-----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, KkJEF9owiavFoqoOrOzLm2bo+XIHHBbA+Mim0vi/zUFVT5vVAGiF1I57eeACrVxl bms0eSj/nxLjg7htmQPXAg== 0001000232-10-000014.txt : 20101112 0001000232-10-000014.hdr.sgml : 20101111 20101112145627 ACCESSION NUMBER: 0001000232-10-000014 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 20100930 FILED AS OF DATE: 20101112 DATE AS OF CHANGE: 20101112 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: 101185796 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 q103.txt FORM 10-Q 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 September 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 November 8, 2010: 2,739,319. 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) 9/30/2010 12/31/2009 Assets Cash and due from banks $ 18,115 $ 12,387 Federal funds sold 7,855 22,034 Cash and cash equivalents 25,970 34,421 Securities available for sale 176,487 168,411 Mortgage loans held for sale 149 191 Loans 415,417 425,418 Allowance for loan losses (7,372) (7,600) Net loans 408,045 417,818 Federal Home Loan Bank stock 6,731 6,731 Real estate owned, net 6,380 4,542 Bank premises and equipment, net 17,670 17,610 Interest receivable 4,627 4,620 Mortgage servicing rights 862 822 Goodwill 13,117 13,117 Other intangible assets 1,072 1,263 Other assets 4,997 5,685 Total assets $ 666,107 $ 675,231 Liabilities and Stockholders' Equity Deposits Non-interest bearing $ 112,890 $ 97,005 Time deposits, $100,000 and over 120,253 105,036 Other interest bearing 305,711 334,405 Total deposits 538,854 536,446 Repurchase agreements and other borrowings 6,437 8,226 Federal Home Loan Bank advances 43,567 56,096 Subordinated debentures 7,217 7,217 Interest payable 2,361 2,123 Other liabilities 2,981 4,158 Total liabilities 601,417 614,266 Stockholders' equity Preferred stock, 300,000 shares authorized and unissued - - Common stock, no par value; 10,000,000 shares authorized; 2,742,506 and 2,739,511 shares issued and outstanding on September 30, 2010 and December 31, 2009 12,489 12,416 Retained earnings 49,185 47,213 Accumulated other comprehensive income 3,016 1,336 Total stockholders' equity 64,690 60,965 Total liabilities & stockholders' equity $ 666,107 $ 675,231 See Accompanying Notes KENTUCKY BANCSHARES, INC. CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (unaudited) (in thousands, except per share amounts) Nine Months Ending 9/30/2010 9/30/2009 INTEREST INCOME: Loans, including fees $ 17,936 $ 18,640 Securities available for sale 4,955 5,361 Other 33 15 Total interest income 22,924 24,016 INTEREST EXPENSE: Deposits 6,296 7,100 Other 1,717 2,566 Total interest expense 8,013 9,666 Net interest income 14,911 14,350 Loan loss provision 1,950 1,350 Net interest income after provision 12,961 13,000 NON-INTEREST INCOME: Service charges 3,707 3,918 Loan service fee income, net 65 69 Trust department income 431 377 Securities available for sale gains, net 1,267 351 Gain on sale of mortgage loans 650 1,026 Other 1,303 1,114 Total other income 7,423 6,855 NON-INTEREST EXPENSE: Salaries and employee benefits 7,574 8,618 Occupancy expenses 2,080 2,031 Repossession expenses, net 947 264 FDIC insurance 768 921 Legal and professional fees 586 300 Data processing 579 558 Debit card expenses 469 479 Amortization 191 195 Advertising and marketing 446 372 Taxes other than payroll, property and income 594 553 Other 1,983 1,862 Total other expenses 16,217 16,153 Income before taxes 4,167 3,702 Income taxes 467 277 Net income $ 3,700 $ 3,425 Other Comprehensive Income, net of tax: Change in Unrealized Gains on Securities 1,680 4,109 Comprehensive Income $ 5,380 $ 7,534 Earnings per share Basic $ 1.35 $ 1.25 Diluted 1.35 1.25 Dividends per share 0.63 0.60 See Accompanying Notes KENTUCKY BANCSHARES, INC. CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (unaudited) (in thousands, except per share amounts) Three Months Ending 9/30/2010 9/30/2009 INTEREST INCOME: Loans, including fees $ 5,909 $ 6,337 Securities available for sale 1,558 1,574 Other 9 1 Total interest income 7,476 7,912 INTEREST EXPENSE: Deposits 2,055 2,204 Other 511 783 Total interest expense 2,566 2,987 Net interest income 4,910 4,925 Loan loss provision 700 450 Net interest income after provision 4,210 4,475 NON-INTEREST INCOME: Service charges 1,320 1,396 Loan service fee income, net (5) 19 Trust department income 121 142 Securities available for sale gains (losses), net 1,053 148 Gain on sale of mortgage loans 341 215 Other 476 370 Total other income 3,306 2,290 NON-INTEREST EXPENSE: Salaries and employee benefits 2,631 2,632 Occupancy expenses 719 738 Repossession expenses, net 319 66 FDIC insurance 272 210 Legal and