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 June 30, 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 August 3, 2004: 2,801,877.
KENTUCKY BANCSHARES, INC.
Table of Contents
Part I - Financial Information
Item 1. Financial Statements
Consolidated Balance Sheets 3
Consolidated Statements of Income and
Comprehensive Income 4
Consolidated Statements of Changes in
Stockholders' Equity 6
Consolidated Statements of Cash Flows 7
Notes to Consolidated Financial Statements 8
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 13
Item 3. Quantitative and Qualitative Disclosures About
Market Risk 20
Item 4. Controls and Procedures 21
Part II - Other Information 22
Signatures 23
Exhibits
31.1 Certifications of Chief Executive Officer pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002. 24
31.2 Certifications of Chief Financial Officer pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002. 26
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. 28
Item 1 - Financial Statements
KENTUCKY BANCSHARES, INC.
CONSOLIDATED BALANCE SHEETS (unaudited)
(thousands) 6/30/2004 12/31/2003
Assets
Cash and due from banks $ 12,186 $ 15,225
Federal funds sold - 6,163
Cash and cash equivalents 12,186 21,388
Securities available for sale 133,224 128,790
Mortgage loans held for sale 6,903 7,759
Loans 334,690 313,002
Allowance for loan losses (4,093) (3,820)
Net loans 330,597 309,182
Federal Home Loan Bank stock 5,029 4,930
Bank premises and equipment, net 11,859 11,606
Interest receivable 3,147 3,250
Goodwill 10,200 10,200
Other intangible assets 959 1,137
Other assets 2,988 2,610
Total assets $ 517,092 $ 500,852
Liabilities and Stockholders' Equity
Deposits
Non-interest bearing $ 68,641 $ 64,842
Time deposits, $100 and over 49,815 49,915
Other interest bearing 260,625 269,842
Total deposits 379,081 384,599
Securities sold under agreements to repurchase 20,420 1,791
Other borrowed funds 8,722 5,494
Subordinated debentures 7,217 7,217
Federal Home Loan Bank advances 54,239 53,232
Interest payable 1,648 1,636
Other liabilities 732 826
Total liabilities 472,059 454,795
Stockholders' equity
Common stock 7,029 6,985
Retained earnings 38,965 37,553
Accumulated other comprehensive income (961) 1,519
Total stockholders' equity 45,033 46,057
Total liabilities & stockholders' equity $ 517,092 $ 500,852
See Accompanying Notes
KENTUCKY BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (unaudited)
(thousands, except per share amounts) Six Months Ending
6/30/2004 6/30/2003
INTEREST INCOME:
Loans, including fees $ 9,813 $ 9,417
Securities available for sale 2,889 1,797
Other 28 59
Total interest income 12,730 11,273
INTEREST EXPENSE:
Deposits 2,848 2,785
Other 1,544 1,183
Total interest expense 4,392 3,968
Net interest income 8,338 7,305
Loan loss provision 450 450
Net interest income after provision 7,888 6,855
OTHER INCOME:
Service charges 2,217 2,075
Loan service fee income 119 124
Trust department income 147 156
Securities available for sale gains (losses), net 76 20
Gain on sale of mortgage loans 238 531
Other 541 468
Total other income 3,338 3,374
OTHER EXPENSES:
Salaries and employee benefits 4,102 3,762
Occupancy expenses 1,129 1,034
Amortization of intangibles 294 241
Advertising and marketing 196 200
Taxes other than payroll, property and income 248 221
Other 1,688 1,479
Total other expenses 7,657 6,937
Income before taxes 3,569 3,292
Income taxes 980 937
Net income $ 2,589 $ 2,355
Other Comprehensive Income, net of tax:
Change in Unrealized Gains on Securities (2,480) 293
Comprehensive Income $ 109 $ 2,648
Earnings per share
Basic $ 0.92 $ 0.85
Diluted 0.92 0.84
See Accompanying Notes
KENTUCKY BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (unaudited)
