Item 1. Business
General
Bourbon Bancshares, Inc. ("Company" or "Bourbon") is a Kentucky corporation organized in 1981 and a bank and savings and loan holding company registered under the Bank Holding Company Act of 1956, as amended ("BHCA") and the Home Owners Loan Act of 1933, as amended ("HOLA").
The Company conducts business in the state of Kentucky through one banking subsidiary, Kentucky Bank. Kentucky Bank is a commercial bank and trust company organized under the laws of Kentucky. Kentucky Bank has its main office in Paris (Bourbon County), with additional offices in Paris, North Middletown (Bourbon County), Winchester (Clark County), Cynthiana (Harrison County), Nicholasville (Jessamine County), Wilmore (Jessamine County), Georgetown (Scott County), and Versailles (Woodford County). The deposits of Kentucky Bank are insured up to prescribed limits by the Bank Insurance Fund ("BIF") and the Savings Association Insurance Fund ("SAIF"), both of the Federal Deposit Insurance Corporation ("FDIC"). Kentucky Bank is engaged in general full-service commercial and consumer banking. 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. Kentucky Bank makes residential mortgage, installment and other loans to its individual and other non-commercial customers. Kentucky Bank also offers its customers the opportunity to obtain a credit card. Kentucky Bank offers its customers a variety of other services, including checking, savings, money market accounts, certificates of deposits, safe deposit facilities and other consumer- oriented financial services. Kentucky Bank has Internet banking, including bill payment available to its customers at www.kybank.com. Through its Wealth Management Department, Kentucky Bank provides brokerage services, annuities, life and long term care insurance, personal trust and agency services (including management agency services).
Competition
The Company and its subsidiary face vigorous competition from a number of sources, including other bank holding companies and commercial banks, consumer finance companies, thrift institutions, other financial institutions and financial intermediaries. In addition to commercial banks, savings and loan associations, savings banks and credit unions actively compete to provide a wide variety of banking services. Mortgage banking firms, finance companies, insurance companies, brokerage companies, financial affiliates of industrial companies and government agencies provide additional competition for loans and for many other financial services. The subsidiary also currently competes for interest-bearing funds with a number of other financial intermediaries, including brokerage firms and mutual funds, which offer a diverse range of investment alternatives.
Supervision and Regulation
As a bank holding company, the Company is subject to the regulation and supervision of the Federal Reserve Board. The Company's subsidiary is subject to supervision and regulation by applicable state and federal banking agencies, including the Federal Reserve Board, the Federal Deposit Insurance Corporation and the Kentucky Department of Financial Institutions. The subsidiary is also subject to various requirements and restrictions under federal and state law, including requirements to maintain reserves against deposits, restrictions on the types and amounts of loans that may be granted and the interest that may be charged thereon, and limitations on the types of investments that may be made and the types of services that may be offered. Various consumer laws and regulations also affect the operations of the subsidiary. In addition to the impact of regulation, the subsidiary is affected significantly by the actions of the Federal Reserve Board as it attempts to control the money supply and credit availability in order to influence the economy.
There are a number of obligations and restrictions imposed on bank holding companies and their depository institution subsidiaries by federal law and regulatory policy that are designed to reduce potential loss exposure to the depositors of such depository institutions and to the FDIC insurance funds in the event the depository institution becomes in danger of default or is in default. For example, under a policy of the Federal Reserve Board with respect to bank holding company operations, a bank holding company is required to serve as a source of financial strength to its subsidiary depository institutions and commit resources to support such institutions in circumstances where it might not do so absent such policy. In addition, the "cross-guarantee" provisions of federal law require insured depository institutions under common control to reimburse the FDIC for any loss suffered or reasonably anticipated as a result of the default of a commonly controlled insured depository institution or for any assistance provided by the FDIC to a commonly controlled insured depository institution in danger of default.
The federal banking agencies have broad powers under current federal law to take prompt corrective action to resolve problems of insured depository institutions. The extent of these powers depends upon whether the institutions in question are "well capitalized", "adequately capitalized", "undercapitalized", "significantly undercapitalized" or "critically undercapitalized", as such terms are defined under uniform regulation defining such capital levels issued by each of the federal banking agencies.
There are various legal and regulatory limits on the extent to which the Company's subsidiary bank may pay dividends or otherwise supply funds to the Company. In addition, federal and state regulatory agencies also have the authority to prevent a bank or bank holding company from paying a dividend or engaging in any other activity that, in the opinion of the agency, would constitute an unsafe or unsound practice.
The Gramm-Leach-Bliley Act of 1999 eliminates restrictions imposed by the Glass-Steagall Financial Services Law, adopted in the 1930s, which prevented banking, insurance and securities firms from fully entering each other's businesses. While it is still uncertain what the impact of this legislation will be, it is likely to result in further consolidation in the financial services industry. In addition, removal of these barriers will likely increase the number of entities providing banking services, thereby increasing competition.
Employees
At December 31, 2002, the number of full time equivalent employees of the Company was 173.
Item 2.
Item 2. Properties
The main banking office of Kentucky Bank, which also serves as the principal office of Bourbon Bancshares, Inc., is located at Fourth and Main Streets, Paris, Kentucky 40361. In addition, Kentucky Bank serves customer needs at 10 other locations. All locations offer a full range of banking services. Kentucky Bank owns all of the properties at which it conducts its business. Kentucky Bank also leases premises in Scott County in which it formerly operated a branch; Kentucky Bank is currently exploring subleasing this building. This Scott County branch was relocated from this leased office in March 2003. The Company owns approximately 70,000 square feet of office space and leases approximately 2,000 square feet of office space, with aggregate annual lease payments of approximately $16 thousand in 2002.
Note 5 to the Company's consolidated financial statements included in this report contains additional information relating to amounts invested in premises and equipment.
Item 3.
Item 3. Legal Proceedings
The Company and its subsidiary are from time to time involved in routine legal proceedings occurring in the ordinary course of business that, in the aggregate, management believes will not have a material impact on the Company's financial condition and results of operation.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
Not Applicable.
PART II
Item 5.
Item 5. Market for Common Equity and Related Stockholder Matters
There is no established public trading market for the Company's Common Stock. The Company's Common Stock is not listed on any national securities exchange nor is it quoted on the NASDAQ system. However, it is listed on the OTC Bulletin Board under the symbol "BBON.OB". Trading in the Common Stock has been infrequent, with retail brokerage firms making the market. The following table sets forth the high and low sales prices of the Common Stock and the dividends declared thereon, for the periods indicated below:
High Low Dividend
2002 Quarter 4 $26.50 $24.00 $.17 Quarter 3 27.00 25.50 .17 Quarter 2 27.50 25.50 .17 Quarter 1 27.00 24.25 .17
2001 Quarter 4 $26.00 $22.40 $.15 Quarter 3 25.50 23.50 .15 Quarter 2 26.00 23.00 .15 Quarter 1 24.50 21.25 .15
Note 14 to the Company's consolidated financial statements included in this report contains additional information relating to amounts available to be paid as dividends.
As of December 31, 2002 the Company had 2,772,754 shares of Common Stock outstanding and approximately 470 holders of record of its Common Stock.
Item 6.
Item 6. Selected Financial Data
The following selected financial data should be read in conjunction with the Company's Consolidated Financial Statements and the accompanying notes presented elsewhere herein. On June 8, 1999, the stockholders approved a two-for-one stock split effective July 15, 1999. All shares and per share amounts have been retroactively restated to reflect the split.
Item 7.
Item 7. Management's Discussion and Analysis
The following discussion and analysis of financial condition and results of operations should be read in conjunction with the Consolidated Financial Statements and accompanying notes included as Exhibit 13. When necessary, reclassifications have been made to prior years' data throughout the following discussion and analysis for purposes of comparability with 2001 data.
