KENTUCKY BANCSHARES, INC. This section presents an analysis of the consolidated financial condition of the Company and its wholly-owned subsidiary,Kentucky Bank , atDecember 31, 2019 and 2018, and the consolidated results of operations for each of the years in the two year period endedDecember 31, 2019 . The following discussion and analysis of financial condition and results of operations should be read in conjunction with the 2019 Consolidated Financial Statements and Notes included in Item 8. When necessary, reclassifications have been made to prior years' data throughout the following discussion and analysis for purposes of comparability with 2019 data.
Critical Accounting Policies
Overview. The accounting and reporting policies of the Company and its subsidiary are in accordance with accounting principles generally accepted inthe United States and conform to general practices within the banking industry. Significant accounting policies are listed in Note 1 of the Company's 2019 Consolidated Financial Statements and Notes included in Item 8. Critical accounting and reporting policies include accounting for loans and the allowance for loan losses, goodwill and fair value. Different assumptions in the application of these policies could result in material changes in the consolidated financial position or consolidated results of operations. Allowance for Loan Losses. Loans are stated at the amount of unpaid principal, reduced by an allowance for loan losses. Interest on loans is recognized on the accrual basis, except for those loans on the nonaccrual status. Interest income received on such loans is accounted for on the cash basis or cost recovery method. The allowance for loan losses is a valuation allowance for probable incurred credit losses. Management estimates the allowance balance required using past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions, and other factors. The accounting policies relating to the allowance for loan losses involve the use of estimates and require significant judgments to be made by management. The loan portfolio also represents the largest asset group on the consolidated balance sheets. Additional information related to the allowance for loan losses that describes the methodology and risk factors can be found under the captions "Asset Quality" and "Loan Losses" in this management's discussion and analysis of financial condition and results of operation, as well as Notes 1 and 4 of the Company's 2019 Consolidated Financial Statements and Notes.Goodwill .Goodwill and intangible assets acquired in a purchase business combination and determined to have an indefinite useful life are not amortized, but tested for impairment at least annually. The Company has selectedDecember 31 as the date to perform the annual impairment test. Intangible assets with definite useful lives are amortized over their estimated useful lives to their estimated residual values.Goodwill is the only intangible asset with an indefinite life on our balance sheet. Fair Value of Securities. Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed in Note 17 of the Company's 2019 Consolidated Financial Statements and Notes. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments, and other factors, especially in the absence of broad markets for particular items. Changes in assumptions or in market conditions could significantly affect the estimates. Forward-Looking Statements This discussion contains forward-looking statements under the Private Securities Litigation Reform Act of 1995 that involve risks and uncertainties. Although the Company believes that the assumptions underlying the forward-looking statements contained herein are reasonable, any of the assumptions could be inaccurate, and therefore, there can be no assurance that the forward-looking statements included herein will prove to be accurate. Factors that could cause actual results to differ from the results discussed in the forward-looking statements include, but are not limited to: economic conditions (both generally and more specifically in the markets, including the tobacco market, the thoroughbred horse industry and the automobile industry relating to Toyota vehicles, in which the Company and its bank operate); competition for the Company's customers from other providers of financial and mortgage services; government legislation, regulation and monetary policy (which changes from time to time and over which the Company has no control); changes in interest rates (both generally and more specifically mortgage interest rates); material unforeseen changes in the liquidity, results of operations, or financial condition of the Company's customers; 17 and other risks detailed in Part 1, Item 1A "Risk Factors" in this report and other risks detailed in the Company's filings with theSecurities and Exchange Commission , all of which are difficult to predict and many of which are beyond the control of the Company. The Company undertakes no obligation to republish revised forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. Overview We conduct our business through our one bank subsidiary,Kentucky Bank , and our one non-bank subsidiaryKBI Insurance Company .Kentucky Bank is engaged in general full-service commercial and consumer banking. A significant part ofKentucky Bank's operating activities include originating loans, approximately 82% of which are secured by real estate atDecember 31, 2019 .Kentucky Bank makes commercial, agricultural and real estate loans to its commercial customers, with emphasis on small-to-medium-sized industrial, service and agricultural businesses. It also makes residential mortgages, installment and other loans to its individual and other non-commercial customers.Kentucky Bank's primary market isBourbon ,Clark ,Elliott ,Fayette ,Harrison ,Jessamine ,Madison ,Rowan ,Scott ,Woodford and surrounding counties inKentucky .KBI Insurance Company is a captive insurance subsidiary and was incorporated in 2014. Net income for the year endedDecember 31, 2019 was$13.2 million , or$2.21 per common share compared to$12.4 million , or$2.09 for 2018. Earnings per share assuming dilution were$2.21 and$2.09 for 2019 and 2018, respectively. For 2019, net income increased$723 thousand , or 5.8%. Net interest income increased$719 thousand , provision for loan losses increased$750 thousand , total non-interest income increased$1.1 million , total non-interest expense increased$926 thousand and income tax expense decreased$577 thousand . For 2018, net income increased$1.7 million , or 16.0%. Net interest income increased$2.2 million , the provision for loan losses showed no change, total other income decreased$845 thousand , while total other expenses increased$1.1 million and income tax expense decreased$1.5 million .
Return on average equity was 11.52% in 2019 compared to 12.36% in 2018. Return on average assets was 1.20% in 2019 compared to 1.18% in 2018.
