UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2003
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ____________________ to ___________________
Commission File Number: 33-96358
KENTUCKY BANCSHARES, INC.
(Exact name of registrant as specified in its charter)
Kentucky 61-0993464
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
P.O. Box 157, Paris, Kentucky 40362-0157
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (859)987-1795
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
Yes X No _____
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes No X___
Number of shares of Common Stock outstanding as of October 31, 2003:
2,786,058.
KENTUCKY BANCSHARES, INC.
Table of Contents
Part I - Financial Information
Item 1. Financial Statements
Consolidated Balance Sheets 3
Consolidated Statements of Income and
Comprehensive Income 4
Consolidated Statements of Changes in
Stockholders' Equity 6
Consolidated Statements of Cash Flows 7
Notes to Consolidated Financial Statements 8
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 12
Item 3. Quantitative and Qualitative Disclosures About
Market Risk 19
Item 4. Controls and Procedures 20
Part II - Other Information 21
Signatures 22
Exhibits
31.1 Certifications of Chief Executive Officer pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002. 23
31.2 Certifications of Chief Financial Officer pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002. 25
32 Certifications of Chief Executive Officer and Chief
Financial Officer pursuant to 18 U.S.C. Section 1350,
as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002. 27
Item 1 - Financial Statements
KENTUCKY BANCSHARES, INC.
CONSOLIDATED BALANCE SHEETS
(thousands) 9/30/2003 12/31/2002
Assets
Cash and due from banks $ 9,995 $ 10,493
Federal funds sold 2,302 18,683
Cash and cash equivalents 12,297 29,176
Securities available for sale 96,872 89,509
Mortgage loans held for sale 7,168 740
Loans 277,697 284,154
Allowance for loan losses (3,166) (3,395)
Net loans 274,531 280,759
Federal Home Loan Bank stock 4,149 4,027
Bank premises and equipment, net 11,045 10,332
Interest receivable 3,205 3,276
Intangible assets 1,316 1,367
Other assets 962 585
Total assets $ 411,545 $ 419,771
Liabilities and Stockholders' Equity
Deposits
Non-interest bearing $ 60,109 $ 53,366
Time deposits, $100 and over 38,855 46,904
Other interest bearing 206,809 222,566
Total deposits 305,773 322,836
Securities sold under agreements to repurchase 1,368 3,505
Other borrowed funds 1,308 1,772
Trust preferred securities 7,000 0
Federal Home Loan Bank advances 46,791 43,937
Interest payable 1,374 1,844
Other liabilities 1,955 1,785
Total liabilities 365,569 375,679
Stockholders' equity
Common stock 6,972 6,807
Retained earnings 37,468 35,436
Accumulated other comprehensive income 1,536 1,849
Total stockholders' equity 45,976 44,092
Total liabilities & stockholders' equity $ 411,545 $ 419,771
KENTUCKY BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (unaudited)
(thousands, except per share amounts) Nine Months Ending
9/30/2003 9/30/2002
INTEREST INCOME:
Loans, including fees $ 13,949 $ 15,505
Securities available for sale 2,589 3,023
Other 80 129
Total interest income 16,618 18,657
INTEREST EXPENSE:
Deposits 3,979 5,444
Other 1,830 1,781
Total interest expense 5,809 7,225
Net interest income 10,809 11,432
Loan loss provision 675 1,003
Net interest income after provision 10,134 10,429
OTHER INCOME:
Service charges 3,133 2,949
Loan service fee income 183 168
Trust department income 238 253
Securities available for sale gains (losses), net 131 243
Gain on sale of mortgage loans 787 428
Other 689 569
Total other income 5,161 4,610
OTHER EXPENSES:
Salaries and employee benefits 5,455 4,882
Occupancy expenses 1,530 1,426
Amortization of intangibles 370 312
Advertising and marketing 300 225
Taxes other than payroll, property and income 332 300
Other 2,361 1,980
Total other expenses 10,348 9,125
Income before taxes 4,947 5,914
Income taxes 1,331 1,772
Net income $ 3,616 $ 4,142
Other Comprehensive Income, net of tax:
Change in Unrealized Gains on Securities (313) 1,195
Comprehensive Income $ 3,303 $ 5,337
Earnings per share
Basic $ 1.30 $ 1.50
Diluted 1.29 1.48
BOURBON BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (unaudited)
(thousands, except per share amounts) Three Months Ending
9/30/2003 9/30/2002
INTEREST INCOME:
Loans, including fees $ 4,532 $ 5,136
Securities available for sale 792 1,025
Other 21 27
Total interest income 5,345 6,188
INTEREST EXPENSE:
Deposits 1,194 1,619
Other 647 590
Total interest expense 1,841 2,209
