Kentucky Bancshares (KTYB) 10-Q 2016 Q2 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 June 30, 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 July 31, 2016:  2,993,851.

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	34
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	44
Item 4.	Controls and Procedures	45
Part II - Other Information		46
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	46
Item 6.	Exhibits	47
Signatures		48

2

Item 1 – Financial Statements

KENTUCKY BANCSHARES, INC.

CONSOLIDATED BALANCE SHEETS (unaudited)

(in thousands, except per share amounts)

	6/30/2016		12/31/2015
ASSETS
Cash and due from banks	$	15,459	$	26,546
Federal funds sold		1,169		1,502
Cash and cash equivalents		16,628		28,048
Interest bearing time deposits		4,829		4,874
Securities available for sale		266,722		264,212
Trading Assets		5,704		5,531
Mortgage loans held for sale		1,485		624
Loans		653,277		624,121
Allowance for loan losses		(7,259)		(6,521)
Net loans		646,018		617,600
Federal Home Loan Bank stock		7,034		7,034
Real estate owned, net		2,440		2,347
Bank premises and equipment, net		16,345		16,597
Interest receivable		3,641		3,681
Mortgage servicing rights		1,233		1,277
Goodwill		14,001		14,001
Other intangible assets		617		773
Other assets		7,371		8,085
Total assets	$	994,068	$	974,684
LIABILITIES AND STOCKHOLDERS’ EQUITY
Deposits
Non-interest bearing	$	205,693	$	209,289
Time deposits, $250,000 and over		67,927		61,199
Other interest bearing		477,776		488,493
Total deposits		751,396		758,981
Repurchase agreements		26,057		18,514
Long-term Federal Home Loan Bank advances		99,617		87,833
Note payable		4,695		4,794
Subordinated debentures		7,217		7,217
Interest payable		693		659
Other liabilities		8,594		7,273
Total liabilities		898,269		885,271
Stockholders’ equity
Preferred stock, 300,000 shares authorized and unissued		—		—
Common stock, no par value; 10,000,000 shares authorized; 2,993,851 and 2,989,205 shares issued and outstanding in June 2016 and December 2015		20,829		20,730
Retained earnings		70,568		68,324
Accumulated other comprehensive income		4,402		359
Total stockholders’ equity		95,799		89,413
Total liabilities and stockholders’ equity	$	994,068	$	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				Six Months Ended
	6/30/2016		6/30/2015		6/30/2016		6/30/2015
INTEREST INCOME:
Loans, including fees	$	7,423	$	6,346	$	14,802	$	12,555
Securities
Taxable		866		692		1,773		1,425
Tax exempt		661		690		1,318		1,366
Trading assets		31		39		73		83
Other		105		68		218		137
Total interest income		9,086		7,835		18,184		15,566
INTEREST EXPENSE:
Deposits		555		493		1,112		979
Repurchase agreements		27		24		53		47
Federal Home Loan Bank advances		393		397		777		799
Note payable		59		—		120		—
Subordinated debentures		67		58		128		115
Total interest expense		1,101		972		2,190		1,940
Net interest income		7,985		6,863		15,994		13,626
Provision for loan losses		225		350		600		650
Net interest income after provision		7,760		6,513		15,394		12,976
NON-INTEREST INCOME:
Service charges		1,264		1,091		2,381		1,995
Loan service fee income, net		(2)		55		49		108
Trust department income		261		259		524		536
Gain on sale of available for sale securities, net		151		243		277		251
Gain (loss) on trading assets		60		(48)		100		(53)
Gain on sale of mortgage loans		457		441		756		768
Brokerage income		250		136		434		242
Debit card interchange income		710		623		1,354		1,164
Other		135		822		158		881
Total other income		3,286		3,622		6,033		5,892
NON-INTEREST EXPENSE:
Salaries and employee benefits		4,562		4,150		8,932		7,944
Occupancy expenses		939		854		1,857		1,786
Repossession expenses, net		31		237		143		282
FDIC Insurance		164		145		338		301
Legal and professional fees		513		293		891		578
Data processing		427		386		853		753
Debit card expenses		368		293		687		549
Amortization expense of intangible assets, excluding mortgage servicing right		77		30		156		61
Advertising and marketing		225		212		450		425
Taxes other than payroll, property and income		279		229		554		459
Telephone		94		77		185		145
Postage		101		90		190		171
Loan fees		46		104		91		197
Other		782		608		1,609		1,274
Total other expenses		8,608		7,708		16,936		14,925
Income before taxes		2,438		2,427		4,491		3,943
Income taxes		356		305		572		306
Net income	$	2,082	$	2,122	$	3,919	$	3,637
Other Comprehensive Income, net of tax:
Change in Unrealized Gains on Securities		1,656		(2,160)		4,043		(1,223)
Comprehensive Income (Loss)	$	3,738	$	(38)	$	7,962	$	2,414
Earnings per share
Basic	$	0.70	$	0.77	$	1.31	$	1.33
Diluted		0.70		0.77		1.31		1.33
Dividends per share		0.27		0.26		0.54		0.52

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	—		80		—		—		80
Common stock purchased and retired	(2,876)		(30)		(57)		—		(87)
Other comprehensive income							4,043		4,043
Net income	—		—		3,919		—		3,919
Dividends declared - $0.54 per share	—		—		(1,618)		—		(1,618)
Balances, June 30, 2016	2,993,851	$	20,829	$	70,568	$	4,402	$	95,799

(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)

	Six Months Ended
	6/30/2016		6/30/2015
Cash Flows From Operating Activities
Net Income	$	3,919	$	3,637
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		819		843
Securities amortization (accretion), net		527		494
Stock based compensation expense		80		66
Provision for loan losses		600		650
Securities available for sale gains, net		(277)		(251)
Net change in trading assets		(173)		(30)
Originations of loans held for sale		(23,913)		(24,562)
Proceeds from sale of loans		23,808		24,387
Losses (gains) on other real estate		—		59
Gain on sale of mortgage loans		(756)		(768)
Write-downs of other real estate, net		85		227
Changes in:
Interest receivable		40		(362)
Other assets		714		(469)
Interest payable		34		16
Other liabilities		(735)		(2,165)
Net cash from operating activities		4,772		1,772
Cash Flows From Investing Activities
Net change in interest bearing time deposits		45		—
Purchases of securities available for sale		(48,094)		(20,074)
Proceeds from sales of securities		21,388		9,051
Proceeds from principal payments, maturities and calls of securities		30,087		18,313
Net change in loans		(29,073)		(11,543)
Purchases of bank premises and equipment		(547)		(440)
Proceeds from the sale of other real estate		15		4,057
Net cash from investing activities		(26,179)		(636)
Cash Flows From Financing Activities:
Net change in deposits		(7,585)		(10,853)
Net change in repurchase agreements and other borrowings		7,543		3,689
Proceeds from short-term Federal Home Loan Bank advances		30,000		15,000
Repayment of short-term Federal Home Loan Bank advances		(30,000)		(10,000)
Proceeds from long-term Federal Home Loan Bank advances		15,000		4,682
Repayment of long-term Federal Home Loan Bank advances		(3,216)		(3,050)
Repayment of note payable		(99)		—
Proceeds from issuance of common stock		49		2
Purchase of common stock		(87)		(10)
Dividends paid		(1,618)		(1,417)
Net cash from financing activities		9,987		(1,957)
Net change in cash and cash equivalents		(11,420)		(821)
Cash and cash equivalents at beginning of period		28,048		17,169
Cash and cash equivalents at end of period	$	16,628	$	16,348
Supplemental disclosures of cash flow information Cash paid during the year for:
Interest expense	$	2,156	$	1,924
Supplemental disclosures of non-cash investing activities
Real estate acquired through foreclosure	$	235	$	3,334

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. 

