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, 2008
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ____________________ to ___________________
Commission File Number: 000-52598
KENTUCKY BANCSHARES, INC.
(Exact name of registrant as specified in its charter)
Kentucky 61-0993464
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
P.O. Box 157, Paris, Kentucky 40362-0157
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (859) 987-1795
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
Yes X No _____
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company.
See definitions of "large accelerated filer," "accelerated filer" and "smaller
reporting company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer ____
Accelerated filer ____
Non-accelerated filer X (Do not check if a smaller reporting company)
Smaller reporting company ____
Indicate by check mark whether the registrant is a shell company (as defined
in Rule 12b-2 of the Exchange Act). Yes No X _
Number of shares of Common Stock outstanding as of October 31, 2008:
2,746,729.
KENTUCKY BANCSHARES, INC.
Table of Contents
Part I - Financial Information
Item 1. Financial Statements
Consolidated Balance Sheets 3
Consolidated Statements of Income and
Comprehensive Income 4
Consolidated Statement of Changes in
Stockholders' Equity 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 15
Item 3. Quantitative and Qualitative Disclosures About
Market Risk 21
Item 4. Controls and Procedures 22
Part II - Other Information 23
Signatures 24
Exhibits
31.1 Certifications of Chief Executive Officer pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002. 25
31.2 Certifications of Chief Financial Officer pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002. 27
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. 29
Item 1 - Financial Statements
KENTUCKY BANCSHARES, INC.
CONSOLIDATED BALANCE SHEETS (unaudited)
(thousands) 9/30/2008 12/31/2007
Assets
Cash and due from banks $ 14,192 $ 15,446
Federal funds sold 14,676 10,361
Cash and cash equivalents 28,868 25,807
Securities available for sale 145,135 147,750
Mortgage loans held for sale 40 -
Loans 420,552 417,388
Allowance for loan losses (5,758) (4,879)
Net loans 414,794 412,509
Federal Home Loan Bank stock 6,731 6,468
Bank premises and equipment, net 17,484 16,323
Interest receivable 5,166 5,220
Goodwill 13,117 13,117
Other intangible assets 1,588 1,787
Mortgage servicing rights 707 697
Other assets 3,049 1,261
Total assets $ 636,679 $ 630,939
Liabilities and Stockholders' Equity
Deposits
Non-interest bearing $ 93,860 $ 88,521
Time deposits, $100,000 and over 75,547 78,060
Other interest bearing 302,172 319,424
Total deposits 471,579 486,005
Repurchase agreements and other borrowings 9,643 6,735
Federal Funds Purchased - -
Federal Home Loan Bank advances 83,669 63,993
Subordinated debentures 7,217 7,217
Interest payable 2,333 4,984
Other liabilities 6,526 3,161
Total liabilities 580,967 572,095
Stockholders' equity
Common stock 12,057 12,517
Additional paid-in capital 257 156
Retained earnings 45,797 46,759
Accumulated other comprehensive income (loss) (2,399) (588)
Total stockholders' equity 55,712 58,844
Total liabilities & stockholders' equity $ 636,679 $ 630,939
See Accompanying Notes
KENTUCKY BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (unaudited)
(thousands, except per share amounts) Nine Months Ending
9/30/2008 9/30/2007
INTEREST INCOME:
Loans, including fees $ 20,976 $ 24,106
Securities available for sale 5,414 4,774
Other 327 761
Total interest income 26,717 29,641
INTEREST EXPENSE:
Deposits 8,776 11,373
Other 2,907 3,001
Total interest expense 11,683 14,374
Net interest income 15,034 15,267
Loan loss provision 1,500 650
Net interest income after provision 13,534 14,617
NON-INTEREST INCOME:
Service charges 3,969 4,194
Loan service fee income 65 46
Trust department income 371 395
Securities available for sale gains (losses), net 21 33
Gain on sale of mortgage loans 342 312
Other 1,243 1,002
Total other income 6,011 5,982
NON-INTEREST EXPENSE:
Salaries and employee benefits 7,806 8,051
Occupancy expenses 2,066 1,864
Amortization 199 204
Advertising and marketing 365 405
Taxes other than payroll, property and income 538 513
Other 3,379 2,503
Total other expenses 14,353 13,540
Income before taxes 5,192 7,059
Income taxes 1,157 1,909
Net income $ 4,035 $ 5,150
Other Comprehensive Income (loss), net of tax:
Change in Unrealized Gains on Securities (1,590) (112)
Comprehensive Income $ 2,445 $ 5,038
Earnings per share
Basic $ 1.44 $ 1.80
Diluted 1.44 1.79
See Accompanying Notes
KENTUCKY BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (unaudited)
(thousands, except per share amounts) Three Months Ending
9/30/2008 9/30/2007
INTEREST INCOME:
Loans, including fees $ 6,893 $ 8,012
Securities available for sale 1,825 1,590
Other 71 199
Total interest income 8,789 9,801
INTEREST EXPENSE: - -
Deposits 2,574 3,663
Other 1,114 990
Total interest expense 3,688 4,653
Net interest income 5,101 5,148
Loan loss provision 600 330
Net interest income after provision 4,501 4,818
NON-INTEREST INCOME: - -
Service charges 1,409 1,421
Loan service fee income 20 14
Trust department income 101 121
Securities available for sale gains (losses), net 6 30
Gain on sale of mortgage loans 64 102
Other 376 357
Total other income 1,976 2,045
NON-INTEREST EXPENSE:
Salaries and employee benefits 2,576 2,669
Occupancy expenses 688 621
Amortization 66 68
Advertising and marketing 112 135
Taxes other than payroll, property and income 180 171
Other 1,115 928
Total other expenses 4,737 4,592
Income before taxes 1,740 2,271
Income taxes 384 601
Net income $ 1,356 $ 1,670
Other Comprehensive Income (loss), net of tax:
Change in Unrealized Gains on Securities (740) 1,269
Comprehensive Income $ 616 $ 2,939
Earnings per share
Basic $ 0.49 0.58
Diluted 0.49 0.58
See Accompanying Notes
KENTUCKY BANCSHARES, INC.