Critical Accounting Policies
The accounting and reporting policies of the Company and its subsidiary are in accordance with accounting principles generally accepted in the United States and conform to general practices within the banking industry. Significant accounting policies are listed in Note 1 in the "Notes to Consolidated Financial Statements". Critical accounting and reporting policies include accounting for securities, loans and leases, the allowance for loan and lease losses and income taxes. The accounting policies relating to the allowance for loan and lease losses and income taxes involve the use of estimates and require significant judgments to be made by management. Different assumptions in the application of these policies could result in material changes in the consolidated financial position or consolidated results of operations.
The Company is required to classify its securities portfolio into three categories: trading securities, securities available for sale and securities held to maturity. Fair value adjustments are made to the securities based on their classification with the exception of the held to maturity category. Currently, the Company has classified all securities in its securities portfolio as available for sale and carries them at fair value. Unrealized gains and losses are recorded in stockholders' equity, net of related income tax.
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.
Income tax expense is the total of the current year income tax due or refundable and the change in deferred tax assets and liabilities. The Company uses the liability method for computing deferred income taxes. Under the liability method, deferred income taxes are based on the change during the year in the deferred tax liability or asset established for the expected future tax consequences of differences in the financial reporting and tax bases of assets and liabilities.
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, in which the Company and its bank operate); competition for the Company's customers from other providers of financial and mortgage services; government legislation and regulation (which changes from time to time and over which the Company has no control); changes in interest rates (both generally and more specifically mortgage interest rates); material unforeseen changes in the liquidity, results of operations, or financial condition of the Company's customers; and other risks detailed in the Company's filings with the Securities and Exchange Commission, all of which are difficult to predict and many of which are beyond the control of the Company. The Company undertakes no obligation to republish revised forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.
Summary
Net income for the year ended December 31, 2002 was $5.9 million, or $2.13 per common share compared to $5.5 million, or $1.98 for 2001 and $5.3 million, or $1.87 for 2000. Earnings per share assuming dilution were $2.10, $1.95 and $1.83 for 2002, 2001 and 2000, respectively. For 2002, net income increased $378 thousand, or 7%. Net interest income increased 5%, loan loss provision increased 13%, other income increased 16% and other expenses increased 6%. During 2001, net income increased $272 thousand, up 5%. Net interest income remained relatively constant, the loan loss provision increased $318 thousand, while other income increased 49% and other expenses increased 13%.
Return on average equity was 14.3% in 2002 compared to 14.6% in 2001 and 15.6% in 2000. Return on average assets was 1.48% in 2002 compared to 1.46% in 2001 and 1.49% in 2000.
Non-performing loans as of a percentage of loans (including held for sale) were 0.83%, 0.79% and 0.66% as of December 31, 2002, 2001 and 2000, respectively. With the upward trend in non-performing loans, management has placed more emphasis on loan quality and, with the creation of a collection department, non-performing loan ratios are expected to improve.
RESULTS OF OPERATIONS
Net Interest Income
Net interest income, the Company's largest source of revenue, on a tax equivalent basis increased from $14.9 million in 2000 to $15.0 million in 2001 to $15.9 million in 2002. The taxable equivalent adjustment (nontaxable interest income on state and municipal securities net of the related non-deductible portion of interest expense) is based on our Federal income tax rate of 34%.
Average earning assets and interest bearing liabilities both increased from 2001 to 2002. Average earning assets increased $20 million, or 6%. Investment securities increased $16 million primarily due to the softening loan demand. Average interest bearing liabilities increased $12 million, or 4% during this same period. Federal Home Loan Bank (FHLB) advances made up $10 million of the increase. The Company continues to actively pursue quality loans and fund these primarily with deposits and FHLB advances.
During 2002 rates were fairly flat. Bank prime rates decreased 50 basis points in the last quarter. However, the declining rate environment in 2001 resulted in a decrease in yields on assets and liabilities in 2002 due to repricing opportunities of interest earning assets and interest bearing liabilities. As a result of this, the tax equivalent yield on earning assets decreased from 7.98% in 2001 to 6.72% in 2002.
The volume rate analysis that follows indicates that $1.4 million of the increase in interest income is attributable to the change in volume, while the decrease in rates contributed to a decrease of $4.6 million in interest income. The rate decrease also caused a decrease in the cost of interest bearing liabilities. The average rate of these liabilities decreased from 4.60% in 2001 to 3.09% in 2002. Based on the volume rate analysis that follows, the change in volume contributed to an increase of $447 thousand to interest expense, while the decrease in rates was responsible for $4.5 million decrease in interest expense. As a result, the 2002 net interest income increase is attributed to increases in volume reduced slightly by the negative impact of decreases in rates. In spite of the positive impact on net interest income that may result from the potential increasing rate environment in 2003, competitive pressures on interest rates will continue and are likely to result in tighter net interest margins.
Based on the volume rate analysis that follows, during 2001, average earning assets and interest bearing liabilities continued to increase. Generally, the increases in volume were offset by the decline in rates. The increase in earning assets of $23 million, offset with a decline of 56 basis points in the tax equivalent yield, resulted in tax equivalent interest income decreasing $69 thousand. Average loans increased $16 million along with a 54 basis point drop in the yield, resulting in the loan income decreasing $22 thousand. These yield declines were mainly attributable to the drop in interest rates. Bank prime rates decreased 475 basis points during the year. Average interest bearing liabilities increased $19 million, which coupled with a 39 basis point decline in the yield, caused the interest on liabilities to increase $2.8 million. The $501 thousand decline in deposit interest is a result of average deposits increasing $10 million and the corresponding yield dropping 40 basis points.
The accompanying analysis of changes in net interest income in the following table shows the relationships of the volume and rate portions of these increases in 2002 and 2001. Changes in interest income and expenses due to both rate and volume are allocated on a pro rata basis.
Noninterest Income and Expenses
Noninterest income was $6.6 million in 2002 compared to $5.7 million in 2001 and $3.8 million in 2000. The $917 thousand increase in 2002 and $1.9 million increase in 2001 is mainly attributable to an increase in service charges and the increase from Gain on sale of mortgage loans.
Securities gains were $219 thousand in 2002, $287 thousand in 2001, compared to $88 thousand of losses in 2000. The increase in gains for 2002 and 2001 is a result of the declining rate environment and municipal securities being called at premiums before their maturities. In addition, U. S. Treasury securities were sold before maturity to recognize some gains and extend out the yield curve.
Gains on loans sold were $948 thousand, $382 thousand and $133 thousand in 2002, 2001 and 2000, respectively. Loans held for sale are generally sold after closing to the Federal Home Loan Mortgage Corporation. During 2002, 2001 and 2000, the Company sold some loans along with their servicing rights and therefore there was a slight decline in loan service fee income in 2002 and 2001. The sales of loans were $41 million, $28 million and $15 million in 2002, 2001 and 2000, respectively. Volume of loan originations are inverse to rate changes. The rate environment in 2002 and 2001 was falling and as a result, has favorably impacted our mortgage loan originations in 2002 and 2001.
Other noninterest income excluding security net gains and gain on sale of mortgage loans was $5.4 million in 2002, $5.0 million in 2001 and $3.8 million in 2000. Service charge income has been a big contributor to this increase in income over this three-year period. Overdraft income increased $239 thousand in 2002 and $1.1 million in 2001, principally the result of increases in deposits and implementation of a new "Kentucky Courtesy" overdraft in the last quarter of 2000. Other income increased from $397 thousand in 2000 to $734 thousand in 2001 to $1.0 million in 2002. The increase in 2002 is mainly a result of title insurance sales of $89 thousand and an increase in brokerage commissions of $98 thousand. The increase in 2001 is mainly a result of title insurance sales of $122 thousand and an increase in brokerage commissions of $124 thousand. The sale of title insurance was started during 2001 and has been very successful. The sale of brokerage services was an effective additional source of income in 2002 and 2001.