professional fees 236 118 Data processing 191 178 Debit card expenses 173 186 Amortization 63 64 Advertising and marketing 155 119 Taxes other than payroll, property and income 200 187 Other 750 806 Total other expenses 5,709 5,304 Income before taxes 1,807 1,461 Income taxes 233 108 Net income $ 1,574 $ 1,353 Other Comprehensive Income (Loss), net of tax: Change in Unrealized Gains on Securities 789 3,290 Comprehensive Income $ 2,363 $ 4,643 Earnings per share Basic $ 0.57 $ 0.49 Diluted 0.57 0.49 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 3,646 - - - - Stock based compensation expense - 83 - - 83 Common stock purchased and retired (651) (10) - - (10) Net change in unrealized gain (loss) on securities available for sale, net of tax - - - 1,680 1,680 Net income - - 3,700 - 3,700 Dividends declared - $0.63 per share - - (1,728) - (1,728) Balances, September 30, 2010 2,742,506 $ 12,489 $ 49,185 $ 3,016 $ 64,690
(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) Nine Months Ended 9/30/2010 9/30/2009 Cash Flows From Operating Activities Net Income $ 3,700 $ 3,425 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 1,234 1,128 Securities amortization, net 695 1,156 Stock based compensation expense 83 86 Provision for loan losses 1,950 1,350 Securities gains, net (1,267) (351) Originations of loans held for sale (23,125) (45,213) Proceeds from sale of loans 23,817 46,239 Gains on sale of fixed assets 3 - Losses (gains on) other real estate, net 39 (78) Gain on sale of mortgage loans (650) (1,026) Changes in: Interest receivable (7) 78 Real estate owned, net 700 1,137 Other assets 382 (2,947) Interest payable 238 (286) Other liabilities (2,042) (797) Net cash from operating activities 5,750 3,901 Cash Flows From Investing Activities Purchases of securities (105,577) (60,799) Proceeds from sales of securities 37,345 20,646 Proceeds from principal payments, maturities and calls of securities 63,273 48,850 Net change in loans 5,324 (5,181) Purchases of bank premises and equipment (975) (555) Proceeds from the sale of bank premises 3 - Net cash from investing activities (607) 2,961 Cash Flows From Financing Activities: Net change in deposits 2,408 (24,225) Net change in repurchase agreements and other borrowings (1,189) 7,657 Advances from Federal Home Loan Bank - 10,000 Payments on Federal Home Loan Bank advances (12,475) (23,817) Payments on note payable (600) (200) Purchase of common stock (10) (150) Dividends paid (1,728) (1,647) Net cash from financing activities (13,594) (32,382) Net change in cash and cash equivalents (8,451) (25,520) Cash and cash equivalents at beginning of period 34,421 37,106 Cash and cash equivalents at end of period $ 25,970 $ 11,586 Supplemental disclosures of cash flow information Cash paid during the year for: Interest expense $ 8,251 $ 9,952 Income taxes - 400 Supplemental disclosures of non-cash investing activities Real estate acquired through foreclosure $ 3,494` $ 4,109 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, Elliott, 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. Reclassifications: Some items in the prior year financial statements were reclassified to conform to the current presentation. 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 September 30, 2010 U.S. government agencies $ 54,758 $ 206 $ (14) $ 54,950 States and political subdivisions 83,523 4,026 (100) 87,449 Mortgage-backed - residential 33,367 443 (23) 33,787 Equity securities 270 31 - 301 Total $ 171,918 $ 4,706 $ (137) $ 176,487 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 September 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 $ 1,513 $ 1,631 Due after one year through five years 40,808 41,087 Due after five years through ten years 39,402 41,005 Due after ten years 56,558 58,676 138,281 142,399 Mortgage-backed - residential 33,367 33,787 Equity 270 301 Total $ 171,918 $ 176,487 Proceeds from sales of securities during the first nine months of 2010 and 2009 were $37.3 million and $20.6 million. Gross gains of $1.268 million and $352 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 $431 thousand and $120 thousand, respectively. Proceeds from sales of securities during the third quarter of 2010 and 2009 were $27.8 million and $3.1 million. Gross gains of $1.053 million and $149 thousand and gross losses of $0 and $1 thousand were realized on those sales, respectively. The tax provision related to these realized gains and losses was $358 thousand and $51 thousand, respectively. Securities with unrealized losses at September 30, 2010 and at December 31, 2009 not recognized in income are as follows:
September 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 $ 5,031 $ (14) $ - $ - $ 5,031 $ (14) States and municipals 3,992 (99) 226 (1) 4,218 (100) Mortgage-backed - residential 3,062 (23) - - 3,062 (23) Total temporarily impaired $12,085 $ (136) $ 226 $ (1) $12,311 $ (137)
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) all rated securities are investment grade and 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) 9/30/10 12/31/09 Commercial $ 24,409 $ 21,933 Real estate construction 13,855 16,865 Real estate mortgage 279,420 287,444 Agricultural 80,295 80,619 Consumer 17,127 18,277 Other 311 280 Total $ 415,417 $ 425,418 Activity in the allowance for loan losses for the nine month periods indicated was as follows: (in thousands) 9/30/10 9/30/09 Beginning balance $ 7,600 $ 5,465 Charge-offs (3,421) (1,602) Recoveries 1,243 1,125 Provision for loan losses 1,950 1,350 Ending balance $ 7,372 $ 6,338 Individually impaired loans were as follows: (in thousands) 9/30/10 12/31/09 Period-end loans with no allocated allowance for loan losses $ 20,448 $ 19,206 Period-end loans with allocated allowance for loan losses 11,378 14,266 Total $ 31,826 $ 33,472 Amount of the allowance for loan losses allocated $ 3,709 $ 4,064 Nine Months Ended 9/30/10 9/30/09 Average of individually impaired loans during the period $ 12,822 $ 13,013 Cash-basis interest income recognized 135 1 Nonperforming loans were as follows: (in thousands) 9/30/10 12/31/09 Loans past due over 90 days still on accrual $ 628 $ 2,526 Nonaccrual loans 15,680 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 nine months of 2010, $3.5 million of impaired loans was transferred to real estate owned and $3.4 million recorded in chargeoffs. The increase in nonaccrual loans was primarily from various smaller balance loans being added during the first quarter of 2010. During the third quarter, the non-accrual loan portfolio increased largely due to one loan which was placed on non-accrual in the amount of $2.2 million. However, also during the third quarter, the Company received a principal payment of $2.9 million of which $2.3 million reduced non-accrual loan balances and $555 thousand was a recovery for the amount previously charged off. The Company has no troubled debt restructurings as of September 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: Nine Months Ended September 30 2010 2009 (in thousands) Basic Earnings Per Share Net Income $ 3,700 $ 3,425 Weighted average common shares outstanding 2,732 2,736 Basic earnings per share $ 1.35 $ 1.25 Diluted Earnings Per Share Net Income $ 3,700 $ 3,425 Weighted average common shares outstanding 2,732 2,736 Add dilutive effects of assumed exercise of stock options - - Weighted average common and dilutive potential common shares outstanding 2,732 2,736 Diluted earnings per share $ 1.35 $ 1.25 Three Months Ended September 30 2010 2009 (in thousands) Basic Earnings Per Share Net Income $ 1,574 $ 1,353 Weighted average common shares outstanding 2,732 2,732 Basic earnings per share $ 0.57 $ 0.49 Diluted Earnings Per Share Net Income $ 1,574 $ 1,353 Weighted average common shares outstanding 2,732 2,732 Add dilutive effects of assumed exercise of stock options - - Weighted average common and dilutive potential common shares outstanding 2,732 2,732 Diluted earnings per share $ 0.57 $ 0.49 Stock options for 33,240 shares of common stock for the nine and three months ended September 30, 2010 and 37,844 shares of common stock for the nine and three months ended September 30, 2009 was excluded from diluted earnings per share because their impact was antidilutive. Stock grants of 21,705 shares of common stock for the nine and three months ended September 30, 2010 and 17,655 shares of common stock for the nine and three months ended September 30, 2009 was 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 (the ?1999 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 (together with the 1999 Plan, the ?Stock Option Plans?), 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. For each Stock Option Plan, 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. The combined summary of activity for 2010 in the expired Stock Option Plans 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 (3,010) 28.15 Exercised - - Outstanding, end of period 33,240 $29.53 41.4 months $ - Vested and expected to vest 33,240 $29.53 41.4 months $ - Exercisable, end of period 33,240 $29.53 41.4 months $ - As of September 30, 2010, there was $0 of total unrecognized compensation cost related to nonvested stock options granted under either Plan. Since both Stock Option Plans have expired, as of September 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 nine months of 2010 and 288 shares forfeited during the first nine months of 2009. As of September 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 September 30, 2010 10,990 $ 242,562 As of September 30, 2010, there was $209,106 of total unrecognized compensation cost related to nonvested shares granted under the restricted stock grant 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 September 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 September 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 $ 54,950 $ - $ 54,950 $ - States and municipals 87,449 - 87,449 - Mortgage-backed - residential 33,787 - 33,787 - Equity securities 301 301 - - Total $176,487 $ 301 $176,186 $ -