Net interest income 3,504 3,979
Loan loss provision 225 301
Net interest income after provision 3,279 3,678
OTHER INCOME:
Service charges 1,058 1,036
Loan service fee income 59 56
Trust department income 82 76
Securities available for sale gains (losses), net 111 62
Gain on sale of mortgage loans 256 259
Other 221 184
Total other income 1,787 1,673
OTHER EXPENSES:
Salaries and employee benefits 1,693 1,559
Occupancy expenses 496 483
Amortization of intangibles 129 107
Advertising and marketing 100 75
Taxes other than payroll, property and income 111 100
Other 882 725
Total other expenses 3,411 3,049
Income before taxes 1,655 2,302
Income taxes 394 677
Net income $ 1,261 $ 1,625
Other Comprehensive Income, net of tax:
Change in Unrealized Gains on Securities (606) 625
Comprehensive Income $ 655 $ 2,250
Earnings per share
Basic $ 0.45 $ 0.59
Diluted 0.45 0.58
KENTUCKY BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (unaudited)
(thousands, except number of shares)
Accumulated
Other Total
----Common Stock---- Retained Comprehensive Stockholders'
Shares Amount Earnings Income Equity
<s> <c> <c> <c> <c> <c>
Balances, December 31, 2002 2,772,754 $ 6,807 $ 35,436 $ 1,849 $ 44,092
Common stock issued 13,704 176 - - 176
Common stock purchased (400) (11) - - (11)
Net change in unrealized gain (loss)
on securities available for sale,
net of tax - - - (313) (313)
Net income - - 3,616 - 3,616
Dividends declared - $0.57 per share - - (1,584) - (1,584)
Balances, September 30, 2003 2,786,058 $ 6,972 $ 37,468 $ 1,536 $ 45,976
KENTUCKY BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
(thousands) Nine Months Ending
9/30/2003 9/30/2002
Cash Flows From Operating Activities
Net Income $ 3,616 $ 4,142
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation 718 746
Amortization 370 312
Securities available for sale amortization
(accretion), net 559 268
Provision for loan losses 675 1,003
Securities available for sale (gains) losses, net (131) (243)
Originations of loans held for sale (36,555) (21,683)
Proceeds from sale of loans 30,914 22,350
Federal Home Loan Bank Stock Dividends (122) (136)
Gain on sale of mortgage loans (787) (428)
Changes in:
Interest receivable 71 (122)
Other assets (502) (124)
Interest payable (470) (1,264)
Other liabilities 138 34
Net cash from operating activities (1,506) 4,855
Cash Flows From Investing Activities
Purchases of securities available for sale (42,066) (35,805)
Proceeds from sales of securities available for sale 6,520 18,839
Proceeds from principal payments, maturities and
calls of securities available for sale 27,280 9,610
Net change in loans 5,553 (11,030)
Purchases of bank premises and equipment, net (1,431) (420)
Net cash from investing activities (4,144) (18,806)
Cash Flows From Financing Activities:
Net change in deposits (17,063) (5,842)
Net change in securities sold under agreements to
repurchase and other borrowings (2,601) 3,521
Proceeds from Trust preferred securities 7,000 -
Advances from Federal Home Loan Bank 12,000 4,250
Payments on Federal Home Loan Bank advances (9,146) (5,857)
Proceeds from issuance of common stock 176 135
Purchase of common stock (11) (94)
Dividends paid (1,584) (1,414)
Net cash from financing activities (11,229) (5,301)
Net change in cash and cash equivalents (16,879) (19,252)
Cash and cash equivalents at beginning of period 29,176 29,638
Cash and cash equivalents at end of period $ 12,297 $ 10,386
KENTUCKY BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. 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 Company's books and records without audit. The
accompanying consolidated financial statements have been prepared in
accordance with the instructions to Form 10-Q and Rule 10-01 of Regulation
S-X. Certain financial information that is normally included in annual
financial statements prepared in accordance with accounting principles
generally accepted in the United States of America, but is not required for
interim reporting purposes, has been condensed or omitted. 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, 2002.
2. INTANGIBLE ASSETS
Information concerning the Company's core deposit intangible follows:
Original Accumulated
Amount Amortization
9/30/2003
Core deposit intangible $2,890,404 $2,436,622
Amortization expense was $209,601 for the first nine months of 2003 and for
the first nine months of 2002.
Estimated amortization expense for the next five years is: 2003 - $279,468;
2004 - $198,895; 2005 - $19,140; 2006 - $19,140; and 2007 - $19,140.
There are no intangible assets not subject to amortization.