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (unaudited)
(thousands, except share information)
Accumulated
Additional Other Total
----Common Stock---- Paid-in Retained Comprehensive Stockholders'
Shares Amount Capital Earnings Income Equity
<s> <c> <c> <c> <c> <c> <c>
Balances, December 31, 2007 2,849,056 $ 12,517 $ 155 $ 46,759 $ (588) $ 58,843
Common stock issued, including tax
benefit, net (including stock grants
of 4,025 shares and employee gifts
of 91 shares) 10,821 15 - - - 15
Stock based compensation expense - - 102 - - 102
Common stock purchased and retired (112,638) (475) - (2,644) - (3,119)
Net change in unrealized gain (loss)
on securities available for sale,
net of tax - - - - (1,590) (1,590)
Net change in SFAS No. 158, net of tax - - - - (221) (221)
Net income - - - 4,035 - 4,035
Dividends declared - $0.84 per share - - - (2,353) - (2,353)
Balances, September 30, 2008 2,747,239 $ 12,057 $ 257 $ 45,797 $ (2,399) $ 55,712
See Accompanying Notes
KENTUCKY BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
(thousands) Nine Months Ending
9/30/2008 9/30/2007
Cash Flows From Operating Activities
Net Income 4,035 $ 5,150
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation and amortization 1,212 1,113
Securities amortization (accretion), net (184) (131)
Noncash compensation expense 102 75
Provision for loan losses 1,500 650
Securities (gains) losses, net (21) (33)
Originations of loans held for sale (16,296) (10,356)
Proceeds from sale of loans 16,598 10,413
Federal Home Loan Bank stock dividends (263) -
Losses (gains) on sale of bank premises and equipment (5) -
Gain on sale of mortgage loans (342) (312)
Changes in:
Interest receivable 54 (52)
Other assets (1,949) (422)
Interest payable (2,651) 668
Other liabilities 3,963 (230)
Net cash from operating activities 5,753 6,533
Cash Flows From Investing Activities
Purchases of securities available for sale (63,690) (70,496)
Proceeds from sales of securities available for sale 9,427 19,324
Proceeds from principal payments, maturities and
calls of securities available for sale 54,674 53,461
Net change in loans (3,785) 20,160
Purchases of bank premises and equipment (2,038) (2,480)
Proceeds from the sale of bank premises and equipment 5 -
Net cash from investing activities (5,407) 19,969
Cash Flows From Financing Activities:
Net change in deposits (14,426) (6,032)
Net change in securities sold under agreements to
repurchase, federal funds purchased and other borrowings (92) 2,215
Advances from Federal Home Loan Bank 51,000 -
Payments on Federal Home Loan Bank advances (31,310) (15,704)
Proceeds from note payable 5,500 -
Payment on note payable (2,500) (500)
Proceeds from issuance of common stock 15 56
Purchase of common stock (3,119) (621)
Dividends paid (2,353) (2,319)
Net cash from financing activities 2,715 (22,905)
Net change in cash and cash equivalents 3,061 3,597
Cash and cash equivalents at beginning of period 25,807 19,011
Cash and cash equivalents at end of period 28,868 22,608
See Accompanying Notes
KENTUCKY BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
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, 2007.
New accounting pronouncements -
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements.
This Statement defines fair value, establishes a framework for measuring
fair value and expands disclosures about fair value measurements. This
Statement establishes a fair value hierarchy about the assumptions used to
measure fair value and clarifies assumptions about risk and the effect of a
restriction on the sale or use of an asset. The Statement is effective for
fiscal years beginning after November 15, 2007. The impact of adoption on
January 1, 2008 was not material.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for
Financial Assets and Financial Liabilities. The Statement provides
companies with an option to report selected financial assets and
liabilities at fair value and establishes presentation and disclosure
requirements designed to facilitate comparisons between companies that
choose different measurement attributes for similar types of assets and
liabilities. The new Statement is effective for the Company on January 1,
2008. The Company did not elect the fair value option for any financial
assets or financial liabilities as of January 1, 2008.
