UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT
PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2005
Farmers Capital Bank Corporation
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(Exact name of registrant as specified in its charter)
Kentucky 0-14412 61-1017851
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(State or other jurisdiction (Commission (IRS Employer
of incorporation) File Number) Identification No.)
P.O. Box 309 Frankfort, KY 40602
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code - (502)-227-1668
Not Applicable
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(Former name or former address, if changed since last report.)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No ____
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Securities Exchange Act of 1934).
Yes X No ____
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Common stock, par value $0.125 per share
6,786,078 shares outstanding at August 5, 2005
TABLE OF CONTENTS
PART I - FINANCIAL INFORMATION.............................................................................................3
Item 1. Financial Statements............................................................................................3
Unaudited Consolidated Balance Sheets.................................................................................3
Unaudited Consolidated Statements of Income...........................................................................4
Unaudited Consolidated Statements of Comprehensive Income.............................................................5
Unaudited Consolidated Statements of Cash Flows.......................................................................6
Unaudited Consolidated Statements of Changes in Shareholders' Equity..................................................7
Notes to Unaudited Consolidated Financial Statements..................................................................8
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.........................11
Item 3. Quantitative and Qualitative Disclosures About Market Risk....................................................27
Item 4. Controls and Procedures.......................................................................................28
PART II - OTHER INFORMATION..............................................................................................28
Item 1. Legal Proceedings.............................................................................................28
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds...................................................28
Item 4. Submission of Matters to a Vote of Security Holders...........................................................28
Item 6. Exhibits......................................................................................................29
SIGNATURES.............................................................................................................30
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
UNAUDITED CONSOLIDATED BALANCE SHEETS
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June 30, December 31,
(In thousands, except share data) 2005 2004
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ASSETS
Cash and cash equivalents:
Cash and due from banks $ 82,261 $ 42,418
Interest bearing deposits in other banks 1,718 2,569
Federal funds sold and securities purchased under agreements to resell 28,133 34,273
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Total cash and cash equivalents 112,112 79,260
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Investment securities:
Available for sale, amortized cost of $308,852 (2005) and $348,240 (2004) 309,610 349,317
Held to maturity, fair value of $18,307 (2005) and $20,555 (2004) 17,843 19,803
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Total investment securities 327,453 369,120
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Loans, net of unearned income 899,385 876,705
Allowance for loan losses (11,775) (12,804)
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Loans, net 887,610 863,901
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Premises and equipment, net 27,878 27,415
Company-owned life insurance 27,524 26,978
Goodwill 8,927 8,722
Other intangibles, net 3,768 4,259
Other assets 23,254 17,489
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Total assets $ 1,418,526 $ 1,397,144
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LIABILITIES
Deposits:
Noninterest bearing $ 196,871 $ 173,522
Interest bearing 954,722 965,505
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Total deposits 1,151,593 1,139,027
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Federal funds purchased and securities sold under agreements to repurchase 67,091 59,758
Other short-term borrowings 393 1,791
Long-term debt 52,245 53,158
Dividends payable 2,236 2,232
Other liabilities 10,495 9,728
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Total liabilities 1,284,053 1,265,694
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SHAREHOLDERS' EQUITY
Common stock, par value $.125 per share
9,608,000 shares authorized; 8,244,933 and 8,234,423
shares issued at June 30, 2005 and December 31, 2004, respectively 1,031 1,029
Capital surplus 21,024 20,744
Retained earnings 153,452 149,985
Treasury stock, at cost; 1,465,755 and 1,450,055 shares
at June 30, 2005 and December 31, 2004, respectively (41,527) (41,008)
Accumulated other comprehensive income 493 700
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Total shareholders' equity 134,473 131,450
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Total liabilities and shareholders' equity $ 1,418,526 $ 1,397,144
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See accompanying notes to unaudited consolidated financial statements.
UNAUDITED CONSOLIDATED STATEMENTS OF INCOME
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Three Months Ended Six Months Ended
June 30, June 30,
(In thousands, except per share data) 2005 2004 2005 2004
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INTEREST INCOME
Interest and fees on loans $ 14,289 $ 11,802 $ 27,992 $ 23,531
Interest on investment securities:
Taxable 2,045 2,021 3,957 3,985
Nontaxable 963 985 1,944 1,931
Interest on deposits in other banks 22 8 34 18
Interest of federal funds sold and securities purchased
under agreements to resell 383 77 383 167
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Total interest income 17,702 14,893 34,810 29,632
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INTEREST EXPENSE
Interest on deposits 5,304 3,602 10,250 7,276
Interest on federal funds purchased and securities sold
under agreements to repurchase 571 249 1,105 467
Interest on other borrowed funds 527 493 1,053 995
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Total interest expense 6,402 4,344 12,408 8,738
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Net interest income 11,300 10,549 22,402 20,894
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Provision for loan losses (17) 448 (64) 813
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Net interest income after provision for loan losses 11,317 10,101 22,466 20,081
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NONINTEREST INCOME
Service charges and fees on deposits 2,524 2,089 4,783 3,983
Allotment processing fees 645 201 1,298 400
Other service charges, commissions, and fees 596 689 1,235 1,374
Data processing income 394 381 734 715
Trust income 427 414 823 828
Investment securities (losses) gains, net (3) (17) (3) 65
Gains on sale of mortgage loans, net 221 71 409 115
Income from company-owned life insurance 340 362 571 767
Other 16 46 834 76
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Total noninterest income 5,160 4,236 10,684 8,323
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NONINTEREST EXPENSE
Salaries and employee benefits 6,154 5,383 12,114 10,777
Occupancy expenses, net 731 634 1,489 1,296
Equipment expenses 681 541 1,364 1,105
Data processing and communications expense 1,099 973 2,133 1,891
Bank franchise tax 362 337 723 678
Correspondent bank fees 276 252 498 440
Other 2,046 1,509 4,537 3,124
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Total noninterest expense 11,349 9,629 22,858 19,311
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Income before income taxes 5,128 4,708 10,292 9,093
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Income tax expense 1,240 967 2,348 1,844
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Net income $ 3,888 $ 3,741 $ 7,944 $ 7,249
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NET INCOME PER COMMON SHARE
Basic $ .57 $ .56 $ 1.17 $ 1.08
Diluted .57 .55 1.16 1.07
WEIGHTED AVERAGE SHARES OUTSTANDING
Basic 6,781 6,730 6,786 6,727
Diluted 6,818 6,778 6,829 6,780
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See accompanying notes to unaudited consolidated financial statements.
UNAUDITED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
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Three Months Ended Six Months Ended
June 30, June 30,
(In thousands) 2005 2004 2005 2004
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NET INCOME $ 3,888 $ 3,741 $ 7,944 $ 7,249
Other comprehensive income:
Unrealized holding gain (loss) on available for sale
securities arising during the period, net of tax
of $1,187, $2,633, $114, and $2,332, respectively 2,205 (4,890) (212) (4,330)
Reclassification adjustment for prior period
unrealized loss (gain) recognized during current period,
net of tax of $22, $9, $3, and $27, respectively 40 (16) 5 (51)
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Other comprehensive income 2,245 (4,906) (207) (4,381)
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Comprehensive Income $ 6,133 $ (1,165) $ 7,737 $ 2,868
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See accompanying notes to unaudited consolidated financial statements.
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
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Six months ended June 30, (In thousands) 2005 2004
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CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 7,944 $ 7,249
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization 2,138 1,437
Net amortization of investment security premiums and (discounts):
Available for sale 218 928
Held to maturity (20) (22)
Provision for loan losses (64) 813
Noncash compensation expense 138
Mortgage loans originated for sale (16,884) (9,629)
Proceeds from sale of mortgage loans 16,264 8,696
Deferred income tax benefit (414) (490)
Gains on sale of mortgage loans, net (409) (115)
Gain on sale of credit card portfolio (700)
Gains on sale of premises and equipment, net (11) (2)
Loss (gain) on sale of available for sale investment securities, net 3 (65)
(Increase) decrease in accrued interest receivable (194) 141
Income from company-owned life insurance (546) (757)
Increase in other assets (4,958) (1,860)
Increase (decrease) in accrued interest payable 253 (65)
Increase in other liabilities 225 1,349
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Net cash provided by operating activities 2,845 7,746
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CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from maturities and calls of investment securities:
Available for sale 122,888 169,136
Held to maturity 1,980 2,140
Proceeds from sale of available for sale investment securities 3,038 35,039
Purchase of available for sale investment securities (86,759) (205,585)
Loans originated for investment, net of principal collected (21,916) (36,587)
Purchase of premises and equipment (2,222) (1,454)
Proceeds from sale of equipment 123 3
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Net cash provided by (used in) investing activities 17,132 (37,308)
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CASH FLOWS FROM FINANCING ACTIVITIES
Net increase (decrease) in deposits 12,566 (65,741)
Net increase in securities sold under agreements to repurchase 7,333 44,450
Proceeds from long-term debt 1,800
Repayments of long-term debt (914) (4,612)
Net increase (decrease) in other short-term borrowings (1,397) 1,244
Dividends paid (4,473) (4,435)
Purchase of common stock (519) (73)
Shares issued under Employee Stock Purchase Plan 99
Stock options exercised 180 417
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Net cash provided by (used in) financing activities 12,875 (26,950)
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Net increase (decrease) in cash and cash equivalents 32,852 (56,512)
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Cash and cash equivalents at beginning of year 79,260 127,216
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Cash and cash equivalents at end of period $ 112,112 $ 70,704
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SUPPLEMENTAL DISCLOSURES
Cash paid during the period for:
Interest $ 12,155 $ 8,803
Income taxes 1,000 1,450
Transfers from loans to repossessed assets 2,341 2,954
Cash dividend declared and unpaid 2,236 2,221
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See accompanying notes to unaudited consolidated financial statements.
