10-Q 1 q091.txt FORM 10Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (Mark One) [ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended March 31, 2009 or [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ____________________ to ___________________ Commission File Number: 000-52598 KENTUCKY BANCSHARES, INC. (Exact name of registrant as specified in its charter) Kentucky 61-0993464 (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) P.O. Box 157, Paris, Kentucky 40362-0157 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (859) 987-1795 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No _____ Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes _____ No _X____ Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act. Large accelerated filer ____ Accelerated filer ____ Non-accelerated filer X (Do not check if a smaller reporting company) Smaller reporting company ____ Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes No X _ Number of shares of Common Stock outstanding as of April 30, 2009: 2,749,443. KENTUCKY BANCSHARES, INC. Table of Contents Part I - Financial Information Item 1. Financial Statements Consolidated Balance Sheets 3 Consolidated Statements of Income and Comprehensive Income 4 Consolidated Statement of Changes in Stockholders' Equity 5 Consolidated Statements of Cash Flows 6 Notes to Consolidated Financial Statements 7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 15 Item 3. Quantitative and Qualitative Disclosures About Market Risk 21 Item 4. Controls and Procedures 22 Part II - Other Information 22 Signatures 23 Exhibits 31.1 Certifications of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 24 31.2 Certifications of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 26 32 Certifications of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 28 Item 1 - Financial Statements KENTUCKY BANCSHARES, INC. CONSOLIDATED BALANCE SHEETS (unaudited) (thousands) 3/31/2009 12/31/2008 Assets Cash and due from banks $ 11,559 $ 16,411 Federal funds sold 2,350 20,695 Cash and cash equivalents 13,909 37,106 Securities available for sale 205,886 172,834 Loans 415,638 424,276 Allowance for loan losses (5,999) (5,465) Net loans 409,639 418,811 Federal Home Loan Bank stock 6,731 6,731 Bank premises and equipment, net 17,875 17,875 Interest receivable 4,505 5,156 Goodwill 13,117 13,117 Other intangible assets 1,456 1,523 Mortgage servicing rights 593 465 Other assets 5,323 5,157 Total assets $ 679,034 $ 678,775 Liabilities and Stockholders' Equity Deposits Non-interest bearing $ 96,195 $ 90,480 Time deposits, $100,000 and over 115,103 108,465 Other interest bearing 315,083 321,863 Total deposits 526,381 520,808 Repurchase agreements and other borrowings 13,546 10,717 Federal Home Loan Bank advances 66,723 77,301 Subordinated debentures 7,217 7,217 Interest payable 3,716 2,874 Other liabilities 2,728 2,817 Total liabilities 620,311 621,734 Stockholders' equity Common stock 12,373 12,053 Retained earnings 45,300 44,974 Accumulated other comprehensive income 1,050 14 Total stockholders' equity 58,723 57,041 Total liabilities & stockholders' equity $ 679,034 $ 678,775 See Accompanying Notes KENTUCKY BANCSHARES, INC. CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (unaudited) (thousands, except per share amounts) Three Months Ending 3/31/2009 3/31/2008 INTEREST INCOME: Loans, including fees $ 6,079 $ 7,308 Securities available for sale 2,108 1,734 Other 10 211 Total interest income 8,197 9,253 INTEREST EXPENSE: Deposits 2,533 3,506 Other 912 851 Total interest expense 3,445 4,357 Net interest income 4,752 4,896 Loan loss provision 450 400 Net interest income after provision 4,302 4,496 NON-INTEREST INCOME: Service charges 1,146 1,189 Loan service fee income 27 24 Trust department income 109 154 Securities available for sale gains (losses), net 4 7 Gain on sale of mortgage loans 378 161 Other 341 440 Total other income 2,005 1,975 NON-INTEREST EXPENSE: Salaries and employee benefits 2,549 2,649 Occupancy expenses 661 734 Amortization 66 67 Advertising and marketing 124 140 Taxes other than payroll, property and income 188 179 Other 1,300 1,193 Total other expenses 4,888 4,962 Income before taxes 1,419 1,509 Income taxes 252 316 Net income $ 1,167 $ 1,193 Other Comprehensive Income, net of tax: Change in Unrealized Gains on Securities 1,036 492 Comprehensive Income $ 2,203 $ 1,685 Earnings per share Basic $ 0.43 $ 0.42 Diluted 0.43 0.42 See Accompanying Notes KENTUCKY BANCSHARES, INC.
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (unaudited) (thousands, except share information) Accumulated Other Total ----Common Stock---- Retained Comprehensive Stockholders' Shares Amount (1) Earnings Income Equity Balances, December 31, 2008 2,745,729 $ 12,344 $ 44,683 $ 14 $ 57,041 Common stock issued, including tax benefit, net (including stock grants of 3,714 shares) 3,714 - - - - Stock based compensation expense - 29 - - 29 Net change in unrealized gain (loss) on securities available for sale, net of tax - - - 1,036 1,036 Net income - - 1,167 - 1,167 Dividends declared - $0.20 per share - - (550) - (550) Balances, March 31, 2009 2,749,443 $ 12,373 $ 45,300 $ 1,050 $ 58,723
(1)Common Stock has no par value; amount includes Additional Paid-in Capital See Accompanying Notes KENTUCKY BANCSHARES, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited) (thousands) Three Months Ending 3/31/2009 3/31/2008 Cash Flows From Operating Activities Net Income $ 1,167 $ 1,193 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation & Amortization 334 392 Securities amortization (accretion), net 200 (147) Stock based compensation expense 29 34 Provision for loan losses 450 400 Securities (gains) losses, net (4) (7) Originations of loans held for sale (17,678) (7,590) Proceeds from sale of loans 18,056 7,751 Gain on sale of mortgage loans (378) (161) Changes in: Interest receivable 651 617 Other assets (343) (585) Interest payable 842 (1,235) Other liabilities (623) (416) Net cash from operating activities 2,703 246 Cash Flows From Investing Activities Purchases of securities available for sale (42,811) (43,700) Proceeds from principal payments, maturities and calls of securities available for sale 11,134 38,759 Net change in loans 8,722 6,360 Purchases of bank premises and equipment (237) (861) Net cash from investing activities (23,192) 558 Cash Flows From Financing Activities: Net change in deposits 5,573 2,902 Net change in securities sold under agreements to repurchase, federal funds purchased and other borrowings 3,029 1,965 Advances from Federal Home Loan Bank - 5,000 Payments on Federal Home