-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, TQl3RMLXdpJAJ7O4C4LAuo0sMP3k8ZC+SjuJd0c1O10c4ojMYb1gI6bSgLI2SzmQ gW8kbrMbEbt5FU2kTqnRBA== 0001000232-05-000004.txt : 20050331 0001000232-05-000004.hdr.sgml : 20050331 20050331123023 ACCESSION NUMBER: 0001000232-05-000004 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 9 CONFORMED PERIOD OF REPORT: 20041231 FILED AS OF DATE: 20050331 DATE AS OF CHANGE: 20050331 FILER: COMPANY DATA: COMPANY CONFORMED NAME: KENTUCKY BANCSHARES INC /KY/ CENTRAL INDEX KEY: 0001000232 STANDARD INDUSTRIAL CLASSIFICATION: STATE COMMERCIAL BANKS [6022] IRS NUMBER: 610993464 FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 033-96358 FILM NUMBER: 05717937 BUSINESS ADDRESS: STREET 1: 4TH & MAIN ST STREET 2: P O BOX 157 CITY: PARIS STATE: KY ZIP: 40362-0157 BUSINESS PHONE: 859-987-1795 MAIL ADDRESS: STREET 1: 4TH & MAIN ST STREET 2: PO BOX 157 CITY: PARIS STATE: KY ZIP: 40362-0157 FORMER COMPANY: FORMER CONFORMED NAME: BOURBON BANCSHARES INC /KY/ DATE OF NAME CHANGE: 19950907 10-K 1 k2004.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, 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 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, 2004 was approximately $74.2 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 29, 2005: 2,683,178. 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. Some of the Company's competitors are not subject to the same degree of regulatory review and restrictions that apply to the Company and its subsidiary bank. In addition, the Company must compete with much larger financial institutions that have greater financial resources than the Company. 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 Office 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. 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. In addition to the laws and regulations discussed above, Kentucky Bank is also subject to certain consumer laws and regulations that are designed to protect consumers in transactions with banks. While the list set forth herein is not exhaustive, these laws and regulations include the Truth in Lending Act, the Truth in Savings Act, the Electronic Funds Transfer Act, the Expedited Funds Availability Act, the Equal Credit Opportunity Act, the Real Estate Settlement Procedures Act, the Fair Housing Act and the Fair and Accurate Transactions Act, among others. These laws and regulations mandate certain disclosure requirements and regulate the manner in which financial institutions must deal with clients when taking deposits or making loans. These laws also limit Kentucky Bank's ability to share information with affiliated and unaffiliated entities. The bank must comply with the applicable provisions of these consumer protection laws and regulations as part of its ongoing business operations. 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. Dividends paid by the subsidiary bank have provided substantially all of the Company's operating funds, and this may reasonably be expected to continue for the foreseeable future. Employees At December 31, 2004, the number of full time equivalent employees of the Company was 167. 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 closing sales prices of the Common Stock from the OTC Bulleting Board and the dividends declared thereon, for the periods indicated below: High Low Dividend 2004 Quarter 4 $32.50 $30.50 $.21 Quarter 3 33.00 31.00 .21 Quarter 2 34.00 31.00 .21 Quarter 1 34.77 31.79 .21 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 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, 2004 the Company had 2,684,498 shares of Common Stock outstanding and approximately 482 holders of record of its Common Stock. 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. In August 2004, the Board of Directors approved and the Company repurchased 122,302 shares from a third-party shareholder at a price of $28 per share. These shares were outside of the previously mentioned stock repurchase programs. Shares will be purchased from time to time in the open market depending on market prices and other considerations. Through December 31, 2004, 84,333 shares have been purchased, with the most recent share repurchase under the Board-approved stock repurchase program having occurred on February 5, 2003. 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) 2004 2003 2002 2001 2000 CONDENSED STATEMENT OF INCOME: Total Interest Income $25,846 $22,329 $24,788 $28,046 $28,207 Total Interest Expense 9,067 7,875 9,367 13,386 13,597 Net Interest Income 16,779 14,454 15,421 14,660 14,610 Provision for Losses 840 1,300 1,204 1,068 750 Net Interest Income After Provision for Losses 15,939 13,154 14,217 13,592 13,860 Noninterest Income 6,796 6,707 6,590 5,672 3,798 Noninterest Expense 14,755 14,171 12,433 11,756 10,374 Income Before Income Tax Expense 7,980 5,690 8,374 7,508 7,284 Income Tax Expense 2,218 1,457 2,471 1,984 2,031 Net Income 5,762 4,233 5,903 5,524 5,253 SHARE DATA: Basic Earnings per Share (EPS) $2.09 $1.52 $2.13 $1.98 $1.87 Diluted EPS 2.07 1.50 2.10 1.95 1.83 Cash Dividends Declared 0.84 0.76 0.68 0.60 0.52 Book Value 16.77 16.90 15.90 14.13 12.77 Average Common Shares-Basic 2,757 2,781 2,770 2,790 2,812 Average Common Shares-Diluted 2,777 2,827 2,806 2,837 2,868 SELECTED BALANCE SHEET DATA: Loans, including loans held for sale $354,294 $316,941 $281,499 $272,129 $269,757 Investment Securities 126,767 128,790 89,509 75,608 68,054 Total Assets 528,544 500,852 419,771 397,257 371,847 Deposits 387,955 384,599 322,836 308,915 300,816 Securities sold under agreements to repurchase and other borrowings 25,593 7,285 5,277 1,602 9,446 Federal Home Loan Bank advances 59,750 53,232 43,937 43,598 21,644 Stockholders' Equity 45,027 46,057 44,092 39,100 35,860 PERFORMANCE RATIOS: (Average Balances) Return on Assets 1.11% 1.00% 1.48% 1.46% 1.49% Return on Stockholders' Equity 12.57% 9.31% 14.27% 14.60% 15.63% Net Interest Margin (1) 3.60% 3.79% 4.23% 4.22% 4.47% Equity to Assets (annual average) 8.82% 10.73% 10.36% 9.99% 9.51% SELECTED STATISTICAL DATA: Dividend Payout Ratio 39.97% 50.00% 31.94% 30.28% 27.84% Number of Employees (at period end) 167 182 173 180 159 ALLOWANCE COVERAGE RATIOS: Allowance to Total Loans 1.16% 1.19% 1.19% 1.24% 1.24% Net Charge-offs as a Percentage of Average Loans 0.15% 0.43% 0.43% 0.39% 0.18% (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 2004 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 loans and the allowance for loan losses. Different assumptions in the application of these policies could result in material changes in the consolidated financial position or consolidated results of operations. 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. The accounting policies relating to the allowance for loan losses involve the use of estimates and require significant judgments to be made by management. 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, regulation and monetary policy (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, 2004 was $5.8 million, or $2.09 per common share compared to $4.2 million, or $1.52 for 2003 and $5.9 million, or $2.13 for 2002. Earnings per share assuming dilution were $2.07, $1.50 and $2.10 for 2004, 2003 and 2002, respectively. For 2004, net income increased $1.5 million, or 36%. Net interest income increased $2.3 million, the loan loss provision decreased $460 thousand, other income increased $89 thousand, while other expenses increased $584 thousand. Management implemented various revenue improvement and cost controlling measures with the continuing expectation of improving net income. 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. Return on average equity was 12.6% in 2004 compared to 9.3% in 2003 and 14.3% in 2002. Return on average assets was 1.11% in 2004 compared to 1.00% in 2003 and 1.48% in 2002. Non-performing loans as of a percentage of loans (including held for sale) were 0.58%, 0.82% and 0.83% as of December 31, 2004, 2003 and 2002, respectively. RESULTS OF OPERATIONS Net Interest Income Net interest income, the Company's largest source of revenue, on a tax equivalent basis decreased from $15.9 million in 2002 to $15.1 million in 2003 but increased to $17.4 million in 2004. 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 2003 to 2004. Average earning assets increased $87 million, or 22%. Investment securities increased $43 million primarily due to the addition of $30 million leverage transactions, including $20 million of securities purchased and funded by repurchase agreements. Loans increased $48 million as a result of improved loan demand and the Cynthiana acquisition in November 2003. Average interest bearing liabilities increased $86 million, or 27% during this same period. The Company continues to actively pursue quality loans and fund these primarily with deposits and FHLB advances. During the second half of 2004 rates started increasing. Bank prime rates increased 125 basis points during this period. However, the declining rate environment commencing in 2001 resulted in a decrease in yields on assets and liabilities in 2002, 2003 and 2004 due to sustained repricing opportunities. As a result of this, the tax equivalent yield on earning assets decreased from 5.77% in 2003 to 5.47% in 2004. The volume rate analysis that follows, during 2004, indicates that $4.5 million of the increase in interest income is attributable to the change in volume, while the lower level of rates contributed to a decrease of $995 thousand in interest income. This low level of rates also caused a decrease in the cost of interest bearing liabilities. The average rate of these liabilities decreased from 2.49% in 2003 to 2.25% in 2004. In addition, the change in volume contributed to an increase of $2.3 million in interest expense, while the low level of rates was responsible for a $1.1 million decrease in interest expense. As a result, the 2004 net interest income increase is primarily attributed to increases in volume. The volume rate analysis for 2003 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 increasing rate environment beginning in 2004 and continuing in 2005, competitive pressures on interest rates will continue and are likely to result in tighter net interest margins. 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 2004 and 2003. Changes in interest income and expenses due to both rate and volume are allocated on a pro rata basis.
2004 vs. 2003 2003 vs. 2002 Increase (Decrease) Due to Change in Increase (Decrease) Due to Change in Volume Rate Net Change Volume Rate Net Change INTEREST INCOME Loans $ 2,942 $ (1,047) $ 1,895 $ 3,065 $ (5,122) $ (2,057) Investment Securities 1,626 24 1,650 440 (791) (351) Federal Funds Sold and Securities Purchased under Agreements to Resell (61) 27 (34) 30 (33) (3) Deposits with Banks 5 1 6 17 (65) (48) Total Interest Income 4,512 (995) 3,517 3,552 (6,011) (2,459) INTEREST EXPENSE Deposits Demand 88 54 142 42 (602) (560) Savings 38 0 38 20 (92) (72) Negotiable Certificates of Deposit and Other Time Deposits 776 (501) 275 122 (1,157) (1,035) Securities sold under agreements to repurchase and other borrowings 780 (147) 633 80 59 139 Federal Home Loan Bank advances 575 (472) 103 135 (99) 36 Total Interest Expense 2,257 (1,066) 1,191 399 (1,891) (1,492) Net Interest Income $ 2,255 $ 71 $ 2,326 $ 3,153 $ (4,120) $ (967)
Average Consolidated Balance Sheets and Net Interest Analysis (dollars in thousands) 2004 2003 2002 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 97,486 3,510 3.60% 56,559 1,907 3.37% 47,090 2,241 4.76% State and Municipal obligations 35,762 1,518 4.24% 32,702 1,431 4.38% 26,476 1,254 4.74% Other Securities 7,035 271 3.85% 7,971 311 3.90% 13,364 505 3.78% Total Securities Available for Sale 140,283 5,299 3.78% 97,232 3,649 3.75% 86,930 4,000 4.60% Total Investment Securities 140,283 5,299 3.78% 97,232 3,649 3.75% 86,930 4,000 4.60% Tax Equivalent Adjustment 638 0.45% 611 0.63% 516 0.59% Tax Equivalent Total 5,937 4.23% 4,260 4.38% 4,516 5.19% Federal Funds Sold and Agreements to Repurchase 4,620 67 1.45% 9,307 101 1.09% 6,912 104 1.50% Interest-Bearing Deposits with Banks 827 10 1.21% 441 4 0.91% 1,620 52 3.21% Loans, Net of Deferred Loan Fees (2) Commercial 28,874 1,564 5.42% 26,871 1,522 5.66% 31,952 2,016 6.31% Real Estate Mortgage 299,062 17,989 6.02% 249,924 15,779 6.31% 230,455 16,788 7.28% Installment 10,529 917 8.71% 13,707 1,274 9.29% 18,698 1,828 9.78% Total Loans 338,465 20,470 6.05% 290,502 18,575 6.39% 281,105 20,632 7.34% Total Interest-Earning Assets 484,195 26,484 5.47% 397,482 22,940 5.77% 376,567 25,304 6.72% Allowance for Loan Losses (4,090) (3,324) (3,555) Cash and Due From Banks 10,642 9,252 9,312 Premises and Equipment 11,787 10,840 10,270 Other Assets 17,494 9,713 6,654 Total Assets 520,028 423,963 399,248 LIABILITIES Interest-Bearing Deposits Negotiable Order of Withdrawal ("NOW") and Money Market Investment Accounts 97,267 784 0.81% 86,039 642 0.75% 83,025 1,202 1.45% Savings 27,547 124 0.45% 19,213 86 0.45% 16,853 158 0.94% Certificates of Deposit and Other Deposits 189,739 4,858 2.56% 160,651 4,583 2.85% 157,167 5,618 3.57% Total Interest-Bearing Deposits 314,553 5,766 1.83% 265,903 5,311 2.00% 257,045 6,978 2.71% Securities sold under agreements to repurchase and other borrowings 29,664 905 3.05% 5,385 272 5.05% 3,585 132 3.68% Federal Home Loan Bank advances 58,421 2,396 4.10% 45,561 2,293 5.03% 42,923 2,257 5.26% Total Interest-Bearing Liabilities 402,638 9,067 2.25% 316,849 7,876 2.49% 303,553 9,367 3.09% Noninterest-Bearing Earning Demand Deposits 68,730 58,263 50,782 Other Liabilities 2,814 3,371 3,539 Total Liabilities 474,182 378,483 357,874 STOCKHOLDERS' EQUITY 45,846 45,480 41,374 Total Liabilities and Shareholders' Equity 520,028 423,963 399,248 Average Equity to Average Total Assets 8.82% 10.73% 10.36% Net Interest Income 16,779 14,453 15,421 Net Interest Income (tax equivalent) (3) 17,417 15,064 15,937 Net Interest Spread (tax equivalent) (3) 3.22% 3.28% 3.63% Net Interest Margin (tax equivalent) (3) 3.60% 3.79% 4.23% (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 $6.8 million in 2004 compared to $6.7 million in 2003 and $6.6 million in 2002. The 2004 and 2003 increase is mainly a result of increased service charges. Securities gains were $289 thousand in 2004, $139 thousand in 2003 and $219 thousand in 2002. The gains in 2004 were primarily as result of the Company taking advantage of the inverse relationship of interest rates and market values, 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 $376 thousand, $853 thousand and $948 thousand in 2004, 2003 and 2002, respectively. Loans held for sale are generally sold after closing to the Federal Home Loan Mortgage Corporation. During 2004, the loan service fee income increased $4 thousand, compared to an increase of $14 thousand in 2003. The sales of loans were $30 million, $37 million and $41 million in 2004, 2003 and 2002, respectively. The volume of loan originations is inverse to rate changes. The low rate environment during 2003 and 2002 favorably impacted our mortgage loan originations. The volume of loan originations during 2004 decreased to $22 million from $43 million in 2003. Other noninterest income excluding security net gains and gain on sale of mortgage loans was $6.1 million in 2004, $5.7 million in 2003 and $5.4 million in 2002. Service charge income has been a big contributor to this increase in income over this three-year period. Overdraft income increased $336 thousand in 2004 and $195 thousand in 2003, 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 $1.0 million in 2002 to $1.1 million in 2003 to $1.2 million in 2004. Noninterest expense increased $584 thousand in 2004 to $14.8 million, and increased $1.8 million in 2003 to $14.2 million from $12.4 million in 2002. The increases in salaries and benefits from $6.7 million in 2002 to $7.4 million in 2003 and to $8.1 million in 2004 are attributable to normal salary and benefit increases. Bonus compensation was $108 thousand higher in 2004 compared to 2003 and $191 thousand lower in 2003 compared to 2002. The 2004 increase is mainly a result of improved net income, while the 2003 decrease is mainly a result of lower net income. Occupancy expense increased $211 thousand, or 10% in 2004 to $2.3 million and increased $136 thousand, or 7% in 2003 to $2.0 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, declined slightly from $990 thousand in 2002, to $961 thousand in 2003 and increased to $994 thousand in 2004. Other noninterest expense increased from $3.8 million in 2002 to $4.8 million in 2003 and decreased to $4.4 million in 2004. The increase in 2003 and subsequent decrease in 2004 is mainly from the legal and professional expenses in 2003 related to the merger. Of the 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) 2004 2003 2002 NON-INTEREST INCOME Service Charges $ 4,358 $ 4,065 $ 3,848 Loan Service Fee Income 246 242 228 Trust Department Income 299 302 346 Investment Securities Gains (Losses),net 289 139 219 Gains on Sale of Mortgage Loans 376 853 948 Other 1,228 1,106 1,001 Total Non-interest Income 6,796 6,707 6,590 NON-INTEREST EXPENSE Salaries and Employee Benefits 8,053 7,373 6,728 Occupancy Expenses 2,255 2,045 1,909 Other 4,447 4,753 3,796 Total Non-interest Expense 14,755 14,171 12,433 Net Non-interest Expense as a Percentage of Average Assets 1.53% 1.76% 1.46% Income Taxes The Company had income tax expense of $2.2 million in 2004 and $1.5 million in 2003 and $2.5 million in 2002. This represents an effective income tax rate of 27.8% in 2004, 25.6% in 2003 and 29.5% in 2002. 