10-K 1 k2003.txt 10K UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K (Mark One) [ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2003 or [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ____________________ to ___________________ Commission File Number: 33-96358 KENTUCKY BANCSHARES, INC. (Exact name of registrant as specified in its charter) Kentucky 61-0993464 (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) P.O. Box 157, Paris, Kentucky 40362-0157 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (859)987-1795 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: None 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ X ] Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes No _X_ Aggregate market value of voting stock held by non-affiliates as of June 30, 2003 was approximately $66.7 million. For purposes of this calculation, it is assumed that directors, executive officers and beneficial owners of more than 5% of the registrant's outstanding voting stock are affiliates. Number of shares of Common Stock outstanding as of March 26, 2004: 2,801,527. PART I Item 1. Business General Kentucky Bancshares, Inc. ("Company" or "Kentucky") is a Kentucky corporation organized in 1981 and a bank and savings and loan holding company registered under the Bank Holding Company Act of 1956, as amended ("BHCA") and the Home Owners Loan Act of 1933, as amended ("HOLA"). The Company conducts business in the state of Kentucky through one banking subsidiary, Kentucky Bank. Kentucky Bank is a commercial bank and trust company organized under the laws of Kentucky. Kentucky Bank has its main office in Paris (Bourbon County), with additional offices in Paris, North Middletown (Bourbon County), Winchester (Clark County), Cynthiana (Harrison County), Nicholasville (Jessamine County), Wilmore (Jessamine County), Georgetown (Scott County), and Versailles (Woodford County). The deposits of Kentucky Bank are insured up to prescribed limits by the Bank Insurance Fund ("BIF") and the Savings Association Insurance Fund ("SAIF"), both of the Federal Deposit Insurance Corporation ("FDIC"). Kentucky Bank is engaged in general full-service commercial and consumer banking. Kentucky Bank makes commercial, agricultural and real estate loans to its commercial customers, with emphasis on small-to-medium-sized industrial, service and agricultural businesses. Kentucky Bank makes residential mortgage, installment and other loans to its individual and other non-commercial customers. Kentucky Bank also offers its customers the opportunity to obtain a credit card. Kentucky Bank offers its customers a variety of other services, including checking, savings, money market accounts, certificates of deposits, safe deposit facilities and other consumer- oriented financial services. Kentucky Bank has Internet banking, including bill payment available to its customers at www.kybank.com. Through its Wealth Management Department, Kentucky Bank provides brokerage services, annuities, life and long term care insurance, personal trust and agency services (including management agency services). Competition The Company and its subsidiary face vigorous competition from a number of sources, including other bank holding companies and commercial banks, consumer finance companies, thrift institutions, other financial institutions and financial intermediaries. In addition to commercial banks, savings and loan associations, savings banks and credit unions actively compete to provide a wide variety of banking services. Mortgage banking firms, finance companies, insurance companies, brokerage companies, financial affiliates of industrial companies and government agencies provide additional competition for loans and for many other financial services. The subsidiary also currently competes for interest-bearing funds with a number of other financial intermediaries, including brokerage firms and mutual funds, which offer a diverse range of investment alternatives. Supervision and Regulation As a bank holding company, the Company is subject to the regulation and supervision of the Federal Reserve Board. The Company's subsidiary is subject to supervision and regulation by applicable state and federal banking agencies, including the Federal Reserve Board, the Federal Deposit Insurance Corporation and the Kentucky Department of Financial Institutions. The subsidiary is also subject to various requirements and restrictions under federal and state law, including requirements to maintain reserves against deposits, restrictions on the types and amounts of loans that may be granted and the interest that may be charged thereon, and limitations on the types of investments that may be made and the types of services that may be offered. Various consumer laws and regulations also affect the operations of the subsidiary. In addition to the impact of regulation, the subsidiary is affected significantly by the actions of the Federal Reserve Board as it attempts to control the money supply and credit availability in order to influence the economy. There are a number of obligations and restrictions imposed on bank holding companies and their depository institution subsidiaries by federal law and regulatory policy that are designed to reduce potential loss exposure to the depositors of such depository institutions and to the FDIC insurance funds in the event the depository institution becomes in danger of default or is in default. For example, under a policy of the Federal Reserve Board with respect to bank holding company operations, a bank holding company is required to serve as a source of financial strength to its subsidiary depository institutions and commit resources to support such institutions in circumstances where it might not do so absent such policy. In addition, the "cross-guarantee" provisions of federal law require insured depository institutions under common control to reimburse the FDIC for any loss suffered or reasonably anticipated as a result of the default of a commonly controlled insured depository institution or for any assistance provided by the FDIC to a commonly controlled insured depository institution in danger of default. The federal banking agencies have broad powers under current federal law to take prompt corrective action to resolve problems of insured depository institutions. The extent of these powers depends upon whether the institutions in question are "well capitalized", "adequately capitalized", "undercapitalized", "significantly undercapitalized" or "critically undercapitalized", as such terms are defined under uniform regulation defining such capital levels issued by each of the federal banking agencies. There are various legal and regulatory limits on the extent to which the Company's subsidiary bank may pay dividends or otherwise supply funds to the Company. In addition, federal and state regulatory agencies also have the authority to prevent a bank or bank holding company from paying a dividend or engaging in any other activity that, in the opinion of the agency, would constitute an unsafe or unsound practice. The Gramm-Leach-Bliley Act of 1999 eliminates restrictions imposed by the Glass-Steagall Financial Services Law, adopted in the 1930s, which prevented banking, insurance and securities firms from fully entering each other's businesses. While it is still uncertain what the impact of this legislation will be, it is likely to result in further consolidation in the financial services industry. In addition, removal of these barriers will likely increase the number of entities providing banking services, thereby increasing competition. Employees At December 31, 2003, the number of full time equivalent employees of the Company was 187. Item 2. Properties The main banking office of Kentucky Bank, which also serves as the principal office of Kentucky Bancshares, Inc., is located at Fourth and Main Streets, Paris, Kentucky 40361. In addition, Kentucky Bank serves customer needs at 11 other locations. All locations offer a full range of banking services. Kentucky Bank owns all of the properties at which it conducts its business. The Company owns approximately 76,000 square feet of office space. Note 5 to the Company's consolidated financial statements included in this report contains additional information relating to amounts invested in premises and equipment. Item 3. Legal Proceedings The Company and its subsidiary are from time to time involved in routine legal proceedings occurring in the ordinary course of business that, in the aggregate, management believes will not have a material impact on the Company's financial condition and results of operation. Item 4. Submission of Matters to a Vote of Security Holders Not Applicable. PART II Item 5. Market for Common Equity and Related Stockholder Matters There is no established public trading market for the Company's Common Stock. The Company's Common Stock is not listed on any national securities exchange nor is it quoted on the NASDAQ system. However, it is listed on the OTC Bulletin Board under the symbol "KTYB.OB". Trading in the Common Stock has been infrequent, with retail brokerage firms making the market. The following table sets forth the high and low sales prices of the Common Stock and the dividends declared thereon, for the periods indicated below: High Low Dividend 2003 Quarter 4 $38.00 $31.00 $.19 Quarter 3 35.00 28.30 .19 Quarter 2 29.00 28.00 .19 Quarter 1 28.50 25.50 .19 2002 Quarter 4 $26.50 $24.00 $.17 Quarter 3 27.00 25.50 .17 Quarter 2 27.50 25.50 .17 Quarter 1 27.00 24.25 .17 Note 15 to the Company's consolidated financial statements included in this report contains additional information relating to amounts available to be paid as dividends. As of December 31, 2003 the Company had 2,799,781 shares of Common Stock outstanding and approximately 463 holders of record of its Common Stock. Item 6. Selected Financial Data The following selected financial data should be read in conjunction with the Company's Consolidated Financial Statements and the accompanying notes presented elsewhere herein.