UNAUDITED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
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(In thousands, except per share data) Accumulated
Other Total
Six months ended Common Stock Capital Retained Treasury Stock Comprehensive Shareholders'
June 30, 2005 and 2004 Shares Amount Surplus Earnings Shares Amount Income Equity
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Balance at January 1, 2005 8,234 $ 1,029 $ 20,744 $ 149,985 1,450 $ (41,008) $ 700 $ 131,450
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Net income 7,944 7,944
Other comprehensive income (207) (207)
Cash dividends declared,
$.66 per share (4,477) (4,477)
Purchase of common stock 16 (519) (519)
Stock options exercised,
including related tax benefits 7 1 182 183
Shares issued pursuant
to Employee Stock Purchase plan 4 1 98 99
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Balance at June 30, 2005 8,245 $ 1,031 $ 21,024 $ 153,452 1,466 $ (41,527) $ 493 $ 134,473
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Balance at January 1, 2004 8,161 $ 1,020 $ 18,670 $ 145,489 1,445 $ (40,830) $ 2,122 $ 126,471
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Net income 7,249 7,249
Other comprehensive income (4,381) (4,381)
Cash dividends declared,
$.66 per share (4,441) (4,441)
Purchase of common stock 2 (73) (73)
Stock options exercised,
including related tax benefits 17 2 418 420
Noncash compensation expense
attributed to stock option grants 138 138
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Balance at June 30, 2004 8,178 $ 1,022 $ 19,226 $ 148,297 1,447 $ (40,903) $ (2,259) $ 125,383
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See accompanying notes to unaudited consolidated financial statements.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION AND NATURE OF OPERATIONS
The consolidated financial statements include the accounts of Farmers Capital
Bank Corporation (the "Company"), a financial holding company, and its
wholly-owned six bank and two active nonbank subsidiaries. Bank subsidiaries
include Farmers Bank & Capital Trust Co. ("Farmers Bank") in Frankfort, KY;
United Bank & Trust Co. in Versailles, KY; Lawrenceburg National Bank in
Harrodsburg, KY; First Citizens Bank in Elizabethtown, KY; Farmers Bank and
Trust Company ("Farmers Georgetown") in Georgetown, KY; and Kentucky Banking
Centers, Inc. in Glasgow, KY. The Company has two active nonbank subsidiaries,
FCB Services, Inc. and Kentucky General Holdings, LLC. FCB Services, Inc. is a
data processing subsidiary located in Frankfort, KY, which provides services to
the Company's banks as well as unaffiliated banks. Kentucky General Holdings,
LLC holds a 50% voting interest in KHL Holdings, LLC, which is the parent
company of Kentucky Home Life Insurance Company. Leasing One Corporation, a
commercial leasing company, and Farmers Capital Insurance Corporation, an
insurance agency, are wholly-owned subsidiaries of Farmers Bank. Pro Mortgage
Partners, LLC, a mortgage brokerage company, is a wholly-owned subsidiary of
Farmers Georgetown. All significant intercompany transactions and balances are
eliminated in consolidation.
The Company provides financial services through its 27 locations in 16
communities throughout Central Kentucky to individual, business, agriculture,
government, and educational customers. Its primary deposit products are
checking, savings, and term certificate accounts. Its primary lending products
are residential mortgage, commercial lending and leasing, and installment loans.
Substantially all loans and leases are secured by specific items of collateral
including business assets, consumer assets, and commercial and residential real
estate. Commercial loans and leases are expected to be repaid from cash flow
from operations of businesses. Farmers Bank has served as the general depository
for the Commonwealth of Kentucky for over 70 years and also provides investment
and other services to the Commonwealth. Other services include, but are not
limited to, cash management services, issuing letters of credit, safe deposit
box rental, and providing funds transfer services. Other financial instruments,
which potentially represent concentrations of credit risk, include deposit
accounts in other financial institutions and federal funds sold.
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 as of the date
of the financial statements and the reported amounts of revenues and expenses
during the reporting period. Estimates used in the preparation of the financial
statements are based on various factors including the current interest rate
environment and the general strength of the local economy. Changes in the
overall interest rate environment can significantly affect the Company's net
interest income and the value of its recorded assets and liabilities. Actual
results could differ from those estimates used in the preparation of the
financial statements.
The financial information presented as of any date other than December 31 has
been prepared from the 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 and do not include
all of the information and the footnotes required by accounting principles
generally accepted in the United States of America for complete statements. 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, 2004.
2. RECLASSIFICATIONS
Certain reclassifications have been made to the consolidated financial
statements of prior periods to conform to the current period presentation. These
reclassifications do not affect net income or total shareholders' equity as
previously reported.
3. NET INCOME PER COMMON SHARE
Basic net income per common share is determined by dividing net income by the
weighted average total number of shares of common stock outstanding. Diluted net
income per common share is determined by dividing net income by the total
weighted average number of shares of common stock outstanding, plus the total
weighted average number of shares that would be issued upon exercise of dilutive
stock options assuming proceeds are used to repurchase shares pursuant to the
treasury stock method. Net income per common share computations were as follows
at June 30, 2005 and 2004.
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Three Months Ended Six Months Ended
June 30, June 30,
(In thousands, except per share data) 2005 2004 2005 2004
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Net income, basic and diluted $ 3,888 $ 3,741 $ 7,944 $ 7,249
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Average shares outstanding 6,781 6,730 6,786 6,727
Effect of dilutive stock options 37 48 43 53
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Average diluted shares outstanding 6,818 6,778 6,829 6,780
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Net income per share, basic $ .57 $ .56 $ 1.17 $ 1.08
Net income per share, diluted .57 .55 1.16 1.07
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4. STOCK-BASED COMPENSATION
In 1997, the Company's Board of Directors approved a nonqualified stock option
plan (the "Plan") that provides for granting of stock options to key employees
and officers of the Company. The Plan was subsequently ratified by the Company's
shareholders at its annual shareholders' meeting held on May 12, 1998, the
measurement date of the options granted during 1997. All stock options are
awarded at a price equal to the fair market value of the Company's common stock
at the date the options are granted. The Company applies Accounting Principles
Board ("APB") Opinion No. 25 and related interpretations in accounting for its
Plan. Accordingly, since options were granted during 1997 at the fair market
value of the Company's stock on the grant date, and the measurement date
occurred during 1998, the Company recognized noncash compensation expense over
the vesting period of the options, which term ended during 2004, based on the
intrinsic value of the stock options measured on the date of shareholder
ratification of the Plan.
The Company granted 40,049 and 54,000 additional options under the Plan during
2004 and 2000 in which there is no compensation expense being recognized
pursuant to APB No. 25. In addition, the Company issued shares pursuant to its
Employee Stock Purchase Plan ("ESPP") during each of the quarters beginning with
the quarter ended September 30, 2004 and recorded no related compensation
expense. Had compensation expense been determined under the fair value method
described in the Financial Accounting Standards Board ("FASB") Statement of
Financial Accounting Standards ("SFAS") No. 123, Accounting for Stock-Based
Compensation, as amended by SFAS No. 148, Accounting for Stock-Based
Compensation-Transition and Disclosure, the Company's net income and income per
common share would have been as shown in the following table.
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Three Months Ended Six Months Ended
June 30, June 30,
(In thousands, except per share data) 2005 2004 2005 2004
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NET INCOME
As reported $ 3,888 $ 3,741 $ 7,944 $ 7,249
Add: Stock-based employee compensation expense
included in reported net income, net of related
tax effects 45 90
Less: Stock-based compensation expense determined
under fair value based method for all awards, net (18) (58) (80) (117)
of related tax effects
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Proforma $ 3,870 $ 3,728 $ 7,864 $ 7,222
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NET INCOME PER COMMON SHARE
Basic, as reported $ .57 $ .56 $ 1.17 $ 1.08
Basic, proforma .57 .55 1.16 1.07
Diluted, as reported .57 .55 1.16 1.07
Diluted, proforma .57 .55 1.15 1.07
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On March 16, 2005 the Compensation Committee of the Company's Board of Directors
acted to approve an immediate and full acceleration of the vesting on options
granted during 2004. As a result, options to purchase 40,049 unvested and
"out-of-the-money" shares of the Company's common stock became immediately
exercisable as of March 16, 2005. The exercise price of these options remains
unchanged at $34.80 per share. The closing price of the Company's shares was
$34.50 on March 15, 2005. None of the accelerated options are granted to
directors or executive officers of the Company.
The purpose of the accelerated vesting is to allow the Company to reduce
anticipated future compensation expense attributed to its stock option grants
pursuant to recently issued SFAS No. 123 (revised), "Share-Based Payment". Under
SFAS No. 123 (revised), the Company will be required to recognize compensation
expense in its income statement beginning January 1, 2006 (in compliance with
SEC Release No. 33-8568) for awards granted or modified on or after that date,
as well as recognizing compensation expense for the portion of existing options
that vest January 1, 2006 or later. Since the options granted during 2004 had an
exercise price in excess of the market price on the date of modification and
there is no future vesting requirement, there will be no compensation expense
recorded for these options in the current or future periods. This represents a
reduction in estimated future compensation expense of approximately $31,000 and
$26,000 for the twelve months ended December 31, 2006 and 2007, respectively.
The Company anticipates that it will record compensation expense pursuant to
SFAS No. 123 (revised) for unvested options from its 2000 grant and shares
issued under its ESPP.
5. EMPLOYEE STOCK PURCHASE PLAN
The Company's 2004 ESPP was approved by its shareholders at the Company's 2004
annual meeting. The purpose of the ESPP is to provide a means by which eligible
employees may purchase, at a discount, shares of common stock of the Company
through payroll withholding. The purchase price of the shares is equal to 85% of
their fair market value on specified dates as defined in the plan. The ESPP was
effective July 1, 2004. There were 1,820 shares and 3,420 shares issued under
the plan during the current three and six-month periods ended June 30, 2005.
Compensation cost related to the ESPP included in the proforma net income
disclosure in the table in Note 4 above was $7,000 and $14,000 for the three and
six-month periods ended June 30, 2005, respectively.
6. SUBSEQUENT EVENT - CITIZENS BANCORP, INC.
On July 1, 2005 the Company announced the signing of an agreement and plan of
merger with Citizens Bancorp, Inc. ("Citizens") whereby Citizens would be
acquired in a cash and stock transaction valued at $38.0 million. Approximately
55% of the purchase price will be paid in cash and the remaining amount will be
in the form of newly issued shares of the Company's common stock. In July 2005
the Company issued $25.0 million of Trust Preferred Securities in connection
with this plan of merger.
Citizens is a bank holding company headquartered in Newport, Kentucky and the
parent corporation of Citizens Bank of Northern Kentucky, Inc. ("Citizens
Bank"). Pending the required approvals from the appropriate regulatory
authorities and subject to the satisfaction of the conditions set forth in the
definitive agreement, this transaction is expected to close during the fourth
quarter of 2005. Citizens Bank operates six offices located in Campbell and
Kenton Counties in Kentucky. As of June 30, 2005, Citizens Bank had total assets
of $186 million, total loans (net of unearned income) of $150 million, total
deposits of $163 million, and shareholders' equity of $16.3 million.
7. SUBSEQUENT EVENT - TRUST PREFERRED SECURITIES AND SUBORDINATED NOTES
In July 2005, the Company completed two private offerings of trust preferred
securities through two separate Delaware statutory trusts sponsored by the
Company. Farmers Capital Bank Trust I ("Trust I") sold $10.0 million of
preferred securities and Farmers Capital Bank Trust II ("Trust II") sold $15.0
million of preferred securities (Trust I and Trust II are hereafter collectively
referred to as the "Trusts"). The proceeds from the offering will be used in
funding the acquisition of Citizens. The Company owns all of the common
securities of each of the Trusts.
The Trusts used the proceeds from the sale of preferred securities to purchase
the Company's junior subordinated notes in amounts and bearing terms that
parallel the amounts and terms of the respective preferred securities. The
subordinated notes mature in 2035 and bear a floating interest rate (current
three-month LIBOR plus 150 basis points in the case of the notes held by Trust I
and current three-month LIBOR plus 165 basis points in the case of the notes
held by Trust II). Interest on the notes is payable quarterly beginning
September 30, 2005.
The subordinated notes are redeemable in whole or in part, without penalty, at
the Company's option on or after September 30, 2010 and mature on September 30,
2035. The notes are junior in right of payment of all present and future senior
indebtedness.
Under FASB Interpretation No. 46 (revised), "CONSOLIDATION OF VARIABLE INTEREST
ENTITIES", the Company does not consolidate the Trusts into its financial
statements. Accordingly, the Company does not report the securities issued by
the Trusts as liabilities, but instead reports as liabilities the subordinated
notes issued by the Company and held by the Trusts. The Company accounts for its
investment in each of the Trusts as assets. The Company records interest expense
on the corresponding notes issued to the Trusts on its statement of income.
