-----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, DMhCGQ3lOW2KEBp8rRC+8aCCi50NzWYUSa3yU5LgsAE9/Y1gv5rKNmazcQSuAcxW Igs01qfwLvkJMTGrIh2vqg== 0000713095-03-000016.txt : 20030813 0000713095-03-000016.hdr.sgml : 20030813 20030813092259 ACCESSION NUMBER: 0000713095-03-000016 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 20030630 FILED AS OF DATE: 20030813 FILER: COMPANY DATA: COMPANY CONFORMED NAME: FARMERS CAPITAL BANK CORP CENTRAL INDEX KEY: 0000713095 STANDARD INDUSTRIAL CLASSIFICATION: NATIONAL COMMERCIAL BANKS [6021] IRS NUMBER: 611017851 STATE OF INCORPORATION: KY FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-14412 FILM NUMBER: 03839143 BUSINESS ADDRESS: STREET 1: PO BOX 309 STREET 2: 202 W MAIN ST CITY: FRANKFORT STATE: KY ZIP: 40602 BUSINESS PHONE: 5022271668 MAIL ADDRESS: STREET 1: P O BOX 309 STREET 2: 202 WEST MAIN STREET CITY: FRANKFORT STATE: KY ZIP: 40602 10-Q 1 a10q063003.txt FORM 10-Q 6-30-03 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2003 or [ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from to ------------ ------------ Commission File Number 0-14412 FARMERS CAPITAL BANK CORPORATION ------------------------------------------------------ (Exact name of registrant as specified in its charter) Kentucky 61-1017851 - ---------------------------------------- --------------------------------------- (State or other jurisdiction of (I.R.S. Employer Identification Number) incorporation or organization) P.O. Box 309, 202 West Main Street Frankfort, Kentucky 40602 - ---------------------------------------- --------------------------------------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (502) 227-1600 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 is an accelerated filer (as defined in Rule 12b-2 of the Securities Exchange Act of 1934). Yes |X| No Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Common stock, par value $0.125 per share 6,712,976 shares outstanding at August 11, 2003 TABLE OF CONTENTS Part I - Financial Information Page No. Item 1 - Financial Statements 3 Unaudited Consolidated Balance Sheets - June 30, 2003 and December 31, 2002 3 Unaudited Consolidated Statements of Income - For the Three Months and Six Months Ended June 30, 2003 and June 30, 2002 4 Unaudited Consolidated Statements of Comprehensive Income - For the Three Months and Six Months Ended June 30, 2003 and June 30, 2002 5 Unaudited Consolidated Statements of Cash Flows - For the Six Months Ended June 30, 2003 and June 30, 2002 6 Unaudited Consolidated Statements of Changes in Shareholders' Equity - For the Six Months Ended June 30, 2003 and June 30, 2002 7 Notes to Unaudited Consolidated Financial Statements 8 Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations 11 Item 3 - Quantitative and Qualitative Disclosures About Market Risk 25 Item 4 - Controls and Procedures 25 Part II - Other Information Item 1 - Legal Proceedings 26 Item 4 - Submission of Matters to a Vote of Security Holders 26 Item 6 - Exhibits and Reports on Form 8-K 26 Signatures 29 PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS - ----------------------------
UNAUDITED CONSOLIDATED BALANCE SHEETS - -------------------------------------------------------------------------------------------------------------------------- June 30, December 31, (In thousands, except share data) 2003 2002 - -------------------------------------------------------------------------------------------------------------------------- ASSETS Cash and cash equivalents: Cash and due from banks $ 95,339 $ 44,083 Interest bearing deposits in other banks 3,475 3,947 Federal funds sold and securities purchased under agreements to resell 39,489 19,071 - -------------------------------------------------------------------------------------------------------------------------- Total cash and cash equivalents 138,303 67,101 - -------------------------------------------------------------------------------------------------------------------------- Investment securities: Available for sale, amortized cost of $295,327 (2003) and $407,560 (2002) 301,222 413,038 Held to maturity, fair value of $27,650 (2003) and $30,312 (2002) 25,767 28,519 - -------------------------------------------------------------------------------------------------------------------------- Total investment securities 326,989 441,557 - -------------------------------------------------------------------------------------------------------------------------- Loans, net of unearned income 742,912 738,639 Allowance for loan losses (11,155) (11,061) - -------------------------------------------------------------------------------------------------------------------------- Loans, net 731,757 727,578 - -------------------------------------------------------------------------------------------------------------------------- Premises and equipment, net 24,219 24,155 Company-owned life insurance 24,674 Other assets 14,064 15,211 - -------------------------------------------------------------------------------------------------------------------------- Total assets $ 1,260,006 $ 1,275,602 - -------------------------------------------------------------------------------------------------------------------------- LIABILITIES Deposits: Noninterest bearing $ 190,044 $ 141,238 Interest bearing 790,317 816,242 - -------------------------------------------------------------------------------------------------------------------------- Total deposits 980,361 957,480 - -------------------------------------------------------------------------------------------------------------------------- Federal funds purchased and securities sold under agreements to repurchase 73,639 115,979 Other short-term borrowings 9,175 9,207 Long-term debt 59,372 57,152 Dividends payable 2,151 2,191 Other liabilities 9,117 7,820 - -------------------------------------------------------------------------------------------------------------------------- Total liabilities 1,133,815 1,149,829 - -------------------------------------------------------------------------------------------------------------------------- Commitments and contingencies SHAREHOLDERS' EQUITY Common stock, par value $.125 per share 9,608,000 shares authorized; 8,142,639 and 8,135,977 shares issued at June 30, 2003 and December 31, 2002, respectively 1,018 1,017 Capital surplus 17,998 17,623 Retained earnings 143,509 141,199 Treasury stock, at cost 1,425,163 and 1,344,463 shares at June 30, 2003 and December 31, 2002, respectively (40,166) (37,627) Accumulated other comprehensive income 3,832 3,561 - -------------------------------------------------------------------------------------------------------------------------- Total shareholders' equity 126,191 125,773 - -------------------------------------------------------------------------------------------------------------------------- Total liabilities and shareholders' equity $ 1,260,006 $ 1,275,602 - -------------------------------------------------------------------------------------------------------------------------- See accompanying notes to unaudited consolidated financial statements.
UNAUDITED CONSOLIDATED STATEMENTS OF INCOME - --------------------------------------------------------------------------------------------------------------------------------- Three Months Ended Six Months Ended June 30, June 30, (In thousands, except per share data) 2003 2002 2003 2002 - --------------------------------------------------------------------------------------------------------------------------------- INTEREST INCOME Interest and fees on loans $ 12,139 $ 12,639 $ 24,368 $ 25,703 Interest on investment securities: Taxable 1,201 2,601 3,500 5,343 Nontaxable 780 938 1,583 1,849 Interest on deposits in other banks 22 133 37 153 Interest of federal funds sold and securities purchased under agreements to resell 215 244 377 455 - --------------------------------------------------------------------------------------------------------------------------------- Total interest income 14,357 16,555 29,865 33,503 - --------------------------------------------------------------------------------------------------------------------------------- INTEREST EXPENSE Interest on deposits 4,316 5,771 8,963 11,752 Interest on federal funds purchased and securities sold under agreements to repurchase 243 434 502 907 Interest on other borrowed funds 557 414 1,107 753 - --------------------------------------------------------------------------------------------------------------------------------- Total interest expense 5,116 6,619 10,572 13,412 - --------------------------------------------------------------------------------------------------------------------------------- Net interest income 9,241 9,936 19,293 20,091 - --------------------------------------------------------------------------------------------------------------------------------- Provision for loan losses 351 988 736 1,109 - --------------------------------------------------------------------------------------------------------------------------------- Net interest income after provision for loan losses 8,890 8,948 18,557 18,982 - --------------------------------------------------------------------------------------------------------------------------------- NONINTEREST INCOME Service charges and fees on deposits 2,018 1,960 3,853 3,779 Other service charges, commissions, and fees 853 875 1,773 1,730 Data processing income 389 387 734 723 Trust income 413 361 812 728 Investment securities (losses) gains, net (3) 396 144 993 Gain on sale of mortgage loans 323 90 512 185 Income from company-owned life insurance 408 673 Other 77 72 143 124 - --------------------------------------------------------------------------------------------------------------------------------- Total noninterest income 4,478 4,141 8,644 8,262 - --------------------------------------------------------------------------------------------------------------------------------- NONINTEREST EXPENSE Salaries and employee benefits 5,213 4,801 10,281 9,951 Occupancy expenses, net 642 588 1,300 1,159 Equipment expenses 924 914 1,861 1,840 Bank franchise tax 331 306 665 613 Other 2,358 2,082 4,500 4,165 - --------------------------------------------------------------------------------------------------------------------------------- Total noninterest expense 9,468 8,691 18,607 17,728 - --------------------------------------------------------------------------------------------------------------------------------- Income before income taxes 3,900 4,398 8,594 9,516 - --------------------------------------------------------------------------------------------------------------------------------- Income tax expense 874 1,082 1,975 2,418 - --------------------------------------------------------------------------------------------------------------------------------- Net income $ 3,026 $ 3,316 $ 6,619 $ 7,098 - --------------------------------------------------------------------------------------------------------------------------------- NET INCOME PER COMMON SHARE Basic $ .45 $ .48 $ .98 $ 1.03 Diluted .45 .48 .98 1.02 - --------------------------------------------------------------------------------------------------------------------------------- WEIGHTED AVERAGE SHARES OUTSTANDING Basic 6,723 6,889 6,743 6,895 Diluted 6,765 6,941 6,781 6,943 - --------------------------------------------------------------------------------------------------------------------------------- See accompanying notes to unaudited consolidated financial statements.
UNAUDITED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME - --------------------------------------------------------------------------------------------------------------------------------- Three Months Ended Six Months Ended June 30, June 30, (In thousands) 2003 2002 2003 2002 - --------------------------------------------------------------------------------------------------------------------------------- NET INCOME $ 3,026 $ 3,316 $ 6,619 $ 7,098 Other comprehensive income: Unrealized holding gain on available for sale securities arising during the period, net of tax of $606, $771, $207, and $405, respectively 1,125 1,432 385 753 Reclassification adjustment for prior period unrealized gain recognized during current period, net of tax of $0, $57, $61, and $324, respectively (106) (114) (601) - --------------------------------------------------------------------------------------------------------------------------------- Other comprehensive income 1,125 1,326 271 152 - --------------------------------------------------------------------------------------------------------------------------------- COMPREHENSIVE INCOME $ 4,151 $ 4,642 $ 6,890 $7,250 - --------------------------------------------------------------------------------------------------------------------------------- See accompanying notes to unaudited consolidated financial statements.
