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 March 31, 2004
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 May 6, 2004: 2,801,527.
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 5
Consolidated Statements of Cash Flows 6
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 11
Item 3. Quantitative and Qualitative Disclosures About
Market Risk 17
Item 4. Controls and Procedures 18
Part II - Other Information 19
Signatures 20
Exhibits
31.1 Certifications of Chief Executive Officer pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002. 21
31.2 Certifications of Chief Financial Officer pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002. 23
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. 25
Item 1 - Financial Statements
KENTUCKY BANCSHARES, INC.
CONSOLIDATED BALANCE SHEETS (unaudited)
(thousands) 3/31/2004 12/31/2003
Assets
Cash and due from banks $ 12,309 $ 15,225
Federal funds sold 752 6,163
Cash and cash equivalents 13,061 21,388
Securities available for sale 157,195 128,790
Mortgage loans held for sale 7,003 7,759
Loans 313,612 313,002
Allowance for loan losses (3,937) (3,820)
Net loans 309,675 309,182
Federal Home Loan Bank stock 4,979 4,930
Bank premises and equipment, net 11,944 11,606
Interest receivable 3,271 3,250
Goodwill 10,200 10,200
Other intangible assets 1,048 1,137
Other assets 2,282 2,610
Total assets $ 520,658 $ 500,852
Liabilities and Stockholders' Equity
Deposits
Non-interest bearing $ 64,063 $ 64,842
Time deposits, $100 and over 49,825 49,915
Other interest bearing 271,631 269,842
Total deposits 385,519 384,599
Securities sold under agreements to repurchase 20,601 1,791
Other borrowed funds 481 5,494
Subordinated debentures 7,217 7,217
Federal Home Loan Bank advances 56,982 53,232
Interest payable 1,579 1,636
Other liabilities 1,255 826
Total liabilities 473,634 454,795
Stockholders' equity
Common stock 7,019 6,985
Retained earnings 38,114 37,553
Accumulated other comprehensive income 1,891 1,519
Total stockholders' equity 47,024 46,057
Total liabilities & stockholders' equity $ 520,658 $ 500,852
KENTUCKY BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (unaudited)
(thousands, except per share amounts) Three Months Ending
3/31/2004 3/31/2003
INTEREST INCOME:
Loans, including fees $ 4,808 $ 4,728
Securities available for sale 1,441 885
Other 18 49
Total interest income 6,267 5,662
INTEREST EXPENSE:
Deposits 1,436 1,450
Other 760 592
Total interest expense 2,196 2,042
Net interest income 4,071 3,620
Loan loss provision 255 225
Net interest income after provision 3,816 3,395
OTHER INCOME:
Service charges 1,055 983
Loan service fee income 59 62
Trust department income 82 95
Securities available for sale gains (losses), net 16 18
Gain on sale of mortgage loans 102 292
Other 248 267
Total other income 1,562 1,717
OTHER EXPENSES:
Salaries and employee benefits 2,042 1,895
Occupancy expenses 589 500
Amortization of intangibles 145 118
Advertising and marketing 100 100
Taxes other than payroll, property and income 123 110
Other 825 728
Total other expenses 3,824 3,451
Income before taxes 1,554 1,661
Income taxes 404 478
Net income $ 1,150 $ 1,183
Other Comprehensive Income, net of tax:
Change in Unrealized Gains on Securities 372 21
Comprehensive Income $ 1,522 $ 1,204
Earnings per share
Basic $ 0.41 $ 0.43
Diluted 0.41 0.42
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, 2003 2,799,781 $ 6,985 $ 37,553 $ 1,519 $ 46,057
Common stock issued 1,746 34 - - 34
Common stock purchased - - - - -
Net change in unrealized gain (loss)
on securities available for sale,
net of tax - - - 372 372
Net income - - 1,150 - 1,150
Dividends declared - $0.21 per share - - (589) - (589)
Balances, March 31, 2004 2,801,527 $ 7,019 $ 38,114 $ 1,891 $ 47,024
