-----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, MC13/dsjtOs5iOA4yDHuYhWQdzQApHvK+1ujby+6LqJ5GYDvcuiCxZjDIKZRfR3e iz1mgi8mPfggZZArRkh6Pw== 0001000232-10-000010.txt : 20100813 0001000232-10-000010.hdr.sgml : 20100813 20100813145217 ACCESSION NUMBER: 0001000232-10-000010 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 20100630 FILED AS OF DATE: 20100813 DATE AS OF CHANGE: 20100813 FILER: COMPANY DATA: COMPANY CONFORMED NAME: KENTUCKY BANCSHARES INC /KY/ CENTRAL INDEX KEY: 0001000232 STANDARD INDUSTRIAL CLASSIFICATION: STATE COMMERCIAL BANKS [6022] IRS NUMBER: 610993464 STATE OF INCORPORATION: KY FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-52598 FILM NUMBER: 101014863 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-Q 1 q102.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 June 30, 2010 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 _____ 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 July 31, 2010: 2,741,536. KENTUCKY BANCSHARES, INC. Table of Contents Part I - Financial Information Item 1. Financial Statements Consolidated Balance Sheets 3 Consolidated Statements of Income and Comprehensive Income 4 Consolidated Statement of Changes in Stockholders? Equity 6 Consolidated Statements of Cash Flows 7 Notes to Consolidated Financial Statements 8 Item 2. Management?s Discussion and Analysis of Financial Condition and Results of Operations 19 Item 3. Quantitative and Qualitative Disclosures About Market Risk 28 Item 4. Controls and Procedures 29 Part II - Other Information 29 Signatures 30 Exhibits 31.1 Certifications of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31 31.2 Certifications of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 33 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. 35 Item 1 - Financial Statements KENTUCKY BANCSHARES, INC. CONSOLIDATED BALANCE SHEETS (unaudited) (in thousands) 6/30/2010 12/31/2009 Assets Cash and due from banks $ 13,567 $ 12,387 Federal funds sold 16,837 22,034 Cash and cash equivalents 30,404 34,421 Securities available for sale 191,625 168,411 Mortgage loans held for sale 295 191 Loans 416,475 425,418 Allowance for loan losses (6,461) (7,600) Net loans 410,014 417,818 Federal Home Loan Bank stock 6,731 6,731 Real estate owned, net 5,548 4,542 Bank premises and equipment, net 17,778 17,610 Interest receivable 4,392 4,620 Mortgage servicing rights 835 822 Goodwill 13,117 13,117 Other intangible assets 1,135 1,263 Other assets 5,281 5,685 Total assets $ 687,155 $ 675,231 Liabilities and Stockholders' Equity Deposits Non-interest bearing $ 117,023 $ 97,005 Time deposits, $100,000 and over 122,787 105,036 Other interest bearing 315,121 334,405 Total deposits 554,931 536,446 Repurchase agreements and other borrowings 6,844 8,226 Federal Home Loan Bank advances 49,110 56,096 Subordinated debentures 7,217 7,217 Interest payable 3,893 2,123 Other liabilities 2,301 4,158 Total liabilities 624,296 614,266 Stockholders' equity Preferred stock, 300,000 shares authorized and unissued - - Common stock, no par value; 10,000,000 shares authorized; 2,742,536 and 2,739,511 shares issued and outstanding on June 30, 2010 and December 31, 2009 12,445 12,416 Retained earnings 48,187 47,213 Accumulated other comprehensive income 2,227 1,336 Total stockholders' equity 62,859 60,965 Total liabilities & stockholders' equity $ 687,155 $ 675,231 See Accompanying Notes KENTUCKY BANCSHARES, INC. CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (unaudited) (in thousands, except per share amounts) Six Months Ending 6/30/2010 6/30/2009 INTEREST INCOME: Loans, including fees $ 12,027 $ 12,303 Securities available for sale 3,397 3,787 Other 24 14 Total interest income 15,448 16,104 INTEREST EXPENSE: Deposits 4,241 4,896 Other 1,206 1,783 Total interest expense 5,447 6,679 Net interest income 10,001 9,425 Loan loss provision 1,250 900 Net interest income after provision 8,751 8,525 NON-INTEREST INCOME: Service charges 2,387 2,522 Loan service fee income 70 50 Trust department income 310 235 Securities available for sale gains, net 214 203 Gain on sale of mortgage loans 309 811 Other 827 744 Total other income 4,117 4,565 NON-INTEREST EXPENSE: Salaries and employee benefits 4,943 5,986 Occupancy expenses 1,359 1,293 Repossession expenses 762 245 FDIC insurance 496 711 Legal and professional fees 350 182 Data processing 388 380 Debit card expenses 296 293 Amortization 128 131 Advertising and marketing 291 253 Taxes other than payroll, property and income 394 366 Other 1,101 1,009 Total other expenses 10,508 10,849 Income before taxes 2,360 2,241 Income taxes 234 170 Net income $ 2,126 $ 2,071 Other Comprehensive Income, net of tax: Change in Unrealized Gains on Securities 891 819 Comprehensive Income $ 3,017 $ 2,890 Earnings per share Basic $ 0.78 $ 0.76 Diluted 0.78 0.76 Dividends per share 0.42 0.40 See Accompanying Notes KENTUCKY BANCSHARES, INC. CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (unaudited) (in thousands, except per share amounts) Three Months Ending 6/30/2010 6/30/2009 INTEREST INCOME: Loans, including fees $ 6,117 $ 6,224 Securities available for sale 1,747 1,679 Other 13 4 Total interest income 7,877 7,907 INTEREST EXPENSE: Deposits 2,149 2,363 Other 596 871 Total interest expense 2,745 3,234 Net interest income 5,132 4,673 Loan loss provision 800 450 Net interest income after provision 4,332 4,223 NON-INTEREST INCOME: Service charges 1,291 1,376 Loan service fee income 45 23 Trust department income 195 126 Securities available for sale gains (losses), net 211 199 Gain on sale of mortgage loans 183 433 Other 445 407 Total other income 2,370 2,564 NON-INTEREST EXPENSE: Salaries and employee benefits 2,494 3,437 Occupancy expenses 671 636 Repossession expenses 426 155 FDIC insurance 254 480 Legal and professional fees 226 135 Data processing 185 178 Debit card expenses 153 154 Amortization 63 65 Advertising and marketing 162 129 Taxes other than payroll, property and income 199 178 Other 503 418 Total other expenses 5,336 5,965 Income before taxes 1,366 822 Income taxes (benefit) 185 (82) Net income $ 1,181 $ 904 Other Comprehensive Income (Loss), net of tax: Change in Unrealized Gains on Securities 685 (217) Comprehensive Income $ 1,866 $ 687 Earnings per share Basic $ 0.43 $ 0.33 Diluted 0.43 0.33 Dividends per share 0.21 0.20 See Accompanying Notes KENTUCKY BANCSHARES, INC.