At or For the Year Ended December 31 (dollars and shares in thousands, except per share amounts) 2003 2002 2001 2000 1999 CONDENSED STATEMENT OF INCOME: Total Interest Income $22,329 $24,788 $28,046 $28,207 $23,453 Total Interest Expense 7,875 9,367 13,386 13,597 10,547 Net Interest Income 14,454 15,421 14,660 14,610 12,906 Provision for Losses 1,300 1,204 1,068 750 700 Net Interest Income After Provision for Losses 13,154 14,217 13,592 13,860 12,206 Noninterest Income 6,707 6,590 5,672 3,798 3,386 Noninterest Expense 14,171 12,433 11,756 10,374 9,422 Income Before Income Tax Expense 5,690 8,374 7,508 7,284 6,170 Income Tax Expense 1,457 2,471 1,984 2,031 1,720 Net Income 4,233 5,903 5,524 5,253 4,450 SHARE DATA: Basic Earnings per Share (EPS) $1.52 $2.13 $1.98 $1.87 $1.59 Diluted EPS 1.50 2.10 1.95 1.83 1.55 Cash Dividends Declared 0.76 0.68 0.60 0.52 0.44 Book Value 16.45 15.90 14.13 12.77 11.32 Average Common Shares-Basic 2,781 2,770 2,790 2,812 2,803 Average Common Shares-Diluted 2,827 2,806 2,837 2,868 2,868 SELECTED BALANCE SHEET DATA: Loans $316,941 $281,499 $272,129 $269,757 $238,998 Investment Securities 128,790 89,509 75,608 68,054 70,623 Total Assets 500,852 419,771 397,257 371,847 347,479 Deposits 384,599 322,836 308,915 300,816 274,566 Securities sold under agreements to repurchase and other borrowings 7,285 5,277 1,602 9,446 11,858 Federal Home Loan Bank advances 53,232 43,937 43,598 21,644 26,592 Stockholders' Equity 46,057 44,092 39,100 35,860 31,720 PERFORMANCE RATIOS: (Average Balances) Return on Assets 1.00% 1.48% 1.46% 1.49% 1.39% Return on Stockholders' Equity 9.31% 14.27% 14.60% 15.63% 14.57% Net Interest Margin (1) 3.79% 4.23% 4.22% 4.47% 4.46% Equity to Assets (annual average) 10.73% 10.36% 9.99% 9.51% 9.54% SELECTED STATISTICAL DATA: Dividend Payout Ratio 50.00% 31.94% 30.28% 27.84% 27.73% Number of Employees (at period end) 187 173 180 159 149 ALLOWANCE COVERAGE RATIOS: Allowance to Total Loans 1.19% 1.19% 1.24% 1.24% 1.28% Net Charge-offs as a Percentage of Average Loans 0.43% 0.43% 0.39% 0.18% 0.15% (1) Tax equivalent
Item 7. Management's Discussion and Analysis The following discussion and analysis of financial condition and results of operations should be read in conjunction with the Consolidated Financial Statements and accompanying notes included as Exhibit 13. When necessary, reclassifications have been made to prior years' data throughout the following discussion and analysis for purposes of comparability with 2002 data. Critical Accounting Policies The accounting and reporting policies of the Company and its subsidiary are in accordance with accounting principles generally accepted in the United States and conform to general practices within the banking industry. Significant accounting policies are listed in Note 1 in the "Notes to Consolidated Financial Statements". Critical accounting and reporting policies include accounting for securities, loans, the allowance for loan losses and income taxes. The accounting policies relating to the allowance for loan losses involve the use of estimates and require significant judgments to be made by management. Different assumptions in the application of these policies could result in material changes in the consolidated financial position or consolidated results of operations. The Company is required to classify its securities portfolio into three categories: trading securities, securities available for sale and securities held to maturity. Fair value adjustments are made to the securities based on their classification with the exception of the held to maturity category. Currently, the Company has classified all securities in its securities portfolio as available for sale and carries them at fair value. Unrealized gains and losses are recorded in stockholders' equity, net of related income tax. Loans are stated at the amount of unpaid principal, reduced by an allowance for loan losses. Interest on loans is recognized on the accrual basis, except for those loans on the nonaccrual status. Interest income received on such loans is accounted for on the cash basis or cost recovery method. The allowance for loan losses is a valuation allowance for probable incurred credit losses. 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. Income tax expense is the total of the current year income tax due or refundable and the change in deferred tax assets and liabilities. The Company uses the liability method for computing deferred income taxes. Under the liability method, deferred income taxes are based on the change during the year in the deferred tax liability or asset established for the expected future tax consequences of differences in the financial reporting and tax bases of assets and liabilities. Forward-Looking Statements This discussion contains forward-looking statements under the Private Securities Litigation Reform Act of 1995 that involve risks and uncertainties. Although the Company believes that the assumptions underlying the forward-looking statements contained herein are reasonable, any of the assumptions could be inaccurate, and therefore, there can be no assurance that the forward-looking statements included herein will prove to be accurate. Factors that could cause actual results to differ from the results discussed in the forward-looking statements include, but are not limited to: economic conditions (both generally and more specifically in the markets, 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. Overview Net income for the year ended December 31, 2003 was $4.2 million, or $1.52 per common share compared to $5.9 million, or $2.13 for 2002 and $5.5 million, or $1.98 for 2001. Earnings per share assuming dilution were $1.50, $2.10 and $1.95 for 2003, 2002 and 2001, respectively. For 2002, net income increased $378 thousand, or 7%. During 2003, net income decreased $1.7 million, down 28%. Net interest income decreased $967 thousand, the loan loss provision increased $96 thousand, while other income increased $118 thousand and other expenses increased $1.7 million. During 2003, the Company completed a strategic acquisition to strengthen its business and grow its customer base. In November 2003, the Company purchased Kentucky First Bancorp, Inc. (Kentucky First) and its subsidiary, First Federal Savings Bank (First Federal) of Cynthiana. Lack of loan demand, tightening margins and one time expenses related to closing the original leased facility in Georgetown and the merger of Kentucky First adversely affected 2003 earnings. During 2004, management will examine the Company's organizational structure to determine if the Company is positioned to deliver services and products to its customer efficiently. Management will also examine ways to improve revenues and control costs, with the expectation of improving net income. Return on average equity was 9.3% in 2003 compared to 14.3% in 2002 and 14.6% in 2001. Return on average assets was 1.00% in 2003 compared to 1.48% in 2002 and 1.46% in 2001. Non-performing loans as of a percentage of loans (including held for sale) were 0.82%, 0.83% and 0.80% as of December 31, 2003, 2002 and 2001, respectively. RESULTS OF OPERATIONS Net Interest Income Net interest income, the Company's largest source of revenue, on a tax equivalent basis increased from $15.0 million in 2001 to $15.9 million in 2002 but decreased to $15.1 million in 2003. The taxable equivalent adjustment (nontaxable interest income on state and municipal obligations net of the related non-deductible portion of interest expense) is based on our Federal income tax rate of 34%. Average earning assets and interest bearing liabilities both increased from 2002 to 2003. Average earning assets increased $21 million, or 6%. Investment securities increased $10 million primarily due to the softening loan demand. Average interest bearing liabilities increased $13 million, or 4% during this same period. The Company continues to actively pursue quality loans and fund these primarily with deposits and FHLB advances. During 2003 rates were fairly flat. Bank prime rates decreased 25 basis points in the second quarter. However, the declining rate environment in 2001 resulted in a decrease in yields on assets and liabilities in 2002 and 2003 due to repricing opportunities in 2001 of interest earning assets and interest bearing liabilities. As a result of this, the tax equivalent yield on earning assets decreased from 6.72% in 2002 to 5.77% in 2003. The volume rate analysis that follows indicates that $3.5 million of the increase in interest income is attributable to the change in volume, while the decrease in rates contributed to a decrease of $6.0 million in interest income. The rate decrease also caused a decrease in the cost of interest bearing liabilities. The average rate of these liabilities decreased from 3.09% in 2002 to 2.49% in 2003. Based on the volume rate analysis that follows, the change in volume contributed to an increase of $399 thousand to interest expense, while the decrease in rates was responsible for a $1.9 million decrease in interest expense. As a result, the 2003 net interest income decrease is attributed to increases in volume reduced by the negative impact of decreases in rates. In spite of the positive impact on net interest income that may result from the potential increasing rate environment in 2004, competitive pressures on interest rates will continue and are likely to result in tighter net interest margins. The volume rate analysis that follows, during 2002, indicates that $1.4 million of the increase in interest income is attributable to the change in volume, while the decrease in rates contributed to a decrease of $4.6 million in interest income. The rate decrease also caused a decrease in the cost of interest bearing liabilities. The average rate of these liabilities decreased from 4.60% in 2001 to 3.09% in 2002. In addition, the change in volume contributed to an increase of $447 thousand to interest expense, while the decrease in rates was responsible for a $4.5 million decrease in interest expense. As a result, the 2002 net interest income increase is attributed to increases in volume reduced slightly by the negative impact of decreases in rates. The accompanying analysis of changes in net interest income in the following table shows the relationships of the volume and rate portions of these changes in 2003 and 2002. Changes in interest income and expenses due to both rate and volume are allocated on a pro rata basis.