Loan Bank advances (10,560) (6,604) Payment on note payable (200) - Proceeds from issuance of common stock - 15 Purchase of common stock - (226) Dividends paid (550) (799) Net cash from financing activities (2,708) 2,253 Net change in cash and cash equivalents (23,197) 3,057 Cash and cash equivalents at beginning of period 37,106 25,807 Cash and cash equivalents at end of period 13,909 28,864 Supplemental disclosures of cash flow information Cash paid during the year for: Interest expense $ 2,603 $ 5,592 Income taxes - - Supplemental schedules of non-cash investing activities Real estate acquired through foreclosure $ 2,890 $ 353 See Accompanying Notes KENTUCKY BANCSHARES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Estimates used in the preparation of the financial statements are based on various factors including the current interest rate environment and the general strength of the local economy. Changes in the overall interest rate environment can significantly affect the Company's net interest income and the value of its recorded assets and liabilities. Actual results could differ from those estimates used in the preparation of the financial statements. The financial information presented as of any date other than December 31 has been prepared from the Company's books and records without audit. The accompanying consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Certain financial information that is normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America, but is not required for interim reporting purposes, has been condensed or omitted. In the opinion of management, all adjustments, consisting of normal recurring adjustments, necessary for a fair presentation of such financial statements, have been included. The results of operations for the interim periods are not necessarily indicative of the results to be expected for the full year. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company's Annual Report on Form 10-K for the year ended December 31, 2008. Recently Issued But Not Yet Effective Accounting Standards In April 2009, the Financial Accounting Standard Board ("FASB") issued FASB Staff Position ("FSP") FAS 157-4, "Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly". This FSP: ? Affirms that the objective of fair value when the market for an asset is not active is the price that would be received to sell the asset in an orderly transaction. ? Clarifies and includes additional factors for determining whether there has been a significant decrease in market activity for an asset when the market for that asset is not active. ? Eliminates the proposed presumption that all transactions are distressed (not orderly) unless proven otherwise. The FSP instead requires an entity to base its conclusion about whether a transaction was not orderly on the weight of the evidence. ? Includes an example that provides additional explanation on estimating fair value when the market activity for an asset has declined significantly. ? Requires an entity to disclose a change in valuation technique (and the related inputs) resulting from the application of the FSP and to quantify its effects, if practicable. ? Applies to all fair value measurements when appropriate. FSP FAS 157-4 must be applied prospectively and is effective for interim and annual periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009. The Company has elected to not early adopt this FSP. The Company does not expect this FSP to have a material impact on the Company's consolidated results of operations or financial position upon adoption. In April 2009, the FASB issued FSP FAS 115-2 and FAS 124-2, "Recognition and Presentation of Other-Than-Temporary Impairments". This FSP: ? Changes existing guidance for determining whether an impairment is other than temporary to debt securities; ? Replaces the existing requirement that the entity's management assert it has both the intent and ability to hold an impaired security until recovery with a requirement that management assert: (a) it does not have the intent to sell the security; and (b) it is more likely than not it will not have to sell the security before recovery of its cost basis; ? Incorporates examples of factors from existing literature that should be considered in determining whether a debt security is other-than- temporarily impaired; ? Requires that an entity recognize noncredit losses on held-to- maturity debt securities in other comprehensive income and amortize that amount over the remaining life of the security in a prospective manner by offsetting the recorded value of the asset unless the security is subsequently sold or there are additional credit losses; ? Requires an entity to present the total other-than-temporary impairment in the statement of earnings with an offset for the amount recognized in other comprehensive income; and ? When adopting FSP FAS 115-2 and FAS 124-2, an entity is required to record a cumulative-effect adjustment as of the beginning of the period of adoption to reclassify the noncredit component of a previously recognized other-temporary impairment from retained earnings to accumulated other comprehensive income if the entity does not intend to sell the security and it is not more likely than not that the entity will be required to sell the security before recovery. FSP FAS 115-2 and FAS 124-2 are effective for interim and annual periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009. The Company has elected to not early adopt this FSP. The Company does not expect this FSP to have a material impact on the Company's consolidated results of operations or financial position upon adoption. In April 2009, the FASB issued FSP FAS 107-1 and APB 28-1, "Interim Disclosures about Fair Value of Financial Instruments". This FSP amends SFAS No. 107, "Disclosures about Fair Value of Financial Instruments", to require an entity to provide disclosures about fair value of financial instruments in interim financial information. This FSP also amends APB Opinion No. 28, "Interim Financial Reporting", to require those disclosures in summarized financial information at interim reporting periods. Under this FSP, a publicly traded company shall include disclosures about the fair value of its financial instruments whenever it issues summarized financial information for interim reporting periods. In addition, an entity shall disclose in the body or in the accompanying notes of its summarized financial information for interim reporting periods and in its financial statements for annual reporting periods the fair value of all financial instruments for which it is