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. 2014-09, Revenue from Contracts with Customers (Topic 606)

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

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

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

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

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

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

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

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

8

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

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

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

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

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
June 30, 2016
U. S. government agencies	$	35,736	$	588	$	—	$	36,324
States and political subdivisions		90,751		4,659		—		95,410
Mortgage-backed - residential		133,245		1,703		(310)		134,638
Equity securities		320		30		—		350
Total	$	260,052	$	6,980	$	(310)	$	266,722
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

9

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

	Amortized		Fair
	Cost		Value
Due in one year or less	$	—	$	—
Due after one year through five years		23,522		24,190
Due after five years through ten years		56,998		58,900
Due after ten years		45,967		48,644
		126,487		131,734
Mortgage-backed - residential		133,245		134,638
Equity		320		350
Total	$	260,052	$	266,722

Proceeds from sales of securities during the first six months of 2016 and 2015 were $21.4 million and $9.1 million.  Gross gains of $277 thousand and $251 thousand and gross losses of $0 and $0 were realized on those sales, respectively.  The tax provision related to these realized net gains was $94 thousand and $85 thousand, respectively. 

Proceeds from sales of securities during the three months ended June 30, 2016 and June 30, 2015 were $12.1 million and $9.1 million.  Gross gains of $151 thousand and $243 thousand and gross losses of $0 and $0 were realized on those sales, respectively.  The tax provision related to these realized net gains was $51 thousand and $83 thousand, respectively.

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

June 30, 2016

	Less than 12 Months				12 Months or More				Total
	Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
Description of Securities	Value		Loss		Value		Loss		Value		Loss
U.S. Government agencies	$	—	$	—	$	—	$	—	$	—	$	—
States and municipals		—		—		—		—		—		—
Mortgage-backed - residential		22,211		(168)		10,390		(142)		32,601		(310)
Total temporarily impaired	$	22,211	$	(168)	$	10,390	$	(142)	$	32,601	$	(310)

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)

10

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 $5.7 million are primarily comprised of cash and cash equivalents and municipal securities which are generally held for 60 days or less.

3.LOANS

Loans at period-end are as follows:

(in thousands)

	6/30/2016		12/31/2015
Commercial	$	72,450	$	55,929
Real estate construction		31,197		29,320
Real estate mortgage:
1-4 family residential		242,462		230,721
Multi-family residential		39,082		38,281
Non-farm & non-residential		180,729		183,692
Agricultural		68,236		66,782
Consumer		18,894		18,880
Other		227		516
Total	$	653,277	$	624,121

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

	6/30/2016		12/31/2015
Commercial	$	1,371	$	1,505
Real estate construction		1,170		1,616
Real estate mortgage:
1-4 family residential		14,102		16,376
Multi-family residential		5,521		5,652
Non-farm & non-residential		20,630		29,029
Agricultural		1,982		2,194
Consumer		189		379
Total	$	44,965	$	56,751

11

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

	Six Months Ended June 30, 2016
	(in thousands)
	Beginning								Ending
	Balance		Charge-offs		Recoveries		Provision		Balance
Commercial	$	486	$	—	$	34	$	146	$	666
Real estate Construction		411		—		13		128		552
Real estate mortgage:
1-4 family residential		2,081		(64)		7		280		2,304
Multi-family residential		458		—		4		45		507
Non-farm & non-residential		1,213		—		273		(328)		1,158
Agricultural		678		—		23		100		801
Consumer		525		(163)		70		118		550
Other		60		(499)		440		49		50
Unallocated		609		—		—		62		671
	$	6,521	$	(726)	$	864	$	600	$	7,259

	Three Months Ended June 30, 2016
	(in thousands)
	Beginning								Ending
	Balance		Charge-offs		Recoveries		Provision		Balance
Commercial	$	508	$	—	$	3	$	155	$	666
Real estate construction		876		—		7		(331)		552
Real estate mortgage:
1-4 family residential		2,176		(52)		2		178		2,304
Multi-family residential		472		—		1		34		507
Non-farm & non-residential		1,181		—		7		(30)		1,158
Agricultural		727		—		12		62		801
Consumer		531		(53)		13		59		550
Other		60		(196)		143		43		50
Unallocated		616		—		—		55		671
	$	7,147	$	(301)	$	188	$	225	$	7,259

	Six Months Ended June 30, 2015
	(in thousands)
	Beginning								Ending
	Balance		Charge-offs		Recoveries		Provision		Balance
Commercial	$	339	$	(25)	$	-	$	85	$	399
Real estate Construction		446		-		2		28		476
Real estate mortgage:
1-4 family residential		1,829		(152)		5		125		1,807
Multi-family residential		495		(94)		2		39		442
Non-farm & non-residential		813		-		-		261		1,074
Agricultural		998		(242)		12		(190)		578
Consumer		520		(163)		27		150		534
Other		32		(493)		409		107		55
Unallocated		540		-		-		45		585
	$	6,012	$	(1,169)	$	457	$	650	$	5,950

12

	Three Months Ended June 30, 2015
	(in thousands)
	Beginning								Ending
	Balance		Charge-offs		Recoveries		Provision		Balance
Commercial	$	340	$	-	$	-	$	59	$	399
Real estate Construction		438		-		-		38		476
Real estate mortgage:
1-4 family residential		1,825		(120)		2		100		1,807
Multi-family residential		499		(94)		2		35		442
Non-farm & non-residential		1,030		-		-		44		1,074
Agricultural		723		0		11		(156)		578
Consumer		497		(82)		12		107		534
Other		34		(251)		200		72		55
Unallocated		534		-		-		51		585
	$	5,920	$	(547)	$	227	$	350	$	5,950

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:

	6/30/2016		12/31/2015
Commercial	$	—	$	4
Real estate mortgage:
Construction		—		8
1-4 family residential		1,837		2,039
Non-farm & non-residential		174		667
Agricultural		282		418
	$	2,293	$	3,136

There was no associated allowance for loan losses as of June 30, 2016 or December 31, 2015 for purchased credit impaired loans.  The contractual principal balance of these loans was $3.2 million at June 30, 2016 and $4.2 million at December 31, 2015.

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

	Three Months Ended		Six Months Ended
	6/30/2016		6/30/2016
Balance, beginning of period	$	339	$	408
New loans purchased		—		—
Accretion of income		111		180
Balance, end of period	$	228	$	228

13

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

	Individually		Collectively		Purchased
As of June 30, 2016	Evaluated for		Evaluated for		Credit
(in thousands)	Impairment		Impairment		Impaired		Total
Allowance for Loan Losses:
Commercial	$	—	$	666	$	—	$	666
Real estate construction		16		536		—		552
Real estate mortgage:
1-4 family residential		127		2,177		—		2,304
Multi-family residential		—		507		—		507
Non-farm & non-residential		46		1,112		—		1,158
Agricultural		427		374		—		801
Consumer		—		550		—		550
Other		—		50		—		50
Unallocated		—		671		—		671
	$	616	$	6,643	$	—	$	7,259
Loans:
Commercial	$	—	$	72,450	$	—	$	72,450
Real estate construction		180		31,017		—		31,197
Real estate mortgage:
1-4 family residential		1,301		239,243		1,918		242,462
Multi-family residential		—		39,082		—		39,082
Non-farm & non-residential		2,141		177,930		658		180,729
Agricultural		4,611		63,219		406		68,236
Consumer		—		18,894		—		18,894
Other		—		227		—		227
	$	8,233	$	642,062	$	2,982	$	653,277

14

	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
Total	$	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 six months ended June 30, 2016 (in thousands):

	Unpaid				Allowance for		Average		Interest		Cash Basis
	Principal		Recorded		Loan Losses		Recorded		Income		Interest
	Balance		Investment		Allocated		Investment		Recognized		Recognized
With no related allowance recorded:
Real estate mortgage:
1-4 family residential	$	238	$	238	$	—	$	304	$	4	$	4
Agricultural		654		654		—		393		25		25
With an allowance recorded:
Real estate mortgage:
Construction		180		180		16		689		20		20
1-4 family residential		1,063		1,063		127		1,067		27		27
Non-farm & non-residential		2,141		2,141		46		2,070		41		41
Agricultural		3,957		3,957		427		3,689		—		—
Total	$	8,233	$	8,233	$	616	$	8,212	$	117	$	117

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

15

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

			Year to Date		Year to Date
	Average		Interest		Cash Basis
	Recorded		Income		Interest
(in thousands):	Investment		Recognized		Recognized
With no related allowance recorded:
Real estate mortgage:
1-4 family residential	$	1,524	$	42	$	42
Agricultural		362		27		27
With an allowance recorded:
Real estate mortgage:
1-4 family residential		556		10		10
Multi-family residential		119		—		—
Non-farm & non-residential		2,940		59		59
Agricultural		5,215		—		—
Total	$	10,716	$	138	$	138

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.