3. INVESTMENT SECURITIES
Period-end securities are as follows:
(in thousands)
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
Available for Sale
September 30, 2003
U.S. Treasury $ 3,037 $ 21 $ - $ 3,058
U.S. government agencies 25,986 180 (79) 26,087
States and political subdivisions 35,941 1,450 (98) 37,293
Mortgage-backed 27,371 616 (53) 27,934
Equity securities 1,201 260 (16) 1,445
Other 1,010 45 - 1,055
Total 94,546 2,572 (246) 96,872
December 31, 2002
U.S. Treasury $ 5,012 $ 47 $ - $ 5,059
U.S. government agencies 5,991 147 - 6,138
States and political subdivisions 29,730 1,300 (6) 31,024
Mortgage-backed 39,459 920 (58) 40,321
Equity securities 3,478 285 (15) 3,748
Other 3,038 197 (16) 3,219
Total 86,708 2,896 (95) 89,509
4. LOANS
Loans at period-end are as follows:
(in thousands)
9/30/2003 12/31/2002
Commercial $ 14,045 $ 16,803
Real estate construction 9,930 15,514
Real estate mortgage 189,345 182,206
Agricultural 51,563 52,188
Consumer 12,814 17,443
Total 277,697 284,154
5. On August 28, 2003, Kentucky Bancshares Statutory Trust I, a trust
subsidiary of the Company, issued 7,000 shares of cumulative trust
preferred securities with a liquidation preference of $1,000 per security.
The proceeds of the offering were loaned to the Company in exchange for
subordinated debentures with terms that are similar to the trust preferred
securities; these debentures are the sole asset of the trust subsidiary.
Distributions on the securities are payable quarterly at a rate per annum
equal to 7.06% through September 17, 2008, and thereafter quarterly in
arrears at the annual rate (adjusted quarterly) equal to the 3-month LIBOR
plus 3.00%. The Company has guaranteed that the trust subsidiary will
make the required distributions to the holders of the trust preferred
securities. The trust preferred securities, which mature September 17,
2033, are subject to mandatory redemption, in whole or in part, upon
repayment of the subordinated debentures at maturity or their earlier
redemption at the liquidation preference. Subject to regulatory approval,
the subordinated debentures are redeemable before the maturity date at the
Company's option on or after September 17, 2008, at their principal amount
plus accrued interest. The subordinated debentures are also redeemable in
whole or in part, from time to time, upon the occurrence of specific events
defined in the debenture indenture. The Company undertook the issuance of
these securities to enhance its regulatory capital position as they are
considered as Tier I capital under current regulatory guidelines. The
Company intends to use the proceeds to assist in funding continued growth
and development of the business, including the November 7, 2003 acquisition
of Kentucky First Bancorp.
6. Basic earnings per common share is net income divided by the weighted
average number of common shares outstanding during the period. Diluted
earnings per common share includes the dilutive effect of additional
potential common shares issuable under stock options.
The factors used in the earnings per share computation follow:
Nine Months Ended
September 30
2003 2002
(in thousands)
Basic Earnings Per Share
Net Income $3,616 $4,142
Weighted average common shares outstanding 2,778 2,770
Basic earnings per share $ 1.30 $ 1.50
Diluted Earnings Per Share
Net Income $3,616 $4,142
Weighted average common shares outstanding 2,778 2,770
Add dilutive effects of assumed exercise
of stock options 33 38
Weighted average common and dilutive
potential common shares outstanding 2,811 2,808
Diluted earnings per share $ 1.29 $ 1.48
Three Months Ended
September 30
2003 2002
(in thousands)
Basic Earnings Per Share
Net Income $1,261 $1,625
Weighted average common shares outstanding 2,782 2,776
Basic earnings per share $ 0.45 $ 0.59
Diluted Earnings Per Share
Net Income $1,261 $1,625
Weighted average common shares outstanding 2,782 2,776
Add dilutive effects of assumed exercise
of stock options 34 37
Weighted average common and dilutive
potential common shares outstanding 2,816 2,813
Diluted earnings per share $ 0.45 $ 0.58
7. Stock Compensation
The Company grants certain officers and key employees stock option awards
which vest and become fully exercisable at the end of five years. The
Company also grants certain directors stock option awards which vest and
become fully exercisable immediately. The exercise price of each option,
which has a ten year life, was equal to the market price of the Company's
stock on the date of grant; therefore, no compensation expense was
recognized.
Employee compensation expense under stock options is reported using the
intrinsic value method. No stock-based compensation cost is reflected in
net income, as all options granted had an exercise price equal to or greater
than the market price of the underlying common stock at date of grant. The
following table illustrates the effect on net income and earnings per share
if expense was measured using the fair value recognition provisions of FASB
Statement No. 123, Accounting for Stock-Based Compensation.
Nine months ended
September 30
2003 2002
(In thousands)
Net income
As reported $ 3,616 $ 4,142
Deduct: Stock-based compensation
expense determined under fair
value based method (25) (91)
Pro forma 3,591 4,051
2003 2002
Basic earnings per share
As reported $ 1.30 $ 1.50
Pro forma 1.29 1.46
Diluted earnings per share
As reported $ 1.29 $ 1.48
Pro forma 1.28 1.44
8. Dividends per share paid for the quarter ended September 30, 2003 were
$0.19 compared to $0.17 for September 30, 2002. This is the same rate of
dividend paid for the first and second quarters of the respective years.