practicable to estimate that value, whether recognized or not recognized in the statement of financial position, as required by SFAS No. 107. FSP 107-1 and APB 28-1 are effective for interim periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009. The Company has elected to not early adopt this FSP. The Company does not expect this FSP to have a material impact on the Company's consolidated results of operations or financial position upon adoption. Adoption of New Accounting Standards Effective January 1, 2009 the Company adopted SFAS No. 141(R), "Business Combinations", SFAS No. 160, "Noncontrolling Interests in Consolidated Financial Statements", SFAS NO. 161, "Disclosures about Derivative Instruments and Hedging Activities", and SFAS No. 163, "Accounting for Financial Guarantee Insurance Contracts". SFAS No. 141(R) establishes principals and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, liabilities assumed, and any noncontrolling interest in an acquiree. The statement also provides guidance for recognizing and measuring goodwill or gain from a bargain purchase in a business combination and determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. The adoption of this statement did not have an impact on the Company's consolidated financial position or results of operations. SFAS No. 160 amends Accounting Research Bulletin ("ARB") No. 51, "Consolidated Financial Statements" to establish accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. The statement also amends certain of ARB No. 51's consolidation procedures for consistency with the requirements of SFAS No. 141(R). The adoption of this statement did not have an impact on the Company's consolidated financial position or results of operations. SFAS No. 161 amends and expands the disclosure requirements of SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities" to provide enhanced disclosures about 1) how and why an entity uses derivative instruments; 2) how derivative instruments and related hedged items are accounted for under SFAS No. 133 and related interpretations; and 3) how derivative instruments and related hedged items affect an entity's financial position, financial performance, and cash flows. The adoption of this statement did not have an impact on the Company's consolidated financial position or results of operations. In April 2009, the FASB ratified the Emerging Issues Task Force's (EITF) concensus on FSP EITF 03-6-1, "Determining Whether Instruments Granted in Share-Based Payment Transactions are Participating Securities". The FSP addresses whether instruments granted in share-based payment transactions are participating securities prior to vesting and, therefore, need to be included in the earnings allocation in computing basic and fully diluted earnings per share. FSP EITF 03-6-1 does not have a significant impact on the Company's consolidated financial position or results of operations. 2. INVESTMENT SECURITIES Period-end securities are as follows: (in thousands) Amortized Unrealized Unrealized Fair Cost Gains Losses Value Available for Sale March 31, 2009 U.S. government agencies $ 31,692 $ 182 $ (3) $ 31,871 States and political subdivisions 70,129 1,164 (1,698) 69,595 Mortgage-backed 102,203 1,988 (64) 104,127 Equity securities 270 23 - 293 Total 204,294 3,357 (1,765) 205,886 December 31, 2008 U.S. government agencies $ 19,138 $ 212 $ - $ 19,350 States and political subdivisions 65,091 1,061 (2,181) 63,971 Mortgage-backed 88,314 1,142 (233) 89,223 Equity securities 270 20 - 290 Total 172,813 2,435 (2,414) 172,834 The Company regularly evaluates its investment securities with significant declines in fair value to determine whether losses are other-than-temporary under the principles of SFAS No. 115, FSP No. 115, and Staff Accounting Bulletin ("SAB") No. 59. A decline in the fair value of any available for sale security below cost that is deemed other-than-temporary results in a charge to earnings and the establishment of a new cost basis for the security. In estimating other-than-temporary losses, management considers each of the following: the length of time and extent that fair value has been less than cost, the financial condition and near term prospects of the issuer, and the Company's ability and intent to hold the security for a period sufficient to allow for any anticipated recovery in fair value. Based on this evaluation, the Company has determined it does not have any other-than-temporary impairment losses and has not recorded any other-than- temporary impairment charges. 3. LOANS Loans at period-end are as follows: (in thousands) 3/31/2009 12/31/2008 Commercial $ 21,468 $ 21,505 Real estate construction 17,531 16,818 Real estate mortgage 278,411 286,846 Agricultural 80,234 80,779 Consumer 17,994 18,328 Total 415,638 424,276 4. EARNINGS PER SHARE Basic earnings per common share is net income divided by the weighted average number of common shares outstanding during the period. Diluted earnings per common share includes the dilutive effect of additional potential common shares issuable under stock options. The factors used in the earnings per share computation follow: Three Months Ended March 31 2009 2008 (in thousands, except per share information) Basic Earnings Per Share Net Income $1,167 $1,193 Weighted average common shares outstanding 2,736 2,841 Basic earnings per share $ 0.43 $ 0.42 Diluted Earnings Per Share Net Income $1,167 $1,193 Weighted average common shares outstanding 2,736 2,841 Add dilutive effects of assumed exercise of stock options 1 6 Weighted average common and dilutive potential common shares outstanding 2,737 2,847 Diluted earnings per share $ 0.43 $ 0.42 Stock options for 37,844 shares of common stock for the three months ended March 31, 2009, and for 30,300 shares of common stock for the three months ended March 31, 2008 were excluded from diluted earnings per share because their impact was antidilutive. 