KENTUCKY BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
(thousands) Three Months Ending
3/31/2004 3/31/2003
Cash Flows From Operating Activities
Net Income $ 1,150 $ 1,183
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation 301 238
Amortization 145 118
Securities available for sale amortization (accretion) 176 189
Provision for loan losses 255 225
Securities available for sale (gains) losses, net (16) (18)
Originations of loans held for sale (5,164) (11,225)
Proceeds from sale of loans 6,022 10,590
Federal Home Loan Bank Stock dividends (49) (40)
Gain on sale of mortgage loans (102) (292)
Changes in:
Interest receivable (21) 163
Other assets 429 (233)
Interest payable (57) 42
Other liabilities 81 63
Net cash from operating activities 3,150 1,003
Cash Flows From Investing Activities
Purchases of securities available for sale (42,526) (19,490)
Proceeds from sales of securities available for sale 19 3,055
Proceeds from principal payments, maturities and
calls of securities available for sale 14,505 9,618
Net change in loans (748) 813
Purchases of bank premises and equipment, net (639) (352)
Net cash from investing activities (29,389) (6,356)
Cash Flows From Financing Activities:
Net change in deposits 920 (8,156)
Net change in securities sold under agreements to
repurchase and other borrowings 13,797 (2,379)
Advances from Federal Home Loan Bank 10,000 -
Payments on Federal Home Loan Bank advances (6,250) (642)
Proceeds from issuance of common stock 34 67
Purchase of common stock - (11)
Dividends paid (589) (528)
Net cash from financing activities 17,912 (11,649)
Net change in cash and cash equivalents (8,327) (17,002)
Cash and cash equivalents at beginning of period 21,388 29,176
Cash and cash equivalents at end of period $ 13,061 $ 12,174
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, 2003.
2. GOODWILL AND OTHER INTANGIBLE ASSETS
The balance for goodwill is $10,199,830 as of March 31, 2004. Goodwill will
not be amortized but instead evaluated periodically for impairment.
Acquired intangible assets were as follows:
Original Accumulated
Amount Amortization
3/31/2004
Core deposit intangible $3,656,403 $2,608,308
Amortization expense was $89,016 for the first three months of 2004 and
$69,867 for the first three months of 2003.
Estimated amortization expense for the next five years is: 2004 - $275,491;
2005 - $95,736; 2006 - $95,736; 2007 - $95,736; and 2008 - $95,736.
The change in balance for intangible assets during the period is as follows:
Beginning of year $1,137,111
Amortization (89,016)
End of period 1,048,095
3. INVESTMENT SECURITIES
Period-end securities are as follows:
(in thousands)
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
Available for Sale
March 31, 2004
U.S. Treasury $ 3,020 $ 35 $ - $ 3,055
U.S. government agencies 42,027 248 (14) 42,261
States and political subdivisions 37,427 1,540 (82) 38,885
Mortgage-backed 69,650 749 (54) 70,345
Equity securities 1,198 391 (3) 1,586
Other 1,008 55 - 1,063
Total 154,330 3,018 (153) 157,195
December 31, 2003
U.S. Treasury $ 3,022 $ 11 $ - $ 3,033
U.S. government agencies 36,642 125 (133) 36,634
States and political subdivisions 37,656 1,536 (50) 39,142
Mortgage-backed 46,944 631 (193) 47,382
Equity securities 1,215 327 (8) 1,534
Other 1,009 56 - 1,065
Total 126,488 2,686 (384) 128,790
4. LOANS
Loans at period-end are as follows:
(in thousands)
3/31/2004 12/31/2003
Commercial $ 14,741 $ 14,278
Real estate construction 14,137 14,313
Real estate mortgage 217,546 214,529
Agricultural 55,427 56,615
Consumer 11,761 13,267
Total 313,612 313,002
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. On November 7, 2003, the Company acquired 100% of the outstanding shares of
Kentucky First Bancorp, Inc., parent of First Federal Savings Bank.