9. The Financial Accounting Standards Board (FASB) recently issued two new
accounting standards, Statement 149, Amendment of Statement 133 on
Derivative Instruments and Hedging Activities, and Statement 150,
Accounting for Certain Financial Instruments with Characteristics of both
Liabilities and Equities, both of which generally become effective in the
quarter beginning July 1, 2003. Management determined that, upon adopting
the new standards, they will not materially affect the Company's operating
results or financial condition (because the Company does not have these
instruments or engage in these activities).
In January 2003, the Financial Accounting Standards Board ("FASB") issued
Interpretation No. 46, Consolidation of Variable Interest Entities, an
Interpretation of ARB No. 51. This Interpretation provides new guidance for
the consolidation of variable interest entities ("VIEs") and requires such
entities to be consolidated by their primary beneficiaries if the entities
do not effectively disperse risk among parties involved. The Interpretation
also adds disclosure requirements for investors that are involved with
unconsolidated VIEs. The consolidation requirements apply immediately to
VIEs created after January 31, 2003 and are effective for the first fiscal
year or interim period ending after December 15, 2003 for VIEs acquired
before February 1, 2003. The adoption of this interpretation is not
expected have a significant impact on the Company's financial condition of
results of operations.
Item 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Forward-Looking Statements
This discussion contains forward-looking statements under the Private
Securities Litigation Reform Act of 1995 that involve risks and uncertainties.
Words such as "believes," "anticipates," "expects," "intends," "plans,"
"targeted," and similar expressions are intended to identify forward-looking
statements but are not the exclusive means of identifying such statements.
Although the Company believes that the assumptions underlying the
forward-looking statements contained herein are reasonable, any of the
assumptions could be inaccurate, and therefore, there can be no assurance that
the forward-looking statements included herein will prove to be accurate.
Factors that could cause actual results to differ from the results discussed
in the forward-looking statements include, but are not limited to: economic
conditions (both generally and more specifically in the markets, including the
tobacco market, in which the Company and its bank operate); competition for
the Company's customers from other providers of financial and mortgage
services; government legislation and regulation (which changes from time to
time and over which the Company has no control); changes in interest rates
(both generally and more specifically mortgage interest rates); material
unforeseen changes in the liquidity, results of operations, or financial
condition of the Company's customers; and other risks detailed in the
Company's filings with the Securities and Exchange Commission, all of which
are difficult to predict and many of which are beyond the control of the
Company. The Company undertakes no obligation to republish revised
forward-looking statements to reflect events or circumstances after the date
hereof or to reflect the occurrence of unanticipated events.
Recent Developments
On July 8, 2003, Bourbon Bancshares, Inc. and Kentucky First Bancorp, Inc.,
announced the execution of a definitive agreement providing for the Company's
acquisition of Kentucky First Bancorp and its wholly-owned subsidiary, First
Federal Savings Bank. The transaction closed on November 7, 2003. As of
November 7, 2003, Kentucky First had total assets of $73 million, total loans
of $32 million and total deposits of $54 million. Total cash consideration
paid by the Company in the transaction was $22.2 million.
Effective July 15, 2003, the Company changed its name from Bourbon Bancshares,
Inc. to Kentucky Bancshares, Inc.
Summary
Kentucky Bancshares, Inc. recorded net income of $3.6 million, or $1.30 basic
earnings per share and $1.29 diluted earnings per share for the first nine
months ended September 30, 2003 compared to $4.1 million, or $1.50 basic
earnings per share and $1.48 diluted earnings per share for the nine month
period ending September 30, 2002. The first nine months reflects a decrease
in net income per share of 13.3% compared to the first nine months of the
prior year. For the three month period ending September 30, 2003, net income
was $1.3 million ($0.45 basic earnings and diluted earnings per share)
compared to $1.6 million ($0.59 basic earnings and $0.58 diluted earnings per
share) for the same period in 2002. This was a decrease in earnings per share
of 23.7%.
Return on average assets was 1.17% for the nine months ended September 30,
2003 and 1.39% for the same time period in 2002, a decrease of 16%. Return on
average assets was 1.22% for the three months ended September 30, 2003
compared to 1.63% for the same time period in 2002, a decrease of 25%. Return
on average equity was 10.7% for the nine month period ended September 30, 2003
and 13.6% for the same period in 2002. Return on average equity was 11.0% and
15.6% for the three months ended September 30, 2003 and 2002, respectively.
Loans decreased $6.5 million from $284.2 million on December 31, 2002 to
$277.7 million on September 30, 2003. An increase of $7.1 million in real
estate mortgage loans was offset by a decrease in real estate construction,
commercial and consumer loans. Management attributes the decrease in loans
primarily to the sluggish economy. The decreased loan demand has contributed
to decreases in net interest income.
Total deposits decreased from $322.8 million on December 31, 2002 to $305.8
million on September 30, 2003, a decrease of $17.0 million. The decrease is
mainly attributable to time deposits of $100,000 and more decreasing $8.0
million and other interest bearing deposits decreasing $15.8 million. This
decrease was partially offset by an increase in non-interest bearing deposits
of $6.7 million. The decline in total deposits is primarily attributable to
our decision to be less aggressive in our deposit gathering activities in
light of softening loan demand.