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (unaudited) (in thousands, except share information) Accumulated Other Total --Common Stock(1)-- Retained Comprehensive Stockholders' Shares Amount Earnings Income Equity Balances, January 1, 2010 2,739,511 $ 12,416 $ 47,213 $ 1,336 $ 60,965 Common stock issued, including tax benefit, net 3,676 - - - - Stock based compensation expense - 55 - - 55 Common stock purchased and retired (651) (26) (26) Net change in unrealized gain (loss) on securities available for sale, net of tax - - - 891 891 Net income - - 2,126 - 2,126 Dividends declared - $0.42 per share - - (1,152) - (1,152) Balances, June 30, 2010 2,742,536 $ 12,445 $ 48,187 $ 2,227 $ 62,859
(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) (in thousands) Six Months Ended 6/30/2010 6/30/2009 Cash Flows From Operating Activities Net Income $ 2,126 $ 2,071 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 787 691 Securities amortization, net 426 811 Stock based compensation expense 55 57 Provision for loan losses 1,250 900 Securities gains, net (214) (203) Originations of loans held for sale (11,086) (36,455) Proceeds from sale of loans 11,291 37,266 Losses on sale of fixed assets 1 - Gains on other real estate, net (40) (57) Gain on sale of mortgage loans (309) (811) Changes in: Interest receivable 228 736 Real estate owned, net 545 980 Other assets 372 (2,872) Interest payable 1,770 1,314 Other liabilities (2,316) 2,143 Net cash from operating activities 4,886 6,571 Cash Flows From Investing Activities Purchases of securities (81,558) (53,208) Proceeds from sales of securities 9,511 17,515 Proceeds from principal payments, maturities and calls of securities 49,972 37,085 Net change in loans 4,963 5,805 Purchases of bank premises and equipment (769) (336) Proceeds from the sale of bank premises 3 - Net cash from investing activities (17,878) 6,861 Cash Flows From Financing Activities: Net change in deposits 18,485 (26,713) Net change in repurchase agreements - and other borrowings (982) 4,670 Payments on Federal Home Loan Bank advances (6,950) (13,417) Payments on note payable (400) (200) Purchase of common stock (26) (79) Dividends paid (1,152) (1,099) Net cash from financing activities 8,975 (36,838) Net change in cash and cash equivalents (4,017) (23,406) Cash and cash equivalents at beginning of period 34,421 37,106 Cash and cash equivalents at end of period $ 30,404 $ 13,700 Supplemental disclosures of cash flow information Cash paid during the year for: Interest expense $ 3,677 $ 6,679 Income taxes - 200 Supplemental disclosures of non-cash investing activities Real estate acquired through foreclosure $ 2,125 $ 3,941 See Accompanying Notes KENTUCKY BANCSHARES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES 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, 2009. Basis of Presentation: The consolidated financial statements include the accounts of Kentucky Bancshares, Inc. (the ?Company?, ?we?, ?our? or ?us?), its wholly-owned subsidiary, Kentucky Bank (the Bank), and the Bank?s wholly-owned subsidiary, KB Special Assets Unit, LLC. Intercompany transactions and balances have been eliminated in consolidation. 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, Elliot, Harrison, Jessamine, Rowan, 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, real estate owned, goodwill and fair value of financial instruments are particularly subject to change. Adoption of New Accounting Standards Accounting Standards Codification (?ASC?) Topic 820, ?Fair Value Measurements and Disclosures?. The Financial Accounting Standards Board issued new accounting guidance under Accounting Standards Update (ASU) No. 2010-06 that requires new disclosures and clarifies existing disclosure requirements about fair value measurement as set forth in ASC Subtopic 820-10. The objective of the new guidance is to improve these disclosures and increase transparency in financial reporting. Specifically, the new guidance requires: A reporting entity to disclose separately the amounts of significant transfers in and out of Level 1 and Level 2 fair value measurements and describe the reasons for the transfers; and In the reconciliation for fair value measurements using significant unobservable inputs, a reporting entity should present separately information about purchases, sales, issuances, and settlements. In addition, the guidance clarifies the requirements of the following existing disclosures: For purposes of reporting fair value measurement for each class of assets and liabilities, a reporting entity needs to use judgment in determining the appropriate classes of assets and liabilities; and A reporting entity should provide disclosures about the valuation techniques and inputs used to measure fair value for both recurring and nonrecurring fair value measurements. ASU 2010-06 is effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. Early application is permitted. Additional disclosures have been made. ASC Topic 860, ?Transfers and Servicing?. Effective January 1, 2010, the Company adopted new accounting guidance under ASC Topic 860 that requires more information about transfers of financial assets, including securitization transactions, and where entities have continuing exposure to the risks related to transferred financial assets. The guidance eliminates the concept of a ?qualifying special-purpose entity,? changes the requirements for derecognizing financial assets, and requires additional disclosures about continuing involvements with transferred financial assets including information about gains and losses resulting from transfers during the period. The adoption of this accounting guidance did not have a material impact on the Company?s consolidated financial position or results of operations. ASC Topic 810, ?Consolidation?. Effective January 1, 2010, the Company adopted new accounting guidance under ASC Topic 810 that amends prior guidance to change how a reporting entity determines when an entity that is insufficiently capitalized or is not controlled through voting (or similar rights) should be consolidated. The determination of whether a reporting entity is required to consolidate another entity is based on, among other things, the other entity?s purpose and design and the reporting entity?s ability to direct the activities of the other entity that most significantly impact the other entity?s economic performance. The new guidance requires a number of new disclosures about an entity?s involvement with variable interest entities and any significant changes in risk exposure due to that involvement. A reporting entity will also be required to disclose how its involvement with a variable interest entity affects the reporting entity?s financial statements. The adoption of this accounting guidance did not have a material impact on the Company?s consolidated financial position or results of operations. 