2003 vs. 2002 2002 vs. 2001 Increase (Decrease) Due to Change in Increase (Decrease) Due to Change in Volume Rate Net Change Volume Rate Net Change INTEREST INCOME Loans $ 3,065 $ (5,122) $ (2,057) $ 642 $ (3,669) $ (3,027) Investment Securities 440 (791) (351) 802 (767) 35 Federal Funds Sold and Securities Purchased under Agreements to Resell 30 (33) (3) (111) (176) (287) Deposits with Banks 17 (65) (48) 24 (3) 21 Total Interest Income 3,552 (6,011) (2,459) 1,357 (4,615) (3,258) INTEREST EXPENSE Deposits Demand 42 (602) (560) 132 (1,209) (1,077) Savings 20 (92) (72) 36 (130) (94) Negotiable Certificates of Deposit and Other Time Deposits 122 (1,157) (1,035) (192) (2,966) (3,158) Securities sold under agreements to repurchase and other borrowings 80 59 139 (43) (47) (90) Federal Home Loan Bank advances 135 (99) 36 514 (114) 400 Total Interest Expense 399 (1,891) (1,492) 447 (4,466) (4,019) Net Interest Income $ 3,153 $ (4,120) $ (967) $ 910 $ (149) $ 761
Average Consolidated Balance Sheets and Net Interest Analysis (dollars in thousands) 2003 2002 2001 Average Average Average Average Average Average Balance Interest Rate Balance Interest Rate Balance Interest Rate ASSETS Interest-Earning Assets Securities Available for Sale (1) U.S. Treasury and Federal Agency Securities 56,559 1,907 3.37% 47,090 2,241 4.76% 41,654 2,421 5.81% State and Municipal obligations 32,702 1,431 4.38% 26,476 1,254 4.74% 17,978 974 5.42% Other Securities 7,971 311 3.90% 13,364 505 3.78% 11,365 570 5.02% Total Securities Available for Sale 97,232 3,649 3.75% 86,930 4,000 4.60% 70,997 3,965 5.58% Total Investment Securities 97,232 3,649 3.75% 86,930 4,000 4.60% 70,997 3,965 5.58% Tax Equivalent Adjustment 611 0.63% 516 0.59% 371 0.52% Tax Equivalent Total 4,260 4.38% 4,516 5.19% 4,336 6.11% Federal Funds Sold and Agreements to Repurchase 9,307 101 1.09% 6,912 104 1.50% 10,893 391 3.59% Interest-Bearing Deposits with Banks 441 4 0.91% 1,620 52 3.21% 870 31 3.56% Loans, Net of Deferred Loan Fees (2) Commercial 26,871 1,522 5.66% 31,952 2,016 6.31% 32,837 2,678 8.16% Real Estate Mortgage 249,924 15,779 6.31% 230,455 16,788 7.28% 217,132 18,543 8.54% Installment 13,707 1,274 9.29% 18,698 1,828 9.78% 23,535 2,438 10.36% Total Loans 290,502 18,575 6.39% 281,105 20,632 7.34% 273,504 23,659 8.65% Total Interest-Earning Assets 397,482 22,940 5.77% 376,567 25,304 6.72% 356,264 28,417 7.98% Allowance for Loan Losses (3,324) (3,555) (3,386) Cash and Due From Banks 9,252 9,312 9,281 Premises and Equipment 10,840 10,270 9,171 Other Assets 9,713 6,654 7,375 Total Assets 423,963 399,248 378,705 LIABILITIES Interest-Bearing Deposits Negotiable Order of Withdrawal ("NOW") and Money Market Investment Accounts 86,039 642 0.75% 83,025 1,202 1.45% 78,220 2,279 2.91% Savings 19,213 86 0.45% 16,853 158 0.94% 14,494 252 1.74% Certificates of Deposit and Other Deposits 160,651 4,583 2.85% 157,167 5,618 3.57% 160,751 8,776 5.46% Total Interest-Bearing Deposits 265,903 5,311 2.00% 257,045 6,978 2.71% 253,465 11,307 4.46% Securities sold under agreements to repurchase and other borrowings 5,385 272 5.05% 3,585 132 3.68% 4,590 222 4.84% Federal Home Loan Bank advances 45,561 2,293 5.03% 42,923 2,257 5.26% 33,247 1,857 5.59% Total Interest-Bearing Liabilities 316,849 7,876 2.49% 303,553 9,367 3.09% 291,302 13,386 4.60% Noninterest-Bearing Earning Demand Deposits 58,263 50,782 45,469 Other Liabilities 3,371 3,539 4,092 Total Liabilities 378,483 357,874 340,863 STOCKHOLDERS' EQUITY 45,480 41,374 37,842 Total Liabilities and Shareholders' Equity 423,963 399,248 378,705 Average Equity to Average Total Assets 10.73% 10.36% 9.99% Net Interest Income 14,453 15,421 14,660 Net Interest Income (tax equivalent) (3) 15,064 15,937 15,031 Net Interest Spread (tax equivalent) (3) 3.28% 3.63% 3.38% Net Interest Margin (tax equivalent) (3) 3.79% 4.23% 4.22% (1) Averages computed at amortized cost. (2) Includes loans on a nonaccrual status and loans held for sale. (3) Tax equivalent difference represents the nontaxable interest income on state and municipal securities net of the related non-deductible portion of interest expense.
Noninterest Income and Expenses Noninterest income was $6.7 million in 2003 compared to $6.6 million in 2002 and $5.7 million in 2001. The 2003 increase is mainly a result of increased service charges. The $917 thousand increase in 2002 is mainly attributable to an increase in service charges and the increase from Gain on sale of mortgage loans. Securities gains were $139 thousand in 2003, $219 thousand in 2002 and $287 in 2001. These gains are a result of the declining rate environment and municipal securities being called at premiums before their maturities. In addition, U. S. Treasury securities were sold before maturity to recognize some gains and extend out the yield curve. Gains on loans sold were $853 thousand, $948 thousand and $383 thousand in 2003, 2002 and 2001, respectively. Loans held for sale are generally sold after closing to the Federal Home Loan Mortgage Corporation. During 2002 and 2001, the Company sold some loans along with their servicing rights and therefore there was a slight decline in loan service fee income in 2002. During 2003, the loan service fee income increased $14 thousand. The sales of loans were $37 million, $41 million and $28 million in 2003, 2002 and 2001, respectively. Volume of loan originations are inverse to rate changes. The low rate environment over the past three years has favorably impacted our mortgage loan originations in 2003, 2002 and 2001. Other noninterest income excluding security net gains and gain on sale of mortgage loans was $5.7 million in 2003, $5.4 million in 2002 and $5.0 million in 2001. Service charge income has been a big contributor to this increase in income over this three-year period. Overdraft income increased $195 thousand in 2003 and $239 thousand in 2002, principally the result of increases in deposits and implementation of a new "Kentucky Courtesy" overdraft in the last quarter of 2000. Other income increased from $734 thousand in 2001 to $1.0 million in 2002 to $1.1 million in 2003. The increase in 2003 is mainly a result of an increase in brokerage commissions of $60 thousand. The increase in 2002 is mainly a result of title insurance sales of $89 thousand and an increase in brokerage commissions of $98 thousand. The sale of title insurance was started during 2001 and has been very successful. The sale of brokerage services was an increasing additional source of income in 2003 and 2002. Noninterest expense increased $1.7 million in 2003 to $14.2 million, and increased $677 thousand in 2002 to $12.4 million from $11.8 million in 2001. The increases in salaries and benefits from $6.0 million in 2001 to $6.7 million in 2002 and to $7.4 million in 2003 are attributable to normal salary and benefit increases. Bonus compensation was $191 thousand lower in 2003 compared to 2002 and $179 thousand higher in 2002 compared to 2001. The 2003 decrease is mainly a result of lower net income. Occupancy expense increased $136 thousand, or 7% in 2003 to $2.0 million and increased $18 thousand, or 1% in 2002 to $1.9 million. The Company completed its construction of a new full service facility in Cynthiana in October 2001. Since 1999, 3 new facilities have been constructed and 2 facilities have been substantially renovated. In 2001, land was purchased in Georgetown to construct a full service facility, and relocate one of our branches in Georgetown, and this facility was opened in March 2003. As part of this relocation, the Company incurred a one time expense of $163 thousand in 2003 for the loss on the leased premises. This overall improvement of our facilities has led to the increase in occupancy expenses. The largest expense, depreciation, increased from $961 thousand in 2001, to $990 thousand in 2002 and declined slightly to $961 thousand in 2003. Other noninterest expense increased from $3.8 million in 2001 and 2002 to $4.8 million in 2003. Of this 2003 increase, $350 thousand is attributable to legal and professional expenses, including merger related legal and consulting expenses amounted of $230 thousand. In addition, mortgage servicing rights amortization increased $74 thousand, and marketing increased $69 thousand from 2002 to 2003. The following table is a summary of noninterest income and expense for the three-year period indicated. For the Year Ended December 31 (in thousands) 2003 2002 2001 NON-INTEREST INCOME Service Charges $ 4,065 $ 3,848 $ 3,664 Loan Service Fee Income 242 228 258 Trust Department Income 302 346 347 Investment Securities Gains (Losses),net 139 219 287 Gains on Sale of Mortgage Loans 853 948 382 Other 1,106 1,001 734 Total Non-interest Income 6,707 6,590 5,672 NON-INTEREST EXPENSE Salaries and Employee Benefits 7,373 6,728 6,019 Occupancy Expenses 2,045 1,909 1,891 Other 4,753 3,796 3,846 Total Non-interest Expense 14,171 12,433 11,756 Net Non-interest Expense as a Percentage of Average Assets 1.76% 1.46% 1.61% Income Taxes The Company had income tax expense of $1.5 million in 2003 and $2.5 million in 2002 and $2.0 million in 2001. This represents an effective income tax rate of 25.6% in 2003, 29.5% in 2002 and 26.4% in 2001. The difference between the effective tax rate and the statutory federal rate of 34% is primarily due to tax exempt income on certain investment securities and loans. Balance Sheet Review Assets grew from $420 million at December 31, 2002 to $501 million at December 31, 2003. Loan growth was $29 million in 2003. Deposits grew $62 million and borrowings grew $19 million. The acquisition of Kentucky First added $31 million in loans and $53 million in deposits. See Note 17 in the "Notes to Consolidated Financial Statements" for more details of this business combination. Assets at year-end 2002 totaled $420 million compared to $397 million in 2001. In 2002, loan growth was $11 million and deposit growth was $14 million. FHLB advances remained level at $44 million. Loans Total loans (including loans held for sale) were $321 million at December 31, 2003 compared to $285 million at the end of 2002 and $276 million in 2001. During 2003, $31.2 million was added to the loan portfolio through the Kentucky First acquisition. This accounts for the majority of the 2003 growth. Loan growth also improved in 2002 compared to 2001. The Company's rate of loan growth has decreased since 2000, and is mainly attributable to the economic downturn starting in 2001. As of the end of 2003 and compared to the prior year-end, commercial loans decreased $2.5 million, real estate construction loans decreased $1.2 million, real estate mortgage loans (including loans held for sale) increased $39.3 million, agricultural loans increased $4.4 million and consumer loans decreased $4.2 million. As of the end of 2002 and compared to the prior year-end, real estate construction loans increased $3.2 million, real estate mortgage loans (including loans held for sale) increased $14.3 million, agricultural loans decreased $1.5 million and installment loans decreased $4.8 million. As