Net Interest Income
Net interest income was $10.8 million for the nine months ended September 30,
2003 and $11.4 million for the nine months ending September 30, 2002,
resulting in a decrease of $623 thousand. Net interest income was $3.5
million for the three months ended September 30, 2003 and $4.0 million for the
three months ended September 30, 2002, resulting in a decrease of $475
thousand. The interest spread was 3.65% for the first nine months of 2003
compared to 3.97% for the same period in 2002, a decrease of 32 basis points.
On June 27, 2003, the Federal Reserve lowered short term interest rates
another 25 basis points. The low interest rates have contributed to tighter
net interest margins.
For the first nine months, the yield on assets decreased from 6.66% in 2002 to
5.74% in 2003. The cost of liabilities decreased from 2.71% in 2002 to 2.09%
in 2003. Year to date average loans are up $5.8 million, or 2.1% from
September 30, 2002 to September 30, 2003. Loan interest income has decreased
$1.6 million for the first nine months of 2003 compared to the first nine
months of 2002, primarily due to loans refinancing at lower rates. Year to
date average deposits also increased from September 30, 2002 to September 30,
2003, up $11.0 million, or 3.5%. Deposit interest expense has decreased $1.5
million for the first nine months of 2003 compared to the same period in 2002,
primarily due to lower rates.
For the three months ended September 30, the yield on assets decreased from
6.58% in 2002 to 5.50% in 2003. The cost of liabilities decreased from 2.45%
in 2002 to 1.93% in 2003, primarily due to the decrease in rates. Loan
interest income has decreased $604 thousand for three months ended September
30, 2003 compared to the three months ended September 30, 2002. Deposit
interest expense has decreased $425 thousand during the three months ended
September 30, 2003 compared to the same time period in 2002.
The declining rate environment in recent years has resulted in tighter margins
in 2002 and 2003, resulting in net interest income decreasing $623 thousand
for the first nine months of 2003 compared to the same period in 2002. The
banking industry continues to battle competition for loan and deposit dollars,
and this trend is expected to continue.
Non-Interest Income
Non-interest income increased $551 thousand for the nine month period ended
September 30, 2003 from $4.6 million to $5.2 million. Non-interest income
increased $114 thousand for the three month period ended September 30, 2003
compared to the same time period in 2002. An increase of $184 thousand in
service charges from the first nine months of 2002 to the comparable 2003
period is mainly attributable to an increase in checking overdraft charges of
$151 thousand (the increase was $15 thousand for the three month period ended
September 30, 2003 compared to September 30, 2002). Overdraft income
increased principally due to the increased utilization of a "Kentucky
Courtesy" overdraft program. This non-contractual program is applied to
qualified accounts, and is an overdraft protection program whereby the Company
may, but is not obligated to, pay checks up to a pre-determined limit.
Gain on sale of mortgage loans increased $359 thousand during the first nine
months of 2003 compared to the same period in 2002. Decreasing rates result
in an increase in loan originations and refinances. Volume of loan
originations and sales are inverse to rate changes. The low level of loan
rates has resulted in the gain from the sale of mortgage loans increasing
during the nine month period ending September 30, 2003 compared to the same
period in 2002. The stabilizing or increasing of interest rates is expected
to cause the income from the sale of loans to be lower in future periods than
in the first nine months of 2003.
Non-Interest Expense
The increase of $1.2 million in non-interest expenses from $9.1 million for
the nine months ended September 30, 2002 to $10.3 million for the same period
in 2003 was a result of several factors. For the three month period ended
September 30, 2003, total non-interest expenses increased $362 thousand to
$3.4 million in 2003. Salaries and benefits increased $573 thousand for the
first nine months of 2003 compared to 2002, an increase of 12%. The increase
is due to annual salary increases and an increased number of employees. In
addition, a market salary adjustment was made effective January 1, 2003.
Employee benefits represented $177 thousand of the increase in salaries and
employee benefits expense during these comparable periods.
Other expenses increased $381 thousand to $2.4 million for the first nine
months of 2003 compared to the same period in 2002. Legal and professional
costs have increased $244 thousand. On July 8, 2003, the Company announced
that it had entered into an agreement to acquire Kentucky First Bancorp, Inc.
of Cynthiana, Kentucky. Merger related legal and consulting fees have
amounted to over $170 thousand through the period ended September 30, 2003.
In addition, consulting fees related to salary reviews, and legal fees related
to loan collections account for the remainder of this increase.
Income Taxes
The tax equivalent rate for the nine months ended September 30 was 27% for
2003 and 30% for 2002. The tax equivalent rate for the three months ended
September 30 was 24% for 2003 and 29% for 2002. These rates are less than the
statutory rate as a result of the tax-free securities and loans held by the
Company.