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS - --------------------------------------------------------------------------------------------------------------------------------- Six months ended June 30, (In thousands) 2003 2002 - --------------------------------------------------------------------------------------------------------------------------------- CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 6,619 $ 7,098 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 1,496 1,472 Net amortization of investment security premiums and (discounts): Available for sale 1,631 342 Held to maturity (36) (33) Provision for loan losses 736 1,109 Noncash compensation expense 213 296 Mortgage loans originated for sale (34,986) (14,399) Proceeds from sale of mortgage loans 33,991 14,414 Deferred income tax expense (benefit) 106 (95) Gain on sale of mortgage loans (512) (185) Gain on sale of premises and equipment (4) (1) Gain on sale of available for sale investment securities, net (144) (993) Decrease in accrued interest receivable 596 1,154 (Increase) decrease in other assets (122) 182 Decrease in accrued interest payable (292) (261) Increase in other liabilities 1,337 556 - --------------------------------------------------------------------------------------------------------------------------------- Net cash provided by operating activities 10,629 10,656 - --------------------------------------------------------------------------------------------------------------------------------- CASH FLOWS FROM INVESTING ACTIVITIES Proceeds from maturities and calls of investment securities: Available for sale 223,257 222,201 Held to maturity 2,788 5,033 Proceeds from sale of available for sale investment securities 74,050 125,436 Purchase of available for sale investment securities (186,561) (305,346) Loans originated for investment, net of principal collected (3,408) 6,181 Purchase of company-owned life insurance (24,001) Purchase of premises and equipment (1,562) (701) Proceeds from sale of equipment 6 2 - --------------------------------------------------------------------------------------------------------------------------------- Net cash provided by (used in) investing activities 84,569 52,806 - --------------------------------------------------------------------------------------------------------------------------------- CASH FLOWS FROM FINANCING ACTIVITIES Net increase in deposits 22,881 27,258 Net (decrease) increase in securities sold under agreements to repurchase (42,340) 31,651 Proceeds from long-term debt 3,874 16,500 Repayments of long-term debt (1,654) (1,064) Net (decrease) increase in other short-term borrowings (32) 6,683 Dividends paid (4,349) (4,290) Purchase of common stock (2,539) (3,133) Stock options exercised 163 1,139 - --------------------------------------------------------------------------------------------------------------------------------- Net cash (used in ) provided by financing activities (23,996) 74,744 - --------------------------------------------------------------------------------------------------------------------------------- Net increase in cash and cash equivalents 71,202 138,206 - --------------------------------------------------------------------------------------------------------------------------------- Cash and cash equivalents at beginning of year 67,101 106,385 - --------------------------------------------------------------------------------------------------------------------------------- Cash and cash equivalents at end of period $138,303 $244,591 - --------------------------------------------------------------------------------------------------------------------------------- SUPPLEMENTAL DISCLOSURES Cash paid during the period for: Interest $ 10,864 $ 13,673 Income taxes 500 2,490 Cash dividend declared and unpaid 2,151 2,137 - --------------------------------------------------------------------------------------------------------------------------------- See accompanying notes to unaudited consolidated financial statements.
UNAUDITED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY - ------------------------------------------------------------------------------------------------------------------------------------ (In thousands, except per share data) Accumulated Other Total Six months ended Common Stock Capital Retained Treasury Stock Comprehensive Shareholders' June 30, 2003 and 2002 Shares Amount Surplus Earnings Shares Amount Income Equity - ------------------------------------------------------------------------------------------------------------------------------------ Balance at January 1, 2003 8,136 $1,017 $17,623 $141,199 1,344 $(37,627) $3,561 $125,773 Net income 6,619 6,619 Other comprehensive income 271 271 Cash dividends declared, $.64 per share (4,309) (4,309) Purchase of common stock 81 (2,539) (2,539) Stock options exercised 6 1 162 163 Noncash compensation expense attributed to stock option grants 213 213 - ------------------------------------------------------------------------------------------------------------------------------------ Balance at June 30, 2003 8,142 $1,018 $17,998 $143,509 1,425 $(40,166) $3,832 $126,191 - ------------------------------------------------------------------------------------------------------------------------------------ - ------------------------------------------------------------------------------------------------------------------------------------ Balance at January 1, 2002 8,058 $1,007 $15,179 $137,227 1,153 $(31,077) $ 1,224 $123,560 Net income 7,098 7,098 Other comprehensive income 152 152 Cash dividends declared, $.62 per share (4,275) (4,275) Purchase of common stock 91 (3,133) (3,133) Stock options exercised 47 6 1,133 1,139 Noncash compensation expense attributed to stock option grants 296 296 - ------------------------------------------------------------------------------------------------------------------------------------ Balance at June 30, 2002 8,105 $1,013 $16,608 $140,050 1,244 $(34,210) $ 1,376 $124,837 - ------------------------------------------------------------------------------------------------------------------------------------ See accompanying notes to unaudited consolidated financial statements.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS 1. BASIS OF PRESENTATION The consolidated financial statements include the accounts of Farmers Capital Bank Corporation (the "Company"), a financial holding company, and its subsidiaries, including its principal subsidiary, Farmers Bank & Capital Trust Company. All significant intercompany transactions and accounts have been eliminated in consolidation. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Estimates used in the preparation of the financial statements are based on various factors including the current interest rate environment and the general strength of the local economy. Changes in the overall interest rate environment can significantly affect the Company's net interest income and the value of its recorded assets and liabilities. Actual results could differ from those estimates used in the preparation of the financial statements. The financial information presented as of any date other than December 31 has been prepared from the 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 and do not include all of the information and the footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. 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, 2002. 2. RECLASSIFICATIONS Certain reclassifications have been made to the consolidated financial statements of prior periods to conform to the current period presentation. Such reclassifications have no effect on previously reported net income or shareholders' equity. 3. RECENTLY ISSUED ACCOUNTING STANDARDS In January 2003, the Financial Accounting Standards Board ("FASB") issued Interpretation No. 46, CONSOLIDATION OF VARIABLE INTEREST ENTITIES, AN INTERPRETATION OF ARB NO. 51. This Interpretation provides new guidance for the consolidation of variable interest entities ("VIEs") and requires such entities to be consolidated by their primary beneficiaries if the entities do not effectively disperse risk among parties involved. The Interpretation also adds disclosure requirements for investors that are involved with unconsolidated VIEs. The consolidation requirements apply immediately to VIEs created after January 31, 2003 and are effective for the first fiscal year or interim period beginning after June 15, 2003 for VIEs acquired before February 1, 2003. The adoption of this interpretation is not expected have a significant impact on the Company's financial condition of results of operations. In April 2003, The FASB issued Statement of Financial Accounting Standards ("SFAS") No. 149, AMENDMENT OF STATEMENT 133 ON DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES. SFAS No. 149 amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities under SFAS No. 133, "ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES." This statement is effective for contracts entered into or modified after June 30, 2003. Because the Company does not have these instruments or is only nominally involved in these instruments, management expects the adoption of this statement will not have a material effect on the Company's consolidated financial statements. In May 2003, the FASB issued SFAS No. 150, "ACCOUNTING FOR CERTAIN FINANCIAL INSTRUMENTS WITH CHARACTERISTICS OF BOTH LIABILITIES AND EQUITY". This statement affects the accounting for certain financial instruments that, under previous guidance, issuers could account for as equity. This statement requires that freestanding financial instruments that embody obligations for the issuer be classified as liabilities on the balance sheet. Most of this statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. Because the Company does not have these instruments or is only nominally involved in these instruments, management expects the adoption of this statement will not have a material effect on the Company's consolidated financial statements. 4. COMPANY-OWNED LIFE INSURANCE The Company has purchased life insurance policies on certain key employees with their knowledge and consent. Company-owned life insurance is recorded at its cash surrender value, or the amount that can be realized, on the consolidated balance sheet. The related change in cash surrender value and proceeds received under the policies are reported on the consolidated statement of income under the caption "Income from company-owned life insurance". 5. NET INCOME PER COMMON SHARE Basic net income per common share is determined by dividing net income by the weighted average total number of shares of common stock outstanding. Diluted net income per common share is determined by dividing net income by the total weighted average number of shares of common stock outstanding, plus the total weighted average number of shares that would be issued upon exercise of dilutive stock options assuming proceeds are used to repurchase shares pursuant to the treasury stock method. Net income per common share computations were as follows at June 30, 2003 and 2002. - --------------------------------------------------------------------------------------------------------- Three Months Ended Six Months Ended June 30, June 30, (In thousands, except per share data) 2003 2002 2003 2002 - --------------------------------------------------------------------------------------------------------- Net income, basic and diluted $ 3,026 $ 3,316 $ 6,619 $ 7,098 - --------------------------------------------------------------------------------------------------------- Average shares outstanding 6,723 6,889 6,743 6,895 Effect of dilutive stock options 42 52 38 48 - --------------------------------------------------------------------------------------------------------- Average diluted shares outstanding 6,765 6,941 6,781 6,943 - --------------------------------------------------------------------------------------------------------- Net income per share, basic $ .45 $ .48 $ .98 $ 1.03 Net income per share, diluted .45 .48 .98 1.02 - ---------------------------------------------------------------------------------------------------------
6. STOCK-BASED COMPENSATION In 1997, the Company's Board of Directors approved a nonqualified stock option plan that provides for granting of stock options to key employees and officers of the Company. The plan was subsequently ratified by the Company's shareholders at its annual shareholders' meeting held on May 12, 1998, the measurement date of the plan. All stock options are awarded at a price equal to the fair market value of the Company's common stock at the date the options are granted. The Company applies Accounting Principles Board ("APB") Opinion No. 25 and related interpretations in accounting for its plan. Accordingly, since options were granted during 1997 at the fair market value of the Company's stock on the grant date, and the measurement date occurred during 1998, the Company recognizes noncash compensation expense based on the intrinsic value of the stock options measured on the date of shareholder ratification of the plan. The Company granted 54,000 options during 2000 in which there is no compensation expense being recognized pursuant to APB No. 25. Had compensation expense been determined under the fair value method described in SFAS No. 123, ACCOUNTING FOR STOCK-BASED COMPENSATION, as amended by SFAS NO. 148, ACCOUNTING FOR STOCK-BASED COMPENSATION-TRANSITION AND DISCLOSURE, the Company's net income and income per common share would have been as shown in the table below. - ------------------------------------------------------------------------------------------------------- Three Months Ended Six Months Ended June 30, June 30, (In thousands, except per share data) 2003 2002 2003 2002 - ------------------------------------------------------------------------------------------------------- NET INCOME As reported $ 3,026 $ 3,316 $ 6,619 $ 7,098 Add: Stock-based employee compensation expense included in reported net income, net of related tax effects 68 84 138 192 Less: Stock-based compensation expense determined under fair value based method for all awards, net of related tax effects (83) (100) (168) (226) - ------------------------------------------------------------------------------------------------------- Proforma $ 3,011 $ 3,300 $ 6,589 $ 7,064 - ------------------------------------------------------------------------------------------------------- NET INCOME PER COMMON SHARE Basic, as reported $ .45 $ .48 $ .98 $ 1.03 Basic, proforma .45 .47 .98 1.02 Diluted, as reported .45 .48 .98 1.02 Diluted, proforma .44 .48 .97 1.02 - -------------------------------------------------------------------------------------------------------