Operating results of Kentucky First Bancorp, Inc. are included in the
consolidated financial statements since the date of the acquisition. As a
result of this acquisition, the Company expects to further solidify its
market share in central Kentucky.
The purchase price in cash was $23.25 per share or $22,271,000. The
purchase price resulted in approximately $10,200,000 in goodwill, and
$766,000 in core deposit intangible. The core deposit intangible asset
will be amortized over 10 years, using the straight line method. Goodwill
will not be amortized but instead evaluated periodically for impairment.
The following table summarizes the estimated fair value of assets acquired
and liabilities assumed at the date of acquisition.
Securities available for sale $ 23,156,000
Loans 31,205,000
Goodwill 10,200,000
Core deposit intangible 766,000
Other assets 18,468,000
Total assets acquired $ 83,795,000
Deposits (52,939,000)
Other liabilities (8,585,000)
Total liabilities assumed $ (61,524,000)
Net assets acquired $ 22,271,000
7. 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:
Three Months Ended
March 31
2004 2003
(in thousands)
Basic Earnings Per Share
Net Income $1,150 $1,183
Weighted average common shares outstanding 2,801 2,774
Basic earnings per share $ 0.41 $ 0.43
Diluted Earnings Per Share
Net Income $1,150 $1,183
Weighted average common shares outstanding 2,801 2,774
Add dilutive effects of assumed exercise
of stock options 22 31
Weighted average common and dilutive
potential common shares outstanding 2,823 2,805
Diluted earnings per share $ 0.41 $ 0.42
8. 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.
Three months ended
March 31
2004 2003
(In thousands)
Net income
As reported $ 1,150 $ 1,183
Deduct: Stock-based compensation
expense determined under fair
value based method (5) (9)
Pro forma 1,145 1,174
2004 2003
Basic earnings per share
As reported $ 0.41 $ 0.43
Pro forma 0.41 0.42
Diluted earnings per share
As reported $ 0.41 $ 0.42
Pro forma 0.41 0.42
9. Dividends per share paid for the quarter ended March 31, 2004 were $0.21
compared to $0.19 for March 31, 2003.
10. Components of Net Periodic Cost
Three Months Ended March 31
(in thousands)
Pension Benefits
2004 2003
Service cost $ 102 $ 79
Interest cost 76 66
Expected return on plan assets (80) (66)
Amortization 3 4
Net Periodic Cost $ 101 $ 83
Employer Contributions
The Company previously disclosed in its financial statements for the year
ended December 31, 2003 that it expected to contribute $375 thousand to its
Pension Plan. No contributions to the Pension Plan were made for the quarter
ended March 31, 2004, and the Company anticipates making its annual
contribution in the fourth quarter of 2004.
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
In January 2004, the Company's staff and management met to discuss new ideas
on profit enhancement. Many projects were identified, and are centered around
cost savings or income generation. These projects are designed to foster the
future net income of the Company in 2004 and future years.
Summary
Kentucky Bancshares, Inc. recorded net income of $1.1 million, or $0.41 basic
earnings per share and $0.41 diluted earnings per share for the first three
months ended March 31, 2004 compared to $1.2 million, or $0.43 basic earnings
per share and $0.42 diluted earnings per share for the three month period
ending March 31, 2003. The first three months reflects a decrease in net
income of 2.8% compared to the first three months of the prior year.
Return on average assets was 0.89% for the three months ended March 31, 2004
and 1.14% for the same time period in 2003, a decrease of 22%. Return on
average equity was 9.6% for the three month period ended March 31, 2004 and
10.6% for the same period in 2003.
Loans increased $610 thousand from $313.0 million on December 31, 2003 to
$313.6 million on March 31, 2004. An increase of $3.0 million in real estate
mortgage loans was offset mainly by a decrease in agricultural and consumer
loans. Management attributes the overall lower growth in loans primarily to
the sluggish economy and increased competition. These factors have also
contributed to decreases in net interest margin.
Total deposits increased from $384.6 million on December 31, 2003 to $385.5
million on March 31, 2004, an increase of $920 thousand. The increase is
mainly attributable to other time deposits increasing $1.8 million and non-
interest bearing deposits decreasing $779 thousand.