(thousands, except per share amounts) Three Months Ending
6/30/2004 6/30/2003
INTEREST INCOME:
Loans, including fees $ 5,005 $ 4,689
Securities available for sale 1,448 912
Other 10 10
Total interest income 6,463 5,611
INTEREST EXPENSE:
Deposits 1,412 1,335
Other 784 591
Total interest expense 2,196 1,926
Net interest income 4,267 3,685
Loan loss provision 195 225
Net interest income after provision 4,072 3,460
OTHER INCOME:
Service charges 1,162 1,092
Loan service fee income 60 62
Trust department income 65 61
Securities available for sale gains (losses), net 60 2
Gain on sale of mortgage loans 136 239
Other 293 201
Total other income 1,776 1,657
OTHER EXPENSES:
Salaries and employee benefits 2,060 1,867
Occupancy expenses 540 534
Amortization of intangibles 149 123
Advertising and marketing 96 100
Taxes other than payroll, property and income 125 111
Other 863 751
Total other expenses 3,833 3,486
Income before taxes 2,015 1,631
Income taxes 576 459
Net income $ 1,439 $ 1,172
Other Comprehensive Income, net of tax:
Change in Unrealized Gains on Securities (2,852) 272
Comprehensive Income $ (1,413) $ 1,444
Earnings per share
Basic $ 0.51 $ 0.42
Diluted 0.51 0.42
See Accompanying Notes
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
Balances, December 31, 2003 2,799,781 $ 6,985 $ 37,553 $ 1,519 $ 46,057
Common stock issued 2,096 44 - - 44
Common stock purchased - - - - -
Net change in unrealized gain (loss)
on securities available for sale,
net of tax - - - (2,480) (2,480)
Net income - - 2,589 - 2,589
Dividends declared - $0.42 per share - - (1,177) - (1,177)
Balances, June 30, 2004 2,801,877 $ 7,029 $ 38,965 $ (961) $ 45,033
KENTUCKY BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
(thousands) Six Months Ending
6/30/2004 6/30/2003
Cash Flows From Operating Activities
Net Income $ 2,589 $ 2,355
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation 541 490
Amortization 294 241
Securities available for sale amortization (accretion) 390 341
Provision for loan losses 450 450
Securities available for sale (gains) losses, net (76) (20)
Originations of loans held for sale (12,301) (22,040)
Proceeds from sale of loans 13,395 18,983
Federal Home Loan Bank Stock dividends (99) (81)
Gain on sale of mortgage loans (238) (531)
Changes in:
Interest receivable 103 330
Other assets (311) (433)
Interest payable 12 (38)
Other liabilities 1,001 (358)
Net cash from operating activities 5,750 (311)
Cash Flows From Investing Activities
Purchases of securities available for sale (56,036) (23,831)
Proceeds from sales of securities available for sale 26,807 5,355
Proceeds from principal payments, maturities and
calls of securities available for sale 20,723 18,246
Net change in loans (21,865) 310
Purchases of bank premises and equipment, net (794) (642)
Proceeds from the sale of bank premises and equipment
Net cash from investing activities (31,165) (562)
Cash Flows From Financing Activities:
Net change in deposits (5,518) (17,498)
Net change in securities sold under agreements to
repurchase and other borrowings 21,857 (1,824)
Advances from Federal Home Loan Bank 10,000 8,000
Payments on Federal Home Loan Bank advances (8,993) (4,967)
Proceeds from issuance of common stock 44 76
Purchase of common stock - (11)
Dividends paid (1,177) (1,056)
Net cash from financing activities 16,213 (17,280)
Net change in cash and cash equivalents (9,202) (18,153)
Cash and cash equivalents at beginning of period 21,388 29,176
Cash and cash equivalents at end of period $ 12,186 $ 11,023
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 was $10,199,830 as of June 30, 2004. Goodwill will
not be amortized but instead evaluated periodically for impairment.