Noninterest expense increased $677 thousand in 2002 to $12.4 million, and increased $1.4 million in 2001 to $11.8 million from $10.4 million in 2000. The increases in salaries and benefits from $5.5 million in 2000 to $6.0 million in 2001 and to $6.7 million in 2002 are attributable to converting the Loan Production Office in Cynthiana to a full service branch in October 2001, and normal salary and benefit increases. Incentives were $179 thousand higher in 2002 compared to 2001 and $82 thousand lower in 2001 compared to 2000. Occupancy expense increased $18 thousand, or 1% in 2002 to $1.9 million and increased $353 thousand, or 23% in 2001 to $1.9 million. The Company completed its construction of a new full service facility in Cynthiana in October 2001. From 1999 to 2001, 3 new facilities have been constructed and 2 facilities have been substantially renovated. In 2001, land was purchased in Georgetown to construct a full service facility, and relocate one of our branches in Georgetown, and this facility was opened in March 2003. This overall improvement of our facilities has led to the increase in occupancy expenses. The largest expense, depreciation, increased from $812 thousand in 2000, to $961 thousand in 2001 to $990 thousand in 2002. Other noninterest expense increased from $3.3 million in 2000 to $3.8 million in 2001 and 2002.
The following table is a summary of noninterest income and expense for the three-year period indicated.
For the Year Ended December 31 (in thousands) 2002 2001 2000 NON-INTEREST INCOME Service Charges $ 3,848 $ 3,664 $ 2,650 Loan Service Fee Income 228 258 287 Trust Department Income 346 347 420 Investment Securities Gains (Losses),net 219 287 (88) Gains on Sale of Mortgage Loans 948 382 132 Other 1,001 734 397 Total Non-interest Income 6,590 5,672 3,798
NON-INTEREST EXPENSE Salaries and Employee Benefits 6,728 6,019 5,539 Occupancy Expenses 1,909 1,891 1,538 Other 3,796 3,846 3,297 Total Non-interest Expense 12,433 11,756 10,374
Net Non-interest Expense as a Percentage of Average Assets 1.46% 1.61% 1.86%
Income Taxes
The Company had income tax expense of $2.5 million in 2002 and $2.0 million in 2001 and 2000. This represents an effective income tax rate of 29.5% in 2002, 26.4% in 2001 and 27.9% in 2000. The difference between the effective tax rate and the statutory federal rate of 34% is primarily due to tax exempt income on certain investment securities. The lower effective rate for 2001 compared to 2000 is a result of an historic tax credit of $240 thousand taken on the Main Office in Paris.
Balance Sheet Review
Assets grew from $397 million at December 31, 2001 to $420 million at December 31, 2002. Loan growth was $11 million in 2002. Deposits grew $14 million and borrowings grew $4 million. FHLB advances remained level at $44 million. Assets at year-end 2001 totaled $397 million compared to $372 million in 2000. In 2001, loan growth was $1 million and deposit growth was $8 million. FHLB advances increased $22 million, while repurchase agreements decline $8 million.
Loans
Total loans (including loans held for sale) were $285 million at December 31, 2002 compared to $276 million at the end of 2001 and $273 million in 2000. Loan growth improved in 2002 compared to 2001. The Company's rate of loan growth has decreased since 2000, and is mainly attributable to the economic downturn starting in 2001. As of the end of 2002 and compared to the prior year-end, real estate construction loans increased $3.2 million, real estate mortgage loans (including loans held for sale) increased $14.3 million, agricultural loans decreased $1.5 million and installment loans decreased $4.8 million. As of the end of 2001 and compared to the prior year-end, commercial loans increased $1.2 million, real estate construction loans decreased $3.0 million, real estate mortgage loans (including loans held for sale) increased $5.5 million, agricultural loans increased $1.6 million and installment loans decreased $2.9 million. Since 1998, management has utilized regional loan goals for each type of loan and this emphasis has resulted in improved sales efforts by the lending personnel.
As of December 31, 2002, the real estate mortgage portfolio comprised 64% of total loans compared to 61% in 2001. Of this, 1-4 family residential property represented 69% in 2002 and 70% in 2001. Agricultural loans comprised 18% in 2002 and 19% in 2001 of the loan portfolio. Approximately 77% of the agricultural loans are secured by real estate for both 2002 and 2001. 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 43% in 2002 and 49% in 2001 of the installment 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. Collateral is generally obtained on these loans after analyzing the repayment ability of the borrower. 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 4% 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.
The 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. Bourbon has no foreign loans or highly leveraged transactions in its loan portfolio.
Loans Outstanding At December 31 (in thousands) 2002 2001 2000 1999 1998 Commercial $ 16,803 $ 18,618 $ 17,452 $ 17,713 $ 15,177 Real Estate Construction 15,514 12,302 15,270 17,003 11,055 Real Estate Mortgage 182,958 168,684 163,190 138,337 124,721 Agricultural 52,188 53,640 52,008 46,443 44,199 Installment 17,134 21,952 24,807 22,358 17,608 Other 309 338 434 280 159 Total Loans 284,906 275,534 273,161 242,134 212,919 Less Deferred Loan Fees 12 19 16 33 76 Total Loans Net of Deferred Loan Fees 284,894 275,515 273,145 242,101 212,843 Less loans held for sale 740 2,343 868 3,494 5,909 Less Allowance For Loan Losses 3,395 3,386 3,388 3,103 2,734 Net Loans 280,759 269,786 268,889 235,504 204,200
The following table sets forth the maturity distribution and interest sensitivity of selected loan categories at December 31, 2002. Maturities are based upon contractual term. The total loans in this report represents 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 schedule is netted with real estate mortgage loans on the following schedule.
Loan Maturities and Interest Sensitivity
At December 31, 2002 (in thousands) One Year One Through Over Total or Less Five Years Five Years Loans Commercial $ 10,426 $ 4,899 $ 1,478 $ 16,803 Real Estate Construction 13,761 1,264 489 15,514 Real Estate Mortgage 20,718 109,243 52,985 182,946 Agricultural 15,624 34,321 2,243 52,188 Installment 5,335 11,686 113 17,134 Other 309 0 0 309 Total Loans 66,173 161,413 57,308 284,894 Fixed Rate Loans 29,728 136,534 12,350 178,612 Floating Rate Loans 36,445 24,879 44,958 106,282 Total 66,173 161,413 57,308 284,894 -
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. Rates have fallen in 2002 and 2001 and as a result, have favorably impacted our loan originations in 2002 compared to 2001. During 2000 interest rates were rising. As a result of these rate changes, mortgage loan originations increased from $13 million in 2000 to $29 million in 2001, and to $39 million in 2002. The sale of loans were $41 million, $28 million and $15 million for the year 2002, 2001 and 2000, respectively. Mortgage loans held for sale decreased from $2.3 million at December 31, 2001 to $740 thousand at December 31, 2002. Volume of loan originations are inverse to rate changes. The rate environment in 2001 was falling in contrast to 2000 when rates were rising and therefore resulted in increased loan originations in 2002 and 2001 compared to 2000. The effect of these changes was also reflected on the income statement. As a result, the gain on sale of mortgage loans was $948 thousand in 2002 compared to $383 thousand in 2001 and $133 thousand in 2000.