Non-performing loans as a percentage of loans (including held for sale) were
0.61% and 0.34% as of
RESULTS OF OPERATIONS Net Interest Income
Net interest income, the Company's largest source of revenue, on a tax
equivalent basis increased from
Average earning assets and average interest bearing liabilities increased from 2018 to 2019. Average earning assets increased$23.7 million , or 2.4%. Average investment securities decreased$22.9 million and average loans increased$39.4 million . Average interest bearing liabilities increased$12.6 million , or 1.8% during this same period. Average interest-bearing deposits increased$15.7 million , or 2.7%, average borrowings from theFederal Home Loan Bank increased$2.5 million , or 2.5%, and average repurchase agreements and other borrowings decreased$5.6 million , or 24.6%. The Company continues to actively pursue quality loans and fund these primarily with deposits andFederal Home Loan Bank advances. The bank prime rates decreased 75 basis points fromDecember 2018 toDecember 2019 . The tax equivalent yield on earning assets increased from 4.39% in 2018 to 4.52% in 2019. 18 The volume rate analysis for 2019 that follows indicates that$1.5 million of the increase in interest income is attributable to an increase in volume, while the change in rates contributed to an increase of$1.4 million in interest income. Further, a decrease in total interest-bearing liability balances resulted in a$37 thousand reduction in interest expense in 2019 compared to 2018 while changes in rates resulted in additional interest expense of$2.2 million over the same period. The average rate of these liabilities increased from 0.95% in 2018 to 1.24% in 2019. In summary, the increase in the Company's 2019 net interest income is attributed mostly to an increase in balances in our loan portfolio. The volume rate analysis for 2018 that follows indicates that$910 thousand of the increase in interest income is attributable to an increase in volume, while the change in rates contributed to an increase of$3.1 million in interest income. Further, a decrease in interest bearing liabilities resulted in a$514 thousand reduction interest expense in 2018 compared to 2017 while changes in rates resulted in additional interest expense of$2.3 million over the same period. The average rate of these liabilities increased from 0.70% in 2017 to 0.95% in 2018. In summary, the increase in the Company's 2018 net interest income is attributed mostly to increases in rates for interest earning assets and an increase in balances in our loan portfolio. The accompanying analysis of changes in net interest income in the following table shows the relationships of the volume and rate portions of these changes in 2019 vs. 2018 and 2018 vs. 2017. Changes in interest income and expenses due to both rate and volume are allocated on a pro rata basis.
Changes in Interest Income and Expense
(in thousands)
2019 vs. 2018 2018 vs. 2017
Increase (Decrease) Due to Change in Increase (Decrease) Due to Change in
(in thousands) Volume Rate Net Change Volume Rate Net Change
INTEREST INCOME
Loans $ 2,046 $ 930 $ 2,976 $ 869 $ 2,276 $ 3,145
Investment Securities (606) 361 (245) 94 621 715
Other 97 72 169 (53) 166 113
Total Interest Income 1,537 1,363 2,900 910 3,063 3,973
INTEREST EXPENSE
Deposits
Demand (6) 693 687 15 980 995
Savings (8) 48 40 - 7 7
Negotiable Certificates of Deposit and
Other Time Deposits 219 1,053 1,272 (50) 595 545
Securities sold under agreements to
repurchase and other borrowings (291) 200 (91) (532) 560 28
Federal Home Loan Bank advances 49 224 273 53 160 213
Total Interest Expense (37) 2,218 2,181 (514) 2,302 1,788
Net Interest Income $ 1,574 $ (855) $ 719 $ 1,424 $ 761 $ 2,185
19
Average Consolidated Balance Sheets and Net Interest Income Analysis ($ in
thousands)
2019 2018
Average Average Average Average
Balance Interest Rate Balance Interest Rate
ASSETS
Interest-Earning Assets
Securities Available for Sale (1)
U.S. Treasury and Federal Agency
Securities $ 245,294 $ 6,314 2.57 % $ 227,793 $ 5,537 2.43 %
State and Municipal obligations 36,227 1,287 3.55 76,580 2,308 3.01
Total Investment Securities 281,521 7,601 2.70 304,373 7,845 2.58
Tax Equivalent Adjustment 276 0.10 475 0.16
Tax Equivalent Total 281,521 7,877 2.80 304,373 8,320 2.73
Federal Home Loan Bank Stock and Other 7,303 358 4.90 7,305 419 5.74
Federal Funds Sold and Agreements to
Repurchase 298 7 2.35 2,165 32 1.48
Interest-Bearing Deposits with Banks 24,155 527 2.18
15,192 273 1.80
Loans, Net of Deferred Loan Fees (2)
Commercial 93,403 4,573 4.90 88,294 4,082 4.62
Real Estate Mortgage 593,505 30,781 5.19 561,121 28,624 5.10
Consumer 20,651 1,685 8.16 18,726 1,357 7.25
Total Loans 707,559 37,039 5.23 668,141 34,063 5.10
Tax Equivalent Adjustment 319 0.05 312 0.05
Tax Equivalent Total 707,559 37,358 5.28 668,141 34,375 5.14
Total Interest-Earning Assets 1,020,836 45,532 4.46 997,176 42,632 4.31
Tax Equivalent Adjustment 595 0.06 787 0.08
Tax Equivalent Total 1,020,836 46,127 4.52 997,176 43,419 4.39
Allowance for Loan Losses (8,072) (8,090)
Cash and Due From Banks 13,180 13,211
Premises and Equipment 17,932 17,416
Other Assets 50,805 39,470
Total Assets $ 1,094,681 $ 1,059,183
LIABILITIES
Interest-Bearing Deposits
Negotiable Order of Withdrawal ("NOW")
and Money Market Investment Accounts $ 295,337 $ 2,797 0.95 % $ 295,616 $ 2,110 0.71 %
Savings 109,698 132 0.12 111,882 92 0.08
Certificates of Deposit and Other
Deposits 201,111 3,311 1.65 182,967 2,039 1.11
Total Interest-Bearing Deposits 606,146 6,240 1.03 590,465 4,241 0.72
Securities sold under agreements to
repurchase and other borrowings 17,140 560 3.27 22,721 651 2.87
Federal Home Loan Bank advances 101,964 2,183 2.14 99,462 1,910 1.92
Total Interest-Bearing Liabilities 725,250 8,983 1.24 712,648 6,802 0.95
Noninterest-Bearing Earning Demand
Deposits 240,284 232,479
Other Liabilities 15,009 6,172
Total Liabilities 980,543 951,299
STOCKHOLDERS' EQUITY 114,138 100,579
Total Liabilities and Stockholders'
Equity $ 1,094,681 $ 1,051,878
Average Equity to Average Total Assets 10.43 % 9.56 %
Net Interest Income 36,549 35,830
Net Interest Income (tax equivalent)
(3) 37,144 36,617
Net Interest Spread (tax equivalent)
(3) 3.28 3.43
Net Interest Margin (tax equivalent)
(3) 3.64 3.70
(1) Averages computed at amortized cost
(2) Includes loans on a nonaccrual status and loans held for sale
(3) Tax equivalent difference represents the nontaxable interest income on state
and municipal securities net of the related non-deductible portion of
interest expense
20
Noninterest Income and Expenses