Acquired intangible assets were as follows:
Original Accumulated
Amount Amortization
6/30/2004
Core deposit intangible $3,656,403 $2,697,324
Amortization expense was $178,032 for the first six months of 2004 and
$139,734 for the first six 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 (178,032)
End of period 959,079
3. INVESTMENT SECURITIES
INVESTMENT SECURITIES
Period-end securities are as follows:
(in thousands)
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
Available for Sale
June 30, 2004
U.S. Treasury $ 3,018 $ - $ (36) $ 2,982
U.S. government agencies 35,922 2 (822) 35,102
States and political subdivisions 36,285 741 (337) 36,689
Mortgage-backed 58,262 293 (1,711) 56,844
Equity securities 1,193 414 - 1,607
Total 134,680 1,450 (2,906) 133,224
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)
6/30/2004 12/31/2003
Commercial $ 16,398 $ 14,278
Real estate construction 21,126 14,313
Real estate mortgage 229,266 214,529
Agricultural 56,696 56,615
Consumer 11,204 13,267
Total 334,690 313,002
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:
Six Months Ended
June 30
2004 2003
(in thousands)
Basic Earnings Per Share
Net Income $2,589 $2,355
Weighted average common shares outstanding 2,801 2,776
Basic earnings per share $ 0.92 $ 0.85
Diluted Earnings Per Share
Net Income $2,589 $2,355
Weighted average common shares outstanding 2,801 2,776
Add dilutive effects of assumed exercise
of stock options 22 17
Weighted average common and dilutive
potential common shares outstanding 2,823 2,793
Diluted earnings per share $ 0.92 $ 0.84
Three Months Ended
June 30
2004 2003
(in thousands)
Basic Earnings Per Share
Net Income $1,439 $1,172
Weighted average common shares outstanding 2,802 2,777
Basic earnings per share $ 0.51 $ 0.42
Diluted Earnings Per Share
Net Income $1,439 $1,172
Weighted average common shares outstanding 2,802 2,777
Add dilutive effects of assumed exercise
of stock options 21 33
Weighted average common and dilutive
potential common shares outstanding 2,823 2,810
Diluted earnings per share $ 0.51 $ 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.
Six months ended June 30
(in thousands)
2004 2003
Net income
As reported $ 2,589 $ 2,355
Deduct: Stock-based compensation
expense determined under fair
value based method (10) (17)
Pro forma 2,579 2,338
Basic earnings per share
As reported $ 0.92 $ 0.85
Pro forma 0.92 0.84
Diluted earnings per share
As reported $ 0.92 $ 0.84
Pro forma 0.91 0.84
9. Dividends per share paid for the quarter ended June 30, 2004 were $0.21
compared to $0.19 for June 30, 2003. This is the same rate of dividend
paid for the first quarters of the respective years.
10. Components of Net Periodic Cost
Six months ended June 30
(in thousands)
Pension Benefits
2004 2003
Service cost $ 185 $ 158
Interest cost 143 133
Expected return on plan assets (160) (133)
Amortization - 8
Net Periodic Cost $ 168 $ 166
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 six
months ended June 30, 2004, and the Company anticipates making its annual
contribution in the third 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.
Summary
Kentucky Bancshares, Inc. recorded net income of $2.6 million, or $0.92 basic
and diluted earnings per share for the first six months ended June 30, 2004
compared to $2.4 million, or $0.85 basic earnings per share and $0.84 diluted
earnings per share for the six month period ending June 30, 2003. The first
six months earnings reflects an increase of 9.9% compared to the same time
period in 2003. The net income for the three months ended June 30, 2004 was
$1.4 million, or $0.51 basic and diluted earnings per share compared to $1.2
million, or $0.42 basic and diluted earnings per share for the three month
period ending June 30, 2003. This three month period reflects an increase in
net income of 22.8% compared to the three months of the prior year.
Return on average assets was 0.99% for the six months ended June 30, 2004 and
1.14% for the six month period ended June 30, 2003. Return on average assets
was 1.20% for the three months ended June 30, 2004 and 1.14% for the same time
period in 2003. Return on average equity was 11.0% for the six month period
ended June 30, 2004 and 10.5% for the same period in 2003. Return on average
equity for the three month period ended June 30, 2004 was 13.7% compared to
10.4% for the same time period in 2003.