The fair value of the options granted are estimated as of the measurement date using the Black-Scholes option pricing model with the following weighted average assumptions used for grants in 2000 and 1997, respectively: dividend yield of 3.12% and 3.18%; expected volatility of 29.6% and 23.4%; risk-free interest rate of 6.71% and 5.75%; and expected life of seven years for both grants. The weighted average fair value of options granted during 2000 and 1997 was $9.25 and $16.11 per share, respectively. The plan provides for the granting of options to purchase up to 450,000 shares of the Company's common stock at a price equal to the fair market value of the Company's common stock on the date the option is granted. The term of the options expires after ten years from the date on which the options are granted. Options granted under the plan vest ratably over various time periods ranging from four to seven years. All options granted must be held for a minimum of one year before they can be exercised. Forfeited options are available for the granting of options under the plan. Item 2. Management's Discussion and Analysis of Financial Condition and Results - -------------------------------------------------------------------------------- of Operations - ------------- FORWARD-LOOKING STATEMENTS This report contains forward-looking statements under the Private Securities Litigation Reform Act of 1995 that involve risks and uncertainties. Although the Company believes that the assumptions underlying the forward-looking statements contained herein are reasonable, any of the assumptions could be inaccurate, and therefore, there can be no assurance that the forward-looking statements included herein will prove to be accurate. Factors that could cause actual results to differ from the results discussed in the forward-looking statements include, but are not limited to: economic conditions (both generally and more specifically in the markets in which the Company and its subsidiaries operate); competition for the Company's customers from other providers of financial services; government legislation and regulation (which changes from time to time and over which the Company has no control); changes in interest rates; material unforeseen changes in the liquidity, results of operations, or financial condition of the Company's customers; and other risks detailed in the Company's filings with the Securities and Exchange Commission, all of which are difficult to predict and many of which are beyond the control of the Company. RESULTS OF OPERATIONS SECOND QUARTER 2003 VS. SECOND QUARTER 2002 ------------------------------------------- The Company reported net income of $3.0 million or $.45 per basic and diluted share for the second quarter of 2003 compared to net income of $3.3 million or $.48 per basic and diluted share for the second quarter of 2002. This represents a 6.3% decrease in basic and diluted per share earnings compared to the prior period. The decrease in net income in the three-month comparison is attributed primarily to a $695 thousand or 7.0% decrease in net interest income. The decline in net interest income is attributed to continued declines in the overall market interest rate environment. Interest rates earned on earning assets have declined more rapidly than the interest rates paid on interest paying liabilities since many of the Company's funding sources, particularly deposits, have approached their repricing floors. The provision for loan losses decreased $637 thousand or 64.5% in the three month comparison. Higher provisions in the second quarter of 2002 related to a group of nonperforming constructions loans secured by residential real estate led to the decrease. Total noninterest income increased $337 thousand or 8.1% despite lower gains reported on the sale of investment securities of $399 thousand in the quarterly comparison. Income from the purchase of company-owned life insurance, instituted in the first quarter of 2003 to offset the rising costs of the Company's employee benefits plans, totaled $408 thousand for the current three months. Gains on the sale of mortgage loans also increased $233 thousand in the comparisons as the low interest rate environment continues to fuel the Company's secondary market mortgage loan originations. Offsetting the increase in noninterest income were increases in noninterest expenses totaling $777 thousand or 8.9% for the current three months. Noninterest expense increased primarily due to an increase in salaries and employee benefits of $412 thousand or 8.6%. These increases relate primarily to employee benefits and normal salary increases. An increase in correspondent banking fees totaling $187 thousand also contributed to the increase in noninterest expenses. The effective income tax rate declined 220 basis points to 22.4% for the three months ended June 30, 2003 compared to the same periods a year earlier. Return on average assets ("ROA") was 0.98% for the current quarter, a decrease of 12 basis points compared to 1.10% reported for the same period in 2002. Negatively impacting ROA was a 46 basis point decline in net interest margin to 3.48% and an increase in noninterest expenses of 19 basis points. Partially offsetting these declines that positively effected ROA was an increase in earning assets that contributed 12 basis points, a decrease in the provision for loan losses that contributed 22 basis points, an increase in noninterest income contributing 8 basis points, and a decrease in income tax expense that contributed 11 basis points. Return on average equity ("ROE") was 9.71% for the second quarter of 2003 compared to 10.71% in the same period of 2002. The decrease is due to lower net income reported in the current period coupled with a slight increase in average equity compared to the same period a year ago. NET INTEREST INCOME - ------------------- Continuing weaknesses in the overall economic environment remain present and have impacted the Company's net interest income. The interest rate environment has continued to trend downward after a period of relative stability throughout much of 2002. Additional actions taken by the Federal Reserve Board (the "Fed") in the fourth quarter of 2002 and the second quarter of 2003 have resulted in a general reduction in short-term interest rates in the reporting periods. Short-term interest rates, left unchanged since December 2001, were reduced 50 basis points by the Fed in November 2002 and an additional 25 basis points in June 2003. The prime rate as reported in The Wall Street Journal was lowered in an identical manner shortly following the Fed changes. The effects of prior rate reductions by the Fed along with intense competition in the Company's market areas continue to negatively impact net interest margin. The effect of the Fed's actions on the Company has generally led to interest rates on earning assets declining more rapidly than rates paid on interest bearing liabilities. During a falling rate environment, the challenge is to reduce the rates paid on interest bearing liabilities (primarily deposits) to offset the decline in the yield on variable rate assets (primarily loans) while remaining competitive in our markets. The Company's tax equivalent ("TE") yield on earning assets for the current three months was 5.3%, a reduction of 111 basis points from 6.4% in the same period a year ago. The cost of funds for the current three months was 2.2%, a decline of 71 basis points compared to 2.9% in the same period a year earlier. A goal of the Company in the current interest rate environment is to increase earning assets and decrease the interest rates paid on interest bearing liabilities. However, many of the Company's funding sources, particularly deposits, have approached their repricing floors. Average earning assets increased $48.5 million or 4.5% to $1.1 billion in the quarterly comparison. As a percentage of total average assets, earning assets increased 205 basis points to 90.43% from 88.38%. This increase had the effect of adding an additional 12 basis points to ROA in the comparison. Interest income totaled $14.4 million for the second quarter of 2003, a decrease of $2.2 million or 13.3% compared to the same period in the prior year. Interest expense totaled $5.1 million, a decrease of $1.5 million or 22.7%. Net interest income fell $695 thousand or 7.0% in the comparison and totaled $9.2 million for the three months ended June 30, 2003. Interest and fees on loans totaled $12.1 million, a decrease of $500 thousand mainly due to a decrease in the average rate earned. Average loans increased $50.7 million or 7.3% to $742.1 million in the comparison due to higher loan demand in a lower rate environment. The tax equivalent yield on loans decreased 79 basis points to 6.6% from 7.4% and offset the effects of higher average balances on interest income. Interest on taxable securities was $1.2 million, a decrease of $1.4 million or 53.8% due primarily to a decrease in the average rate earned and the effect of higher premium amortization on mortgage-backed securities. Prepayemnts on mortgage-backed securities have increased greatly due to corresponding refinancing of home mortgages that serve as collateral for these investment securities. The increase in activity is directly related to the lower interest rate environment. The average rate earned on taxable securities decreased 243 basis points to 2.1% from 4.5% while the average balance remained relatively unchanged at $231.3 million. Interest on nontaxable securities declined $158 thousand or 16.8% due to a $12.2 million decrease in the average balance to $70.1 million from $82.3 million. Interest on short-term investments, including time deposits in other banks, federal funds sold, and securities purchased under agreements to resell, decreased $140 thousand due primarily to a decrease in the average rate earned on these investments of 110 basis points to 1.3% from 2.4%. Interest expense on deposits decreased $1.5 million or 25.2% to $4.3 million in the quarterly comparison. This decrease resulted from a general decline in the average rate paid throughout the deposit portfolio and correlates with the general decline in market interest rates in the reporting periods. The decline in the average rates paid offset a general increase in average balances. The decline in interest expense on deposits was as follows: time deposits $1.1 million or 23.8%; interest bearing demand deposits $170 thousand or 32.5%; and savings deposits $180 thousand or 30.1%. The average rate paid on time deposits, the largest component of interest bearing deposits, was 3.3% for the second quarter of 2003 compared to 4.6% for the same period of 2002. The average balance of time deposits increased $22.9 million or 5.7% to $426.2 million. The average rate paid on interest bearing demand deposits declined 33 basis points to .65% from .98% while the average balance increased $4.9 million or 2.3% to $219.0 million. The average rate paid on savings deposits decreased 42 basis points to 1.0% from 1.5% while the average balance declined $2.9 million or 1.7% to $163.0 million from $165.9 million. Interest expense on overnight borrowings, consisting of federal funds purchased and securities sold under agreements to repurchase, decreased $191 thousand due to a 44 basis point decline in the average rate paid along with a $24.7 million decline in the average balance. Interest expense on other borrowed funds increased $143 thousand in the comparison as additional borrowings from the Federal Home Loan Bank increased the average balance outstanding. The average balance of other borrowed funds totaled $66.7 million, an increase of $21.2 million or 46.5% in the comparison. The average rate paid on other borrowed funds declined 29 basis points to 3.4% from 3.6%. The net interest margin (TE) decreased 46 basis points to 3.48% during the second quarter of 2003 compared to 3.94% in the second quarter of 2002. The decrease in net interest margin is primarily attributed to a 40 basis point decline in the spread between rates earned on earning assets and the rates paid on interest bearing liabilities to 3.15% in the current quarter from 3.55% in the second quarter of 2002. The effect of noninterest bearing sources of funds contributed an additional 6 basis points to the decline in net interest margin. The effect of noninterest bearing sources of funds on net interest margin typically declines in a falling rate environment. The following tables present an analysis of net interest income for the quarterly periods ended June 30.