2. SECURITIES AVAILABLE FOR SALE INVESTMENT SECURITIES Period-end securities are as follows: (in thousands) Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value Available for Sale June 30, 2010 U.S. government agencies $ 65,354 $ 475 $ (1) $ 65,828 States and political subdivisions 85,209 1,867 (373) 86,703 Mortgage-backed - residential 37,418 1,377 - 38,795 Equity securities 270 29 - 299 Total $ 188,251 $ 3,748 $ (374) $ 191,625 December 31, 2009 U.S. government agencies $ 45,168 $ 13 $ (448) $ 44,733 States and political subdivisions 78,794 1,691 (362) 80,123 Mortgage-backed - residential 42,155 1,259 (151) 43,263 Equity securities 270 22 - 292 Total $ 166,387 $ 2,985 $ (961) $ 168,411 The amortized cost and fair value of securities at June 30, 2010, 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. (in thousands) Amortized Fair Cost Value Due in one year or less $ 1,628 $ 1,733 Due after one year through five years 45,726 46,104 Due after five years through ten years 46,636 47,885 Due after ten years 56,573 56,809 150,563 152,531 Mortgage-backed - residential 37,418 38,795 Equity 270 299 Total $ 188,251 $ 191,625 Proceeds from sales of securities during the first six months of 2010 and 2009 were $9.5 million and $17.5 million. Gross gains of $215 thousand and $204 thousand and gross losses of $1 thousand and $1 thousand, were realized on those sales, respectively. The tax provision related to these realized gains and losses was $73 thousand and $69 thousand, respectively. Proceeds from sales of securities during the three months of 2010 and 2009 were $9.5 million and $17.5 million. Gross gains of $212 thousand and $200 thousand and gross losses of $1 thousand and $1 thousand, were realized on those sales, respectively. The tax provision related to these realized gains and losses was $72 thousand and $68 thousand, respectively. Securities with unrealized losses at June 30, 2010 and at December 31, 2009 not recognized in income are as follows:
June 30, 2010 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 agencies $ 2,033 $ (1) $ - $ - $ 2,033 $ (1) States and municipals 28,269 (373) - - 28,269 (373) Total temporarily impaired $30,302 $ (374) $ - $ - $30,302 $ (374)
December 31, 2009 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 agencies $35,216 $ (448) $ - $ - $35,216 $ (448) States and municipals 25,126 (348) 870 (14) 25,996 (362) Mortgage-backed - residential 11,930 (151) - - 11,930 (151) Total temporarily impaired $72,272 $ (947) $ 870 $ (14) $73,142 $ (961)
We evaluate securities for other than temporary impairment at least on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. In analyzing an issuer?s financial condition, we may consider many factors including, (1) whether the securities are issued by the federal government or its agencies, (2) whether downgrades by bond rating agencies have occurred, (3) the results of reviews of the issuer?s financial condition and near-term prospects, (4) the length of time and the extent to which the fair value has been less than cost, and (5) whether we intend to sell the investment security or more likely than not will be required to sell the investment security before its anticipated recovery.. Unrealized losses on securities included in the tables above have not been recognized into income because (1) management believes the issues are of high credit quality, (2) management does not intend to sell and it is more likely than not that management would not be required to sell the securities prior to their anticipated recovery, (3) management believes the decline in fair value is largely due to changes in interest rates and (4) management believes the declines in fair value are temporary. The Company believes the fair value is expected to recover as the securities approach maturity. 3. LOANS Loans at period-end are as follows: (in thousands) 6/30/10 12/31/09 Commercial $ 24,725 $ 21,933 Real estate construction 14,691 16,865 Real estate mortgage 279,820 287,444 Agricultural 80,933 80,619 Consumer 16,018 18,277 Other 288 280 Total $ 416,475 $ 425,418 Activity in the allowance for loan losses for the six month periods indicated was as follows: (in thousands) 6/30/10 6/30/09 Beginning balance $ 7,600 $ 5,465 Charge-offs (2,904) (818) Recoveries 515 826 Provision for loan losses 1,250 900 Ending balance $ 6,461 $ 6,373 Individually impaired loans were as follows: (in thousands) 6/30/10 12/31/09 Period-end loans with no allocated allowance for loan losses $ 20,083 $ 19,206 Period-end loans with allocated Allowance for loan losses 14,003 14,266 Total $ 34,086 $ 33,472 Amount of the allowance for loan losses allocated $ 2,905 $ 4,064 6/30/10 6/30/09 Average of individually impaired loans during the period $ 32,260 $ 6,460 Cash-basis interest income recognized 77 1 Nonperforming loans were as follows: (in thousands) 6/30/10 12/31/09 Loans past due over 90 days still on accrual $ 300 $ 2,526 Nonaccrual loans 14,433 12,038 Nonaccrual loans are included in impaired loans. A loan is impaired when full payment under the contractual terms is not expected. Nonaccrual loans and loans past due 90 days still on accrual include both smaller balance homogeneous loans that are collectively evaluated for impairment and individually classified impaired loans. During the first six months of 2010, $2.1 million of impaired loans was transferred to real estate owned and $2.9 million recorded in chargeoffs. The increase in nonaccrual loans was primarily from various smaller balance loans being added during the first quarter of 2010. We have no troubled debt restructurings as of June 30, 2010 and December 31, 2009. 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: Six Months Ended June 30 2010 2009 (in thousands) Basic Earnings Per Share Net Income $ 2,126 $ 2,071 Weighted average common shares outstanding 2,732 2,737 Basic earnings per share $ 0.78 $ 0.76 Diluted Earnings Per Share Net Income $ 2,126 $ 2,071 Weighted average common shares outstanding 2,732 2,737 Add dilutive effects of assumed exercise of stock options - 1 Weighted average common and dilutive potential common shares outstanding 2,732 2,738 Diluted earnings per share $ 0.78 $ 0.76 Three Months Ended June 30 2010 2009 (in thousands) Basic Earnings Per Share Net Income $ 1,181 $ 904 Weighted average common shares outstanding 2,732 2,738 Basic earnings per share $ 0.43 $ 0.33 Diluted Earnings Per Share Net Income $ 1,181 $ 904 Weighted average common shares outstanding 2,732 2,738 Add dilutive effects of assumed exercise of stock options - 1 Weighted average common and dilutive potential common shares outstanding 2,732 2,739 Diluted earnings per share $ 0.43 $ 0.33 Stock options of 33,490 shares common stock for the six and three months ended June 30, 2010 and 37,844 shares common stock for the six and three months ended June 30, 2009 were excluded from diluted earnings per share because their impact was antidilutive. Stock grants of 21,705 shares common stock for the six and three months ended June 30, 2010 and 13,505 shares common stock for the six and three months ended June 30, 2009 were excluded from diluted earnings per share because their impact was antidilutive. 5. STOCK COMPENSATION We have four share based compensation plans as described below. Two Stock Option Plans Under our now expired 1999 Employee Stock Option Plan, we granted certain officers and key employees stock option awards which vest and become fully exercisable at the end of five years and provide for issuance of up to 100,000 options. Under the now expired 1993 Non-Employee Directors Stock Ownership Incentive Plan, we also granted certain directors stock option awards which vest and become fully exercisable immediately and provide for issuance 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 our stock on the date of grant. Summary of activity in the stock option plan for 2010 follows: Weighted Weighted Average Average Remaining Aggregate Exercise Contractual Intrinsic Shares Price Term Value Outstanding, beginning of year 36,250 $29.42 Granted - - Forfeited or expired (2,760) 27.93 Exercised - - Outstanding, end of period 33,490 $29.54 44.4 months $ - Vested and expected to vest 33,490 $29.54 44.4 months $ - Exercisable, end of period 33,490 $29.54 44.4 months $ - As of June 30, 2010, there was $0 of total unrecognized compensation cost related to nonvested stock options granted under the Plan. Since both stock option plans have expired, as of June 30, 2010 no additional options can be granted under either of these plans. 