Stock Repurchase Program
On October 25, 2000, the Company announced that its Board of Directors
approved a stock repurchase program. The Company is authorized to purchase up
to 100,000 shares of its outstanding common stock. On November 11, 2002, the
Board of Directors approved and authorized the Company's repurchase of an
additional 100,000 shares. Shares will be purchased from time to time in the
open market depending on market prices and other considerations. Through
September 30, 2003, 84,333 shares have been purchased. The repurchase program
has had a positive effect on earnings per share calculations.
Liquidity and Funding
Liquidity risk is the possibility that the Company may not be able to meet its
cash requirements. Management of liquidity risk includes maintenance of
adequate cash and sources of cash to fund operations and meeting the needs of
borrowers, depositors and creditors. Excess liquidity has a negative impact
on earnings as a result of the lower yields on short-term assets.
Cash and cash equivalents were $12.3 million as of September 30, 2003 compared
to $29.2 million at December 31, 2002. The decrease in cash and cash
equivalents is mainly attributable to a decrease in federal funds sold. In
addition to cash and cash equivalents, the securities portfolio provides an
important source of liquidity. Total securities available for sale totaled
$96.9 million at September 30, 2003. The available for sale securities are
available to meet liquidity needs on a continuing basis. The Company
maintains a relatively stable base of customer deposits, which is expected to
be adequate to meet its funding demands.
Generally, the Company relies upon net cash inflows from financing activities,
supplemented by net cash inflows from operating activities, to provide cash
used in its investing activities. As is typical of many financial
institutions, significant financing activities include deposit gathering, and
the use of short-term borrowings, such as federal funds purchased and
securities sold under repurchase agreements along with long-term debt. The
Company's primary investing activities include purchasing investment
securities and loan originations.
On August 28, 2003, Kentucky Bancshares Statutory Trust I, a trust subsidiary
of the Company, issued 7,000 shares of cumulative trust preferred securities
with a liquidation preference of $1,000 per security. The proceeds of the
offering were loaned to the Company in exchange for subordinated debentures
with terms that are similar to the trust preferred securities; these
debentures are the sole asset of the trust subsidiary. Distributions on the
securities are payable quarterly at a rate per annum equal to 7.06% through
September 17, 2008, and thereafter quarterly in arrears at the annual rate
(adjusted quarterly) equal to the 3-month LIBOR plus 3.00%. The Company has
guaranteed that the trust subsidiary will make the required distributions to
the holders of the trust preferred securities. The trust preferred securities,
which mature September 17, 2033, are subject to mandatory redemption, in whole
or in part, upon repayment of the subordinated debentures at maturity or their
earlier redemption at the liquidation preference. Subject to regulatory
approval, the subordinated debentures are redeemable before the maturity date
at the Company's option on or after September 17, 2008, at their principal
amount plus accrued interest. The subordinated debentures are also redeemable
in whole or in part, from time to time, upon the occurrence of specific events
defined in the debenture indenture. The Company undertook the issuance of
these securities to enhance its regulatory capital position as they are
considered as Tier I capital under current regulatory guidelines. The Company
intends to use the proceeds to assist in funding continued growth and
development of the business, including the November 7, 2003 acquisition of
Kentucky First Bancorp.
Management believes there is sufficient cash flow from operations to meet
investing and liquidity needs related to reasonable borrower, depositor and
creditor needs in the present economic environment.
Management is aware of the potential problem of funding sustained loan growth.
Therefore, in addition to deposits, other sources of funds, such as Federal
Home Loan Bank (FHLB) advances, may be used. The Company relies on FHLB
advances for both liquidity and asset/liability management purposes. These
advances are used primarily to fund long-term fixed rate residential mortgage
loans. As of September 30, 2003, we have sufficient collateral to borrow an
additional $16 million from the FHLB. In addition, as of September 30, 2003,
over $63 million is available in overnight borrowing through various
correspondent banks. In light of this, management believes there is
sufficient liquidity to meet all reasonable borrower, depositor and creditor
needs in the present economic environment.
Non-Performing Assets
As of September 30, 2003, the Company's non-performing loans totaled $2.0
million or 0.7% of loans compared to $2.4 million or 0.8% of loans at December
31, 2002. (See table below) The decrease in non-accrual loans is mainly
attributable to the charge-off amounting to $481 thousand for a large
commercial loan customer with indebtedness of $750 thousand recorded in the
second quarter of 2003. Real estate loans composed 67% and 65% of the non-
performing loans as of September 30, 2003 and December 31, 2002, respectively.
Forgone interest income on the non-accrual loans for both 2003 and 2002 is
immaterial.