of December 31, 2003, the real estate mortgage portfolio comprised 69% of total loans compared to 64% in 2002. Of this, 1-4 family residential property represented 70% in 2003 and 69% in 2002. Agricultural loans comprised 18% in both 2003 and 2002 of the loan portfolio. Approximately 78% of the agricultural loans are secured by real estate in 2003 compared to 77% in 2002. The remainder of the agricultural portfolio is used to purchase livestock, equipment and other capital improvements and for general operation of the farm. Generally, a secured interest is obtained in the capital assets, equipment, livestock or crops. Automobile loans account for 36% in 2003 and 43% in 2002 of the consumer loan portfolio, while the purpose of the remainder of this portfolio is used by customers for purchasing retail goods, home improvement or other personal reasons. Collateral is generally obtained on these loans after analyzing the repayment ability of the borrower. The commercial loan portfolio is mainly for capital outlays and business operation. Collateral is requested depending on the creditworthiness of the borrower. Unsecured loans are made to individuals or companies mainly based on the creditworthiness of the customer. Approximately 4% of the loan portfolio is unsecured. Management is not aware of any significant concentrations that may cause future material risks, which may result in significant problems with future income and capital requirements. The following table represents a summary of the Company's loan portfolio by category for each of the last five years. There is no concentration of loans (greater than 5% of the loan portfolio) in any industry. The Company has no foreign loans or highly leveraged transactions in its loan portfolio. Loans Outstanding At December 31 (in thousands) 2003 2002 2001 2000 1999 Commercial $ 14,278 $ 16,803 $ 18,618 $ 17,452 $ 17,713 Real Estate Construction 14,313 15,514 12,302 15,270 17,003 Real Estate Mortgage 222,342 182,958 168,684 163,190 138,337 Agricultural 56,615 52,188 53,640 52,008 46,443 Installment 12,978 17,134 21,952 24,807 22,358 Other 289 309 338 434 280 Total Loans 320,815 284,906 275,534 273,161 242,134 Less Deferred Loan Fees 54 12 19 16 33 Total Loans Net of Deferred Loan Fees 320,761 284,894 275,515 273,145 242,101 Less loans held for sale 7,759 740 2,343 868 3,494 Less Allowance For Loan Losses 3,820 3,395 3,386 3,388 3,103 Net Loans 309,182 280,759 269,786 268,889 235,504 The following table sets forth the maturity distribution and interest sensitivity of selected loan categories at December 31, 2003. Maturities are based upon contractual term. The total loans in this report represent loans net of deferred loan fees, including loans held for sale but excluding the allowance for loan losses. In addition, deferred loan fees on the above schedule is netted with real estate mortgage loans on the following schedule. Loan Maturities and Interest Sensitivity At December 31, 2003 (in thousands) One Year One Through Over Total or Less Five Years Five Years Loans Commercial $ 8,091 $ 4,917 $ 1,270 $ 14,278 Real Estate Construction 7,624 4,409 2,280 14,313 Real Estate Mortgage 19,074 112,254 90,960 222,288 Agricultural 16,044 35,937 4,634 56,615 Installment 3,699 7,068 2,211 12,978 Other 289 0 0 289 Total Loans 54,821 164,585 101,355 320,761 Fixed Rate Loans 19,762 134,660 40,002 194,424 Floating Rate Loans 35,059 29,925 61,353 126,337 Total 54,821 164,585 101,355 320,761 Mortgage Banking The Company has been in Mortgage Banking since the early 1980's. The activity in origination and sale of these loans fluctuates, mainly due to changes in interest rates. Rates have fallen in 2002 and 2001 and as a result, have favorably impacted our loan originations in 2002 compared to 2001. As a result of these rate changes, mortgage loan originations increased from $29 million in 2001 to $39 million in 2002, and to $43 million in 2003. The sale of loans were $37 million, $41 million and $28 million for the year 2003, 2002 and 2001, respectively. Mortgage loans held for sale increased from $740 thousand at December 31, 2002 to $7.8 million at December 31, 2003. The increase is a result of management's decision to hold about $7 million of fifteen year loans for an indefinite period. The volume of loan originations is inverse to rate changes. The rate environment in 2001 was falling, and continued into 2002 and 2003, and therefore resulted in increased loan originations in 2003 and 2002 compared to 2001. The effect of these changes was also reflected on the income statement. As a result, the gain on sale of mortgage loans was $853 thousand in 2003 compared to $948 thousand in 2002 and $383 thousand in 2001. The Bank has sold various loans to the Federal Home Loan Mortgage Corporation (FHLMC) while retaining the servicing rights. Gains and losses on loan sales are recorded at the time of the cash sale, which represents the premium or discount paid by the FHLMC. The Bank receives a servicing fee from the FHLMC on each loan sold. Servicing rights are capitalized based on the relative fair value of the rights and the expected life of the loan and are included in intangible assets on the balance sheet and expensed in proportion to, and over the period of, estimated net servicing revenues. Mortgage servicing rights were $861 thousand at December 31, 2003, $704 thousand at December 31, 2002 and $463 thousand at December 31, 2001. Amortization of mortgage servicing rights was $224 thousand, $150 thousand and $140 thousand for the years ended December 31, 2003, 2002 and 2001, respectively. See Note 4 in the notes to consolidated financial statements included as Exhibit 13 for additional information. Deposits Total deposits increased to $385 million in 2003, up $62 million from 2002. Noninterest bearing deposits increased $11.5 million, time deposits of $100 thousand and over increased $3.0 million, and other interest bearing deposits increased $47.3 million. Public funds totaled $45 million at the end of 2003 ($43 million was interest bearing). In November 2003, $53 million in deposits were obtained through the Kentucky First acquisition. For 2002, total deposits increased $14 million to $323 million. Noninterest bearing deposits increased $6 million, while time deposits of $100 thousand and over increased $5 million, and other interest bearing deposits increased $3 million. Public funds totaled $36 million at the end of 2002 ($35 million was interest bearing). Due to the downturn in the economy in 2001 and the softening loan demand, deposits have not been aggressively pursued. The table below provides information on the maturities of time deposits of $100,000 or more at December 31, 2003: Maturity of Time Deposits of $100,000 or More At December 31, 2003 (in thousands) Maturing 3 Months or Less $9,962 Maturing over 3 Months through 6 Months 7,681 Maturing over 6 Months through 12 Months 16,698 Maturing over 12 Months 15,574 Total $49,915 Borrowings The Company utilizes both long and short term borrowing. Long term borrowing is mainly from the Federal Home Loan Bank (FHLB). This borrowing is mainly used to fund longer term, fixed rate mortgages and to assist in asset/liability management. Advances are either paid monthly or at maturity. FHLB advances were $53.2 million at December 31, 2003. During 2003, $10.8 million of FHLB borrowing was paid, and advances were made for an additional $12 million. The 2001 advances were obtained mainly to fund fixed rate mortgages, as detailed above. As of December 31, 2002, $43.9 million was borrowed from FHLB, an increase of $339 thousand from 2001. In 2002, $6.6 million of FHLB advances were paid, and advances were made for an additional $6.9 million. In August 2003, the Company issued $7 million in trust preferred securities. The Company used the trust preferred proceeds mainly to assist in funding the acquisition of Kentucky First, and to supplement regulatory capital ratios. The following table depicts relevant information concerning our short term borrowings. Short Term Borrowings As of and for the year ended December 31 (in thousands) 2003 2002 2001 Federal Funds Purchased: Balance at Year end $ 5,266 $ - $ - Average Balance During the Year 249 240 6 Maximum Month End Balance 5,266 6,852 0 Year end rate 1.19% 0.00% 0.00% Average annual rate 1.46% 1.97% 5.89% Repurchase Agreements: Balance at Year end $ 1,791 $ 3,505 $ 683 Average Balance During the Year 1,691 2,097 3,303 Maximum Month End Balance 2,411 3,505 5,164 Year end rate 1.65% 0.84% 1.59% Average annual rate 1.34% 1.22% 3.35% Other Borrowed Funds: Balance at Year end $ 228 $ 1,772 $ 919 Average Balance During the Year 1,048 1,248 1,281 Maximum Month End Balance 1,777 1,883 1,768 Year end rate 0.73% 6.56% 7.24% Average annual rate 7.27% 8.16% 8.67% Contractual Obligations The Bank has required future payments for a defined benefit retirement plan, time deposits and long-term debt. See Note 13 to the consolidated financial statements for further information on the defined benefit retirement plan. The other required payments under such commitments at December 31, 2003 are as follows: Payments due by period (in thousands) Less More than 1 1-3 3-5 than 5 Contractual Obligations Total year years years years FHLB advances $ 53,232 $ 18,409 $17,865 $ 5,936 $11,022 Subordinated debentures 7,217 - - - 7,217 Time deposits 190,358 130,497 47,315 12,546 - Asset Quality With respect to asset quality, management considers three categories of assets to merit close scrutiny. These categories include: loans that are currently nonperforming, other real estate, and loans that are currently performing but which management believes require special attention. During periods of economic slowdown, the Company may experience an increase in nonperforming loans. The Company discontinues the accrual of interest on loans that become 90 days past due as to principal or interest unless reasons for delinquency are documented such as the loan being well collateralized and in the process of collection. A loan remains in a non-accrual status until factors indicating doubtful collection no longer exist. A loan is classified as a restructured loan when the interest rate is materially reduced or the term is extended beyond the original maturity date because of the inability of the borrower to service the interest payments at market rates. Other real estate is recorded at the lower of cost or fair market value less estimated costs to sell. A summary of the components of nonperforming assets, including several ratios using period-end data, is shown below. Nonperforming Assets At December 31 (dollars in thousands) 2003 2002 2001 2000 1999 Non-accrual Loans $1,844 $1,573 $ 935 $ 307 $ 63 Accruing Loans which are Contractually past due 90 days or more 779 789 1,278 1,365 549 Restructured Loans 0 0 0 130 131 Total Nonperforming Loans 2,623 2,362 2,213 1,802 743 Other Real Estate 375 172 212 165 371 Total Nonperforming Assets 2,998 2,534 2,425 1,967 1,114 Total Nonperforming Loans as a Percentage of Net Loans (including loans