16

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

	Three Months Ending June 30, 2016
	Average		Interest		Cash Basis
	Recorded		Income		Interest
(in thousands):	Investment		Recognized		Recognized
With no related allowance recorded:
Real estate mortgage:	$
1-4 family residential		947		40		2
Agricultural		292		47		3
With an allowance recorded:
Real estate mortgage:
Construction		2,394		—		32
1-4 family residential		720		1		5
Non-farm & non-residential		2,070		23		18
Agricultural		3,957		—		—
Total	$	8,849	$	60	$	60

	Three Months Ending June 30, 2015
	Average		Interest		Cash Basis
	Recorded		Income		Interest
	Investment		Recognized		Recognized
With no related allowance recorded:
Real estate mortgage:
1-4 family residential	$	1,476	$	28	$	28
Agricultural		322		17		17
With an allowance recorded:
Real estate mortgage:
1-4 family residential		556		5		5
Multi-family residential		47		—		—
Non-farm & non-residential		2,931		30		30
Agricultural		4,025		—		—
Total	$	9,357	$	80	$	80

17

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 June 30, 2016 and December 31, 2015:

			Loans Past Due
			Over 90 Days
As of June 30, 2016			Still		Troubled Debt
(in thousands)	Nonaccrual		Accruing		Restructurings
Commercial	$	—	$	—	$	—
Real estate construction		—		—		—
Real estate mortgage:
1-4 family residential		1,165		186		461
Multi-family residential		126		—		—
Non-farm & non-residential		78		390		1,752
Agricultural		4,251		23		—
Consumer		8		15		—
Total	$	5,628	$	614	$	2,213
Loans included in totals above acquired from Madison Financial Corporation	$	642	$	—	$	—

			Loans Past Due
			Over 90 Days
As of December 31, 2015			Still		Troubled Debt
(in thousands)	Nonaccrual		Accruing		Restructurings
Commercial	$	6	$	—	$	—
Real estate construction		145		365		—
Real estate mortgage:
1-4 family residential		1,531		471		468
Multi-family residential		—		—		—
Non-farm & non-residential		481		137		1,777
Agricultural		4,171		—		—
Consumer		17		27		—
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 97.3% of the total nonaccrual loan balances at June 30, 2016.

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

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

18

interruptions in cash flow, but ultimately are current or less than 90 days past due with respect to principal and interest and for which we anticipate full payment of principal and interest but not in accordance with contractual terms.

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

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

	30–59		60–89		Greater than				Total
As of June 30, 2016	Days		Days		90 Days				Past Due &		Loans Not
(in thousands)	Past Due		Past Due		Past Due		Non-accrual		Non-accrual		Past Due
Commercial	$	350	$	4	$	—	$	—	$	354	$	72,096
Real estate construction		—		—		—		—		—		31,197
Real estate mortgage:
1-4 family residential		1,499		357		186		1,165		3,207		239,255
Multi-family residential		—		—		—		126		126		38,956
Non-farm & non-residential		244		—		390		78		712		180,017
Agricultural		64		—		23		4,251		4,338		63,898
Consumer		63		14		15		8		100		18,794
Other		—		—		—		—		—		227
Total	$	2,220	$	375	$	614	$	5,628	$	8,837	$	644,440
Loans included in totals above acquired from Madison Financial Corp.	$	161	$	—	$	—	$	642	$	803	$	44,162

	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 $79 thousand in specific reserves to customers whose loan terms have been modified in troubled debt restructurings as of June 30, 2016.  The Company allocated $101 thousand for specific reserves to customers whose loan terms had been modified in troubled debt restructuring as of December 31, 2015.  The Company has not committed to lend additional amounts as of June 30, 2016 and December 31, 2015 to customers with outstanding loans that are classified as troubled debt restructurings.

19

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  June 30, 2016 and December 31, 2015.  No loans were modified as troubled debt restructurings during the first six months ended of 2016 or 2015.

Credit Quality Indicators:

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

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

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

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

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

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

As of June 30, 2016			Special
(in thousands)	Pass		Mention		Substandard		Doubtful
Commercial	$	71,041	$	1,197	$	212	$	—
Real estate construction		28,337		2,183		677		—
Real estate mortgage:
1-4 family residential		230,497		5,169		6,770		26
Multi-family residential		34,236		3,914		932		—
Non-farm & non-residential		175,919		3,820		990		—
Agricultural		58,804		3,732		5,697		3
Total	$	598,834	$	20,015	$	15,278	$	29
Loans included in totals above acquired from Madison Financial Corporation	$	37,875	$	4,148	$	2,942	$	—

20

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 $23 thousand at June 30, 2016 and $6 thousand at December 31, 2015.

4.REAL ESTATE OWNED

Activity in real estate owned, net was as follows:

	Six Months Ended
	June 30,
	2016		2015
Beginning of year	$	2,347	$	4,603
Additions		193		3,334
Sales		(15)		(4,727)
(Additions) subtractions to valuation allowance, net		(85)		385
End of period	$	2,440	$	3,595

Activity in the valuation allowance was as follows:

	Six Months Ended
	June 30,
	2016		2015
Beginning of year	$	616	$	1,583
Write-downs of other real estate, net		85		227
Reductions from sale		—		(612)
End of Period	$	701	$	1,198

21

Expenses related to foreclosed assets include:

	Six Months Ended
	June 30,
	2016		2015
Net loss on sales	$	—	$	59
Additions to valuation allowance, net		85		227
Operating expenses, net of rental income		58		55
Repossession expense, net		143		282
Net expenses	$	143	$	341

	Three Months Ended
	June 30,
	2016		2015
		(in thousands)
Net loss on sales	$	—	$	20
Additions to valuation allowance, net		—		201
Operating expenses, net of rental income		31		36
Repossession expenses, net		31		237
For the period	$	31	$	257

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:

	Six Months Ended
	June 30,
	2016		2015
	(in thousands)
Basic Earnings Per Share
Net Income	$	3,919	$	3,637
Weighted average common shares outstanding		2,977		2,707
Basic earnings per share	$	1.31	$	1.33
Diluted Earnings Per Share
Net Income	$	3,919	$	3,637
Weighted average common shares outstanding		2,977		2,707
Weighted average common and dilutive potential common shares outstanding		2,977		2,707
Diluted earnings per share	$	1.31	$	1.33

22

	Three Months Ended
	June 30,
	2016		2015
	(in thousands)
Basic Earnings Per Share
Net Income	$	2,082	$	2,122
Weighted average common shares outstanding		2,977		2,707
Basic earnings per share	$	0.70	$	0.77
Diluted Earnings Per Share
Net Income	$	2,082	$	2,122
Weighted average common shares outstanding		2,977		2,707
Weighted average common and dilutive potential common shares outstanding		2,977		2,707
Diluted earnings per share	$	0.70	$	0.77

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

6.STOCK COMPENSATION

We have four stock based compensation plans as described below.