The Bank has sold various loans to the Federal Home Loan Mortgage Corporation (FHLMC) 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. The Bank receives a servicing fee from the FHLMC on each loan sold. Servicing rights are capitalized based on the relative fair value of the rights and the life of the loan and are included in intangible assets on the balance sheet and expensed in proportion to, and over the period of, estimated net servicing revenues. Mortgage servicing rights were $704 thousand at December 31, 2002, $463 thousand at December 31, 2001 and $521 thousand at December 31, 2000. Amortization of mortgage servicing rights was $150 thousand, $140 thousand and $155 thousand for the years ended December 31, 2002, 2001 and 2000, respectively. See Note 4 in the notes to consolidated financial statements included as Exhibit 13 for additional information.
Deposits
For 2002, total deposits increased $14 million to $323 million. Noninterest bearing deposits increased $6 million, while time deposits of $100 thousand and over increased $5 million, and other interest bearing deposits increased $3 million. Public funds totaled $36 million at the end of 2002 ($35 million was interest bearing).
Total deposits increased to $309 million in 2001, up $8 million from 2000. Noninterest bearing deposits decreased $816 thousand, while time deposits of $100 thousand and over increased $1.4 million, and other interest bearing deposits increased $7.5 million. Public funds totaled $34 million at the end of 1999 ($33 million was interest bearing). Due to the downturn in the economy in 2001 and the softening loan demand, deposits were not aggressively pursued.
The table below provides information on the maturities of time deposits of $100,000 or more at December 31, 2002:
Maturity of Time Deposits of $100,000 or More
At December 31, 2002 (in thousands) Maturing 3 Months or Less $7,385 Maturing over 3 Months through 6 Months 8,352 Maturing over 6 Months through 12 Months 19,452 Maturing over 12 Months 11,715
Total $46,904
Borrowing
The Company utilizes both long and short term borrowing. Long term borrowing is mainly from the Federal Home Loan Bank (FHLB). This borrowing is mainly used to fund long term, fixed rate mortgages and to assist in asset/liability management. Advances are either paid monthly or at maturity. As of December 31, 2002, $43.9 million was borrowed from FHLB, an increase of $339 thousand from 2001. In 2002, $6.6 million of FHLB advances were paid, and advances were made for an additional $6.9 million. FHLB advances were $43.6 million at December 31, 2001. During 2001, $246 thousand of FHLB borrowing was paid, and advances were made for an additional $22 million. The 2001 advances were obtained for a $10 million arbitrage transaction and the remainder to fund fixed rate mortgages, as detailed above. The following table depicts relevant information concerning our short term borrowings.
Short Term Borrowings As of and for the year ended December 31 (in thousands) 2002 2001 2000 Federal Funds Purchased: Balance at Year end $ - $ - $ - Average Balance During the Year 240 6 373 Maximum Month End Balance 6,852 0 2,300 Year end rate 0.00% 0.00% 0.00% Average annual rate 1.97% 5.89% 6.95% Repurchase Agreements: Balance at Year end $ 3,505 $ 683 $ 8,189 Average Balance During the Year 2,097 3,303 8,727 Maximum Month End Balance 3,505 5,164 12,310 Year end rate 0.84% 1.59% 5.92% Average annual rate 1.22% 3.35% 5.51% Other Borrowed Funds: Balance at Year end $ 1,772 $ 919 $ 1,257 Average Balance During the Year 1,248 1,281 1,216 Maximum Month End Balance 1,883 1,768 1,766 Year end rate 6.56% 7.24% 11.71% Average annual rate 8.16% 8.67% 10.13%
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 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 the lower of cost or fair market value less estimated costs to sell. A summary of the components of nonperforming assets, including several ratios using period-end data, is shown below.
Nonperforming Assets At December 31 (dollars in thousands) 2002 2001 2000 1999 1998 Non-accrual Loans $1,573 $ 935 $ 307 $ 63 $ 136 Accruing Loans which are Contractually past due 90 days or more 789 1,278 1,365 549 790 Restructured Loans 0 0 130 131 147 Total Nonperforming Loans 2,362 2,213 1,802 743 1,073 Other Real Estate 172 212 165 371 70 Total Nonperforming Assets 2,534 2,425 1,967 1,114 1,143 Total Nonperforming Loans as a Percentage of Net Loans (including loans held for sale) (1) 0.83% 0.80% 0.66% 0.31% 0.50% Total Nonperforming Assets as a Percentage of Total Assets 0.60% 0.61% 0.53% 0.32% 0.37% Allowance to nonperforming assets 1.34 1.40 1.72 2.79 2.39
(1) Net of deferred loan fees
Total nonperforming assets at December 31, 2002 were $2.5 million compared to $2.4 million at December 31, 2001 and $2.0 million at December 31, 2000. Total nonperforming loans were $2.4 million, $2.2 million and $1.8 million at December 31, 2002, 2001 and 2000, respectively. The non-accrual loan increase from 2001 to 2002 is mainly attributable to one credit line totaling $750 thousand. A loan loss reserve of $500 thousand is set aside for this loan. Two mortgage loans totaling $453 thousand account for the increase in 2001 on non-accrual loans. The economic downturn in 2001 was a contributing factor to the increase in nonaccrual loans. Two lines totaling $376 thousand account for most of the change (considering the loan of $790 thousand in 2000 that follows was paid in full in 2001). For 2000, the increase in loans that are 90 days or more past due is mainly attributable to one Small Business Administration loan of $790 thousand. The amount of lost interest on our non-accrual loans is immaterial. At December 31, 2002, loans currently performing but which management believes require special attention were not significant. The Company continues to follow its long-standing policy of not engaging in international lending and not concentrating lending activity in any one industry.
Impaired loans as of December 31, 2002 were $1.6 million compared to $964 thousand in 2001 and $395 thousand in 2000. These amounts are included in the total nonperforming and restructured loans presented in the table above. See Note 4 in the notes to consolidated financial statements included as Exhibit 13.
A loan is considered impaired when it is probable that all principal and interest amounts will not be collected according to the loan contract. The allowance for loan losses on impaired loans is determined using 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 $675 thousand, $249 thousand and $117 thousand on December 31, 2002, 2001 and 2000, respectively.
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) 2002 2001 2000 1999 1998 Balance at Beginning of Year $ 3,386 $ 3,388 $ 3,103 $ 2,735 $ 2,322 Amounts Charged-off: Commercial 536 178 14 0 13 Real Estate Construction 18 0 0 0 0 Real Estate Mortgage 69 171 115 50 36 Agricultural 5 46 30 72 19 Consumer 701 751 400 289 300 Total Charged-off Loans 1,329 1,146 559 411 368 Recoveries on Amounts Previously Charged-off: Commercial 15 4 14 5 4 Real Estate Construction 0 0 0 0 0 Real Estate Mortgage 19 2 7 1 9 Agricultural 10 1 8 32 2 Consumer 90 69 65 41 66 Total Recoveries 134 76 94 79 81 Net Charge-offs 1,195 1,070 465 332 287 Provision for Loan Losses 1,204 1,068 750 700 700 Balance at End of Year 3,395 3,386 3,388 3,103 2,735 Total Loans, Net of Deferred Loan Fees Average 281,105 273,504 257,711 221,309 193,182 At December 31 284,894 275,515 273,145 242,101 212,843 As a Percentage of Average Loans: Net Charge-offs 0.43% 0.39% 0.18% 0.15% 0.15% Provision for Loan Losses 0.43% 0.39% 0.29% 0.32% 0.36% Allowance as a Percentage of Year-end Net Loans (1) 1.19% 1.23% 1.24% 1.28% 1.28% Beginning Allowance as a Multiple of Net Charge-offs 2.8 3.2 6.7 8.2 8.1 Ending Allowance as a Multiple of Nonperforming Assets 1.34 1.43 1.72 2.79 2.39
(1) Net of deferred loan fees
Loans are typically charged-off after being 120 days delinquent. Limited exceptions for not charging-off a loan would be well documented and approved by the appropriate responsible party or committee. The provision for loan losses for 2002 was $1.2 million compared to $1.1 million in 2001 and $750 thousand in 2000. Net charge-offs were $1.2 million in 2002, $1.1 million in 2001 and $465 thousand in 2000. Net charge-offs to average loans were 0.43%, 0.39% and 0.18% in 2002, 2001 and 2000, respectively. With the current quality of the loan portfolio, the loan loss provision increased $136 thousand from 2001 to 2002 and $318 thousand from 2000 to 2001. The trend in the loan loss provision increasing for 2002 is a result of considering our probable losses and risk analysis of our loan portfolio. In evaluating the allowance for loan losses, management considers the composition of the loan portfolio, historical loan loss experience, the overall quality of the loans and an assessment of current economic conditions. The economic downturn in 2002 and 2001 resulted in higher loan losses and, as a result, higher provisions than in previous years. In light of this, management has increased its emphasis on the lending process in order to improve loan quality. At December 31, 2002, the allowance for loan losses was 1.19% of loans outstanding compared to 1.23% at year-end 2001 and 1.24% in 2000. Management believes the allowance for loan losses at the end of 2002 is adequate to cover probable credit losses within the portfolio.