held for sale) (1) 0.82% 0.83% 0.80% 0.66% 0.31% Total Nonperforming Assets as a Percentage of Total Assets 0.60% 0.60% 0.61% 0.53% 0.32% Allowance to nonperforming assets 1.27 1.34 1.40 1.72 2.79 (1) Net of deferred loan fees Total nonperforming assets at December 31, 2003 were $3.0 million compared to $2.5 million at December 31, 2002 and $2.4 million at December 31, 2001. The increase from 2002 to 2003 is attributable to various loans being put on non-accrual and a $203 thousand increase in other real estate. Total nonperforming loans were $2.6 million, $2.4 million and $2.2 million at December 31, 2003, 2002 and 2001, respectively. The non-accrual loan increase from 2001 to 2002 is mainly attributable to one credit line totaling $750 thousand. A loan loss reserve of $500 thousand was set aside for this loan, and this loan was subsequently charged off in 2003. The economic downturn beginning in 2001 was a contributing factor to the increase in nonaccrual loans. The amount of lost interest on our non-accrual loans is immaterial. At December 31, 2003, loans currently performing but which management believes require special attention were not significant. The Company continues to follow its long-standing policy of not engaging in international lending and not concentrating lending activity in any one industry. Impaired loans as of December 31, 2003 were $1.8 million compared to $1.6 million in 2002 and $964 thousand in 2001. These amounts are included in the total nonperforming and restructured loans presented in the table above. See Note 4 in the notes to consolidated financial statements included as Exhibit 13. A loan is considered impaired when it is probable that all principal and interest amounts will not be collected according to the loan contract. The allowance for loan losses on impaired loans is determined using the present value of estimated future cash flows of the loan, discounted at the loan's effective interest rate or the fair value of the underlying collateral. The entire change in present value of expected cash flows is reported as a provision for loan losses in the same manner in which impairment initially was recognized or as a reduction in the amount of provision for loan losses that otherwise would be reported. The total allowance for loan losses related to these loans was $345 thousand, $675 thousand and $249 thousand on December 31, 2003, 2002 and 2001, respectively. Loan Losses The following table is a summary of the Company's loan loss experience for each of the past five years. For the Year Ended December 31 (in thousands) 2003 2002 2001 2000 1999 Balance at Beginning of Year $ 3,395 $ 3,386 $ 3,388 $ 3,103 $ 2,735 Balance of Allowance for Loan Losses of Acquired Branch at Acquisition Date 363 Amounts Charged-off: Commercial 569 536 178 14 0 Real Estate Construction 0 18 0 0 0 Real Estate Mortgage 276 69 171 115 50 Agricultural 24 5 46 30 72 Consumer 529 701 751 400 289 Total Charged-off Loans 1,398 1,329 1,146 559 411 Recoveries on Amounts Previously Charged-off: Commercial 11 15 4 14 5 Real Estate Construction 0 0 0 0 0 Real Estate Mortgage 1 19 2 7 1 Agricultural 21 10 1 8 32 Consumer 127 90 69 65 41 Total Recoveries 160 134 76 94 79 Net Charge-offs 1,238 1,195 1,070 465 332 Provision for Loan Losses 1,300 1,204 1,068 750 700 Balance at End of Year 3,820 3,395 3,386 3,388 3,103 Total Loans, Net of Deferred Loan Fees Average 290,502 281,105 273,504 257,711 221,309 At December 31 320,761 284,894 275,515 273,145 242,101 As a Percentage of Average Loans: Net Charge-offs 0.43% 0.43% 0.39% 0.18% 0.15% Provision for Loan Losses 0.45% 0.43% 0.39% 0.29% 0.32% Allowance as a Percentage of Year-end Net Loans (1) 1.19% 1.19% 1.23% 1.24% 1.28% Beginning Allowance as a Multiple of Net Charge-offs 2.7 2.8 3.2 6.7 8.2 Ending Allowance as a Multiple of Nonperforming Assets 1.27 1.34 1.40 1.72 2.79 (1) Net of deferred loan fees Loans are typically charged-off after being 120 days delinquent. Limited exceptions for not charging-off a loan would be well documented and approved by the appropriate responsible party or committee. The provision for loan losses for 2003 was $1.3 million compared to $1.2 million in 2002 and $1.1 million in 2001. Net charge-offs were $1.2 million in 2003, $1.2 million in 2002 and $1.1 million in 2001. Net charge-offs to average loans were 0.43%, 0.43% and 0.39% in 2003, 2002 and 2001, respectively. With the current quality of the loan portfolio, the loan loss provision increased $96 thousand from 2002 to 2003 and $136 thousand from 2001 to 2002. The trend in the loan loss provision increasing for 2003 is a result of considering our probable losses and risk analysis of our loan portfolio. In evaluating the allowance for loan losses, management considers the composition of the loan portfolio, historical loan loss experience, the overall quality of the loans and an assessment of current economic conditions. The economic downturn in 2003, 2002 and 2001 resulted in higher loan losses and, as a result, higher provisions than in previous years. In light of this, management has increased its emphasis on the lending process in order to improve loan quality. At December 31, 2003, the allowance for loan losses was 1.19% of loans outstanding compared to 1.19% at year-end 2002 and 1.23% in 2001. Management believes the allowance for loan losses at the end of 2003 is adequate to cover probable credit losses within the portfolio. The following tables set forth an allocation for the allowance for loan losses and loans by category and a percentage distribution of the allowance allocation. In making the allocation, management evaluates the risk in each category, current economic conditions and charge-off experience. An allocation for the allowance for loan losses is an estimate of the portion of the allowance that will be used to cover future charge-offs in each loan category, but it does not preclude any portion of the allowance allocated to one type of loan being used to absorb losses of another loan type. Allowance for Loan Losses
At December 31 (in thousands) 2003 2002 2001 2000 1999 Dollars Percentage Dollars Percentage Dollars Percentage Dollars Percentage Dollars Percentage Commercial $ 262 6.86% $ 820 24.15% $ 291 8.59% $ 275 8.12% $ 275 8.86% Real Estate Construction 266 6.96% 216 6.36% 194 5.73% 244 7.20% 294 9.47% Real Estate Mortgage 1,804 47.23% 1,166 34.34% 1,602 47.31% 1,563 46.13% 1,471 47.41% Agricultural 995 26.05% 698 20.56% 693 20.47% 668 19.72% 565 18.21% Consumer 493 12.91% 495 14.58% 606 17.90% 638 18.83% 498 16.05% Total 3,820 100.00% 3,395 100.00% 3,386 100.00% 3,388 100.00% 3,103 100.00%
Loans
At December 31 (in thousands) 2003 2002 2001 2000 1999 Dollars Percentage Dollars Percentage Dollars Percentage Dollars Percentage Dollars Percentage Commercial $ 14,278 4.45% $ 16,803 5.90% $ 18,618 6.76% $17,452 6.39% $ 17,713 7.32% Real Estate Construction 14,313 4.46% 15,514 5.45% 12,302 4.47% 15,270 5.59% 17,003 7.02% Real Estate Mortgage 222,288 69.30% 182,946 64.22% 168,665 61.22% 163,174 59.74% 138,304 57.13% Agricultural 56,615 17.65% 52,188 18.32% 53,640 19.47% 52,008 19.04% 46,443 19.18% Consumer 12,978 4.05% 17,134 6.01% 21,952 7.97% 24,807 9.08% 22,358 9.23% Other 289 0.09% 309 0.11% 338 0.12% 434 0.16% 280 0.12% Total, Net (1) 320,761 100.00% 284,894 100.00% 275,515 100.00% 273,145 100.00% 242,101 100.00% (1) Net of deferred loan fees
Off-balance Sheet Arrangements Some financial instruments, such as loan commitments, credit lines, letters of credit, and overdraft protection, are issued to meet customer financing needs. These are agreements to provide credit or to support the credit of others, as long as conditions established in the contract are met, and usually have expiration dates. Commitments may expire without being used. Off-balance sheet risk to credit loss exists up to the face amount of these instruments, although material losses are not anticipated. The same credit policies are used to make such commitments as are used for loans, including obtaining collateral at exercise of the commitment. Financial instruments with off-balance sheet risk were as follows at year-end: 2003 2002 Unused lines of credit $ 47,148,000 $ 44,943,000 Commitments to make loans 1,379,000 - Letters of credit 252,000 345,000 Unused lines of credit are substantially all at variable rates. Commitments to make loans are generally made for a period of 60 days or less and are primarily fixed at current market rates ranging from 4.875% to 6.50% with maturities ranging from 15 to 30 years and are intended to be sold. Capital As displayed by the following table, the Company's Tier I capital (as defined by the Federal Reserve Board under the Board's risk-based guidelines) at December 31, 2003 decreased $1.4 million to $40.1 million. Total stockholders' equity, excluding accumulated other comprehensive income was $51.5 million at December 31, 2003. Included in Tier I capital is $7 million of trust preferred securities issued in August 2003. The increase in the disallowed amount of stockholders' equity is mainly attributable to the goodwill and core deposit intangible, resulting from the Kentucky First acquisition (see Note 6 and Note 17 in the Notes to Consolidated Financial Statements for more information on the business combination, and goodwill and core deposit intangible assets). The Company's risk-based capital and leverage ratios, as shown in the following table, exceeded the levels required to be considered "well capitalized". The leverage ratio compares Tier I capital to total average assets less disallowed amounts of goodwill. At December 31 (dollars in thousands) 2003 2002 Change Stockholders' Equity (1) $ 51,538 $ 42,243 9,295 Less Disallowed Amount 11,423 719 10,704 Tier I Capital 40,115 41,524 (1,409) Allowance for Loan Losses 3,820 3,395 425 Other 143 122 21 Tier II Capital 3,963 3,517 446 Total Capital 44,078 45,041 (963) Total Risk Weighted Assets 316,982 290,589 26,393 Ratios: Tier I Capital to Risk-weighted Assets 12.66% 14.29% -1.63% Total Capital to Risk-weighted Assets 13.91% 15.50% -1.59% Leverage 8.82% 10.21% -1.39% (1) Excluding accumulated other comprehensive income. The Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA") established five capital categories for insured depository institutions under its Prompt Corrective Action Provisions. The bank regulatory agencies adopted regulations, which became effective in 1992, defining these five capital categories for banks they regulate. The categories vary from "well capitalized" to "critically undercapitalized". A "well capitalized" bank is defined as one with a total risk-based capital ratio of 10% or more, a Tier I risk-based capital ratio of 6% or more, a leverage ratio of 5% or more, and one not subject to any order, written agreement, capital directive, or prompt corrective action directive to meet or maintain a specific capital level. At December 31, 2003, the bank had ratios that exceeded the minimum requirements established for the "well capitalized" category. In management's opinion, there are