2005 Restricted Stock Grant Plan On May 10, 2005, our stockholders approved a restricted stock grant plan. Total shares issuable under the plan are 50,000. There were 4,020 shares issued during 2010 and 4,150 shares issued during 2009. There were 344 shares forfeited during the first six months of 2010 and 334 shares forfeited during the first six months of 2009. As of June 30, 2010, the restricted stock grant plan allows for additional restricted stock share awards of up to 30,171 shares. 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 January 1, 2010 10,122 $ 261,033 Granted 4,020 65,928 Vested (2,808) (75,926) Forfeited (344) (8,473) Nonvested at June 30, 2010 10,990 $ 242,562 As of June 30, 2010, there was $242,562 of total unrecognized compensation cost related to nonvested shares granted under the Plan. The cost is expected to be recognized over a weighted-average period of 5 years. 2009 Stock Award Plan On May 13, 2009, our stockholders approved a stock award plan that provides for the granting of both incentive and nonqualified stock options and other share based awards. Total shares issuable under the plan are 150,000. As of June 30, 2010 no awards have been granted under the plan and 150,000 shares are still available. 6. FAIR VALUE MEASUREMENTS ASC Topic 820, ?Fair Value Measurements and Disclosures?, defines fair value, establishes a framework for measuring fair value, and sets forth disclosures about fair value measurements. ASC Topic 825, ?Financial Instruments?, allows entities to choose to measure certain financial assets and liabilities at fair value. The Company has not elected the fair value option for any financial assets or liabilities. ASC Topic 820 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. It also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. This Topic 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 company?s own assumptions about the assumptions that market participants would use in pricing an asset or liability. The Company used the following methods and significant assumptions to estimate the fair value: Investment Securities: The fair values for available for sale investment securities are determined by quoted market prices, if available (Level 1). For securities where quoted prices are not available, fair values are calculated based on market prices of similar securities (Level 2). For securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows or other market indicators (Level 3). Impaired Loans: 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 usually significant and typically result in a Level 3 classification of the inputs for determining fair value. Other Real Estate Owned: Nonrecurring adjustments to certain commercial and residential real estate properties classified as other real estate owned (OREO) are measured at the lower of carrying amount or fair value, less costs to sell. Fair values are generally based on third party appraisals of the property, resulting in a Level 3 classification. In cases where the carrying amount exceeds the fair value, less costs to sell, an impairment loss is recognized. Mortgage Servicing Rights: Fair value is based on market prices for comparable mortgage servicing contracts, when available, or alternatively based on a valuation model that calculates the present value of estimated future net servicing income, resulting in a Level 3 classification. Assets and Liabilities Measured on a Recurring Basis 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 tables below.
(In thousands) Fair Value Measurements at June 30, 2010 Using: Quoted Prices In Active Markets for Significant Other Significant Identical Observable Unobservable Carrying Assets Inputs Inputs Description Value (Level 1) (Level 2) (Level 3) U. S. government agencies $ 65,828 $ - $ 65,828 $ - States and municipals 86,703 - 86,703 - Mortgage-backed - residential 38,795 - 38,795 - Equity securities 299 299 - - Total $191,625 $ 299 $191,326 $ -
(In thousands) Fair Value Measurements at December 31, 2009 Using: Quoted Prices In Active Markets for Significant Other Significant Identical Observable Unobservable Carrying Assets Inputs Inputs Description Value (Level 1) (Level 2) (Level 3) U. S. government agencies $ 44,733 $ - $ 44,733 $ - States and municipals 80,123 - 80,123 - Mortgage-backed - residential 43,263 - 43,263 - Equity securities 292 292 - - Total $168,411 $ 292 $168,119 $ -
Assets measured at fair value on a non-recurring basis are summarized below: (In thousands) Fair Value Measurements at June 30, 2010 Using: Quoted Prices In Active Markets for Significant Other Significant Identical Observable Unobservable Carrying Assets Inputs Inputs Description Value (Level 1) (Level 2) (Level 3) Impaired loans $ 11,098 $ - $ - $ 11,098 Other real estate Owned 4,583 - - 4,583 Mortgage servicing rights 262 - - 262 (In thousands) Fair Value Measurements at December 31, 2009 Using: Quoted Prices In Active Markets for Significant Other Significant Identical Observable Unobservable Carrying Assets Inputs Inputs Description Value (Level 1) (Level 2) (Level 3) Impaired loans $10,202 $ - $ - $ 10,202 Other real estate Owned 68 - - 68 Mortgage servicing rights 626 - - 626 Impaired loans, which are measured for impairment using the fair value of the collateral for collateral dependent loans, had a carrying amount of $14.0 million, with a valuation allowance of $2.9 million at June 30, 2010, resulting in an additional provision of $1.1 million for loan losses for the six months ending June 30, 2010. The provision for the three months ending June 30, 2010 is $1.1 million. Other real estate owned which is measured at fair value less costs to sell, had a net carrying amount of $4.6 million, which is made up of the outstanding balance of $5.1 million, net of a valuation allowance of $470 thousand at June 30, 2010, resulting in a write-down of $470 thousand for the six months ending June 30, 2010. The write-down for the three months ending June 30, 2010 is $191 thousand. Fair Value of Financial Instruments The fair values of the Company?s financial instruments at June 30, 2010 and December 31, 2009 are as follows: June 30, 2010 December 31, 2009 Carrying Carrying Amount Fair Value Amount Fair Value (In Thousands) Financial assets Cash and cash equivalents $ 30,404 $ 30,404 $ 34,421 $ 34,421 Securities 191,625 191,625 168,411 168,411 Mortgage loans held for sale 295 302 191 192 Loans, net 410,014 409,100 417,818 417,759 FHLB stock 6,731 N/A 6,731 N/A Interest receivable 4,392 4,392 4,621 4,621 Financial liabilities Deposits $ 554,931 $ 559,468 $ 536,446 $ 541,691 Securities sold under agreements to repurchase and other borrowings 6,844 6,870 8,226 8,252 FHLB advances 49,110 51,240 56,096 57,633 Subordinated debentures 7,217 5,052 7,217 6,029 Interest payable 3,893 3,893 2,122 2,122 The methods and assumptions, not previously presented, used to estimate fair value are described as follows: Carrying amount is the estimated fair value for cash and cash equivalents, interest bearing deposits, accrued interest receivable and payable, demand deposits, short-term debt, and variable rate loans or deposits that reprice frequently and fully. The methods for determining the fair values for securities were described previously. 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 (including consideration of widening credit spreads). Fair value of debt is based on current rates for similar financing. It was not practicable to determine the fair value of FHLB stock due to restrictions placed on its transferability. The fair value of off-balance sheet items is not considered material. 