In March 2005, the Federal Reserve Board adopted final rules that continue to
allow the inclusion of trust preferred securities in Tier 1 capital for
regulatory capital adequacy purposes in an amount not to exceed 25% of Tier 1
capital, net of goodwill and any related deferred tax liabilities. The amount of
trust preferred securities and certain other elements in excess of the limit may
be included in Tier 2 capital, subject to restrictions.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
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OF OPERATIONS
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FORWARD-LOOKING STATEMENTS
This report contains forward-looking statements under the Private Securities
Litigation Reform Act of 1995 that involve risks and uncertainties. Although the
Company believes that the assumptions underlying the forward-looking statements
contained herein are reasonable, any of the assumptions could be inaccurate, and
therefore, there can be no assurance that the forward-looking statements
included herein will prove to be accurate. Factors that could cause actual
results to differ from the results discussed in the forward-looking statements
include, but are not limited to: economic conditions (both generally and more
specifically in the markets in which the Company and its subsidiaries operate);
competition for the Company's customers from other providers of financial
services; government legislation and regulation (which changes from time to time
and over which the Company has no control); changes in interest rates; material
unforeseen changes in the liquidity, results of operations, or financial
condition of the Company's customers; and other risks detailed in the Company's
filings with the Securities and Exchange Commission, all of which are difficult
to predict and many of which are beyond the control of the Company. The Company
expressly disclaims any intent or obligation to update any forward-looking
statements after the date hereof to conform such statements to actual results or
to changes in our opinions or expectations.
RESULTS OF OPERATIONS
SECOND QUARTER 2005 VS. SECOND QUARTER 2004
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The Company reported net income of $3.9 million, an increase of $147 thousand or
3.9% compared to $3.7 million for the same period in 2004. Basic and diluted net
income per share were $.57 for the current three months, an increase of $.01 or
1.8% and $.02 or 3.6%, respectively compared to $.56 and $.55 in the same period
a year ago. The operating results related to Citizens Bank (Kentucky), Inc.
("Citizens Georgetown") acquired on July 1, 2004 and Financial National
Electronic Transfer, Inc. ("FiNET") acquired on October 8, 2004 are included in
the financial results presented for the current quarter. Since these
acquisitions occurred in the last half of 2004, there are no comparable results
for the prior year period. Net loans and deposits acquired from Citizens
Georgetown on the date of purchase were $50.1 million and $62.4 million,
respectively. Net assets acquired from FiNET on the date of purchase, primarily
intangibles, were approximately $6.6 million.
The increase in net income for the three months ended June 30, 2005 is primarily
attributed to an increase in net interest income and a lower provision for loan
losses offset by a higher effective federal income tax rate. Net interest income
for the current quarter was $11.3 million, an increase of $751 thousand or 7.1%
compared to $10.5 during the same period a year earlier. The increase in net
interest income in the quarterly comparison can be attributed to higher interest
income, primarily on loans, which offset the growth in interest expense.
The provision for loans losses decreased $465 thousand or 103.8% in the
three-month comparison. The negative provision for loan losses of $17 thousand
for the current three months is attributed to a $454 thousand and $4.4 million
reduction in nonperforming loans in the current three and six-month periods
ended June 30, 2005 and the sale of the Company's credit card portfolio during
the first six months of 2005. Nonperforming loans include nonaccrual loans,
restructured loans, and loans past due 90 days or more in which interest is
still accruing. Nonperforming loans and credit card loans typically have larger
allowances due to their identified risk of loss characteristics.
Noninterest income increased $924 thousand or 21.8% in the quarterly comparison.
The increase in noninterest income was led by an increase in allotment
processing fees of $444 thousand or 220.9% and is attributed to the FiNET
acquisition late during 2004. Other significant increases in noninterest income
include service charges and fees on deposits of $435 thousand or 20.8% and gains
on the sale of mortgage loans of $150 thousand or 211.3%. Notable declines in
noninterest income include income from bank owned life insurance of $22 thousand
or 6.1% due to lower crediting rates on the underlying investments and lower
service charges, commissions, and fees of $93 thousand or 13.5%. Up until
recently, the underlying investments related to the bank owned life insurance
have been repricing in a lower interest rate environment.
Noninterest expenses increased $1.7 million or 17.9% in the current three months
compared to the same period a year ago. These increases offset the $924 thousand
higher amount of reported noninterest income. The increase in noninterest
expenses occurred across a broad range of line items and is generally attributed
to the Company's business expansion during the last half of 2004. The most
significant increase was salaries and employee benefits, which grew $771
thousand or 14.3% in the comparison as the average number of full time
equivalent employees rose to 519 from 468. Other notable increases include
amortization of intangibles of $246 thousand and auditing expenses of $69
thousand compared to the same period a year earlier. The effective income tax
rate increased to 24.2% from 20.5%, resulting in an increase in income tax
expense of $273 thousand or 28.2%.
The return on average assets ("ROA") was 1.09% for the current quarter, a
decrease of 6 basis points compared to 1.15% reported for the same period in
2004. The decrease in ROA was driven by a 21 basis point increase in noninterest
expenses as a percentage of average total assets and a 10 basis point decline in
net interest margin to 3.73% from 3.83%. These amounts were partially offset by
a lower provision for loan losses amounting to 14 basis points and higher
noninterest income totaling 15 basis points. Other negative effects on ROA
include higher income tax expense of 3 basis points and the effect of a lower
earning asset ratio contributing 1 basis point. Return on average equity ("ROE")
was 11.80% for the second quarter of 2005 compared to 11.93% in the same period
of 2004. This represents a decrease of 13 basis points and is attributed to a
higher average equity balance, which grew at a faster pace than reported net
income.
NET INTEREST INCOME
- -------------------
The trend of the general interest rate environment in the current three months
ended June 30, 2005 compared to the same period a year earlier has been upward
primarily as a result of short-term interest rate increases by the Board of
Governors of the Federal Reserve System (the "Fed"). The Fed has increased
short-term interest rates by 225 basis points in nine equal increments of 25
basis points since June 30, 2004. The effects of these rate increases by the Fed
has generally led to higher average rates earned and paid on interest earning
assets and interest bearing liabilities with a faster increase in the average
rates paid on interest bearing liabilities due to their repricing
characteristics.
Net interest income is the most significant component of the Company's earnings.
Net interest income is the excess of the interest income earned on earning
assets over the interest paid for funds to support those assets. The two most
common metrics used to analyze net interest income are net interest spread and
net interest margin. Net interest spread represents the difference between the
yields on earning assets and the rates paid on interest bearing liabilities. Net
interest margin represents the percentage of net interest income to average
earning assets. Net interest margin will exceed net interest spread because of
the existence of noninterest bearing sources of funds, principally demand
deposits and shareholders' equity, which are also available to fund earning
assets. Changes in net interest income and margin result from the interaction
between the volume and the composition of earning assets, their related yields,
and the associated cost and composition of the interest bearing liabilities.
Accordingly, portfolio size, composition, and the related yields earned and the
average rates paid can have a significant impact on net interest spread and
margin. The table on the following page represents the major components of
interest earning assets and interest bearing liabilities on a tax equivalent
basis. To compare the tax-exempt asset yields to taxable yields, amounts are
adjusted to pretax equivalents based on the marginal corporate Federal tax rate
of 35%.
The Company's tax equivalent ("TE") yield on earning assets for the current
three months was 5.8%, an increase of 42 basis points from 5.3% in the same
period a year ago. The cost of funds for the current three months was 2.3%, an
increase of 59 basis points compared to 1.8% in the same period a year earlier.
A goal of the Company in the current interest rate environment is to increase
earning assets while maintaining the current relatively low interest rates paid
on interest bearing liabilities. The Company strives to accomplish this goal
while providing excellent service to its customers and maintaining its core
deposit base. Maintaining the relatively low cost of funds is becoming
increasingly difficult due to the recent rise in general interest rates and
competitive market forces. Average earning assets increased $105 million or 9.0%
to $1.3 billion in the quarterly comparison, helped in part to the acquisition
of Citizens Georgetown during the last half of 2004. As a percentage of total
average assets, earning assets decreased 59 basis points to 88.47% from 89.06%.
This decrease had the effect of reducing ROA by one basis point in the quarterly
comparison.
Interest income results from interest earned on earning assets, which primarily
include loans and investment securities. Interest income is affected by volume
(average balance), composition of earning assets, and the related rates earned
on those assets. Total interest income for the second quarter of 2005 was $17.7
million, an increase of $2.8 million or 18.9% from the same period in the
previous year. The growth in interest income was mainly attributed to higher
interest income on loans. Interest income on loans increased mainly as a result
of higher average loan balances outstanding resulting from both the Citizens
Georgetown acquisition and internally generated loan growth. The Company's tax
equivalent yield on earning assets for the current period was 5.8%, an increase
of 42 basis points compared to the same period a year ago.
Interest and fees on loans was $14.3 million, an increase of $2.5 million mainly
due to higher average loan balances outstanding along with an increase in the
average rate earned. Average loans increased $105 million or 13.4% to $888
million in the comparison due to higher loan demand in what remains a relatively
low interest rate environment and, to a lesser extent, the loans acquired in the
Citizens Georgetown acquisition. On July 1, 2004, the Company purchased
approximately $50.1 million in loans related to the Citizens Georgetown
acquisition. The tax equivalent yield on loans increased 39 basis points to 6.5%
from 6.1% in the quarterly comparison. Interest on taxable securities was $2.0
million, relatively unchanged in the comparison as a $16.4 million decrease in
the average balance outstanding was offset by a 26 basis point increase in the
average rate earned. Interest on nontaxable securities was also relatively
unchanged at $963 thousand. A $1.6 million decline in the average balance
outstanding coupled with a 10 basis point decrease in the average rate earned
resulted in a decrease in interest income on nontaxable securities of $22
thousand or 2.2% in the comparison. Interest on short-term investments,
including time deposits in other banks, federal funds sold, and securities
purchased under agreements to resell, increased $320 thousand due to a 211 basis
point increase in the average rate earned to 3.1% from 1.0% and, to a lesser
extent, an increase in the average balance outstanding of $17.9 million or 51.7%
to $52.5 million from $34.6 million. The higher average rate earned on
short-term investments is closely related to the increases in general market
interest rates resulting from the Fed's increase of short-term interest rates
over the last year.
Interest expense results from incurring interest on interest bearing
liabilities, which include interest bearing deposits, federal funds purchased
and securities sold under agreements to repurchase, and other borrowed funds.
Interest expense is affected by volume, composition of interest bearing
liabilities, and the related rates paid on those liabilities. Total interest
expense was $6.4 million for second quarter of 2005, an increase of $2.1 million
or 47.4% from the same period in prior year. Interest expense increased
primarily as a result of higher average rates paid on interest bearing deposits,
with an increase in average balances outstanding of certain deposit categories
contributing to a smaller degree. The Company's cost of funds was 2.3% for the
second quarter of 2005, an increase of 59 basis points from 1.8% for the prior
year. The increase in cost of funds was led by a 180 basis point increase in
federal funds purchased and securities sold under agreements to repurchase,
which generally reprice more quickly than other interest bearing sources of
funds and correlates with the increase in general short-term market interest
rates.