The Company adopted FASB Interpretation 48, Accounting for Uncertainty in
Income Taxes ("FIN 48"), as of January 1, 2007. A tax position is
recognized as a benefit only if it is "more likely than not" that the tax
position would be sustained in a tax examination, with a tax examination
being presumed to occur. The amount recognized is the largest amount of
tax benefit that is greater than 50% likely of being realized on
examination. For tax positions not meeting the "more likely than not"
test, no tax benefit is recorded. The adoption had no effect on the
Company's financial statements, and the Company had no unrecognized tax
benefits at December 31, 2007 or September 30, 2008.
The Company and its subsidiaries are subject to U.S. federal income tax.
The Company is no longer subject to examination by taxing authorities for
years before 2005. The Company does not expect the total amount of
unrecognized tax benefits to significantly increase in the next twelve
months.
The Company recognizes interest related to income tax matters as interest
expense and penalties related to income tax matters as other expense. The
Company did not have any amounts accrued for interest and penalties at
December 31, 2007 or September 30, 2008.
2. INVESTMENT SECURITIES
INVESTMENT SECURITIES
Period-end securities are as follows:
(in thousands)
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
Available for Sale
September 30, 2008
U.S. government agencies $ 16,783 $ 118 $ (93) $ 16,808
States and political subdivisions 63,345 529 (2,940) 60,934
Mortgage-backed 67,002 410 (305) 67,107
Equity securities 270 16 - 286
Total 147,400 1,073 (3,338) 145,135
December 31, 2007
U.S. government agencies $ 35,535 $ 496 $ (10) $ 36,021
States and political subdivisions 59,332 691 (662) 59,361
Mortgage-backed 52,470 218 (610) 52,078
Equity securities 270 20 - 290
Total 147,607 1,425 (1,282) 147,750
The Company regularly evaluates its investment securities with significant
declines in fair value to determine whether losses are other-than-temporary
under the principles of SFAS No. 115, FSP No. 115, and Staff Accounting
Bulletin ("SAB") No. 59. A decline in the market value of any available
for sale security below cost that is deemed other-than-temporary results in
a charge to earnings and the establishment of a new cost basis for the
security. In estimating other-than-temporary losses, management considers
each of the following: the length of time and extent that fair value has
been less than cost, the financial condition and near term prospects of the
issuer, and the Company's ability and intent to hold the security for a
period sufficient to allow for any anticipated recovery in fair value.
Based on this evaluation, the Company has determined it does not have any
other-than-temporary impairment losses and has not recorded any other-than-
temporary impairment charges.
3. LOANS
Loans at period-end are as follows:
(in thousands)
9/30/2008 12/31/2007
Commercial $ 22,213 $ 22,924
Real estate construction 20,141 26,172
Real estate mortgage 275,442 270,494
Agricultural 83,218 80,774
Consumer 19,538 17,024
Total 420,552 417,388
4. EARNINGS PER SHARE
Basic earnings per common share is net income divided by the weighted
average number of common shares outstanding during the period. Diluted
earnings per common share includes the dilutive effect of additional
potential common shares issuable under stock options.
The factors used in the earnings per share computation follow:
Nine Months Ended
September 30
2008 2007
(in thousands, except per share information)
Basic Earnings Per Share
Net Income $4,035 $5,150
Weighted average common shares outstanding 2,792 2,855
Basic earnings per share $ 1.44 $ 1.80
Diluted Earnings Per Share
Net Income $4,035 $5,150
Weighted average common shares outstanding 2,792 2,855
Add dilutive effects of assumed exercise
of stock options 2 10
Weighted average common and dilutive
potential common shares outstanding 2,794 2,865
Diluted earnings per share $ 1.44 $ 1.79
Three Months Ended
September 30
2008 2007
(in thousands, except per share information)
Basic Earnings Per Share
Net Income $1,356 $1,670
Weighted average common shares outstanding 2,767 2,845
Basic earnings per share $ 0.49 $ 0.58
Diluted Earnings Per Share
Net Income $1,356 $1,670
Weighted average common shares outstanding 2,767 2,845
Add dilutive effects of assumed exercise
of stock options 3 10
Weighted average common and dilutive
potential common shares outstanding 2,770 2,855
Diluted earnings per share $ 0.49 $ 0.58
Stock options for 39,761 shares of common stock for the nine months and three
months ended September 30, 2008, and for 10,407 shares of common stock for
nine months and the three months ended September 30, 2007 were excluded from
diluted earnings per share because their impact was antidilutive.
5. STOCK COMPENSATION
The Company has two share based compensation plans as described below.
Stock Option Plan
The Company grants certain officers and key employees stock option awards
which vest and become fully exercisable at the end of five years and
provides for issue of up to 220,000 options. The Company also grants
certain directors stock option awards which vest and become fully
exercisable immediately and provides for issue of up to 20,000 options. 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.
The fair value of each option award is estimated on the date of grant using
a closed form option valuation (Black-Scholes) model that uses the
assumptions noted in the table below. Expected volatilities are based on
historical volatilities of the Company's common stock. The Company uses
historical data to estimate option exercise and post-vesting termination
behavior. The expected term of options granted is based on historical data
and represents the period of time that options granted are expected to be
outstanding, which takes into account that the options are not
transferable. The risk-free interest rate for the expected term of the
option is based on the U.S. Treasury yield curve in effect at the time of
the grant.