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. These statements are not historical facts, but rather statements based on our current expectations regarding our business strategies and their intended results and our future performance. Forward- looking statements are preceded by terms such as ?expects,? ?believes,? ?anticipates,? ?intends? and similar expressions. Although we believe 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 and the thoroughbred horse industry, in which we and our bank operate); competition for our customers from other providers of financial and mortgage services; government legislation, regulation and monetary policy (which changes from time to time and over which we have 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 our customers; and other risks detailed in our filings with the Securities and Exchange Commission, all of which are difficult to predict and many of which are beyond our control. We undertake no obligation to republish revised forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. Summary We recorded net income of $2.13 million, or $0.78 basic earnings and diluted earnings per share for the first six months ending June 30, 2010 compared to $2.07 million, or $0.76 basic earnings and diluted earnings per share for the six month period ending June 30, 2009. The first six months earnings reflects an increase of 2.6% compared to the same time period in 2009, due primarily to an increase in net interest income of $576 thousand and a decrease in salaries and employee benefits of $1.0 million. Employee benefits were higher in 2009 due to $860 thousand being expensed for final costs associated with the settlement of the defined benefit plan that was terminated as of December 31, 2008. Salaries and employee benefit expense has decreased in 2010 also due to the voluntary separation offers that were offered to certain employees during the third and fourth quarters of 2009. These positive changes to net income during 2010 were partially offset by a decrease in the gain on sold loans of $502 thousand and an increase in repossession expenses of $517 thousand. The earnings for the three months ended June 30, 2010 were $1.2 million, or $.43 basic and diluted earnings per share for the three month period ending June 30, 2010 compared to $904 thousand, or $.33 basic and diluted earnings per share for the three month period ending June 30, 2009. This three month period earnings reflects a 31% increase compared to the same time period in 2009. Return on average assets was 0.60% for the six months ended June 30, 2010 and 0.61% for the six month period ended June 30, 2009. Return on average assets was 0.66% for the three months ended June 30, 2010 and 0.54% for the three months ended June 30, 2009. Return on average equity was 6.9% for the six month period ended June 30, 2010 and 7.1% for the same period in 2009. Return on average equity was 7.6% for the three months ended June 30, 2010 and 6.1% for the same time period in 2009. Gross Loans decreased $8.9 million from $425.4 million on December 31, 2009 to $416.5 million on June 30, 2010. The overall decrease is attributed to decreases in real estate construction loans, real estate mortgage loans and consumer loans. Decreases to these sectors of the loan portfolio were partially offset by an increase of $2.8 million in commercial loans. Total deposits increased from $536.4 million on December 31, 2009 to $554.9 million on June 30, 2010, an increase of $18.5 million. This increase is primarily the result of an increase in non-interest bearing deposit accounts of $20.0 million and an increase in interest bearing time deposit accounts over $100 thousand of $17.8 million. Deposits are up due to temporary cash influxes in our existing deposit base. Of this increase, $18 million is expected to be withdrawn during the third quarter of 2010. Net Interest Income Net interest income was $10.0 million for the six months ended June 30, 2010 compared to $9.4 million for the six months ended June 30, 2009, an increase of 6.1%. The interest spread of 3.05% for the first six months of 2010 is up from 2.94% reported for the same period in 2009, an increase of 11 basis points. Net interest income was $5.1 million for the three month period ending June 30, 2010 compared to $4.7 million for the three month period ending June 30, 2009, an increase of 9.8%. The interest spread was 3.08% for three month period ending June 30, 2010 compared to 2.93% for the three month period in 2009, an increase of 15 basis points. Rates have remained fairly low in the past year. In addition to lower rates and tightening margins, the net interest spread for 2010 is affected by an increase in ?lost? loan interest during 2010 that can be attributed to an increase in non-performing loans in our loan portfolio. For the first six months, the yield on assets decreased from 5.13% in 2009 to 4.76% in 2010. The cost of liabilities decreased from 2.19% in 2009 to 1.71% in 2010. Year to date average loans increased $3.7 million, or 0.89% from June 30, 2009 to June 30, 2010. Loan interest income has decreased $276 thousand for the first six months of 2010 compared to the first six months of 2009. Year to date average deposits increased from June 30, 2009 to June 30, 2010, up $50.7 million or 9.6%. The increase is primarily the result of an increase in non-interest bearing deposits and time deposits with balances greater than $100 thousand. Deposit interest expense has decreased $655 thousand for the first six months of 2010 compared to the same period in 2009. Year to date average borrowings decreased $22.6 million, or 24.97% from June 30, 2009 to June 30, 2010. The decrease is primarily the result of paying off FHLB advances when they come due and not replacing them because of the influx in deposits. Interest expense on borrowed funds has decreased $577 thousand for the first six months of 2010 compared to the same period in 2009. The volume rate analysis for 2010 that follows indicates that $834 thousand of the decrease in interest income is attributable to the decrease in rates, while the change in volume contributed to an increase of $178 thousand 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 2.19% in 2009 to 1.71% in 2010. Based on the volume rate analysis that follows, the lower level of interest rates contributed to a decrease of $1.6 million in interest expense, while the change in volume was responsible for a $395 thousand increase in interest expense. As a result, the 2010 net interest income increase is attributed to decreases in rates. In addition to the negative impact on net interest income that may result from the decreasing rate environment that began in 2007 and continued into 2010 competitive pressures on interest rates will continue and are likely to result in continued downward pressure on 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 2010. Changes in interest income and expenses due to both rate and volume are allocated on a pro rata basis. Changes in Interest Income and Expense Six Months Ended June 30, 2010 2010 vs. 2009 Increase (Decrease) Due to Change in Volume Rate Net Change INTEREST INCOME Loans $ 325 $ (601) $ (276) Investment Securities (171) (219) (390) Federal Funds Sold and Securities Purchased under Agreements to Resell 19 (5) 14 Deposits with Banks 5 (9) (4) Total Interest Income 178 (834) (656) INTEREST EXPENSE Deposits Demand 64 146 210 Savings (32) (139) (171) Negotiable Certificates of Deposit and Other Time Deposits 777 (1,471) (694) Securities sold under agreements to repurchase and other borrowings (122) (3) (125) Federal Home Loan Bank advances (292) (160) (452) Total Interest Expense 395 (1,627) (1,232) Net Interest Income $ (217) $ 793 $ 576 Non-Interest Income Non-interest income decreased $448 thousand for the six months ended June 30, 2010 compared to the same period in 2009 to $4.1 million, due primarily to a decrease in the gains on the sale of mortgage loans of $502 thousand and a decrease in service charges of $135 thousand. These reductions to income were partially offset by an increase in other non-interest income of $83 thousand. The decrease in service charges was primarily the result of a decrease in fees collected for title insurance of $70 thousand and a decline in overdraft income of $70 thousand. Other non-interest income increased mostly do to an increase in debit card interchange income of $80 thousand compared to the same period one year ago. Non-interest income decreased $194 thousand for the three months ended June 30, 2010 compared to the three months ended June 30, 2009. The decrease was primarily due a reduction in the gains on sold mortgage loans of $250 thousand and a decrease in service charges of $85 thousand. Trust department fee income increased $69 thousand, primarily from $75 thousand collected for part of an estate fee. The gain on the sale of mortgage loans decreased from $811 thousand in the first six months of 2009 to $309 thousand during the first six months of 2010. For the three months ended June 30, 2010 compared to the same time period in 2009, the gain on the sale of mortgage loans decreased $250 thousand. The volume of loans sold during the first six months of 2010 decreased $25.3 million compared to the same time period in 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 $341 thousand for the six month period ended June 30, 2010 compared to the same period in 2009. For the three month period ended June 30, 2010 compared to the three months ending June 30, 2009, total non-interest expense decreased $629 thousand. For the comparable six month periods, salaries and benefits decreased $1.0 million, a decrease of 17.4%. The decrease in salaries & benefits is primarily attributed to our terminating the defined benefit plan offered to our employees as of December 31, 2008. During the second quarter of 2009, we recognized $860 thousand for the final expenses related to settling the plan. In addition, we have recognized savings during 2010 related to having fewer full time equivalent employees compared to the same period one year ago. The reduced staff is the result of our offering voluntary separation options to certain employees during the third and fourth quarters of 2009. The number of full time equivalent employees decreased from 194 at June 30, 2009 to 177 at June 30, 2010. Salaries and employee benefits decreased $943 thousand for the three month period ending June 30, 2010 compared to the same time period in 2009. Occupancy expenses increased $66 thousand to $1.4 million for the first six months of 2010 compared to the same time period in 2009. Occupancy expenses increased $35 thousand for the three month period ended June 30, 2010 compared to the same time period in 2009. The increase in year to date occupancy expense during 2010 is mainly attributable to an increase in depreciation expense of $105 thousand. Legal and professional fees increased $168 thousand for the first six months ended June 30, 2010 compared to the same time period in 2009. Legal and professional fees increased $91 thousand for the three month period ending June 30, 2010 compared to the same time period in 2009. The increase is primarily from additional collection efforts for problem loans. Repossession expenses increased $517 thousand for the first six months ended June 30, 2010 compared to the same time period in 2009. The increase is primarily attributable to write-downs of other real estate owned. Repossession expenses increased $271 thousand for the three month period ending June 30, 2010 compared to the same three months ending June 30, 2009. These increases were partially offset by a decrease in the cost of FDIC insurance premiums of $215 thousand for the six months ending June 30, 2010 compared to the six months ending June 30, 2009. FDIC insurance expense decreased $226 thousand for the three months ending June 30, 2010 compared to the same time period one year ago. Due to the downturn in the financial industry and related bank failures, the FDIC increased the FDIC insurance premiums in 2009. The decrease in FDIC insurance expense in 2010 compared to 2009 is attributed to the one-time special assessment the FDIC assessed on all FDIC insured banks in May of 2009, which cost the Company $296 thousand in 2009. 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 our 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 five basis points as of June 30, 2009. The special assessment amounted to $296 thousand and was paid on September 30, 2009. 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. On November 12, 2009, the FDIC adopted a final rule requiring insured depository institutions to prepay their estimated quarterly risk-based assessments for the fourth quarter of 2009, and for all of 2010, 2011, and 2012. The prepaid amount will be amortized over the prepayment period. The Company?s prepayment was $3.1 million. Financing Corporation (?FICO?) assessment costs were $30 thousand for the six months ended June 30, 2010 and $27 thousand for 2009. FICO is a mixed- ownership government corporation established by the Competitive Equality Banking Act of 1987 possessing assessment powers in addition to the FDIC. The FDIC acts as a collection agent for FICO, whose sole purpose is to function as a financing vehicle for the now defunct Federal Savings & Loan Insurance Corporation. Income Taxes The effective tax rate for the six months ended June 30, 2010 was 9.9% compared to 7.6% in 2009. The effective tax rate for the three months ended June 30, 2010 was 13.5% compared to (10.0%) for the three months ended June 30, 2009. 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 2010 are higher due to the higher level of income for 2010 and also tax credits for investments we held related to historic and low income housing that expired at the end of 2009. Nontaxable interest income increased $431 thousand for the first six months of 2010 compared to the same time period in 2009. Liquidity and Funding Liquidity risk is the possibility that we may not be able to meet our 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 $30.4 million as of June 30, 2010 compared to $34.4 million at December 31, 2009. The decrease in cash and cash equivalents is mainly attributable to a decrease in federal funds sold resulting primarily from an increase in our security portfolio. In addition to cash and cash equivalents, the securities portfolio provides an important source of liquidity. Securities available for sale totaled $191.6 million at June 30, 2010 compared to $168.4 million at December 31, 2009. The available for sale securities are available to meet liquidity needs on a continuing basis. We expect our customers? deposits to be adequate to meet our funding demands. Generally, we rely upon net cash inflows from financing activities, supplemented by net cash inflows from operating activities, to provide cash used in our 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. Our primary investing activities include purchasing investment securities and loan originations. For the first six months of 2010, deposits have increased $18 million. With loan demand being slow, we have been able to increase our investment portfolio by $23 million. And to a lesser degree, we have paid down FHLB advances $7 million and will continue to pay those down as they mature. 