Loans increased $21.7 million from $313.0 million on December 31, 2003 to
$334.7 million on June 30, 2004. Increases in commercial, real estate
construction and real estate mortgage loans were offset somewhat by a decrease
in consumer loans. Management attributes the overall growth in loans
primarily to an improvement in the economy.
Total deposits decreased from $384.6 million on December 31, 2003 to $379.1
million on June 30, 2004, a decrease of $5.5 million. The decrease is mainly
attributable to other interest bearing deposits decreasing $9.2 million and
non-interest bearing deposits increasing $3.8 million.
Net Interest Income
Net interest income was $8.3 million for the six months ended June 30, 2004
and $7.3 million for the six months ended June 30, 2003, an increase of 14.1%.
Net interest income was $4.3 million for the three months ended June 30, 2004
and $3.7 million for the three months ending June 30, 2003, resulting in an
increase of $582 thousand. The interest spread was 3.41% for the first six
months of 2004 compared to 3.69% for the same period in 2003, a decrease of 28
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
six months of 2004 compared to 2003.
For the first six months, the yield on assets decreased from 5.86% in 2003 to
5.26% in 2004. The cost of liabilities decreased from 2.17% in 2003 to 1.86%
in 2004. Year to date average loans are up $34.4 million, or 12.1% from June
30, 2003 to June 30, 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 $396 thousand for the
first six months of 2004 compared to the first six months of 2003. Year to
date average deposits also increased from June 30, 2003 to June 30, 2004, up
$70.0 million, or 21.7%. The above mentioned acquisition added $52.9 million
in deposits. Deposit interest expense has increased $63 thousand for the
first six 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 $1.0 million for the first six 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 have added $232 thousand to net income before
taxes for the first six months of 2004.
Non-Interest Income
Non-interest income decreased $36 thousand for the six months ended June 30,
2004 compared to the same period in 2003 from $3.4 million to $3.3 million,
due primarily to the decrease in gain on sale of mortgage loans discussed
below. Non-interest income increased $119 thousand for the three month period
ended June 30, 2004 compared to the same period in 2003. An increase of $142
thousand in service charges from the first six months of 2003 to the
comparable 2004 period is mainly attributable to an increase in checking
overdraft charges of $192 thousand, offset mainly by a decrease in title
insurance of $19 thousand and merchant processing of $23 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 $293 thousand during the first six
months of 2004 compared to the same period in 2003. The gain on sale of
mortgage loans decreased $103 thousand for the three month period ended June
30, 2004 compared to the same three month 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 thus we expect the income from the sale of loans to be lower in
future periods than in the 2003, if interest rates continue to rise.
Non-Interest Expense
Total non-interest expenses increased $720 thousand for the six month period
ended June 30, 2004 compared to the same period in 2003, including an increase
of $347 thousand in non-interest expenses from $3.5 million for the three
months ended June 30, 2003 to $3.8 million for the same period in 2004. For
the comparable six month periods, salaries and benefits increased $340
thousand, an increase of 9%. The increase is due to annual salary increases
and an increased number of employees. Employee benefits represented $67
thousand of the increase in salaries and employee benefits expense during
these comparable periods.
Occupancy expenses increased $95 thousand from $1.0 million for the first six
months of 2003 compared to $1.1 million for the same period in 2004.
Occupancy expenses increased $6 thousand for the three month period ended June
30, 2004 compared to June 30, 2003.
Other expenses increased $209 thousand for the six months ended June 30, 2004
compared to the same time period in 2003. Other expenses increased $112
thousand for the three months ended June 30, 2004 compared to the same period
in 2003. Debit card expenses, amortization expenses and repossession expenses
have increased $32 thousand, $38 thousand and $52 thousand, respectively, when
compared to the same six month 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 six months ended June 30, 2004 was 27%
compared to 28% in 2003. The tax equivalent rate for the three months ended
June 30 was 29% for 2004 and 28% 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 June
30, 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 $12.2 million as of June 30, 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 $133.2
million at June 30, 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 June 30, 2004, we have sufficient collateral to borrow an
additional $35 million from the FHLB. In addition, as of June 30, 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 June 30, 2004, the Company's non-performing loans totaled $1.9 million
or 0.6% of loans compared to $2.6 million or 0.8% of loans at December 31,
2003. (See table below) The changes in non-accrual loans and in accruing
loans past due 90 days or more is attributable to various smaller consumer and
real estate loans. Real estate loans composed 89% of the non-performing loans
as of June 30, 2004 and 69% as of December 31, 2003. Forgone interest income
on the non-accrual loans for both 2004 and 2003 is immaterial.