The fair value of options granted was determined using the following
weighted-average assumptions as of grant date.
2008 2007
Weighted-average fair value of options
granted during the year $2.38 $4.22
Risk-free interest rate 2.96% 4.51%
Expected option life 8 years 8 years
Expected stock price volatility 11.05% 12.69%
Expected dividend yield 3.61% 3.48%
Summary of activity in the stock option plan for the nine months ended
September 30, 2008 follows:
Weighted
Weighted Average
Average Remaining Aggregate
Exercise Contractual Intrinsic
Shares Price Term Value
Outstanding, beginning of year 58,774 $27.80
Granted 800 31.00
Forfeited or expired (2,020) 28.40
Exercised (6,705) 22.12
Outstanding, end of period 50,849 28.58 57.7 months $40,845
Vested and expected to vest 50,849 28.58 57.7 months 40,845
Options exercisable at period end 42,159 28.06 54.5 months 40,845
The intrinsic value for stock options is calculated based on the exercise
price of the underlying awards and the market price of our common stock as
of the reporting date. The Company recorded $102 thousand in stock
compensation expense during the nine months ended September 30, 2008 to
salaries and employee benefits.
Stock Grant Plan
On February 15, 2005, the Company's Board of Directors adopted a restricted
stock grant plan. Total shares issuable under the plan are 50,000. A
summary of changes in the Company's nonvested shares for the year follows:
Weighted-Average
Grant-Date
Nonvested Shares Shares Fair Value
Nonvested at December 31, 2007 8,037 $ 243,494
Granted 4,025 124,755
Vested (1,744) (52,691)
Forfeited - -
Nonvested at September 30, 2008 10,318 $ 315,558
6. DIVIDENDS
Dividends per share paid for the quarter ended September 30, 2008 were
$0.28 compared to $0.27 for September 30, 2007. This is the same rate of
dividend paid for the first three quarters of the respective years.
7. RETIREMENT PLAN
Components of Net Periodic Benefit Cost
Nine months ended September 30
(in thousands)
Pension Benefits
2008 2007
Service cost $ 386 $ 355
Interest cost 350 304
Expected return on plan assets (361) (328)
(Gain) loss amortization 24 26
Net Periodic Benefit Cost $ 399 $ 357
Three months ended September 30
(in thousands)
Pension Benefits
2008 2007
Service cost $ 132 $ 118
Interest cost 119 91
Expected return on plan assets (120) (99)
(Gain) loss amortization 10 10
Net Periodic Benefit Cost $ 141 $ 120
Employer Contributions
The estimates are based on assuming the Company's 2008 annual contribution
to the Pension Plan to be zero. No contributions to the Pension Plan were
made for the quarter ended September 30, 2008. The Company has decided to
terminate the retirement plan at the end of 2008. Future material
contributions to the plan are expected to be determined in the fourth
quarter of 2008.
8. Fair Value Measurements
Effective January 1, 2008 the Company adopted SFAS No. 157 and SFAS No.
159. SFAS No. 157 defines fair value, establishes a framework for
measuring fair value, and expands disclosures about fair value
measurements. SFAS No. 157 applies whenever other standards require or
permit assets or liabilities to be measured at fair value, but does not
require any new fair value measurements. The Company applied SFAS No. 157
prospectively as of the beginning of the year. SFAS No. 159 permits
entities to choose to measure certain financial assets and liabilities at
fair value. The Company has not elected the fair value option for any
financial assets or liabilities.
In February 2008, the FASB issued Staff Position ("FSP") 157-2, "Effective
Date of FASB Statement No. 157". This FSP delays the effective date of
SFAS No. 157 for all nonfinancial assets and nonfinancial liabilities,
except those that are recognized or disclosed at fair value on a recurring
basis (at least annually) to fiscal years beginning after November 15,
2008, and interim periods within those fiscal years.
SFAS No. 157 defines fair value as the price that would be received to sell
an asset or paid to transfer a liability in an orderly transaction between
market participants at the measurement date. SFAS No. 157 also establishes
a fair value hierarchy which requires an entity to maximize the use of
observable inputs and minimize the use of unobservable inputs when
measuring fair value. The standard describes three levels of inputs that
may be used to measure fair value:
Level 1 - Quoted prices for identical assets or liabilities in active
markets that the entity has the ability to access at the measurement
date.
Level 2 - Significant other observable inputs other than Level 1 prices
such as quoted prices for similar assets or liabilities; quoted prices in
markets that are not active; or other inputs that are observable or can
be corroborated by observable market data.
Level 3 - Significant unobservable inputs that reflect a reporting
entity's own assumptions about the assumptions that market participants
would use in pricing the asset or liability.
Following is a description of the valuation method used for instruments
measured at fair value on a recurring basis. For this disclosure, the
Company only has available for sale investment securities that meet the
requirement.
Available for sale investment securities valued primarily by independent
third party pricing services under the market valuation approach that
include, but not limited to, the following inputs:
Marketable equity securities are priced utilizing real-time data feeds
from active market exchanges for identical securities.