5. STOCK COMPENSATION The Company has two share based compensation plans as described below. Stock Option Plan The Company grants certain officers and key employees stock option awards which vest and become fully exercisable at the end of five years and provides for issue of up to 100,000 options. The Company also grants certain directors stock option awards which vest and become fully exercisable immediately and provides for issue of up to 20,000 options. The exercise price of each option, which has a ten year life, was equal to the market price of the Company's stock on the date of grant. The fair value of each option award is estimated on the date of grant using a closed form option valuation (Black-Scholes) model that uses the assumptions noted in the table below. Expected volatilities are based on historical volatilities of the Company's common stock. The Company uses historical data to estimate option exercise and post-vesting termination behavior. The expected term of options granted is based on historical data and represents the period of time that options granted are expected to be outstanding, which takes into account that the options are not transferable. The risk-free interest rate for the expected term of the option is based on the U.S. Treasury yield curve in effect at the time of the grant. The fair value of options granted was determined using the following weighted-average assumptions as of grant date. No options have been granted in 2009. 2008 Weighted-average fair value of options granted during the year $2.38 Risk-free interest rate 2.96% Expected option life 8 years Expected stock price volatility 11.05% Expected dividend yield 3.61% Summary of activity in the stock option plan for the three months ended March 31, 2009 follows: Weighted Weighted Average Average Remaining Aggregate Exercise Contractual Intrinsic Shares Price Term Value Outstanding, beginning of year 50,169 $28.57 Forfeited or expired (12,325) 25.86 Outstanding, end of period 37,844 29.45 57.6 months $ - Vested and expected to vest 37,844 29.45 57.6 months - Options exercisable at period end 35,374 29.38 56.8 months - The intrinsic value for stock options is calculated based on the exercise price of the underlying awards and the market price of our common stock as of the reporting date. The Company recorded $29 thousand in stock compensation expense during the three months ended March 31, 2009 to salaries and employee benefits. Stock Grant Plan On February 15, 2005, the Company's Board of Directors adopted a restricted stock grant plan. Total shares issuable under the plan are 50,000. A summary of changes in the Company's nonvested shares for the year follows: Weighted-Average Grant-Date Nonvested Shares Shares Fair Value Nonvested at December 31, 2008 10,006 $ 306,023 Granted 4,150 71,173 Vested (2,702) (81,576) Forfeited (280) (7,225) Nonvested at March 31, 2009 11,174 $ 288,395 6. DIVIDENDS Dividends per share paid for the quarter ended March 31, 2009 were $0.20 compared to $0.28 for the quarter ending March 31, 2008. 7. RETIREMENT PLAN Components of Net Periodic Benefit Cost Three months ended March 31 (in thousands) Pension Benefits 2009 2008 Service cost $ - $ 121 Interest cost - 112 Expected return on plan assets - (120) (Gain) loss amortization - 4 Net Periodic Benefit Cost $ - $ 117 Employer Contributions The defined benefit plan offered to employees by the Company was terminated effective December 31, 2008. Therefore, the company had no contributions to the plan during the first quarter of this year and will also have no contributions going forward. As of December 31, 2008, the date of termination, the projected benefit obligation was $6,749,694 and the fair value of the plan assets was $5,206,908. The difference of $1,542,786 is recognized in other liabilities on the consolidated balance sheet. 8. Fair Value Measurements Statement 157 establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value: Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date. Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data. Level 3: Significant unobservable inputs that reflect a reporting entity's own assumptions about the assumptions that market participants would use in pricing an asset or liability. The fair values of securities available for sale are determined by obtaining quoted prices on nationally recognized securities exchanges (Level 1 inputs) or matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities' relationship to other benchmark quoted securities (Level 2 inputs). The fair value of servicing rights is based on a valuation model that calculates the present value of estimated net servicing income. The valuation model incorporates assumptions that market participants would use in estimating future net servicing income. The Company is able to compare the valuation model inputs and results to widely available published industry data for reasonableness (Level 2 inputs). The fair value of impaired loans with specific allocations of the allowance for loan losses is generally based on recent real estate appraisals. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are typically significant and result in a Level 3 classification of the inputs for determining fair value. Assets and Liabilities Measured on a Recurring Basis For this disclosure, the Company only has available for sale investment securities that meet the requirement. Available for sale investment securities are the Company's only balance sheet item that meet the disclosure requirements for instruments measured at fair value on a recurring basis. Disclosures are as follows in the table below. (In thousands) Fair Value Measurements at March 31, 2009 Using Quoted Prices In Active Markets for Significant Other Significant Identical Observable Unobservable Fair Value Assets Inputs Inputs Description 3/31/09 (Level 1) (Level 2) (Level 3) Available for Sale $205,886 $ 293 $205,593 $ - Securities (In thousands) Fair Value Measurements at December 31, 2008 Using Quoted Prices In Active Markets for Significant Other Significant Identical Observable Unobservable Fair Value Assets Inputs Inputs Description 12/31/08 (Level 1) (Level 2) (Level 3) Available for Sale Securities $172,834 $ 290 $172,544 $ - Assets and Liabilities Measured on a Non-Recurring Basis Servicing rights are carried at lower of cost or fair value. The current value of $593 thousand includes a valuation allowance of $213 thousand, which was recorded during the fourth quarter of 2008. Impaired loans totaled $1,819,000 at March 31, 2009 and $5,131,000 at December 31, 2008. The total allowance for loan losses related to these loans was $320,000 and $320,000 at March 31, 2009 and December 31, 2008. Impaired loans are measured at fair value based on the underlying collateral and are considered level 3 inputs. Item 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Forward-Looking Statements This discussion contains forward-looking statements under the Private Securities Litigation Reform Act of 1995 that involve risks and uncertainties. Words such as "believes," "anticipates," "expects," "intends," "plans," "targeted," and similar expressions are intended to identify forward-looking statements but are not the exclusive means of identifying such statements. Although the Company believes that