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 $501 million at December 31, 2003 to $529 million at December 31, 2004. Loan growth was $45 million in 2004. Deposits grew $3 million and borrowings grew $25 million. Assets at year-end 2003 totaled $501 million compared to $420 million in 2002. In 2003, loan growth was $29 million and deposit growth was $62 million. Other borrowings increased $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. Loans Total loans (including loans held for sale) were $358 million at December 31, 2004 compared to $321 million at the end of 2003 and $285 million in 2002. Loan growth improved in 2004 compared to 2003. The increase is mainly attributable to improved loan demand. 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. As of the end of 2004 and compared to the prior year-end, commercial loans increased $5.7 million, real estate construction loans increased $17.9 million, real estate mortgage loans (including loans held for sale) increased $16.3 million, agricultural loans increased $882 thousand and installment loans decreased $3.9 million. 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 December 31, 2004, the real estate mortgage portfolio comprised 67% of total loans compared to 69% in 2003. Of this, 1-4 family residential property represented 67% in 2004 and 70% in 2003. Agricultural loans comprised 16% in 2004 and 18% in 2003 of the loan portfolio. Approximately 80% of the agricultural loans are secured by real estate in 2004 compared to 78% in 2003. 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 31% in 2004 and 36% in 2003 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. 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 3% 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) 2004 2003 2002 2001 2000 Commercial $ 19,999 $ 14,278 $ 16,803 $ 18,618 $ 17,452 Real Estate Construction 32,256 14,313 15,514 12,302 15,270 Real Estate Mortgage 238,661 222,342 182,958 168,684 163,190 Agricultural 57,497 56,615 52,188 53,640 52,008 Installment 9,062 12,978 17,134 21,952 24,807 Other 991 289 309 338 434 Total Loans 358,466 320,815 284,906 275,534 273,161 Less Deferred Loan Fees 10 54 12 19 16 Total Loans, Net of Deferred Loan Fees 358,456 320,761 284,894 275,515 273,145 Less loans held for sale 175 7,759 740 2,343 868 Less Allowance For Loan Losses 4,163 3,820 3,395 3,386 3,388 Net Loans 354,118 309,182 280,759 269,786 268,889 The following table sets forth the maturity distribution and interest sensitivity of selected loan categories at December 31, 2004. 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, 2004 (in thousands) One Year One Through Over Total or Less Five Years Five Years Loans Commercial $ 8,523 $ 8,634 $ 2,842 $ 19,999 Real Estate Construction 23,101 7,253 1,902 32,256 Real Estate Mortgage 23,808 116,363 98,480 238,651 Agricultural 15,208 37,101 5,188 57,497 Installment 3,507 5,390 165 9,062 Other 991 0 0 991 Total Loans, Net of Deferred Loan Fees 75,138 174,741 108,577 358,456 Fixed Rate Loans 23,136 136,850 35,643 195,629 Floating Rate Loans 52,002 37,891 72,934 162,827 Total Loans, Net of Deferred Loan Fees 75,138 174,741 108,577 358,456 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. Mortgage loan originations increased from $39 million in 2002 to $43 million in 2003, but dropped to $22 million in 2004. The sale of loans were $41 million, $37 million and $30 million for the year 2004, 2003 and 2002, respectively. Mortgage loans held for sale decreased from $7.8 million at December 31, 2003 to $175 thousand at December 31, 2004. The decrease is a result of management's decision to sell $7 million of fifteen year loans held at December 31, 2003. The volume of loan originations is inverse to rate changes. The rate environment in 2001 was falling, and continued into 2002 and 2003 before leveling in 2004, and therefore resulted in increased loan originations in 2003 and 2002, and decreased loan originations in 2004. The effect of these changes was also reflected on the income statement. As a result, the gain on sale of mortgage loans was $376 thousand in 2004 compared to $853 thousand in 2003 and $948 thousand in 2002. 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 $876 thousand at December 31, 2004, $861 thousand at December 31, 2003 and $704 thousand at December 31, 2002. Amortization of mortgage servicing rights was $249 thousand, $224 thousand and $150 thousand for the years ended December 31, 2004, 2003 and 2002, respectively. See Note 4 in the notes to consolidated financial statements included as Exhibit 13 for additional information. Deposits For 2004, total deposits increased $3 million to $388 million. Noninterest bearing deposits increased $9 million, while time deposits of $100 thousand and over increased $10 million, and other interest bearing deposits decreased $15 million. Public funds totaled $39 million at the end of 2004 ($37 million was interest bearing). 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. The table below provides information on the maturities of time deposits of $100,000 or more at December 31, 2004: Maturity of Time Deposits of $100,000 or More At December 31, 2004 (in thousands) Maturing 3 Months or Less $10,616 Maturing over 3 Months through 6 Months 13,421 Maturing over 6 Months through 12 Months 23,480 Maturing over 12 Months 11,952 Total $59,469 Borrowings The Company utilizes both long and short term borrowing. Long term borrowing at the Bank is mainly from the Federal Home Loan Bank (FHLB). This borrowing is mainly used to fund longer term, fixed rate mortgages, as part of a leverage strategy and to assist in asset/liability management. Advances are either paid monthly or at maturity. FHLB advances were $59.7 million at December 31, 2004. During 2004, $18.4 million of FHLB borrowing was paid, and advances were made for an additional $25 million ($10 million for a leverage transaction). The 2004 advances were obtained mainly to fund fixed rate mortgages, as detailed above. As of December 31, 2003, $53.2 million was borrowed from FHLB, an increase of $1.2 million from 2002. In 2003, $10.8 million of FHLB advances were paid, and advances were made for an additional $12 million. In August 2003, the Company formed Kentucky Bancshares, Statutory Trust I ("Trust"). The Trust issued $7,000,000 of fixed/variable rate trust preferred securities as part of a pooled offering of such securities. The Company issued $7,217,000 subordinated debentures to the Trust in exchange for the proceeds of the offering, which debentures represent the sole asset of the Trust. The Company used the trust preferred proceeds mainly to assist in funding the acquisition of Kentucky First, and to supplement regulatory capital ratios. During 2004, repurchase agreements were obtained as part of a $20 million leverage transaction. 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) 2004 2003 2002 Federal Funds Purchased: Balance at Year end $ 6,383 $ 5,266 $ - Average Balance During the Year 3,706 249 240 Maximum Month End Balance 11,306 5,266 6,852 Year end rate 2.50% 1.19% 0.00% Average annual rate 1.52% 1.46% 1.97% Repurchase Agreements: Balance at Year end $18,314 $ 1,791 $ 3,505 Average Balance During the Year 18,398 1,691 2,097 Maximum Month End Balance 21,947 2,411 3,505 Year end rate 2.94% 1.65% 0.84% Average annual rate 1.90% 1.34% 1.22% Other Borrowed Funds: Balance at Year end $ 896 $ 228 $ 1,772 Average Balance During the Year 343 1,048 1,248 Maximum Month End Balance 1,011 1,777 1,883 Year end rate 1.87% 0.73% 6.56% Average annual rate 1.51% 7.27% 8.16% 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, 2004 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 $ 59,750 $ 8,256 $20,882 $23,991 $ 6,621 Subordinated debentures 7,217 - - - 7,217 Time deposits 198,292 147,473 46,077 4,742 - 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) 2004 2003 2002 2001 2000 Non-accrual Loans $1,781 $1,844 $1,573 $ 935 $ 307 Accruing Loans which are Contractually past due 90 days or more 308 779 789 1,278 1,365 Restructured Loans 0 0 0 0 130 Total Nonperforming Loans 2,089 2,623 2,362 2,213 1,802 Other Real Estate 676 375 172 212 165 Total Nonperforming Assets 2,765 2,998 2,534 2,425 1,967 Total Nonperforming Loans as a Percentage of Loans (including loans held for sale) (1) 0.58% 0.82% 0.83% 0.80% 0.66% Total Nonperforming Assets as a Percentage of Total Assets 0.52% 0.60% 0.60% 0.61% 0.53% Allowance to nonperforming assets 1.51 1.27 1.34 1.40 1.72 (1) Net of deferred loan fees Total nonperforming assets at December 31, 2004 were $2.8 million compared to $3.0 million at December 31, 2003 and $2.5 million at December 31, 2002. The decrease from 2003 to 2004 is attributable to the decrease in various loans being put on non-accrual offset by a $301 thousand increase in other real estate. Total nonperforming loans were $2.1 million, $2.6 million and $2.4 million at December 31, 2004, 2003 and 2002, respectively. The non-accrual loan decrease from 2003 to 2004 is mainly attributable to more concentration on improving loan quality. The amount of lost interest on our non-accrual loans is immaterial. At December 31, 2004, 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, 2004 were $1.8 million compared to $1.8 million in 2003 and $1.6 million in 2002. 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 $416 thousand, $345 thousand and $675 thousand on December 31, 2004, 2003 and 2002, 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) 2004 2003 2002 2001 2000 Balance at Beginning of Year $ 3,820 $ 3,395 $ 3,386 $ 3,388 $ 3,103 Balance of Allowance for Loan Losses of Acquired Bank at Acquisition Date 363 Amounts Charged-off: Commercial 197 569 536 178 14 Real Estate Construction 0 0 18 0 0 Real Estate Mortgage 110 276 69 171 115 Agricultural 88 24 5 46 30 Consumer 293 529 701 751 400 Total Charged-off Loans 688 1,398 1,329 1,146 559 Recoveries on Amounts Previously Charged-off: Commercial 10 11 15 4 14 Real Estate Construction 0 0 0 0 0 Real Estate Mortgage 42 1 19 2 7 Agricultural 21 21 10 1 8 Consumer 118 127 90 69 65 Total Recoveries 191 160 134 76 94 Net Charge-offs 497 1,238 1,195 1,070 465 Provision for Loan Losses 840 1,300 1,204 1,068 750 Balance at End of Year 4,163 3,820 3,395 3,386 3,388 Total Loans (1) Average 338,465 290,502 281,105 273,504 257,711 At December 31 358,456 320,761 284,894 275,515 273,145 As a Percentage of Average Loans (1): Net Charge-offs 0.15% 0.43% 0.43% 0.39% 0.18% Provision for Loan Losses 0.25% 0.45% 0.43% 0.39% 0.29% Allowance as a Percentage of Year-end Loans (1) 1.16% 1.19% 1.19% 1.23% 1.24% Beginning Allowance as a Multiple of Net Charge-offs 7.7 2.7 2.8 3.2 6.7 Ending Allowance as a Multiple of Nonperforming Assets 1.51 1.27 1.34 1.40 1.72 (1) Including loans held for sale, 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 2004 was $840 thousand compared to $1.3 million in 2003 and $1.2 million in 2002. Net charge-offs were $497 thousand in 2004, $1.3 million in 2003 and $1.2 million in 2002. Net charge-offs to average loans were 0.15%, 0.43% and 0.43% in 2004, 2003 and 2002, respectively. Based on the quality of the loan portfolio, the loan loss provision decreased $460 thousand from 2003 to 2004 and increased $96 thousand from 2002 to 2003. The loan loss provision decreasing for 2004 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 recent improvement in the economy along with management's emphasis on improving the lending process resulted in fewer loan losses, lower loan loss provision and improved loan quality numbers in 2004. The economic downturn in 2003 and 2002 resulted in higher loan losses and, as a result, higher provisions in these years. At December 31, 2004, the allowance for loan losses was 1.16% of loans outstanding compared to 1.19% at year-end 2003 and 1.19% in 2002. Management believes the allowance for loan losses at the end of 2004 is adequate to cover probable and incurred 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) 2004 2003 2002 2001 2000 Dollars Percentage Dollars Percentage Dollars Percentage Dollars Percentage Dollars Percentage Allowance for Loan Losses Commercial $ 350 8.41% $ 262 6.86% $ 820 24.15% $ 291 8.59% $ 275 8.12% Real Estate Construction 566 13.60% 266 6.96% 216 6.36% 194 5.73% 244 7.20% Real Estate Mortgage 1,801 43.26% 1,804 47.23% 1,166 34.34% 1,602 47.31% 1,563 46.13% Agricultural 1,028 24.69% 995 26.05% 698 20.56% 693 20.47% 668 19.72% Consumer 418 10.04% 493 12.91% 495 14.58% 606 17.90% 638 18.83% Total 4,163 100.00% 3,820 100.00% 3,395 100.00% 3,386 100.00% 3,388 100.00%
Loans