Government-sponsored agency debt securities and obligations of states and
political subdivisions are priced with available market information
through processes using benchmark yields, matrix pricing, prepayment
speeds, cash flows, live trading data, and market spreads sourced from
new issues, dealer quotes, and trade prices, among others sources.
Investments in the Federal Home Loan Bank totaling $6.7 million at
September 30, 2008 is carried at cost and not included in the table below,
as they are outside the scope of SFAS No. 157.
Available for sale investment securities are the Company's only balance
sheet item that meet the disclosure requirements for instruments measured
at fair value on a recurring basis. Disclosures are as follows in the
table below.
(In thousands) Fair Value Measurements at September 30, 2008 Using
Quoted Prices
In Active
Markets for Significant Other Significant
Identical Observable Unobservable
Fair Value Assets Inputs Inputs
Description 9/30/08 (Level 1) (Level 2) (Level 3)
Available for Sale $145,135 $ 286 $144,849 $ -
The Company may be required to measure and disclose certain other assets
and liabilities at fair value on a nonrecurring basis to comply with GAAP,
primarily to adjust assets to fair value under the application of lower of
cost or fair value accounting. Disclosures may also include financial
assets and liabilities acquired in a business combination, which are
initially measured at fair value and evaluated periodically for impairment.
For disclosures about assets and liabilities measured at fair value on a
nonrecurring basis, the Company's only current disclosure obligation
consists of impaired loans. Loans are considered impaired when full
payment under the contractual terms is not expected. In general, impaired
loans are also on nonaccrual status. Impaired loans are measured at the
present value of expected future cash flows discounted at the loan's
effective interest rate, at the loan's observable market price, or at the
fair value of the collateral if the loan is collateral dependent. If the
value of an impaired loan is less than the unpaid balance, the difference
is credited to the allowance for loan losses with a corresponding charge to
provision for loan losses. Loan losses are charged against the allowance
for loan losses when management believes the uncollectibility of a loan is
confirmed.
Impaired loans in the amount of $10.0 million have been written down to
their estimated fair value of $8.7 million at September 30, 2008. At
December 31, 2007 impaired loans of $6.4 million had an estimated fair
value of $5.4 million. Impaired loans are measured at fair value based on
the underlying collateral and are considered level 3 inputs.
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 (the Company and its bank operate in areas affected by various
markets); 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 update or revise
forward-looking statements to reflect events or circumstances after the date
hereof or to reflect the occurrence of unanticipated events.
Summary
Kentucky Bancshares, Inc. recorded net income of $4.0 million, or $1.44 basic
earnings and diluted earnings per share for the first nine months ending
September 30, 2008 compared to $5.1 million, or $1.80 basic earnings per share
and $1.79 diluted earnings per share for the nine month period ending
September 30, 2007. The first nine months earnings reflects a decrease of
21.6% compared to the same time period in 2007, due primarily to a decrease in
net interest income of $233 thousand, an increase in the loan loss provision
of $850 thousand and an increase in other expenses of $813 thousand. These
decreases to net income were partially offset by a reduction in income tax
expense of $752 thousand. The earnings for the three months ended September
30, 2008 were $1.4 million, or $.49 basic and diluted earnings per share
compared to $1.7 million, or $.58 basic and diluted earnings per share for the
three month period ending September 30, 2007. This three months period
earnings reflects a decrease of 18.8% compared to the same time period in
2007.
Return on average assets was 0.85% for the nine months ended September 30,
2008 and 1.08% for the nine month period ended September 30, 2007. Return on
average assets was 0.85% for the three months ended September 30, 2008 and
1.08% for the three month period ended September 30, 2007. Return on average
equity was 9.3% for the nine month period ended September 30, 2008 and 12.2%
for the same period in 2007. Return on average equity was 9.4% for the three
months ended September 30, 2008 and 12.0% for the same time period in 2007.
Loans increased $3.2 million from $417.4 million on December 31, 2007 to
$420.6 million on September 30, 2008. Decreases in commercial & real estate
construction loans were partially offset by an increase in real estate
mortgage, agricultural & consumer loans.
Total deposits decreased from $486.0 million on December 31, 2007 to $471.6
million on September 30, 2008, a decrease of $14.4 million. This decrease is
primarily the result of a decrease in interest bearing deposit accounts with
balances less than $100 thousand. Management attributes the decrease mainly
to increased competition for deposits. As a result of this, management has
utilized other lower costing funding sources, such as Federal Home Loan Bank
advances.
Net Interest Income
Net interest income was $15.0 million for the nine months ended September 30,
2008 compared to $15.3 million for the nine months ended September 30, 2007, a
decrease of 1.5%. The interest spread of 3.33% for the first nine months of
2008 is comparable to 3.35% for the same period in 2007, a decrease of 2 basis
points. Net interest income was $5.1 million for the three month period
ending September 30, 2008 and $5.1 million for the three month period ending
September 30, 2007. The interest spread was 3.35% for the three month period
ending September 30, 2008 compared to 3.44% for the three month period in
2007, a decrease of 9 basis points. Net interest margins have thus far
remained steady in 2008. The year to date net interest spread for 2008 is
lower than 2007 primarily due to an increase in "lost" loan interest during
2008 that can be attributed to an increase in non-performing loans in our loan
portfolio.