The following tables set forth an allocation for the allowance for loan losses and loans by category and a percentage distribution of the allowance allocation. 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 will be used to cover future charge-offs 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
Loans
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, 2002 increased $4.1 million to $41.5 million. Total stockholders' equity, excluding accumulated other comprehensive income was $42.2 million at December 31, 2002. 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.
At December 31 (dollars in thousands) 2002 2001 Change Stockholders' Equity (1) $ 42,243 $ 38,353 3,890 Less Disallowed Amount 719 943 (224) Tier I Capital 41,524 37,410 4,114 Allowance for Loan Losses 3,395 3,386 9 Other 122 104 18 Tier II Capital 3,517 3,490 27 Total Capital 45,041 40,900 4,141 Total Risk Weighted Assets 290,589 283,541 7,048 Ratios: Tier I Capital to Risk-weighted Assets 14.29% 13.19% 1.10% Total Capital to Risk-weighted Assets 15.50% 14.42% 1.08% Leverage 10.21% 9.63% 0.58%
(1) Excluding accumulated other comprehensive income.
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 6% 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, 2002, the bank had ratios that exceeded the minimum requirements established for the "well capitalized" category.
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, including those classified as held to maturity and available for sale, increased from $75.6 million at December 31, 2001 to $89.5 million at December 31, 2002. The increase is mainly attributable to the lower loan demand. Federal funds sold totaled $18.7 million at December 31, 2002 and $14.4 million at December 31, 2001. As allowed in conjunction with the adoption of the new "derivative" standard, the Company transferred its entire securities held to maturity portfolio to available for sale on January 1, 2001.
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. Of the $11.2 million of adjustable asset backed securities held on December 31, 2002, $5.2 million are repriceable monthly and the remaining $6.0 million are repriceable annually. Of the $11.3 million of adjustable asset backed securities held on December 31, 2001, $6.3 million are repriceable monthly and the remaining $5.0 million are repriceable annually. 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 of December 31, 2002.
Investment Securities (Held to maturity at amortized cost, available for sale at market value) At December 31 (in thousands) 2002 2001 2000 Available for Sale U.S. treasury $ 5,059 $ 7,218 $ 14,992 U.S. government agencies 6,138 6,118 5,028 States and political subdivisions 31,024 19,470 3,366 Mortgage-backed Fixed - GNMA, FNMA, FHLMC Passthroughs 17,465 12,672 5,580 GNMA, FNMA, FHLMC CMO's 11,682 5,057 4,941 Total 29,147 17,729 10,521 Variable - GNMA, FNMA, FHLMC Passthroughs 8,645 8,402 9,374 GNMA, FNMA, FHLMC CMO's 2,529 2,925 2,983 Total 11,174 11,327 12,357 Total mortgage-backed 40,321 29,056 22,878 Other 6,967 13,746 6,559 Total 89,509 75,608 52,823
Held to Maturity States and political subdivisions $ - $ - $ 15,231
Total $ 89,509 $ 75,608 $ 68,054
Maturity Distribution of Securities
Impact of Inflation and Changing Prices
The majority of Bourbon's assets and liabilities are monetary in nature. Therefore, Bourbon 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.
Other Accounting Issues
Beginning January 1, 2001, a new accounting standard requires all derivatives to be recorded at fair value. Unless designated as hedges, changes in these fair values will be recorded in the income statement. Fair value changes involving hedges will generally be recorded by offsetting gains and losses on the hedge and on the hedged item, even if the fair value of the hedged item is not otherwise recorded. The Company periodically enters into non-exchange traded mandatory forward sales contracts in conjunction with its mortgage banking operation. These contracts, considered derivatives, typically last 90 days and are used to hedge the risk of interest rate changes between the time of the commitment to make a loan to a borrower at a stated rate and when the loan is sold. The Company did not have any mandatory forward sales contracts at December 31, 2002 and 2001. As allowed in conjunction with the adoption of this standard, the Company transferred its entire securities held to maturity portfolio to available for sale. As a result of this transfer and the corresponding adjustment to fair value, on January 1, 2001 securities increased $407,000, other assets decreased $138,000, and accumulated other comprehensive income increased $269,000.
A new accounting standard requires all business combinations to be recorded using the purchase method of accounting for any transaction initiated after June 30, 2001. Under the purchase method, all identifiable tangible and intangible assets and liabilities of the acquired company must be recorded at fair value at date of acquisition, and the excess of cost over fair value of net assets acquired is recorded as goodwill. Identifiable intangible assets must be separated from goodwill. Identifiable intangible assets with finite useful lives are amortized under the new standard, whereas goodwill, both amounts previously recorded and future amounts purchased, ceased being amortized in 2002. Annual impairment testing is required for goodwill with impairment being recorded if the carrying amount of goodwill exceeds its implied fair value. All recorded acquisition intangibles are identified with specific assets. A subsequent accounting standard also required goodwill on branch acquisitions to cease being amortized separate from core deposit intangible assets which will continue to be amortized. Adoption of this standard on January 1, 2002 did not have a material effect on the Company's financial statements, as there are no intangible assets identified as goodwill.
New accounting standards on asset retirement obligations, restructuring activities and exit costs, operating leases, and early extinguishment of debt were issued in 2002. Management determined that when the new accounting standards are adopted in 2003 they will not have a material impact on the Company's financial condition or results of operations.
Item 7A.
Item 7A. Asset/Liability Management, Interest Rate Sensitivity, Market Risk and Liquidity
Asset/Liability management control is designed to ensure safety and soundness, maintain liquidity and regulatory capital standards, and achieve acceptable net interest income. The Company's exposure to market risk is reviewed on a regular basis by the Asset/Liability Committee. Management considers interest rate risk to be the most significant market risk. Interest rate risk is the potential of economic losses due to future interest rate changes. These economic losses can be reflected as a loss of future net interest income and/or a loss of current fair market values. The objective is to measure the effect on net interest income and to adjust the balance sheet to minimize the inherent risk while at the same time maximize income. Management realizes certain risks are inherent and that the goal is to identify and minimize the risks. The primary tool used by management is an interest rate shock simulation model. Certain assumptions, such as prepayment risks, are included in the model. However, actual prepayments may differ from those assumptions. In addition, immediate withdrawal of interest checking and other savings accounts may have an effect on the results of the model. The Bank has no market risk sensitive instruments held for trading purposes.
