual amounts and ratios are presented in the table below:

36

									To Be Well
									Capitalized
									Under Prompt
					For Capital				Corrective
	Actual				Adequacy Purposes				Action Provisions
	Amount		Ratio		Amount		Ratio		Amount		Ratio
	(Dollars in Thousands)
March 31, 2016
Consolidated
Total Capital (to Risk-Weighted Assets)	$	90,106	13.4	%	$	53,891	8.0	%		N/A	N/A
Tier I Capital (to Risk-Weighted Assets)		82,871	12.3			40,418	6.0			N/A	N/A
Common Equity Tier 1 Capital (to Risk-Weighted Assets)		75,871	11.3			30,314	4.5			N/A	N/A
Tier I Capital (to Average Assets)		82,871	8.4			39,527	4.0			N/A	N/A
Bank Only
Total Capital (to Risk-Weighted Assets)	$	92,288	13.7	%	$	53,846	8.0	%	$	67,308	10.0	%
Tier I Capital (to Risk-Weighted Assets)		85,053	12.6			40,385	6.0			53,846	8.0
Common Equity Tier 1 Capital (to Risk-Weighted Assets)		85,053	12.6			30,288	4.5			43,750	6.5
Tier I Capital (to Average Assets)		85,053	8.8			38,871	4.0			48,589	5.0
December 31, 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

Non-Performing Assets

As of March 31, 2016, our non-performing assets totaled $11.1 million or 1.12% of assets compared to $11.9 million or 1.23% of assets at December 31, 2015 (See table below.)  The Company experienced a decrease of $250 thousand in non-accrual loans from December 31, 2015 to March 31, 2016.  As of March 31, 2016, non-accrual loans include$ 4.2 million in loans secured by farmland,  $1.5 million in loans secured by 1-4 family properties, $249 thousand in loans secured by non-farm and non-residential properties and $145 thousand in loans secured by real estate construction loans.  Real estate loans composed 98.9% of the non-performing loans as of March 31, 2016 and 96.5% as of December 31, 2015.  Forgone interest income on non-accrual loans totaled $26 thousand for the first three months of 2016 compared to forgone interest of $15 thousand for the same time period in 2015.  Accruing loans that are contractually 90 days or more past due as of March 31, 2016 totaled $344 thousand compared to $1.0 million at December 31, 2015, an increase of $656 thousand.

Total nonperforming and restructured loans decreased $922 thousand from December 31, 2015 to March 31, 2016.  The decrease in non-accrual loan balances contributed to the decrease in the ratio of nonperforming and restructured loans to loans which decreased 18 basis points to 1.36% from December 31, 2015 to March 31, 2016.

37

In addition, the amount the Company has recorded as other real estate owned increased $36 thousand from December 31, 2015 to March 31, 2016.  As of March 31, 2016, the amount recorded as other real estate owned totaled $2.4 million compared to $2.3 million at December 31, 2015.  During the first three months of 2016, $163 thousand in loan balances were foreclosed upon and added to other real estate properties while $0 in other real estate properties were sold.  The allowance as a percentage of non-performing and restructured loans and other real estate owned increased from 55% at December 31, 2015 to 65% at March 31, 2016.

Nonperforming and Restructured Assets

	3/31/2016			12/31/2015
	(in thousands)
Non-accrual Loans	$	6,101		$	6,351
Accruing Loans which are Contractually past due 90 days or more		344			1,000
Accruing Troubled Debt Restructurings		2,229			2,245
Total Nonperforming and Restructured Loans		8,674			9,596
Other Real Estate		2,383			2,347
Total Nonperforming and Restructured Loans and Other Real Estate	$	11,057		$	11,943
Nonperforming and Restructured Loans as a Percentage of Loans		1.36	%		1.54	%
Nonperforming and Restructured Loans and Other Real Estate as a Percentage of Total Assets		1.12	%		1.23	%
Allowance as a Percentage of Period-end Loans		1.12	%		1.04	%
Allowance as a Percentage of Non-performing and Restructured Loans and Other Real Estate		65	%		55	%

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

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

Provision for Loan Losses

The loan loss provision for the first three months of 2016 was $375 thousand compared to $300 thousand for the first three months of 2015.   The increase in the total loan loss provision during the first three months of 2016 compared to the same time period in 2015 is attributed to growth in the Bank’s loan portfolio and one loan becoming impaired during the first quarter of 2016 which had a specific reserve of $350 thousand as of March 31, 2016.  Further, during the first quarter of 2016, the Company recovered $259 thousand for a loan that was charged off in a prior year which was included in the allowance for loan losses as of March 31, 2016 and reduced the need for additional loan loss provision expense.