DISTRIBUTION OF ASSETS, LIABILITIES AND SHAREHOLDERS' EQUITY: INTEREST RATES AND INTEREST DIFFERENTIAL - --------------------------------------------------------------------------------------------------------------------------------- Quarter Ended June 30, 2003 2002 - --------------------------------------------------------------------------------------------------------------------------------- Average Average Average Average (In thousands) Balance Interest Rate Balance Interest Rate - --------------------------------------------------------------------------------------------------------------------------------- EARNING ASSETS Investment securities Taxable $ 231,260 $ 1,201 2.08% $ 231,433 $ 2,601 4.51% Nontaxable1 70,133 1,147 6.56 82,347 1,372 6.68 Time deposits with banks, federal funds sold and securities purchased under agreements to resell 73,562 237 1.29 63,383 377 2.39 Loans1,2,3 742,142 12,245 6.62 691,429 12,775 7.41 - --------------------------------------------------------------------------------------------------------------------------------- Total earning assets 1,117,097 $ 14,830 5.32% 1,068,592 $17,125 6.43% - --------------------------------------------------------------------------------------------------------------------------------- Allowance for loan losses (11,248) (10,393) - --------------------------------------------------------------------------------------------------------------------------------- Total earning assets, net of allowance for loan losses 1,105,849 1,058,199 - --------------------------------------------------------------------------------------------------------------------------------- NONEARNING ASSETS Cash and due from banks 70,281 112,936 Premises and equipment, net 24,314 24,312 Other assets 34,838 13,602 - --------------------------------------------------------------------------------------------------------------------------------- Total assets $ 1,235,282 $ 1,209,049 - --------------------------------------------------------------------------------------------------------------------------------- INTEREST BEARING LIABILITIES Deposits Interest bearing demand $ 219,011 $ 353 0.65% $ 214,116 $ 523 0.98% Savings 163,032 418 1.03 165,918 598 1.45 Time 426,174 3,545 3.34 403,276 4,650 4.62 Federal funds purchased and securities sold under agreements to repurchase 68,815 243 1.42 93,539 434 1.86 Other borrowed funds 66,747 557 3.35 45,576 414 3.64 - --------------------------------------------------------------------------------------------------------------------------------- Total interest bearing liabilities 943,779 $ 5,116 2.17% 922,425 $ 6,619 2.88% - --------------------------------------------------------------------------------------------------------------------------------- NONINTEREST BEARING LIABILITIES Commonwealth of Kentucky deposits 38,662 39,927 Other demand deposits 122,979 114,413 Other liabilities 4,845 8,095 - --------------------------------------------------------------------------------------------------------------------------------- Total liabilities 1,110,265 1,084,860 - --------------------------------------------------------------------------------------------------------------------------------- Shareholders' equity 125,017 124,189 - --------------------------------------------------------------------------------------------------------------------------------- Total liabilities and shareholders' equity $ 1,235,282 $ 1,209,049 - --------------------------------------------------------------------------------------------------------------------------------- Net interest income 9,714 10,506 TE basis adjustment (473) (570) - --------------------------------------------------------------------------------------------------------------------------------- Net interest income $ 9,241 $ 9,936 - --------------------------------------------------------------------------------------------------------------------------------- Net interest spread 3.15% 3.55% Impact of noninterest bearing sources of funds .33 .39 - --------------------------------------------------------------------------------------------------------------------------------- Net interest margin 3.48% 3.94% - --------------------------------------------------------------------------------------------------------------------------------- 1Income and yield stated at a fully tax equivalent basis using the marginal corporate Federal tax rate of 35%. 2Loan balances include principal balances on nonaccrual loans. 3Loan fees included in interest income amount to $612 thousand and $476 thousand in 2003 and 2002, respectively.
ANALYSIS OF CHANGES IN NET INTEREST INCOME (TAX EQUIVALENT BASIS) - ------------------------------------------------------------------------------------------------------------------- (In thousands) Variance Variance Attributed to Quarter Ended June 30, 2003/20021 Volume Rate - ------------------------------------------------------------------------------------------------------------------- INTEREST INCOME Taxable investment securities $(1,400) $ (2) $ (1,398) Nontaxable investment securities2 (225) (201) (24) Time deposits with banks, federal funds sold and securities purchased under agreements to resell (140) 324 (464) Loans2 (530) 4,237 (4,767) - ------------------------------------------------------------------------------------------------------------------- Total interest income (2,295) 4,358 (6,653) - ------------------------------------------------------------------------------------------------------------------- INTEREST EXPENSE Interest bearing demand deposits (170) 79 (249) Savings deposits (180) (10) (170) Time deposits (1,105) 1,568 (2,673) Federal funds purchased and securities sold under agreements to repurchase (191) (101) (90) Other borrowed funds 143 348 (205) - ------------------------------------------------------------------------------------------------------------------- Total interest expense (1,503) 1,884 (3,387) - ------------------------------------------------------------------------------------------------------------------- Net interest income $ (792) $ 2,474 $ (3,266) - ------------------------------------------------------------------------------------------------------------------- Percentage change 100.0% (312.4)% 412.4% - ------------------------------------------------------------------------------------------------------------------- 1The changes that are not solely due to rate or volume are allocated on a percentage basis using the absolute values of rate and volume variances as a basis for allocation. 2Income stated at fully tax equivalent basis using the marginal corporate Federal tax rate of 35%.
NONINTEREST INCOME - ------------------ Noninterest income was $4.5 million for the current quarter, an increase of $337 thousand or 8.1% compared to the second quarter of the prior year. Service charges and fees on deposits, the largest component of noninterest income, increased a modest $58 thousand or 3.0% to $2.0 million. Overdraft fees declined $61 thousand or 4.6% and service charges on demand deposit accounts declined $19 thousand or 7.7% in the comparison. Partially offsetting these declines was an increase in fees related to the Commonwealth of Kentucky of $119 thousand. Other service charges, commissions, and fees declined $22 thousand or 2.5% to $853 thousand. Data processing fees were relatively unchanged at $389 thousand. Trust income totaled $413 thousand, an increase of $52 thousand or 14.4% compared to $361 thousand a year earlier. A net loss of $3 thousand on the sale of available for sale securities was reported in the current quarter compared to a net gain of $396 thousand in the comparable period a year ago as the Company sought to manage the composition of its balance sheet in an increasingly difficult economic environment. Net gains on the sale of mortgage loans were $323 thousand, an increase of $233 thousand from $90 thousand in the prior year as mortgage loans originated for sale increased $13.7 million in the comparison due to the low interest rate environment. Income from the purchase of company-owned life insurance near the end of the first quarter of 2003 was $408 thousand in the current three-month period. Other noninterest income totaled $77 thousand, an increase of $5 thousand or 6.9%. NONINTEREST EXPENSE - ------------------- Total noninterest expenses increased $777 thousand or 8.9% from the second quarter of 2003 compared to the second quarter of 2002 and totaled $9.5 million. Salaries and employee benefits account for more than half of the total increase in noninterest expense. Total salaries and benefits increased $412 thousand or 8.6% to $5.2 million in the quarterly comparison. Employee benefit related expenses account for a significant amount of the increase. Employee benefit expenses increased $283 thousand primarily due to increased health insurance costs, which include additional amounts associated with the new postretirement health insurance coverage initiated during the first quarter of 2003. Salary and related payroll expenses increased $155 thousand or 3.9% in the comparison while noncash compensation expense related to the Company's nonqualified stock option plan declined $26 thousand or 19.6% due to the structure of the vesting schedule and forfeitures. The number of full time equivalent employees decreased to 462 from 469 reported in the prior period. Occupancy expense, net of rental income, increased $54 thousand or 9.2% and totaled $642 thousand. The increase in net occupancy expense is attributed to increases in maintenance and repairs, utilities costs, and depreciation. Equipment expense was relatively unchanged at $924 thousand. Other noninterest expense, including bank franchise taxes, increased $301 thousand or 12.6% to $2.7 million due mainly to a $187 thousand increase in correspondent bank fees related to activity attributed to the Commonwealth of Kentucky. INCOME TAXES - ------------ Income tax expense for the second quarter of 2003 was $874 thousand, a decrease of $208 thousand or 19.2% from the same period a year earlier. The effective tax rate decreased 220 basis points to 22.4% from 24.6% in 2002. The change in the effective tax rate is due to a combination of factors, primarily including credits derived from qualified zone academy bonds and nontaxable income accrued from the increase in cash surrender value on life insurance purchased on key employees. FIRST SIX MONTHS OF 2003 VS. FIRST SIX MONTHS OF 2002 ----------------------------------------------------- Net income for the six months ended June 30, 2003 was $6.6 million compared to net income of $7.1 million for the same period in 2002, a decrease of $479 thousand or 6.7%. Basic and diluted net income per share were $0.98 for the current six months, a decrease of $.05 or 4.9% and $.04 or 3.9%, respectively. The decrease in net income in the six-month comparison is attributed primarily to a $798 thousand or 4.0% decrease in net interest income. The decline in net interest income is attributed to continued declines in the overall market interest rate environment. Interest rates earned on earning assets have declined more rapidly than the interest rates paid on interest paying liabilities since many of the Company's funding sources, particularly deposits, have approached their repricing floors. The provision for loan losses decreased $373,000 or 33.6% in the six-month comparison. Higher provisions in the second quarter of 2002 related to a group of nonperforming constructions loans secured by residential real estate led to the decrease. Total noninterest income increased $382 thousand or 4.6% in the comparisons despite lower gains reported on the sale of investment securities of $849 thousand in the current period. Income from the purchase of company-owned life insurance, instituted in the first quarter of 2003 to offset the rising costs of the Company's employee benefits plans, totaled $673 thousand for the current six months. Gains on the sale of mortgage loans also increased $327 thousand in the comparison as the low interest rate environment continues to fuel the Company's secondary market mortgage loan originations. Offsetting the increase in noninterest income were increases in noninterest expenses totaling $879 thousand or 5.0% for the current six months. Noninterest expense increased primarily due to an increase in salaries and employee benefits of $330 thousand or 3.3%. These increases relate primarily to increases in