For the first nine months, the yield on assets decreased from 6.70% in 2007 to
6.06% in 2008. The cost of liabilities decreased from 3.35% in 2007 to 2.72%
in 2008. Year to date average loans are down $20.0 million, or 4.6% from
September 30, 2007 to September 30, 2008. Loan interest income has decreased
$3.1 million for the first nine months of 2008 compared to the first nine
months of 2007. Year to date average deposits decreased from September 30,
2007 to September 30, 2008, down $2.9 million or 0.6%. The slight decrease is
primarily the result of a decline in interest bearing deposits with balances
less than $100 thousand. The decline in interest bearing deposit accounts was
offset by a slight increase in non-interest bearing deposits. Deposit
interest expense has decreased $2.6 million for the first nine months of 2008
compared to the same period in 2007.
Non-Interest Income
Non-interest income increased $29 thousand for the nine months ended September
30, 2008 compared to the same period in 2007 to $6.0 million, due primarily to
an increase in other non-interest income of $241 thousand, offset by a
decrease in service charges of $225 thousand. The decrease in service charges
was primarily due to a decrease in overdraft income of $264 thousand for the
first nine months of 2008. The other non-interest income increase was
primarily due to an increase of $125 thousand in debit card interchange income
and an increase in brokerage income of $92 thousand. The $69 thousand
decrease in non-interest income for the three months ended September 30, 2008
compared to same time period in 2007 is primarily due to a decrease in the
gains on the sale of mortgage loans of $38 thousand and a decrease in gains of
$24 thousand on the sale of securities available for sale.
Gain on sale of mortgage loans increased from $312 thousand in the first nine
months of 2007 to $342 thousand during the first nine months of 2008. For the
three months ended September 30, 2008 compared to the same time period in
2007, the gain on sale of mortgage loans decreased $38 thousand. The volume
of mortgage loan originations and sales is generally inverse to rate changes.
A change in the mortgage loan rate environment can have a significant impact
on the related gain on sale of mortgage loans.
Non-Interest Expense
Total non-interest expenses increased $813 thousand for the nine month period
ended September 30, 2008 compared to the same period in 2007. For the three
month period ended September 30, 2008, total non-interest expense increased
$145 thousand.
For the comparable nine month periods, salaries and benefits decreased $245
thousand, a decrease of 3.0%. Incentives decreased $445 thousand, due to the
lower level of net income reported by the Company. Salaries & benefits
decreased $93 thousand for the three month period ending September 30, 2008
compared to the same time period in 2007. As mentioned previously, the
retirement plan will be terminated in December 2008, which will result in some
reduction in the benefit cost starting in 2009.
Occupancy expenses increased $202 thousand to $2.1 million for the first nine
months of 2008 compared to the same time period in 2007. Occupancy expenses
increased $67 thousand for the three month period ended September 30, 2008
compared to the same time period in 2007. The increase in the 2008 year to
date occupancy expense is mainly attributable to two additional facilities;
the first being opened in the fourth quarter of 2007 and the second being
opened during the first quarter of 2008. The relocation of the Nicholasville
branch, scheduled to be complete in the fourth quarter of 2008, is expected to
result in a slight increase in occupancy expense starting in the first quarter
of 2009.
Other expenses increased $876 thousand for the first nine months ended
September 30, 2008 compared to the same time period in 2007. For the three
month period ended September 30, 2008 other expenses increased $187 thousand
compared to the three month period ended September 30, 2007. The year to date
increase is mainly a result of an increase of data processing fees of $474
thousand, an increase in ATM & debit card processing of $97 thousand, and an
increase in legal and professional fees of $81 thousand. In August 2007, the
Company started outsourcing its account processing to Fiserv, Inc. causing the
data processing to be more in 2008 compared to 2007. The increase in ATM and
debit card processing is a result of more customer usage. Higher legal and
professional fees are mainly a result of outsourcing loan review, loan
collection costs and other corporate matters.
Due to the downturn in the financial industry and related bank failures, the
FDIC is expected to increase the FDIC insurance premiums in 2009. Although
the amount of the increase is unknown at this time, the increase in expense to
the Company is expected to be significant.
Income Taxes
The effective tax rate for the nine months ended September 30, 2008 was 22.3%
compared to 27.0% in 2007. The effective tax rate for the three months ended
September 30, 2008 was 22.1% compared to 26.5% for the three month period
ended September 30, 2007. These rates are less than the statutory rate as a
result of the tax-free securities and loans held by the Company. The rates
for 2008 are lower due to the lower level of income for 2008. Nontaxable
interest income increased $295 thousand for the first nine months of 2008
compared to the same time period in 2007.
Stock Repurchase Program
On October 25, 2000, the Company announced that its Board of Directors
approved a stock repurchase program 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. On May 20, 2008, the Board of Directors approved and authorized the
Company to repurchase 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, 2008, 256,491 shares have been
purchased under the program. The most recent share repurchase occurred on
October 29, 2008.