the assumptions underlying the forward-looking statements contained herein are reasonable, any of the assumptions could be inaccurate, and therefore, there can be no assurance that the forward-looking statements included herein will prove to be accurate. Factors that could cause actual results to differ from the results discussed in the forward-looking statements include, but are not limited to: economic conditions (the Company and its bank operate in areas affected by various markets); competition for the Company's customers from other providers of financial and mortgage services; government legislation and regulation (which changes from time to time and over which the Company has no control); changes in interest rates (both generally and more specifically mortgage interest rates); material unforeseen changes in the liquidity, results of operations, or financial condition of the Company's customers; and other risks detailed in the Company's filings with the Securities and Exchange Commission, all of which are difficult to predict and many of which are beyond the control of the Company. The Company undertakes no obligation to update or revise forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. Summary Kentucky Bancshares, Inc. recorded net income of $1.2 million, or $0.43 basic earnings and diluted earnings per share for the first three months ending March 31, 2009 compared to $1.2 million, or $0.42 basic earnings and diluted earnings per share for the three month period ending March 31, 2008. The first three months earnings reflects a decrease of 2.2% compared to the same time period in 2008, due primarily to a decrease in net interest income of $144 thousand, an increase in the loan loss provision of $50 thousand and an increase in other expenses of $107 thousand. These decreases to net income were partially offset by a reduction in income tax expense of $64 thousand. Return on average assets was 0.68% for the three months ended March 31, 2009 and 0.75% for the three month period ended March 31, 2008. Return on average equity was 8.1% for the three month period ended March 31, 2009 and 8.0% for the same period in 2008. Loans decreased $8.7 million from $424.3 million on December 31, 2008 to $415.6 million on March 31, 2009. The decrease is primarily attributed to a decrease in real estate mortgage loans of $8.4 million slightly offset by an increase of $713 thousand in real estate construction loans. Smaller decreases in commercial, agricultural & consumer loans also contributed to the overall decline in the loan portfolio balance. Total deposits increased from $520.8 million on December 31, 2008 to $526.4 million on March 31, 2009, an increase of $5.6 million. This increase is primarily the result of an increase in non-interest bearing deposit accounts of $5.7 million and an increase in interest bearing time deposit accounts over $100 thousand of $6.6 million. These increases were partially offset by a decrease in other interest bearing deposit accounts of $6.8 million. Management attributes the increase mainly to obtaining a large public fund account in early January. As a result of this, management has paid off Federal Home Loan Bank advances that came due during 2009. Because of this, as of March 31, 2009, Federal Home Bank advances have declined $10.7 million since December 31, 2008. Net Interest Income Net interest income was $4.8 million for the three months ended March 31, 2009 compared to $4.9 million for the three months ended March 31, 2008, a decrease of 2.9%. The interest spread of 2.95% for the first three months of 2009 is down from 3.26% reported for the same period in 2008, a decrease of 31 basis points. During the first quarter of 2009, the prime interest rate was two hundred basis points less than a year ago. This has significantly impacted the Company's interest spread. In addition to lower rates and tightening margins, the net interest spread for 2009 is also lower than 2008 due to an increase in "lost" loan interest during 2009 that can be attributed to an increase in non-performing loans in our loan portfolio. For the first three months, the yield on assets decreased from 6.34% in 2008 to 5.18% in 2009. The cost of liabilities decreased from 3.08% in 2008 to 2.23% in 2009. Year to date average loans increased $7.5 million, or 1.8% from March 31, 2008 to March 31, 2009. Loan interest income has decreased $1.2 million for the first three months of 2009 compared to the first three months of 2008. Year to date average deposits increased from March 31, 2008 to March 31, 2009, up $45.4 million or 9.3%. The increase is primarily the result of an increase in interest bearing deposits with balances greater than $100 thousand. Deposit interest expense has decreased $973 thousand for the first three months of 2009 compared to the same period in 2008. Non-Interest Income Non-interest income increased $30 thousand for the three months ended March 31, 2009 compared to the same period in 2008 to $2.0 million, due primarily to an increase in the gain on sold mortgage loans of $217 thousand, offset by a decrease in service charges of $43 thousand and a decrease in other non- interest income of $99 thousand. The decrease in service charges was primarily due to a decrease in overdraft income of $75 thousand. The other non-interest income decrease was primarily due to a decrease of $108 thousand in brokerage income. Gain on sale of mortgage loans increased from $161 thousand in the first three months of 2008 to $378 thousand during the first three months of 2009. The volume of mortgage loan originations and sales is generally inverse to rate changes. A change in the mortgage loan rate environment can have a significant impact on the related gain on sale of mortgage loans. Non-Interest Expense Total non-interest expenses decreased $74 thousand for the three month period ended March 31, 2009 compared to the same period in 2008. For the comparable three month periods, salaries and benefits decreased $100 thousand, a decrease of 3.8%. The decrease in salaries & benefits is primarily attributed to the company terminating the defined benefit plan offered to employees as of December 31, 2008. As of March 31, 2009, the company has saved $117 thousand by terminating the defined benefit plan. Occupancy expenses decreased $73 thousand to $661 thousand for the first three months of 2009 compared to the same time period in 2008. The decrease during 2009 is mainly attributable to a decrease in depreciation expense of $48 thousand. The decrease in depreciation expense is due to assets with a high cost basis becoming fully