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

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

38

Nonperforming loans and restructured loans decreased $922 thousand from December 31, 2015 to $8.7 million as of March 31, 2016.  Other real estate owned properties owned increased $36 thousand over this same time period.  Additions to other real estate properties totaled $163 thousand, sales of other real estate owned properties totaled $0 and valuation adjustments were a net write-down of $85 thousand.

The Company recorded net recoveries of $251 thousand for the three months ended March 31, 2016 compared to net charge-offs of $392 thousand for the three months ended March 31, 2015.  During the first quarter of 2016, the Company recorded a recovery of $259 for one loan which was charged-off in a prior year.  Future levels of charge-offs will be determined by the particular facts and circumstances surrounding individual loans.

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

Loan Losses

	Three Months Ended March 31,
	(in thousands)
		2016			2015
Balance at Beginning of Period Amounts Charged-off:	$	6,521		$	6,012
Commercial		—			25
1-4 family residential		—			32
Multi-family residential		12			—
Agricultural		—			242
Consumer and other		413			323
Total Charged-off Loans		425			622
Recoveries on Amounts Previously Charged-off:
Commercial		31			—
Real Estate Construction		6			2
1-4 family residential		5			3
Multi-family residential		3			—
Non-farm & non-residential		266			—
Agricultural		11			1
Consumer and other		354			224
Total Recoveries		676			230
Net Charge-offs		(251)			392
Provision for Loan Losses		375			300
Balance at End of Period		7,147			5,920
Loans
Average		629,122			536,998
At March 31,		635,783			538,644
As a Percentage of Average Loans:
Net Charge-offs for the period		(0.04)	%		0.07	%
Provision for Loan Losses for the period		0.06	%		0.06	%
Allowance as a Multiple of Net Charge-offs annualized		(7.1)			3.8

Item 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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

39

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

Management realizes certain risks are inherent and that the goal is to identify and minimize the risks.  The primary tools used by management are interest rate shock and economic value of equity (EVE) simulations.  The Company has $5.5 million in market risk sensitive instruments which are held for trading purposes.  These assets are held for a minimal period of time and are used to generate profits on short-term differences in price while earning interest for the time they are held.

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

The projections are based on balance sheet growth assumptions and repricing opportunities for new, maturing and adjustable rate amounts.  As of March 31, 2016, the projected percentage changes are within limits approved by our Board of Directors (“Board”).  Although management does analyze and monitor the projected percentage change in a declining interest rate environment, due to the current rate environment many of the current deposit rates cannot decline an additional 100 basis points.  Therefore, management places more emphasis in the rising rate environment scenarios.  Similar to prior periods, this period’s volatility is slightly lower in each rate shock simulation when compared to the same period a year ago.  The projected net interest income report summarizing our interest rate sensitivity as of March 31, 2016 is as follows:

PROJECTED NET INTEREST INCOME

(dollars in thousands)

	Level
Change in basis points:	- 100			Rates		+ 100			+ 300
Year One (4/16 - 3/17)
Net interest income	$	31,284		$	31,994	$	31,996		$	31,787
Net interest income dollar change		(709)			N/A		2			(207)
Net interest income percentage change		(2.2)	%		N/A		0.0	%		(0.7)	%
Board approved limit		>-4.0	%		N/A		>-4.0	%		>-10.0	%

The projected net interest income report summarizing the Company’s interest rate sensitivity as of March 31, 2015 is as follows:

PROJECTED NET INTEREST INCOME

(dollars in thousands)

	Level
Change in basis points:	- 100			Rates		+ 100			+ 300
Year One (4/15 - 3/16)
Net interest income	$	27,403		$	28,266	$	28,478		$	28,417
Net interest income dollar change		(864)			N/A		212			151
Net interest income percentage change		(3.1)	%		N/A		0.8	%		0.5	%
Board approved limit		>-4.0	%		N/A		>-4.0	%		>-10.0	%

Projections from March 31, 2016, year one reflected a decline in net interest income of 2.2% with a 100 basis point decline compared to the 3.1% decline in 2015.  The 100 basis point increase in rates reflected a 0.0% increase in net interest income in 2016 compared to an increase of 0.8% in 2015.