2004 2003 2002 2001 2000 Dollars Percentage Dollars Percentage Dollars Percentage Dollars Percentage Dollars Percentage Commercial $ 19,999 5.58% $ 14,278 4.45% $ 16,803 5.90% $ 18,618 6.76% $ 17,452 6.39% Real Estate Construction 32,256 9.00% 14,313 4.46% 15,514 5.45% 12,302 4.47% 15,270 5.59% Real Estate Mortgage 238,651 66.58% 222,288 69.30% 182,946 64.22% 168,665 61.22% 163,174 59.74% Agricultural 57,497 16.04% 56,615 17.65% 52,188 18.32% 53,640 19.47% 52,008 19.04% Consumer 9,062 2.53% 12,978 4.05% 17,134 6.01% 21,952 7.97% 24,807 9.08% Other 991 0.28% 289 0.09% 309 0.11% 338 0.12% 434 0.16% Total, Net (1) 358,456 100.00% 320,761 100.00% 284,894 100.00% 275,515 100.00% 273,145 100.00% (1) Including loans held for sale, 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: 2004 2003 Unused lines of credit $ 54,785,000 $ 47,148,000 Commitments to make loans 1,272,000 1,379,000 Letters of credit 145,000 252,000 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 5.75% 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, 2004 increased $1.5 million to $41.7 million. During 2004, the Company purchased 122,302 shares of its stock for $3.4 million. This partially offsets the $5.8 million in net income for 2004. Stockholders' equity, excluding accumulated other comprehensive income was $44.7 million at December 31, 2004. Included in Tier I capital is $7 million of trust preferred securities issued in August 2003. 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) 2004 2003 Change Stockholders' Equity (1) $ 44,703 $ 44,538 165 Trust Preferred Securities 7,000 7,000 - Less Disallowed Amount 10,043 11,423 (1,380) Tier I Capital 41,660 40,115 1,545 Allowance for Loan Losses 4,163 3,820 343 Other 164 143 21 Tier II Capital 4,327 3,963 364 Total Capital 45,987 44,078 1,909 Total Risk Weighted Assets 348,191 316,982 31,209 Ratios: Tier I Capital to Risk-weighted Assets 12.0% 12.7% -0.7% Total Capital to Risk-weighted Assets 13.2% 13.9% -0.7% Leverage 8.2% 8.8% -0.6% (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, 2004, 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, classified as available for sale, decreased from $128.8 million at December 31, 2003 to $126.8 million at December 31, 2004. The decrease is mainly attributable to higher loan demand. Federal funds sold totaled $3.2 million at December 31, 2004 and $6.2 million at December 31, 2003. 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 $2.3 million of adjustable asset backed securities held on December 31, 2004, $650 thousand are repriceable monthly and the remaining $1.6 million are repriceable annually. 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. 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, 2004. Investment Securities at market value At December 31 (in thousands) 2004 2003 2002 Available for Sale U.S. treasury $ 2,984 $ 3,033 $ 5,059 U.S. government agencies 39,031 36,634 6,138 States and political subdivisions 35,160 39,142 31,024 Mortgage-backed Fixed - GNMA, FNMA, FHLMC Passthroughs 35,013 29,079 17,465 GNMA, FNMA, FHLMC CMO's 11,335 12,940 11,682 Total 46,348 42,019 29,147 Variable - GNMA, FNMA, FHLMC Passthroughs 1,623 4,161 8,645 GNMA, FNMA, FHLMC CMO's 649 1,202 2,529 Total 2,272 5,363 11,174 Total mortgage-backed 48,620 47,382 40,321 Other 972 2,599 6,967 Total 126,767 128,790 89,509 Maturity Distribution of Securities
December 31, 2004 (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 $ - $ 2,984 $ - $ - $ - $ 2,984 U.S. government agencies 444 27,108 11,479 0 0 39,031 States and political subdivisions 1,726 4,785 11,844 16,805 0 35,160 Mortgage-backed 0 0 0 0 48,620 48,620 Equity Securities 0 0 0 0 972 972 Other 0 0 0 0 Total 2,170 34,877 23,323 16,805 49,592 126,767 Percent of Total 1.7% 27.5% 18.4% 13.3% 39.1% 100.0% Weighted Average Yield (1) 6.13% 3.84% 5.31% 6.69% 4.13% 4.64% (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 FAS 123, Revised, requires all public companies to record compensation cost for stock options provided to employees in return for employee service. The cost is measured at the fair value of the options when granted, and this cost is expensed over the employee service period, which is normally the vesting period of the options. This will apply to awards granted or modified after the first quarter or year beginning after Jun 15, 2005. Compensation cost will also be recorded for prior options granted that vest after the date of adoption. The effect on results of operations will depend on the level of future option grants and the calculation of the fair value of the options granted at such future date, as well as the vesting periods provided, and so cannot currently be predicted. Existing options that will vest after adoption date are expected to result in additional compensation expense of approximately $30,000 during the balance of 2005. There will be no significant effect on financial position as total equity will not change. 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, 2004 the projected net interest income percentage change of down 100 and down 300 basis points is outside the Board of Directors limits. As of January 31, 2005, the Company was within the Board limits in the down 100 basis point scenario. 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, 2004 and December 31, 2003 is as follows: Projected Net Interest Income (December 31, 2004)
Level -300 -100 Rates +100 +300 Year One (1/05 - 12/05) Interest Income $21,816 $25,843 $27,887 $29,798 $33,486 Interest Expense 8,899 9,538 10,762 11,985 14,433 Net Interest Income 12,917 16,305 17,125 17,813 19,053 Net interest income dollar change (4,208) (820) 688 1,928 Net interest income percentage change -24.6% -4.8% N/A 4.0% 11.3% Limitation on % Change >-10.0% >-4.0% N/A >-4.0% >-10.0%
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 10,126 12,396 Net Interest Income 13,941 16,626 17,190 17,757 18,895 Net interest income dollar change (3,249) (564) 567 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%
The numbers in 2004 show slightly greater fluctuation when compared to 2003. In 2004, year one reflected a decrease in net interest income of 4.8% compared to 3.3% projected decrease from 2003 with a 100 basis point decline. The 300 basis point increase in rates reflected a 11.3% increase in net interest income in 2004 compared to a 9.9% increase in 2003. The risk is more in 2004 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 $17.6 million at December 31, 2004. Additionally, securities available-for- sale with maturities greater than one year totaled $124.6 million at December 31, 2004. The available for sale securities are available to meet liquidity needs on a continuing basis. The Company maintains a relatively stable base of customer deposits 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, 2004 these balances totaled $59.5 million, approximately 15% 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 $38 million from the FHLB at December 31, 2004. 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 2004 2003 2002 Average Loans (including loans held for sale)/Average Deposits 88.3% 89.6% 91.3% Average Securities sold under agreements to repurchase and other borrowings/Average Assets 5.7% 1.3% 0.9% This chart shows that the loan to deposit ratio decreased in 2004 and 2003. 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. The increase in the latter ratio above is mainly a result of the leverage transaction entered into in the beginning on 2004. Twenty million dollars of securities were purchased and were funded by repurchase agreements. 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 2004 Annual Report to Stockholders included as Exhibit 13, and are incorporated herein by reference. No other portion of the 2004 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, 2004. 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, 2004. There was no change in the Company's internal control over financial reporting during the fourth quarter of 2004 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 2005: Henry Hinkle, age 53, is President of Hinkle Construction Company. He has been a director of Kentucky Bank and the Company since 1989. Theodore Kuster, age 61, 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 55, 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 57, is retired President and CEO of First Federal, Cynthiana. She has been a director of the Company since 2003. Ted McClain, age 53, is an insurance agent with Hopewell Insurance Company. He has been a director of Kentucky Bank since 2002 and the Company since 2003. Buckner Woodford, age 60, is Chairman of the Board of Kentucky Bancshares, Inc. and Kentucky Bank. He was President and Chief Executive Officer of the Company from 1991 to 2004, and President and Chief Executive Officer of the Kentucky Bank from 1984 to 2004. He has been a director of Kentucky Bank since 1971 and the Company since inception. Terms expiring in 2007: William Arvin, age 64, is an attorney. He has been a director of Kentucky Bank and the Company since 1995. Louis Prichard, age 51, is President and Chief Executive Officer of Kentucky Bank. He was President and Chief Operating Officer of Kentucky Bank from 2003 to 2004. He has been a director of Kentucky Bank and the Company since 2003. Since 1983, he was in banking in Danville and was the Chairman and Chief Executive Officer of Boyle Bancshares, Inc. and their banking subsidiary, Farmers Bank for 7 years before joining the Company in 2003. The Company's other executive officers are Norman J. Fryman, age 55 and Gregory J. Dawson, age 44. Mr. Fryman is the Vice President of Sales and Service of Kentucky Bank 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, without charge, 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 Chairman of the Board (Buckner Woodford), President and Chief Executive Officer (Louis Prichard) and Vice President of Sales and Service (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 All Other Name Salary Bonus Compensation Granted Compensation(2) Buckner Woodford 2004 $203,000 $ 39,585 (1) 1,000 $ 13,653 2003 $200,000 $ 24,000 (1) 1,000 14,000 2002 $180,008 $ 39,825 (1) 500 12,000 Louis Prichard 2004 140,000 20,475 (1) 1,000 9,160 2003 125,000 11,700 (1) 3,000 7,605 Norman J. Fryman 2004 105,265 17,958 (1) 500 6,871 2003 97,057 8,371 (1) 500 6,763 (1) Less than the lesser of $50,000 or 10% of annual salary and bonuses (2) Represents the Company's matching contribution to the qualified profit sharing plan that includes a 401(k) provision The following table contains information regarding the grant of stock options under the Company's stock option plan to the Chairman of the Board, President and Chief Executive Officer and Vice President of Sales and Service during the year ended December 31, 2004. In addition, in accordance with rules of the Securities and Exchange Commission, the following table sets forth the hypothetical grant date present value with respect to the referenced options, using the Black-Scholes Option Pricing Model. Option Grants in the Last Fiscal Year % of Total Options Grant Shares Granted to Exercise Date Granted Employees Price Expiration Present Name (#) in 2004 ($/Sh) Date Value($) Buckner Woodford 1,000 9.0% $33.90 1/2/14 $5,720 Louis Prichard 1,000 9.0 33.90 1/2/14 5,720 Norman J. Fryman 500 4.5 33.90 1/2/14 2,860 The following table sets forth certain information regarding options exercised by the Chairman of the Board, President and Chief Executive Officer and Vice President of Sales and Service during calendar year 2004 and unexercised stock options held by them as of December 31, 2004.
Aggregated Option Exercises in Calendar 2004 and Year-end Stock Option Values Shares Number of Securities Value of Unexercised Acquired Value Underlying Unexercised In-the-Money on Exercise Realized Options at 12/31/04 Options at 12/31/04 Name (#) ($) Exercisable/Unexercisable Exercisable/Unexercisable Buckner Woodford n/a n/a 4,700/2,400 $ 42,150/$ 7,400 Louis Prichard n/a n/a 600/3,400 3,000/ 12,000 Norman J. Fryman n/a n/a 1,040/1,260 9,860/ 4,040 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 5 10 15 20 25 30 35 $ 25,000 $ 1,250 $ 2,500 $ 3,750 $ 5,000 $ 6,250 $ 7,500 $ 8,750 50,000 2,500 5,000 7,500 10,000 12,500 15,000 17,500 75,000 3,750 7,500 11,250 15,000 18,750 22,500 26,250 100,000 5,000 10,000 15,000 20,000 25,000 30,000 35,000 125,000 6,250 12,500 18,750 25,000 31,250 37,500 43,750 150,000 7,500 15,000 22,500 30,000 37,500 45,000 52,500 175,000 8,750 17,500 26,250 35,000 43,750 52,500 61,250 200,000 10,000 20,000 30,000 40,000 50,000 60,000 70,000 225,000 11,250 22,500 33,750 45,000 56,250 67,500 78,750 250,000 12,500 25,000 37,500 50,000 62,500 75,000 87,500 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 32 years for Mr. Woodford, 2 year for Mr. Prichard and 19 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, 2004. Name Shares Beneficially Owned(1) Number Percentage William Arvin (2) 30,071 1.1% Gregory J. Dawson (3) 9,475 * Norman J. Fryman (4) 2,445 * Henry Hinkle (5) 30,655 1.1% Theodore Kuster (6) 17,960 * Betty J. Long (7) 1,600 * Ted McClain (8) 1,375 * Louis Prichard (9) 910 * Robert G. Thompson (10) 6,150 * Woodford Van Meter (11) 31,300 1.1% Buckner Woodford (12) 247,488 9.1% All directors and officers (11 persons) as a group (consisting of those persons named above)(13) 379,429 13.9% * 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 650 shares that Mr. Arvin may acquire upon exercise of outstanding stock options. 3) Includes 3,450 shares that Mr. Dawson may acquire upon exercise of outstanding stock options. 4) Includes 1,040 shares that Mr. Fryman may acquire upon exercise of outstanding stock options. 5) Includes 1,000 shares held by his wife and 640 shares held by three sons, as to which Mr. Hinkle disclaims beneficial ownership. Includes 26,500 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. 6) Includes 6,260 shares 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 350 shares that Mr. Kuster may acquire upon exercise of outstanding stock options. 7) Includes 1,600 shares held in a retirement account. 8) Includes 200 shares that Mr. McClain may acquire upon exercise of outstanding stock options. 9) Includes 600 shares that Mr. Prichard may acquire upon exercise of outstanding stock options. 10) Includes 200 shares held of record by Mr. Thomprson's wife, as to which Mr. Thompson disclaims beneficial ownership. Includes 750 shares that Mr. Thompson may acquire upon exercise of outstanding stock options. 11) Includes 2,200 shares held of record by Mr. Van Meter's wife, as to which Mr. Van Meter disclaims beneficial ownership. 12) 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 4,700 shares that Mr. Woodford may acquire upon exercise of outstanding stock options. 13) Includes 11,450 shares that may be acquired upon exercise of outstanding stock options. The following table sets forth as of December 31, 2004 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 12 in the preceding table for further information. Name and Address Shares Beneficially of Beneficial Owner Owned Percentage Buckner Woodford 247,488 9.1% 340 Stoner Avenue Paris, Kentucky 40361 The following table sets forth as of December 31, 2004 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 647 1993 Employee Stock Ownership Incentive Plan 27,060 17.11 0 1993 Non-Employee Directors Stock Ownership Plan 5,250 24.59 10,450 1999 Employee Stock Option Plan 28,254 28.33 70,394 Total 60,564 $23.00 81,491