Nonperforming Assets
9/30/03 12/31/02
(in thousands)
Non-accrual Loans $ 684 $ 1,573
Accruing Loans which are
Contractually past due
90 days or more 1,349 789
Total Nonperforming and Restructured 2,033 2,362
Other Real Estate 253 172
Total Nonperforming and Restructured
Loans and Other Real Estate $ 2,286 $ 2,534
Nonperforming and Restructured Loans
as a Percentage of Loans 0.73% 0.83%
Nonperforming and Restructured Loans
and Other Real Estate as a Percentage
of Total Assets 0.56% 0.60%
Provision for Loan Losses
The first nine months 2003 provision for loan losses of $675 thousand is lower
than the comparable 2002 period by $328 thousand. The September 30, 2003
three month provision of $225 thousand is lower than the three month provision
for the period ended September 30, 2002 by $76 thousand. An increase in
nonperforming loans required management to increase the provision in 2002 in
order to maintain an allowance for loan losses that is representative of the
risk of loss based on the quality of loans currently in the portfolio. Net
charge-offs for the nine month period ended September 30, 2003 were $904
thousand compared to $1.0 million for the same time period in 2002. Net
charge-offs for the three month period ending September 30, 2003 were $100
thousand compared to $792 thousand for the same period in 2002. Future levels
of charge-offs will be determined by the economic environment surrounding
individual loans. Management feels the current loan loss reserve is
sufficient to meet incurred loan losses.
Loan Losses
Nine Months Ended September 30
(in thousands)
2003 2002
Balance at Beginning of Period $ 3,395 $ 3,386
Amounts Charged-off:
Commercial 539 532
Real Estate Construction - 18
Real Estate Mortgage 112 18
Agricultural 20 -
Consumer 355 581
Total Charged-off Loans 1,026 1,149
Recoveries on Amounts
Previously Charged-off:
Commercial 9 15
Real Estate Construction - -
Real Estate Mortgage 1 20
Agricultural 21 9
Consumer 91 65
Total Recoveries 122 109
Net Charge-offs 904 1,040
Provision for Loan Losses 675 1,003
Balance at End of Period 3,166 3,349
Loans
Average 281,944 278,113
At September 30 277,697 283,162
As a Percentage of Average Loans:
Net Charge-offs 0.32% 0.37%
Provision for Loan Losses 0.24% 0.36%
Allowance as a Percentage of
Period-end Loans 1.14% 1.18%
Allowance as a Multiple of
Net Charge-offs 3.5 3.2
Allowance as a Percentage of
Non-performing and Restructured Loans 156% 129%
Loan Losses
Quarter Ended September 30
(in thousands)
2003 2002
Balance at Beginning of Period $ 3,041 $ 3,840
Amounts Charged-off:
Commercial 10 484
Real Estate Construction - -
Real Estate Mortgage 24 10
Agricultural - -
Consumer 98 319
Total Charged-off Loans 132 813
Recoveries on Amounts
Previously Charged-off:
Commercial - -
Real Estate Construction - -
Real Estate Mortgage - -
Agricultural - 1
Consumer 32 20
Total Recoveries 32 21
Net Charge-offs 100 792
Provision for Loan Losses 225 301
Balance at End of Period 3,166 3,349
Loans
Average 280,286 283,887
At September 30 277,697 283,162
As a Percentage of Average Loans:
Net Charge-offs 0.04% 0.28%
Provision for Loan Losses 0.08% 0.11%
Allowance as a Multiple of
Net Charge-offs 31.7 4.2
Item 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Asset/Liability management control is designed to ensure safety and soundness,
maintain liquidity and regulatory capital standards, and achieve acceptable
net interest income. Management considers interest rate risk to be the most
significant market risk. The Company's exposure to market risk is reviewed on
a regular basis by the Asset/Liability Committee. Interest rate risk is the
potential of economic losses due to future interest rate changes. These
economic losses can be reflected as a loss of future net interest income
and/or a loss of current fair market values. The objective is to measure the
effect on net interest income and to adjust the balance sheet to minimize the
inherent risk while at the same time maximize income.
Management realizes certain risks are inherent and that the goal is to
identify and minimize the risks. The primary tool used by management is an
interest rate shock simulation model. The Bank has no market risk sensitive
instruments held for trading purposes.