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 to meet the needs of
borrowers, depositors and creditors. Excess liquidity has a negative impact
on earnings as a result of the lower yields on short-term assets.
Cash and cash equivalents were $28.9 million as of September 30, 2008 compared
to $25.8 million at December 31, 2007. The increase in cash and cash
equivalents is mainly attributable to an increase in federal funds sold
resulting primarily from a slight decrease in the Company's security
portfolio. In addition to cash and cash equivalents, the securities portfolio
provides an important source of liquidity. Securities available for sale
totaled $145.1 million at September 30, 2008. The available for sale
securities are available to meet liquidity needs on a continuing basis. The
Company expects the customers' deposits 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.
Management is aware of the challenge of funding sustained loan growth.
Therefore, in addition to deposits, other sources of funds, such as Federal
Home Loan Bank (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. In early July 2008, the Company received deposits from being the
successful bidder on $20 million in public deposits. As of October 30, 2008,
these deposits had declined $4.7 million, with the remainder expected to roll
off by June 2009. As of September 30, 2008, we have sufficient collateral to
borrow an additional $2 million from the FHLB. Additional real estate
collateral has been pledged to the FHLB and we now have an additional
borrowing capacity of $20 million. In addition, as of September 30, 2008,
over $48 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, 2008, the Company's non-performing loans totaled $10.7
million or 2.54% of loans compared to $6.5 million or 1.57% of loans at
December 31, 2007. (See table below) The Company experienced an increase of
$3.7 million in non-accrual loans from December 31, 2007 to September 30,
2008, mainly due to some large dollar commercial real estate loans becoming
classified as non-accrual. As of September 30, 2008, non-accrual loans
include $2.9 million in loans secured by 1-4 family residential real estate,
$2.3 million in real estate construction and $4.2 million in loans secured by
non-farm non-residential properties. Real estate loans composed 99% of the
non-performing loans as of September 30, 2008 and 98% as of December 31, 2007.
Forgone interest income on the non-accrual loans was $455 thousand for the
first nine months of 2008 compared to $177 thousand for the same time period
in 2007.
Nonperforming Assets
9/30/08 12/31/07
(in thousands)
Non-accrual Loans $ 10,010 $ 6,358
Accruing Loans which are
Contractually past due
90 days or more 693 195
Restructured Loans - -
Total Nonperforming and Restructured 10,703 6,553
Other Real Estate 1,602 768
Total Nonperforming and Restructured
Loans and Other Real Estate $ 12,305 $ 7,321
Nonperforming and Restructured Loans
as a Percentage of Loans 2.54% 1.57%
Nonperforming and Restructured Loans
and Other Real Estate as a Percentage
of Total Assets 1.93% 1.16%
Allowance as a Percentage of
Period-end Loans 1.37% 1.17%
Allowance as a Percentage of
Non-performing and Restructured Loans 54% 74%
Provision for Loan Losses
The loan loss provision for the first nine months was $1.5 million for 2008
and $650 thousand for the same period in 2007. The loan loss provision for
the three months ended September 30, 2008 was $600 thousand and $330 thousand
for the same period in 2007. The current level of nonperforming loans has
caused management to increase the 2008 provision 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 nine month period ended September 30, 2008 were $621
thousand compared to $860 thousand for the same period in 2007. Net charge-
offs for the three month period ended September 30, 2008 were $236 thousand
compared to $505 thousand during the same time period in 2007. Future levels
of charge-offs will be determined by the particular facts and circumstances
surrounding individual loans. Management believes the current loan loss
allowance is sufficient to meet probable incurred loan losses.
Loan Losses
Nine Months Ended September 30
(in thousands)
2008 2007
Balance at Beginning of Period $ 4,879 $ 4,991
Amounts Charged-off:
Commercial 57 127
Real Estate Construction 217 330
Real Estate Mortgage 171 167
Agricultural 12 25
Consumer 792 693
Total Charged-off Loans 1,249 1,342
Recoveries on Amounts
Previously Charged-off:
Commercial 6 5
Real Estate Construction 2 14
Real Estate Mortgage 13 2
Agricultural 30 64
Consumer 577 397
Total Recoveries 628 482
Net Charge-offs 621 860
Provision for Loan Losses 1,500 650
Balance at End of Period 5,758 4,781
Loans
Average 415,785 435,797
At September 30 420,552 423,130
As a Percentage of Average Loans:
Net Charge-offs 0.15% 0.20%
Provision for Loan Losses 0.36% 0.15%
Allowance as a Multiple of
Net Charge-offs 7.0 4.2
Loan Losses
Quarter Ended September 30
(in thousands)
2008 2007
Balance at Beginning of Period $ 5,394 $ 4,956
Amounts Charged-off:
Commercial 52 -
Real Estate Construction - 330
Real Estate Mortgage 116 76
Agricultural - 25
Consumer 180 211
Total Charged-off Loans 348 642
Recoveries on Amounts
Previously Charged-off:
Commercial 1 4
Real Estate Construction - 4
Real Estate Mortgage 1 -
Agricultural - 35
Consumer 110 94
Total Recoveries 112 137
Net Charge-offs 236 505
Provision for Loan Losses 600 330
Balance at End of Period 5,758 4,781
Loans
Average 422,257 428,273
At September 30 420,552 423,130
As a Percentage of Average Loans:
Net Charge-offs 0.06% 0.12%
Provision for Loan Losses 0.14% 0.08%
Allowance as a Multiple of
Net Charge-offs 6.1 2.4
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 tools used by management are
interest rate shock and economic value of equity (EVE) simulations. The
Company has no market risk sensitive instruments held for trading purposes.