employee benefits and normal salary increases. An increase in correspondent banking fees totaling $301 thousand also contributed to the increase in noninterest expenses. The effective income tax rate declined 243 basis points to 23.0% for the six months ended June 30, 2003 compared to the same period a year earlier. ROA was 1.07% for the six months ended June 30, 2003, a decrease of 12 basis points from the same period in 2002. Negatively impacting ROA was a 35 basis point decline in net interest margin to 3.61% and an increase in noninterest expenses of 5 basis points. Partially offsetting these declines that positively effected ROA was an increase in earning assets that contributed 9 basis points, a decrease in the provision for loan losses that contributed 7 basis points, an increase in noninterest income contributing 1 basis point, and a decrease in income tax expense that contributed 11 basis points. Return on average equity ("ROE") was 10.68% for the first six months of 2003 compared to 11.53% for the same period of 2002. The decrease is due to lower net income reported in the current period coupled with a slight increase in average equity compared to the same period a year ago. NET INTEREST INCOME - ------------------- Continuing weaknesses in the overall economic environment remain present and have impacted the Company's net interest income. The interest rate environment has continued to trend downward after a period of relative stability throughout much of 2002. Additional actions taken by the Fed in the fourth quarter of 2002 and the second quarter of 2003 have resulted in a general reduction in short-term interest rates in the reporting periods. Short-term interest rates, left unchanged since December 2001, were reduced 50 basis points by the Fed in November 2002 and an additional 25 basis points in June 2003. The prime rate as reported in The Wall Street Journal was lowered in an identical manner shortly following the Fed changes. The effects of prior rate reductions by the Fed along with intense competition in the Company's market areas continue to negatively impact net interest margin. The effect of the Fed's actions on the Company has generally led to interest rates on earning assets declining more rapidly than rates paid on interest bearing liabilities. During a falling rate environment, the challenge is to reduce the rates paid on interest bearing liabilities (primarily deposits) to offset the decline in the yield on variable rate assets (primarily loans) while remaining competitive in our markets. The Company's tax equivalent yield on earning assets for the current six months was 5.5%, a reduction of 98 basis points from 6.5% in the same period a year ago. The cost of funds for the current six months was 2.2%, a decline of 69 basis points compared to 2.9% in the same period a year earlier. A goal of the Company in the current interest rate environment is to increase earning assets and decrease the interest rates paid on interest bearing liabilities. However, many of the Company's funding sources, particularly deposits, have approached their repricing floors. Average earning assets increased $54.7 million or 5.1% to $1.1 billion in the comparison. As a percentage of total average assets, earning assets increased 161 basis points to 91.24% from 89.63%. This increase had the effect of adding an additional 9 basis points to ROA in the comparison. Interest income totaled $29.9 million for the first six months of 2003, a decrease of $3.6 million or 10.9% compared to the same period in the prior year. Interest expense totaled $10.6 million, a decrease of $2.8 million or 21.2%. Net interest income fell $798 thousand or 4.0% in the comparison and totaled $19.3 million at June 30, 2003. Interest and fees on loans totaled $24.4 million, a decrease of $1.3 million mainly due to a decrease in the average rate earned. Average loans increased $48.9 million or 7.1% to $739.1 million in the comparison due to higher loan demand in a lower rate environment. The tax equivalent yield on loans decreased 88 basis points to 6.7% from 7.6% and offset the effects of higher average balances on interest income. Interest on taxable securities was $3.5 million, a decrease of $1.8 million or 34.5% due primarily to a decrease in the average rate earned and the effect of higher premium amortization on mortgage-backed securities. Prepayements on mortgage-backed securities have increased greatly due to corresponding refinancing of home mortgages that serve as collateral for these investment securities. The increase in activity is directly related to the lower interest rate environment. The average rate earned on taxable securities decreased 163 basis points to 2.8% from 4.4% while the average balance increased $10.8 million or 4.4%. Interest on nontaxable securities declined $266 thousand or 14.4% due to an $11.0 million or 13.4% decrease in the average balance to $70.9 million from $81.9 million. Interest on short-term investments, including time deposits in other banks, federal funds sold, and securities purchased under agreements to resell, decreased $194 thousand due primarily to a decrease in the average rate earned on these investments of 77 basis points to 1.3% from 2.0%. Interest expense on deposits decreased $2.8 million or 23.7% to $9.0 million in the six month comparison. This decrease resulted from a general decline in the average rate paid throughout the deposit portfolio and correlates with the general decline in market interest rates in the reporting periods. The decline in the average rates paid offset a general increase in average balances. The decline in interest expense on deposits was as follows: time deposits $2.1 million or 21.9%; interest bearing demand deposits $375 thousand or 34.7%; and savings deposits $340 thousand or 28.1%. The average rate paid on time deposits, the largest component of interest bearing deposits, was 3.5% for the six months ended June 30, 2003 compared to 4.8% for the same period of 2002. The average balance of time deposits increased $20.3 million or 5.1% to $421.9 million. The average rate paid on interest bearing demand deposits declined 36 basis points to .65% from 1.01% while the average balance increased $5.7 million or 2.6% to $220.9 million. The average rate paid on savings deposits decreased 44 basis points to 1.1% from 1.5% while the average balance increased $2.3 million or 1.4% to $166.6 million from $164.3 million. Interest expense on overnight borrowings, consisting of federal funds purchased and securities sold under agreements to repurchase, decreased $405 thousand due to a 46 basis point decline in the average rate paid along with a $26.2 million decline in the average balance. Interest expense on other borrowed funds increased $354 thousand in the comparison as additional borrowings from the Federal Home Loan Bank increased the average balance outstanding. The average balance of other borrowed funds totaled $66.2 million, an increase of $25.7 million or 63.7% in the comparison. The average rate paid on other borrowed funds declined 39 basis points to 3.4% from 3.8%. The net interest margin (TE) decreased 35 basis points to 3.61% during the six months ended June 30, 2003 compared to 3.96% in the same period of 2002. The decrease in net interest margin is primarily attributed to a 29 basis point decline in the spread between rates earned on earning assets and the rates paid on interest bearing liabilities to 3.25% in the current six months from 3.54% in the same period in 2002. The effect of noninterest bearing sources of funds contributed an additional 6 basis points to the decline in net interest margin. The effect of noninterest bearing sources of funds on net interest margin typically declines in a falling rate environment. The following tables present an analysis of net interest income for the six months ended June 30.
DISTRIBUTION OF ASSETS, LIABILITIES AND SHAREHOLDERS' EQUITY: INTEREST RATES AND INTEREST DIFFERENTIAL - --------------------------------------------------------------------------------------------------------------------------------- Six Months Ended June 30, 2003 2002 - --------------------------------------------------------------------------------------------------------------------------------- Average Average Average Average (In thousands) Balance Interest Rate Balance Interest Rate - --------------------------------------------------------------------------------------------------------------------------------- EARNING ASSETS Investment securities Taxable $ 256,913 $ 3,500 2.75% $ 246,098 $ 5,343 4.38% Nontaxable1 70,891 2,328 6.62 81,876 2,699 6.65 Time deposits with banks, federal funds sold and securities purchased under agreements to resell 66,295 414 1.26 60,279 608 2.03 Loans1,2,3 739,127 24,584 6.71 690,242 25,968 7.59 - --------------------------------------------------------------------------------------------------------------------------------- Total earning assets 1,133,226 $ 30,826 5.49% 1,078,495 $ 34,618 6.47% - --------------------------------------------------------------------------------------------------------------------------------- Allowance for loan losses (11,263) (10,476) - --------------------------------------------------------------------------------------------------------------------------------- Total earning assets, net of allowance for loan losses 1,121,963 1,068,019 - --------------------------------------------------------------------------------------------------------------------------------- NONEARNING ASSETS Cash and due from banks 67,332 99,222 Premises and equipment, net 24,180 24,502 Other assets 28,576 11,511 - --------------------------------------------------------------------------------------------------------------------------------- Total assets $ 1,242,051 $ 1,203,254 - --------------------------------------------------------------------------------------------------------------------------------- INTEREST BEARING LIABILITIES Deposits Interest bearing demand $ 220,945 $ 707 0.65% $ 215,265 $ 1,082 1.01% Savings 166,608 871 1.05 164,324 1,211 1.49 Time 421,920 7,385 3.53 401,646 9,459 4.75 Federal funds purchased and securities sold under agreements to repurchase 74,823 502 1.35 101,037 907 1.81 Other borrowed funds 66,179 1,107 3.37 40,432 753 3.76 - --------------------------------------------------------------------------------------------------------------------------------- Total interest bearing liabilities 950,475 $ 10,572 2.24% 922,704 $ 13,412 2.93% - --------------------------------------------------------------------------------------------------------------------------------- NONINTEREST BEARING LIABILITIES Commonwealth of Kentucky deposits 35,790 35,146 Other demand deposits 121,996 114,910 Other liabilities 8,821 6,355 - --------------------------------------------------------------------------------------------------------------------------------- Total liabilities 1,117,082 1,079,115 - --------------------------------------------------------------------------------------------------------------------------------- Shareholders' equity 124,969 124,139 - --------------------------------------------------------------------------------------------------------------------------------- Total liabilities and shareholders' equity $ 1,242,051 $ 1,203,254 - --------------------------------------------------------------------------------------------------------------------------------- Net interest income 20,254 21,206 TE basis adjustment (961) (1,115) - --------------------------------------------------------------------------------------------------------------------------------- Net interest income $ 19,293 $ 20,091 - --------------------------------------------------------------------------------------------------------------------------------- Net interest spread 3.25% 3.54% Impact of noninterest bearing sources of funds .36 .42 - --------------------------------------------------------------------------------------------------------------------------------- Net interest margin 3.61% 3.96% - --------------------------------------------------------------------------------------------------------------------------------- 1Income and yield stated at a fully tax equivalent basis using the marginal corporate Federal tax rate of 35%. 2Loan balances include principal balances on nonaccrual loans. 3Loan fees included in interest income amount to $1.1 million and $906 thousand in 2003 and 2002, respectively.