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. We rely on FHLB advances for both liquidity and asset/liability management purposes. These advances are used primarily to fund long-term fixed rate residential mortgage loans. As of June 30, 2010, we have sufficient collateral to borrow an additional $40 million from the FHLB. In addition, as of June 30, 2010, over $33 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. Capital Requirements 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 June 30, 2010 and December 31, 2009, 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 (Dollars in Thousands) June 30, 2010 Consolidated Total Capital (to Risk-Weighted Assets) $ 59,577 12.8% $ 37,230 8% $ 46,538 N/A Tier I Capital (to Risk-Weighted Assets) 53,739 11.6 18,615 4 27,923 N/A Tier I Capital (to Average Assets) 53,739 7.6 28,257 4 35,321 N/A Bank Only Total Capital (to Risk-Weighted Assets) $ 61,674 13.3% $ 37,223 8% $ 46,528 10% Tier I Capital (to Risk-Weighted Assets) 55,836 12.0 18,611 4 27,917 6 Tier I Capital (to Average Assets) 55,836 7.9 28,235 4 35,293 5 December 31, 2009 Consolidated Total Capital (to Risk-Weighted Assets) $ 58,398 12.6% $ 36,957 8% $ 46,196 N/A Tier I Capital (to Risk-Weighted Assets) 52,593 11.4 18,478 4 27,718 N/A Tier I Capital (to Average Assets) 52,593 8.0 26,201 4 32,752 N/A Bank Only Total Capital (to Risk-Weighted Assets) $ 60,675 13.1% $ 36,941 8% $ 46,177 10% Tier I Capital (to Risk-Weighted Assets) 54,869 11.9 18,471 4 27,706 6 Tier I Capital (to Average Assets) 54,869 8.4 26,200 4 32,750 5
Non-Performing Assets As of June 30, 2010, our non-performing assets totaled $20.2 million or 2.95% of assets compared to $19.1 million or 2.83% of assets at December 31, 2009. (See table below) We experienced an increase of $2.4 million in non-accrual loans from December 31, 2009 to June 30, 2010, largely due to an increase in non-accrual loans secured by real estate of $2.5 million. As of June 30, 2010, non-accrual loans include $4.7 million in loans secured by non-farm and non-residential real estate, $4.2 million in loans secured by real estate construction, $3.7 million in loans secured by 1-4 family residential real estate, $900 thousand in loans secured by multi-family real estate properties and $800 thousand in loans secured by farmland. Real estate loans composed 99% of the non-performing loans as of June 30, 2010 and 98% as of December 31, 2009. Forgone interest income on the non-accrual loans was $355 thousand for the first six months of 2010 compared to $367 thousand for the same time period in 2009. Accruing loans that are contractually 90 days or more past due as of June 30, 2010 totaled $300 thousand compared to $2.5 million at December 31, 2009, a decrease of $2.2 million. The decrease is primarily due to one loan amounting to $1.4 million being paid off during the period. The total nonperforming loans increased $169 thousand from December 31, 2009 to June 30, 2010, resulting in a slight increase in the ratio of nonperforming loans to loans of 12 basis points to 3.54%. In addition, the amount the Company has booked as ?Other Real Estate? has increased $1.0 million from December 31, 2009 to June 30, 2010. As of June 30, 2010 the amount booked as ?Other Real Estate? totaled $5.5 million compared to $4.5 million at December 31, 2009. The increase is largely attributed to one loan customer who specialized in commercial & land development properties that totaled $1.2 million, that was previously on non-accrual. The allowance as a percentage of non-performing and restructured loans increased slightly from 40% at December 31, 2009 to 44% at June 30, 2010. Nonperforming Assets 6/30/10 12/31/09 (in thousands) Non-accrual Loans $ 14,433 $ 12,038 Accruing Loans which are Contractually past due 90 days or more 300 2,526 Total Nonperforming and Restructured 14,733 14,564 Other Real Estate 5,548 4,542 Total Nonperforming and Restructured Loans and Other Real Estate $ 20,281 $ 19,106 Nonperforming and Restructured Loans as a Percentage of Loans 3.54% 3.42% Nonperforming and Restructured Loans and Other Real Estate as a Percentage of Total Assets 2.95% 2.83% Allowance as a Percentage of Period-end Loans 1.55% 1.79% Allowance as a Percentage of Non-performing and Restructured Loans 44% 40% We maintain a ?watch list? of agricultural, commercial, real estate mortgage, and real estate construction loans and reviews those loans on a regular basis. Generally, assets are designated as ?watch list? loans to ensure more frequent monitoring. If we determine that there is serious doubt as to performance in accordance with original terms of the contract, then the loan is generally downgraded and often placed on non-accrual status. We review and evaluate nonaccrual loans, past due loans, and loans graded substandard or worse on a regular basis to determine if specific allocations are needed. Provision for Loan Losses The loan loss provision for the first six months was $1.25 million for 2010 and $900 thousand for 2009. The loan loss provision for the three months ended June 30, 2010 was $800 thousand and $450 thousand for the same period in 2009. Management evaluates the loan portfolio by reviewing the historical loss rate for each respective loan type and assigns risk multiples to certain categories to account for qualitative factors including current economic conditions. The average loss rates are reviewed in the analysis, as well as comparisons to peer group loss rates. Management makes allocations within the allowance for loan losses for specifically classified loans regardless of loan amount, collateral or loan type. Loan categories are evaluated utilizing subjective factors in addition to the historical loss calculations to determine a loss allocation for each of those types. As this analysis, or any similar analysis, is an imprecise measure of loss, the allowance is subject to ongoing adjustments. Therefore, management will often take into account other significant factors that may be necessary or prudent in order to reflect probable incurred losses in the total loan portfolio. Net charge-offs for the six month period ended June 30, 2010 were $2.4 million compared to net recoveries of $8 thousand for the same period in 2009. Net charge-offs for the three month period ended June 30, 2010 were $103 thousand compared to $76 thousand during the same period in 2009. Based on our internal loan review as of December 31, 2009, an addition of $1.8 million was made to the allowance for loan losses in the fourth quarter of 2009. Three borrowers that total $1.8 million were charged off in the first quarter of 2010 and were directly related to the additional provision in the fourth quarter of 2009. Future levels of charge-offs will be determined by the particular facts and circumstances surrounding individual loans. Based on the above information, Management believes the current loan loss allowance is sufficient to meet probable incurred loan losses. Loan Losses Six Months Ended June 30 (in thousands) 2010 2009 Balance at Beginning of Period $ 7,600 $ 5,465 Amounts Charged-off: Commercial 19 67 Real Estate Construction 547 39 Real Estate Mortgage 1,793 82 Agricultural 74 6 Consumer 471 624 Total Charged-off Loans 2,904 818 Recoveries on Amounts Previously Charged-off: Commercial 43 2 Real Estate Construction - 35 Real Estate Mortgage 172 387 Agricultural 10 - Consumer 290 402 Total Recoveries 515 826 Net Charge-offs (Recoveries) 2,389 (8) Provision for Loan Losses 1,250 900 Balance at End of Period 6,461 6,373 Loans Average 422,081 418,375 At June 30 416,475 417,556 As a Percentage of Average Loans: Net