Net Interest Income
Net interest income was $4.1 million for the three months ended March 31, 2004
and $3.6 million for the three months ending March 31, 2003, resulting in an
increase of $451 thousand. The interest spread was 3.37% for the first three
months of 2004 compared to 3.64% for the same period in 2003, a decrease of 27
basis points. The latest drop in rates was on June 27, 2003. The Federal
Reserve lowered short term interest rates another 25 basis points. Generally,
the low interest rate environment, in conjunction with the addition of the
trust preferred securities with their 7.06% fixed rate of interest have
contributed to tighter net interest margins in the first quarter of 2004
compared to 2003.
For the first three months, the yield on assets decreased from 5.86% in 2003
to 5.25% in 2004. The cost of liabilities decreased from 2.22% in 2003 to
1.88% in 2004. Year to date average loans are up $29.7 million, or 10.5% from
March 31, 2003 to March 31, 2004. On November 7, 2004, the acquisition of
Kentucky First Bancorp, Inc. resulted in $31.2 million being added to the
outstanding balance of loans. Loan interest income has increased $80 thousand
for the first three months of 2004 compared to the first three months of 2003.
Year to date average deposits also increased from March 31, 2003 to March 31,
2004, up $72.5 million, or 22.7%. The above mentioned acquisition added $52.9
million in deposits. Deposit interest expense has decreased $14 thousand for
the first three months of 2004 compared to the same period in 2003.
The declining rate environment in recent years has resulted in tighter margins
in 2003 and 2004. However, due to the acquisition, net interest income has
increased $451 thousand for the first three months of 2004 compared to the
same period in 2003. The banking industry continues to battle competition for
loan and deposit dollars, and this trend is expected to continue.
During the first quarter of 2004, the Company determined that it was in its
best interest to purchase additional investment securities. The Company
implemented leverage strategies amounting to $30 million. Investments were
purchased and funded by repurchase agreements and Federal Home Loan Bank
advances. These strategies are expected to initially add $50 thousand to net
income before taxes.
Non-Interest Income
Non-interest income decreased $155 thousand for the three month period ended
March 31, 2004 from $1.7 million to $1.6 million. An increase of $73 thousand
in service charges from the first three months of 2003 to the comparable 2004
period is mainly attributable to an increase in checking overdraft charges of
$92 thousand. The accounts acquired through the acquisition of Kentucky First
in November 2003 have also added to the increase.
Gain on sale of mortgage loans decreased $190 thousand during the first three
months of 2004 compared to the same period in 2003. The volume of loan
originations and sales are inverse to rate changes. The stabilizing or
increasing of interest rates has caused the income to be lower in 2004 than in
2003, and this expectation will cause the income from the sale of loans to be
lower in future periods than in the 2003.
Non-Interest Expense
The increase of $373 thousand in non-interest expenses from $3.4 million for
the three months ended March 31, 2003 to $3.8 million for the same period in
2004 was a result of several factors. Salaries and benefits increased $147
thousand for the first three months of 2004 compared to 2003, an increase of
8%. The increase is due to annual salary increases and an increased number of
employees. Employee benefits represented $22 thousand of the increase in
salaries and employee benefits expense during these comparable periods.
Occupancy expenses increased $89 thousand from $500 thousand for the first
three months of 2003 compared to $589 thousand for the same period in 2004.
Other expenses increased $97 thousand to $825 thousand for the first three
months of 2004 compared to the same period in 2003. Debit card expenses and
repossession expenses have increased $34 thousand and $39 thousand,
respectively, when compared to the same period in 2003.
The acquisition of Kentucky First in November 2003 was a main contributor in
the expenses increasing from 2003 to 2004.
Income Taxes
The tax equivalent rate for the three months ended March 31 was 26% for 2004
and 29% for 2003. 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
March 31, 2004, 84,333 shares have been purchased, with the most recent share
repurchase having occurred on February 5, 2003. 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 $13.1 million as of March 31, 2004 compared to
$21.4 million at December 31, 2003. 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 $157.2
million at March 31, 2004. 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.