(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 September 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 Real estate construction $ 1,102 $ - $ - $ 1,102 Real estate mortgage 6,567 - - 6,567 Total 7,669 - - 7,669 Other real estate owned Real estate construction 2,684 - - 2,684 Real estate mortgage 1,472 - - 1,472 Total 4,156 - - 4,156 Mortgage servicing rights 166 - - 166
(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 $7.7 million, with a valuation allowance of $3.7 million at September 30, 2010, resulting in an additional provision of $1.95 million for loan losses for the nine months ending September 30, 2010. The provision for the three months ending September 30, 2010 is $700 thousand. Other real estate owned which is measured at fair value less costs to sell, had a net carrying amount of $4.2 million, which is made up of the outstanding balance of $4.7 million, net of a valuation allowance of $586 thousand at September 30, 2010, resulting in a write-down of $660 thousand for the nine months ending September 30, 2010. The write-down for the three months ending September 30, 2010 is $187 thousand. Fair Value of Financial Instruments The fair values of the Company?s financial instruments at September 30, 2010 and December 31, 2009 are as follows: September 30, 2010 December 31, 2009 Carrying Carrying Amount Fair Value Amount Fair Value (In Thousands) Financial assets Cash and cash equivalents $ 25,970 $ 25,970 $ 34,421 $ 34,421 Securities 176,487 176,487 168,411 168,411 Mortgage loans held for sale 149 153 191 192 Loans, net 408,045 407,583 417,818 417,759 FHLB stock 6,731 N/A 6,731 N/A Interest receivable 4,627 4,627 4,620 4,620 Financial liabilities Deposits $ 538,854 $ 542,945 $ 536,446 $ 541,691 Securities sold under agreements to repurchase and other borrowings 6,437 6,455 8,226 8,252 FHLB advances 43,567 46,069 56,096 57,633 Subordinated debentures 7,217 4,558 7,217 6,029 Interest payable 2,361 2,361 2,123 2,123 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 The Company recorded net income of $3.7 million, or $1.35 basic earnings and diluted earnings per share for the first nine months ending September 30, 2010 compared to $3.4 million, or $1.25 basic earnings and diluted earnings per share for the nine month period ending September 30, 2009. The first nine months earnings reflects an increase of 8.0% compared to the same time period in 2009, due primarily to an increase in net interest income of $561 thousand, an increase in the gain of sold securities of $916 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 $376 thousand and an increase in repossession expenses of $683 thousand. The earnings for the three months ended September 30, 2010 were $1.6 million, or $0.57 basic and diluted earnings per share for the three month period ending September 30, 2010 compared to $1.4 million, or $0.49 basic and diluted earnings per share for the three month period ending September 30, 2009. This three month period earnings reflects a 16% increase compared to the same time period in 2009. Return on average assets was 0.70% for the nine months ended September 30, 2010 and 0.68% for the nine month period ended September 30, 2009. Return on average assets was 0.91% for the three months ended September 30, 2010 and 0.82% for the three months ended September 30, 2009. Return on average equity was 7.9% for the nine month period ended September 30, 2010 and 7.8% for the same period in 2009. Return on average equity was 10.0% for the three months ended September 30, 2010 and 9.1% for the same time period in 2009. Gross Loans decreased $10.0 million from $425.4 million on December 31, 2009 to $415.4 million on September 30, 2010. The overall decrease is attributed to decreases in real estate construction loans, real estate mortgage loans, agricultural and consumer loans. Decreases to these sectors of the loan portfolio were partially offset by an increase of $2.5 million in commercial loans. Total deposits increased from $536.4 million on December 31, 2009 to $538.8 million on September 30, 2010, an increase of $2.4 million. This increase is primarily the result of an increase in non-interest bearing deposit accounts of $15.9 million and an increase in interest bearing time deposit accounts over $100 thousand of $15.2 million. Other interest bearing deposits decreased $28.7 million from $334.4 million at December 31, 2009 to $305.7 million at September 30, 2010. Deposits are up largely due to temporary cash influxes in our existing deposit base. Of this increase, $7 million is expected to be withdrawn during the fourth quarter of 2010. Net Interest Income Net interest income was $14.9 million for the nine months ended September 30, 2010 compared to $14.4 million for the nine months ended September 30, 2009, an increase of 3.9%. The interest spread of 3.06% for the first nine months of 2010 is up from 3.04% reported for the same period in 2009, an increase of 2 basis points. Net interest income was $4.9 million for the three month period ending September 30, 2010 compared to $4.9 million for the three month period ending September 30, 2009, a decrease of 0.3% or $15 thousand. The interest spread was 3.07% for three month period ending September 30, 2010 compared to 3.23% for the three month period in 2009, a decrease of 16 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 nine months, the yield on assets decreased from 5.17% in 2009 to 4.74% in 2010. The cost of liabilities decreased from 2.13% in 2009 to 1.68% in 2010. Year to date average loans increased $1.0 million, or 0.23% from September 30, 2009 to September 30, 2010. Loan interest income has decreased $704 thousand for the first nine months of 2010 compared to the first nine months of 2009. Year to date average deposits increased from September 30, 2009 to September 30, 2010, up $52.3 million or 10.0%. 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 $804 thousand for the first nine months of 2010 compared to the same period in 2009. Year to date average borrowings decreased $22.7 million, or 25.94% from September 30, 2009 to September 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 $849 thousand for the first nine months of 2010 compared to the same period in 2009. The volume rate analysis for 2010 that follows indicates that $1.2 million of the decrease in interest income is attributable to the decrease in rates, while the change in volume contributed to an increase of $130 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 2.13% in 2009 to 1.68% in 2010. Based on the volume rate analysis that follows, the lower level of interest rates contributed to a decrease of $1.7 million in interest expense, while the change in volume was responsible for a $26 thousand increase in interest expense. As a result, the 2010 net interest income increase is mostly 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 Nine Months Ended September 30, 2010 2010 vs. 2009 Increase (Decrease) Due to Change in Volume Rate Net Change INTEREST INCOME Loans $ 72 $ (776) $ (704) Investment Securities 31 (437) (406) Federal Funds Sold and Securities Purchased under Agreements to Resell 24 (3) 21 Deposits with Banks 3 (6) (3) Total Interest Income 130 (1,222) (1,092) INTEREST EXPENSE Deposits Demand 86 182 268 Savings (28) (173) (201) Negotiable Certificates of Deposit and Other Time Deposits 566 (1,437) (871) Securities sold under agreements to repurchase and other borrowings (160) (18) (178) Federal Home Loan Bank advances (438) (233) (671) Total Interest Expense 26 (1,679) (1,653) Net Interest Income $ 104 $ 457 $ 561 Non-Interest Income Non-interest income increased $568 thousand for the nine months ended September 30, 2010 compared to the same period in 2009 to $7.4 million, due primarily to an increase in the gain on sold securities of $916 thousand which increased from $351 thousand for the first nine months in 2009 to $1.267 million for the first nine months of 2010. The gain on securities were primarily used to offset the additions to the loan loss reserve. The gain on the sale of securities was partially offset by a decrease in service charges of $211 thousand and the gain on the sale of mortgage loans of $376 thousand. Other non-interest income increased $189 thousand for the nine months ended September 30, 2010 compared to the same period one year ago. The decrease in service charges was primarily the result of a decrease in fees collected for title insurance of $69 thousand and a decline in overdraft income of $152 thousand. Other non-interest income increased mostly due to an increase in debit card interchange income of $137 thousand compared to the same period one