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, 2004. 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 $1.9 million as of December 31, 2004 and $2.5 million as of December 31, 2003. See Note 4 in the notes to consolidated financial statements included as Exhibit 13. The Company purchased various types of insurance with aggregate premiums amounting to $218 thousand in 2004 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 2004 and for 2003 were as follows: Audit fees - Fees for the financial statement audit, and the review of the Company's Form 10-Q's were $99,250 for 2004 and $65,600 for 2003. Audit related fees - Aggregate fees for all assurance and related services were $12,950 for 2004 and $10,500 for 2003. These fees were incurred for audits of benefit plans. The 2004 and 2003 amounts were preapproved by the audit committee. Tax fees - Fees related to tax compliance, advice and planning were $14,145 for 2004 and $6,400 for 2003. The 2004 and 2003 amounts were preapproved by the audit committee. All other fees - Consulting fees related to acquisitions and profitability were $16,000 for 2004 and $17,095 for 2003. Loan review fees were $0 for 2004 and $23,800 for 2003. The 2004 and 2003 amounts were preapproved by the audit committee. All services provided by the Corporation's primary independent auditor in 2004 and 2003 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.* 10.4 Schedule of 2005 Compensation Arrangements for Named Executive Officers.* 10.5 2005 Restricted Stock Grant Plan, including form of Award Agreement, as incorporated by reference to Exhibit 10.1 of the Registrant's Current Report on Form 8-K dated February 15, 2005 (File No. 33-96358).* 11 Computation of earnings per share - See Note 12 in the notes to consolidated financial statements included as Exhibit 13. 13 Kentucky Bancshares, Inc. 2004 Annual Report and Proxy Statement, including 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. 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/Louis Prichard __ Louis Prichard, President and Chief Executive Officer, Director March 30, 2005 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/Louis Prichard _______ March 29, 2005 Louis Prichard, President and Chief Executive Officer, Director __/s/Gregory J. Dawson_______ March 29, 2005 Gregory J. Dawson, Chief Financial and Accounting Officer __/s/Buckner Woodford________ March 29, 2005 Buckner Woodford, Chairman of the Board, Director _____________________________ March 29, 2005 William Arvin, Director __/s/Henry Hinkle __ ____ March 29, 2005 Henry Hinkle, Director _____________________________ March 29, 2005 Theodore Kuster, Director __/s/Betty J. Long___________ March 29, 2005 Betty J. Long, Director __/s/Ted McClain____________ March 29, 2005 Ted McClain, Director __/s/Robert G. Thompson______ March 29, 2005 Robert G. Thompson, Director _____________________________ March 29, 2005 Woodford Van Meter, 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.* 10.4 Schedule of 2005 Compensation Arrangements for Named Executive Officers.* 10.5 2005 Restricted Stock Grant Plan, including form of Award Agreement, as incorporated by reference to Exhibit 10.1 of the Registrant's Current Report on Form 8-K dated February 15, 2005 (File No. 33-96358).* 11 Computation of earnings per share - See Note 10 in the notes to consolidated financial statements included as Exhibit 13. 13 Kentucky Bancshares, Inc. 2004 Annual Report and Proxy Statement, including 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. 6 22 BOURBON BANCSHARES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2000, 1999 and 1998 44 41 EX-10 2 exhibit104.txt COMPENSATION SCHEDULE Exhibit 10.4 Schedule of 2005 Compensation Arrangements for Named Executive Officers With respect to compensation in 2005, the table below sets forth the salary of each of the named executive officers, effective as of January 1, 2005. The Board's Compensation Committee approved the salaries of Messrs. Woodford and Prichard on November 16, 2004, and the salary of Mr. Fryman on December 22, 2004. The Compensation Committee granted the options listed below on January 2, 2005. Also, on February 15, 2005, the Compensation Committee approved targets for the Registrant's management incentive program for its executive officers. Based upon the Registrant's net income performance relative to 2005 budget, Mr. Prichard may earn up to 40% of his annual salary in bonus compensation. Based upon the Registrant's net income performance relative to 2005 budget, Mr. Fryman may earn up to 22.5% of his annual salary in bonus compensation; based upon the his performance relative to individual performance measures established by the President and CEO, Mr. Fryman may earn up to an additional 7.5% of his annual salary in bonus compensation. Based upon the his performance relative to individual performance measures established by the President and CEO, Mr. Woodford may earn up to an additional 30% of his annual salary in bonus compensation. 2005 Salary Stock Options Buckner Woodford Chairman $ 80,000 1,000 Louis Prichard President and CEO 175,000 4,000 Norman J. Fryman Vice President of Sales and Service 113,949 500 42 EX-13 3 exhibit13annualrpt.txt ANNUAL REPORT AND PROXY Exhibit 13 KENTUCKY BANCSHARES, INC. ANNUAL REPORT 2004 LETTER TO THE SHAREHOLDERS Financial results for Kentucky Bancshares, Inc. improved significantly with $2.07 earnings per share. I am pleased we have this positive momentum as my period of time as CEO ends. As previously announced, Louis Prichard assumed that position beginning in 2005. This change has my complete support. It has put into place excellent leadership for our future. I have stepped back and am now Chairman. For me it is not retirement as I still have an office and continue to work, but on a reduced schedule. My plans are to continue to help Louis build our franchise. I am deeply grateful to both current and past directors for the opportunity they gave me to lead this organization. The job of being a community bank CEO is both enjoyable and fulfilling. It enabled me to live in my hometown, raise a family, earn a living and help build a growing business enterprise. I had the opportunity to work with a wonderful group of fellow employees and build lasting friendships. Many of you are aware that I am the fourth generation of my family to be involved in this same bank. That has meant a lot to me also. It feels as if I am sharing an experience with them, contributing to a business enterprise they began before me. Those directors who gave me this opportunity enriched my life, and I can't thank them enough for that. Retiring from our board of directors at year-end were two men who made great contributions to our success over the years. William R. Stamler provided the company with thoughtful advice and guidance on many important issues throughout his service. He was instrumental in 1984 in the merger of Peoples Deposit Bank and Bourbon Agricultural Bank in Paris, creating a bank that has a market share in Bourbon County of over 65%. Dr. James L. Ferrell has been our Chairman since 1990. He has shown valuable leadership through the years. During that time our bank has expanded from one county to six counties surrounding Lexington. We are fortunate that Dr. Ferrell will remain on the board of our subsidiary, Kentucky Bank. I expect that I will find continued satisfaction in my new position as Chairman. It is with optimism about our future that I look forward to serving our company in that role. Sincerely, Buck Woodford Chairman of the Board Kentucky Bancshares, Inc. LETTER TO THE SHAREHOLDERS Dear Shareholders: The financial results of your company in 2004 were significantly improved over the performance of 2003. Assets increased 5.5% from $501.9 million to $528.5 million. Much of that increase was fueled by a 14.5% increase in the bank's loan portfolio. Our net interest income increased from $14.5 million to $16.8 million, a 16.1% increase. Along with this strong loan growth, we implemented a number of measures to control costs. Those were extremely beneficial in limiting the growth of non- interest expense to 4.1%. As a result, net income increased 36.1% from $4.2 million to $5.7 million. This bottom line increase allowed us to improve our return on average assets and our return on average equity to 1.11% and 12.6%, respectively. Our improved operating results, along with the repurchase of a large block of stock, ultimately led to a 38% increase in earnings per share to $2.07 on a diluted basis. As is the case in most well run businesses, success is the result of a team effort. This is true at Kentucky Bancshares as well. Your company is fortunate to have an experienced, well qualified group of people committed to the goal of enhancing the value of your company. People like James Ferrell and William R. Stamler, as directors, have been extremely dedicated to providing guidance to assist management in creating and implementing strong strategic initiatives. They have been invaluable to our success, and we would like to thank them for their past commitment to our institution. Mr. Stamler will be retiring from both the bank board as well as the holding company board, and Dr. Ferrell will be retiring from the holding company board, but will be continuing as a member of the Kentucky Bank board. We want to thank Mr. Stamler for his long-standing commitment to our institution and we want to thank Dr. Ferrell for his contributions as chairman of our holding company and we look forward to his future involvement as he continues as a bank board director. As shareholders, we should appreciate the outstanding leadership that Buck Woodford has provided over his past 31 years as Chief Executive Officer. We have expanded from a bank located in one county to a bank holding company with 13 locations in 6 counties throughout Central Kentucky. In those years, the shareholder equity of your bank has grown from $750 thousand to a market capitalization value of nearly $80 million. The value of your stock has increased from approximately $0.30 a share over that 31 year period to a value of almost $30 per share. I want to take this time to thank Buck on behalf of all of us, for his vision and the significant financial results that have been brought to all of us. I look forward to working with Buck in his new role as chairman of both Kentucky Bank and Kentucky Bancshares. His insight and knowledge will be of great value to me. In closing, I would say that our eye is on the future and that our goal will be to continue to build our franchise as has been done so successfully in the past. Sincerely, Louis Prichard President and Chief Executive Officer Financial Highlights... Kentucky Bancshares, Inc. 2004 2003 2002 Assets ($ thousands) $ 528,544 $ 500,852 $ 397,257 Net Income ($ thousands) $ 5,762 $ 4,233 $ 5,903 Per Share Results... Earnings (assuming dilution) $ 2.07 $ 1.50 $ 2.10 Dividend $ .84 $ .76 $ .68 Shareholder Information... Corporate Headquarters Kentucky Bancshares, Inc. 4th and Main Streets Paris, Kentucky 40361 859-987-1795 Transfer, Registrar and Dividend Agent Registrar and Transfer Company 10 Commerce Drive Cranford, New Jersey 07016 800-368-5948 rtco.com Kentucky Bancshares, Inc. - KTYB.OB Active Market Makers Hilliard Lyons West Vine Street, Suite 400 Lexington, Kentucky 40507 800-944-2663 Howe Barnes Investments, Inc. 135 South LaSalle Street, Suite 150 Chicago, Illinois, 60603-4398 312-655-2995 Morgan Keegan & Company 489 E. Main Street Lexington, Kentucky 40507 800-937-0161 Annual Meeting The annual meeting of Kentucky Bancshares, Inc. will be held Tuesday, May 10, 2005 at 11:00 in the corporate headquarters. Investor Information Any individual requesting a copy of the Corporation's 2004 Form 10-K Report may obtain these by writing to Investor Relations at the Corporate Headquarters. CONSOLIDATED BALANCE SHEETS December 31 2004 2003 ASSETS Cash and due from banks $ 12,248,975 $ 15,224,513 Federal funds sold 3,206,000 6,163,000 Cash and cash equivalents 15,454,975 21,387,513 Securities available for sale 126,766,861 128,789,830 Mortgage loans held for sale 175,471 7,758,583 Loans 358,281,554 313,002,258 Allowance for loan losses (4,163,315) (3,819,842) Net loans 354,118,239 309,182,416 Federal Home Loan Bank stock 5,136,500 4,930,100 Bank premises and equipment, net 11,378,012 11,606,373 Interest receivable 3,226,479 3,249,834 Goodwill 9,110,524 10,199,830 Other intangible assets 1,737,254 1,998,231 Other assets 1,439,331 1,749,434 Total assets $ 528,543,646 $ 500,852,144 LIABILITIES AND STOCKHOLDERS' EQUITY Deposits Non-interest bearing $ 74,048,291 $ 64,841,638 Time deposits, $100,000 and over 59,468,813 49,914,659 Other interest bearing 254,437,718 269,842,299 Total deposits 387,954,822 384,598,596 Repurchase agreements and other borrowings 25,592,844 7,285,258 Federal Home Loan Bank advances 59,749,666 53,232,296 Subordinated debentures 7,217,000 7,217,000 Interest payable 1,849,468 1,635,784 Other liabilities 1,153,035 826,569 Total liabilities 483,516,835 454,795,503 Stockholders' equity Preferred stock, 300,000 shares authorized and unissued - - Common stock, no par value; 10,000,000 shares authorized; 2,684,498 and 2,799,781 shares issued and outstanding in 2004 and 2003 6,818,664 6,984,784 Retained earnings 37,884,215 37,552,620 Accumulated other comprehensive income (loss) 323,932 1,519,237 Total stockholders' equity 45,026,811 46,056,641 Total liabilities and stockholders' equity $ 528,543,646 $ 500,852,144 CONSOLIDATED STATEMENTS OF INCOME Years Ended December 31 2004 2003 2002 Interest income Loans, including fees $ 20,470,306 $ 18,574,690 $ 20,632,003 Securities Taxable 3,574,235 2,049,835 2,564,539 Tax exempt 1,518,275 1,430,589 1,254,065 Other 283,196 274,003 337,397 25,846,012 22,329,117 24,788,004 Interest expense Deposits 5,765,690 5,310,791 6,977,969 Repurchase agreements and other borrowings 411,492 27,460 42,148 Federal Home Loan Bank advances 2,395,898 2,293,297 2,257,413 Subordinated debentures 494,052 169,000 - Other - 75,000 90,000 9,067,132 7,875,548 9,367,530 Net interest income 16,778,880 14,453,569 15,420,474 Provision for loan losses 840,000 1,300,000 1,204,000 Net interest income after provision for loan losses 15,938,880 13,153,569 14,216,474 Other income Service charges 4,357,658 4,065,210 3,848,055 Loan service fee income 246,356 242,479 228,121 Trust department income 299,448 301,612 345,730 Securities gains (losses), net 288,950 139,438 218,604 Gain on sale of mortgage loans 376,157 853,340 948,369 Other 1,227,614 1,105,534 1,000,716 6,796,183 6,707,613 6,589,595 Other expenses Salaries and employee benefits 8,053,306 7,373,501 6,728,443 Occupancy expenses 2,255,071 2,044,515 1,908,479 Amortization 524,839 516,390 429,366 Advertising and marketing 378,410 399,483 330,069 Taxes other than payroll, property and income 499,251 439,084 406,077 Other 3,044,294 3,398,292 2,630,321 14,755,171 14,171,265 12,432,755 Income before income taxes 7,979,892 5,689,917 8,373,314 Provision for income taxes 2,217,783 1,456,540 2,470,789 Net income $ 5,762,109 $ 4,233,377 $ 5,902,525 Earnings per share: Basic $ 2.09 $ 1.52 $ 2.13 Diluted 2.07 1.50 2.10 CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME Years Ended December 31 2004 2003 2002 Net income $ 5,762,109 $ 4,233,377 $ 5,902,525 Other comprehensive income (loss), net of tax: Unrealized gains (losses) on securities arising during the period (1,004,597) (237,693) 1,245,448 Reclassification of realized amount (190,708) (92,029) (144,279) Net change in unrealized gain (loss) on securities (1,195,305) (329,722) 1,101,169 Comprehensive income $ 4,566,804 $ 3,903,655 $ 7,003,694 CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY Years Ended December 31, 2004, 2003 and 2002
Accumulated Other Total Common Stock Retained Comprehensive Stockholders' Shares Amount Earnings Income Equity Balances, January 1, 2002 2,766,917 $ 6,649,018 $ 31,703,573 $ 747,790 $ 39,100,381 Common stock issued (including employee gifts of 85 shares) 20,879 260,183 - - 260,183 Common stock purchased (15,042) (102,314) (285,051) - (387,365) Net change in unrealized gain (loss) on securities available for sale, net of tax - - - 1,101,169 1,101,169 Net income - - 5,902,525 - 5,902,525 Dividends declared - $.68 per share - - (1,885,051) - (1,885,051) Balances, December 31, 2002 2,772,754 6,806,887 35,435,996 1,848,959 44,091,842 Common stock issued (including employee gifts of 54 shares) 36,410 507,071 - - 507,071 Common stock purchased (9,383) (329,174) - - (329,174) Net change in unrealized gain (loss) on securities available for sale, net of tax - - - (329,722) (329,722) Net income - - 4,233,377 - 4,233,377 Dividends declared - $.76 per share - - (2,116,753) - (2,116,753) Balances, December 31, 2003 2,799,781 6,984,784 37,552,620 1,519,237 46,056,641 Common stock issued (including employee gifts of 89 shares) 7,019 131,041 - - 131,041 Common stock purchased (122,302) (297,161) (3,127,295) - (3,424,456) Net change in unrealized gain (loss) on securities available for sale, net of tax - - - (1,195,305) (1,195,305) Net income - - 5,762,109 - 5,762,109 Dividends declared - $.84 per share - - (2,303,219) - (2,303,219) Balances, December 31, 2004 2,684,498 $ 6,818,664 $ 37,884,215 $ 323,932 $ 45,026,811
CONSOLIDATED STATEMENTS OF CASH FLOWS Years Ended December 31