Two Stock Option Plans

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

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

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

				Weighted
		Weighted		Average
		Average		Remaining		Aggregate
		Exercise		Contractual		Intrinsic
	Shares	Price		Term		Value
Outstanding, beginning of year	2,400	$	30.37
Granted	—		—
Forfeited or expired	(1,200)		29.75
Exercised	—		—
Outstanding, end of year	1,200	$	31.00	14.0	months	$	—
Vested and expected to vest	1,200	$	31.00	14.0	months	$	—
Exercisable, end of period	1,200	$	31.00	14.0	months	$	—

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

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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 six months of 2016 and 5,385 shares issued during the first six months of 2015.  The plan is now expired and no additional shares will be issued from the 2005 plan.  There were no shares forfeited during the first six 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	(5,799)		(125,087)		21.57
Forfeited	—		—		—
Nonvested at June 30, 2016	6,897	$	146,278	$	21.21

As of June 30, 2016, there was $230 thousand of total unrecognized compensation cost related to nonvested shares granted under the restricted stock grant plan.  The cost is expected to be recognized over a weighted-average period of 2.7 years. As June 30, 2016, no additional shares are available for issuance under the restricted stock grant plan.

2009 Stock Award Plan

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

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

		Weighted-Average		Fair
		Grant-Date		Value
Nonvested Shares	Shares	Fair Value		Per Share
Nonvested at January 1, 2016	6,800	$	170,263	$	25.04
Granted	6,170		182,941		29.65
Vested	(353)		(9,749)		27.62
Forfeited	—		—		—
Nonvested at June 30, 2016	12,617	$	343,455	$	27.22

As of June 30, 2016, there was $205 thousand of total unrecognized compensation cost related to nonvested shares granted under the restricted stock grant plan.  The cost is expected to be recognized over a weighted-average period of  4.3 years. As of June 30, 2016, 140,013 shares are still available for issuance.

7.REPURCHASE AGREEMENTS

Repurchase agreements totaled $26.1 million as of June 30, 2016. Of this, $20.1 million were overnight obligations and $6.0 million had terms extending through May 2020 and a weighted average life of 2.2 years. The Company pledged agency-backed securities with a carrying amount of $33.2 million to secure repurchase agreements as of June 30, 2016.

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8.OTHER BORROWINGS

On July 20, 2015, the Company borrowed $5 million which had an outstanding balance of $4.7 million at June 30, 2016. The term loan has a fixed interest rate of 5.02 %, requires quarterly principal and interest payments, matures July 20, 2025 and is collateralized by the Company’s stock.  The maturity schedule for the term loan as of June 30, 2016 is as follows:

2016	$	203
2017		420
2018		441
2019		464
2020		488
Thereafter		2,679
	$	4,695

9.FAIR VALUE MEASUREMENTS

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

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

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

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

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

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

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

Impaired Loans:  The fair value of impaired loans with specific allocations of the allowance for loan losses is generally based on recent third party real estate appraisals.  These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available for similar loans and collateral underlying such loans.  Such adjustments were $100 thousand for the first six months of 2016 and $14 thousand for the first six months of 2015, and $19 thousand for the three months ended June 30, 2016 and $42 thousand for the three months ended June 30, 2015, and resulted in a Level 3 classification of the inputs for

25

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 for the six months ended June 30, 2016 and $227 thousand for the six months ended June 30, 2015 and resulted in a Level 3 classification of the inputs for determining fair value.  Real estate owned properties are evaluated on a quarterly basis for additional impairment and adjusted accordingly.

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

Assets and Liabilities Measured on a Recurring Basis

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

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

			Quoted Prices
			In Active
			Markets for		Significant Other		Significant
			Identical		Observable		Unobservable
	Carrying		Assets		Inputs		Inputs
Description	Value		(Level 1)		(Level 2)		(Level 3)
U. S. government agencies	$	36,324	$	—	$	36,324	$	—
States and municipals		95,410		—		95,410		—
Mortgage-backed - residential		134,638		—		134,638		—
Equity securities		350		350		—		—
Trading Assets		5,704		5,704		—		—
Total	$	272,426	$	6,054	$	266,372	$	—

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

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

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

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

	Fair Value Measurements at June 30, 2016 Using :
			Quoted Prices
			In Active
			Markets for	Significant Other	Significant
			Identical	Observable	Unobservable
	Carrying		Assets	Inputs	Inputs
(In thousands)	Value		(Level 1)	(Level 2)	(Level 3)
Description
Impaired loans:
Real Estate Mortgage:
Construction	$	164	—	—	$	164
1-4 family Residential		526	—	—		526
Non-farm & non-residential		371	—	—		371
Other real estate owned, net:
Residential		1,419	—	—		1,419
Loan servicing rights		1,106	—	—		1,106

	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

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Impaired loans, which are measured for impairment using the fair value of the collateral for collateral dependent loans, had a carrying amount of $1.1 million, which includes a valuation allowance of $109 thousand at June 30, 2016.  During the first six months of 2016, two new loans became impaired resulting in additional loan loss provision expense of $34 thousand. The total allowance for specific impaired loans decreased $32 thousand for the six months ended June 30, 2016 and decreased $301 thousand for the six months ended June 30, 2015.The total allowance for specific impaired loans decreased $399 thousand for the three months ended June 30, 2016 and decreased $101 thousand for the three months ended June 30, 2015. The decrease of $399 thousand in the allowance for specific impaired loans during the second quarter of 2016 was mostly attributed to one loan, which had a specific reserve of $350 thousand at March 31, 2016, no longer requiring a specific reserve at June 30, 2016.  This loan had no specific reserve at December 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 June 30, 2016.  The Company recorded $85 thousand in write-downs of other real estate owned properties for the six months ended June 30, 2016. The Company recorded $227 thousand in net write-downs of other real estate owned properties during the six months ended June 30, 2015.  The Company recorded no write-downs of other real estate owned properties during the three months ended June 30, 2016 and $201 thousand in write-downs of other real-estate owned properties during the three months ended June 30, 2015.

Impaired loan servicing rights, which are carried at the lower of cost or fair value, were carried at their fair value of $1.1 million, which is made up of the outstanding balance of $1.2 million, net of a valuation allowance of $61 thousand at June 30, 2016. For the first six months of 2016, the Company recorded net write-downs of $42 thousand and  a net recovery of prior write-downs of $34 thousand for the six months ended June 30, 2015.  For the three months ended June 30, 2016, the Company recorded net write-downs of $45 thousand.  For the three months ended June 30, 2015, the Company recorded a net recovery of $20 thousand.  At December 31, 2015, impaired loan servicing rights were carried at their fair value of $87 thousand, which is made up of the outstanding balance of $106 thousand, net of a valuation allowance of $19 thousand.

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

				Range
June 30, 2016	Fair	Valuation	Unobservable	(Weighted
(In thousands)	Value	Technique(s)	Input(s)	Average)
Impaired loans
Construction	164	sales comparison	adjustment for differences between the comparable sales	1%-4%	(3)%
1-4 family	526	sales comparison	adjustment for differences between the comparable sales	0%-12%	(7)%
Non-farm & non-residential	371	sales comparison	adjustment for differences between the comparable sales	4%-44%	(23)%
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	1,106	discounted cash flow	discount rate	9%-20%	(11)%

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				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)%

Fair Value of Financial Instruments

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

June 30, 2016:

	Carrying
(in thousands)	Value		Level 1		Level 2		Level 3		Total
Financial assets
Cash and cash equivalents	$	16,628	$	16,628	$	—	$	—	$	16,628
Interest bearing deposits		4,829		4,829		—		—		4,829
Securities		266,722		350		266,372		—		266,722
Trading assets		5,704		5,704		—		—		5,704
Mortgage loans held for sale		1,485		—		1,532		—		1,532
Loans, net		646,018		—		—		645,250		645,250
FHLB Stock		7,034		—		—		—		N/A
Interest receivable		3,641		—		1,322		2,319		3,641
Financial liabilities
Deposits	$	751,396	$	557,472	$	195,233	$	—	$	752,705
Securities sold under agreements to repurchase		26,057		—		26,108		—		26,108
FHLB advances		99,617		—		98,366		—		98,366
Note payable		4,695				5,273				5,273
Subordinated debentures		7,217		—		—		7,208		7,208
Interest payable		693		—		623		70		693

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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.