ANALYSIS OF CHANGES IN NET INTEREST INCOME (TAX EQUIVALENT BASIS) - ------------------------------------------------------------------------------------------------------------------- (In thousands) Variance Variance Attributed to Six Months Ended June 30, 2003/20021 Volume Rate - ------------------------------------------------------------------------------------------------------------------- Interest Income Taxable investment securities $ (1,843) $ 653 $ (2,496) Nontaxable investment securities2 (371) (359) (12) Time deposits with banks, federal funds sold and securities purchased under agreements to resell (194) 153 (347) Loans2 (1,384) 4,082 (5,466) - ------------------------------------------------------------------------------------------------------------------- Total interest income (3,792) 4,529 (8,321) - ------------------------------------------------------------------------------------------------------------------- Interest Expense Interest bearing demand deposits (375) 80 (455) Savings deposits (340) 50 (390) Time deposits (2,074) 1,269 (3,343) Federal funds purchased and securities sold under agreements to repurchase (405) (204) (201) Other borrowed funds 354 576 (222) - ------------------------------------------------------------------------------------------------------------------- Total interest expense (2,840) 1,771 (4,611) - ------------------------------------------------------------------------------------------------------------------- Net interest income $ (952) $ 2,758 $ (3,710) - ------------------------------------------------------------------------------------------------------------------- Percentage change 100.0% (289.7)% 389.7% - ------------------------------------------------------------------------------------------------------------------- 1The changes that are not solely due to rate or volume are allocated on a percentage basis using the absolute values of rate and volume variances as a basis for allocation. 2Income stated at fully tax equivalent basis using the marginal corporate Federal tax rate of 35%.
NONINTEREST INCOME - ------------------ Noninterest income was $8.6 million for the first six months of 2003, an increase of $382 thousand or 4.6% compared to the same period in 2002. Service charges and fees on deposits, the largest component of noninterest income, increased $74 thousand or 2.0% to $3.9 million. Overdraft fees declined $106 thousand or 4.2% and service charges on demand deposit accounts declined $44 thousand or 8.9% in the comparison. Offsetting these declines was an increase in fees related to the Commonwealth of Kentucky of $185 thousand. Other service charges, commissions, and fees increased $43 thousand or 2.5% to $1.8 million. Data processing fees were up $11 thousand or 1.5% and totaled $734 thousand for the first six months of 2003. Trust fees increased $84 thousand or 11.5%. Net gains on the sale of available for sale securities was $144 thousand for the current six months, a decrease of $849 thousand or 85.5% compared to $993 thousand in the comparable period a year ago as the Company sought to manage the composition of its balance sheet in an increasingly difficult economic environment. Net gains on the sale of mortgage loans were $512 thousand, an increase of $327 thousand from $185 thousand in the prior year as mortgage loans originated for sale increased $20.6 million in the comparison due to the low interest rate environment. Income from the purchase of company-owned life insurance near the end of the first quarter of 2003 was $673 thousand. Other noninterest income totaled $143 thousand, an increase of $19 thousand or 15.3%. NONINTEREST EXPENSE - ------------------- Noninterest expenses totaled $18.6 million for the first six months of 2003, an increase of $879 thousand or 5.0% compared to the same period in 2002. Salaries and employee benefits, the largest component of noninterest expense, increased $330 thousand or 3.3% and totaled $10.3 million at June 30, 2003. Employee benefit expenses increased $183 thousand primarily due to increased health insurance costs, which include additional amounts associated with the new postretirement health insurance coverage initiated during the first quarter of 2003. Salary and related payroll expenses increased $236 thousand or 3.0% in the comparison while noncash compensation expense related to the Company's nonqualified stock option plan declined $89 thousand or 29.6% due to the structure of the vesting schedule and forfeitures. The number of full time equivalent employees decreased to 462 from 469 reported in the prior period. Occupancy expense, net of rental income, increased $141 thousand or 12.2% and totaled $1.3 million. The increase in net occupancy expense is attributed to increases in maintenance and repairs, utilities costs, and depreciation. Equipment expense was relatively unchanged at $1.9 million. Other noninterest expense, including bank franchise taxes, increased $387 thousand or 8.1% to $5.2 million mainly due to a $301 thousand increase in correspondent bank fees related to activity attributed to the Commonwealth of Kentucky. INCOME TAXES - ------------ Income tax expense for the first six months of 2003 was $2.0 million, a decrease of $443 thousand or 18.3% from the same period a year earlier. The effective tax rate decreased 243 basis points to 23.0% from 25.4% in 2002. The change in the effective tax rate is due to a combination of factors, primarily including credits derived from qualified zone academy bonds and nontaxable income accrued from the increase in cash surrender value on life insurance purchased on key employees. FINANCIAL CONDITION Total assets were $1.3 billion on June 30, 2003, a decrease of $15.6 million or 1.2% from December 31, 2002. The decrease in assets includes a $114.6 million lower balance in the securities portfolio, offset by a $71.2 million increase in cash and cash equivalents and a $23.6 million increase in other assets resulting primarily from the purchase of company-owned life insurance during the first quarter of 2003. Fed funds purchased and securities sold under agreements to repurchase declined $42.3 million and correspond to the decline in assets during the period. The makeup of the balance sheet continually changes as the Company responds to extremely competitive market forces. Management of the Company considers it noteworthy to understand the relationship between the Company's principal subsidiary, Farmers Bank & Capital Trust Co., and the Commonwealth of Kentucky. Farmers Bank provides various services to state agencies of the Commonwealth. As the depository for the Commonwealth, these agencies issue checks drawn on Farmers Bank, including paychecks and state income tax refunds. Farmers Bank also processes vouchers of the WIC (Women, Infants and Children) program for the Cabinet for Human Resources. The Bank's investment department also provides services to the Teacher's Retirement systems. As the depository for the Commonwealth, large fluctuations in deposits are likely to occur on a daily basis. Therefore, reviewing average balances is also important to understanding the financial condition of the Company. On an average basis, total assets were $1.2 billion for the first six months of 2003, an increase of $35.7 million or 3.0% from year-end 2002. Average earning assets, primarily loans and securities, were $1.1 billion at June 30, 2003, an increase of $42.8 million or 3.9% from year-end 2002. Average earning assets represent 91.24% of total average assets on June 30, 2003, an increase of 49 basis points compared to 90.75% at year-end 2002. LOANS - ----- Loans, net of unearned income, totaled $742.9 million at June 30, 2003, an increase of $4.3 million or 0.6% from year-end 2002. The composition of the loan portfolio is summarized in the table below. - -------------------------------------------------------------------------------- June 30, 2003 December 31, 2002 (Dollars in thousands) Amount % Amount % - -------------------------------------------------------------------------------- Commercial, financial, and agriculture $ 107,297 14.4% $ 110,056 14.9% Real estate - construction 53,078 7.1 55,896 7.6 Real estate - mortgage 474,346 63.9 459,620 62.2 Installment 73,198 9.9 76,162 10.3 Lease financing 34,993 4.7 36,905 5.0 - -------------------------------------------------------------------------------- Total $ 742,912 100.0% $ 738,639 100.0% - -------------------------------------------------------------------------------- On average, loans represented 65.2% of earning assets during the current six month period compared to 64.7% for year-end 2002. As loan demand fluctuates, the available funds are reallocated between loans and lower earning temporary investments or investment securities, which typically involve a decrease in credit risk and lower yields. ALLOWANCE FOR LOAN LOSSES - ------------------------- The allowance for loan losses was $11.2 million at June 30, 2003, an increase of $94 thousand or 0.8% from the prior year-end. The allowance for loan losses was 1.50% of loans net of unearned income at June 30, 2003, unchanged from December 31, 2002. The provision for loan losses decreased $637 thousand and $373 thousand in the current three-month and six-month period, respectively, compared to the same periods in 2002. The decrease in the provision for loan losses in the comparison is attributed to higher provisions in the second quarter of the prior year related to a group of nonperforming construction loans secured by residential real estate. The Company had net charge-offs of $324 thousand and $624 thousand in the current three and six months of 2003, respectively, compared to net charge-offs of $291 thousand and $632 thousand in the same periods of 2002. Annualized net charge-offs represent 0.18% of average net loans for three and six months ended June 30, 2003 compared to 0.60% at year-end 2002. The allowance for loan losses as a percentage of nonperforming loans totaled 70.2% and 57.3% at June 30, 2003 and December 31, 2002, respectively. The increase is primarily reflective of the decline in nonperforming assets of $3.7 million in the comparison. Management continues to emphasize collection efforts and evaluation of risks within the loan portfolio. In management's opinion, the provision for loan losses represents incurred credit losses during the periods presented and the allowance for loan losses is adequate to cover losses inherent in the loan portfolio. NONPERFORMING ASSETS - -------------------- Nonperforming assets for the Company include nonperforming loans, other real estate owned, and other foreclosed assets. Nonperforming loans consist of nonaccrual loans, restructured loans, and loans past due ninety days or more on which interest is still accruing. Nonperforming assets totaled $16.1 million at June 30, 2003, a decrease of $3.7 million or 18.6% from the prior year-end. Nonperforming loans totaled $15.9 million at June 30, 2003 a decrease of $3.4 million or 17.7% compared to year-end 2002. Nonperforming loans include a pool of constructions loans secured by residential real estate to a financially troubled builder. This pool of loans totaled $10.5 million at June 30, 2003. Interest income lost on this group of loans due to their nonaccrual status totaled $177 thousand and $366 thousand during the three and six months ended June 30, 2003, respectively. It is currently estimated that a total of $150 thousand of interest income will be lost in each subsequent quarter related to this credit while it remains on nonaccrual status. Nonperforming loans as a percentage of net loans were 2.14% at June 30, 2003, a decrease of 47 basis points from 2.61% compared to year-end 2002. Other real estate owned, which had a balance of $385 thousand at year-end 2002, decreased $329 thousand or 85.5% to $56 thousand on June 30, 2003. TEMPORARY INVESTMENTS - --------------------- Temporary investments consist of interest bearing deposits with other banks, federal funds sold, and securities purchased under agreements to resell and totaled $43.0 million at June 30, 2003, an increase of $19.9 million or 86.7% from year-end 2002. Temporary investments averaged $66.3 million for the first six months of 2003, a decrease of $2.7 million from year-end 2002. The decrease is primarily a result of the Company's net funding position and the relationship between its principal subsidiary and the Commonwealth of Kentucky as described in preceding sections of this report. Temporary investments are reallocated as loan demand and other investment alternatives present the opportunity. INVESTMENT SECURITIES - --------------------- Investment