Charge-offs for the period 0.57% 0.00% Provision for Loan Losses for the period 0.30% 0.22% Allowance as a Multiple of Net Charge-offs (annualized) 1.4 (398.3) Three Months Ended June 30 (in thousands) 2010 2009 Balance at Beginning of Period $ 5,763 $ 5,999 Amounts Charged-off: Commercial - 67 Real Estate Construction - 36 Real Estate Mortgage 80 34 Agricultural - 353 Consumer 235 - Total Charged-off Loans 315 490 Recoveries on Amounts Previously Charged-off: Commercial - 2 Real Estate Construction - 35 Real Estate Mortgage 69 152 Agricultural 2 - Consumer 142 225 Total Recoveries 213 414 Net Charge-offs 102 76 Provision for Loan Losses 800 450 Balance at End of Period 6,461 6,373 Loans Average 420,998 418,038 At June 30 416,475 417,556 As a Percentage of Average Loans: Net Charge-offs for the period 0.02% 0.02% Provision for Loan Losses for the period 0.19% 0.11% Allowance as a Multiple of Net Charge-offs (annualized) 15.7 21.0 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. Our 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. We have 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 June 30, 2010, the projected percentage changes are within the Board approved limits. 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 simulation both in a falling and rising rate environment when compared to the same period a year ago. The projected net interest income report summarizing our interest rate sensitivity as of June 30, 2010 is as follows: PROJECTED NET INTEREST INCOME (dollars in thousands) Level Change in basis points: - 300 - 100 Rates + 100 + 300 Year One (7/10 - 6/11) Net interest income $22,943 $23,738 $23,932 $24,190 $24,622 Net interest income dollar change (989) (193) N/A 258 690 Net interest income percentage change -4.1% -0.8% N/A 1.1% 2.9% 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 June 30, 2009 is as follows: PROJECTED NET INTEREST INCOME (dollars in thousands) Level Change in basis points: - 300 - 100 Rates + 100 + 300 Year One (7/09 - 6/10) Net interest income $20,407 $21,487 $22,415 $22,957 $23,420 Net interest income dollar change (2,008) (928) N/A 542 1,005 Net interest income percentage change -9.0% -4.1% N/A 2.4% 4.5% Board approved limit >-10.0% >-4.0% N/A >-4.0% >- 10.0% Projections from June 30, 2010, year one reflected a decline in net interest income of 0.8% with a 100 basis point decline compared to the 4.1% decline in 2009. The 100 basis point increase in rates reflected a 1.1% increase in net interest income in 2010 compared to 2.4% in 2009. 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 June 30, 2010 balance sheet, a 100 basis point increase in rates results in a 7.4% decrease in EVE. A 100 basis point decrease in rates results in a 4.9% 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, our management, including the Chief Executive Officer and the Chief Financial Officer, carried out an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures. Based on the foregoing, our 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. We 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, our 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 We are not a party to any material legal proceedings. Item 1A. Risk Factors A wide range of regulatory initiatives directed at the financial services industry have been proposed in recent months. One of those initiatives, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the ?Dodd-Frank Act?), was signed into law by President Obama on July 21, 2010. The Dodd-Frank Act represents a comprehensive overhaul of the financial services industry within the United States, establishes the new federal Bureau of Consumer Financial Protection (the ?BCFP?), and will require the BCFP and other federal agencies to implement many new rules. At this time, it is difficult to predict the extent to which the Dodd-Frank Act or the resulting regulations will impact the Company?s business. However, compliance with these new laws and regulations will result in additional costs, which may adversely impact the Company?s results of operations, financial condition or liquidity, any of which may impact the market price of the Company?s common stock. Other than the additional risk factor mentioned above, there are no material changes from the risk factors set forth under Part I, Item 1A ?Risk Factors? in our Annual Report on Form 10-K for the year ended December 31, 2009. Item 2. Unregistered Sales of Equity Securities and Use of Proceeds ISSUER PURCHASES OF EQUITY SECURITIES (a) (b) (c) Total Number (d) Maximum Number Total of Shares (or Units) (or Approximate Dollar Number of Average Purchased as Part Value) of Shares (or Shares (or Price Paid of Publicly Units) that May Yet Be Units) Per Share Announced Plans Purchased Under the Period Purchased (or Unit) Or Programs Plans of Programs 4/1/10 ? 4/30/10 - $ - - 32,199 shares 5/1/10 ? 5/31/10 - - - 32,199 shares 6/1/10 ? 6/30/10 651 15.75 651 31,548 shares Total 651 - 651 31,548 shares On October 25, 2000, we announced that our Board of Directors approved a stock repurchase program and authorized the Company 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 purchase an additional 100,000 shares. Shares will be purchased from time to time in the open market depending on market prices and other considerations. Through June 30, 2010, 268,452 shares have been purchased. 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 _____8/13/10_______ __/s/Louis Prichard______________ Louis Prichard, President and C.E.O. Date _____8/13/10_______ __/s/Gregory J. Dawson___________ Gregory J. Dawson, Chief Financial Officer 22 Lexlibrary/197885.1 EX-31 2 ex311.txt EXHIBIT 31.1 Exhibit 31.1 CERTIFICATIONS OF CHIEF EXECUTIVE OFFICER PURSUANT TO SECTION 302 OF SARBANES-OXLEY ACT I, Louis Prichard, certify that: 1. I have reviewed this quarterly report on Form 10-Q 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)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d- 15(f)) 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) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c) 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 d) 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: August 13, 2010 BY /s/ Louis Prichard Louis Prichard President & Chief Executive Officer 32 EX-32 3 ex312.txt EXHIBIT 31.2 Exhibit 31.2 CERTIFICATIONS OF CHIEF FINANCIAL OFFICER PURSUANT TO SECTION 302 OF SARBANES-OXLEY ACT I, Gregory J. Dawson, certify that: 1. I have reviewed this quarterly report on Form 10-Q 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)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d- 15(f)) 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) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c) 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 d) 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: August 13, 2010 BY /s/ Gregory J. Dawson Gregory J. Dawson Chief Financial Officer 34 EX-32 4 ex32.txt EXHIBIT 32.1 Exhibit 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) In connection with the Quarterly Report of Kentucky Bancshares, Inc. (the ?Company?) on Form 10-Q for the period ended June 30, 2010, as filed with the Securities and Exchange Commission on the date hereof (the ?Report?), the undersigned, the Chief Executive Officer and Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, that: (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 results of operations of the Company. Date: August 13, 2010 By /s/ Louis Prichard Louis Prichard President & Chief Executive Officer Date: August 13, 2010 By /s/ Gregory J. Dawson Gregory J. Dawson Chief Financial Officer 35 Lexlibrary/197885.1 -----END PRIVACY-ENHANCED MESSAGE-----