To assist in funding the Company's continued growth and development of its
business, including the November 7, 2003 acquisition of Kentucky First
Bancorp, 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.
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 March 31, 2004, we have sufficient collateral to borrow an
additional $33 million from the FHLB. In addition, as of March 31, 2004, over
$53 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 March 31, 2004, the Company's non-performing loans totaled $2.6 million
or 0.8% of loans compared to $2.6 million or 0.8% of loans at December 31,
2003. (See table below) The decrease in non-accrual loans and the increase
in accruing loans past due 90 days or more is attributable to various smaller
consumer or real estate loans. Real estate loans composed 69% of the non-
performing loans as of March 31, 2004 and as of December 31, 2003,
respectively. Forgone interest income on the non-accrual loans for both 2004
and 2003 is immaterial.
Nonperforming Assets
3/31/04 12/31/03
(in thousands)
Non-accrual Loans $ 1,166 $ 1,844
Accruing Loans which are
Contractually past due
90 days or more 1,478 779
Restructured Loans - -
Total Nonperforming and Restructured 2,644 2,623
Other Real Estate 516 375
Total Nonperforming and Restructured
Loans and Other Real Estate $ 3,160 $ 2,998
Nonperforming and Restructured Loans
as a Percentage of Loans 0.84% 0.82%
Nonperforming and Restructured Loans
and Other Real Estate as a Percentage
of Total Assets 0.61% 0.60%
Provision for Loan Losses
The first three months 2004 provision for loan losses of $255 thousand is
greater than the comparable 2003 period by $30 thousand. An increase in
nonperforming loans caused management to increase the provision in 2004 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.
Management estimates the allowance balance required using past loan loss
experience, the nature and volume of the portfolio, information about specific
borrower situations and estimated collateral values, economic conditions, and
other factors. Net charge-offs for the three month period ended March 31,
2004 were $138 thousand compared to $182 thousand for the same time period in
2003. Future levels of charge-offs will be determined by the particular facts
and circumstances surrounding individual loans. Management believes the
current loan loss reserve is sufficient to meet probable incurred loan losses.
Loan Losses
Three Months Ended March 31
(in thousands)
2004 2003
Balance at Beginning of Period $ 3,820 $ 3,395
Amounts Charged-off:
Commercial 15 42
Agricultural 83 20
Consumer 112 157
Total Charged-off Loans 210 219
Recoveries on Amounts
Previously Charged-off:
Commercial 4 4
Real Estate Mortgage 34 -
Agricultural 4 1
Consumer 30 32
Total Recoveries 72 37
Net Charge-offs 138 182
Provision for Loan Losses 255 225
Balance at End of Period 3,937 3,438
Loans
Average 312,334 283,128
At March 31 313,612 283,259
As a Percentage of Average Loans:
Net Charge-offs 0.04% 0.06%
Provision for Loan Losses 0.08% 0.08%
Allowance as a Percentage of
Period-end Loans 1.26% 1.21%
Allowance as a Multiple of
Net Charge-offs 28.5 18.9
Allowance as a Percentage of
Non-performing and Restructured Loans 149% 105%
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 March 31, 2004 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 lessen the impact of changing
interest rates. Therefore, the Company currently has slightly less volatility
to changing rates than existing a year ago. The projected net interest income
report summarizing the Company's interest rate sensitivity as of March 31,
2004 is as follows:
(dollars in thousands)
PROJECTED NET INTEREST INCOME
Level
Change in basis points: - 300 - 100 Rates + 100 + 300
Year One (4/04 - 3/05)
Interest Income $21,641 $24,670 $26,301 $27,932 $31,197