Interest expense on time deposits, the largest component of total interest
expense, increased $1.2 million or 42.1% to $4.1 million. The increase was
driven mainly by a $97.6 million or 22.7% higher average balance outstanding in
the current period that was boosted by the promotion of the FlexSpender
certificate of deposit product during the last half of 2004 and the effect of
the $62.4 million additional deposits from the Citizens Georgetown acquisition.
In addition, the average rate paid on time deposits rose by 42 basis points to
3.1% from 2.7% a year earlier. Interest expense on savings deposits and interest
bearing demand deposits increased $187 thousand or 45.1% and $295 thousand or
101.4%, respectively. These increases were due almost entirely to an increase in
the average rates paid on savings and interest bearing demand deposits of 37
basis points or 42.5% and 46 basis points or 93.9%, respectively. The increase
in average rates paid follows the trend of increasing general short-term market
interest rates between the comparable periods. The average outstanding balances
of savings and interest bearing demand deposits grew $2.0 million or 1.0% and
$9.5 million or 4.0%, respectively.
The net interest margin (TE) decreased 10 basis points to 3.73% during the
second quarter of 2005 compared to 3.83% in the second quarter of 2004. The
decrease in net interest margin is primarily attributed to a 17 basis point
decrease in the spread between rates earned on earning assets and the rates paid
on interest bearing liabilities to 3.41% in the current quarter from 3.58% in
the second quarter of 2004. The effect of noninterest bearing sources of funds
offset the 17 basis point lower spread by 7 basis points, resulting in the
decrease in net interest margin. The effect of noninterest bearing sources of
funds on net interest margin typically increases in a rising rate environment.
The following tables present an analysis of net interest income for the
quarterly periods ended June 30.
DISTRIBUTION OF ASSETS, LIABILITIES AND SHAREHOLDERS' EQUITY: INTEREST RATES AND INTEREST DIFFERENTIAL
- -------------------------------------------------------------------------------------------------------------------------------
Quarter Ended June 30, 2005 2004
- -------------------------------------------------------------------------------------------------------------------------------
Average Average Average Average
(In thousands) Balance Interest Rate Balance Interest Rate
- -------------------------------------------------------------------------------------------------------------------------------
EARNING ASSETS
Investment securities
Taxable $ 236,035 $ 2,045 3.48% $ 252,474 $ 2,021 3.22%
Nontaxable(1) 94,571 1,412 5.99 96,168 1,456 6.09
Time deposits with banks, federal
funds sold and securities purchased
under agreements to resell 52,475 405 3.10 34,595 85 .99
Loans(1,2,3) 888,004 14,374 6.49 783,088 11,885 6.10
- -------------------------------------------------------------------------------------------------------------------------------
Total earning assets 1,271,085 $ 18,236 5.75% 1,166,325 $ 15,447 5.33%
- -------------------------------------------------------------------------------------------------------------------------------
Allowance for loan losses (12,402) (11,383)
- -------------------------------------------------------------------------------------------------------------------------------
Total earning assets, net of
allowance for loan losses 1,258,683 1,154,942
- -------------------------------------------------------------------------------------------------------------------------------
NONEARNING ASSETS
Cash and due from banks 87,651 91,741
Premises and equipment, net 27,452 24,242
Other assets 62,998 38,611
- -------------------------------------------------------------------------------------------------------------------------------
Total assets $ 1,436,784 $ 1,309,536
- -------------------------------------------------------------------------------------------------------------------------------
INTEREST BEARING LIABILITIES
Deposits
Interest bearing demand $ 246,320 $ 586 .95% $ 236,795 $ 291 .49%
Savings 194,135 602 1.24 192,147 415 .87
Time 528,062 4,116 3.13 430,452 2,896 2.71
Federal funds purchased and
securities sold under agreements
to repurchase 76,962 571 2.98 84,941 249 1.18
Other borrowed funds 53,336 527 3.96 54,309 493 3.65
- -------------------------------------------------------------------------------------------------------------------------------
Total interest bearing liabilities 1,098,815 $ 6,402 2.34% 998,644 $ 4,344 1.75%
- -------------------------------------------------------------------------------------------------------------------------------
NONINTEREST BEARING LIABILITIES
Commonwealth of Kentucky deposits 46,502 41,075
Other demand deposits 148,699 134,952
Other liabilities 10,643 8,734
- -------------------------------------------------------------------------------------------------------------------------------
Total liabilities 1,304,659 1,183,405
- -------------------------------------------------------------------------------------------------------------------------------
Shareholders' equity 132,125 126,131
- -------------------------------------------------------------------------------------------------------------------------------
Total liabilities and shareholders'
equity $ 1,436,784 $ 1,309,536
- -------------------------------------------------------------------------------------------------------------------------------
Net interest income 11,834 11,103
TE basis adjustment (534) (554)
- -------------------------------------------------------------------------------------------------------------------------------
Net interest income $ 11,300 $ 10,549
- -------------------------------------------------------------------------------------------------------------------------------
Net interest spread 3.41% 3.58%
Impact of noninterest bearing sources
of funds .32 .25
- -------------------------------------------------------------------------------------------------------------------------------
Net interest margin 3.73% 3.83%
- -------------------------------------------------------------------------------------------------------------------------------
(1)Income and yield stated at a fully tax equivalent basis using the marginal corporate Federal tax rate of 35%.
(2)Loan balances include principal balances on nonaccrual loans.
(3)Loan fees included in interest income amounted to $621 thousand and $625 thousand in 2005 and 2004, respectively.
ANALYSIS OF CHANGES IN NET INTEREST INCOME (TAX EQUIVALENT BASIS)
- -----------------------------------------------------------------------------------------------------------------
(In thousands) Variance Variance Attributed to
Quarter Ended June 30, 2005/2004(1) Volume Rate
- -----------------------------------------------------------------------------------------------------------------
INTEREST INCOME
Taxable investment securities $ 24 $ (575) $ 599
Nontaxable investment securities(2) (44) (22) (22)
Time deposits with banks, federal funds sold and
securities purchased under agreements to resell 320 62 258
Loans(2) 2,489 1,685 804
- -----------------------------------------------------------------------------------------------------------------
Total interest income 2,789 1,150 1,639
- -----------------------------------------------------------------------------------------------------------------
INTEREST EXPENSE
Interest bearing demand deposits 295 12 283
Savings deposits 187 4 183
Time deposits 1,220 725 495
Federal funds purchased and securities sold under
agreements to repurchase 322 (158) 480
Other borrowed funds 34 (53) 87
- -----------------------------------------------------------------------------------------------------------------
Total interest expense 2,058 530 1,528
- -----------------------------------------------------------------------------------------------------------------
Net interest income $ 731 $ 620 $ 111
- -----------------------------------------------------------------------------------------------------------------
Percentage change 100.0% 84.8% 15.2%
- -----------------------------------------------------------------------------------------------------------------
(1)The changes that are not solely due to rate or volume are allocated on a percentage basis using the absolute
values of rate and volume variances as a basis for allocation.
(2)Income stated at fully tax equivalent basis using the marginal corporate Federal tax rate of 35%.
NONINTEREST INCOME
Noninterest income totaled $5.2 million for the second quarter of 2005, an
increase of $924 thousand or 21.8% compared to $4.2 million for the same period
in the prior year. Noninterest income represents 22.6% of total revenue for the
current quarter, an increase of 43 basis points from 22.1% for the same period
last year. The increase in noninterest income is due primarily to an increase in
allotment processing fees of $444 thousand attributed to the FiNET acquisition
during the fourth quarter of 2004, higher service charges and fees on deposit
accounts of $435 thousand or 20.8%, and an increase in net gains on the sale of
mortgage loans of $150 thousand. The increased net gains on the sale of mortgage
loans is attributed to higher mortgage loans originated for sale of $3.6 million
or 61.1% in the comparison and is mainly attributed to the operations of Pro
Mortgage Partners, a mortgage company the Company opened during 2004. The
increase in service charges and fees on deposit accounts is due mainly to fees
related to new deposit accounts resulting from the FiNET acquisition. Since this
is a recent acquisition, the increase in service charges and fees related to
these deposit accounts is expected to level off once there are comparable
periods in the future.
Other service charges, commissions, and fees declined $93 thousand or 13.5% to
$596 thousand from $689 thousand in the quarterly comparison, with no
significant decline in any single category. Income from company-owned life
insurance was $340 thousand, a decrease of $22 thousand or 6.1% from $362
thousand in the second quarter of 2004. The decline is attributed to lower
crediting rates on the underlying investments. Until recently, the underlying
investments related to the company-owned life insurance have been repricing
downward in a lower interest rate environment.
NONINTEREST EXPENSE
Total noninterest expenses were $11.3 million for the three months ended June
30, 2005, an increase of $1.7 million or 17.9% compared to the same period in
2004. The increase in noninterest expenses are mainly a result of the Citizens
Georgetown and FiNET acquisitions and the expansion of banking operations into
the Lexington, Kentucky market, all of which occurred during the last six months
of 2004. The largest increase in noninterest expenses was salaries and employee
benefits, which increased $771 thousand or 14.3% as the average number of full
time equivalent employees rose 10.9% to 519 from 468 in the three-month
comparison. A significant portion of the increase in full time equivalent
employees is attributed to the Citizens Georgetown and FiNET acquisitions and
additional employees at Pro Mortgage Partners. Salaries and related payroll
taxes increased $585 thousand or 13.6% to $4.9 million due to increased
personnel and normal salary increases. Noncash compensation expense related to
the Company's nonqualified stock option plan declined $68 thousand or 100.0% due
to the structure of the vesting schedule. All options for which the Company had
previously recorded noncash compensation expense became fully vested during the
fourth quarter of 2004. Therefore, there is no further noncash compensation
expense recorded for these stock options. Employee benefit expenses increased
$255 thousand or 25.0% due mainly to unusually low health care costs in the
prior year.
Occupancy expense, net of rental income, increased $97 thousand or 15.3% and
totaled $731 thousand at June 30, 2005. The increase was driven by the Company's
business acquisitions and expansion during the final half of 2004. Equipment
expenses were $681 thousand, an increase of $140 thousand or 25.9% that was also
driven by business expansion. Data processing and communications expense rose
$126 thousand or 12.9% to $1.1 million from $973 thousand. The increase is
attributed to larger processing volumes in the comparison periods. Other
noninterest expenses increased $537 thousand or 35.6% to $2.0 million from $1.5
million. Included in this increase is $123 thousand of amortization expense of
core deposit intangibles and $123 thousand of customer relationship intangibles
related to the Company's acquisition activity in which there is no corresponding
amount for the second quarter of 2004. Additionally, there was an increase in
auditing expenses of approximately $69 thousand in the current quarter compared
to the same period in 2004 attributed to Sarbanes-Oxley compliance, a $78
thousand increase in net expenses attributed to the Company's foreclosed real
estate properties, and increases in other general expenses relating to the
Company's acquisitions and business expansion activity during 2004.