depreciated at the end of 2008. The relocation of the Nicholasville branch, scheduled to be complete in the second quarter of 2009, is expected to result in a slight increase in occupancy expense starting in the second quarter of 2009. Other expenses increased $107 thousand for the first three months ended March 31, 2009 compared to the same time period in 2008. The year to date increase is mainly a result of an increase in FDIC insurance premiums (see below for more details) of $218 thousand and an increase in repossession expense of $57 thousand. These increases were partially offset by a decrease in legal & professional fees of $93 thousand. Due to the downturn in the financial industry and related bank failures, the FDIC is expected to increase the FDIC insurance premiums in 2009. Although the amount of the increase is unknown at this time, the increase in expense to the Company is expected to be significant. Deposit Insurance: In February 2009, the FDIC adopted a long-term deposit insurance fund ("DIF") restoration plan as well as an additional emergency assessment for 2009. The restoration plan increases base assessment rates for banks in all risk categories with the goal of raising the DIF reserve ratio from its current 0.40% to 1.15% within seven years. Banks in the best risk category, which include the Company's subsidiary bank, will pay initial base rates ranging from 12 to 16 basis points of assessable deposits beginning April 1, 2009, up from the initial base rate range of 12 to 14 basis points. Additionally, the FDIC approved an interim rule imposing a special emergency assessment to all financial institutions of 20 basis points of insured deposits as of June 30, 2009. The interim rule was subject to a 30-day comment period and in early March 2009 a proposal was introduced in Congress to lower the special emergency assessment to 10 basis points from the initial 20 basis points. The special emergency assessment is estimated to be $1.1 million for the Company as currently adopted under the 20 basis point rule and will be collected on September 30, 2009. The amount of the special emergency assessment would decrease to $530 thousand if the 10 basis point scenario is adopted. The FDIC is also permitted to impose an emergency special assessment after June 30, 2009 of up to 10 basis points if necessary to maintain public confidence in federal deposit insurance. The increase in assessments by the FDIC could have a material adverse effect on the Company's earnings. Temporary Liquidity Guarantee Program ("TLGP"): The TLGP consists of two separate programs implemented by the FDIC in October 2008. This includes the Debt Guarantee Program ("DGP") and the Transaction Account Guarantee Program ("TAGP"). These programs were initially provided at no cost to participants during the first 30 days. Eligible institutions that do not "opt out" of either of these programs become participants by default and will incur the fees assessed for taking part. Under the DGP, the FDIC will guarantee senior unsecured debt issued on or after October 14, 2008 through June 30, 2009 up to certain limits by participating entities. The FDIC will provide guarantee coverage for debt issued between those dates until the earlier of the maturity date of the debt or June 30, 2012. The Company chose to opt out of the DGP. Under the TAGP, the FDIC guarantees 100% of certain noninterest bearing transaction accounts up to any amount to participating FDIC insured institutions. The unlimited coverage is applicable until December 31, 2009. The Company opted to participate in the TAGP; as such, it will incur an additional quarterly-assessed 10 basis point fee on balances in noninterest bearing transaction accounts exceeding the recently increased $250 thousand deposit limit that became effective on November 13, 2008. The previous deposit insurance limit amount was $100 thousand. Emergency Economic Stabilization Act of 2008 ("EESA"): EESA was signed into law by the President on October 3, 2008 as a measure to stabilize and provide liquidity to the U.S. financial markets. Under EESA, the Troubled Asset Relief Program ("TARP") was created. TARP granted the Treasury authority to, among other things, invest in financial institutions and purchase troubled assets in an aggregate amount up to $700 billion. In connection with TARP, the Capital Purchase Program ("CPP") was launched on October 14, 2008. Under the CPP, the Treasury announced a plan to use up to $250 billion of TARP funds to purchase equity stakes in certain eligible financial institutions, including the Company. The Company was preliminarily approved for $13 million of equity capital in December 2008, and subsequently withdrew its application. Income Taxes The effective tax rate for the three months ended March 31, 2009 was 17.8% compared to 20.9% in 2008. These rates are less than the statutory rate as a result of the tax-free securities and loans held by the Company. The rates for 2009 are lower due to the lower level of income for 2009. Nontaxable interest income increased $58 thousand for the first three months of 2009 compared to the same time period in 2008. Stock Repurchase Program On October 25, 2000, the Company announced that its Board of Directors approved a stock repurchase program to purchase up to 100,000 shares of its outstanding common stock. On November 11, 2002, the Board of Directors approved and authorized the Company's repurchase of an additional 100,000 shares. On May 20, 2008, the Board of Directors approved and authorized the Company to repurchase an additional 100,000 shares. Shares will be purchased from time to time in the open market depending on market prices and other considerations. Through March 31, 2009, 258,001 shares have been purchased under the program. The most recent share repurchase occurred on December 22, 2008. Liquidity and Funding Liquidity risk is the possibility that the Company may not be able to meet its cash requirements. Management of liquidity risk includes maintenance of adequate cash and sources of cash to fund operations and to meet the needs of borrowers, depositors and creditors. Excess liquidity has a negative impact on earnings as a result of the lower yields on short-term assets. Cash and cash equivalents were $13.9 million as of March 31, 2009 compared to $37.1 million at December 31, 2008. The decrease in cash and cash equivalents is mainly attributable to a decrease in federal funds sold resulting primarily from an increase in the Company's security portfolio. In addition to cash and cash equivalents, the securities portfolio provides an