Noninterest income was$14.2 million in 2019 and$13.1 million in 2018. In 2019, increases in gains on available for sale securities and debit card interchange income were offset by reductions in brokerage income and loan service fee income. In 2018, reductions in gains on available for sale securities and gains on the sale of loans were offset by gains in service charges and debit card interchange income. Securities gains (losses) were$857 thousand in 2019 and$(65) thousand in 2018. The net gains recognized in 2019 are attributed to selling securities which had gains in market value due to declining market interest rates and the related inverse relationship of interest rates and market values. Management evaluates the structure of the portfolio, periodically, and may strategically sell securities to diversify the portfolio. Additionally, the securities available for sale portfolio is a source of liquidity for the Company; therefore securities may be sold to generate cash. Gains on loans sold were$1.6 million for both 2019 and 2018, respectively. Loans held for sale are generally sold after closing to the Federal Home Loan Mortgage Corporation or other government agencies. During 2019, the loan servicing fee income, net of amortization expense for the mortgage servicing right asset, decreased$93 thousand , compared to a decrease of$82 thousand in 2018. In 2019, the mortgage servicing right asset had net write-downs of$71 thousand compared to net recoveries of prior write-downs of$17 thousand in the valuation allowance in 2018. Proceeds from the sale of loans were$72 million and$64 million in 2019 and 2018, respectively. The volume of loan originations is inverse to rate changes with historic low rates spurring activity. The volume of loan originations during 2019 was$71 million and$63 million in 2018. Other noninterest income, excluding net security gains (losses) and the sale of mortgage loans, was$11.8 million in 2019 and$11.6 million in 2018. Service charge income, and more particularly overdraft income, is the largest contributor to these numbers. Overdraft income was$2.5 million in 2019 and$2.6 million in 2018. Debit card interchange income was the second largest contributor to noninterest income. Debit card interchange income was$3.5 million in 2019 and$3.3 million in 2018. Other income was$459 thousand in 2019 and$594 thousand in 2018.
Noninterest expense increased
Salaries and benefits, the largest contributor to total non-interest expense, increased$249 thousand from$18.9 million in 2018 to$19.2 million in 2019 due to normal staff merit increases. Full-time equivalent employees increased from 232 atDecember 31, 2018 to 233 atDecember 31, 2019 . The largest component of occupancy expense, depreciation expense, remained flat from 2018 to 2019 at$1.2 million . Building rent expense, included in occupancy expense, increased$119 thousand from 2018 to 2019, mostly due to additional lease expense for the new branches opening in 2020 in theLexington, Kentucky market. Total noninterest expense, excluding salaries and benefits expense and occupancy expense, increased from$11.5 million in 2018 to$12.1 million in 2019. Legal and professional fees increased$275 thousand from$908 thousand in 2018 to$1.2 million in 2019. Other non-interest expense decreased$496 thousand from 2018 to 2019. Of this,$187 thousand of the decrease was attributed to a decrease in postage expense due to the Company outsourcing that function. However, the change also contributed to an increase in data processing expense. In addition,FDIC insurance expense decreased$235 thousnd from 2018 to 2019. Amortization expense of core deposits was$102 thousand in 2019 and$130 thousand in 2018. See Note 7 in the Company's Consolidated Financial Statements and Notes included in Item 8 for more detail of the goodwill and intangible assets. 21 The following table is a summary of noninterest income and expense for the two year period indicated. For the Year ended December 31, (in thousands) 2019 2018 NON-INTEREST INCOME Service Charges $ 5,368 $ 5,266 Loan Service Fee Income (Loss), net 140 233 Trust Department Income 1,411 1,348 Investment Securities Gains (Losses),net 857 (65) Gains on Sale of Mortgage Loans 1,552 1,560 Brokerage Income 543 665 Debit Card Interchange Income 3,470 3,273 Income from Bank-Owned Life Insurance 439 262 Other 459 594 Total Non-interest Income$ 14,239 $ 13,136 NON-INTEREST EXPENSE Salaries and Employee Benefits$ 19,187 $ 18,938 Occupancy Expense 4,066 3,944 Other 12,055 11,500 Total Non-interest Expense$ 35,308
Net Non-interest Expense as a Percentage of Average Assets 1.92 % 2.02 % Income Taxes As part of normal business,Kentucky Bank typically makes tax free loans to select municipalities in our market and invests in selected tax free securities, primarily in theCommonwealth of Kentucky . In making these investments, the Company considers the overall impact to managing our net interest margin, credit worthiness of the underlying issuer and the favorable impact on our tax position. For the year endedDecember 31, 2019 , the Company averaged$36.3 million in tax free securities, and$42.8 million in tax free loans. For the year endedDecember 31, 2018 , the Company averaged$60.1 million in tax free securities and$38.2 million in tax free loans. As ofDecember 31, 2019 , the weighted average remaining maturity for the tax free securities is 103 months, while the weighted average remaining maturity for the tax free loans is 131 months. The Company had income tax expense of$1.1 million in 2019 and$1.7 million in 2018. This represents an effective income tax rate of 7.6% in 2019 and 11.7% in 2018. The difference between the effective tax rate and the statutory federal rate of 21% in both 2019 and 2018 is primarily due to tax exempt income on certain investment securities and loans. In addition, the Company had additional tax credits which also contributed to the lower effective income tax rates. The Company had tax credits totaling$553 thousand in 2019 and$555 thousand in 2018 for investments made in affordable housing project investments. OnMarch 26, 2019 ,Governor Bevin signed House Bill 354 into law which, among other things, repealed the bank franchise tax structure inKentucky . The capital based franchise tax structure will be replaced with the state-wide corporate income tax structure starting in 2021.Kentucky Bancshares, Inc. has historically filed a separate return inKentucky , and has generated aKentucky net operating loss ("NOL") carryforward, given the nature of its operations. Given House Bill 354,Kentucky Bancshares, Inc. will file a combined return in 2021, unless the Company decides to timely elect to file on a consolidated basis. OnApril 9, 2019 ,Governor Bevin signed House Bill 458 into law which, among other things, allows a taxpayer to utilize certain net operating loss ("NOL") carryforwards to offset other members in the combined filing group starting in 2021. As a result of these tax law changes, we recorded a deferred tax asset of$606 thousand during 2019. 22 Balance Sheet Review