Interest Expense 6,959 7,203 8,365 9,533 11,868
Net Interest Income 14,682 17,467 17,936 18,399 19,329
PROJECTED DOLLAR INCREASE (DECREASE) FROM "LEVEL RATES"
Year One (4/04 - 3/05)
Interest Income $(4,660) $(1,631) N/A $ 1,631 $ 4,896
Interest Expense (1,406) (1,162) N/A 1,168 3,503
Net Interest Income (3,254) (469) N/A 463 1,393
PROJECTED PERCENTAGE INCREASE (DECREASE) FROM "LEVEL RATES"
Year One (4/04 - 3/05)
Interest Income -17.7% -6.2% N/A 6.2% 18.6%
Interest Expense -16.8% -13.9% N/A 14.0% 41.9%
Net Interest Income -18.1% -2.6% N/A 2.6% 7.8%
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 March 31, 2003 is as follows:
(dollars in thousands)
PROJECTED NET INTEREST INCOME
Level
Change in basis points: - 300 - 100 Rates + 100 + 300
Year One (4/03 - 3/04)
Interest Income $ 19,248 $ 21,849 $ 23,291 $ 24,733 $ 27,624
Interest Expense 6,224 6,821 7,734 8,652 10,487
Net Interest Income 13,024 15,028 15,557 16,081 17,137
PROJECTED DOLLAR INCREASE (DECREASE) FROM "LEVEL RATES"
Year One (4/03 - 3/04)
Interest Income $ (4,043) $ (1,442) N/A $ 1,442 $ 4,333
Interest Expense (1,510) (913) N/A 918 2,753
Net Interest Income (2,533) (529) N/A 524 1,580
PROJECTED PERCENTAGE INCREASE (DECREASE) FROM "LEVEL RATES"
Year One (4/03 - 3/04)
Interest Income -17.4% -6.2% N/A 6.2% 18.6%
Interest Expense -19.5% -11.8% N/A 11.9% 35.6%
Net Interest Income -16.3% -3.4% N/A 3.4% 10.2%
Board approved limit >-10.0% >-4.0% N/A >-4.0% >-10.0%
These projected changes in net interest income as of March 31, 2004 are less
when compared to the projected changes in net interest income as of March 31,
2003. Projections from March 31, 2004, year one reflected a decline in net
interest income of 2.6% with a 100 basis point decline compared to the 3.4%
decline in 2003. The 300 basis point increase in rates reflected a 7.8%
increase in net interest income in 2004 compared to 10.2% in 2003. Percentage
changes in 2004 are less when compared to 2003. These changes are also
attributable in part to the $30 million leverage transactions discussed in
Item 2 above. Therefore, changes in interest rates should have a smaller
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, Use of Proceeds and Issuer Purchases of
Equity Securities
None
Item 3. Defaults upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
The registrant's 2004 Annual Meeting of Shareholders was held May 5,
2004. Proxies were solicited by the registrant's Board of Directors.
There was no solicitation in opposition to the board's nominees as
listed in the proxy statement, and all of the nominees were elected by
vote of the shareholders. Voting results for each nominee were as
follows:
Votes For Votes Withheld
William M. Arvin 1,902,820 20,888
James L. Ferrell 1,902,920 20,788
Louis Prichard 1,902,920 20,788
Woodrow Van Meter 1,923,508 200
Betty J. Long 1,920,800 2,908
The following directors have a term of office that will continue
following the Annual Meeting: Henry Hinkle, Theodore Kuster, Ted
McClain, William Stamler, Robert G. Thompson and Buckner Woodford, IV.
The total number of Common Shares outstanding as of March 26, 2004, the
record date for the Annual Meeting of Shareholders, was 2,801,527.
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 February 10, 2003, Item 7
and Item 12 to report the mailing to its shareholders of
its operating results for the twelve-month period ended
December 31, 2003.
The Company filed a Form 8-K dated February 18, 2004, Item 5
announcing an increase in its dividend for the first quarter
of 2004.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
KENTUCKY BANCSHARES, INC.
Date ____5/14/04_________ __/s/Buckner Woodford____________
Buckner Woodford, President and C.E.O.
Date ____5/14/04_________ __/s/Gregory J. Dawson___________
Gregory J. Dawson, Chief Financial Officer
2
3
11
Lexlibrary/197885.1