important source of liquidity. Securities available for sale totaled $205.9 million at March 31, 2009 compared to $172.8 million at December 31, 2008. The available for sale securities are available to meet liquidity needs on a continuing basis. The Company expects the customers' deposits to be adequate to meet its funding demands. Generally, the Company relies upon net cash inflows from financing activities, supplemented by net cash inflows from operating activities, to provide cash used in its investing activities. As is typical of many financial institutions, significant financing activities include deposit gathering and the use of short-term borrowings, such as federal funds purchased and securities sold under repurchase agreements along with long-term debt. The Company's primary investing activities include purchasing investment securities and loan originations. Management is aware of the challenge of funding sustained loan growth. Therefore, in addition to deposits, other sources of funds, such as Federal Home Loan Bank (FHLB) advances, may be used. The Company relies on FHLB advances for both liquidity and asset/liability management purposes. These advances are used primarily to fund long-term fixed rate residential mortgage loans. In early July 2008, the Company received deposits from being the successful bidder on $20 million in public deposits. As of March 31, 2009, these deposits had declined $5.7 million, with the remainder expected to roll off by June 2009. In addition, in early January 2009, the Company received deposits in the amount of $18 million as a result of being the successful bidder on a public fund account. As of March 31, 2009, $4.7 million had rolled off. It is expected that $11.3 million of the remaining $13.3 million will roll off during the remainder of 2009 and another $2.0 million will mature in the first quarter of 2010. As of March 31, 2009, we have sufficient collateral to borrow an additional $39 million from the FHLB. In addition, as of March 31, 2009, over $35 million is available in overnight borrowing through various correspondent banks. In light of this, management believes there is sufficient liquidity to meet all reasonable borrower, depositor and creditor needs in the present economic environment. Non-Performing Assets As of March 31, 2009, the Company's non-performing assets totaled $14.8 million or 2.49% of loans compared to $9.2 million or 1.73% of loans at December 31, 2008. (See table below) The Company experienced an increase of $1.6 million in non-accrual loans from December 31, 2008 to March 31, 2009, largely due to an increase in non-accrual loans secured by real estate of $1.3 million and an increase in non-accrual commercial loans of $437 thousand. As of March 31, 2009, non-accrual loans include $2.3 million in loans secured by 1-4 family residential real estate, $1.8 million in real estate construction and $2.9 million in loans secured by non-farm non-residential properties. Real estate loans composed 95% of the non-performing loans as of March 31, 2009 and 96% as of December 31, 2008. Forgone interest income on the non- accrual loans was $205 thousand for the first three months of 2009 compared to $18 thousand for the same time period in 2008. Accruing loans that are contractually 90 days or more past due as of March 31, 2009 totaled $2.2 million compared to $779 thousand for the same period a year ago, an increase of $1.5 million. The increase is mainly attributed to an increase in closed end loans secured by 1-4 family residential properties. As of March 31, 2009, closed end loans secured by 1-4 family residential properties that were contractually 90 days or more past due and still accruing totaled $2.0 million compared to $221 thousand as of December 31, 2008, an increase of $1.8 million. In addition, the amount the Company has booked as "Other Real Estate" has increased $2.6 million from December 31, 2008 to March 31, 2009. As of March 31, 2009 the amount booked as "Other Real Estate" totaled $4.4 million compared to $1.8 million at December 31, 2008. The increase is largely attributed to two loan customers who specialized in commercial & land development properties. Nonperforming Assets 3/31/09 12/31/08 (in thousands) Non-accrual Loans $ 8,129 $ 6,562 Accruing Loans which are Contractually past due 90 days or more 2,239 779 Total Nonperforming and Restructured 10,368 7,341 Other Real Estate 4,439 1,840 Total Nonperforming and Restructured Loans and Other Real Estate $ 14,807 $ 9,181 Nonperforming and Restructured Loans as a Percentage of Loans 2.49% 1.73% Nonperforming and Restructured Loans and Other Real Estate as a Percentage of Total Assets 2.18% 1.35% Allowance as a Percentage of Period-end Loans 1.44% 1.29% Allowance as a Percentage of Non-performing and Restructured Loans 58% 60% Provision for Loan Losses The loan loss provision for the first three months was $450 thousand for 2009 and $400 thousand for the same period in 2008. The current level of nonperforming loans has caused management to increase the 2009 provision in order to maintain an allowance for loan losses that is representative of the risk of loss based on the quality of loans currently in the portfolio. Management estimates the allowance balance required using past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions, and other factors. Net recoveries for the three month period ended March 31, 2009 were $84 thousand compared to net charge-offs of $188 thousand for the same period in 2008. Future levels of charge-offs will be determined by the particular facts and circumstances surrounding individual loans. Management believes the current loan loss allowance is sufficient to meet probable incurred loan losses. Loan Losses Three Months Ended March 31, 2009 (in thousands) 2009 2008 Balance at Beginning of Period $ 5,465 $ 4,879 Amounts Charged-off: Real Estate Construction 3 125 Real Estate Mortgage 48 24 Agricultural 6 12 Consumer 271 358 Total Charged-off Loans 328 519 Recoveries on Amounts Previously Charged-off: Commercial - 4 Real Estate Construction - 2 Real Estate Mortgage 235 7 Agricultural - 29 Consumer 177 289 Total Recoveries 412 331 Net Charge-offs (84) 188 Provision for Loan Losses 450 400 Balance at End of Period 5,999 5,091 Loans Average 418,712 411,258 At March 31 415,638 410,840 As a Percentage of Average Loans: Net Charge-offs (0.02)% 0.05% Provision for Loan Losses 0.11% 0.10% Allowance as a Multiple of Net Charge-offs (17.9) 6.8 Item 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Asset/Liability management control is designed to ensure safety and soundness, maintain