Assets remained steady at
Loans Total loans (including loans held for sale) were$746 million atDecember 31, 2019 compared to$687 million atDecember 31, 2018 . As ofDecember 31, 2019 and compared to the prior year-end, commercial loans increased$403 thousand , real estate construction loans increased$8.0 million , 1-4 family residential property loans increased$39.1 million , multi-family residential property loans increased$2.2 million , non-farm & non-residential property loans increased$8.2 million , agricultural loans decreased$2.9 million and consumer loans and other loans increased$3.1 million . As of bothDecember 31, 2019 andDecember 31, 2018 , the real estate mortgage portfolio comprised 82% of total loans. The real estate mortage portfolio is comprised of real estate construction, 1-4 family residential, multi-family residential, non-farm and non-residential and agricultural loans. 1-4 family residential represented 39% of the total loan portfolio as ofDecember 31, 2019 and 37% as ofDecember 31, 2018 . Real estate constructions loans accounted for 4% of the total loan portfolio as ofDecember 31, 2019 andDecember 31, 2018 . Multi-family loans represented 7% of the total loan portfolio for the periods endedDecember 31, 2019 andDecember 31, 2018 . Non-farm and non-residential loans totaled 28% of the total loan portfolio as ofDecember 31, 2019 and 29% of the total loan portfolio as ofDecember 31, 2018 . Agricultural loans comprised 8% of the total loan portfolio atDecember 31, 2019 and 9% of total loans atDecember 31, 2018 . Approximately 88% of the agricultural loans are secured by real estate atDecember 31, 2019 and 87% atDecember 31, 2018 . The remainder of the agricultural portfolio is used to purchase livestock, equipment and other capital improvements and for general operation of the farm. Generally, a secured interest is obtained in the capital assets, equipment, livestock or crops.
Automobile loans account for 20%, in 2019 and 16% in 2018, of the consumer loan portfolio, while the purpose of the remainder of this portfolio is used by customers for purchasing retail goods, home improvement or other personal reasons. The commercial loan portfolio is mainly for capital outlays and business operation.
Collateral is requested depending on the creditworthiness of the
borrower. Unsecured loans are made to individuals or companies mainly based on
the creditworthiness of the customer. Approximately 9% of the loan portfolio is
unsecured. Management is not aware of any significant concentrations that may
cause future material risks, which may result in significant problems with
future income and capital requirements.
23The following table represents a summary of the Company's loan portfolio by category for each of the last five years. There is no concentration of loans (greater than 5% of the loan portfolio) in any industry. The Company has no foreign loans or highly leveraged transactions in its loan portfolio.
December 31, (in thousands)
Loans Outstanding 2019 2018 2017 2016 2015
Commercial $ 86,552 $ 86,149 $ 80,070 $ 77,436 $ 55,929
Real Estate Construction 32,219 24,254 20,816 29,169 29,320
Real Estate Mortgage:
1-4 Family Residential 293,870 253,797 239,672 245,674 231,479
Multi-Family Residential 48,622 46,403 39,926 47,199 38,281
Non-Farm & Non-Residential 204,908 196,674 192,074 176,024 183,692
Agricultural 57,166 60,049 59,176 62,491 66,782
Consumer 23,122 20,089 18,182 18,867 18,880
Other 305 208 170 183 516
Total Loans 746,764 687,623 650,086 657,043 624,879
Less Deferred Loan Fees 307 276 320 312 134
Total Loans, Net of Deferred Loan Fees 746,457 687,347 649,766 656,731 624,745
Less loans held for sale 2,144 1,203 1,231 724 624
Less Allowance for Loan Losses 8,460 8,127 7,720 7,541 6,521
Net Loans $ 735,853 $ 678,017 $ 640,815 $ 648,466 $ 617,600
The following table sets forth the maturity distribution and interest
sensitivity of selected loan categories at December 31, 2019 . Maturities are
based upon contractual term. The total loans in this report represent loans net
of deferred loan fees, including loans held for sale but excluding the allowance
for loan losses. In addition, deferred loan fees on the above table are netted
with real estate mortgage loans on the following table.
December 31, 2019 (in thousands)
One Year One Through Over Total
Loan Maturities and Interest Sensitivity or Less Five Years Five Years Loans
Commercial $ 35,229 $ 35,891 $ 15,432 $ 86,552
Real Estate Construction 17,284 2,045 12,890 32,219
Real Estate Mortgage:
1-4 Family Residential 98,511 130,296 65,063 293,870
Multi-Family Residential 4,531 42,180 1,911 48,622
Non-Farm & Non-Residential 32,846 117,818 54,244 204,908
Agricultural 18,293 36,825 2,048 57,166
Consumer 5,953 16,134 1,035 23,122
Other 305 - - 305
Total Loans, Net of Deferred Loan Fees 212,952 381,189 152,623 746,764
Fixed Rate Loans 15,583 72,132 116,935 204,650
Floating Rate Loans 197,369 309,057
35,688 542,114
Total Loans, Net of Deferred Loan Fees
Mortgage Banking The Company has been in mortgage banking since the early 1980's. The activity in origination and sale of these loans fluctuates, mainly due to changes in interest rates. Mortgage loan originations increased from$63 million in 2018 to$71 million in 2019. Proceeds from the sale of loans were$64 million and$72 million for 2018 and 2019, respectively. Mortgage loans held for sale were$2.1 million atDecember 31, 2019 and$1.2 million atDecember 31, 2018 . Fixed rate residential mortgage loans are generally sold when they are made. The volume of loan originations is inverse to rate changes. During 2019, declining mortgage rates resulted in additional loan volume due to an increased number of borrowers who chose to refinance their existing mortgages. However, due to compressed margins, the gain on sale of loans was flat from 2018 to 2019 at$1.6 million . 24 The Bank has sold various loans to the Federal Home Loan Mortgage Corporation (FHLMC) and theFederal Home Loan Bank (FHLB) while retaining the servicing rights. Gains and losses on loan sales are recorded at the time of the cash sale, which represents the premium or discount paid by the FHLMC and FHLB. The Bank receives a servicing fee from the FHLMC and FHLB on each loan sold. Servicing rights are carried using the amortized cost method and are capitalized based on the relative fair value of the rights and the expected life of the loan and are expensed in proportion to, and over the period of, estimated net servicing revenues.