INCOME TAXES
Income tax expense for the second quarter of 2005 was $1.2 million, an increase
of $273 thousand or 28.2% from the same period a year earlier. The effective tax
rate increased 364 basis points to 24.2% from 20.5% in 2004. The change in the
effective tax rate is due to increased revenues from taxable sources and a
decrease in revenue from nontaxable investment securities.
FIRST SIX MONTHS OF 2005 VS. FIRST SIX MONTHS OF 2004
-----------------------------------------------------
Net income for the six months ended June 30, 2005 was $7.9 million compared to
net income of $7.2 million for the same period in 2004, an increase of $695
thousand or 9.6%. Basic and diluted net income per share was $1.17 and $1.16 for
the current six months, an increase of $.09 on both a basic and diluted per
share basis compared to $1.08 and $1.07 for the prior year. This represents an
increase of 8.3% and 8.4% on a basic and diluted per share basis, respectively.
The operating results related to Citizens Georgetown acquired on July 1, 2004
and FiNET acquired on October 8, 2004 are included in the financial results
presented for the current six-month period. Since these acquisitions occurred in
the last half of 2004, there are no comparable results for the prior year
period. Net loans and deposits acquired from Citizens Georgetown on the date of
purchase were $50.1 million and $62.4 million, respectively. Net assets acquired
from FiNET on the date of purchase, primarily intangibles, were approximately
$6.6 million.
The increase in net income for the six months ended June 30, 2005 is primarily
attributed to an increase in net interest income and a lower provision for loan
losses offset by a higher effective federal income tax rate. Net interest income
for the current six months was $22.4 million, an increase of $1.5 million or
7.2% compared to $20.9 during the same period a year earlier. The increase in
net interest income in the quarterly comparison can be attributed to higher
interest income, primarily on loans, which offset the growth in interest
expense, mainly on deposits.
The provision for loans losses decreased $877 thousand or 107.9% in the
six-month comparison. The negative provision for loan losses of $64 thousand for
the current period is attributed to a $4.4 million reduction in nonperforming
loans in the current six-month period ended June 30, 2005 and the sale of the
Company's credit card portfolio during the first six months of 2005.
Nonperforming loans include nonaccrual loans, restructured loans, and loans past
due 90 days or more in which interest is still accruing. Nonperforming loans and
credit card loans typically have larger allowances due to their identified risk
of loss characteristics.
Noninterest income increased $2.4 million or 28.4% in the six-month comparison.
The increase in noninterest income was led by higher allotment processing fees
of $898 thousand or 224.5% and is attributed to the FiNET acquisition late
during 2004. Other significant increases in noninterest income include service
charges and fees on deposits of $800 thousand or 20.1%, gains on the sale of
mortgage loans of $294 thousand or 255.7%, and a one-time gain of $700 thousand
on the sale of the Company's $3.2 million credit card portfolio during the
current six months. Under the sale agreement, the Company will continue to offer
its customers credit cards via an agency arrangement with the purchaser. All
existing credit card accounts on the purchase date remained active. Notable
declines in noninterest income include income from bank owned life insurance of
$196 thousand or 25.6% due to lower crediting rates on the underlying
investments and lower service charges, commissions, and fees of $139 thousand or
10.1%. Up until recently, the underlying investments related to the bank owned
life insurance have been repricing in a lower interest rate environment.
Noninterest expenses increased $3.5 million or 18.4% in the current six months
compared to the same period a year ago. These increases offset the $2.4 million
higher amount of reported noninterest income. The increase in noninterest
expenses occurred across a broad range of line items and is generally attributed
to the Company's business expansion during the last half of 2004. The most
significant increase was salaries and employee benefits, which grew $1.3 million
or 12.4% in the comparison as the average number of full time equivalent
employees rose to 517 from 462. Other notable increases include amortization of
intangibles of $491 thousand and auditing expenses of $187 thousand compared to
the same period a year earlier. The effective income tax rate increased to 22.8%
from 20.3%, resulting in an increase in income tax expense of $504 thousand or
27.3%.
ROA was 1.11% for the current six-month period, a decrease of 1 basis point
compared to 1.12% reported for the same period in 2004. Significant factors that
positively impacted ROA and their amount include the lower provision for loan
losses of 14 basis points and higher noninterest income relative to average
assets of 21 basis points. Significant factors that negatively impacted ROA
include a lower net interest margin of 13 basis points, higher noninterest
expenses relative to average assets of 22 basis points, and higher income taxes
contributing 2 basis points. ROE was 12.16% for the first six month of 2005
compared to 11.51% for the same period of 2004. This represents an increase of
65 basis points and is attributed to a 67 basis point increase in financial
leverage to 10.9% from 10.3% combined with the increase in net income. Financial
leverage represents the degree in which borrowed funds, as opposed to equity,
are used in the funding of assets.
NET INTEREST INCOME
The trend of the general interest rate environment in the current six months
ended June 30, 2005 compared to the same period a year earlier has been upward
primarily as a result of short-term interest rate increases by the Fed. The Fed
has increased short-term interest rates by 225 basis points in nine equal
increments of 25 basis points since June 30, 2004. The effects of these rate
increases by the Fed has generally led to higher average rates earned and paid
on interest earning assets and interest bearing liabilities with a faster
increase in the average rates paid on interest bearing liabilities due to their
repricing characteristics.
Net interest income is the most significant component of the Company's earnings.
Net interest income is the excess of the interest income earned on earning
assets over the interest paid for funds to support those assets. The two most
common metrics used to analyze net interest income are net interest spread and
net interest margin. Net interest spread represents the difference between the
yields on earning assets and the rates paid on interest bearing liabilities. Net
interest margin represents the percentage of net interest income to average
earning assets. Net interest margin will exceed net interest spread because of
the existence of noninterest bearing sources of funds, principally demand
deposits and shareholders' equity, which are also available to fund earning
assets. Changes in net interest income and margin result from the interaction
between the volume and the composition of earning assets, their related yields,
and the associated cost and composition of the interest bearing liabilities.
Accordingly, portfolio size, composition, and the related yields earned and the
average rates paid can have a significant impact on net interest spread and
margin. The table on the following page represents the major components of
interest earning assets and interest bearing liabilities on a tax equivalent
basis. To compare the tax-exempt asset yields to taxable yields, amounts are
adjusted to pretax equivalents based on the marginal corporate Federal tax rate
of 35%.
The Company's tax equivalent yield on earning assets for the current six months
was 5.7%, an increase of 30 basis points from 5.4% in the same period a year
ago. The cost of funds for the current six months was 2.3%, an increase of 49
basis points compared to 1.8% in the same period a year earlier. A goal of the
Company in the current interest rate environment is to increase earning assets
while maintaining the current relatively low interest rates paid on interest
bearing liabilities. The Company strives to accomplish this goal while providing
excellent service to its customers and maintaining its core deposit base.
Maintaining the relatively low cost of funds is becoming more difficult due to
the recent rise in general interest rates and competitive market forces. Average
earning assets increased $124 million or 10.8% to $1.3 billion in the six month
comparison, helped in part to the acquisition of Citizens Georgetown during the
last half of 2004. As a percentage of total average assets, earning assets
decreased 9 basis points to 88.97% from 89.06%.
Interest income results from interest earned on earning assets, which primarily
include loans and investment securities. Interest income is affected by volume
(average balance), composition of earning assets, and the related rates earned
on those assets. Total interest income for the first six months of 2005 was
$34.8 million, an increase of $5.2 million or 17.5% from the same period in the
previous year. The growth in interest income was mainly attributed to higher
interest income on loans, with an increase in the average rate earned also
contributing to the increase. Interest income on loans increased mainly as a
result of higher average loan balances outstanding resulting from both the
Citizens Georgetown acquisition and internally generated loan growth. The
Company's tax equivalent yield on earning assets for the current period was
5.7%, an increase of 30 basis points compared to the same period a year ago.
Interest and fees on loans was $28.0 million, an increase of $4.5 million or
19.0% mainly due to higher average loan balances outstanding along with an
increase in the average rate earned. Average loans increased $110 million or
14.2% to $884 million in the comparison due to higher loan demand in what
remains a relatively low interest rate environment and, to a lesser extent, the
loans acquired in the Citizens Georgetown acquisition. On July 1, 2004, the
Company purchased approximately $50.1 million in loans related to the Citizens
Georgetown acquisition. The tax equivalent yield on loans increased 27 basis
points to 6.4% from 6.2% in the six-month comparison. Interest on taxable
securities was $4.0 million, a decrease of $28 thousand or less than 1.0% in the
comparison as an $18.3 million decrease in the average balance outstanding was
offset by a 24 basis point increase in the average rate earned. Interest on
nontaxable securities was also relatively unchanged and totaled $2.0 million in
the current and comparable period a year ago. Interest on short-term
investments, including time deposits in other banks, federal funds sold, and
securities purchased under agreements to resell, increased $732 thousand due to
a 168 basis point increase in the average rate earned to 2.7% from 1.0% and, to
a lesser extent, an increase in the average balance outstanding of $31.4 million
or 83.2% to $69.2 million from $37.7 million. The higher average rate earned on
short-term investments correlates to the increases in general market interest
rates resulting from the Fed's increase of short-term interest rates over the
last year.
Interest expense results from incurring interest on interest bearing
liabilities, which include interest bearing deposits, federal funds purchased
and securities sold under agreements to repurchase, and other borrowed funds.
Interest expense is affected by volume, composition of interest bearing
liabilities, and the related rates paid on those liabilities. Total interest
expense was $12.4 million for first six months of 2005, an increase of $3.7
million or 42.0% from the same period in the prior year. Interest expense
increased primarily as a result of higher average rates paid throughout the
entire deposit portfolio, with an increase in average balances outstanding of
certain deposit categories, particularly time deposits, contributing to a lesser
degree. The Company's cost of funds was 2.3% for the six months ending June 30,
2005, an increase of 49 basis points from 1.8% for the prior year. The increase
in cost of funds was led by a 158 basis point increase in federal funds
purchased and securities sold under agreements to repurchase, which generally
reprice more quickly than other interest bearing sources of funds and correlates
with the increase in general short-term market interest rates.
Interest expense on time deposits, the largest component of total interest
expense, increased $2.1 million or 35.8% to $8.0 million. The increase was
driven mainly by a $98.5 million or 23.0% higher average balance outstanding in
the current six-month period that was boosted by the promotion of the
FlexSpender certificate of deposit product during the last half of 2004 and the
effect of the $62.4 million additional deposits from the Citizens Georgetown
acquisition. In addition, the average rate paid on time deposits increased 30
basis points to 3.1% from 2.8% a year earlier. Interest expense on savings
deposits and interest bearing demand deposits increased $323 thousand or 39.2%
and $549 thousand or 95.8%, respectively. These increases were due almost
entirely to an increase in the average rates paid on savings and interest
bearing demand deposits of 32 basis points or 36.8% and 42 basis points or
85.7%, respectively. The increase in average rates paid follows upward movement
in general short-term market interest rates between the comparable periods. The
average outstanding balances of savings and interest bearing demand deposits
grew $3.2 million or 1.7% and $11.9 million or 5.0%, respectively.