2004 2003 2002 Cash flows from operating activities Net income $ 5,762,109 $ 4,233,377 $ 5,902,525 Adjustments to reconcile net income to net cash from operating activities Depreciation and amortization 1,419,794 1,460,429 1,419,205 Provision for loan losses 840,000 1,300,000 1,204,000 Securities amortization (accretion), net 635,725 703,502 385,050 Securities (gains) losses, net (288,950) (139,438) (218,604) Originations of loans held for sale (22,065,215) (42,872,837) (38,541,844) Proceeds from sale of loans 30,024,484 36,707,617 40,702,420 Gain on sale of mortgage loans (376,157) (853,340) (948,369) Federal Home Loan Bank stock Dividends (206,400) (170,800) (180,800) Losses (gain) on sale of fixed assets (16,722) 161,849 - Changes in: Interest receivable 23,355 360,511 231,041 Other assets 1,135,547 451,918 32,115 Interest payable 213,684 (306,069) (969,876) Other liabilities 942,501 (1,390,747) (9,331) Net cash from operating activities 18,043,755 (354,028) 9,007,532 Cash flows from investing activities Purchases of securities available for sale (70,689,970) (65,248,350) (49,204,809) Proceeds from sales of securities available for sale 37,973,553 8,434,570 18,838,747 Proceeds from principal payments and maturities of securities available for sale 32,581,271 39,625,276 17,966,641 Cash paid for bank acquisition - (7,000,205) - Net change in loans (45,775,823) 1,481,580 (12,176,153) Purchases of bank premises and equipment, net (748,824) (1,632,487) (816,553) Net cash from investing activities (46,659,793) (24,339,616) (25,392,127) Cash flows from financing activities Net change in deposits 3,356,226 8,662,228 13,920,771 Net change in repurchase agreements and other borrowings 18,307,586 2,008,563 3,674,713 Proceeds from Subordinated debentures - 7,000,000 - Advances from Federal Home Loan Bank 25,000,000 12,000,000 6,980,000 Payments on Federal Home Loan Bank advances (18,383,678) (10,827,273) (6,640,623) Proceeds from issuance of common stock 131,041 188,697 187,889 Purchase of common stock (3,424,456) (10,800) (315,071) Dividends paid (2,303,219) (2,116,753) (1,885,051) Net cash from financing activities 22,683,500 16,904,662 15,922,628 CONSOLIDATED STATEMENTS OF CASH FLOWS Years Ended December 31 2004 2003 2002 Net change in cash and cash equivalents $ (5,932,538) $(7,788,982) $ (461,967) Cash and cash equivalents at beginning of year 21,387,513 29,176,495 29,638,462 Cash and cash equivalents at end of year $ 15,454,975 $ 21,387,513 $ 29,176,495 Supplemental disclosures of cash flow information Cash paid during the year for: Interest expense $ 8,853,448 $ 8,084,469 $ 10,337,406 Income taxes 777,401 1,637,706 2,150,000 Supplemental schedules of non-cash investing Activities Real estate acquired through foreclosure $ 1,325,942 $ 349,748 $ -
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Basis of Presentation: The consolidated financial statements include the accounts of Kentucky Bancshares, Inc. (formerly Bourbon Bancshares, Inc.) (the Company) and its wholly-owned subsidiary, Kentucky Bank (the Bank). Intercompany transactions and balances have been eliminated in consolidation. On November 7, 2003, the Company acquired 100% of Kentucky First Bancorp, Inc., parent of First Federal Savings Bank, Cynthiana, Harrison County, Kentucky, as discussed in Note 17. Nature of Operations: The Bank operates under a state bank charter and provides full banking services, including trust services, to customers located in Bourbon, Clark, Harrison, Jessamine, Scott, Woodford and adjoining counties in Kentucky. As a state bank, the Bank is subject to regulation by the Kentucky Department of Financial Institutions and the Federal Deposit Insurance Corporation (FDIC). The Company, a bank holding company, is regulated by the Federal Reserve. Estimates in the Financial Statements: 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 at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The allowance for loan losses, mortgage servicing rights and fair value of financial instruments are particularly subject to change. Cash Flows: For purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks, federal funds sold, and certain short-term investments with maturities of less than three months. Generally, federal funds are sold for one-day periods. Net cash flows are reported for loan, deposit and short-term borrowing transactions. Securities: 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. The Company has no investments classified as trading securities, or securities held to maturity. Securities available for sale are carried at fair value, with unrealized holding gains and losses reported in other comprehensive income. Other securities such as Federal Home Loan Bank stock are carried at cost. Interest income includes amortization of purchase premium or discount. Premiums and discounts on securities are amortized on the level-yield method without anticipating prepayments. Gains and losses on sales are recorded on the settlement date and determined using the specific identification method. Declines in the fair value of securities below their cost that are other than temporary are reflected as realized losses. In estimating other-than-temporary losses, management considers: (1) the length of time and extent that fair value has been less than cost, (2) the financial condition and near term prospects of the issuer, and (3) the Company's ability and intent to hold the security for a period sufficient to allow for any anticipated recovery in fair value. Loans Held for Sale: Loans held for sale are valued at the lower of cost or market as determined by outstanding commitments from investors or current secondary market prices, calculated on the aggregate loan basis. The Company also provides for any losses on uncovered commitments to lend or sell. Loans: Loans are stated at the amount of unpaid principal, reduced by an allowance for loan losses. Interest income on loans is recognized on the accrual basis except for those loans on a nonaccrual status. The accrual of interest on impaired loans is discontinued when management believes, after consideration of economic and business conditions and collection efforts, that the borrowers' financial condition is such that collection of interest is doubtful. Interest income on mortgage and consumer loans is discontinued at the time the loan is 90 days delinquent, and interest income on commercial loans is discontinued at the time the loan is 120 days delinquent, unless the loan is well-secured and in process of collection. Past due status is based on the contractual terms of the loan. When interest accrual is discontinued, interest income received on such loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured. Consumer and credit card loans are typically charged off no later than 120 days past due. Loans are placed on nonaccrual or charged-off at an earlier date if collection of principal or interest is considered doubtful. Loan origination fees and certain direct origination costs are capitalized and recognized as an adjustment of the yield on the related loan. Allowance for Loan Losses: The allowance for loan losses is a valuation allowance for probable incurred credit losses, increased by the provision for loan losses and decreased by charge-offs less recoveries. 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. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management's judgment, should be charged-off. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. A loan is impaired when full payment under the loan terms is not expected. Impairment is evaluated in total for smaller-balance loans of similar nature such as residential mortgage, consumer, and credit card loans, and on an individual loan basis for other loans. If a loan is impaired, a portion of the allowance is allocated so that the loan is reported, net, at the present value of estimated future cash flows using the loan's existing rate or at the fair value of collateral if repayment is expected solely from the collateral. Large groups of smaller balance homogenous loans, such as consumer and residential real estate loans are collectively evaluated for impairment, and accordingly, they are not separately identified for impairment disclosures. Mortgage Servicing Rights: 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 represent the allocated value of retained servicing rights on loans sold and the cost of purchased rights. Servicing assets are expensed in proportion to, and over the period of, estimated net servicing revenues. Impairment is evaluated based on the fair value of the assets, using interest rates, and geographic and prepayment characteristics. Fair value is determined using prices for similar assets with similar characteristics, when available, or based upon discounted cash flows using market-based assumptions. Any impairment of a grouping is reported as a valuation allowance, to the extent that fair value is less than the capitalized amount for a grouping. Federal Home Loan Bank Stock: Amount is carried at cost. Bank Premises and Equipment: Land is carried at cost. Bank premises and equipment are stated at cost less accumulated depreciation. Depreciation is recorded principally by the straight-line method over the estimated useful lives of the bank premises and equipment with useful lives ranging from 3 to 50 years. Real Estate Acquired Through Foreclosure: Real estate acquired through foreclosure is carried at the lower of the recorded investment in the property or its fair value. The value of the underlying loan is written down to the fair value of the real estate to be acquired by a charge to the allowance for loan losses, if necessary. Any subsequent write-downs are charged to operating expenses. Operating expenses of such properties, net of related income, and gains and losses on their disposition are included in other expenses. Repurchase Agreements: Substantially all repurchase agreement liabilities represent amounts advanced by various customers. Securities are pledged to cover these liabilities, which are not covered by federal deposit insurance. Stock Compensation: 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. 2004 2003 2002 Net income As reported $ 5,762,109 $ 4,233,377 $ 5,902,525 Deduct: Stock-based compensation expense determined under fair value based method (20,997) (31,972) (129,172) Pro forma 5,741,112 4,201,405 5,773,353 2004 2003 2002 Basic earnings per share As reported $ 2.09 $ 1.52 $ 2.13 Pro forma 2.08 1.51 2.08 Diluted earnings per share As reported $ 2.07 $ 1.50 $ 2.10 Pro forma 2.07 1.49 2.06 Weighted averages Fair value of options granted $ 3.01 $ 1.07 $ 2.43 Risk free interest rate 3.86% 3.40% 4.30% Expected life 8 years 8 years 8 years Expected volatility 13.74% 16.90% 22.28% Expected dividend yield 2.47% 2.96% 2.72% Income Taxes: 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. Goodwill: Goodwill results from prior business acquisitions and represents the excess of the purchase price over the fair value of acquired tangible assets and liabilities and identifiable intangible assets. Goodwill is assessed at least annually for impairment and any such impairment will be recognized in the period identified. Intangible Assets: Intangible assets include a premium on deposits paid in connection with the acquisition of a bank and branches which is being amortized on a straight-line basis over ten or fifteen years and capitalized mortgage servicing rights which are being amortized over the life of the related loans. Earnings Per Common Share: Basic earnings per common share is net income divided by the weighted average number of common shares outstanding during the period. Diluted earnings per common share include the dilutive effect of additional potential common shares issuable under stock options. Earnings and dividends per share are restated for all stock splits and dividends through the date of issuance of the financial statements. Comprehensive Income: Comprehensive income consists of net income and other comprehensive income. Other comprehensive income includes unrealized gains and losses on securities available for sale which are also recognized as a separate component of equity. Derivatives: The Company periodically enters into non-exchange traded mandatory forward sales contracts in conjunction with its mortgage banking operation. These contracts, considered derivatives, typically last 60 to 90 days and are used to offset the risk of interest rate changes between the time of the commitment to make a loan to a borrower at a stated rate and when the loan is sold. The Company did not have any mandatory forward sales contracts at December 31, 2004 and 2003. Adoption of New Accounting Standards: During 2004, 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. Industry Segments: While the Company's chief decision makers monitor the revenue streams of the various Company products and services, operations are managed and financial performance is evaluated on a Company-wide basis. Accordingly, all of the Company's operations are considered by management to be aggregated into one reportable operating segment. NOTE 2 - RESTRICTIONS ON CASH AND DUE FROM BANKS Included in cash and due from banks are certain non-interest bearing deposits that are held at the Federal Reserve or maintained in vault cash in accordance with average balance requirements specified by the Federal Reserve Board of Governors. The reserve requirement at December 31, 2004 and 2003 was $144,000 and $51,000. NOTE 3 - SECURITIES Year-end securities available for sale are as follows: Fair Unrealized Unrealized Value Gains Losses 2004 U. S. Treasury $ 2,984,375 $ - $ (30,033) U. S. government agencies 39,029,910 4,220 (384,112) States and political subdivisions 35,160,329 1,297,405 (163,285) Mortgage-backed 48,620,711 79,835 (677,298) Equity securities 971,536 363,589 - Total $ 126,766,861 $ 1,745,049 $(1,254,728) 2003 U. S. Treasury $ 3,033,125 $ 11,262 $ - U. S. government agencies 36,633,788 125,206 (132,778) States and political subdivisions 39,141,793 1,536,367 (49,808) Mortgage-backed 47,381,940 630,553 (192,657) Equity securities 1,534,666 326,787 (8,289) Other 1,064,518 55,503 - Total $ 128,789,830 $ 2,685,678 $ (383,532) The fair value of securities available for sale at December 31, 2004, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Securities not due at a single maturity are shown separately. Fair Value Due in one year or less $ 2,169,979 Due after one year through five years 34,877,005 Due after five years through ten years 23,322,989 Due after ten years 16,804,641 77,174,614 Mortgage-backed 48,620,711 Equity 971,536 Total $ 126,766,861 Proceeds from sales of securities during 2004, 2003 and 2002 were $37,973,553, $8,434,570 and $18,838,747. Gross gains of $483,888, $157,474 and $260,096 and gross losses of $194,938, $18,036 and $41,492, were realized on those sales, resprectively. The tax provision related to these realized gains and losses was $98,243, $47,409 and $74,325, respectively. Securities with an approximate carrying value of $103,979,000 and $83,220,000 at December 31, 2004 and 2003, were pledged to secure public deposits, trust funds, securities sold under agreements to repurchase and for other purposes as required or permitted by law. Securities with unrealized losses at year end 2004 and 2003 not recognized in income are as follows:
2004 Less than 12 Months 12 Months or More Total Fair Unrealized Fair Unrealized Fair Unrealized Description of Securities Value Loss Value Loss Value Loss U.S. Treasury $ 2,984,375 $ (30,033) $ - $ - $ 2,984,375 $ (30,033) U.S. Government securities 33,139,473 (384,112) - - 33,139,473 (384,112) States and political subdivisions 4,156,727 (91,011) 2,811,479 (72,274) 6,968,206 (163,285) Mortgage-backed 36,918,846 (571,246) 4,705,311 (106,052) 41,624,157 (677,298) Total temporarily impaired $77,199,421 $(1,076,402) $ 7,516,790 $ (178,326) $ 84,716,211 $(1,254,728)