no other known trends, events or uncertainties that will have or that are reasonably likely to have a material effect on the Company's liquidity, capital resources or operations. Securities and Federal Funds Sold Securities, including those classified as held to maturity and available for sale, increased from $89.5 million at December 31, 2002 to $129.8 million at December 31, 2003. The increase is mainly attributable to the lower loan demand and $23 million received in the acquisition of Kentucky First in November 2003. Federal funds sold totaled $6.2 million at December 31, 2003 and $18.7 million at December 31, 2002. Per Company policy, fixed rate asset backed securities will not have an average life exceeding seven years, but final maturity may be longer. Adjustable rate securities shall adjust within three years per Company policy. Of the $7.4 million of adjustable asset backed securities held on December 31, 2003, $3.3 million are repriceable monthly and the remaining $4.1 million are repriceable annually. Of the $11.3 million of adjustable asset backed securities held on December 31, 2002, $5.2 million are repriceable monthly and the remaining $6.0 million are repriceable annually. Unrealized gains (losses) on investment securities are temporary and change inversely with movements in interest rates. In addition, some prepayment risk exists on mortgage-backed securities and prepayments are likely to increase with decreases in interest rates. The following tables present the investment securities for each of the past three years and the maturity and yield characteristics of securities as of December 31, 2003. Investment Securities at market value At December 31 (in thousands) 2003 2002 2001 Available for Sale U.S. treasury $ 3,033 $ 5,059 $ 7,218 U.S. government agencies 36,634 6,138 6,118 States and political subdivisions 39,142 31,024 19,470 Mortgage-backed Fixed - GNMA, FNMA, FHLMC Passthroughs 29,079 17,465 12,672 GNMA, FNMA, FHLMC CMO's 12,940 11,682 5,057 Total 42,019 29,147 17,729 Variable - GNMA, FNMA, FHLMC Passthroughs 4,161 8,645 8,402 GNMA, FNMA, FHLMC CMO's 1,202 2,529 2,925 Total 5,363 11,174 11,327 Total mortgage-backed 47,382 40,321 29,056 Other 2,599 6,967 13,746 Total 128,790 89,509 75,608 Maturity Distribution of Securities
December 31, 2003 (in thousands) Over One Over Five Asset Year Years Backed One Year Through Through Over Ten & Equity or Less Five Years Ten Years Years Securities Total Available for Sale U.S. treasury $ - $ 3,033 $ - $ - $ - $ 3,033 U.S. government agencies 4,047 22,099 9,479 1,009 0 36,634 States and political subdivisions 2,577 7,305 11,461 17,799 0 39,142 Mortgage-backed 0 0 0 0 47,382 47,382 Equity Securities 0 0 0 0 1,535 1,535 Other 0 1,064 0 0 1,064 Total 6,624 33,501 20,940 18,808 48,917 128,790 Percent of Total 5.1% 26.0% 16.3% 14.6% 38.0% 100.0% Weighted Average Yield (1) 5.20% 4.16% 5.12% 6.75% 4.49% 4.88% (1) Tax Equivalent Yield
Impact of Inflation and Changing Prices The majority of the Company's assets and liabilities are monetary in nature. Therefore, the Company differs greatly from most commercial and industrial companies that have significant investments in nonmonetary assets and inventories. However, inflation does have an important impact on the growth of assets in the banking industry and the resulting need to increase equity capital at higher than normal rates in order to maintain an appropriate equity to assets ratio. Inflation also affects other expenses, which tend to rise during periods of inflation. Other Accounting Issues During 2003, the Company adopted FASB Statement 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities, FASB Statement 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equities, FASB Statement 132 (revised 2003), Employers' Disclosures about Pensions and Other Postretirement Benefits, FASB Interpretation 45, Guarantor's Accounting and Disclosure Requirements for Guarantees, and FASB Interpretation 46, Consolidation of Variable Interest Entities. Adoption of the new standards did not materially affect the Company's operating results or financial condition. Item 7A. Asset/Liability Management, Interest Rate Sensitivity, Market Risk and Liquidity Asset/Liability management control is designed to ensure safety and soundness, maintain liquidity and regulatory capital standards, and achieve acceptable net interest income. The Company's exposure to market risk is reviewed on a regular basis by the Asset/Liability Committee. Management considers interest rate risk to be the most significant market risk. 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. Certain assumptions, such as prepayment risks, are included in the model. However, actual prepayments may differ from those assumptions. In addition, immediate withdrawal of interest checking and other savings accounts may have an effect on the results of the 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. The projections are based on balance sheet growth assumptions and repricing opportunities for new, maturing and adjustable rate amounts. In addition, the projected percentage changes from level rates are outlined below along with the Board of Directors approved limits. As of December 31, 2003 the projected net interest income percentage change of down 300 basis points is outside the Board of Directors limits. Because of the low level of rates, an across the board drop of 300 basis points is impossible. This along with a higher likelihood of increasing rates in the future have resulted in Management believing this risk is acceptable under the current conditions. This limit variation has been reviewed with the Asset/Liability Committee and the Board of Directors. The projected net interest income report summarizing the Company's interest rate sensitivity as of December 31, 2003 and December 31, 2002 is as follows: Projected Net Interest Income (December 31, 2003)
Level -300 -100 Rates +100 +300 Year One (1/04 - 12/04) Interest Income $21,425 $24,482 $26,181 $27,883 $31,291 Interest Expense 7,484 7,856 8,991 10,127 12,396 Net Interest Income 13,941 16,626 17,190 17,756 18,895 Net interest income dollar change (3,249) (564) 566 1,705 Net interest income percentage change -18.9% -3.3% N/A 3.3% 9.9% Limitation on % Change >-10.0% >-4.0% N/A >-4.0% >-10.0%
Projected Net Interest Income (December 31, 2002)
Level -300 -100 Rates +100 +300 Year One (1/03 - 12/03) Interest Income $19,906 $22,469 $24,019 $25,576 $28,704 Interest Expense 6,528 7,382 8,317 9,243 11,107 Net Interest Income 13,378 15,087 15,702 16,333 17,597 Net interest income dollar change (2,324) (615) 631 1,895 Net interest income percentage change -14.8% -3.9% N/A 4.0% 12.1% Limitation on % Change >-10.0% >-4.0% N/A >-4.0% >-10.0%
The numbers in 2003 show lesser fluctuation when compared to 2002. In 2003, year one reflected a decrease in net interest income of 3.3% compared to 3.9% projected decrease from 2002 with a 100 basis point decline. The 300 basis point increase in rates reflected a 9.9% increase in net interest income in 2003 compared to a 12.1% increase in 2002. The risk is less in 2003 due to the current status of existing interest rates (being low) and their effect on rate sensitive assets and rate sensitive liabilities. An increase in rates would improve net interest income. Management measures the Company's interest rate risk by computing estimated changes in net interest income in the event of a range of assumed changes in market interest rates. The Company's exposure to interest rates is reviewed on a monthly basis by senior management and quarterly with the Board of Directors. Exposure to interest rate risk is measured with the use of interest rate sensitivity analysis to determine the change in net interest income in the event of hypothetical changes in interest rates, while interest rate sensitivity gap analysis is used to determine the repricing characteristics of the Company's assets and liabilities. If estimated changes to net interest income are not within the limits established by the Board, the Board may direct management to adjust the Company's asset and liability mix to bring interest rate risk within Board approved limits. 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 meet the needs of borrowers, depositors and creditors. Excess liquidity has a negative impact on earnings resulting from the lower yields on short-term assets. In addition to cash and cash equivalents, the securities portfolio provides an important source of liquidity. Total securities maturing within one year along with cash and cash equivalents totaled $28.0 million at December 31, 2003. Additionally, securities available-for- sale with maturities greater than one year totaled $122.2 million at December 31, 2003. The available for sale securities are available to meet liquidity needs on a continuing basis. The Company maintains a relatively stable base of customer deposits and its steady growth is expected to be adequate to meet its funding demands. In addition, management believes the majority of its $100,000 or more certificates of deposit are no more volatile than its core deposits. At December 31, 2003 these balances totaled $49.9 million, approximately 13.0% of total deposits. The Company also 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. We have sufficient collateral to borrow an additional $39 million from the FHLB at December 31, 2003. 