The net interest margin (TE) decreased 13 basis points to 3.70% during the first
six months of 2005 compared to 3.83% in the same period of 2004. The decrease in
net interest margin is primarily attributed to a 19 basis point decline in the
spread between rates earned on earning assets and the rates paid on interest
bearing liabilities to 3.39% in the current period from 3.58% in the comparable
period in 2004. The effect of noninterest bearing sources of funds offset the 19
basis point lower spread by 6 basis points, resulting in the decrease in net
interest margin. The effect of noninterest bearing sources of funds on net
interest margin typically increases in a rising rate environment.
The following tables present an analysis of net interest income for the six
months ended June 30.
DISTRIBUTION OF ASSETS, LIABILITIES AND SHAREHOLDERS' EQUITY: INTEREST RATES AND INTEREST DIFFERENTIAL
- -----------------------------------------------------------------------------------------------------------------------------
Six Months Ended June 30, 2005 2004
- -----------------------------------------------------------------------------------------------------------------------------
Average Average Average Average
(In thousands) Balance Interest Rate Balance Interest Rate
- -----------------------------------------------------------------------------------------------------------------------------
EARNING ASSETS
Investment securities
Taxable $ 231,957 $ 3,957 3.44% $ 250,214 $ 3,985 3.20%
Nontaxable(1) 95,082 2,851 6.05 94,121 2,854 6.10
Time deposits with banks, federal
funds sold and securities purchased
under agreements to resell 69,153 917 2.67 37,737 185 .99
Loans(1,2,3) 883,769 28,163 6.43 773,642 23,703 6.16
- -----------------------------------------------------------------------------------------------------------------------------
Total earning assets 1,279,961 $ 35,888 5.65% 1,155,714 $ 30,727 5.35%
- -----------------------------------------------------------------------------------------------------------------------------
Allowance for loan losses (12,614) (11,394)
- -----------------------------------------------------------------------------------------------------------------------------
Total earning assets, net of
allowance for loan losses 1,267,347 1,144,320
- -----------------------------------------------------------------------------------------------------------------------------
NONEARNING ASSETS
Cash and due from banks 82,283 92,817
Premises and equipment, net 27,476 24,216
Other assets 61,554 36,268
- -----------------------------------------------------------------------------------------------------------------------------
Total assets $ 1,438,660 $ 1,297,621
- -----------------------------------------------------------------------------------------------------------------------------
INTEREST BEARING LIABILITIES
Deposits
Interest bearing demand $ 247,833 $ 1,122 .91% $ 235,922 $ 573 .49%
Savings 194,001 1,147 1.19 190,787 824 .87
Time 526,693 7,981 3.06 428,162 5,879 2.76
Federal funds purchased and
securities sold under agreements
to repurchase 81,599 1,105 2.73 81,684 467 1.15
Other borrowed funds 55,091 1,053 3.85 54,679 995 3.66
- -----------------------------------------------------------------------------------------------------------------------------
Total interest bearing liabilities 1,105,217 $ 12,408 2.26% 991,234 $ 8,738 1.77%
- -----------------------------------------------------------------------------------------------------------------------------
NONINTEREST BEARING LIABILITIES
Commonwealth of Kentucky deposits 40,577 38,729
Other demand deposits 150,608 133,889
Other liabilities 10,545 7,121
- -----------------------------------------------------------------------------------------------------------------------------
Total liabilities 1,306,947 1,170,973
- -----------------------------------------------------------------------------------------------------------------------------
Shareholders' equity 131,713 126,648
- -----------------------------------------------------------------------------------------------------------------------------
Total liabilities and shareholders'
equity $ 1,438,660 $ 1,297,621
- -----------------------------------------------------------------------------------------------------------------------------
Net interest income 23,480 21,989
TE basis adjustment (1,078) (1,095)
- -----------------------------------------------------------------------------------------------------------------------------
Net interest income $ 22,402 $ 20,894
- -----------------------------------------------------------------------------------------------------------------------------
Net interest spread 3.39% 3.58%
Impact of noninterest bearing sources
of funds .31 .25
- -----------------------------------------------------------------------------------------------------------------------------
Net interest margin 3.70% 3.83%
- -----------------------------------------------------------------------------------------------------------------------------
(1)Income and yield stated at a fully tax equivalent basis using the marginal corporate Federal tax rate of 35%.
(2)Loan balances include principal balances on nonaccrual loans.
(3)Loan fees included in interest income amounted to $1.2 million in each of the periods presented.
ANALYSIS OF CHANGES IN NET INTEREST INCOME (TAX EQUIVALENT BASIS)
- --------------------------------------------------------------------------------------------------------
(In thousands) Variance Variance Attributed to
Six Months Ended June 30, 2005/2004(1) Volume Rate
- --------------------------------------------------------------------------------------------------------
INTEREST INCOME
Taxable investment securities $ (28) $ (606) $ 578
Nontaxable investment securities(2) (3) 51 (54)
Time deposits with banks, federal funds sold and
securities purchased under agreements to resell 732 241 491
Loans(2) 4,460 3,410 1,050
- --------------------------------------------------------------------------------------------------------
Total interest income 5,161 3,096 2,065
- --------------------------------------------------------------------------------------------------------
INTEREST EXPENSE
Interest bearing demand deposits 549 30 519
Savings deposits 323 14 309
Time deposits 2,102 1,428 674
Federal funds purchased and securities sold under
agreements to repurchase 638 (2) 640
Other borrowed funds 58 7 51
- --------------------------------------------------------------------------------------------------------
Total interest expense 3,670 1,477 2,193
- --------------------------------------------------------------------------------------------------------
Net interest income $ 1,491 $ 1,619 $ (128)
- --------------------------------------------------------------------------------------------------------
Percentage change 100.0% 108.6% (8.6)%
- --------------------------------------------------------------------------------------------------------
(1)The changes that are not solely due to rate or volume are allocated on a percentage basis using the absolute
values of rate and volume variances as a basis for allocation.
(2)Income stated at fully tax equivalent basis using the marginal corporate Federal tax rate of 35%.
NONINTEREST INCOME
- ------------------
Noninterest income totaled $10.7 million for the first six months of 2005, an
increase of $2.4 million or 28.4% compared to $8.3 million for the same period
in the prior year. Noninterest income represents 23.5% of total revenue for the
current six months, an increase of 155 basis points from 21.9% for the same
period last year. The increase in noninterest income is due primarily to an
increase in allotment processing fees of $898 thousand attributed to the FiNET
acquisition late during 2004, higher service charges and fees on deposit
accounts of $800 thousand or 20.1%, and an increase in net gains on the sale of
mortgage loans of $294 thousand. The increased net gains on the sale of mortgage
loans is attributed to higher mortgage loans originated for sale of $7.3 million
or 75.3% in the comparison and is mainly attributed to the operations of Pro
Mortgage Partners, a mortgage company the Company opened during 2004. The
increase in service charges and fees on deposit accounts is due mainly to fees
related to new deposit accounts resulting from the FiNET acquisition during the
fourth quarter of 2004. Since this is a recent acquisition, the increase in
service charges and fees related to these deposit accounts is expected to level
off once there are comparable periods in the future.
Other service charges, commissions, and fees declined $139 thousand or 10.1% to
$1.2 million from $1.4 million in the six-month comparison. The decrease
occurred over many categories, with no significant decline in any single
category. Income from company-owned life insurance was $571 thousand, a decrease
of $196 thousand or 25.6% from $767 thousand in the prior year. The decline is
attributed to lower crediting rates on the underlying investments. Until
recently, the underlying investments related to the company-owned life insurance
have been repricing downward in a lower interest rate environment.
NONINTEREST EXPENSE
- -------------------
Total noninterest expenses were $22.9 million for the six months ended June 30,
2005, an increase of $3.5 million or 18.4% compared to the same period in 2004.
The increase in noninterest expenses are mainly a result of the Citizens
Georgetown and FiNET acquisitions and the expansion of banking operations into
the Lexington, Kentucky market, all of which occurred during the last six months
of 2004. The largest increase in noninterest expenses was salaries and employee
benefits, which rose $1.3 million or 12.4% as the average number of full time
equivalent employees increased 11.9% to 517 from 462 in the six-month
comparison. A significant portion of the increase in full time equivalent
employees is attributed to the Citizens Georgetown and FiNET acquisitions and
additional employees at Pro Mortgage Partners. Salaries and related payroll
taxes increased $1.3 million or 15.9% to $9.8 million due to increased personnel
and normal salary increases. Noncash compensation expense related to the
Company's nonqualified stock option plan declined $138 thousand or 100.0% due to
the structure of the vesting schedule. All options for which the Company had
previously recorded noncash compensation expense became fully vested during the
fourth quarter of 2004. Therefore, there is no further noncash compensation
expense recorded for these stock options. Employee benefit expenses increased
$132 thousand or 6.1% due mainly to higher health care costs.
Occupancy expense, net of rental income, increased $193 thousand or 14.9% to
$1.5 million for the six months ended June 30, 2005. The increase was driven by
the Company's business acquisitions and expansion during the final half of 2004.
Equipment expenses were $1.4 million, an increase of $259 thousand or 23.4% that
was also driven by business expansion. Data processing and communications
expense rose $242 thousand or 12.8% to $2.1 million from $1.9 million. The
increase is mainly attributed to higher processing volumes in the comparison
periods. Other noninterest expenses increased $1.4 million or 45.2% to $4.5
million from $3.1 million. Included in this increase is $245 thousand of
amortization expense of core deposit intangibles and $246 thousand of customer
relationship intangibles related to the Company's acquisition activity in which
there is no corresponding amount for the six-month period of 2004. Additionally,
there was an increase in auditing expenses of approximately $187 thousand in the
current six-month period compared to the same period in 2004 attributed to
Sarbanes-Oxley compliance, a $243 thousand increase in net expenses attributed
to the Company's foreclosed real estate properties, and increases in other
general expenses relating to the Company's acquisitions and business expansion
activity during 2004. The increase in net expenses attributed to the Company's
foreclosed real estate properties is unusually high since there were
approximately $100 thousand in gains reported in the comparable period a year
earlier.
INCOME TAXES
- ------------
Income tax expense for the first six months of 2005 was $2.3 million, an
increase of $504 thousand or 27.3% from the same period a year earlier. The
effective tax rate increased 253 basis points to 22.8% from 20.3% in 2004. The
increase in the effective tax rate is due to increased revenues from taxable
sources and a decrease in revenue from nontaxable investment securities.
FINANCIAL CONDITION
Total assets were $1.4 billion on June 30, 2005, an increase of $21.4 million or
1.5% from the prior year-end. The growth in assets was the result of a $32.9
million or 41.4% increase in cash and cash equivalents, a $23.7 million or 2.7%
increase in net loans, and a $6.5 million or 7.6% increase in other assets,
partially offset by a decline in investment securities of $41.7 million or
11.3%. The $6.5 million higher other assets total is due mainly to an increase
in other real estate owned of $5.9 million or 158.0%. The increase in total
assets correlates to additional net funding sources, primarily $12.6 million or
1.1% in additional deposits, $7.3 million or 12.3% increase in federal funds
purchased and securities sold under agreements to repurchase, offset by a $2.3
million or 4.2% decrease in other borrowed funds. The increase in deposits is
mainly due to higher noninterest bearing deposits of $23.3 million or 13.5% and
is related primarily to deposit activity of the Commonwealth of Kentucky. The
higher noninterest bearing deposit totals was partially offset by a $10.8
million or 1.1% decline in interest bearing deposits. Total shareholders' equity
increased $3.0 million or 2.3% due mainly to net income of $7.9 million offset
by dividends paid to shareholders of $4.5 million.