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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 Six Months Ended June 30,
	2016		2015
Beginning Balance	$	359	$	791
Unrealized holding gains (losses) for the period, net of tax		4,226		(1,057)
Reclassification adjustment for:
Securities gains realized in income, net		277		251
Income taxes		(94)		(85)
		183		166
Net current period other comprehensive income		4,043		(1,223)
Ending balance	$	4,402	$	(432)

31

	Unrealized
	Gains and Losses on
	Available for Sale
	Securities
	For the Three Months Ended June 30,
	2016		2015
Beginning Balance	$	2,746	$	1,728
Unrealized holding gains (losses) for the period, net of tax		1,756		(2,000)
Reclassification adjustment for:
Securities gains realized in income, net		151		243
Income taxes		(51)		(83)
		100		160
Net current period other comprehensive income		1,656		(2,160)
Ending balance	$	4,402	$	(432)

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

June 30, 2016

Details about	Amount		Affected Line Item
Accumulated Other	Reclassified From		in the Statement
Comprehensive	Accumulated Other		Where Net
Income Components	Comprehensive Income		Income is Presented
Unrealized gains and losses on available-for-sale securities	$	277	Gain on sale of available for sale securities, net
		94	Income taxes
		183	Net income

June 30, 2015

Details about	Amount		Affected Line Item
Accumulated Other	Reclassified From		in the Statement
Comprehensive	Accumulated Other		Where Net
Income Components	Comprehensive Income		Income is Presented
Unrealized gains and losses on available-for-sale securities	$	251	Gain on sale of available for sale securities, net
		85	Income taxes
		166	Net income

32

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

June 30, 2016

Details about	Amount		Affected Line Item
Accumulated Other	Reclassified From		in the Statement
Comprehensive	Accumulated Other		Where Net
Income Components	Comprehensive Income		Income is Presented
Unrealized gains and losses on available-for-sale securities	$	151	Gain on sale of available for sale securities, net
		51	Provision for income taxes
		100	Net of tax

June 30, 2015

Details about	Amount		Affected Line Item
Accumulated Other	Reclassified From		in the Statement
Comprehensive	Accumulated Other		Where Net
Income Components	Comprehensive Income		Income is Presented
Unrealized gains and losses on available-for-sale securities	$	243	Gain on sale of available for sale securities, net
		83	Provision for income taxes
		160	Net of tax

33

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

Forward-Looking Statements

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

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

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

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

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

Summary

The Company recorded net income of $3.9 million, or $1.31 basic earnings and diluted earnings per share for the first six months ended June 30, 2016 compared to $3.6 million or $1.33 basic earnings and diluted earnings per share for the six month period ended June 30, 2015.  The first six months net earnings reflect an increase of $300 thousand, or 7.8%, compared to the same time period in 2015.  The increase in net earnings is mostly attributed to an increase of $2.4 million, or 17.4%, in net interest income and an increase of $141 thousand, or 2.4%, in non-interest income.  These positive variances were partially offset by an increase of $2.0 million, or 13.5%, in non-interest expense.  Increases in both income and expense are largely attributed to the Company acquiring Madison Financial Corportion on July 24, 2015.  The earnings for the three months ended June 30, 2016 were $2.1 million or $0.70 basic and diluted earnings per share compared to $2.1 million or $0.77 basic and diluted earnings per share for the three month period ended June 30, 2015. The earnings for the three month period in 2016 reflect a decrease of 1.9% compared to the same time period in 2014.

34

For the six months ended June 30, 2016 and compared to the six months ended June 30, 2015, service charges increased $386 thousand, brokerage fee income increased $192 thousand and debit card interchange income increased $190 thousand.  Other income decreased $723 thousand due to the Company receiving restitution for a legal settlement in 2015.   Salaries and benefits expense increased $988 thousand, legal and professional fees increased $313 thousand and other expenses increased $335 thousand.   For the three months ended June 30, 2016 and compared to the three months ended June 30, 2015, service charges increased $173 thousand and brokerage income increased $114 thousand.  Other income decreased $687 thousand due to the Company receiving restitution for a legal settlement in 2015.  For the three months ended June 30, 2016 and compared to the three months ended June 30, 2015, salaries and benefits expense increased $412 thousand and legal and professional fees increased $220 thousand, while repossession expense decreased $206 thousand.

Return on average assets was 0.79% for the six months ended June 30, 2016 and 0.84% for the six months ended June 30, 2015. Return on average assets was 0.83% for the three months ended June 30, 2016 and 0.99% for the three months ended June 30, 2015.   Return on average equity was 8.49% for the six month period ended June 30, 2016 and 9.14% for the six month period ended June 30, 2015.  Return on average equity was 8.91% for the three month period ended June 30, 2016 and 10.64% for the three month period ended June 30, 2015. 

Securities available for sale increased $2.5 million from $264.2 million at December 31, 2015 to $266.7 million at June 30, 2016.  Trading assets totaled $5.7 million at June 30, 2016 compared to $5.5 million at December 31, 2015 and includes income on the investment totaling $173 thousand during the first six months of 2016 compared to $30 thousand for the six months ended June 30, 2015.  Income (loss) on the trading account totaled $91 thousand for the three months ended June 30, 2016 compared to ($9) thousand for the three months ended June 30, 2015. 

Gross Loans increased $29.2 million from $624.1 million on December 31, 2015 to $653.3  million at June 30, 2016.  Loans acquired with Madison Financial Corporation had outstanding loan balances of $45.0 million at June 30, 2016.

The overall increase in loan balances from December 31, 2015 to June 30, 2016 is comprised of the following: an increase of $11.7 million in 1-4 family residential loans, an increase of $16.5 million in commercial loans, an increase of $1.9 million in real-estate construction loans, an increase of $1.5 million in agricultural loans, an increase of $801 thousand in multi-family residential loans, offset by a decrease of $3.0 million in non-farm and non-residential loans and a decrease of $275 thousand in consumer and other loans.

Total deposits decreased from $759.0 million on December 31, 2015 to $751.4 million on June 30, 2016, a decrease of $7.6 million.  Non-interest bearing demand deposit accounts decreased $3.6 million from December 31, 2015 to June 30, 2016 while time deposits $250 thousand and over increased $6.7 million and other interest bearing deposit accounts decreased $10.7 million from December 31, 2015 to June 30, 2016.

Public fund account balances decreased $13.2 million from December 31, 2015 to June 30, 2016.  Public fund accounts typically decrease during the first three quarters of the year and increase during the last quarter of the year due to tax payments collected during the fourth quarter and then withdrawn from the Bank during the following months.

Borrowings from the Federal Home Loan Bank increased $11.8 million from December 31, 2015 to June 30, 2016 and  repurchase agreements increased $7.5 million from December 31, 2015 to June 30, 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 $16.0 million for the six months ended June 30, 2016 compared to $13.6 million for the six months ended June 30, 2015, an increase of 17.4%.   Net interest income was $8.0 million for the three months ended June 30, 2016 compared to $6.9 million for the three months ended June 30, 2015, an increase of 16.3%.