year ago and an increase in brokerage income of $50 thousand. Non-interest income increased $1.016 million for the three months ended September 30, 2010 compared to the three months ended September 30, 2009. The increase was primarily due to an increase in the gains of sold securities of $905 thousand and in the gains on sold mortgage loans of $126 thousand. These positive variances to non-interest income were partially offset by a decrease in service charges of $76 thousand, a decrease in loan service fee income of $24 thousand and a decrease in trust commissions of $21 thousand. The gain on the sale of mortgage loans decreased from $1.026 million in the first nine months of 2009 to $650 thousand during the first nine months of 2010. For the three months ended September 30, 2010 compared to the same time period in 2009, the gain on the sale of mortgage loans increased $126 thousand. The volume of loans sold during the first nine months of 2010 decreased $22.1 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. Loan service fee income was $65 thousand for the nine months ending September 30, 2010 compared to $69 thousand for the nine months ending September 30, 2009, a decrease of $4 thousand. During the third quarter of 2010, $24 thousand was expensed for the write-down of the mortgage servicing right due to impairment which is reflected in the loan service fee income. A positive adjustment of $24 thousand was made during the second quarter of 2010. Non-Interest Expense Total non-interest expenses increased $64 thousand for the nine month period ended September 30, 2010 compared to the same period in 2009. For the three month period ended September 30, 2010 compared to the three months ending September 30, 2009, total non-interest expense increased $405 thousand. For the comparable nine month periods, salaries and benefits decreased $1.0 million, a decrease of 12.1%. 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, the Company 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 increased from 186 at September 30, 2009 to 187 at September 30, 2010. However, the number of full time equivalent employees reached 194 at June 30, 2009 and has since declined to 187 full time equivalent employees at September 30, 2010 resulting in a decline in the year to date salary and employee benefits expense in 2010. Salaries and employee benefits decreased $1 thousand for the three month period ending September 30, 2010 compared to the same time period in 2009. Occupancy expenses increased $49 thousand to $2.1 million for the first nine months of 2010 compared to the same time period in 2009. Occupancy expenses decreased $19 thousand for the three month period ended September 30, 2010 compared to the same time period in 2009. The increase in year to date occupancy expense during 2010 is primarily the result of an increase in depreciation expense of $91 thousand, an increase in taxes on premises and equipment of $28 thousand offset by a decrease in computer maintenance of $39 thousand and a decrease in building repairs and maintenance of $43 thousand. Legal and professional fees increased $286 thousand for the first nine months ended September 30, 2010 compared to the same time period in 2009. Legal and professional fees increased $118 thousand for the three month period ending September 30, 2010 compared to the same time period in 2009. The increase is primarily from additional collection efforts for problem loans. Repossession expenses increased $683 thousand for the first nine months ended September 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 $253 thousand for the three month period ending September 30, 2010 compared to the same three months ending September 30, 2009. Repossession expenses are reported net of income earned on the repossessed properties. These increases were partially offset by a decrease in the cost of FDIC insurance premiums of $153 thousand for the nine months ending September 30, 2010 compared to the nine months ending September 30, 2009. FDIC insurance expense increased $62 thousand for the three months ending September 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, paid 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 $44 thousand for the nine months ended September 30, 2010 and $40 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 nine months ended September 30, 2010 was 11.2% compared to 7.5% in 2009. The effective tax rate for the three months ended September 30, 2010 was 12.9% compared to 7.3% for the three months ended September 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 the Company held related to historic and low income housing that expired at