Management of the Company considers it noteworthy to understand the relationship
between the Company's principal subsidiary, Farmers Bank & Capital Trust Co.,
and the Commonwealth of Kentucky. Farmers Bank provides various services to
state agencies of the Commonwealth. As the depository for the Commonwealth,
checks are drawn on Farmers Bank by these agencies, which include paychecks and
state income tax refunds. Farmers Bank also processes vouchers of the WIC
(Women, Infants and Children) program for the Cabinet for Human Resources. The
Bank's investment department also provides services to the Teacher's Retirement
systems. As the depository for the Commonwealth, large fluctuations in deposits
are likely to occur on a daily basis. Therefore, reviewing average balances is
important to understanding the financial condition of the Company.
On an average basis, total assets were $1.4 billion for the first six months of
2005, an increase of $91.1 million or 6.8% from year-end 2004. Average earning
assets, primarily loans and securities, were $1.3 billion at June 30, 2005, an
increase of $79.2 million or 6.6% from year-end 2004. Average earning assets
represent 88.9% of total average assets for the six-month period ended June 30,
2005, a decrease of 13 basis points compared to 89.1% for year-end 2004.
LOANS
- -----
Loans, net of unearned income, totaled $899 million at June 30, 2005, an
increase of $22.7 million or 2.6% from year-end 2004. The composition of the
loan portfolio is summarized in the table below.
- --------------------------------------------------------------------------------
June 30, 2005 December 31, 2004
(Dollars in thousands) Amount % Amount %
- --------------------------------------------------------------------------------
Commercial, financial,
and agriculture $ 135,804 15.1% $ 134,016 15.3%
Real estate - construction 67,588 7.5 63,156 7.2
Real estate mortgage - residential 318,464 35.4 313,711 35.8
Real estate mortgage farmland and
other commercial enterprises 274,313 30.5 251,094 28.6
Installment 64,666 7.2 75,271 8.6
Lease financing 38,550 4.3 39,457 4.5
- --------------------------------------------------------------------------------
Total $ 899,385 100.0% $ 876,705 100.0%
- --------------------------------------------------------------------------------
On average, loans represented 69.0% of earning assets during the current six
month period compared to 68.2% for year-end 2004. As loan demand fluctuates, the
available funds are reallocated between loans and lower earning temporary
investments or investment securities, which typically involve a decrease in
credit risk and lower yields.
ALLOWANCE FOR LOAN LOSSES
- -------------------------
The allowance for loan losses was $11.8 million at June 30, 2005, a decrease of
$1.0 million or 8.0% from the prior year-end. The allowance for loan losses was
1.31% of loans net of unearned income at June 30, 2005, a decrease of nine and
15 basis points from 1.40% and 1.46% at March 31, 2005 and December 31, 2004,
respectively. The provision for loan losses decreased $465 thousand or 103.8%
and $877 thousand or 107.9% in the current three-month and six-month periods,
respectively, compared to the same periods in 2004. A negative provision for
loans losses of $17 thousand and $64 thousand in the current three and six
months periods resulted from a $454 thousand and $4.4 million reduction in
nonperforming loans in the current three and six-month periods ended June 30,
2005. Additionally, the Company sold its $3.2 million credit card portfolio in
the current six-month period. These factors contributed to a lower allowance for
loans losses at June 30, 2005. Nonperforming loans include nonaccrual loans,
restructured loans, and loans past due 90 days or more in which interest is
still accruing. Nonperforming loans and credit card loans typically have larger
allowances due to their identified risk of loss characteristics.
The Company had net charge-offs of $621 thousand and $966 thousand in the
current three and six months of 2005, respectively, compared to net charge-offs
of $324 thousand and $687 thousand in the same periods of 2004. Annualized net
charge-offs represent .28% and .22% of average net loans for three and six
months ended June 30, 2005, respectively compared to .32% at year-end 2004. The
allowance for loan losses as a percentage of nonperforming loans totaled 209.0%
and 203.9% at June 30, 2005 and December 31, 2004, respectively. Management
continues to emphasize collection efforts and evaluation of risks within the
loan portfolio.
NONPERFORMING ASSETS
- --------------------
Nonperforming assets for the Company include nonperforming loans, other real
estate owned, and other foreclosed assets. Nonperforming assets totaled $15.4
million at June 30, 2005, an increase of $1.6 million or 11.3% from the prior
year-end. Nonperforming loans totaled $5.6 million at June 30, 2005 a decrease
of $4.4 million or 43.8% compared to $10.0 million at year-end 2004. The decline
in nonperforming loans was driven primarily by two extensions of credit secured
by real estate. One involves a balance of approximately $1.3 million to a
financially trouble builder secured by multifamily residential real estate, the
other relates to approximately $1.4 million secured by commercial real estate.
The underlying collateral securing the credit to the financially troubled
builder was transferred to the Company through foreclosure during the first
quarter of 2005. The $1.4 million commercial real estate credit was collected in
the first quarter of 2005. Nonperforming loans represent .6% of loans net of
unearned income at June 30, 2005, a decrease of 51 basis points from 1.1%
compared to year-end 2004.
Other real estate owned was $9.6 million at June 30, 2005. This represents an
increase of $5.9 million or 158.0% compared to $3.7 million at year-end 2004.
The increase is attributed mainly to the transfer of $6.3 million of residential
real estate to the Company through foreclosure related to the previously
disclosed financially troubled builder.
TEMPORARY INVESTMENTS
- ---------------------
Temporary investments consist of interest bearing deposits in other banks and
federal funds sold and securities purchased under agreements to resell. The
Company uses these funds in the management of liquidity and interest rate
sensitivity. At June 30, 2005, temporary investments were $29.9 million, a
decrease of $7.0 million or 19.0% compared to $36.8 million at year-end 2004.
Temporary investments averaged $69.2 million during the first six months of
2005, an increase of $28.6 million or 70.6% from year-end 2004. The increase is
primarily a result of the Company's net funding position, which was driven by an
increase in average interest bearing deposits of $76.0 million or 8.5%.
Temporary investments are reallocated as loan demand and other investment
alternatives present the opportunity.
INVESTMENT SECURITIES
- ---------------------
The investment securities portfolio is comprised primarily of U.S. Government
agency securities, mortgage-backed securities, and tax-exempt securities of
states and political subdivisions. Total investment securities were $328 million
on June 30, 2005, a decrease of $41.7 million or 11.3% from year-end 2004.
Total investment securities averaged $327 million for the current six-month
period, a decrease of $14.2 million or 4.2% from the average 2004 year-end
balance. The decrease in average investment securities was driven by a $35.1
million net decline in mortgage-backed securities, which was partially offset by
net additional purchases of U.S. Government agency securities averaging $23.1
million during the current six-month period. The Company had a net unrealized
gain on available for sale investment securities of $758 thousand at June 30,
2005, a decrease of $319 thousand or 29.6% compared to $1.1 million at year-end
2004. The decrease in the current six-month period is due primarily to the
impact of changing economic conditions, including an increase in short-term
market interest rates that have generally lowered the value of the investment
portfolio at the end of the current period. As overall market interest rates
have drifted higher in the current period, the portfolio has declined in value.
Market values of fixed rate investments are inversely related to changes in
market interest rates.
COMPANY-OWNED LIFE INSURANCE
- ----------------------------
Company-owned life insurance totaled $27.5 million at June 30, 2005, an increase
of $546 thousand or 2.0% from $27.0 million at year-end 2004. Income from
company-owned life insurance was $340 thousand and $571 thousand for the three
and six months ended June 30, 2005, respectively. This represents a decrease of
$22 thousand or 6.1% and $196 thousand or 25.6% in the three and six-month
comparisons. The decline is due to lower crediting rates on the underlying
investments. Until recently, the underlying investments related to the
company-owned life insurance have been repricing downward in a lower interest
rate environment.
DEPOSITS
- --------
The Company's primary source of funding for its lending and investment
activities results from its customer deposits, which consist of noninterest and
interest bearing demand, savings, and time deposits. On June 30, 2005, deposits
totaled $1.2 billion, an increase of $12.6 million or 1.1% from year-end 2004.
The growth in deposits was due to a $23.3 million or 13.5% increase in
noninterest bearing deposits partially offset by a $10.8 million or 1.1% decline
in interest bearing deposits. The increase in noninterest bearing deposits is
attributed to $26.8 million higher balance related to the Commonwealth of
Kentucky. Excluding the Commonwealth of Kentucky deposits, noninterest bearing
deposits decreased $3.4 million or 2.2% in the comparison. The net decrease in
interest bearing deposits include higher time deposits of $14.3 million or 2.8%,
offset by lower savings deposit balances of $18.2 million or 9.0% and lower
interest bearing demand deposits of $6.9 million or 2.8%. Time deposits grew
primarily as a result of a net additional $22.4 million of FlexSpender
certificate of deposit accounts opened during the six months ended June 30,
2005. The Company anticipates that the growth of FlexSpender accounts will
diminish since marketing efforts to sell this product have been scaled back.
Average total deposits were $1.2 billion for the first six months of 2005, an
increase of $87.2 million or 8.1% compared to the average for the twelve months
ended December 31, 2004. Net increases in average deposits were consistent
throughout most of the deposit portfolio as follows: noninterest bearing demand
of $11.2 million or 6.2%; interest bearing demand of $5.7 million or 2.4%;
savings accounts of $2.9 million or 1.5%; and time deposits of $67.4 million or
14.7%. The increase in time deposits is attributed to the growth in FlexSpender
certificate of deposits, which were introduced during 2004.
BORROWED FUNDS
- --------------
Borrowed funds totaled $120 million at June 30, 2005, an increase of $5.0
million or 4.4% from $115 million at year-end 2004. The increase was made up of
a $5.9 million or 9.6% increase in short-term borrowings partially offset by a
decline of $914 thousand or 1.7% in long-term borrowings. Federal funds
purchased and securities sold under agreements to repurchase increased
short-term borrowings by $7.3 million or 12.3%. This increase was partially
offset by the repayment of short-term Federal Home Loan Bank ("FHLB") borrowings
of $1.0 million. The increase in federal funds purchased and securities sold
under agreements to repurchase is mainly due to higher balances related to the
Commonwealth of Kentucky and, to a lesser extent, increased correspondent
banking activity. The $914 thousand decrease in long-term borrowings is
primarily attributed to repayments of borrowed funds from the FHLB. Total
borrowed funds averaged $137 million, a decrease of $1.2 million or less than
1.0% from $138 million at year-end 2004.