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The interest spread, excluding tax equivalent adjustments, was 3.37% for the first six months of 2016 compared to 3.35% for the first six months of 2015.  For the first six months in 2016, the yield on assets remained unchanged from 3.86% in 2015, excluding tax equivalent adjustments.  The yield on loans decreased 3 basis points compared to the six months ended June 30, 2015 from 4.68% to 4.65% for the six months ended June 30, 2016.  The yield on securities, excluding tax equivalent adjustments, increased 3 basis points during the first six months of 2016 compared to 2015 from 2.30% in 2015 to 2.33% in 2016.  The cost of liabilities was 0.49% for the first six months in 2016 compared to 0.50% in 2015.  The acquisition of Madison Financial on July 24, 2015 significantly resulted in larger average balances on our balance sheet.  Year to date average loans, excluding overdrafts, increased $96.4 million, or 17.9% for the six months ended June 30, 2016 compared to the six months ended June 30, 2015.  Loan interest income increased $2.2 million during the first six months of 2016 compared to the first six months of 2015.  Year to date average total deposits increased from June 30, 2015 to June 30, 2016, up $104.8 million or 15.7%.  Year to date average interest bearing deposits increased $79.4 million, or 16.4%, from June 30, 2015 to June 30, 2016.  Deposit interest expense increased $133 thousand for the first six months of 2016 compared to the same period in 2015.  Year to date average borrowings, including repurchase agreements, increased $17.0 million, or 15.8% from June 30, 2015 to June 30, 2016.  Interest expense on borrowed funds, including repurchase agreements, increased $117 thousand for the first six months of 2016 compared to the same period in 2015. 

The volume rate analysis for the six months ended June 30, 2016 indicates that $2.2 million of the increase in interest income is attributable to an increase in loan volume and $265 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 $3 thousand in interest income and an increase in rates in our security portfolio contributed an increase of $25 thousand in interest income.  The net effect to interest income was an increase of $2.6 million for the first six months of 2016 compared to the same time period in 2015.

Also based on the following volume rate analysis for the six months ended June 30, 2016, an increase in demand deposit interest rates resulted in $92 thousand additional interest expense while decreases in interest rates paid for time deposits resulted in a reduction of $177 thousand in interest expense and a decrease in rates paid for Federal Home Loan Bank borrowings resulted in savings of $57 thousand in interest expense.  The change in volume in deposits and borrowings was responsible for a $379 thousand increase in interest expense, of which an increase in time deposits resulted in an increase of $171 thousand in interest expense and an increase in repurchase agreements and other borrowings resulted in an increase of $171 thousand in interest expense.  The net effect to interest expense was an increase of $250 thousand.  As a result, the increase in net interest income for the first six months in 2016 is mostly attributed to growth in the Company’s loan and security portfolios.

The volume rate analysis for the three months ended June 30, 2016 indicates that $1.0 million of the increase in net interest income is attributable to growth in the Company’s balance sheet and $94 thousand is attributed to changes in rates.

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Changes in Interest Income and Expense

	Six Months Ended
	2016 vs. 2015
	Increase (Decrease) Due to Change in
(in thousands)	Volume		Rate		Net Change
INTEREST INCOME
Loans	$	2,244	$	3	$	2,247
Investment Securities		265		25		290
Other		84		(3)		81
Total Interest Income		2,593		25		2,618
INTEREST EXPENSE
Deposits
Demand		43		92		135
Savings		—		4		4
Negotiable Certificates of Deposit and Other Time Deposits		171		(177)		(6)
Securities sold under agreements to repurchase and other borrowings		130		9		139
Federal Home Loan						—
Bank advances		35		(57)		(22)
Total Interest Expense		379		(129)		250
Net Interest Income	$	2,214	$	154	$	2,368

	Three Months Ended
	2016 vs. 2015
	Increase (Decrease) Due to Change in
	Volume		Rate		Net Change
INTEREST INCOME
Loans	$	1,165	$	(88)	$	1,077
Investment Securities		158		(23)		135
Other		11		28		39
Total Interest Income		1,334		(83)		1,251
INTEREST EXPENSE
Deposits
Demand		21		43		64
Savings		—		1		1
Negotiable Certificates of Deposit and Other Time Deposits		169		(172)		(3)
Securities sold under agreements to repurchase and other borrowings		74		(3)		71
Federal Home Loan		—		—		—
Bank advances		42		(46)		(4)
Total Interest Expense		306		(177)		129
Net Interest Income	$	1,028	$	94	$	1,122

Non-Interest Income

Non-interest income increased $141 thousand for the six months ended June 30, 2016, compared to the same period in 2015, to $6.0 million.  Non-interest income decreased $336 thousand for the three months ended June 30, 2016, compared to the thee months ended June 30 2015, to $3.3 million.

As previously noted, non-interest income increased $141 thousand for the six months ended June 30, 2016 in comparison the six months ended June 30, 2015.  Decreases to non-interest income for the six month period ended June 30, 2016 compared to the six months ended June 30, 2015 include a decrease of $723 thousand in other income. 

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Other income was higher in 2015 due to the Company receiving $747 thousand in June 2015 for restitution related to the settlement of the pension dispute disclosed in prior filings.   Favorable variances to non-interest income for the first six months of 2016 includes an increase of $386 thousand in service charge income, an increase of $192 thousand in brokerage fee income,  an increase of $190 thousand in debit card interchange income and an increase of $150 thousand in gains on trading assets.  Decreases to non-interest income for the three months ended June 30, 2016 compared to the three months ended June 30, 2015 include a decrease of $687 thousand in other income.  Favorable variances in non-interest income for the three month period ended June 30, 2015 compared to the same time period in 2015 includes a gain of $173 thousand in service charge income, an increase of $114 thousand in brokerage fee income and an increase of $108 thousand in gains on trading assets.  

The gain on the sale of mortgage loans decreased from $768 thousand during the first six months of 2015 to $756 thousand during the first six months of 2016, a decrease of $12 thousand.  For the three months ended June 30, the gain on the sale of mortgage loans increased from $441 thousand in 2015 to $457 thousand in 2016. 

The volume of loans originated to sell during the first six months of 2016 decreased $649 thousand compared to the same time period in 2015.  The volume of loans originated to sell the during the three months ended June 30, 2016 compared to the three months ended June 30, 2015 increased $1.0 million.  The volume of mortgage loan originations and sales is generally inverse to rate changes.  A change in the mortgage loan rate environment can have a significant impact on the related gain on sale of mortgage loans.  Loan service fee income, net of amortization and impairment expense, was $49 thousand for the six months ended June 30, 2016 compared to $108 thousand for the six months ended June 30, 2015, a decrease of $59 thousand.  Loan service fee income, net of amortization and impairment expense, was $(2) thousand for the three months ended June 30, 2016 compared to $55 thousand for the three months ended June 30, 2015, a decrease of $57 thousand.  During the first six months of 2016, the market value adjustment to the carrying value of the mortgage servicing right was a net write-down of $42 thousand, as the fair value of this asset decreased.  During the first six months of 2015, the market value adjustment to the carrying value of the mortgage servicing right asset was a positive valuation adjustment of $34 thousand as the fair value of the mortgage servicing asset increased.  For the three months ended June 30, 2016, the market value adjustment to the carrying value of the mortgage serving right asset was a net write-down of $45 thousand compared to a positive valuation adjustment of $20 thousand during the second quarter of 2015.

Non-Interest Expense

Total non-interest expense increased $2.0 million for the six month period ended June 30, 2016 compared to the same period in 2015.  Total non-interest expense increased $900 thousand for the three month period ended June 30, 2016 compared to the three months ended June 30, 2015. 

For the comparable six month periods, salaries and employees benefits expense increased $988 thousand, an increase of 12.4%.  The number of full-time employee equivalent employees increased from 228 at June 30, 2015 to 246 at June 30, 2016, an increase of 18 full-time employee equivalent employees.  The increase in the number of employees is largely attributed to the Company acquiring Madison Financial Corporation on July 24, 2015.  For the three months ended June 30, 2016 compared to the three months ended June 30, 2015, salaries and employee benefits expense increased $412 thousand, or 9.9%. 