EVE applies discounting techniques to future cash flows to determine the present value of assets, liabilities, and therefore equity.  Based upon applying these techniques to the March 31, 2016,balance sheet, a 100 basis point increase in rates results in a 10.4% decrease in EVE.  A 100 basis point decrease in rates results in a 0.2% increase in EVE.  These are within the Board approved limits.

40

Item 4 - CONTROLS AND PROCEDURES

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

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

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

Part II - Other Information

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

ISSUER PURCHASES OF EQUITY SECURITIES

	(a)			(c) Total Number	(d) Maximum Number
	Total	(b)		of Shares (or Units)	(or Approximate Dollar
	Number of	Average		Purchased as Part	Value) of Shares (or
	Shares (or	Price Paid		of Publicly	Units) that May Yet Be
	Units)	Per Share		Announced Plans	Purchased Under the
Period	Purchased	(or Unit)		Or Programs	Plans or Programs
1/1/16-1/31/16	—	$	—	—	82,256	shares
2/1/16-2/29/16	500		26.61	500	81,756	shares
3/1/16-3/31/16	—		—	—	81,756	shares
Total	500	$	26.61	500	81,756	shares

On October 25, 2000, we announced that our Board approved a stock repurchase program and authorized the Company to purchase up to 100,000 shares of its outstanding common stock.  On November 11, 2002, the Board approved and authorized the Company’s repurchase of an additional 100,000 shares.  On May 20, 2008, the Board of Directors approved and authorized the Company to purchase an additional 100,000 shares.  On May 17, 2011, the Board approved and authorized the Company’s repurchase of an additional 100,000 shares.  Shares will be purchased from time to time in the open market depending on market prices and other considerations.  Through March 31, 2016, 318,244 shares have been purchased.

41

Item 6.     Exhibits

Ay
2.1	Agreement and Plan of Merger with Peoples Bancorp of Sandy Hook is incorporated by reference to Exhibit 2.1 of the Registrant’s Current Report on Form 8-K dated and filed February 24, 2006.
2.2	Agreement and Plan of Share Exchange with Madison Financial Corporation is incorporated by reference to Exhibit 2.1 of the Registrant’s Current Report on Form 8-K dated and filed January 21, 2015.
3.1	Amended and Restated Articles of Incorporation of the Registrant are incorporated by reference to Exhibit 3.1 of the Registrant’s Quarterly Report on Form 10-Q for the quarterly period ending March 31, 2000 and filed May 15, 2000.
3.2	Bylaws of the Registrant are incorporated by reference to Exhibit 3.1 of the Registrant’s Current Report on Form 8-K dated and filed November 21, 2007.
3.3	Articles of Amendment to Amended and Restated Articles of Incorporation of the Registrant are incorporated by reference to Exhibit 3.3 of the Registrant’s Annual Report of Form 10-K for the period ending December 31, 2005 and filed March 29, 2006.
31.1	Certifications of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2	Certifications of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32	Certifications of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101	The following financial information from Kentucky Bancshares, Inc. Quarterly Report on Form 10-Q for the period ended March 31, 2016, filed with the SEC on May 13, 2016, formatted in Extensible Business Reporting Language (XBRL): (i) Consolidated Balance Sheets at March 31, 2016,and December 31, 2015, (ii) Consolidated Statements of Income and Comprehensive Income (Loss) for the three months ended March 31, 2016 and March 31, 2015, (iii) Consolidated Statement of Stockholders’ Equity for the three months ended March 31, 2016, (iv) Consolidated Statements of Cash Flows for the three months ended March 31, 2016 and March 31, 2015 and (v) Notes to Consolidated Financial Statements.

42

SIGNATURES

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

		KENTUCKY BANCSHARES, INC.
Date	5/13/16	/s/Louis Prichard
		Louis Prichard, President and C.E.O.
Date	5/13/16	/s/Gregory J. Dawson
		Gregory J. Dawson, Chief Financial Officer

43