LIQUIDITY
The Parent Company's primary use of cash consists of dividend payments to its
common shareholders, purchases of its common stock, corporate acquisitions, and
other general operating purposes. Liquidity of the Parent Company depends
primarily on the receipt of dividends from its subsidiary banks and cash
balances maintained. As of June 30, 2005 combined retained earnings of the
subsidiary banks were $52.1 million, of which $5.0 million was available for the
payment of dividends to the Parent Company without obtaining prior approval from
bank regulatory agencies. As a practical matter, payment of future dividends is
also subject to the maintenance of capital ratio requirements. Management
expects that in the aggregate, its subsidiary banks will continue to have the
ability to pay dividends in order to provide funds to the Parent Company during
the remainder of 2005 sufficient to meet its liquidity needs. The Parent Company
had cash balances of $9.2 million at June 30, 2005, a decrease of $1.6 million
or 14.9% from $10.8 million at year-end 2004. The $1.6 million decrease in cash
at the Parent Company is due primarily to $4.5 million in dividends paid to the
Company's shareholders and for the payment of general operating expenses. The
Company received approximately $3.8 million in dividends from its affiliated
banks, which partially offset cash outflows for dividend payments and operating
expenses.
The Company's objective as it relates to liquidity is to ensure that the
subsidiary banks have funds available to meet deposit withdrawals and credit
demands without unduly penalizing profitability. In order to maintain a proper
level of liquidity, the subsidiary banks have several sources of funds available
on a daily basis that can be used for liquidity purposes. Those sources of funds
include the subsidiary banks' core deposits, consisting of both business and
nonbusiness deposits; cash flow generated by repayment of principal and interest
on loans and investment securities; FHLB borrowings; and federal funds purchased
and securities sold under agreements to repurchase. While maturities and
scheduled amortization of loans and investment securities are generally a
predictable source of funds, deposit outflows and mortgage prepayments are
influenced significantly by general interest rates, economic conditions, and
competition in our local markets. As of June 30, 2005 the Company had
approximately $162 million in additional borrowing capacity under various FHLB
and federal funds borrowing agreements with unaffiliated entities. However,
there is no guarantee that these sources of funds will continue to be available
to the Company, or that current borrowings can be refinanced upon maturity,
although the Company is not aware of any events or uncertainties that are likely
to cause a decrease in our liquidity from these sources.
For the longer term, the liquidity position is managed by balancing the maturity
structure of the balance sheet. This process allows for an orderly flow of funds
over an extended period of time. The Company's Asset and Liability Management
Committee, both at the bank subsidiary level and on a consolidated basis, meets
regularly and monitors the composition of the balance sheet to ensure
comprehensive management of interest rate risk and liquidity.
Liquid assets consist of cash, cash equivalents, and securities available for
sale. At June 30, 2005, such assets totaled $422 million, a decrease of $6.9
million or 1.6% from year-end 2004. The decrease in liquid assets is attributed
to the overall funding position of the Company. Net cash provided by operating
activities was $2.8 million in the first six months of 2005, a decline of $4.9
million or 63.3% compared $7.7 million for the same period a year earlier. The
decrease in net cash provided by operating activities in the comparable periods
is attributed to an increase in other assets, primarily a $5.9 million higher
balance of other real estate owned. Net cash provided by investing activities
was $17.1 million in the current six-month period compared to $37.3 million net
use of cash in the same period last year. This represents an increase in net
cash provided by investing activities of $54.4 million in the six-month
comparable periods. The most significant items include $40.4 million higher net
cash flows provided by investment securities activities and a $14.7 million
decrease from loans originated for investment, net of principal collected that
positively affected cash flow. Net cash provided by financing activities was
$12.9 million for the six months ended June 30, 2005 compared to $27.0 million
net cash used in the same six-month period a year earlier. This represents an
increase in cash flows of $39.8 million in the comparison and is related mainly
to $78.3 million attributed to increased deposit activity partially offset by
$37.1 million related to lower federal funds purchased and securities sold under
agreements to repurchase activity in the comparable periods.
Commitments to extend credit are considered in addressing the Company's
liquidity management. The Company does not expect these commitments to
significantly effect the liquidity position in future periods.
CAPITAL RESOURCES
Shareholders' equity was $134 million on June 30, 2005. This represents an
increase of $3.0 million or 2.3% from year-end 2004 due mainly to an increase in
retained earnings of $3.5 million or 2.3%. Retained earnings increased as a
result of $7.9 million in net income offset by $4.5 million, or $.66 per share,
in dividends declared during the current six-month period. The Company issued
seven thousand and four thousand shares of common stock during the current six
months pursuant to its nonqualified stock option plan and ESPP, respectively.
The issuance of these shares increased shareholders' equity by $282 thousand.
The Company purchased approximately 16 thousand shares of its outstanding common
stock at a total cost of $519 thousand during the current year to date period of
2005.
Accumulated other comprehensive income, consisting of net unrealized holding
losses on available for sale securities (net of tax), was $493 thousand at June
30, 2005, a decrease of $207 thousand from year-end 2004. The decrease is due
primarily to the impact of changing economic conditions, including an increase
in short-term market interest rates that have generally lowered the value of the
investment portfolio at the end of the current period. As overall market rates
have drifted higher in the current period, the portfolio has declined in value.
Market values of fixed rate investments are inversely related to changes in
market interest rates.
Consistent with the objective of operating a sound financial organization, the
Company's goal is to maintain capital ratios well above the regulatory minimum
requirements. The Company's capital ratios as of June 30, 2004, the regulatory
minimums and the regulatory standard for a "well capitalized" institution are as
follows.
Farmers Capital Regulatory Well
Bank Corporation Minimum Capitalized
- -------------------------------------------------------------------------------
Tier 1 risk based 12.64% 4.00% 6.00%
Total risk based 13.86% 8.00% 10.00%
Leverage 8.52% 4.00% 5.00%
As of June 30, 2005, all of the Company's subsidiary banks were in excess of the
well-capitalized regulatory ratio requirements as calculated under guidelines
established by federal banking agencies.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company uses a simulation model as a tool to monitor and evaluate interest
rate risk exposure. The model is designed to measure the sensitivity of net
interest income and net income to changing interest rates over future time
periods. Forecasting net interest income and its sensitivity to changes in
interest rates requires the Company to make assumptions about the volume and
characteristics of many attributes, including assumptions relating to the
replacement of maturing earning assets and liabilities. Other assumptions
include, but are not limited to, projected prepayments, projected new volume,
and the predicted relationship between changes in market interest rates and
changes in customer account balances. These effects are combined with the
Company's estimate of the most likely rate environment to produce a forecast of
net interest income and net income. The forecasted results are then adjusted for
the effect of a gradual increase and decrease in market interest rates on the
Company's net interest income and net income. Because assumptions are inherently
uncertain, the model cannot precisely estimate net interest income or net income
or the effect of interest rate changes on net interest income and net income.
Actual results could differ significantly from simulated results.
At June 30, 2005, the model indicated that if rates were to gradually increase
by 150 basis points during the calendar year, then net interest income and net
income would increase .42% and .89%, respectively for the year ending December
31, 2005. The model indicated that if rates were to gradually decrease by 150
basis points over the same period, then net interest income and net income would
decrease 2.0% and 4.5%, respectively.
In the current low interest rate environment, it is not practical or possible to
reduce certain deposit rates by the same magnitude as rates on earning assets.
The average rate paid on some of the Company's deposits is below 1.5%. This
situation magnifies the model's predicted results when modeling a decrease in
interest rates, as earning assets with higher yields have more of an opportunity
to reprice at lower rates than lower-rate deposits.
ITEM 4. CONTROLS AND PROCEDURES
The Registrant's Chief Executive Officer and Chief Financial Officer have
reviewed and evaluated the effectiveness of the Registrant's disclosure controls
and procedures as of the end of the period covered by this report, and have
concluded that the Registrant's disclosure controls and procedures were adequate
and effective to ensure that all material information required to be disclosed
in this annual report has been made known to them in a timely fashion.
There were no significant changes in the Registrant's internal controls or in
other factors that could significantly affect these controls subsequent to the
date of the Chief Executive Officer and Chief Financial Officers evaluation, nor
were there any material weaknesses in the controls which required corrective
action.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
As of June 30, 2005, there were various pending legal actions and proceedings
against the Company arising from the normal course of business and in which
claims for damages are asserted. Management, after discussion with legal
counsel, believes that these actions are without merit and that the ultimate
liability resulting from these legal actions and proceedings, if any, will not
have a material effect upon the consolidated financial statements of the
Company.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
The following table provides information with respect to shares of common stock
repurchased by the Company during the quarter ended June 30, 2005.
- --------------------------------------------------------------------------------------------------------------------------------
Total Number of Shares Maximum Number of
Purchased as Part of Shares that May Yet Be
Total Number of Average Price Publicly Announced Purchased Under the
Period Shares Purchased Paid per Share Plans or Programs Plans or Programs
- --------------------------------------------------------------------------------------------------------------------------------
April 1, 2005 to April 30, 2005 10,400 $ 33.07 10,400 185,708
- --------------------------------------------------------------------------------------------------------------------------------
May 1, 2005 to May 31, 2005 5,000 32.40 5,000 180,708
- --------------------------------------------------------------------------------------------------------------------------------
June 1, 2005 to June 30, 2005 180,708
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Total 15,400 $ 32.85 15,400
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On January 27, 2003, the Company's Board of Directors authorized the purchase of
up to 300,000 shares of the Company's outstanding common stock. No stated
expiration date was established under this plan.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The annual meeting of shareholders was held May 10, 2005. The matters that were
voted upon included the election of four directors for three-year terms ending
in 2008 or until their successors have been elected and qualified.
The outcome of the voting was as follows:
ELECTION OF DIRECTORS
NAME FOR AGAINST WITHHELD ABSTAINED
- --------------------------------------------------------------------------------
G. Anthony Busseni 5,739,076 0 85,048 22,751
Shelley S. Sweeney 5,801,173 0 22,951 22,751
Michael M. Sullivan 5,687,591 0 136,533 22,751
Frank R. Hamilton, Jr. 5,799,773 0 24,351 22,751
- --------------------------------------------------------------------------------
Listed below are the names of each director whose term of office continued after
the meeting.
Frank W. Sower, Jr. Lloyd C. Hillard, Jr.
J. Barry Banker Harold G. Mays
Dr. John D. Sutterlin Robert Roach, Jr.
Dr. Donald J. Mullineaux Cecil D. Bell, Jr.
In addition to the directors above, Dr. John P. Stewart, Chairman Emeritus, E.
Bruce Dungan, and Charles T. Mitchell serve as advisory directors for the
Company.
ITEM 6. EXHIBITS
List of Exhibits
----------------
3i. Amended and Restated Articles of Incorporation of Farmers Capital Bank
Corporation (incorporated by reference to Quarterly Report on Form
10-Q for the quarterly period ended June 30, 1998).
3ii. Amended and Restated By-Laws of Farmers Capital Bank Corporation
(incorporated by reference to Annual Report of Form 10-K for the
fiscal year ended December 31, 1997.
3iia Amendments to By-Laws of Farmers Capital Bank Corporation
(incorporated by reference to Quarterly Report of Form 10-Q for the
quarterly period ended March 31, 2003).
31.1 CEO Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of
2002 (page 31)
31.2 CFO Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of
2002 (page 32)
32 CEO & CFO Certifications Pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002 (page 33)
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.
Date: August 8, 2005 /s/ G. Anthony Busseni
------------------- -------------------------------------------------
G. Anthony Busseni,
President and CEO
(Principal Executive Officer)
Date: 8-8-05 /s/ Doug Carpenter
------------------- -------------------------------------------------
C. Douglas Carpenter,
Vice President, Secretary, and CFO
(Principal Financial and Accounting Officer)