Occupancy expense increased $71 thousand to $1.9 million for the first six months of 2016 compared to the same time period in 2015.  Building rent expense increased $56 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 $25 thousand for the six months ended June 30, 2016 compared to June 30, 2015.  Expenses incurred for assets with a cost of less than one thousand decreased $74 thousand during the first six months of 2016 compared to the first six months of 2015.  This decrease is attributed to purchasing additional equipment during the first quarter of 2015 which resulted in additional expense. Occupancy expense increased $85 thousand to $939 thousand for the three months ended June 30, 2016 compared to the comparable three months in 2015.

Legal and professional fees increased $313 thousand for the six months ended June 30, 2016 compared to the first six months in 2015 and increased $220 thousand for the three months ended June 30, 2016 compared to the three months

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ended June 30, 2015.  Debit card expenses increased $138 thousand for the six months ended June 30, 2016 compared to the first six months of 2015 due to increased volume and increased $75 thousand for the three months ended June 30, 2016 compared to the three months ended June 30, 2015.  The increase in debit card expense is attributed to an increase in debit card interchange activity which also resulted in increases in debit card interchange income as shown on the income statement.   Repossession expenses decreased $139 thousand for the first six months ended June 30, 2016 compared to the same time period in 2015 and decreased $206 thousand for the three month period ended June 30, 2016 compared to the three months ended June 30, 2015.  Repossession expenses are reported net of rental income earned on repossessed properties.  Net repossession expenses were lower during the first six months of 2016 when compared to 2015 due to net write-downs totaling $85 thousand in 2016 compared to net write-downs of $227 thousand in 2015. 

Income Taxes

The effective tax rate for the six months ended June 30, 2016 was 12.7% compared to 7.8% in 2015.  The effective tax rate for the three months ended June 30, 2016 was 14.6% compared to 12.6% 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 $266 thousand for the six months ended June 30, 2016 compared to the first six months in 2015.  Income tax expense increased largely due to an increase of $548 thousand in income before tax expense.  Tax-exempt interest income increased $229 thousand for the first six months of 2016 compared to the first six months of 2015.  Further, for the first six months of 2016, the Company had tax credits totaling $204 thousand for investments made in low income housing projects which represented a decrease of $102 thousand compared to similar tax credits for the first six 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 six months ended June 30, 2016, the Company averaged $90.1 million in tax free securities and $37.2 million in tax free loans.  As of June 30, 2016, the weighted average remaining maturity for the tax free securities is 101 months, while the weighted average remaining maturity for the tax free loans is 153 months.

Liquidity and Funding

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

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

Cash and cash equivalents were $16.6 million as of June 30, 2016 compared to $28.0 million at December 31, 2015.  The decrease in cash and cash equivalents is attributed to a decrease of $11.1 million in cash and due from banks and a decrease of $333 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 $266.7 million at June 30, 2016 compared to $264.2 million at December 31, 2015.  Securities classified as trading assets totaled $5.7 million at June 30, 2016 compared to $5.5 million at December 31, 2015.

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

Generally, we rely upon net cash inflows from financing activities, supplemented by net cash inflows from operating activities, to provide cash used in our investing activities.  As is typical of many financial institutions, significant

39

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 six months of 2016, deposits decreased $7.6 million compared to December 31, 2015.  The Company’s borrowed funds from the Federal Home Loan Bank increased $11.8 million from December 31, 2015 to June 30, 2016 and total repurchase agreements increased $7.5 million from December 31, 2015 to June 30, 2016.

Management is aware of the challenge of funding sustained loan growth.  Therefore, in addition to deposits, other sources of funds, such as Federal Home Loan Bank advances, may be used.  We rely on Federal Home Loan Bank advances for both liquidity and asset/liability management purposes.  These advances are used primarily to fund long-term fixed rate residential mortgage loans.  As of June 30, 2016, we have sufficient collateral to borrow an additional $61 million from the Federal Home Loan Bank.  In addition, as of June 30, 2016, $61 million is available in overnight borrowing through various correspondent banks and the Company has access to an additional $287 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 June 30, 2016 and December 31, 2015, that the Company and the Bank meet all capital adequacy requirements to which they are subject.

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

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

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.

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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 June 30, 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. The Company’s and the Bank’s actual amounts and ratios are presented in the table below:

									To Be Well
									Capitalized
									Under Prompt
					For Capital				Corrective
	Actual				Adequacy Purposes				Action Provisions
	Amount		Ratio		Amount		Ratio		Amount		Ratio
	(Dollars in Thousands)
June 30, 2016
Consolidated
Total Capital (to Risk-Weighted Assets)	$	91,500	13.6	%	$	53,798	8.0	%		N/A	N/A
Tier I Capital (to Risk-Weighted Assets)		84,152	12.5			40,348	6.0			N/A	N/A
Common Equity Tier 1 Capital (to Risk-Weighted Assets)		77,152	11.5			30,261	4.5			N/A	N/A
Tier I Capital (to Average Assets)		84,152	8.5			39,432	4.0			N/A	N/A
Bank Only
Total Capital (to Risk-Weighted Assets)	$	93,225	13.9	%	$	53,758	8.0	%	$	67,197	10.0	%
Tier I Capital (to Risk-Weighted Assets)		85,877	12.8			40,318	6.0			53,758	8.0
Common Equity Tier 1 Capital (to Risk-Weighted Assets)		85,877	12.8			30,239	4.5			43,678	6.5
Tier I Capital (to Average Assets)		85,877	8.7			39,333	4.0			49,166	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 June 30, 2016, our non-performing assets totaled $10.9 million or 1.10% 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 $723 thousand in non-accrual loans from December 31, 2015 to June 30, 2016.  As of June 30, 2016, non-accrual loans include$ 4.1 million in loans secured by farmland,  $1.2 million in loans secured by 1-4 family properties, $78 thousand in loans secured by non-farm and non-residential properties, $126 thousand in loans secured by multi-family residential loans, $142 thousand in agricultural production loans and $8 thousand in consumer loans.  Loans secured by real estate composed 97.3% of the non-performing loans as of June 30, 2016 and 96.5% as of December 31, 2015.  Forgone interest

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income on non-accrual loans totaled $108 thousand for the first six months of 2016 compared to forgone interest of $18 thousand for the same time period in 2015.  Accruing loans that are contractually 90 days or more past due as of June 30, 2016 totaled $614 thousand compared to $1.0 million at December 31, 2015, a decrease of $386 thousand.

Total nonperforming and restructured loans decreased $1.1 million from December 31, 2015 to June 30, 2016.  The decrease in non-performing loan balances contributed to the decrease in the ratio of nonperforming and restructured loans to loans which decreased 25 basis points to 1.29% from December 31, 2015 to June 30, 2016.

In addition, the amount the Company has recorded as other real estate owned increased $93 thousand from December 31, 2015 to June 30, 2016.  As of June 30, 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 six months of 2016, $235 thousand in loan balances were foreclosed upon and added to other real estate properties while $15 thousand in other real estate properties were sold.  The allowance as a percentage of non-performing and restructured loans and other real estate owned increased from 55% at December 31, 2015 to 67% at June 30, 2016.

Nonperforming and Restructured Assets

	6/30/2016			12/31/2015
	(in thousands)
Non-accrual Loans	$	5,628		$	6,351
Accruing Loans which are Contractually past due 90 days or more		614			1,000
Accruing Troubled Debt Restructurings		2,213			2,245
Total Nonperforming and Restructured Loans		8,455			9,596
Other Real Estate		2,440			2,347
Total Nonperforming and Restructured Loans and Other Real Estate	$	10,895		$	11,943
Nonperforming and Restructured Loans as a Percentage of Loans		1.29	%		1.54	%
Nonperforming and Restructured Loans and Other Real Estate as a Percentage of Total Assets		1.10	%		1.23	%
Allowance as a Percentage of Period-end Loans		1.11	%		1.04	%
Allowance as a Percentage of Non-performing and Restructured Loans and Other Real Estate		67	%		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 six months of 2016 was $600 thousand compared to $650 thousand for the first six months of 2015.  The loan loss provision for the first three months of 2016 was $225 thousand compared to $350 thousand for the first three months of 2015.   The decrease in the total loan loss provision during the first six months of 2016 compared to the same time period in 2015 is attributed to improved loan quality in the Bank’s loan portfolio and, during the first quarter of 2016, the Company recovered $259 thousand for a loan that was charged off in a prior year.  This recovery of a prior charge-off resulted in increasing the allowance for loan losses by $259 thousand with no additional provision for loan loss expense.  