Using interest rate shock simulations, the following table depicts the change
in net interest income resulting from 100 and 300 basis point changes in rates
on the Company's interest earning assets and interest bearing liabilities.
The projections are based on balance sheet growth assumptions and repricing
opportunities for new, maturing and adjustable rate amounts. As of September
30, 2008, the projected percentage changes are within the Board approved
limits. This period's volatility is higher in each rate shock both in a
falling and rising rate environment when compared to the same period a year
ago. The projected net interest income report summarizing the Company's
interest rate sensitivity as of September 30, 2008 is as follows:
(dollars in thousands)
PROJECTED NET INTEREST INCOME
Level
Rate Change: - 300 - 100 Rates + 100 + 300
Year One (10/08 - 9/09)
Net interest income $21,100 $21,851 $22,646 $23,357 $23,901
Net interest income dollar change (1,546) (795) N/A 711 1,255
Net interest income percentage change -6.8% -3.5% N/A 3.1% 5.5%
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 September 30, 2007 is as follows:
PROJECTED NET INTEREST INCOME
(dollars in thousands)
Level
Change in basis points: - 300 - 100 Rates + 100 + 300
Year One (10/07 - 9/08)
Net interest income $21,742 $22,020 $22,373 $22,520 $22,675
Net interest income dollar change (631) (353) N/A 147 302
Net interest income percentage change -2.8% -1.6% N/A 0.7% 1.3%
Board approved limit >-10.0% >-4.0% N/A >-4.0% >-10.0%
Projections from September 30, 2008, year one reflected a decline in net
interest income of 3.5% with a 100 basis point decline compared to the 1.6%
decline in 2007. The 100 basis point increase in rates reflected a 3.1%
increase in net interest income in 2008 compared to .7% in 2007. The
additional volatility is due to lengthening our certificate of deposit
maturities and having more federal funds sold.
EVE applies discounting techniques to future cash flows to determine the
present value of assets, liabilities, and therefore equity. Based on applying
these techniques to the September 30, 2008 balance sheet, a 100 basis point
increase in rates results in a 2.6% decrease in EVE. A 100 basis point
decrease in rates results in a .7% increase in EVE. These are within the
Board approved limits.
Item 4 - CONTROLS AND PROCEDURES
As of the end of the period covered by this report, 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 1A. Risk Factors
The U.S. government's plan to purchase capital stock of financial
institutions as part of the $700 billion bail-out program may not be
effective and/or it may not be available to the Company.
In response to the financial crises affecting the banking system and
financial markets and the going concern threats to the ability of
investment banks and other financial institutions, the U.S. Congress
adopted the new Emergency Economic Stabilization Act of 2008 ("EESA")
commonly referred to as a bailout of the US financial system. The
primary feature of the EESA is the establishment of the Troubled Asset
Relief Program ("TARP"), under which the U.S. Treasury Department will
have up to $700 billion to purchase distressed assets from financial
institutions and to purchase the capital stock of financial
institutions. The purpose of the EESA and TARP is to stabilize the
financial markets and improve liquidity. However, there can be no
assurance as to the impact of the EESA and TARP on the stabilization of
the financial markets. The failure of the U.S. government to execute
this program expeditiously could have a material adverse effect on the
financial markets, which in turn could materially and adversely affect
the Company's business, financial condition and results of operations.
The Company is currently evaluating the TARP guidelines and whether
participation in the program will be beneficial.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
ISSUER PURCHASES OF EQUITY SECURITIES
Period (a) Total (b) (c) Total Number (d) Maximum Number
Number of Average of Shares (or Units) (or Approximate Dollar
Shares (or Price Paid Purchased as Part Value) of Shares (or
Units) Per Share of Publicly Units) that May Yet Be
Purchased (or Unit) Announced Plans Purchased Under the
Or Programs Plans of Programs
7/1/08 -
7/31/08 10,570 $26.16 10,570 43,509 shares
8/1/08 -
8/31/08 - - - 43,509 shares
9/1/08 -
9/30/08 - - - 43,059 shares
Total 10,570 10,570 43,059 shares
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. On May 20, 2008, the Board of Directors approved
and authorized 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, 2008, 256,491 shares have been
purchased.
Item 3. Defaults upon Senior Securities
None
Item 5. Other Information
None
Item 6. Exhibits
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.
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 _____11/14/08_______ __/s/Louis Prichard______________
Louis Prichard, President and C.E.O.
Date _____11/14/08_______ __/s/Gregory J. Dawson___________
Gregory J. Dawson, Chief Financial Officer