The following table depicts the change in net interest income resulting from 100 and 300 basis point changes in rates. The projections are based on balance sheet growth assumptions and repricing opportunities for new, maturing and adjustable rate amounts. In addition, the projected percentage changes from level rates are outlined below along with the Board of Directors approved limits. As of December 31, 2002 the projected net interest income percentage change of down 300 basis points is outside the Board of Directors limits. Because of the low level of rates, an across the board drop of 300 basis points is impossible. This along with a higher likelihood of increasing rates in the future have resulted in Management believing this risk is acceptable under the current conditions. This limit variation has been reviewed with the Asset/Liability Committee and the Board of Directors. The projected net interest income report summarizing the Company's interest rate sensitivity as of December 31, 2002 and December 31, 2001 is as follows:
Projected Net Interest Income (December 31, 2002)
The numbers in 2002 show greater fluctuation when compared to 2001. In 2002, year one reflected a decrease in net interest income of 14.8% compared to 6.0% projected decrease from 2001 with a 300 basis point decline. The 300 basis point increase in rates reflected a 12.1% increase in net interest income in 2002 compared to a 3.0% increase in 2001. The risk is greater in 2002 due to the current status of existing interest rates (being low) and their effect on rate sensitive assets and rate sensitive liabilities. An increase in rates would improve net interest income.
Management measures the Company's interest rate risk by computing estimated changes in net interest income in the event of a range of assumed changes in market interest rates. The Company's exposure to interest rates is reviewed on a monthly basis by senior management and quarterly with the Board of Directors. Exposure to interest rate risk is measured with the use of interest rate sensitivity analysis to determine the change in net interest income in the event of hypothetical changes in interest rates, while interest rate sensitivity gap analysis is used to determine the repricing characteristics of the Company's assets and liabilities. If estimated changes to net interest income are not within the limits established by the Board, the Board may direct management to adjust the Company's asset and liability mix to bring interest rate risk within Board approved limits.
Liquidity risk is the possibility that the Company may not be able to meet its cash requirements. Management of liquidity risk includes maintenance of adequate cash and sources of cash to fund operations and meeting the needs of borrowers, depositors and creditors. Excess liquidity has a negative impact on earnings resulting from the lower yields on short-term assets.
In addition to cash and cash equivalents, the securities portfolio provides an important source of liquidity. Total securities maturing within one year along with cash and cash equivalents totaled $35.8 million at December 31, 2002. Additionally, securities available-for- sale with maturities greater than one year totaled $82.9 million at December 31, 2002. As part of the new accounting pronouncement mentioned in Note 1 of the Notes to Consolidated Financial Statements included in Exhibit 13 the Company transferred its entire securities held to maturity portfolio to available for sale on January 1, 2001. This added an additional $15.6 million in securities to the available for sale portfolio. The available for sale securities are available to meet liquidity needs on a continuing basis.
Bourbon maintains a relatively stable base of customer deposits and its steady growth is expected to be adequate to meet its funding demands. In addition, management believes the majority of its $100,000 or more certificates of deposit are no more volatile than its core deposits. At December 31, 2002 these balances totaled $46.9 million, approximately 14.5% of total deposits.
The Company also relies on FHLB advances for both liquidity and asset/liability management purposes. These advances are used primarily to fund long-term fixed rate residential mortgage loans. We have sufficient collateral to borrow an additional $31 million from the FHLB at December 31, 2002.
Generally, Bourbon relies upon net cash inflows from financing activities, supplemented by net cash inflows from operating activities, to provide cash used in its investing activities. As is typical of many financial institutions, significant financing activities include deposit gathering, and the use of short-term borrowings, such as federal funds purchased and securities sold under repurchase agreements along with long-term debt. The Company's primary investing activities include purchasing investment securities and loan originations. Management believes there is sufficient cash flow from operations to meet investing and liquidity needs related to reasonable borrower, depositor and creditor needs in the present economic environment.
The cash flow statements for the periods presented provide an indication of the Company's sources and uses of cash as well as an indication of the ability of the Company to maintain an adequate level of liquidity.
A number of other techniques are used to measure the liquidity position, including the ratios presented below. These ratios are calculated based on annual averages for each year.
Liquidity Ratios December 31 2002 2001 2000 Average Loans (including loans held for sale)/Average Deposits 91.3% 91.5% 89.9% Average Securities sold under agreements to repurchase and other borrowings/Average Assets 0.9% 1.2% 2.9%
This chart shows that the loan to deposit ratio decreased slightly in 2002 compared to an increase in 2001. Loan growth of 3% and deposit growth of 3% in 2002, coupled with loan growth of 6% and deposit growth of 5% in 2001 have been contributing factors to the change in this ratio over the past two years.
Item 8.
Item 8. Financial Statements
The consolidated financial statements of the Company together with the notes thereto and report of independent auditors are contained in the Company's 2002 Annual Report to Stockholders included as Exhibit 13, and are incorporated herein by reference. No other portion of the 2002 Annual Report to Stockholders is to be deemed "filed" as part of this filing.
Item 9.
Item 9. Changes In and Disagreements with Accountants on Accounting and Financial Disclosure
Not Applicable
PART III
Item 10.
Item 10. Directors and Executive Officers of the Registrant
Under the Company's Articles of Incorporation, the Board of Directors consists of three different classes, each to serve, subject to the provisions of the Articles of Incorporation and Bylaws, for a three year term and until his successor is duly elected and qualified. The names of the directors and their terms are set forth below.
Terms expiring in 2003:
William R. Stamler, age 68, is Chairman of Signal Investments, Inc. He has been a director of Kentucky Bank since 1984 and the Company since 1988.
Buckner Woodford, age 58, is President and Chief Executive Officer of Bourbon Bancshares, Inc. and Chief Executive Officer of Kentucky Bank. He has been a director of Kentucky Bank since 1971 and the Company since inception.
Terms expiring in 2004:
William Arvin, age 62, is an attorney. He has been a director of Kentucky Bank and the Company since 1995.
James L. Ferrell, M.D., age 68, is a Physician. He has been a director of Kentucky Bank since 1980 and the Company since inception.
Louis Prichard, age 49, is President and Chief Operating Officer of Kentucky Bank. He has been a director of Kentucky Bank and the Company since 2003.
Terms expiring in 2005:
Henry Hinkle, age 51, is President of Hinkle Construction Company. He has been a director of Kentucky Bank and the Company since 1989.
Theodore Kuster, age 59, is a farmer and thoroughbred horse breeder. He has been a director of Kentucky Bank since 1979 and the Company since 1985.
Robert G. Thompson, age 53, is Executive Director of the Paris Bourbon County YMCA, a farmer and thoroughbred horse breeder. He has been a director of Kentucky Bank and the Company since 1991.
The Company's other executive officer is Gregory J. Dawson, age 42. He is the Chief Financial Officer and has been with the Company since 1985 and serves at the pleasure of the Board of Directors.
Item 11.
Item 11. Executive Compensation
The following table sets forth information with respect to the compensation of the President and Chief Executive Officer of the Company, Buckner Woodford. No other executive officer earned total salary and bonus in excess of $100,000.
Summary Compensation Table Annual Compensation Other Annual Options Name Year Salary Bonus Compensation Granted Buckner Woodford 2002 $180,008 $ 39,825 (1) 500
Buckner Woodford 2001 $175,000 $ 19,250 (1) 500
Buckner Woodford 2000 168,500 49,630 (1) 500
(1) Less than the lesser of $50,000 or 10% of annual salary and bonuses
The following table contains information regarding the grant of stock options under the Company's stock option plan to the Chief Executive Officer during the year ended December 31, 2002. In addition, in accordance with rules of the Securities and Exchange Commission, the following table sets forth the hypothetical grant date present value with respect to the referenced options, using the Black-Scholes Option Pricing Model.
Option Grants in the Last Fiscal Year
% of Total Options Grant Shares Granted to Exercise Date Granted Employees Price Expiration Present Name (#) in 2002 ($/Sh) Date Value($)
Buckner Woodford 500 8.4% $26.00 1/2/12 $1,215
The following table sets forth certain information regarding options exercised by the Chief Executive Officer during calendar year 2002 and unexercised stock options held by him as of December 31, 2002.