liquidity and regulatory capital standards, and achieve acceptable net interest income. Management considers interest rate risk to be the most significant market risk. The Company's exposure to market risk is reviewed on a regular basis by the Asset/Liability Committee. Interest rate risk is the potential of economic losses due to future interest rate changes. These economic losses can be reflected as a loss of future net interest income and/or a loss of current fair market values. The objective is to measure the effect on net interest income and to adjust the balance sheet to minimize the inherent risk, while at the same time, maximize income. Management realizes certain risks are inherent and that the goal is to identify and minimize the risks. The primary tools used by management are interest rate shock and economic value of equity (EVE) simulations. The Company has no market risk sensitive instruments held for trading purposes. Using interest rate shock simulations, the following table depicts the change in net interest income resulting from 100 and 300 basis point changes in rates on the Company's interest earning assets and interest bearing liabilities. The projections are based on balance sheet growth assumptions and repricing opportunities for new, maturing and adjustable rate amounts. As of March 31, 2009, the projected percentage changes are within the Board approved limits except when assuming rates declining 100 basis points. Although management does analyze and monitor the projected percentage change in a declining interest rate environment, due to the current rate environment many of the current deposit rates cannot decline an additional 100 basis points. Therefore, management places more emphasis in the rising rate environment scenarios. This period's volatility is higher in each rate shock both in a falling and rising rate environment when compared to the same period a year ago. The projected net interest income report summarizing the Company's interest rate sensitivity as of March 31, 2009 is as follows: (dollars in thousands) PROJECTED NET INTEREST INCOME Level Rate Change: - 300 - 100 Rates + 100 + 300 Year One (4/09 - 3/10) Net interest income $20,351 $21,431 $22,359 $22,901 $23,364 Net interest income dollar change (2,008) (928) N/A 542 1,005 Net interest income percentage change -8.9% -4.1% N/A 2.4% 4.5% Board approved limit >-10.0% >-4.0% N/A >-4.0% >-10.0% The projected net interest income report summarizing the Company's interest rate sensitivity as March 31, 2008 is as follows: PROJECTED NET INTEREST INCOME (dollars in thousands) Level Change in basis points: - 300 - 100 Rates + 100 + 300 Year One (4/08 - 3/09) Net interest income $21,052 $21,807 $22,534 $22,861 $23,256 Net interest income dollar change (1,482) (727) N/A 327 722 Net interest income percentage change -6.6% -3.2% N/A 1.5% 3.2% Board approved limit >-10.0% >-4.0% N/A >-4.0% >-10.0% Projections from March 31, 2009, year one reflected a decline in net interest income of 4.1% with a 100 basis point decline compared to the 3.2% decline in 2008. The 100 basis point increase in rates reflected a 2.4% increase in net interest income in 2009 compared to 1.5% in 2008. The additional volatility is due to lengthening our certificate of deposit maturities and increasing our security portfolio. EVE applies discounting techniques to future cash flows to determine the present value of assets, liabilities, and therefore equity. Based on applying these techniques to the March 31, 2009 balance sheet, a 100 basis point increase in rates results in a 4.2% decrease in EVE. A 100 basis point decrease in rates results in a 2.3% increase in EVE. These are within the Board approved limits. Item 4 - CONTROLS AND PROCEDURES As of the end of the period covered by this report, the Company carried out an evaluation, under the supervision and with the participation of the Company's management, including the Company's Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures. Based on the foregoing, the Company's Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures were effective, in all material respects, to ensure that information required to be disclosed in the reports the Company files and submits under the Exchange Act is recorded, processed, summarized and reported as and when required. The Company also conducted an evaluation of internal control over financial reporting to determine whether any changes occurred during the quarter covered by this report that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting. Based on this evaluation, there has been no such change during the quarter covered by this report. Part II - Other Information Item 1. Legal Proceedings The Company is not a party to any material legal proceedings. Item 1A. Risk Factors There have been no material changes in risk factors, as previously disclosed in the December 31, 2008 Form 10-K. Item 2. Unregistered Sales of Equity Securities and Use of Proceeds ISSUER PURCHASES OF EQUITY SECURITIES Period (a) Total (b) (c) Total Number (d) Maximum Number Number of Average of Shares (or Units) (or Approximate Dollar Shares (or Price Paid Purchased as Part Value) of Shares (or Units) Per Share of Publicly Units) that May Yet Be Purchased (or Unit) Announced Plans Purchased Under the Or Programs Plans of Programs 1/1/09 - 1/31/09 - $ - - 41,999 shares 2/1/09 - 2/28/09 - - - 41,999 shares 3/1/09 - 3/31/09 - - - 41,999 shares Total - - - 41,999 shares On October 25, 2000, the Company announced that its Board of Directors approved a stock repurchase program. The Company is authorized to purchase up to 100,000 shares of its outstanding common stock. On November 11, 2002, the Board of Directors approved and authorized the Company's repurchase of an additional 100,000 shares. On May 20, 2008, the Board of Directors approved and authorized an additional 100,000 shares. Shares will be purchased from time to time in the open market depending on market prices and other considerations. Through March 31, 2009, 258,001 shares have been purchased. Item 3. Defaults upon Senior Securities None Item 5. Other Information None Item 6. Exhibits 31.1 Certifications of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.2 Certifications of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32 Certifications of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. KENTUCKY BANCSHARES, INC. Date _____5/14/09_______ __/s/Louis Prichard______________ Louis Prichard, President and C.E.O. Date _____5/14/09_______ __/s/Gregory J. Dawson___________ Gregory J. Dawson, Chief Financial Officer 2 3 23 Lexlibrary/197885.1