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 believes there is sufficient cash flow from operations to meet investing and liquidity needs related to reasonable borrower, depositor and creditor needs in the present economic environment. The cash flow statements for the periods presented provide an indication of the Company's sources and uses of cash as well as an indication of the ability of the Company to maintain an adequate level of liquidity. A number of other techniques are used to measure the liquidity position, including the ratios presented below. These ratios are calculated based on annual averages for each year. Liquidity Ratios December 31 2003 2002 2001 Average Loans (including loans held for sale)/Average Deposits 89.6% 91.3% 91.5% Average Securities sold under agreements to repurchase and other borrowings/Average Assets 1.3% 0.9% 1.2% This chart shows that the loan to deposit ratio decreased in 2003 and 2002. The decline in 2003 compared to 2002 is mainly attributable to the Kentucky First acquisition, in which the Company acquired $31.2 million in loans and $52.9 million in deposits. Loan growth of 3% and deposit growth of 3% in 2002 have also been contributing factors to the change in this ratio over the past two years. Item 8. Financial Statements The consolidated financial statements of the Company together with the notes thereto and report of independent auditors are contained in the Company's 2003 Annual Report to Stockholders included as Exhibit 13, and are incorporated herein by reference. No other portion of the 2003 Annual Report to Stockholders is to be deemed "filed" as part of this filing. Item 9. Changes In and Disagreements with Accountants on Accounting and Financial Disclosure None Item 9A. Controls and Procedures The Company's management, with participation of the Company's Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Company's disclosure controls and procedures as of December 31, 2003. Based on the evaluation, the Company's Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures were effective as of December 31, 2003. There was no change in the Company's internal control over financial reporting during the fourth quarter of 2003 that has materially affected, or is reasonably likely to materially affect, such internal control over financial reporting. PART III Item 10. Directors and Executive Officers of the Registrant Under the Company's Articles of Incorporation, the Board of Directors consists of three different classes, each to serve, subject to the provisions of the Articles of Incorporation and Bylaws, for a three year term and until his successor is duly elected and qualified. The names of the directors and their terms are set forth below. Terms expiring in 2004: William Arvin, age 63, is an attorney. He has been a director of Kentucky Bank and the Company since 1995. James L. Ferrell, M.D., age 69, is a Physician. He has been a director of Kentucky Bank since 1980 and the Company since inception. Louis Prichard, age 50, is President and Chief Operating Officer of Kentucky Bank. He has been a director of Kentucky Bank and the Company since 2003. Since 1983, he was in banking in Danville and was the President and Chief Executive Officer before joining the Company in 2003. Terms expiring in 2005: Henry Hinkle, age 52, is President of Hinkle Construction Company. He has been a director of Kentucky Bank and the Company since 1989. Theodore Kuster, age 60, is a farmer and thoroughbred horse breeder. He has been a director of Kentucky Bank since 1979 and the Company since 1985. Robert G. Thompson, age 54, is a farmer and thoroughbred horse breeder. He has been a director of Kentucky Bank and the Company since 1991. Terms expiring in 2006: Betty J. Long, age 56, is retired President and CEO of First Federal, Cynthiana. She has been a director of the Company since 2003. Ted McClain, age 52, is an insurance agent with Hopewell Insurance Company. He has been a director of Kentucky Bank since 2002 and the Company since 2003. William R. Stamler, age 69, is Chairman of Signal Investments, Inc. He has been a director of Kentucky Bank since 1984 and the Company since 1988. Buckner Woodford, age 59, is President and Chief Executive Officer of Kentucky Bancshares, Inc. and Chief Executive Officer of Kentucky Bank. He has been a director of Kentucky Bank since 1971 and the Company since inception. The Company's other executive officers are Norman J. Fryman, age 54 and Gregory J. Dawson, age 43. Mr. Fryman is the Director of Lending of Kentucky Bank (disclosed in Item 11) and has been with the Company since 1977. Mr. Dawson is the Chief Financial Officer and has been with the Company since 1985 and serves at the pleasure of the Board of Directors. The Company has adopted a code of ethics for its Chief Executive Officer and its Chief Financial Officer. A copy of the code of ethics may be obtained by contacting the CFO. The Company has named Betty J. Long of the audit committee as its financial expert and she is independent as that term is used in Item 7(d)(3)(iv) of Schedule 14A under the Securities Exchange Act of 1934. Item 11. Executive Compensation The following table sets forth information with respect to the compensation of the Chief Executive Officer (Buckner Woodford), President (Louis Prichard) and Director of Lending (Joe Fryman) of the Company. No other executive officer earned total salary and bonus in excess of $100,000. Summary Compensation Table Annual Compensation Other Annual Options Name Salary Bonus Compensation Granted 2003 Buckner Woodford $200,000 $ 24,000 (1) 1,000 Louis Prichard 125,000 11,700 (1) 3,000 Norman J. Fryman 97,057 8,371 (1) 500 2002 Buckner Woodford $180,008 $ 39,825 (1) 500 2001 Buckner Woodford $175,000 $ 19,250 (1) 500 (1) Less than the lesser of $50,000 or 10% of annual salary and bonuses The following table contains information regarding the grant of stock options under the Company's stock option plan to the Chief Executive Officer, President and Director of Lending during the year ended December 31, 2003. In addition, in accordance with rules of the Securities and Exchange Commission, the following table sets forth the hypothetical grant date present value with respect to the referenced options, using the Black-Scholes Option Pricing Model. Option Grants in the Last Fiscal Year % of Total Options Grant Shares Granted to Exercise Date Granted Employees Price Expiration Present Name (#) in 2003 ($/Sh) Date Value($) Buckner Woodford 1,000 7.6% $25.50 1/2/13 $1,215 Louis Prichard 3,000 22.7 25.50 1/2/13 3,210 Norman J. Fryman 500 3.8 25.50 1/2/13 535 The following table sets forth certain information regarding options exercised by the Chief Executive Officer, President and Director of Lending during calendar year 2003 and unexercised stock options held by them as of December 31, 2003.
Aggregated Option Exercises in Calendar 2003 and Year-end Stock Option Values Shares Number of Securities Value of Unexercised Acquired Value Underlying Unexercised In-the-Money on Exercise Realized Options at 12/31/03 Options at 12/31/03 Name (#) ($) Exercisable/Unexercisable Exercisable/Unexercisable Buckner Woodford 17,000 $377,800 3,480/1,620 $ 44,072/$17,818 Louis Prichard n/a n/a n/a /3,000 n/a / 25,200 Norman J. Fryman n/a n/a 760/1,040 10,864/ 9,156 No SAR's exist for the Company.
Compensation of Directors Each director of the Company is a director of Kentucky Bank, except for Betty J. Long. Company Directors are paid $400 for each Company and Kentucky Bank board meeting attended and non-employee Company directors are paid $100 for each Kentucky Bank committee meeting attended. Non- employee Directors of Kentucky Bank are also granted a 10-year option to purchase 100 shares of the Company's common stock following each year in which Kentucky Bank has a return on assets of 1 percent or greater. The option's exercise price is the fair market value per share on the date of grant. Pension Plan The following table sets forth the annual benefits which an eligible employee would receive under the Company's qualified defined benefit pension plan based on remuneration that is covered under the plan and years of service with the Company and its subsidiaries. Years of Service Remuneration 15 20 25 30 35 $ 25,000 $ 3,750 $ 5,000 $ 6,250 $ 7,500 $ 8,750 50,000 7,500 10,000 12,500 15,000 17,500 75,000 11,250 15,000 18,750 22,500 26,250 100,000 15,000 20,000 25,000 30,000 35,000 125,000 18,750 25,000 31,250 37,500 43,750 150,000 22,500 30,000 37,500 45,000 52,500 175,000 26,250 35,000 43,750 52,500 61,250 200,000 30,000 40,000 50,000 60,000 70,000 225,000 33,750 45,000 56,250 67,500 78,750 In general, a participant's remuneration covered by the Company's pension plan is his or her average annual cash compensation (W-2 earnings) for the last 5 years. The years of service are 31 years for Mr. Woodford, 1 year for Mr. Prichard and 18 years for Mr. Fryman. Item 12. Security Ownership of Certain Beneficial Owners and Management Set forth below are the number of shares of the Company's common stock beneficially owned by each director and executive officer, and all current directors and executive officers as a group as of December 31, 2003. Name Shares Beneficially Owned(1) Number Percentage William Arvin (2) 29,971 1.1% Gregory J. Dawson (3) 9,085 * James L. Ferrell, M.D. (4) 28,250 * Norman J. Fryman (5) 3,780 * Henry Hinkle (6) 28,055 * Theodore Kuster (7) 17,855 * Betty J. Long - * Ted McClain 815 * Louis Prichard 310 * William R. Stamler (8) 31,470 1.1% Robert G. Thompson (9) 5,950 * Buckner Woodford (10) 249,548 8.8% All directors and officers (12 persons) as a group (consisting of those persons named above)(11) 405,089 14.3% * Less than 1% 1) Beneficial ownership as reported in the above table has been determined in accordance with Rule 13d-3 under the Exchange Act. Unless otherwise indicated, beneficial ownership includes both sole or shared voting and sole or shared investment power. 2) Includes 11,858 shares held in a retirement account, 11,968 shares held of record by Mr. Arvin's wife, as to which Mr. Arvin disclaims beneficial ownership, 5,465 held jointly with his wife and 550 shares that Mr. Arvin may acquire upon exercise of outstanding stock options. 3) Includes 3,060 shares that Mr. Dawson may acquire upon exercise of outstanding stock options. 4) Includes 4,000 shares held in a retirement account and 750 shares that Dr. Ferrell may acquire upon exercise of outstanding stock options. Also, includes 3,000 shares held by Dr. Ferrell's wife, as to which Dr. Ferrell disclaims beneficial ownership. 5) Includes 760 shares that Mr. Fryman may acquire upon exercise of outstanding stock options. 6) Includes 1,000 shares held by his wife and 640 shares held by three sons, as to which Mr. Hinkle disclaims beneficial ownership. Includes 24,000 shares held of record by Hinkle Contracting Company, as to which Mr. Hinkle, as president, has shared voting power. Also includes 750 shares that Mr. Hinkle may acquire upon exercise of outstanding stock options. 7) Includes 6,260 share held of record by Mr. Kuster's wife, as to which Mr. Kuster disclaims beneficial ownership. Also includes 5,500 shares held in a retirement account and 250 shares that Mr. Kuster may acquire upon exercise of outstanding stock options. 8) Includes 7,860 shares held by Signal Investments Corporation, as to which Mr. Stamler, as the chief executive officer and majority stockholder of such corporation, has sole voting and investment power. Also includes 250 shares that Mr. Stamler may acquire upon exercise of outstanding stock options. 9) Includes 750 shares that Mr. Thompson may acquire upon exercise of outstanding stock options. 10) Includes 8,000 shares held by his wife, as to which Mr. Woodford disclaims beneficial ownership. Also includes 208 shares held in a retirement account and 3,480 shares that Mr. Woodford may acquire upon exercise of outstanding stock options. 11) Includes 10,600 shares that may be acquired upon exercise of outstanding stock options. The following table sets forth as of December 31, 2003 the only person known by the Company to own beneficially (as determined in accordance with the rules and regulations of the Commission) more than 5% of the outstanding common stock. See note 10 in the preceding table for further information. Name and Address Shares Beneficially of Beneficial Owner Owned Percentage Buckner Woodford 249,548 8.8% 340 Stoner Avenue Paris, Kentucky 40361 The following table sets forth as of December 31, 2003 the Company's common stock authorized for issuance under equity compensation plans. The Company's shareholders have approved all of the Company's equity compensation plans.