Compensation of Directors
Each director of the Company is a director of Kentucky Bank. Company Directors are paid $400 for each Company and Kentucky Bank board meeting attended and non-employee Company directors are paid $100 for each Kentucky Bank committee meeting attended. Non-employee Directors of Kentucky Bank are also granted a 10-year option to purchase 50 shares of the Company's common stock following each year in which Kentucky Bank has a return on assets of 1 percent or greater. The option's exercise price is the fair market value per share on the date of grant.
Pension Plan
The following table sets forth the annual benefits which an eligible employee would receive under the Company's qualified defined benefit pension plan based on remuneration that is covered under the plan and years of service with the Company and its subsidiaries.
Years of Service
Remuneration 15 20 25 30 35
$ 25,000 $ 3,750 $ 5,000 $ 6,250 $ 7,500 $ 8,750 50,000 7,500 10,000 12,500 15,000 17,500 75,000 11,250 15,000 18,750 22,500 26,250 100,000 15,000 20,000 25,000 30,000 35,000 125,000 18,750 25,000 31,250 37,500 43,750 150,000 22,500 30,000 37,500 45,000 52,500 175,000 26,250 35,000 43,750 52,500 61,250 200,000 30,000 40,000 50,000 60,000 70,000 225,000 33,750 45,000 56,250 67,500 78,750
In general, a participant's remuneration covered by the Company's pension plan is his or her average annual cash compensation (W-2 earnings) for the last 5 years. The years of service for Mr. Woodford are 30 years.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management
Set forth below are the number of shares of the Company's common stock beneficially owned by each director and executive officer, and all current directors and executive officers as a group as of December 31, 2002.
Name Shares Beneficially Owned(1) Number Percentage
William Arvin (2) 33,409 1.2%
Gregory J. Dawson (3) 9,175 *
James L. Ferrell, M.D. (4) 29,550 1.0%
Henry Hinkle (5) 27,955 *
Theodore Kuster (6) 18,120 *
Louis Prichard (7) 3,000 *
William R. Stamler (8) 31,370 1.1%
Robert G. Thompson (9) 7,650 *
Buckner Woodford (10) 254,478 9.0%
All directors and officers (9 persons) as a group (consisting of those persons named above)(11) 411,707 14.5%
* Less than 1%
1) Beneficial ownership as reported in the above table has been determined in accordance with Rule 13d-3 under the Exchange Act. Unless otherwise indicated, beneficial ownership includes both sole or shared voting and sole or shared investment power. 2) Includes 11,858 shares held in a retirement account, 13,695 shares held of record by Mr. Arvin's wife, as to which Mr. Arvin disclaims beneficial ownership, 7,276 held jointly with his wife and 450 shares that Mr. Arvin may acquire upon exercise of outstanding stock options. 3) Includes 4,270 shares that Mr. Dawson may acquire upon exercise of outstanding stock options. 4) Includes 5,400 shares held in a retirement account and 850 shares that Dr. Ferrell may acquire upon exercise of outstanding stock options. Also, includes 3,000 shares held by Dr. Ferrell's wife, as to which Dr. Ferrell disclaims beneficial ownership. 5) Includes 1,000 shares held by his wife and 640 shares held by three sons, as to which Mr. Hinkle disclaims beneficial ownership. Includes 24,000 shares held of record by Hinkle Contracting Company, as to which Mr. Hinkle, as president, has shared voting power. Also includes 850 shares that Mr. Hinkle may acquire upon exercise of outstanding stock options. 6) Includes 6,270 share held of record by Mr. Kuster's wife, as to which Mr. Kuster disclaims beneficial ownership. Also includes 5,350 shares held in a retirement account and 650 shares that Mr. Kuster may acquire upon exercise of outstanding stock options. 7) Includes 3,000 shares that Mr. Prichard may acquire upon exercise of outstanding stock options. 8) Includes 7,860 shares held by Signal Investments Corporation, as to which Mr. Stamler, as the chief executive officer and majority stockholder of such corporation, has sole voting and investment power. Also includes 430 shares that Mr. Stamler may acquire upon exercise of outstanding stock options. 9) Includes 650 shares that Mr. Thompson may acquire upon exercise of outstanding stock options. 10) Includes 8,000 shares held by his wife, as to which Mr. Woodford disclaims beneficial ownership. Also includes 208 shares held in a retirement account and 18,700 shares that Mr. Woodford may acquire upon exercise of outstanding stock options. 11) Includes 26,850 shares that may be acquired upon exercise of outstanding stock options.
The following table sets forth as of December 31, 2002 the only person known by the Company to own beneficially (as determined in accordance with the rules and regulations of the Commission) more than 5% of the outstanding common stock. See note 10 in the preceding table for further information.
Name and Address Shares Beneficially of Beneficial Owner Owned Percentage
Buckner Woodford 254,478 9.0% 340 Stoner Avenue Paris, Kentucky 40361
The following table sets forth as of December 31, 2002 the Company's common stock authorized for issuance under equity compensation plans. The Company's shareholders have approved all of the Company's equity compensation plans.
Item 13.
Item 13. Certain Relationships and Related Transactions
Directors and officers of the Company and their associates were customers of and had transactions with the Company's subsidiary bank in the ordinary course of business during the year ended December 31, 2002. Similar transactions may be expected to take place with the Company's subsidiary bank in the future. Outstanding loans and commitments made by such subsidiary bank in transactions with the Company's directors and officers and their associates were made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other persons and did not involve more than a normal risk of collectibility or present other unfavorable features. Certain directors and executive officers were loan customers of Kentucky Bank and outstanding loans were $1.6 million as of December 31, 2002 and $1.5 million as of December 31, 2001. See Note 4 in the notes to consolidated financial statements included as Exhibit 13.
Item 14
Item 14 - Controls and Procedures
Within the 90 days prior to the filing date of this report, the Company carried out an evaluation, under the supervision and with the participation of the Company's management, including the Company's Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based upon that evaluation, the Company's Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures are effective in all material respects. Disclosure controls and procedures are controls and procedures that are designed to ensure that information required to be disclosed in Company reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms, and is accumulated and communicated to management, including the Chief Executive Officer and the Chief Financial Officer, as appropriate to allow for timely disclosure.
There have been no significant changes in our internal controls or in other factors that could significantly affect internal controls subsequent to the date we carried out this evaluation.
Part IV
Item 15.
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a) The following exhibits are incorporated by reference herein or made a part of this Form 10-K:
3.1 Articles of Incorporation of the Registrant are incorporated by reference to Exhibit 3.1 of the Registrant's Quarterly Report on Form 10-Q for the quarterly period ending March 31, 2000 (File No. 33-96358).
3.2 Bylaws of the Registrant are incorporated by reference to Exhibit 3.1 of the Registrant's Quarterly Report on Form 10-Q for the quarterly period ending June 30, 2000 (File No. 33-96358).
10.1 Bourbon's 1993 Employee Stock Ownership Incentive Plan is incorporated by reference to Exhibit 10.2 of the Registrant's Registration Statement on Form S-4 (File No. 33-96358).*
10.2 Bourbon's 1993 Non-Employee Directors Stock Ownership Incentive Plan is incorporated by reference to Exhibit 10.3 of the Registrant's Registration Statement on Form S-4 (File No. 33-96358).*
10.3 Bourbon Bancshares, Inc. 1999 Employee Stock Option Plan is incorporated by reference to Exhibit 99.1 of the Registrant's Form 10-K for the fiscal year ended December 31, 1998.*
11 Computation of earnings per share - See Note 10 in the notes to consolidated financial statements included as Exhibit 13.