the end of 2009. Nontaxable interest income increased $656 thousand for the first nine 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 $26.0 million as of September 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 and an increase in our ?due from? accounts with correspondent banks. In addition to cash and cash equivalents, the securities portfolio provides an important source of liquidity. Securities available for sale totaled $176.5 million at September 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 nine months of 2010, deposits have increased $2.4 million. With loan demand being slow, the Company has been able to increase its investment portfolio by $8 million. In addition, the Company has paid down FHLB advances by $12.5 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 September 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 September 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) September 30, 2010 Consolidated Total Capital (to Risk-Weighted Assets) $ 60,600 13.2% $ 36,739 8% $ 45,924 N/A Tier I Capital (to Risk-Weighted Assets) 54,824 11.9 18,370 4 27,554 N/A Tier I Capital (to Average Assets) 54,824 8.1 26,987 4 33,734 N/A Bank Only Total Capital (to Risk-Weighted Assets) $ 62,433 13.6% $ 36,728 8% $ 45,910 10% Tier I Capital (to Risk-Weighted Assets) 56,659 12.3 18,364 4 27,546 6 Tier I Capital (to Average Assets) 56,659 8.4 26,978 4 33,722 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 September 30, 2010, our non-performing assets totaled $22.7 million or 3.41% of assets compared to $19.1 million or 2.83% of assets at December 31, 2009. (See table below) We experienced an increase of $3.6 million in non- accrual loans from December 31, 2009 to September 30, 2010, largely due to an increase in non-accrual loans secured by real estate of $3.7 million. As of September 30, 2010, non-accrual loans include $2.5 million in loans secured by non-farm and non-residential real estate, $4.2 million in loans secured by real estate construction, $4.7 million in loans secured by 1-4 family residential real estate, $3.3 million in loans secured by multi-family real estate properties and $800 thousand in loans secured by farmland. Real estate loans composed 99.7% of the non-performing loans as of September 30, 2010 and 98% as of December 31, 2009. Forgone interest income on the non- accrual loans was $436 thousand for the first nine months of 2010 compared to $394 thousand for the same time period in 2009. Accruing loans that are contractually 90 days or more past due as of September 30, 2010 totaled $628 thousand compared to $2.5 million at December 31, 2009, a decrease of $1.9 million. The decrease is primarily due to one loan amounting to $1.4 million being paid off during the period and other loans being reclassified as non- accrual. The total nonperforming loans increased $1.7 million from December 31, 2009 to September 30, 2010, resulting in an increase in the ratio of nonperforming loans to loans of 51 basis points to 3.93%. In addition, the amount the Company has booked as ?Other Real Estate? has increased $1.9 million from December 31, 2009 to September 30, 2010. As of September 30, 2010 the amount booked as ?Other Real Estate? totaled $6.4 million compared to $4.5 million at December 31, 2009. The increase is largely attributed to two loan customers who specialized in commercial & land development properties that totaled $2.4 million that was previously on non-accrual. The allowance as a percentage of non-performing and restructured loans and Other Real Estate decreased from 40% at December 31, 2009 to 32% at September 30, 2010. The decrease is largely attributed to the addition of $1.8 million made to the allowance for loan losses in the fourth quarter of 2009 for loans that were charged off in the first quarter of 2010. Nonperforming Assets 9/30/10 12/31/09 (in thousands) Non-accrual Loans $ 15,680 $ 12,038 Accruing Loans which are Contractually past due 90 days or more 628 2,526 Total Nonperforming and Restructured 16,308 14,564 Other Real Estate 6,380 4,542 Total Nonperforming and Restructured Loans and Other Real Estate $ 22,688 $ 19,106 Nonperforming and Restructured Loans as a Percentage of Loans 3.93% 3.42% Nonperforming and Restructured Loans and Other Real Estate as a Percentage of Total Assets 3.41% 2.83% Allowance as a Percentage of Period-end Loans 1.77% 1.79% Allowance as a Percentage of Non-performing and Restructured Loans 32% 40% and Other Real Estate 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 nine months was $1.95 million for 2010 and $1.35 million for 2009. The loan loss provision for the three months ended September 30, 2010 was $700 