securities were $327.0 million on June 30, 2003, a decrease of $114.6 million or 25.9% from year-end 2002. Available for sale and held to maturity securities were $301.2 million and $25.8 million, respectively. Investment securities averaged $327.8 million for the first six months of 2003, an increase of $11.4 million or 3.6% from year-end 2002. The increase in average investment securities is attributable to the Company's continued efforts to manage its net interest margin during a period of low market interest rates and correlates with the increase in average borrowed funds. The Company had an unrealized gain on available for sale investment securities of $5.9 million at June 30, 2003 compared to $5.5 million at year-end 2002. COMPANY-OWNED LIFE INSURANCE - ---------------------------- The Company purchased life insurance policies on certain key employees, with their knowledge and consent, during the current year at a cost of $24.0 million. Company-owned life insurance is recorded at its cash surrender value, or the amount that can be realized, on the consolidated balance sheet with the related change in cash surrender value and proceeds received under the policies reported on the consolidated statement of income as tax-free noninterest income, which totaled $673 thousand for the current six-month period. The Company is the sole beneficiary of proceeds received under the policies. Expected income from the purchase of the insurance policies will be used to offset the rising costs of the Company's various benefit plans as well as the additional costs of implementing a new postretirement health insurance program. Under the new postretirement health insurance plan, any employee that meets the service requirements upon retirement would be eligible to continue their health insurance coverage, identical to the coverage that is offered to active employees. The employee will pay 50% of the cost and the Company will pay 50%. It is currently estimated that the expense related to the new postretirement health insurance plan will be approximately $114 thousand per quarter for the remainder of 2003. DEPOSITS - -------- Total deposits were $980.4 million at June 30, 2003, an increase of $22.9 million or 2.4% from year-end 2002. Noninterest bearing deposits increased $48.8 million or 34.6% in the comparison. This increase is primarily due to the relationship between the Company's principal subsidiary and the Commonwealth of Kentucky as described in preceding sections of this report. On average, noninterest bearing deposits were $157.8 million during the current period, an increase of $7.0 million or 4.6%. End of period interest bearing deposit balances decreased $25.9 million or 3.2% during the six months ended June 30, 2003 due to decreases in interest bearing checking accounts of $10.5 million or 4.7%, money market deposit accounts of $24.8 million or 21.7%, and savings accounts of $4.3 million or 6.6%. Time deposits increased $13.7 million in the end of period comparisons. On average, interest bearing deposits were $809.5 million in the current period, an increase of $22.0 million or 2.8% from year-end 2002. The increase in average interest bearing deposits is attributable to increases in interest bearing demand deposits of $5.2 million or 2.4%, time deposits of $17.3 million or 4.3%, and savings accounts of $2.6 million or 4.3%. Average money market deposit accounts declined $3.0 million or 2.8% in the comparison. Total deposits averaged $967.3 million, an increase of $29.0 million or 3.1% from year-end 2002. BORROWED FUNDS - -------------- Borrowed funds totaled $142.2 million at June 30, 2003, a decrease of $40.2 million or 22.0% from $182.3 million at year-end 2002. A $2.2 million net increase in long-term borrowings was offset by a $42.4 million decrease in short-term borrowings, which account for the total decrease in borrowed funds. Federal funds purchased and securities sold under agreements to repurchase decreased $42.3 million or 36.5% due primarily to the relationship between the Company's principal subsidiary and the Commonwealth of Kentucky as described in preceding sections of this report. Other short-term borrowings, primarily short-term borrowings from the Federal Home Loan Bank ("FHLB") were relatively unchanged at $9.2 million. The $2.2 million increase in long-term borrowings is attributed to the funding of new data processing equipment financed over a term of four years and an additional $1.2 million in additional net borrowings from the FHLB. Total borrowed funds averaged $141.0 million, an increase of $5.0 million or 3.7% from year-end 2002. LIQUIDITY The Parent Company's primary use of cash consists of dividend payments to its common shareholders, purchases of its common stock, and other general operating purposes. Liquidity of the Parent Company depends primarily on the receipt of dividends from its subsidiary banks and cash balances maintained. As of June 30, 2003 combined retained earnings of the subsidiary banks were $41.6 million, of which $2.4 million was available for the payment of dividends to the Parent Company without obtaining prior approval from bank regulatory agencies. As a practical matter, payment of future dividends is also subject to the maintenance of other capital ratio requirements. During the current six months ended June 30, 2003 the Parent Company received dividends of $30.8 million. Management expects that in the aggregate, its subsidiary banks will continue to have the ability to pay dividends in order to provide funds to the Parent Company during the remainder of 2003 sufficient to meet its liquidity needs. The Parent Company had cash balances of $28.1 million at June 30, 2003. The Company's objective as it relates to liquidity is to insure that subsidiary banks have funds available to meet deposit withdrawals and credit demands without unduly penalizing profitability. In order to maintain a proper level of liquidity, the banks have several sources of funds available on a daily basis, which can be used for liquidity purposes. These sources of funds primarily include the subsidiary banks' core deposits, consisting of both business and nonbusiness deposits; cash flow generated by repayment of loan principal and interest; and federal funds purchased and securities sold under agreements to repurchase. The terms of the recent FHLB advances have been taken into consideration in relation to the overall funding needs of the Company. For the longer term, the liquidity position is managed by balancing the maturity structure of the balance sheet. This process allows for an orderly flow of funds over an extended period of time. The Company's Asset and Liability Management Committee meets regularly and monitors the composition of the balance sheet to ensure comprehensive management of interest rate risk and liquidity. Liquid assets consist of cash, cash equivalents, and securities available for sale. At June 30, 2003, such assets totaled $439.5 million, a decrease of $40.6 million or 8.5% from year-end 2002. The decrease in liquid assets is attributed to the overall funding position of the Company combined with the purchase of company-owned life insurance on key employees during the current six months. Net cash provided by operating activities was $10.6 million in the first six months of 2003, relatively unchanged from $10.7 million compared to the same period last year. Net cash provided by investing activities was $84.6 million, an increase of $31.8 million due primarily to a $66.2 million increase from investments securities transactions offset by the purchase of company-owned life insurance on key employees of $24.0 million. An increase in loan volume during the six-month periods used an additional $9.6 million in the comparison. Net cash used in financing activities was $24.0 million for the six months ended June 30, 2003. In the prior six-month comparison financing activities provided $74.7 million. The change is mainly due to lower funding activity during the current six-month period compared to the activity in the same period a year earlier. CAPITAL RESOURCES Shareholders' equity was $126.2 million on June 30, 2003, an increase of $418 thousand or 0.3% from year-end 2002. The Company purchased 81 thousand shares of its outstanding common stock during the first six months of 2003 for a total cost of $2.5 million. The Company issued 6 thousand shares of common stock during the first six months of 2003 pursuant to its nonqualified stock option plan. Dividends of $4.3 million or $.64 per share were declared during the first six months of 2003, an increase of 3.2% per share compared to the prior year. Accumulated other comprehensive income, consisting of the unrealized holding gain on available for sale investment securities (net of tax) increased $271 thousand from year-end 2002. Consistent with the objective of operating a sound financial organization, the Company's goal is to maintain capital ratios well above the regulatory minimum requirements. The Company's capital ratios as of June 30, 2003, the regulatory minimums and the regulatory standard for a "well capitalized" institution are as follows3 Farmers Capital Regulatory Well Bank Corporation Minimum Capitalized - -------------------------------------------------------------------------------- Tier 1 risk based 15.19% 4.00% 6.00% Total risk based 16.45% 8.00% 10.00% Leverage 9.85% 4.00% 5.00% The capital ratios of all the subsidiary banks, on an individual basis, were in excess of the applicable minimum regulatory capital ratio requirements at June 30, 2003. RECENTLY ISSUED ACCOUNTING STANDARDS In January 2003, the Financial Accounting Standards Board ("FASB") issued Interpretation No. 46, CONSOLIDATION OF VARIABLE INTEREST ENTITIES, AN INTERPRETATION OF ARB NO. 51. This Interpretation provides new guidance for the consolidation of variable interest entities ("VIEs") and requires such entities to be consolidated by their primary beneficiaries if the entities do not effectively disperse risk among parties involved. The Interpretation also adds disclosure requirements for investors that are involved with unconsolidated VIEs. The consolidation requirements apply immediately to VIEs created after January 31, 2003 and are effective for the first fiscal year or interim period beginning after June 15, 2003 for VIEs acquired before February 1, 2003. The adoption of this interpretation is not expected have a significant impact on the Company's financial condition of results of operations. In April 2003, The FASB issued Statement of Financial Accounting Standards ("SFAS") No. 149, AMENDMENT OF STATEMENT 133 ON DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES. SFAS No. 149 amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities under SFAS No. 133, "ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES." This statement is effective for contracts entered into or modified after June 30, 2003. Because the Company does not have these instruments or is only nominally involved in these instruments, management expects the adoption of this statement will not have a material effect on the Company's consolidated financial statements. In May 2003, the FASB issued SFAS No. 150, "ACCOUNTING FOR CERTAIN FINANCIAL INSTRUMENTS WITH CHARACTERISTICS OF BOTH LIABILITIES AND EQUITY". This statement affects the accounting for certain financial instruments that, under previous guidance, issuers could account for as equity. This statement requires that freestanding financial instruments that embody obligations for the issuer be classified as liabilities on the balance sheet. Most of this statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. Because the Company does not have these instruments or is only nominally involved in these instruments, management expects the adoption of this statement will not have a material effect on the Company's consolidated financial statements. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK - ------------------------------------------------------------------- The Company uses a simulation model as a tool to monitor and evaluate interest rate risk exposure. The model is designed to measure the sensitivity of net interest income and net income to changing interest rates over future time periods. Forecasting net interest income and its sensitivity to changes in interest rates requires the Company to make assumptions about the volume and characteristics of many attributes, including assumptions relating to the replacement of maturing earning assets and liabilities. Other assumptions include, but are not limited to, projected prepayments, projected new volume, and the predicted relationship between changes in market interest rates and changes in customer account balances. These effects are combined with the Company's estimate of the most likely rate environment to produce a forecast of net interest income and net income. The forecasted results are then adjusted for the effect of a gradual increase and decrease in market interest rates on the Company's net interest income and net income. Because assumptions are inherently uncertain, the model cannot precisely estimate net interest income or net income or the effect of interest rate changes on net interest income and net income. Actual results could differ significantly from simulated results. At June 30, 2003, the model indicated that if rates were to gradually increase by 150 basis points during the calendar year, then net interest income and net income would increase 0.35% and 0.73%, respectively for the year ending December 31, 2003. The model indicated that if rates were to gradually decrease by 150 basis points over the same period, then net interest income and net income would decrease 1.4% and 3.3%, respectively. In the current low interest rate environment, it is not practical or possible to reduce certain deposit rates by the same magnitude as rates on earning assets. The average rates paid on some of the Company's deposits are well below 1.5%. This situation magnifies the model's predicted results when modeling a decrease in interest rates, as earning assets with higher yields have more of an opportunity to reprice at lower rates than lower-rate deposits. ITEM 4. CONTROLS AND PROCEDURES - -------------------------------- The Company's Chief Executive Officer and Chief Financial Officer have reviewed and evaluated the Company's disclosure controls and procedures as of the end of the period covered by this report, and have concluded that the Company's disclosure controls and procedures were adequate and effective to ensure that information required to be disclosed is recorded, processed, summarized, and reported in a timely manner. There were no significant changes in the Company's internal controls or in other factors that could significantly affect these controls subsequent to the date of the Chief Executive Officer and Chief Financial Officers evaluation, nor were there any significant deficiencies or material weaknesses in the controls which required corrective action. PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS - -------------------------- In September 1992, Farmers Bank & Capital Trust Company (the "Bank") was named as a defendant in Case No. 92CIO5734 in Jefferson Circuit Court, Louisville, Kentucky, in a case styled SHILLING ET AL. V. FARMERS BANK & Capital Trust Company. Details of this case have been disclosed in previous Annual Reports on Form 10-K and subsequent 10-Q filings. The named plaintiffs purported to represent a class consisting of all present and former owners of the County of Jefferson, Kentucky, Nursing Home Refunding Revenue Bonds (Filson Care Home Project) Series 1986A and County of Jefferson, Kentucky, Nursing Home Improvement Revenue Bonds (Filson Care Home Project) Series 1986B (collectively "the Bonds"). The plaintiffs alleged that the class had been damaged through a reduction in the value of the Bonds and a loss of interest on the Bonds because of the actions of the Bank in its capacity as indenture trustee for the Bondholders. The plaintiffs demanded compensatory and punitive damages. On July 6, 1993, the Court denied the plaintiffs' motion to certify the case as a class action. Subsequently, the plaintiffs amended their complaint to join additional Bondholders as plaintiffs. The plaintiffs claimed to hold Bonds in the aggregate principal amount of $480,000. Before trial, the Court dismissed thirty-nine of the plaintiffs because they were unable or unwilling to present testimony to support their claims. The case was tried to a jury beginning on March 28, 2000 on the claims of four plaintiffs holding Bonds in the aggregate principal amount of $80,000. The Court granted a directed verdict in favor of the Bank on the plaintiffs' claim that the Bank had engaged in commercial bribery and that the legal fees that were paid by the Bank should be disgorged because of an alleged conflict of interest of the Bank's counsel. The jury found for the plaintiffs on the claim that the Bank had breached its fiduciary duty and awarded the plaintiffs $99,875 in compensatory damages and $600,000 in punitive damages. The Bank filed a motion for judgment notwithstanding the verdict or, in the alternative, for a new trial, asserting that the jury's verdict that the Bank breached its fiduciary duty was not supported by sufficient evidence, that the jury's award of damages was speculative and was not supported by the evidence, and that the jury's award of punitive damages was not supported by sufficient evidence. The Bank also asserted that a new trial was warranted because of the erroneous admission of evidence concerning legal fees paid by the Bank. Plaintiffs filed an appeal contending that the denial of class certification was erroneous, that the individual plaintiffs should not have been dismissed from the lawsuit, that certain evidence was erroneously excluded, and that the directed verdict regarding the disgorgement of legal fees and the commercial bribery claims was erroneous. On August 1, 2000, the Kentucky Court of Appeals dismissed the appeal as having been prematurely filed. On January 3, 2001, the Jefferson Circuit Court entered judgment in favor of the Bank notwithstanding the jury's verdict in favor of the plaintiffs, holding that the Bank reasonably relied in good faith on the advice of its counsel, that there was no evidence that the Bank breached its fiduciary duty to the plaintiffs, and that there was no evidence that the Bank caused the plaintiffs' losses. On January 31, 2001, the plaintiff bondholders appealed, and on February 9, 2001, defendant Bank cross-appealed, the judgment of the Jefferson Circuit Court to the Kentucky Court of Appeals. In their appeal, the Bondholders claim that the trial court's denial of class certification was erroneous, that certain individual plaintiffs should not have been dismissed from the lawsuit, that the trial court erroneously directed a verdict against them on the issue of a conflict of interest, and that the judgment notwithstanding the verdict was erroneously granted because the evidence was sufficient to support the jury's verdict. In its cross-appeal, the Bank claims that the trial court erroneously bifurcated the trial on the issue of liability and damages, that certain witnesses should have been excluded from the trial, that the Bank should have been granted summary judgment, and that certain evidence and testimony regarding attorneys' fees should have been excluded. On May 10, 2002, the Kentucky Court of Appeals affirmed the Jefferson Circuit Court's judgment in favor of the Bank. The plaintiff bondholders filed a motion for discretionary review to the Kentucky Supreme Court on June 7, 2002. On June 7, 2002, the plaintiffs filed with the Kentucky Supreme Court a motion for discretionary review. The Bank filed a response opposing the plaintiffs' motion On April 17, 2003 the Kentucky Supreme Court denied plaintiffs' motion for discretionary review. The judgment in favor of the Bank is therefore now final and subject to no further appeal or judicial review. As of June 30, 2003, there were various other pending legal actions and proceedings against the Company arising from the normal course of business and in which claims for damages are asserted. Management, after discussion with legal counsel, believes that these actions are without merit and that the ultimate liability resulting from these legal actions and proceedings, if any, will not have a material adverse effect upon the consolidated financial statements of the Company. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS - ------------------------------------------------------------ The annual meeting of shareholders was held May 13, 2003. The matters that were voted upon included the election of four directors for three-year terms ending in 2006 or until their successors have been elected and qualified. The outcome of the voting was as follows: NAME FOR AGAINST WITHHELD ABSTAINED Frank W. Sower, Jr. 5,822,220 0 5,784 300 J. Barry Banker 5,821,970 0 6,034 300 Dr. John D. Sutterlin 5,827,054 0 950 300 Dr. Donald J. Mullineaux 5,822,370 0 5,634 300 Listed below are the names of each director whose term of office continued after the meeting. Lloyd C. Hillard, Jr. Shelley S. Sweeney Harold G. Mays W. Benjamin Crain Robert Roach, Jr. Michael M. Sullivan Gerald R. Hignite G. Anthony Busseni In addition to the directors above, Dr. John P. Stewart, Chairman Emeritus, E. Bruce Dungan, and Charles T. Mitchell serve as advisory directors for the Company. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K - ----------------------------------------- a) List of Exhibits ---------------- 3i. Amended and Restated Articles of Incorporation of Farmers Capital Bank Corporation (incorporated by reference to Quarterly Report on Form 10-Q for the quarterly period ended June 30, 1998). 3ii. Amended and Restated By-Laws of Farmers Capital Bank Corporation (incorporated by reference to Annual Report of Form 10-K for the fiscal year ended December 31, 1997. 3iia Amendments to By-Laws of Farmers Capital Bank Corporation (incorporated by reference to Quarterly Report of Form 10-Q for the quarterly period ended March 31, 2003). 31.1 CEO Certification (page 30) 31.2 CFO Certification (page 31) 32 CEO & CFO Certifications Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (page 32) b) Reports on Form 8-K ------------------- On July 21, 2003, the Registrant filed a report on Form 8-K under Item 9 (furnished under Item 12) in accordance with SEC release No. 33-8216 reporting its earnings for the second quarter of 2003. There were no financial statements filed with this Form 8-K. 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. Date: 8-12-03 /s/ G. Anthony Busseni ----------------- ----------------------------------------- G. Anthony Busseni, President and CEO (Principal Executive Officer) Date: 8-12-03 /s/ C Douglas Carpenter ----------------- ----------------------------------------- C. Douglas Carpenter, Vice President, Secretary, and CFO (Principal Financial and Accounting Officer) EX-31 3 ceo063003.txt CEO CERTIFICATION Exhibit 31.1 CEO CERTIFICATION I, G. Anthony Busseni, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Farmers Capital Bank Corporation; 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(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) 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(s) 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 the 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 control over financial reporting. Date: 8-12-03 /s/ G. Anthony Busseni ------------- -------------------------- G. Anthony Busseni President and CEO EX-31 4 cfo063003.txt CFO CERTIFICATION Exhibit 31.2 CFO CERTIFICATION I, C. Douglas Carpenter, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Farmers Capital Bank Corporation; 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(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) 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(s) 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 the 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 control over financial reporting. Date: 8/12/03 /s/ C Douglas Carpenter ------------- ----------------------------------- C. Douglas Carpenter Vice President, Secretary, and CFO EX-32 5 a906-63003.txt 906 CERTIFICATIONS Exhibit 32 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of Farmers Capital Bank Corporation on Form 10-Q for the period ended June 30, 2003 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), each of the undersigned hereby certifies in his capacity as officer of Farmers Capital Bank Corporation, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 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: 8-12-03 /s/ G. Anthony Busseni ------------- ----------------------------------- G. Anthony Busseni President and CEO Date: 8-12-03 /s/ C Douglas Carpenter ------------- ----------------------------------- C. Douglas Carpenter Vice President, Secretary, and CFO A signed original of this written statement required by Section 906 has been provided to Farmers Capital Bank Corporation and will be retained by Farmers Capital Bank Corporation and furnished to the Securities and Exchange Commission or its staff upon request. -----END PRIVACY-ENHANCED MESSAGE-----