Mortgage servicing rights were
Amortization of mortgage servicing rights was$403 thousand (including$71 thousand for negative fair value adjustments) and$310 thousand (including$17 thousand for positive fair value adjustments) for the years endedDecember 31, 2019 and 2018, respectively. See Note 4 in the Company's 2019 Consolidated Financial Statements and Notes included in Item 8 for additional information. Deposits For 2019, total deposits decreased$7.8 million to$842.7 million . Noninterest bearing deposits increased$3.8 million , time deposits of$250 thousand and over decreased$16.4 million , and other interest bearing deposits increased$4.8 million . Public fund balances totaled$143 million atDecember 31, 2019 , of which$135 million was interest bearing.
The table below provides information on the maturities of time deposits of
At December 31, 2019
Maturity of Time Deposits of $100,000 or More (in thousands)
Maturing 3 Months or Less $ 25,028
Maturing over 3 Months through 6 Months 17,806
Maturing over 6 Months through 12 Months 31,921
Maturing over 12 Months 29,036
Total $ 103,791
Borrowings
The Company utilizes both long-term and short-term borrowings. Long-term
borrowing at the Bank is primarily from the Federal Home Loan Bank (FHLB). This
borrowing is mainly used to fund longer term, fixed rate mortgages, as part of a
leverage strategy and to assist in asset/liability management. Advances are
either paid monthly or at maturity. As of December 31, 2019 , $116.4 million was
borrowed from FHLB, an increase of $16.0 million from December 31, 2018 .
Throughout 2019, the Bank had a net increase of $13.4 million in short-term
borrowings from the FHLB which were outstanding at December 31, 2019 . As of
December 31, 2018 , $11.6 million in short-term borrowings from the FHLB were
outstanding. FHLB advances classified as short-term have an original maturity of
less than 1 year. Also, during 2019, the Bank borrowed $18.5 million in
long-term advances and repaid $15.9 million in long term advances. These
advances each had an original maturity of more than 1 year.
On July 20, 2015 , the Company borrowed $5.0 million which had an outstanding
balance of $2.7 million at December 31, 2018 . The term loan had a fixed interest
rate of 5.0%, required quarterly principal and interest payments, had a maturity
date of July 20, 2025 and was collateralized by Kentucky Bank stock. During
December 2019 , the Company prepaid the total outstanding balance of the note.
25
The following table depicts relevant information concerning our short term
borrowings.
As of and for the year ended
December 31, (in thousands)
Short Term Borrowings 2019 2018
Federal Funds Purchased:
Balance at Year end $ - $ -
Average Balance During the Year 618 3,159
Maximum Month End Balance 16,365 17,857
Year end rate - -
Average annual rate 2.91 % 2.28 %
Repurchase Agreements:
Balance at Year end $ 5,994 $ 8,077
Average Balance During the Year 6,996 9,313
Maximum Month End Balance 8,947 9,751
Year end rate 0.50 % 0.60 %
Average annual rate 0.53 % 0.67 %
Federal Home Loan Bank Advances:
Balance at Year end $ 25,000 $ 11,600
Average Balance During the Year 12,880 10,734
Maximum Month End Balance 25,000 31,900
Year end rate 1.80 % 2.57 %
Average annual rate 2.24 % 2.08 %
Contractual Obligations
The Bank has required future payments for time deposits and long-term debt.
The
other required payments are the approximate future minimum lease payments due
under the aforementioned operating leases for their base term and are as
follows:
Payments due by period (in thousands)
Less More
than 1 1-3 3-5 than 5
Contractual Obligations Total year years years years
Federal Home Loan Bank advances $ 116,418 $ 45,934 $ 37,161 $ 28,243 $ 5,080
Subordinated debentures 7,217 - - - 7,217
Time deposits 212,566 160,003 41,060 11,403 100
Lease payments on premises 3,458 423 806 612 1,617
Asset Quality
With respect to asset quality, management considers three categories of assets
to merit close scrutiny. These categories include: loans that are currently
nonperforming, other real estate, and loans that are currently performing but
which management believes require special attention.
During periods of economic slowdown, the Company may experience an increase in nonperforming loans.
The Company discontinues the accrual of interest on loans that become 90 days
past due as to principal or interest unless reasons for delinquency are
documented such as the loan being well collateralized and in the process of
collection. A loan remains in a non-accrual status until factors indicating
doubtful collection no longer exist. A loan is classified as a restructured loan
when the interest rate is materially reduced or the term is extended beyond the
original maturity date because of the inability of the borrower to service the
interest payments at market rates. Other real estate is recorded at fair value
less estimated costs to sell.
26A summary of the components of nonperforming assets, including several ratios using period-end data, is shown as follows.