2003 Less than 12 Months 12 Months or More Total Fair Unrealized Fair Unrealized Fair Unrealized Description of Securities Value Loss Value Loss Value Loss U.S. Government securities $ 1,023,844 $ (3,186) $15,971,530 $ (129,592) $ 16,995,374 $ (132,778) States and political subdivisions 681,517 (4,057) 4,129,333 (45,751) 4,810,850 (49,808) Mortgage-backed - - 16,190,489 (192,657) 16,190,489 (192,657) Other 170,050 (8,289) - - 170,050 (8,289) Total temporarily impaired $ 1,875,411 $ (15,532) $36,291,352 $ (368,000) $ 38,166,763 $ (383,532)
The Company evaluates securities for other-than-temporary impairment-at least on an annual basis, and more frequently when economic or market concerns warrant such evaluation. Consideration is given to the length of time and the extent to which the fair value has been less than cost, the financial condition and near-term prospects of the issuer, and the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. In analyzing an issuer's financial condition, the Company may consider whether the securities are issued by the federal government or its agencies, whether downgrades by bond rating agencies have occurred, and the results of reviews of the issuer's financial condition. NOTE 4 - LOANS Loans at year-end were as follows: 2004 2003 Commercial $ 19,999,038 $ 14,277,927 Real estate construction 32,256,168 14,313,068 Real estate mortgage 238,475,554 214,529,347 Agricultural 57,497,465 56,615,266 Consumer 9,062,518 12,977,419 Other 990,811 289,231 $ 358,281,554 $ 313,002,258 Activity in the allowance for loan losses was as follows: 2004 2003 2002 Beginning balance $ 3,819,842 $ 3,395,075 $ 3,386,425 Allowance from acquisition - 362,900 - Charge-offs (687,798) (1,397,822) (1,329,218) Recoveries 191,271 159,689 133,868 Provision for loan losses 840,000 1,300,000 1,204,000 Ending balance $ 4,163,315 $ 3,819,842 $ 3,395,075 Impaired loans totaled $1,781,000 and $1,844,000 at December 31, 2004 and 2003. The average recorded investment in impaired loans during 2004, 2003 and 2002 was $1,781,000, $1,051,000 and $1,441,000. The total allowance for loan losses related to these loans was $416,000 and $345,000 at December 31, 2004 and 2003. Interest income on impaired loans of $22,000, $14,000 and $8,000 was recognized for cash payments received in 2004, 2003 and 2002. Nonperforming loans were as follows: 2004 2003 2002 Loans past due over 90 days still on accrual $ 308,000 $ 779,000 $ 789,000 Nonaccrual loans 1,781,000 1,844,000 1,573,000 Nonperforming loans include impaired loans and smaller balance homogeneous loans, such as residential mortgage and consumer loans, that are collectively evaluated for impairment. Mortgage loans serviced for others are not included in the accompanying consolidated balance sheets. The unpaid principal balances of mortgage loans serviced for others was approximately $102,024,000 and $91,789,000 at December 31, 2004 and 2003. Custodial escrow balances maintained in connection with the foregoing loan servicing, and included in demand deposits, were approximately $467,000 and $658,000 at December 31, 2004 and 2003. Changes in mortgage servicing rights were as follows: 2004 2003 2002 Beginning balance $ 861,120 $ 704,034 $ 463,067 Additions 263,861 381,205 390,865 Amortization (249,348) (224,119) (149,898) Ending balance $ 875,633 $ 861,120 $ 704,034 Certain directors and executive officers of the Company and companies in which they have beneficiary ownership were loan customers of the Bank during 2004 and 2003. Such loans were made in the ordinary course of business at the Bank's normal credit terms and interest rates. An analysis of the activity with respect to all director and executive officer loans is as follows: 2004 2003 Balance, beginning of year $ 2,486,000 $ 1,626,000 Additions, including loans now meeting disclosure requirements 1,054,000 1,648,000 Amounts collected, including loans no longer meeting disclosure requirements (1,636,000) (788,000) Balance, end of year $ 1,904,000 $ 2,486,000 NOTE 5 - PREMISES AND EQUIPMENT Year-end premises and equipment were as follows: 2004 2003 Land and buildings $ 12,804,599 $ 12,242,809 Furniture and equipment 9,732,639 9,241,247 22,537,238 21,484,056 Less accumulated depreciation (11,159,226) (9,877,683) $ 11,378,012 $ 11,606,373 Depreciation expense was $993,907, $960,512 and $989,839 in 2004, 2003, and 2002. NOTE 6 - GOODWILL AND INTANGIBLE ASSETS The change in balance for goodwill during the year is as follows: 2004 2003 Beginning of year $ 10,199,830 $ - Acquired goodwill 10,199,830 Adjustment to goodwill (1,089,306) - End of year $ 9,110,524 $ 10,199,830 The adjustment to goodwill is a result of post merger Goodwill will not be amortized but instead evaluated periodically for impairment. Acquired intangible assets were as follows at year-end: 2004 2003 Gross Gross Carrying Accumulated Carrying Accumulated Amount Amortization Amount Amortization Amortized intangible assets: Core deposit intangibles $3,656,403 $2,794,782 $3,656,403 $2,519,292 Aggregate amortization expense was $275,490, $292,271 and $279,468 for 2004, 2003 and 2002. Estimated amortization expense for each of the next five years: 2005 $ 95,736 2006 95,736 2007 95,736 2008 95,736 2009 95,736 The change in balance for intangible assets during the year is as follows: 2004 2003 Beginning of year $ 1,137,111 $ 663,382 Amortization (275,490) (292,271) Acquired core deposit intangible - 766,000 End of year $ 861,621 $1,137,111 NOTE 7 - DEPOSITS At December 31, 2004, the scheduled maturities of time deposits are as follows: 2005 $ 147,472,621 2006 31,979,796 2007 14,097,399 2008 3,477,497 2009 1,264,782 Certain directors and executive officers of the Company and companies in which they have beneficial ownership are deposit customers of the Bank. The amount of these deposits was approximately $3,421,000 and $1,397,000 at December 31, 2004 and 2003. NOTE 8 - REPURCHASE AGREEMENTS Securities sold under agreements to repurchase are secured by U.S. Government securities with a carrying amount of $27,275,000 and $3,022,000 at year-end 2004 and 2003 Repurchase agreements generally mature within one year from the transaction date and range in maturities from 1 day to 3 years. The securities underlying the agreements are maintained in a third-party custodian's account under a written custodial agreement. Information concerning repurchase agreements for 2004 and 2003 is summarized as follows: 2004 2003 Average daily balance during the year $ 18,398,243 $ 1,691,154 Average interest rate during the year 1.90% 1.34% Maximum month-end balance during the year $ 21,946,746 $ 2,411,269 Weighted average interest rate at year end 2.94% 1.65% NOTE 9 - FEDERAL HOME LOAN BANK ADVANCES The Bank owns stock of the Federal Home Loan Bank (FHLB) of Cincinnati, Ohio. This stock allows the Bank to borrow advances from the FHLB. At December 31, 2004 and 2003, $59,749,666 and $53,232,296 represented the balance due on advances from the FHLB. All advances are paid either on a monthly basis or at maturity, over remaining terms of two months to twenty-six years, with fixed interest rates ranging from 1.52% to 7.23%. All advances require a prepayment penalty and certain advances are callable by the FHLB at various call dates throughout the term of the advance. Advances are secured by the FHLB stock and substantially all first mortgage loans. Scheduled principal payments due on advances during the years subsequent to December 31, 2004 are as follows: 2005 $ 8,256,036 2006 12,928,179 2007 7,953,684 2008 9,980,527 2009 14,010,028 Thereafter 6,621,212 $ 59,749,666 NOTE 10 - SUBORDINATED DEBENTURES In August 2003, the Company formed Kentucky Bancshares, Statutory Trust I ("Trust"). The Trust issued $7,000,000 of fixed/variable rate trust preferred securities as part of a pooled offering of such securities. The Company issued $7,217,000 subordinated debentures to the Trust in exchange for the proceeds of the offering, which debentures represent the sole asset of the Trust. The debentures pay interest quarterly at 7.06% for the first 5 years. Starting September 2008, the rate converts to three-month LIBOR plus 3.00 adjusted quarterly. The Company may redeem the subordinated debentures, in whole or in part, beginning September 2008 at a price of 100% of face value. The subordinated debentures must be redeemed no later than 2033. In accordance with FASB Interpretation No. 46, the Trust is not consolidated with the Company. Accordingly, the Company does not report the securities issued by the Trust as liabilities, and instead reports as liabilities the subordinated debentures issued by the Company and held by the Trust, as these are no longer eliminated in consolidation. NOTE 11 - INCOME TAXES Income tax expense was as follows: 2004 2003 2002 Current $ 2,179,238 $ 1,166,575 $ 2,189,931 Deferred 38,545 289,965 280,858 $ 2,217,783 $ 1,456,540 $ 2,470,789 Year-end deferred tax assets and liabilities were due to the following. No valuation allowance for the realization of deferred tax assets is considered necessary. 2004 2003 Deferred tax assets Allowance for loan losses $ 1,241,615 $ 942,354 Core deposit intangibles 46,720 18,569 Other 358,420 174,723 Deferred tax liabilities Unrealized gain on securities (166,874) (782,909) Bank premises and equipment (511,174) (460,980) FHLB stock (929,394) (859,218) Mortgage servicing rights (297,715) (292,781) Other (299,235) (401,183) Net deferred tax asset (liability) $ (557,637) $ (1,661,425) Effective tax rates differ from federal statutory rates applied to financial statement income due to the following: 2004 2003 2002 U. S. federal income tax rate 34.0% 34.0% 34.0% Changes from the statutory rate Tax-exempt investment income (7.0) (9.3) (5.7) Non-deductible interest expense related to carrying tax-exempt investments .6 .8 .6 Other .2 .1 .6 27.8% 25.6% 29.5% Federal income tax laws provided First Federal Savings Bank with additional bad debt deductions through 1987, totaling $1.3 million. Accounting standards do not require a deferred tax liability to be recorded on this amount, which otherwise would total a $441,000 liability at December 31, 2004. The Company's acquisition of First Federal Savings Bank did not require the recapture of the bad debt reserve. However, if Kentucky Bank was liquidated or otherwise ceased to be a bank, or if tax laws were to change, the $441,000 would be recorded as expense. NOTE 12 - EARNINGS PER SHARE The factors used in the earnings per share computation follow: 2004 2003 2002 Basic Earnings Per Share Net income $ 5,762,109 $ 4,233,377 $ 5,902,525 Weighted average common shares outstanding 2,757,233 2,781,146 2,770,282 Basic earnings per share $ 2.09 $ 1.52 $ 2.13 Diluted Earnings Per Share Net income $ 5,762,109 $ 4,233,377 $ 5,902,525 Weighted average common shares outstanding 2,757,233 2,781,146 2,770,282 Add dilutive effects of assumed exercise of stock options 20,203 45,640 35,836 Weighted average common and dilutive potential common shares outstanding 2,777,436 2,826,786 2,806,118 Diluted earnings per share $ 2.07 $ 1.50 $ 2.10 Stock options for 3,050 shares common stock from 2002 and for 11,350 shares of common stock were excluded from 2004 diluted earnings per share because their impact was antidilutive. There were no shares that were antidilutive in 2003. NOTE 13 - RETIREMENT PLANS The Company has a defined benefit pension plan covering substantially all of its employees. The Company's funding policy is to contribute annually the maximum amount that can be deducted for federal income tax purposes. Benefits are based on one percent of employee average earnings for the previous five years times years of credited service. Information about the pension plan was as follows: 2004 2003 Change in benefit obligation: Beginning benefit obligation $ 4,290,391 $ 4,385,567 Service cost 369,481 314,935 Interest cost 286,326 265,034 Actuarial adjustment 630,729 (601,900) Benefits paid (95,414) (73,245) Ending benefit obligation 5,481,513 4,290,391 Change in plan assets, at fair value: Beginning plan assets 4,075,719 3,397,218 Actual return 541,419 358,868 Employer contribution 276,984 392,878 Benefits paid (95,414) (73,245) Ending plan assets 4,798,708 4,075,719 Funded status (682,805) (214,672) Unrecognized net actuarial (gain) loss 932,175 523,815 Unrecognized prior transition asset (1,485) (1,857) Net pension prepaid benefit $ 247,885 $ 307,286 Amounts recognized in the balance sheet consist of: Prepaid benefit cost $ 247,885 Accrued benefit cost - Net amount recognized $ 247,885 The accumulated benefit obligation for defined benefit pension plans was $3,976,697 at year-end 2004. The projected benefit obligation, accumulated benefit obligation, and fair value of plan assets for the pension plans were $5,481,513, $3,976,697, and $4,798,708 respectively, as of year end 2004. Net periodic pension cost include the following components: 2004 2003 2002 Service cost $ 369,481 $ 314,935 $ 299,744 Interest cost 286,326 265,034 245,253 Expected return on plan assets (319,050) (265,117) (255,964) Amortization (372) 16,758 5,221 Net periodic cost $ 336,385 $ 331,610 $ 294,254 Weighted-average assumptions used to determine net cost 2004 2003 2002 Discount rate on benefit obligation 6% 7% 7% Long-term expected rate of return on plan assets 8% 8% 8% Rate of compensation increase 4% 5% 5% The Company's pension plan asset allocation at year-end 2004, target allocation for 2005, and expected long-term rate of return by asset category are as follows: Weighted Percentage Percentage Average of Plan of Plan Expected Target Assets at Assets at Long-Term Allocation Year-End Year-End Rate of Return Asset Category 2005 2004 2003 2004 Equity securities 55-65 64.9 51.7 10% Debt securities 35-45 34.6 38.1 6 Cash 5-15 0.5 10.2 4 Total 100.0 100.0 The asset allocation objective for 2005 and following is to be 60% in equity securities and 40% in debt securities. These percentages may vary 5-10 basis points based on market conditions of equity and bond markets. The Company expects to contribute $255,000 to its pension plan in 2005. The Company also has a qualified profit sharing plan which covers substantially all employees and includes a 401(k) provision. Profit sharing contributions, excluding the 401(k) provision, are at the discretion of the Company's Board of Directors. Expense recognized in connection with the plan was $309,741, $271,684 and $270,048 in 2004, 2003 and 2002. NOTE 14 - STOCK OPTION PLAN The Company grants certain officers and key employees stock option awards which vest and become fully exercisable at the end of five years and provides for issue of up to 220,000 options. The Company also grants certain directors stock option awards which vest and become fully exercisable immediately and provides for issue of up to 20,000 options. The exercise price of each option, which has a ten year life, was equal to the market price of the Company's stock on the date of grant; therefore, no compensation expense was recognized. Summary of stock option transactions are as follows:
2004 2003 2002 Weighted Weighted Weighted Option Option Option Options Price Options Price Options Price Outstanding, beginning of year 57,560 $20.23 83,114 $16.72 103,484 $15.52 Granted 12,250 33.65 14,500 25.72 6,520 25.85 Expired (2,316) 27.03 (3,698) 25.00 (6,096) 20.84 Exercised (6,930) 17.55 (36,356) 13.89 (20,794) 12.41 Outstanding, end of year 60,564 $23.00 57,560 $20.23 83,114 $16.72 Weighted remaining contractual Life 67.0 months 67.9 months 64.7 months
Options outstanding at year-end 2004 were as follows:
Outstanding Exercisable Weighted Average Weighted Weighted Remaining Average Average Contractual Exercise Exercise Range of Exercise Prices Options Life Price Options Price From $12.50 to $15.50 per share 15,320 26.6 $14.02 15,320 $14.02 From $18.00 to $20.63 per share 13,640 48.1 20.52 13,640 20.52 From $23.50 to $28.00 per share 20,354 87.1 25.37 8,216 25.32 From $33.90 to $34.00 per share 11,250 108.3 33.91 1,100 34.00 60,564 38,276