The following table depicts the change in net interest income resulting from
100 and 300 basis point changes in rates on the Company's interest earning
assets and interest bearing liabilities. The projections are based on balance
sheet growth assumptions and repricing opportunities for new, maturing and
adjustable rate amounts. As of September 30, 2003 the projected percentage
changes are within the Board approved limits, except for the "- 300". In the
"- 300" scenario, most of the rates used in the model cannot decline 300 basis
points because of the current low level of rates. In this scenario, the net
interest income changes are outside the Board approved limit, and are
monitored by the Board on a monthly basis. In addition, management has made
some asset/liability decisions that would take advantage of rising interest
rates. Therefore, the Company currently has slightly more volatility to
changing rates than existing a year ago. The projected net interest income
report summarizing the Company's interest rate sensitivity as of September 30,
2003 is as follows:
(dollars in thousands)
PROJECTED NET INTEREST INCOME
Level
Change in basis points: - 300 - 100 Rates + 100 + 300
Year One (10/03 - 9/04)
Interest Income $18,440 $21,041 $22,459 $23,880 $26,723
Interest Expense 5,881 6,162 6,992 7,826 9,495
Net Interest Income 12,559 14,879 15,467 16,054 17,228
PROJECTED DOLLAR INCREASE (DECREASE) FROM "LEVEL RATES"
Year One (10/03 - 9/04)
Interest Income $(4,019) $(1,418) N/A $ 1,421 $ 4,264
Interest Expense (1,111) (830) N/A 834 2,503
Net Interest Income (2,908) (588) N/A 587 1,761
PROJECTED PERCENTAGE INCREASE (DECREASE) FROM "LEVEL RATES"
Year One (10/03 - 9/04)
Interest Income -17.9% -6.3% N/A 6.3% 19.0%
Interest Expense -15.9% -11.9% N/A 11.9% 35.8%
Net Interest Income -18.8% -3.8% N/A 3.8% 11.4%
Board approved limit >-10.0% >-4.0% N/A >-4.0% >-10.0%
The projected net interest income report summarizing the Company's interest
rate sensitivity as of September 30, 2002 is as follows:
(dollars in thousands)
PROJECTED NET INTEREST INCOME
Level
Change in basis points: - 300 - 100 Rates + 100 + 300
Year One (10/02 - 9/03)
Interest Income $ 21,107 $ 23,530 $ 24,863 $ 26,201 $ 28,879
Interest Expense 6,854 7,894 8,698 9,503 11,113
Net Interest Income 14,253 15,636 16,165 16,698 17,766
PROJECTED DOLLAR INCREASE (DECREASE) FROM "LEVEL RATES"
Year One (10/02 - 9/03)
Interest Income $ (3,756) $ (1,333) N/A $ 1,338 $ 4,016
Interest Expense (1,844) (804) N/A 805 2,415
Net Interest Income (1,912) (529) N/A 533 1,601
PROJECTED PERCENTAGE INCREASE (DECREASE) FROM "LEVEL RATES"
Year One (10/02 - 9/03)
Interest Income -15.1% -5.4% N/A 5.4% 16.2%
Interest Expense -21.2% -9.2% N/A 9.3% 27.8%
Net Interest Income -11.8% -3.3% N/A 3.3% 9.9%
Board approved limit >-10.0% >-4.0% N/A >-4.0% >-10.0%
These projected changes in net interest income as of September 30, 2003 are
greater when compared to the projected changes in net interest income as of
September 30, 2002. Projections from September 30, 2003, year one reflected a
decline in net interest income of 3.8% with a 100 basis point decline compared
to the 3.3% decline in 2002. The 300 basis point increase in rates reflected
a 11.4% increase in net interest income in 2003 compared to 9.9% in 2002.
Percentage changes in 2003 are greater when compared to 2002. Therefore,
changes in interest rates should have a larger effect on net interest income.
Item 4 - CONTROLS AND PROCEDURES
As of the end of the period covered by this report, the Company carried out an
evaluation, under the supervision and with the participation of the Company's
management, including the Company's Chief Executive Officer and Chief
Financial Officer, of the effectiveness of the design and operation of the
Company's disclosure controls and procedures. Based on the foregoing, the
Company's Chief Executive Officer and Chief Financial Officer concluded that
the Company's disclosure controls and procedures were effective, in all
material respects, to ensure that information required to be disclosed in the
reports the Company files and submits under the Exchange Act is recorded,
processed, summarized and reported as and when required.
The Company also conducted an evaluation of internal control over financial
reporting to determine whether any changes occurred during the quarter covered
by this report that have materially affected, or are reasonably likely to
materially affect, the Company's internal control over financial reporting.
Based on this evaluation, there has been no such change during the quarter
covered by this report.
Part II - Other Information
Item 1. Legal Proceedings
The Company is not a party to any material legal proceedings.
Item 2. Changes in Securities
None
Item 3. Defaults upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
1. Exhibits as required by Item 601 of Regulation S-K.
31.1 Certifications of Chief Executive Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Certifications of Chief Financial Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
32 Certifications of Chief Executive Officer and Chief
Financial Officer pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
2. Reports on Form 8-K
The Company filed a Form 8-K dated July 8, 2003, Item 5
announcing the merger transaction with Kentucky First
Bancorp, Inc.
The Company filed a Form 8-K dated July 15, 2003, Item 5 to
report its name change and Item 9 and
Item 12 to report the issuance of a press release announcing
its operating results for the six-month period ended
June 30, 2003.
The Company filed a Form 8-K dated August 6, 2003, Item 7 and
Item 12 to report the mailing to its shareholders of
its operating results for the six-month period ended
June 30, 2003.
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant caused
the report to be signed on its behalf by the undersigned, thereunto duly
authorized.
KENTUCKY BANCSHARES, INC.
Date ___11/14/03_________ __/s/Buckner Woodford____________
Buckner Woodford, President and C.E.O.
Date ___11/14/03_________ __/s/Gregory J. Dawson___________
Gregory J. Dawson, Chief Financial Officer
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