Nonperforming Assets
6/30/04 12/31/03
(in thousands)
Non-accrual Loans $ 882 $ 1,844
Accruing Loans which are
Contractually past due
90 days or more 1,007 779
Total Nonperforming and Restructured 1,889 2,623
Other Real Estate 537 375
Total Nonperforming and Restructured
Loans and Other Real Estate $ 2,426 $ 2,998
Nonperforming and Restructured Loans
as a Percentage of Loans 0.56% 0.82%
Nonperforming and Restructured Loans
and Other Real Estate as a Percentage
of Total Assets 0.47% 0.60%
Provision for Loan Losses
The loan loss provision for the first six months was $450 thousand for 2004
and 2003. The provision for the three months ended June 30, 2004 was $195
thousand compared to $225 thousand for the same period in 2003. A decrease in
nonperforming loans caused management to decrease the 2004 second quarter
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 six month period ended
June 30, 2004 were $177 thousand compared to $804 thousand for the same period
in 2003. Net charge-offs for the three month period ended June 30, 2004 were
$39 thousand compared to $622 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
Six Months Ended June 30
(in thousands)
2004 2003
Balance at Beginning of Period $ 3,820 $ 3,395
Amounts Charged-off:
Commercial 45 529
Real Estate Construction - -
Real Estate Mortgage 19 88
Agricultural 83 20
Consumer 149 257
Total Charged-off Loans 296 894
Recoveries on Amounts
Previously Charged-off:
Commercial 6 9
Real Estate Construction - -
Real Estate Mortgage 37 1
Agricultural 5 21
Consumer 71 59
Total Recoveries 119 90
Net Charge-offs 177 804
Provision for Loan Losses 450 450
Balance at End of Period 4,093 3,041
Loans
Average 317,597 282,773
At June 30 334,690 283,040
As a Percentage of Average Loans:
Net Charge-offs 0.06% 0.28%
Provision for Loan Losses 0.14% 0.16%
Allowance as a Percentage of
Period-end Loans 1.22% 1.07%
Allowance as a Multiple of
Net Charge-offs 11.6 1.9
Allowance as a Percentage of
Non-performing and Restructured Loans 217% 175%
Loan Losses
Quarter Ended June 30
(in thousands)
2004 2003
Balance at Beginning of Period $ 3,937 $ 3,438
Amounts Charged-off:
Commercial 30 487
Real Estate Construction - -
Real Estate Mortgage 19 88
Agricultural - -
Consumer 37 100
Total Charged-off Loans 86 675
Recoveries on Amounts
Previously Charged-off:
Commercial 2 5
Real Estate Construction - -
Real Estate Mortgage 3 1
Agricultural 1 20
Consumer 41 27
Total Recoveries 47 53
Net Charge-offs 39 622
Provision for Loan Losses 195 225
Balance at End of Period 4,093 3,041
Loans
Average 322,860 282,418
At June 30 334,690 283,040
As a Percentage of Average Loans:
Net Charge-offs 0.01% 0.22%
Provision for Loan Losses 0.06% 0.08%
Allowance as a Multiple of
Net Charge-offs 26.2 1.2
Item 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Asset/Liability management control is designed to ensure safety and soundness,
maintain liquidity and regulatory capital standards, and achieve acceptable
net interest income. Management considers interest rate risk to be the most
significant market risk. The Company's exposure to market risk is reviewed on
a regular basis by the Asset/Liability Committee. Interest rate risk is the
potential of economic losses due to future interest rate changes. These
economic losses can be reflected as a loss of future net interest income
and/or a loss of current fair market values. The objective is to measure the
effect on net interest income and to adjust the balance sheet to minimize the
inherent risk while at the same time maximize income.