NOTE 15 - LIMITATION ON BANK DIVIDENDS The Company's principal source of funds is dividends received from the Bank. Banking regulations limit the amount of dividends that may be paid by the Bank without prior approval of regulatory agencies. Under these regulations, the amount of dividends that may be paid in any calendar year is limited to the current year's net profits, as defined, combined with the retained net profits of the preceding two years. During 2005 the Bank could, without prior approval, declare dividends of approximately $4,015,000 plus any 2005 net profits retained to the date of the dividend declaration. NOTE 16 - DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS The fair values of the Company's financial instruments at December 31, 2004 and 2003 are as follows: 2004 2003 Carrying Carrying Amount Fair Value Amount Fair Value (In Thousands) Financial assets Cash and cash equivalents $ 15,455 $ 15,455 $ 21,388 $ 21,388 Securities 126,767 126,767 128,790 128,790 Mortgage loans held for sale 176 178 7,759 7,851 Loans, net 354,118 350,912 309,182 312,596 FHLB stock 5,136 5,136 4,930 4,930 Interest receivable 3,226 3,226 3,250 3,250 Financial liabilities Deposits $ 387,955 $ 390,296 $ 384,599 $ 387,083 Securities sold under agreements to repurchase and other borrowings 25,593 25,467 7,285 7,285 FHLB advances 59,750 59,281 53,232 53,747 Subordinated debentures 7,217 7,354 7,217 7,385 Interest payable 1,849 1,849 1,636 1,636 Carrying amount is the estimated fair value for cash and cash equivalents, short-term borrowings, Federal Home Loan Bank stock, accrued interest receivable and payable, demand deposits, short-term debt, and variable rate loans or deposits that reprice frequently and fully. Security fair values are based on market prices or dealer quotes, and if no such information is available, on the rate and term of the security and information about the issuer. For fixed rate loans or deposits and for variable rate loans or deposits with infrequent repricing or repricing limits, fair value is based on discounted cash flows using current market rates applied to the estimated life and credit risk. Fair values for impaired loans are estimated using discounted cash flow analysis or underlying collateral values. Fair value of debt is based on current rates for similar financing. The fair value of commitments to extend credit and standby letters of credit is not considered material. NOTE 17 - BUSINESS COMBINATION 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 $9,111,000 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 9,111,000 Core deposit intangible 766,000 Other assets 19,557,000 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 The following table presents pro forma information as if the acquisition had occurred at the beginning of 2004 and 2003. The pro forma information includes adjustments for interest income on loans and securities acquired, amortization of intangibles arising from the transaction, depreciation expense on property acquired, interest expense on deposits acquired, and the related income tax effects. The pro forma financial information is not necessarily indicative of the results of operations as they would have been had the transactions been effected on the assumed dates. 2003 2002 Net interest income $ 16,368,000 $ 16,368,000 Net income $ 4,838,000 $ 4,838,000 Basic earnings per share $ 1.74 $ 1.74 Diluted earnings per share $ 1.71 $ 1.71 NOTE 18 - OFF-BALANCE SHEET ACTIVITIES AND COMMITMENTS 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: 2004 2003 Unused lines of credit $ 54,930,000 $ 47,148,000 Commitments to make loans 1,272,000 1,379,000 Letters of credit 145,000 252,000 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 5.75% with maturities ranging from 15 to 30 years and are intended to be sold. NOTE 19 - CONTINGENT LIABILITIES The Bank is a defendant in legal actions arising from normal business activities. Management believes these actions are without merit or that the ultimate liability, if any, resulting from them will not materially affect the Company's consolidated financial position or results of operations. NOTE 20 - CAPITAL REQUIREMENTS Regulatory Matters: The Company and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possible additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of the Company's and the Bank's assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Company and Bank capital amounts and classifications are also subject to qualitative judgments by regulators about components, risk weightings, and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (set forth in the following table) of Total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital to average assets (as defined). Management believes, as of December 31, 2004 and 2003, that the Company and the Bank meet all capital adequacy requirements to which they are subject. The most recent notification from the Federal Deposit Insurance Corporation categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Bank must maintain minimum Total risk-based, Tier I risk-based and Tier I leverage ratios as set forth in the following table. There are no conditions or events since that notification that management believes have changed the institution's category. The Company's and the Bank's actual amounts and ratios are presented in the table below:
To Be Well Capitalized Under Prompt For Capital Corrective Actual Adequacy Purposes Action Provisions Amount Ratio Amount Ratio Amount Ratio 2004 (Dollars in Thousands) Consolidated Total Capital (to Risk-Weighted Assets) $ 45,987 13.2% $ 27,855 8% $ 34,819 10% Tier I Capital (to Risk-Weighted Assets) 41,660 12.0 13,928 4 20,891 6 Tier I Capital (to Average Assets) 41,660 8.2 20,410 4 25,512 5 Bank Only Total Capital (to Risk-Weighted Assets) $ 44,512 12.8% $ 27,791 8% $ 34,739 10% Tier I Capital (to Risk-Weighted Assets) 40,338 11.6 13,895 4 20,843 6 Tier I Capital (to Average Assets) 40,338 7.9 20,368 4 25,460 5 2003 Consolidated Total Capital (to Risk-Weighted Assets) $ 44,078 13.9% $ 25,359 8% $ 31,698 10% Tier I Capital (to Risk-Weighted Assets) 40,115 12.7 12,679 4 19,019 6 Tier I Capital (to Average Assets) 40,115 8.8 18,154 4 22,692 5 Bank Only Total Capital (to Risk-Weighted Assets) $ 40,762 12.9% $ 25,264 8% $ 31,580 10% Tier I Capital (to Risk-Weighted Assets) 36,932 11.7 12,632 4 18,948 6 Tier I Capital (to Average Assets) 36,932 8.1 18,105 4 22,632 5
NOTE 21 - PARENT COMPANY FINANCIAL STATEMENTS Condensed Balance Sheets December 31 2004 2003 (In Thousands) ASSETS Cash on deposit with subsidiary $ 721 $ 1,783 Investment in subsidiary 50,481 49,593 Securities available for sale 698 1,247 Other assets 363 670 Total assets $ 52,263 $ 53,293 LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities Subordinated debentures $ 7,217 $ 7,217 Other Liabilities 19 19 Stockholders' equity Preferred stock - - Common stock 6,819 6,985 Retained earnings 37,884 37,553 Accumulated other comprehensive income 324 1,519 Total liabilities and stockholders' equity $ 52,263 $ 53,293 Condensed Statements of Income and Comprehensive Income Years Ended December 31 2004 2003 2002 (In Thousands) Income Dividends from subsidiary $ 3,650 $ 13,025 $ 3,400 Securities gains (losses), net 82 7 145 Interest income 24 20 32 Total income 3,756 13,052 3,577 Expenses Interest expense 494 169 - Other expenses 157 360 55 Income before income taxes and equity in undistributed income of subsidiary 3,105 12,523 3,522 Applicable income tax (expense) benefits 177 175 (29) Income before equity in undistributed income of subsidiary 3,282 12,698 3,493 Equity in undistributed income of subsidiary 2,480 (8,465) 2,410 Net income 5,762 4,233 5,903 Other comprehensive income (loss), net of tax: Unrealized gains (losses) on securities arising during the period (1,004) (237) 1,245 Reclassification of realized amount (191) (92) (144) Net change in unrealized gain (loss) on securities (1,195) (329) 1,101 Comprehensive income $ 4,567 $ 3,904 $ 7,004 Condensed Statements of Cash Flows Years Ended December 31 2004 2003 2002 (In Thousands) Cash flows from operating activities Net income $ 5,762 $ 4,233 $ 5,903 Adjustments to reconcile net income to net cash from operating activities Equity in undistributed earnings of Subsidiary (2,480) 8,465 (2,410) Securities (gains) losses, net (82) (7) (145) Change in other assets 659 (553) (100) Change in other liabilities - (10) 103 Net cash from operating activities 3,859 12,128 3,351 Cash flows from investing activities Purchase of securities available for sale - (82) (109) Proceeds from sales of securities available for sale 675 65 869 Acquisition of Kentucky First Bancorp, Inc. - (20,998) - Net cash from investing activities 675 (21,015) 760 Cash flows from financing activities Proceeds from subordinated debentures - 7,000 - Dividends paid (2,303) (2,117) (1,885) Proceeds from issuance of common stock 131 189 188 Purchase of common stock (3,424) (11) (315) Net cash from financing activities (5,596) 5,061 (2,012) Net change in cash (1,062) (3,826) 2,099 Cash at beginning of year 1,783 5,609 3,510 Cash at end of year $ 721 $ 1,783 $ 5,609 NOTE 22 - QUARTERLY FINANCIAL DATA (UNAUDITED) Interest Net Interest Net Earnings Per Share Income Income Income Basic Fully Diluted 2004 First quarter $ 6,267 $ 4,071 $ 1,150 $ .41 $ .41 Second quarter 6,463 4,267 1,439 .51 .51 Third quarter 6,506 4,252 1,579 .58 .57 Fourth quarter 6,610 4,189 1,594 .59 .58 2003 First quarter $ 5,662 $ 3,620 $ 1,183 $ .43 $ .42 Second quarter 5,611 3,685 1,172 .42 .42 Third quarter 5,345 3,505 1,261 .45 .45 Fourth quarter 5,711 3,644 617 .22 .21 The fourth quarter 2003 decrease in net income is mainly attributable to an addition to the allowance for loan losses, business combination expenses and a loss on sale of fixed assets. REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Board of Directors Kentucky Bancshares, Inc. Paris, Kentucky We have audited the accompanying consolidated balance sheets of Kentucky Bancshares, Inc. as of December 31, 2004 and 2003, and the related consolidated statements of income, comprehensive income, changes in stockholders' equity and cash flows for each of the three years in the period ended December 31, 2004. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Kentucky Bancshares, Inc. as of December 31, 2004 and 2003, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2004, in conformity with accounting principles generally accepted in the United States of America. Crowe Chizek and Company LLC Lexington, Kentucky March 1, 2005 Meet Our Officers... SENIOR MANAGEMENT Louis Prichard, President and Chief Executive Officer Norman J. Fryman, Sr. Vice President, Director of Sales and Service Greg Dawson, VP, Chief Financial Officer Brenda Bragonier, VP, Director of Marketing and Human Resources Hugh Crombie, VP, Director of Operations Clark Nyberg, VP, Director of Wealth Management OFFICERS BOURBON COUNTY Karen Anderson, Electronic Banking Officer Heather Barger, VP, Director of Risk Management Melinda Biddle, Government Reporting Officer Brenda Berry, AVP, Senior Accountant Rhonda Brown, Consumer Lender Wallis Brooks, Branch Manager, CRA Officer Patricia Carpenter, AVP, Data Management Officer R.W. Collins, VP, Agricultural Lender Robbie Cox, Senior Auditor Cynthia Criswell, Data Processing Officer Brandon Eason, Consumer Lender Nancye Fightmaster, VP, Bourbon County Regional Manager David Foster, VP, Agricultural Lender Janice Hash, AVP, Senior Accountant, Purchasing Lisa Highley, Personal Trust Officer Philip Hurst, Assistant Branch Manager Perry Ingram, AVP, Network Manager Susan Lemons, AVP, Branch Manager, Consumer Lender Jane Mogge, Document Management Officer Donnie Roe, AVP, Senior Data Processing Officer Lydia Sosby, AVP, Director of Training and Sales Judith Taylor, VP, Human Resource Manager George Wilder, VP, Commercial Lender Buckner Woodford, Chairman of the Board Martha Woodford, VP, Assistant Director of Operations Jan Worth, AVP, Personal Trust Officer CLARK COUNTY Nick Carter, VP, Clark County Regional Manager Darren Henry, VP, Director of Commercial Lending Kathy Newkirk, Branch Manager, Consumer Lender Rowena Ruff, Investment Advisor Teresa Shimfessel, AVP, Consumer Lender James Brandon Sumpter, Consumer Lender Carolyn Wilkins, Overdraft Management Officer HARRISON COUNTY Ken DeVasher, VP, Harrison County Regional Manager Dreama Harris, AVP, Consumer Lender Catherine Hill, VP, Collections Officer Mary Moreland, AVP, Collections Officer Iva Joyce Rainey, Consumer Lender Arnita Willoughby, Mortgage Operations Manager JESSAMINE COUNTY Mike Lovell, VP, Commercial Lender Rick Walling, VP, Jessamine County Regional Manager SCOTT COUNTY Shane Foley, VP, Mortgage Lender Pam Jessie, VP, Scott County Regional Manager Sharon Whitlock, Branch Manager, Consumer Lender WOODFORD COUNTY Duncan Gardiner, VP, Woodford County Regional Manager A. J. Gullett, VP, Commercial Lender Board of Directors - Kentucky Bank William M. Arvin, Attorney Dan Brewer, President and CEO Bluegrass Energy Gus Bynum, Physician Loren Carl, Field Representative, Congressman Ben Chandler James Ferrell, Physician Mary Beth Hendricks, Director of Clark County Child Support Services Henry Hinkle, President, Hinkle Contracting Corporation Theodore Kuster, Farmer and Thoroughbred Breeder, Westview-Hillside Farms Ted McClain, Agent, Hopewell Insurance Company Louis Prichard, President and CEO, Kentucky Bank William R. Stamler, Chairman, Signal Investments, Inc. Joel Techau, CEO, Techau Inc. Robert G. Thompson, Farmer and Thoroughbred Breeder, Snowhill Farm Woodford Van Meter, Ophthalmologist Buckner Woodford, Chairman, Kentucky Bank CLARK Mary Beth Hendricks, Director, Clark County Child Support Services Donald Pace, Executive Director, Central Kentucky Educational Co-op with UK John Roche, Optician Edwin Saunier, President, Saunier North American, Inc. HARRISON K. Bruce Florence, Director, Licking Valley College Betty Long, Retired President, First Federal Savings Bank of Cynthiana Brad Marshall, Farmer and Owner, Marshall's Tractor Supply Joel Techau, CEO, Techau Inc. Gerry Whalen, Broker, Whalen and Company JESSAMINE William M. Arvin, Attorney Dan Brewer, President and CEO, Bluegrass Energy Tom Buford, State Senator Jonah Mitchell, President, Jonah Mitchell Real Estate and Auction Company Eva McDaniel, Jessamine County Clerk SCOTT Gus Bynum, Physician Mike Hockensmith, Owner and President, The Hockensmith Agency, Inc. R. C. Johnson, Jr., Owner and President, Johnson's Funeral Home George Lusby, County Judge Executive Everette Varney, Mayor WOODFORD Loren Carl, Field Representative, Congressman Ben Chandler William Graul, Physician James Kay, Businessman, Farmer Tricia Kittinger, Woodford County Circuit Clerk 27 Kentucky Bancshares, Inc. LOUIS PRICHARD President and CEO, Kentucky Bank and Kentucky Bancshares, Inc. JAMES FERRELL Physician BUCKNER WOODFORD Chairman, Kentucky Bank and Kentucky Bancshares, Inc. WILLIAM STAMLER Chairman, Signal Investments, Inc. TED McCLAIN Agent, Hopewell Insurance Company BETTY LONG Retired President, First Federal Savings of Cynthiana ROBERT G. THOMPSON Farmer and Thoroughbred Breeder, Snowhill Farm HENRY HINKLE President, Hinkle Contacting Corporation THEODORE KUSTER Farmer and Thoroughbred Breeder, Westview-Hillside Farms WILLIAM M. ARVIN Attorney, William M. Arvin Associates WOODFORD VAN METER Opthalmologist KENTUCKY BANCSHARES, INC. PROXY STATEMENT Introduction This Proxy Statement is being furnished to shareholders of Kentucky Bancshares, Inc., a Kentucky corporation (the "Company"), in connection with the solicitation of proxies by the Board of Directors of the Company (the "Board") from holders of record of the Company's outstanding Common Shares (the "Common Shares") as of the close of business on March 18, 2005 (the "Annual Meeting Record Date"), for use at the Annual Meeting of