Number of Securities Number of Securities remaining available for To be issued Weighted average future issuance under Upon exercise of exercise price of equity compensation plans Outstanding options, outstanding options, (excluding securities Plan category warrants and rights warrants and rights reflected in column (a) Equity compensation plans Approved by security holders: Employee Gift Program 0 $ n/a 736 1993 Employee Stock Ownership Incentive Plan 32,126 16.97 0 1993 Non-Employee Directors Stock Ownership Plan 5,450 21.37 11,650 1999 Employee Stock Option Plan 19,984 25.18 79,448 Total 57,560 $16.72 91,834
Item 13. Certain Relationships and Related Transactions Directors and officers of the Company and their associates were customers of and had transactions with the Company's subsidiary bank in the ordinary course of business during the year ended December 31, 2003. Similar transactions may be expected to take place with the Company's subsidiary bank in the future. Outstanding loans and commitments made by such subsidiary bank in transactions with the Company's directors and officers and their associates were made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other persons and did not involve more than a normal risk of collectibility or present other unfavorable features. Certain directors and executive officers were loan customers of Kentucky Bank and outstanding loans were $2.5 million as of December 31, 2003 and $1.6 million as of December 31, 2002. See Note 4 in the notes to consolidated financial statements included as Exhibit 13. The Company purchased various types of insurance amounting to $220 thousand in 2003 from Hopewell Insurance Company. Director Ted McClain owns 33% of this company and is one of their insurance agents. Item 14. Principal Accountant Fees and Services The Audit Committee has pre-approved that management of the Company may consult with the primary independent auditor concerning certain additional services outside of the audit work that was specifically approved in the engagement letter for those services. Included were services such as: 1. Discussions related to accounting for mergers and acquisitions, 2. Tax return preparation 3. Discussions concerning loan review, 4. Discussions regarding regulatory requirements, 5. Data processing and retirement plan audits, and 6. Profit enhancement and other consulting. The fees for services provided by the primary independent auditor, Crowe Chizek for 2003 and for 2002 were as follows: Audit fees - Fees for the financial statement audit, and the review of the Company's Form 10-Q's were $65,600 for 2003 and $63,200 for 2002. Audit related fees - Aggregate fees for all assurance and related services were $10,500 for 2003 and $10,500 for 2002. These fees were incurred for audits of benefit plans. The 2003 amounts were preapproved by the audit committee. Tax fees - Fees related to tax compliance, advice and planning were $6,400 for 2003 and $6,400 for 2002. The 2003 amounts were preapproved by the audit committee. All other fees - Consulting fees related to acquisitions and profitability were $17,095 for 2003 and $5,005 for 2002. Loan review fees were $23,800 for 2003 and $23,600 for 2002. The 2003 amounts were preapproved by the audit committee. All services provided by the Corporation's primary independent auditor in 2003 and 2002 were approved by the Audit Committee. Part IV Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K (a) The following exhibits are incorporated by reference herein or made a part of this Form 10-K: 3.1 Articles of Incorporation of the Registrant are incorporated by reference to Exhibit 3.1 of the Registrant's Quarterly Report on Form 10-Q for the quarterly period ending March 31, 2000 (File No. 33-96358). 3.2 Bylaws of the Registrant are incorporated by reference to Exhibit 3.1 of the Registrant's Quarterly Report on Form 10-Q for the quarterly period ending June 30, 2000 (File No. 33-96358). 10.1 Kentucky Bancshares, Inc. 1993 Employee Stock Ownership Incentive Plan is incorporated by reference to Exhibit 10.2 of the Registrant's Registration Statement on Form S-4 (File No. 33-96358).* 10.2 Kentucky Bancshares, Inc. 1993 Non-Employee Directors Stock Ownership Incentive Plan is incorporated by reference to Exhibit 10.3 of the Registrant's Registration Statement on Form S-4 (File No. 33-96358).* 10.3 Kentucky Bancshares, Inc. 1999 Employee Stock Option Plan is incorporated by reference to Exhibit 99.1 of the Registrant's Form 10-K for the fiscal year ended December 31, 1998.* 11 Computation of earnings per share - See Note 12 in the notes to consolidated financial statements included as Exhibit 13. 13 Financial Statements: Consolidated Balance Sheets Consolidated Statements of Income Consolidated Statements of Comprehensive Income Consolidated Statements of Changes in Stockholders' Equity Consolidated Statements of Cash Flows Notes to Consolidated Financial Statements Report of Independent Auditors 21 Subsidiaries of Registrant 23 Consent of Crowe Chizek and Company LLC 31.1 Certification of Chief Executive Officer pursuant to Rule 13a- 14(a) and Rule 15d-14(a) of the Securities Exchange Act, as amended. 31.2 Certification of Chief Financial Officer pursuant to Rule 13a- 14(a) and Rule 15d-14(a) of the Securities Exchange Act, as amended. 32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.2 Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. * Denotes a management contract or compensatory plan or arrangement of the Registrant required to be filed as an exhibit pursuant to Item 601(10) (iii) of Regulation S-K. (b) Current Reports on Form 8-K during the quarter ended December 31, 2003 The Company filed a Form 8-K dated October 16, 2003, Item 7 and Item 12 to report the issuance of a press release announcing its operating results for the nine-month period ended September 30, 2003. The Company filed a Form 8-K dated October 24, 2003, Item 5 announcing shareholder approval from Kentucky First Bancorp, Inc. of the Agreement and Plan of Merger. The Company filed a Form 8-K dated November 12, 2003, Item 5 announcing the closing of the merger with Kentucky First Bancorp, Inc. SIGNATURES Pursuant to the requirements of Section 13 or 15(d) 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. By: __/s/Buckner Woodford__ Buckner Woodford, President and Chief Executive Officer, Director March 30, 2004 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. __/s/Buckner Woodford _______ March 30, 2004 Buckner Woodford, President and Chief Executive Officer, Director __/s/Gregory J. Dawson_______ March 30, 2004 Gregory J. Dawson, Chief Financial and Accounting Officer __/s/James L. Ferrell________ March 30, 2004 James L. Ferrell, M.D., Chairman of the Board, Director _____________________________ March 30, 2004 William Arvin, Director __ __ ____ March 30, 2004 Henry Hinkle, Director _____________________________ March 30, 2004 Theodore Kuster, Director __/s/Betty J. Long___________ March 29, 2004 Betty J. Long, Director __/s/Ted McClain____________ March 30, 2004 Ted McClain, Director __/s/Louis Prichard__________ March 30, 2004 Louis Prichard, Director _____________________________ March 30, 2004 William R. Stamler, Director __/s/Robert G. Thompson______ March 30, 2004 Robert G. Thompson, Director SUPPLEMENTAL INFORMATION TO BE FURNISHED WITH REPORTS FILED PURSUANT TO SECTION 15(d) OF THE ACT BY REGISTRANTS WHICH HAVE NOT REGISTERED SECURITIES PURSUANT TO SECTION 12 OF THE ACT. The Registrant refers to Exhibit 13 to the Form 10-K. INDEX TO EXHIBITS Exhibit Number Description of Document 3.1 Articles of Incorporation of the Registrant are incorporated by reference to Exhibit 3.1 of the Registrant's Quarterly Report on Form 10-Q for the quarterly period ending March 31, 2000 (File No. 33-96358). 3.2 Bylaws of the Registrant are incorporated by reference to Exhibit 3.1 of the Registrant's Quarterly Report on Form 10- Q for the quarterly period ending June 30, 2000 (File No. 33-96358). 10.1 Kentucky Bancshares, Inc. 1993 Employee Stock Ownership Incentive Plan is incorporated by reference to Exhibit 10.2 of the Registrant's Registration Statement on Form S-4 (File No. 33-96358).* 10.2 Kentucky Bancshares, Inc. 1993 Non-Employee Directors Stock Ownership Incentive Plan is incorporated by reference to Exhibit 10.3 of the Registrant's Registration Statement on Form S-4 (File No. 33-96358).* 10.3 Kentucky Bancshares, Inc. 1999 Employee Stock Option Plan is incorporated by reference to Exhibit 99.1 of the Registrant's Form 10-K for the fiscal year ended December 31, 1998.* 11 Computation of earnings per share - See Note 10 in the notes to consolidated financial statements included as Exhibit 13. 13 Kentucky Bancshares, Inc. 2003 Annual Report 21 Subsidiaries of Registrant 23 Consent of Crowe Chizek and Company LLC 31.1 Certification of Chief Executive Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, as amended. 31.2 Certification of Chief Financial Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, as amended. 32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.2 Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. * Denotes a management contract or compensatory plan or arrangement of the Registrant required to be filed as an exhibit pursuant to Item 601(10) (iii) of Regulation S-K. 6 22 BOURBON BANCSHARES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2000, 1999 and 1998 44 40