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 for trends 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 nine month period ended September 30, 2010 were $2.2 million compared to net charge-offs of $477 thousand for the same period in 2009. Net charge-offs for the three month period ended September 30, 2010 were positive and equated to a net recovery of $211 thousand compared to net charge-offs of $485 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 Nine Months Ended September 30 (in thousands) 2010 2009 Balance at Beginning of Period $ 7,600 $ 5,465 Amounts Charged-off: Commercial 19 289 Real Estate Construction 547 39 Real Estate Mortgage 1,967 221 Agricultural 74 6 Consumer 814 1,047 Total Charged-off Loans 3,421 1,602 Recoveries on Amounts Previously Charged-off: Commercial 43 2 Real Estate Construction - 35 Real Estate Mortgage 736 393 Agricultural 11 - Consumer 453 695 Total Recoveries 1,243 1,125 Net Charge-offs 2,178 477 Provision for Loan Losses 1,950 1,350 Balance at End of Period 7,372 6,338 Loans Average 420,621 420,364 At September 30 415,417 427,921 As a Percentage of Average Loans: Net Charge-offs for the period 0.52% 0.11% Provision for Loan Losses for the period 0.46% 0.32% Allowance as a Multiple of Net Charge-offs (annualized) 2.5 10.0 Three Months Ended September 30 (in thousands) 2010 2009 Balance at Beginning of Period $ 6,461 $ 6,373 Amounts Charged-off: Commercial - 222 Real Estate Construction - - Real Estate Mortgage 175 139 Agricultural - - Consumer 342 423 Total Charged-off Loans 517 784 Recoveries on Amounts Previously Charged-off: Commercial - - Real Estate Construction - - Real Estate Mortgage 564 6 Agricultural 1 - Consumer 163 293 Total Recoveries 728 299 Net Charge-offs (Recoveries) (211) 485 Provision for Loan Losses 700 450 Balance at End of Period 7,372 6,338 Loans Average 417,701 424,342 At September 30 415,417 427,921 As a Percentage of Average Loans: Net Charge-offs for the period (0.05)% 0.11% Provision for Loan Losses for the period 0.17% 0.11% Allowance as a Multiple of Net Charge-offs (annualized) (8.7) 3.3 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 September 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 September 30, 2010 is as follows: PROJECTED NET INTEREST INCOME (dollars in thousands) Level Change in basis points: - 300 - 100 Rates + 100 + 300 Year One (10/10 - 9/11) Net interest income $22,784 $23,550 $23,853 $23,967 $24,268 Net interest income dollar change (1,069) (303) N/A 114 415 Net interest income percentage change -4.5% -1.3% N/A 0.5% 1.7% 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 September 30, 2009 is as follows: PROJECTED NET INTEREST INCOME (dollars in thousands) Level Change in basis points: - 300 - 100 Rates + 100 + 300 Year One (10/09 - 9/10) Net interest income $20,843 $21,447 $21,938 $22,122 $22,280 Net interest income dollar change (1,095) (491) N/A 184 342 Net interest income percentage change -5.0% -2.2% N/A 0.8% 1.6% Board approved limit >-10.0% >-4.0% N/A >-4.0% >-10.0% Projections from September 30, 2010, year one reflected a decline in net interest income of 1.3% with a 100 basis point decline compared to the 2.2% decline in 2009. The 100 basis point increase in rates reflected a 0.5% increase in net interest income in 2010 compared to 0.8% 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 September 30, 2010 balance sheet, a 100 basis point increase in rates results in a 4.0% decrease in EVE. A 100 basis point decrease in rates results in a 0.4% decrease 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 7/1/10 ? 7/31/10 - $ - - 31,548 shares 8/1/10 ? 8/31/10 - - - 31,548 shares 9/1/10 ? 9/30/10 - - - 31,548 shares Total - - - 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 September 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 ___11/12/10_______ __/s/Louis Prichard______________ Louis Prichard, President and C.E.O. Date ___11/12/10_______ __/s/Gregory J. Dawson___________ Gregory J. Dawson, Chief Financial Officer 4 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: November 12, 2010 BY /s/ Louis Prichard Louis Prichard President & Chief Executive Officer 31 EX-31 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: November 12, 2010 BY /s/ Gregory J. Dawson Gregory J. Dawson Chief Financial Officer 33 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 September 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: November 12, 2010 By /s/ Louis Prichard Louis Prichard President & Chief Executive Officer Date: November 12, 2010 By /s/ Gregory J. Dawson Gregory J. Dawson Chief Financial Officer 35 Lexlibrary/197885.1 -----END PRIVACY-ENHANCED MESSAGE-----