Shareholders of the Company (the "Annual Meeting") to be held on Tuesday, May 10, 2005, at 11:00 a.m. (Eastern Daylight Time) in the Board Room of Kentucky Bank, Fourth and Main Streets, Paris, Kentucky, and at any adjournment or postponement thereof. This Proxy Statement is first being mailed to the Company's shareholders on or about March 28, 2005. The principal executive offices of the Company are located at Fourth and Main Streets, Paris, Kentucky 40361. Its telephone number is (859) 987-1795. Purposes of the Annual Meeting At the Annual Meeting, holders of Common Shares will be asked to consider and to vote upon the following matters: (1) To elect three Class III directors; (2) To approve the adoption of the 2005 Restricted Stock Grant Plan (the "Stock Grant Plan") and (3) To transact such other business as may properly come before the meeting. The Board recommends that shareholders vote FOR the election of the Board's nominees for Class III directors and FOR the adoption of the Stock Grant Plan. As of the date of this Proxy Statement, the Board knows of no other business to come before the Annual Meeting. Voting Rights and Proxy Information Only holders of record of Common Shares as of the close of business on the Annual Meeting Record Date will be entitled to notice of and to vote at the Annual Meeting or any adjournment or postponement thereof. As of the Annual Meeting Record Date, there were 2,684,698 Common Shares outstanding and entitled to vote at the Annual Meeting. The presence, either in person or by properly executed proxy, of the holders of a majority of the outstanding Common Shares as of the Annual Meeting Record Date is necessary to constitute a quorum at the Annual Meeting. Holders of Common Shares are entitled to one vote per share on any matter, other than the election of directors, that may properly come before the Annual Meeting. In the election of directors, holders of Common Shares have cumulative voting rights whereby each holder is entitled to vote the number of Common Shares owned multiplied by three (the number of directors to be elected at the Annual Meeting), and each holder may cast the whole number of votes for one candidate or distribute such votes among two or more candidates. The Board of Directors is soliciting discretionary authority for the individuals appointed in the proxies to cumulate votes represented by properly executed proxies and to vote for less than all the Company's nominees to the Board if deemed appropriate to ensure the election of as many of the Company's nominees to the Board as possible. Those persons receiving the three highest number of votes in the election of directors will be elected to the Board. The Stock Grant Plan will be approved if the holders of a majority of the Common Shares represented in person or by proxy at the Annual Meeting vote in favor of its adoption. All Common Shares that are represented at the Annual Meeting by properly executed proxies received before or at the Annual Meeting and not revoked will be voted at the Annual Meeting in accordance with the instructions indicated in such proxies. If no instructions are indicated, such proxies will be voted "FOR" the election of the Board's three nominees as Class III directors of the Company (or, if deemed appropriate by the individuals appointed in the proxies, cumulatively voted for less than all of the Board's nominees), and "FOR" the adoption of the Stock Grant Plan. Any proxy given pursuant to this solicitation may be revoked by the person giving it at any time before it is voted. Proxies may be revoked by (i) filing with the Company, to the attention of Gregory J. Dawson, Secretary, at or before the Annual Meeting, a written notice of revocation bearing a later date than the proxy, (ii) duly executing a subsequent proxy relating to the same Common Shares and delivering it to the Company at or before the Annual Meeting or (iii) attending the Annual Meeting and voting in person (although attendance at the Annual Meeting will not in and of itself constitute a revocation of a proxy). Any written notice revoking a proxy should be sent to Kentucky Bancshares, Inc., P. O. Box 157, Paris, Kentucky 40362-0157, Attention Gregory J. Dawson, Secretary. The Company will bear the cost of the solicitation of proxies by the Board in connection with the Annual Meeting. In addition to solicitation by mail, the Company will request banks, brokers and other custodian nominees and fiduciaries to supply proxy material to the beneficial owners of Common Shares, and will reimburse them for their expenses in so doing. Certain directors, officers and other employees of the Company, not specially employed for this purpose, may solicit proxies without additional remuneration therefore, by personal interview, mail, telephone, facsimile or other electronic means. Item 1 - Election of Directors Under the Company's Amended and Restated Articles of Incorporation, the Board of Directors consists of three different classes (Class I, Class II and Class III), each to serve, subject to the provisions of the Amended and Restated Articles of Incorporation and Bylaws, for a three year term and until his successor is duly elected and qualified. Except as listed below, each nominee for a Class III directorship has held the specified position for the last five years. The names of the nominees proposed for election as Class III directors, all of whom are presently directors of the Company, are set forth below. The Company is not aware of any other individual who may be nominated for election to the Board of Directors at the Annual Meeting. Henry L. Hinkle is president of Hinkle Contracting Corporation. He became a director of Kentucky Bank and the Company in 1989. Theodore Kuster is a farmer and thoroughbred breeder with West View Equine. He became a director of Kentucky Bank in 1979 and the Company in 1985. Robert G. Thompson is a farmer and thoroughbred breeder with Snowhill Farm. He became a director of Kentucky Bank and the Company in 1991. The Board of Directors does not contemplate that any of the nominees will be unable to accept election as a director for any reason. However, if one or more of such nominees is unable or unwilling to accept or is unavailable to serve, the persons named in the proxies or their substitutes shall have authority, according to their judgment, to vote or to refrain from voting for other individuals as directors. The Board recommends that shareholders vote "FOR" each of the above nominees for election as Class III directors of the Company. Item 2 - Adoption of Stock Grant Plan On February 15, 2005, the Company's Board of Directors adopted the 2005 Restricted Stock Grant Plan, subject to shareholder approval. A copy of the Stock Grant Plan is attached to the Proxy Statement as Annex A. The purpose of the Stock Grant Plan is to promote the growth and general prosperity of the Company and its subsidiaries by granting Company stock to employees who will largely be responsible for the long-term success and development of the Company and to better align their interests with those of Company shareholders. The Company further intends to use stock grants ("Restricted Stock Awards") to attract and retain new employees and stimulate their efforts on behalf of the Company. The Stock Grant Plan will be administered by a committee (the "Committee") appointed by the Board. Subject to the provisions of the Stock Grant Plan, the Committee will have full authority to administer the Stock Grant Plan, including without limitation, the authority to: (a) select participants to whom Restricted Stock Awards are granted; (b) determine the size and frequency of Restricted Stock Awards granted under the Stock Grant Plan; (c) determine the terms and conditions of Restricted Stock Awards, including any restrictions or conditions, which need not be identical; (d) waive any or all the restrictions and conditions applicable to, any Restricted Stock Award, for any reason; (e) construe and interpret the Stock Grant Plan and any agreement or instrument entered into under the Stock Grant Plan; (f) establish, amend and rescind rules and regulations for the Stock Grant Plan's administration; and (g) amend the terms and conditions of any outstanding Restricted Stock Award to the extent such terms and conditions are within the discretion of the Committee as provided in the Stock Grant Plan. The maximum number of shares which may be issued under to the Stock Grant Plan is 50,000 Common Shares. The Restricted Stock Awards and the maximum number of shares that may be issued under the Stock Grant Plan will be adjusted by the Board, but only in order to prevent dilution or enlargement of such awards in the event of a stock dividend, stock split-up or share combination, exchange of shares, recapitalizations, merger, consolidation, acquisition of property or shares, separation, reorganization, liquidation, or the like of or by Company. All employees of the Company and its subsidiaries are eligible to receive awards under the Stock Grant Plan. In selecting employees to receive awards under the Stock Grant Plan, as well as in determining the number of Common Shares subject to and the other terms and conditions applicable to each award, the Committee will take into consideration such factors as it deems relevant in promoting the purposes of the Stock Grant Plan, including the duties of the employees, their present and potential contribution to the success of Company and their anticipated number of years in active service remaining with Company or a subsidiary. The Stock Grant Plan will become effective on January 1, 2006, if the Stock Grant Plan has been approved by the Stockholders at the Annual Meeting. The Board recommends that shareholders vote "FOR" the adoption of the Stock Grant Plan. Item 3 - Other Matters As of the date of this Proxy Statement, the Company knows of no business that will be presented for consideration at the Annual Meeting other than that referred to above. At the Annual Meeting, only such business will be conducted, and only such proposals or director nominations will be acted upon, as have been properly brought before the meeting in accordance with the Company's Bylaws. Proxies in the enclosed form will be voted in respect of any other business that is properly brought before the Annual Meeting in accordance with the judgment of the person or persons voting the proxies. By Order of the Board of Directors Gregory J. Dawson, Secretary March 28, 2005 This Proxy Form is Solicited by the Board of Directors Kentucky Bancshares, Inc. Paris, Kentucky The undersigned hereby appoints Buckner Woodford IV and Gregory J. Dawson, or either one of them (with full power to act alone), my proxy, each with the power to appoint his substitute, to represent me to vote all of the Corporation's Common Stock which I held of record or am otherwise entitled to vote at the close of business on March 18, 2005, at the 2005 Annual Meeting of Shareholders to be held on May 10, 2005 and at any adjournments thereof, with all powers the undersigned would possess if personally present, as follows: 1. ELECTION OF DIRECTORS FOR all nominees listed below (except as otherwise indicated below) AGAINST all nominees listed below Henry L. Hinkle, Theodore Kuster, and Robert G. Thompson (INSTRUCTION: To withhold authority to vote for any individual nominee, write the nominee's name on the line) _________________________________________________________________ 2. ADOPTION OF STOCK GRANT PLAN FOR AGAINST ABSTAIN 3. OTHER BUSINESS. In their discretion, the Proxies are authorized to act upon such other matters as may properly be brought before the Annual Meeting or any adjournment thereof. THE BOARD OF DIRECTORS RECOMMENDS A VOTE "FOR" ALL OF THE NOMINEES LISTED IN ITEM I AND "FOR" THE ADOPTION OF THE STOCK GRANT PLAN IN ITEM 2. (PLEASE DATE, MARK, SIGN AND RETURN IMMEDIATELY) This proxy form relates to ALL shares owned by the undersigned. This proxy form is solicited by the Board of Directors and will be voted as specified and in accordance with the accompanying proxy statement. If no instruction is indicated, this proxy form will be voted "FOR" all of the nominees listed in Item 1 and "FOR" the adoption of the Stock Grant Plan in Item 2. Please sign exactly as name appears. When shares are held by joint tenants, both should sign. When signing as attorney, as executor, administrator, trustee, or guardian, please give full title as such. If a corporation, please sign full corporate name by President or other authorized officer. If a partnership, please sign partnership name by authorized person. DATE___________, 2005 ________________________________ Signature ________________________________ Signature if held jointly 89 EX-21 4 exhibit21subsidiaries.txt SUBSIDIARIES Exhibit 21 Subsidiaries of Registrant Kentucky Bancshares, Inc.'s Subsidiary Kentucky Bank 90 EX-23 5 exhibit23.txt CONSENT EXHIBIT 23 CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM We hereby consent to the incorporation by reference in the Form S-8 Registration Statement No. 333-92725 of Kentucky Bancshares, Inc., of our report dated March 1, 2005 on the consolidated financial statements of Kentucky Bancshares, Inc. as of December 31, 2004 and 2003 and for each of the three years in the period ended December 31, 2004 as included in the registrant's annual report on Form 10-K. /s/Crowe Chizek and Company LLC Crowe Chizek and Company LLC Lexington, Kentucky March 29, 2005 91 EX-31 6 exhibit311.txt CEO CERTIFICATION Exhibit 31.1 CERTIFICATION OF CHIEF EXECUTIVE OFFICER PURSUANT TO SECTION 302 OF SARBANES-OXLEY ACT I, Louis Prichard, certify that: 1. I have reviewed this annual report on Form 10-K of Kentucky Bancshares, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls over financial reporting. Date: March 30, 2005 BY /s/ Louis Prichard Louis Prichard President & Chief Executive Officer 92 92 EX-31 7 exhibit312.txt CFO CERTIFICATION Exhibit 31.2 CERTIFICATION OF CHIEF FINANCIAL OFFICER PURSUANT TO SECTION 302 OF SARBANES-OXLEY ACT I, Gregory J. Dawson, certify that: 1. I have reviewed this annual report on Form 10-K of Kentucky Bancshares, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls over financial reporting. Date: March 30, 2005 BY /s/ Gregory J. Dawson Gregory J. Dawson Chief Financial Officer 93 EX-32 8 exhibit321.txt CEO CERTIFICATION Exhibit 32.1 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of Kentucky Bancshares, Inc. (the "Company") on Form 10-K for the period ended December 31, 2004 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Louis Prichard, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes- Oxley Act of 2002, that to my knowledge: (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company. ___/s/ Louis Prichard_______ Chief Executive Officer March 30, 2005 A signed original of this written statement required by Section 906 has been provided to Kentucky Bancshares, Inc. and will be retained by Kentucky Bancshares, Inc. and furnished to the Securities and Exchange Commission or its staff upon request. 94 EX-32 9 exhibit322.txt CFO CERTIFICATION Exhibit 32.2 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of Kentucky Bancshares, Inc. (the "Company") on Form 10-K for the period ended December 31, 2004 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Gregory J. Dawson, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that to my knowledge: (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company. ___/s/ Gregory J. Dawson____ Chief Financial Officer March 30, 2005 A signed original of this written statement required by Section 906 has been provided to Kentucky Bancshares, Inc. and will be retained by Kentucky Bancshares, Inc. and furnished to the Securities and Exchange Commission or its staff upon request. 95 -----END PRIVACY-ENHANCED MESSAGE-----