Year Ended December 31,
Nonperforming Assets 2019 2018 2017 2016 2015
Non-accrual Loans $ 3,081 $ 1,141 $ 1,193 $ 4,566 $ 6,351
Accruing Loans which are Contractually
past due over 89 days 1,499 1,182 231 927 1,000
Accruing Troubled Debt Restructurings - - - 2,063 2,245
Total Nonperforming and Restructured Loans 4,580 2,323 1,424 7,556 9,596 Other Real Estate 2,148 830 2,404 1,824 2,347 Total Nonperforming and Restructured Loans and Other Real Estate$ 6,728 $ 3,153 $ 3,828 $ 9,380 $ 11,943 Nonperforming and Restructured Loans as a Percentage of Loans (including loans held for sale) (1) 0.61 % 0.34 % 0.22 % 1.15 % 1.54 % Nonperforming and Restructured Loans andOther Real Estate as a Percentage of Total Assets 0.61 % 0.29 % 0.36 % 0.91 % 1.23 % Allowance as a Percentage of Non-performing and Restructured Loans and Other Real Estate 126 % 258 % 202 %
80 % 55 %
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(1) Net of deferred loan fees
Total nonperforming assets atDecember 31, 2019 were$6.7 million compared to$3.2 million atDecember 31, 2018 . The increase from 2018 to 2019 is mostly attributed to increases in non-accrual loans and other real estate. Total other real estate properties totaled$2.1 million atDecember 31, 2019 , of which,$426 thousand were income producing properties. Total nonperforming loans were$4.6 million and$2.3 million atDecember 31, 2019 and 2018, respectively. The decrease in restructured loans during 2017 is attributed to restructured loans with a balance atDecember 31, 2016 paying off during 2017. No restructured notes were held in 2019. Total net loan charge offs in 2019 were$917 thousand . The amount of lost interest on our non-accrual loans was$65 thousand for 2019 and$108 thousand for 2018. AtDecember 31, 2019 , loans currently performing but which management believes requires special attention were$25.1 million , with 36% being non-farm and non-residential, 18% being agriculturual, 14% being 1-4 family residential, 16% being multi-family, 11% being commercial and 5% being real estate construction. The Company continues to follow its long-standing policy of not engaging in international lending and not concentrating lending activity in any one industry. The carrying amount of impaired loans as ofDecember 31, 2019 was$1.4 million compared to$993 thousand as ofDecember 31, 2018 . These amounts are generally included in the total nonperforming and restructured loans presented in the table above. See Note 17 in the Company's 2019 Consolidated Financial Statements and Notes included in Item 8 herein. A loan is considered impaired when, based on current information and events, it is probable that a creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement. All amounts due according to the contractual terms means that both the contractual interest payments and the contractual principal payments of a loan will be collected as scheduled in the loan agreement. Nonaccrual loans are loans for which payments in full of principal or interest is not expected or which principal or interest has been in default for a period of 90 days or more unless the asset is both well secured and in the process of collection. Impaired loans may be loans showing signs of weakness or interruptions in cash flow, but ultimately are current or less than 90 days past due with respect to principal and interest and for which we anticipate full payment of principal and interest through collateral liquidation. Additional factors considered by management in determining impairment and non-accrual status include payment status, collateral value, availability of current financial information, and the probability of collecting all contractual principal and interest payments. AtDecember 31, 2019 , loans individually evaluated for impairment totaled$4.5 million . Of this,$1.5 million in balances had specific impairment allocations of$52 thousand . The remaining$3.0 million in impaired loan balances did not have a specific impairment allocation. 27
At
The allowance for loan losses on impaired loans is determined using one of two methods. Either the present value of estimated future cash flows of the loan, discounted at the loan's effective interest rate or the fair value of the underlying collateral. The entire change in present value of expected cash flows is reported as a provision for loan losses in the same manner in which impairment initially was recognized or as a reduction in the amount of provision for loan losses that otherwise would be reported. The total allowance for loan losses related to these loans was$52 thousand and$201 thousand onDecember 31, 2019 and 2018, respectively.Kentucky Bank has a "Problem Loan Committee" that meets at least quarterly to review problem loans, including past due and non-performing loans, and other real estate. When analyzing the problem loans and the loan quality as ofDecember 31, 2019 , the following factors have been considered:
· Changes in lending policies and procedures, including changes in underwriting
standards and collection, charge-off and recovery practices not considered
elsewhere in estimating credit losses.
· Change in international, national, regional and local economic and business
conditions and developments that affect the collectability of the portfolio,
including the condition of various market segments.
· Changes in the nature and volume of the portfolio and in the terms of loans.
· Changes in the experience, ability and depth of lending management and other
relevant staff.
· Changes in the volume and severity of past due loans; the volume of non-accrual
loans, and the volume and severity of adversely classified or graded loans.
· Changes in the quality of the Bank's loan review system.
· Changes in the value of underlying collateral for collateral-dependent loans.
· The existence and effect of any concentrations of credit, and changes in the
level of such concentrations.
· The effect of other external factors such as competition and legal and
regulatory requirements on the level of estimated credit losses in the Bank's
existing portfolio.
28
Loan Losses
The following table is a summary of the Company's loan loss experience for each
of the past five years.
For the Year ended December 31, (in thousands)
2019 2018 2017 2016 2015
Balance at Beginning of Year $ 8,127 $ 7,720 $ 7,541 $ 6,521 $ 6,012
Amounts Charged-off:
Commercial (260) (23) (35) (5) (30)
Real Estate Construction - - - - -
Real Estate Mortgage:
1-4 Family Residential (168) (98) (249) (126) (284)
Multi-Family Residential - - - - (94)
Non-Farm & Non-Residential (17) (31) (42) - -
Agricultural - - - (193) (242)
Consumer and other (1,298) (1,108) (1,076) (1,206) (1,300)
Total Charged-off Loans (1,743) (1,260) (1,402) (1,530) (1,950)
Recoveries on Amounts Previously
Charged-off:
Commercial 21 10 19 39 -
Real Estate Construction - - 1 15 11
Real Estate Mortgage
1-4 Family Residential 19 272 20 19 33
Multi-Family Residential 15 10 181 12 30
Non-Farm & Non-Residential - - - 454 86
Agricultural 8 191 57 50 23
Consumer and other 763 684 803 811 826
Total Recoveries 826 1,167 1,081 1,400 1,009
Net Charge-offs (917) (93) (321) (130) (941)
Provision for Loan Losses 1,250 500 500 1,150 1,450
Balance at End of Year 8,460 8,127 7,720 7,541 6,521
Total Loans (1)
Average 710,728 670,063 651,668 647,278 574,141
At December 31 746,457 687,347 649,766 656,731 624,745
As a Percentage of Average Loans
(1):
Net Charge-offs 0.13 % 0.01 % 0.05 % 0.02 % 0.16 %
Provision for Loan Losses 0.18 % 0.07 % 0.08 % 0.18 % 0.25 %
Allowance as a Percentage of
Year-end Loans (1) 1.13 % 1.18 % 1.19 % 1.15 % 1.04 %
Beginning Allowance as a Multiple
of Net Charge-offs 8.9 83.0 23.5 50.2 6.4
Ending Allowance as a Multiple of
Nonperforming Assets 1.26 2.58 2.02 0.80 0.55
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(1) Net of deferred loan fees and includes loans held for sale
Loans are typically charged-off when the collection of principal is considered doubtful, and would be well documented and approved by the appropriate responsible party or committee. The provision for loan losses for 2019 was$1.3 million compared to$500 thousand in 2018. Net charge-offs were$917 thousand in 2019 and$93 thousand in 2018. Net charge-offs to average loans were 0.13% and 0.01% in 2019 and 2018, respectively. The provision for loan losses increased$750 thousand from 2018 to 2019. The allowance for loan losses increased$333 thousand fromDecember 31, 2018 toDecember 31, 2019 .