Management realizes certain risks are inherent and that the goal is to
identify and minimize the risks. The primary tool used by management is an
interest rate shock simulation model. The Bank has no market risk sensitive
instruments held for trading purposes.
The following table depicts the change in net interest income resulting from
100 and 300 basis point changes in rates on the Company's interest earning
assets and interest bearing liabilities. The projections are based on balance
sheet growth assumptions and repricing opportunities for new, maturing and
adjustable rate amounts. As of June 30, 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 June 30, 2004
is as follows:
(dollars in thousands)
PROJECTED NET INTEREST INCOME
Level
Change in basis points: - 300 - 100 Rates + 100 + 300
Year One (7/04 - 6/05)
Interest Income $21,667 $25,017 $26,735 $28,454 $31,896
Interest Expense 6,787 7,122 8,457 9,800 12,488
Net Interest Income 14,880 17,895 18,278 18,654 19,408
PROJECTED DOLLAR INCREASE (DECREASE) FROM "LEVEL RATES"
Year One (7/04 - 6/05)
Interest Income $(5,068) $(1,718) N/A $ 1,719 $ 5,161
Interest Expense (1,670) (1,335) N/A 1,343 4,031
Net Interest Income (3,398) (383) N/A 376 1,130
PROJECTED PERCENTAGE INCREASE (DECREASE) FROM "LEVEL RATES"
Year One (7/04 - 6/05)
Interest Income -19.0% -6.4% N/A 6.4% 19.3%
Interest Expense -19.7% -15.8% N/A 15.9% 47.7%
Net Interest Income -18.6% -2.1% N/A 2.1% 6.2%
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 June 30, 2003 is as follows:
(dollars in thousands)
PROJECTED NET INTEREST INCOME
Level
Change in basis points: - 300 - 100 Rates + 100 + 300
Year One (7/03 - 6/04)
Interest Income $ 18,524 $ 21,107 $ 22,525 $ 23,945 $ 26,793
Interest Expense 6,108 6,396 7,259 8,129 9,870
Net Interest Income 12,416 14,711 15,266 15,816 16,923
PROJECTED DOLLAR INCREASE (DECREASE) FROM "LEVEL RATES"
Year One (7/03 - 6/04)
Interest Income $ (4,001) $ (1,418) N/A $ 1,420 $ 4,268
Interest Expense (1,151) (863) N/A 870 2,611
Net Interest Income (2,850) (555) N/A 550 1,657
PROJECTED PERCENTAGE INCREASE (DECREASE) FROM "LEVEL RATES"
Year One (7/03 - 6/04)
Interest Income -17.8% -6.3% N/A 6.3% 18.9%
Interest Expense -15.9% -11.9% N/A 12.0% 36.0%
Net Interest Income -18.7% -3.6% N/A 3.6% 10.9%
Board approved limit >-10.0% >-4.0% N/A >-4.0% >-10.0%
These projected changes in net interest income as of June 30, 2004 are less
when compared to the projected changes in net interest income as of June 30,
2003. Projections from June 30, 2004, year one reflected a decline in net
interest income of 2.1% with a 100 basis point decline compared to the 3.6%
decline in 2003. The 300 basis point increase in rates reflected a 6.2%
increase in net interest income in 2004 compared to 10.9% 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
None
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
1. Exhibits as required by Item 601 of Regulation S-K.
31.1 Certifications of Chief Executive Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Certifications of Chief Financial Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
32 Certifications of Chief Executive Officer and Chief
Financial Officer pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
2. Reports on Form 8-K
The Company filed a Form 8-K dated May 5, 2004, Item 7
and Item 12 to report the mailing to its shareholders of
its operating results for the three-month period ended
March 31, 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 ____8/13/04_________ __/s/Buckner Woodford____________
Buckner Woodford, President and C.E.O.
Date ____8/13/04_________ __/s/Gregory J. Dawson___________
Gregory J. Dawson, Chief Financial Officer
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