Management evaluates the loan portfolio by reviewing the historical loss rate for each respective loan type and assigns risk multiples to certain categories to account for qualitative factors including current economic conditions.  The average

42

loss rates are reviewed for trends in the analysis, as well as comparisons to peer group loss rates.  Management makes allocations within the allowance for loan losses for specifically classified loans regardless of loan amount, collateral or loan type.  Loan categories are evaluated utilizing subjective factors in addition to the historical loss calculations to determine a loss allocation for each of those types.

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

Nonperforming loans and restructured loans decreased $1.1 million from December 31, 2015 to $8.5 million at June 30, 2016.  The Company recorded net recoveries of $138 thousand for the six months ended June 30, 2016 compared to net charge-offs of $712 thousand for the six months ended June 30, 2015.  During the first quarter of 2016, the Company recorded a recovery of $259 for one loan which was charged-off in a prior year.  Future levels of charge-offs will be determined by the particular facts and circumstances surrounding individual loans.

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

Loan Losses

	Six Months Ended June 30,
	(in thousands)
		2016			2015
Balance at Beginning of Period Amounts Charged-off:	$	6,521		$	6,012
Commercial		—			25
1-4 family residential		64			152
Multi-family residential		—			94
Agricultural		—			242
Consumer and other		662			656
Total Charged-off Loans		726			1,169
Recoveries on Amounts Previously Charged-off:
Commercial		34			—
Real Estate Construction		13			2
1-4 family residential		7			5
Multi-family residential		4			2
Non-farm & non-residential		273			—
Agricultural		23			12
Consumer and other		510			436
Total Recoveries		864			457
Net Charge-offs (Recoveries)		(138)			712
Provision for Loan Losses		600			650
Balance at End of Period		7,259			5,950
Loans
Average		636,852			540,316
At June 30,		653,277			546,085
As a Percentage of Average Loans:
Net Charge-offs for the period		(0.02)	%		0.13	%
Provision for Loan Losses for the period		0.09	%		0.12	%
Allowance as a Multiple of Net Charge-offs annualized		(26.3)			4.2

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	Three Months Ended June 30,
	(in thousands)
	2016			2015
Balance at Beginning of Period Amounts Charged-off:	$	7,147		$	5,920
Commercial		—			—
1-4 family residential		52			120
Multi-family residential		—			94
Agricultural		—			—
Consumer and other		249			333
Total Charged-off Loans		301			547
Recoveries on Amounts Previously Charged-off:
Commercial		3			—
Real Estate Construction		7			—
1-4 family residential		2			2
Multi-family residential		1			2
Non-farm & non-residential		7			—
Agricultural		12			11
Consumer and other		156			212
Total Recoveries		188			227
Net Charge-offs		113			320
Provision for Loan Losses		225			350
Balance at End of Period		7,259			5,950
Loans
Average		646,788			543,634
At June 30,		653,277			546,085
As a Percentage of Average Loans:
Net Charge-offs (Recoveries) for the period		0.02	%		0.06	%
Provision for Loan Losses for the period		0.03	%		0.06	%
Allowance as a Multiple of Net Charge-offs annualized		16.1			4.6

Item 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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

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

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

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

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The projections are based on balance sheet growth assumptions and repricing opportunities for new, maturing and adjustable rate amounts.  As of June 30, 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 June 30, 2016 is as follows:

PROJECTED NET INTEREST INCOME

(dollars in thousands)

	Level
Change in basis points:	- 100			Rates		+ 100			+ 300
Year One (7/16 - 7/17)
Net interest income	$	31,429		$	32,294	$	32,412		$	32,314
Net interest income dollar change		(865)			N/A		118			20
Net interest income percentage change		(2.7)	%		N/A		0.4	%		0.1	%
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 June 30, 2015 is as follows:

PROJECTED NET INTEREST INCOME

(dollars in thousands)

	Level
Change in basis points:	- 100			Rates		+ 100			+ 300
Year One (7/15 - 7/16)
Net interest income	$	26,878		$	27,629	$	27,713		$	27,663
Net interest income dollar change		(750)			N/A		84			35
Net interest income percentage change		(2.7)	%		N/A		0.3	%		0.1	%
Board approved limit		>(4.0)	%		N/A		>(4.0)	%		>(10.0)	%

Projections from June 30, 2016 and June 30, 2015, year one reflected a decline in net interest income of 2.7% with a 100 basis point decline.  The 100 basis point increase in rates reflected a 0.4% increase in net interest income in 2016 compared to an increase of 0.3% 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 June 30, 2016, balance sheet, a 100 basis point increase in rates results in a 12.4% decrease in EVE.  A 100 basis point decrease in rates results in a 1.5% decrease in EVE.  These are within the Board approved limits.

Item 4 - CONTROLS AND PROCEDURES

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

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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
4/1/16-4/30/16	—	$	—	—	81,756	shares
5/1/16-5/31/16	1,250		27.20	1,250	80,506	shares
6/1/16-6/30/16	1,126		27.38	1,126	79,380	shares
Total	2,376	$	27.29	2,376	79,380	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 June 30, 2016, 320,620 shares have been purchased.

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Item 6.     Exhibits

Ay
2.1	Agreement and Plan of Merger with Peoples Bancorp of Sandy Hook is incorporated by reference to Exhibit 2.1 of the Registrant’s Current Report on Form 8-K dated and filed February 24, 2006.
2.2	Agreement and Plan of Share Exchange with Madison Financial Corporation is incorporated by reference to Exhibit 2.1 of the Registrant’s Current Report on Form 8-K dated and filed January 21, 2015.
3.1	Amended and Restated Articles of Incorporation of the Registrant are incorporated by reference to Exhibit 3.1 of the Registrant’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2000 and filed May 15, 2000.
3.2	Bylaws of the Registrant are incorporated by reference to Exhibit 3.1 of the Registrant’s Current Report on Form 8-K dated and filed November 21, 2007.
3.3	Articles of Amendment to Amended and Restated Articles of Incorporation of the Registrant are incorporated by reference to Exhibit 3.3 of the Registrant’s Annual Report of Form 10-K for the period ended December 31, 2005 and filed March 29, 2006.
31.1	Certifications of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2	Certifications of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32	Certifications of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101	The following financial information from Kentucky Bancshares, Inc. Quarterly Report on Form 10-Q for the period ended June 30, 2016, filed with the SEC on August 12, 2016, formatted in Extensible Business Reporting Language (XBRL): (i) Consolidated Balance Sheets at June 30, 2016,and December 31, 2015, (ii) Consolidated Statements of Income and Comprehensive Income (Loss) for the six months and three months ended June 30, 2016 and June 30, 2015, (iii) Consolidated Statement of Stockholders’ Equity for the six months ended June 30, 2016, (iv) Consolidated Statements of Cash Flows for the six months ended June 30, 2016 and June 30, 2015 and (v) Notes to Consolidated Financial Statements.

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SIGNATURES

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

		KENTUCKY BANCSHARES, INC.
Date	8/12/16	/s/Louis Prichard
		Louis Prichard, President and C.E.O.
Date	8/12/16	/s/Gregory J. Dawson
		Gregory J. Dawson, Chief Financial Officer

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