In evaluating the allowance for loan losses, management considers the composition of the loan portfolio, the historical loan loss experience, the overall quality of the loans and an assessment of current economic conditions.
At
29
The following tables set forth an allocation for the allowance for loan losses
and loans by category. In making the allocation, management evaluates the risk
in each category, current economic conditions and charge-off experience. An
allocation for the allowance for loan losses is an estimate of the portion of
the allowance that represents probable incurred losses in each loan category,
but it does not preclude any portion of the allowance allocated to one type of
loan being used to absorb losses of another loan type.
Allowance for Loan Losses (in thousands) 2019 2018 2017
2016 2015 Commercial$ 1,003 $ 1,265 $ 1,069 $ 862 $ 536 Real Estate Construction 601 451 507 616 453 Real Estate Mortgage: 1-4 Family Residential 3,162 2,843 2,538 2,515 2,296 Multi-family Residential 880 800 702 635 505 Non-farm & Non-residential 1,791 1,799 1,704 1,315 1,338 Agricultural 424 458 542 935 748 Consumer and other 599 511 658 663 645 Total$ 8,460 $ 8,127 $ 7,720 $ 7,541 $ 6,521 2019 2018 2017 2016 2015
Loans (in thousands) Dollars Percentage Dollars Percentage
Dollars Percentage Dollars Percentage Dollars Percentage
Commercial $ 86,552 11.63 % $ 86,149 12.56 % $ 80,070 12.35 % $ 77,436 11.80 % $ 55,929 8.96 %
Real Estate
Construction 32,219 4.33 % 24,254 3.54 % 20,816 3.21 % 29,169 4.45 % 29,320 4.70 %
Real Estate
Mortgage:
1-4 Family
Residential 291,419 39.15 % 252,318 36.77 % 238,121 36.72 % 244,638 37.29 % 230,721 36.97 %
Multi-family
Residential 48,622 6.53 % 46,403 6.76 % 39,926 6.16 % 47,199 7.19 % 38,281 6.13 %
Non-farm &
Non-residential 204,908 27.53 % 196,674 28.66 % 192,074 29.62 % 176,024 26.83 % 183,692 29.43 %
Agricultural 57,166 7.68 % 60,049 8.75 % 59,176 9.12 % 62,491 9.53 % 66,782 10.70 %
Consumer 23,122 3.11 % 20,089 2.93 % 18,182 2.80 % 18,867 2.88 % 18,880 3.03 %
Other 305 0.04 % 208 0.03 % 170 0.03 % 183 0.03 % 516 0.08 %
Total, Net (1) $ 744,313 100.00 % $ 686,144 100.00 % $ 648,535 100.00 % $ 656,007 100.00 % $ 624,121 100.00 %
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(1) Net of deferred loan fees
Off-balance Sheet Arrangements
Some financial instruments, such as loan commitments, credit lines, letters of
credit, and overdraft protection, are issued to meet customer financing
needs. These are agreements to provide credit or to support the credit of
others, as long as conditions established in the contract are met, and usually
have expiration dates. Commitments may expire without being used. Off-balance
sheet risk to credit loss exists up to the face amount of these instruments,
although material losses are not anticipated. The same credit policies are used
to make such commitments as are used for loans, including obtaining collateral
at exercise of the commitment.
Financial instruments with off-balance sheet risk were as follows at year-end
(in thousands):
2019 2018
Unused lines of credit $ 117,265 $ 117,660
Commitments to make loans 28,743 17,200
Letters of credit 461 552
Unused lines of credit are substantially all at variable rates. Commitments to
make loans are generally made for a period of 60 days or less and are primarily
fixed at current market rates ranging from 4.00% to 4.90% with maturities
ranging up to 30 years.
30
Capital
As displayed by the following table, the Company's Tier I capital (as defined by
the Federal Reserve Board under the Board's risk-based guidelines) at
December 31, 2019 increased $8.2 million to $111.2 million from December 31,
2018 . Stockholders' equity, excluding accumulated other comprehensive income,
was $118.4 million at December 31, 2019 compared to $110.3 million at December
31, 2018 . Included in Tier I capital is $7 million of trust preferred securities
issued in August 2003 . The disallowed amount of stockholders' equity is mainly
attributable to the goodwill and/or core deposit intangibles, resulting from the
Kentucky First acquisition in 2003, the Peoples Bank acquisition in 2006 and the
Madison Financial Corporation acquisition in 2015. The Company's risk-based
capital and leverage ratios, as shown in the following table, exceeded the
levels required to be considered "well capitalized". The leverage ratio compares
Tier I capital to total average assets less disallowed amounts of goodwill.
For the Year Ended December 31, (in
thousands)
Consolidated 2019 2018 Change
Stockholders' Equity (1) $ 118,350 $ 110,271 $ 8,079
Trust Preferred Securities 7,000 7,000 -
Less Disallowed Amount (14,108) (14,188) 80
Tier I Capital 111,242 103,083 8,159
Allowance for Loan Losses 8,535 8,202 333
Tier II Capital 8,535 8,202 333
Total Capital 119,777 111,285 8,492
Total Risk Weighted Assets $ 758,261 $ 718,552 $ 39,709
Ratios:
Common Equity Tier I Capital to Risk-weighted Assets 13.7 % 13.4 % 0.3 %
Tier I Capital to Risk-weighted Assets 14.7 % 14.3 % 0.4 %
Total Capital to Risk-weighted Assets 15.8 % 15.5 % 0.3 %
Leverage 10.0 % 9.7 % 0.3 %
For the Year Ended December 31, (in
thousands)
Bank Only 2019 2018 Change
Stockholders' Equity (1) $ 116,867 $ 111,331 $ 5,536
Less Disallowed Amount (14,108) (14,188) 80
Tier I Capital 102,759 97,143 5,616
Allowance for Loan Losses 8,535 8,202 333
Tier II Capital 8,535 8,202 333
Total Capital 111,294 105,345 5,949
Total Risk Weighted Assets $ 757,306 $ 718,698 $ 38,608
Ratios:
Common Equity Tier I Capital to Risk-weighted Assets 13.6 % 13.5 % 0.1 %
Tier I Capital to Risk-weighted Assets 13.6 % 13.5 % 0.1 %
Total Capital to Risk-weighted Assets 14.7 % 14.7 % - %
Leverage 9.3 % 9.2 % 0.1 %
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(1) Excluding accumulated other comprehensive income/loss.
The Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA")
established five capital categories for insured depository institutions under
its Prompt Corrective Action Provisions. The bank regulatory agencies adopted
regulations, which became effective in 1992, defining these five capital
categories for banks they regulate. The categories vary from "well capitalized"
to "critically undercapitalized".
A "well capitalized" bank is defined as one with a total risk-based capital
ratio of 10% or more, a Tier I risk-based capital ratio of 8% or more, a
leverage ratio of 5% or more, and one not subject to any order, written
agreement, capital directive, or prompt corrective action directive to meet or
maintain a specific capital level. At December 31, 2019 , the bank had ratios
that exceeded the minimum requirements established for the "well capitalized"
category.
31
In July 2013 , the FDIC and the other federal bank regulatory agencies issued a
final rule that will revise their leverage and risk-based capital requirements
and the method of calculating risk-weighted assets to make them consistent with
agreements that were reached by the Basel Committee on Banking Supervision and
certain provisions of the Dodd-Frank Act. Among other things, the
rule establishes a new common equity Tier 1 minimum capital requirement (4.5% of
risk-weighted assets), increases the minimum Tier 1 capital to risk-based assets
requirement (from 4% to 6% of risk-weighted assets) and assigns a higher risk
weight (150%) to exposures that are more than 90 days past due or are on
nonaccrual status and to certain commercial real estate facilities that finance
the acquisition, development or construction of real property.
The final rule also requires unrealized gains and losses on certain
"available-for-sale" securities holdings to be included for purposes of
calculating regulatory capital requirement unless a one-time opt-in or opt-out
is exercised. The rule limits a banking organization's capital distributions and
certain discretionary bonus payments if the banking organization does not hold a
"capital conservation buffer" consisting of 2.5% of common equity Tier 1 capital
to risk-weighted assets in addition to the amount necessary to meet its minimum
risk-based capital requirements. The final rules implementing the Basel
Committee on Banking Supervision's capital guidelines for US banks (Basel III
rules) became effective for the Company on January 1, 2015 with full compliance
with all of the requirements being phased in over a multi-year schedule and was
fully phased in on January 1, 2019 . Under the Basell III rules, the Bank must
hold a capital conservation buffer above the adequately capitalized risk-based
capital ratios. The capital conservation buffer was phased in from 0.0% for 2015
to 2.50% for 2019. The capital conservation buffer for 2019 was 2.50% and was
1.875% for 2018. The net unrealized gain or loss on available for sale
securities is not included in computing regulatory capital.The final rule became
effective for the Bank on January 1, 2015 . The capital conservation buffer
requirement was phased in beginning January 1, 2016 ended January 1, 2019 , when
the full capital conservation buffer requirement was effective.
In management's opinion, there are no other known trends, events or uncertainties that will have or that are reasonably likely to have a material effect on the Company's liquidity, capital resources or operations.
Securities and Federal Funds Sold
Securities, classified as available for sale, decreased from$315.4 million atDecember 31, 2018 to$265.3 million atDecember 31, 2019 . Federal funds sold totaled$260 thousand atDecember 31, 2019 and$266 thousand atDecember 31, 2018 . Per Company policy, fixed rate asset backed securities will not have an average life exceeding seven years, but final maturity may be longer. Adjustable rate securities shall adjust within three years per Company policy. As ofDecember 31, 2019 and 2018, the Company held$38 million and$11 million in adjustable-rate mortgage backed securities. Unrealized gains (losses) on investment securities are temporary and change inversely with movements in interest rates. In addition, some prepayment risk exists on mortgage-backed securities and prepayments are likely to increase with decreases in interest rates. The following tables present the investment securities for each of the past three years and the maturity and yield characteristics of securities as ofDecember 31, 2019 .
Securities Available for Sale at Fair Value
For the Year ended December 31,
(in thousands)
Investment Securities (at fair value) 2019 2018
Available for Sale
U.S. treasury notes $ 9,168 $ 3,975
U.S. government agencies 23,735 41,178
States and political subdivisions 32,589 64,204
Mortgage-backed
GNMA, FNMA, FHLMC Passthroughs 54,470 39,078
GNMA, FNMA, FHLMC CMO's 109,872 156,734
Total mortgage backed 164,342 195,812
Asset-backed 35,496 10,200
Total $ 265,330 $ 315,369
32
Maturity Distribution of Securities Available for Sale
December 31, 2019 (in thousands)
Over One Over Five
Year Years
Asset &
One Year Through Through Over Mortgage
or Less Five Years Ten Years Ten Years Backed Total
Available for Sale
U.S. treasury note $ - $ 9,168 $ - $ - $ - $ 9,168
U.S. government agencies 10,976 4,803 5,756 2,200 - 23,735
States and political subdivisions 1,393 4,667 12,430 14,099 - 32,589
Mortgage-backed - - - - 164,342 164,342
Asset-backed - - - - 35,496 35,496
Total 12,369 18,638 18,186 16,299 199,838 265,330
Percent of Total 4.7 % 7.0 % 6.9 % 6.1 % 75.3 % 100 %
Weighted Average Yield 1.92 % 2.37 % 2.87 % 3.43 % 3.11 % 3.01 %
Impact of Inflation and Changing Prices
The majority of the Company's assets and liabilities are monetary in nature. Therefore, the Company differs greatly from most commercial and industrial companies that have significant investments in nonmonetary assets and inventories. However, inflation does have an important impact on the growth of assets in the banking industry and the resulting need to increase equity capital at higher than normal rates in order to maintain an appropriate equity to assets ratio. Inflation also affects other expenses, which tend to rise during periods of inflation.
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