13 Financial Statements: Consolidated Balance Sheets Consolidated Statements of Income Consolidated Statements of Comprehensive Income Consolidated Statements of Changes in Stockholders' Equity Consolidated Statements of Cash Flows Notes to Consolidated Financial Statements Report of Independent Auditors
21 Subsidiaries of Registrant
23 Consent of Crowe, Chizek and Company LLP
99.1 Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
99.2 Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
* Denotes a management contract or compensatory plan or arrangement of the Registrant required to be filed as an exhibit pursuant to Item 601(10) (iii) of Regulation S-K.
(b) Current Reports on Form 8-K during the quarter ended December 31, 2002 None
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
Bourbon Bancshares, Inc. By: __/s/Buckner Woodford__ Buckner Woodford, President and Chief Executive Officer, Director March 28, 2003
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
__/s/Buckner Woodford _______ March 31, 2003 Buckner Woodford, President and Chief Executive Officer, Director
__/s/Gregory J. Dawson_______ March 31, 2003 Gregory J. Dawson, Chief Financial and Accounting Officer
__/s/James L. Ferrell________ March 31, 2003 James L. Ferrell, M.D., Chairman of the Board, Director
_____________________________ March 31, 2003 William Arvin, Director
__/s/Henry Hinkle __ ____ March 31, 2003 Henry Hinkle, Director
_____________________________ March 31, 2003 Theodore Kuster, Director
__/s/Louis Prichard__________ March 31, 2003 Louis Prichard, Director
_____________________________ March 31, 2003 William R. Stamler, Director
__/s/Robert G. Thompson______ March 31, 2003 Robert G. Thompson, Director
SUPPLEMENTAL INFORMATION TO BE FURNISHED WITH REPORTS FILED PURSUANT TO SECTION 15(d) OF THE ACT BY REGISTRANTS WHICH HAVE NOT REGISTERED SECURITIES PURSUANT TO SECTION 12 OF THE ACT.
The Registrant refers to Exhibit 13 to the Form 10-K.
Certifications
I, Buckner Woodford, certify that:
1. I have reviewed this annual report on Form 10-K of Bourbon Bancshares, Inc.; 2. Based on my knowledge, this annual 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 annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual 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 annual report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have: a) designed such disclosure controls and procedures 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 annual report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: March 31, 2003 ___/s/ Buckner Woodford_____ Buckner Woodford President & Chief Executive Officer
I, Gregory J. Dawson, certify that:
1. I have reviewed this annual report on Form 10-K of Bourbon Bancshares, Inc.; 2. Based on my knowledge, this annual 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 annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual 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 annual report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have: a) designed such disclosure controls and procedures 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 annual report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: March 31, 2003 ___/s/ Gregory J. Dawson____ Gregory J. Dawson Chief Financial Officer
INDEX TO EXHIBITS
Exhibit Number Description of Document
3.1 Articles of Incorporation of the Registrant are incorporated by reference to Exhibit 3.1 of the Registrant's Quarterly Report on Form 10-Q for the quarterly period ending March 31, 2000 (File No. 33-96358).
3.2 Bylaws of the Registrant are incorporated by reference to Exhibit 3.1 of the Registrant's Quarterly Report on Form 10- Q for the quarterly period ending June 30, 2000 (File No. 33-96358).
10.1 Bourbon's 1993 Employee Stock Ownership Incentive Plan is incorporated by reference to Exhibit 10.2 of the Registrant's Registration Statement on Form S-4 (File No. 33-96358).*
10.2 Bourbon's 1993 Non-Employee Directors Stock Ownership Incentive Plan is incorporated by reference to Exhibit 10.3 of the Registrant's Registration Statement on Form S-4 (File No. 33-96358).*
10.3 Bourbon Bancshares, Inc. 1999 Employee Stock Option Plan is incorporated by reference to Exhibit 99.1 of the Registrant's Form 10-K for the fiscal year ended December 31, 1998.*
11 Computation of earnings per share - See Note 10 in the notes to consolidated financial statements included as Exhibit 13.
13 Bourbon Bancshares, Inc. 2002 Annual Report
21 Subsidiaries of Registrant
23 Consent of Crowe, Chizek and Company LLP
99.1 Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
99.2 Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
* Denotes a management contract or compensatory plan or arrangement of the Registrant required to be filed as an exhibit pursuant to Item 601(10) (iii) of Regulation S-K.
Exhibit 13
BOURBON BANCSHARES, INC.
ANNUAL REPORT 2002
Letter to the Shareholders.
Dear Shareholders,
As we begin a new year in 2003, we welcome a strong addition to our management team. Louis Prichard joins us as President and Chief Operating Officer of our subsidiary, Kentucky Bank. I will move up to the title of Chairman of the bank. My role as CEO of the bank, and President and CEO of Bourbon Bancshares remains unchanged.
Louis comes to us from Danville, where he was President and CEO of a very successful community bank serving three counties. His presence makes an already strong management team even stronger and deeper. This should position us very well to meet the challenges of building shareholder value, and the competitive challenges found in the thriving communities we serve.
My role in the organization will now be to focus on identifying new business opportunities for us. I will turn over to Louis much of the responsibility for managing our existing business.
We are especially proud of our year end results given the weakness in our economy. That weakness has led to some decline in credit quality for most banks, including us. It has also given us the challenge of managing the rapid drop to record low interest rates. In spite of these two obstacles, we still improved earnings in 2002.
The strong second half of the year boosted our financial performance. For the full year we earned $5.9 million, up about 7% from the prior year. Earnings per share assuming dilution were $2.10, a nice increase from $1.95 a year ago. We also increased our dividend to shareholders for the twentieth consecutive year.
We are nearing completion of our new branch office in Georgetown, and expect it to open in the first quarter of this year. It is located on Blossom Park Drive, which is a very rapidly growing part of that community.
Involvement in the Bluegrass communities we call home is a vital part of our future growth. We continue our commitment to build our earnings and increase the value of your franchise.
Buckner Woodford President
FINANCIAL HIGHLIGHTS...
BOURBON BANCSHARES, INC. 2002 2001 2000
Assets ($ thousands) $419,771 $397,257 $371,847
Net Income ($ thousands)	 $ 5,903 $ 5,524 $ 5,253
Per Share Results
Earnings(assuming dilution) $ 2.10 $ 1.95 $ 1.83
Dividends $ .68 $ .60 $ .52
Shareholder Information
CORPORATE HEADQUARTERS Bourbon Bancshares, Inc. 4th and Main Street Paris, Kentucky 40361 859-987-1795
MARKET MAKERS
Morgan Keegan & Co. 489 East Main Street Lexington, Kentucky 40507 800-937-0161
Hilliard Lyons West Vine Street, Suite 400 Lexington, Kentucky 40507 800-944-2663
Howe Barnes Investments, Inc. 135 South LaSalle Street, Suite 150 Chicago, Illinois 60603-4398 800-800-4693
TRANSFER, REGISTRAR AND DIVIDEND AGENT Registrar and Transfer Company 10 Commerce Drive Cranford, NJ 07016-3572 800-368-5948 rtco.com
INVESTOR INFORMATION Any individual requesting general information or a copy of the Corporation's 2002 Form 10-K Report may obtain these by writing Investor Relations at the Corporate Headquarters.
CONSOLIDATED BALANCE SHEETS December 31 2002 2001
ASSETS Cash and due from banks $ 10,493,495 $ 15,229,462 Federal funds sold 18,683,000 14,409,000 Cash and cash equivalents 29,176,495 29,638,462 Securities available for sale 89,509,140 75,607,874 Mortgage loans held for sale 740,023 2,343,095
Loans 284,153,605 273,172,802 Allowance for loan losses (3,395,075) (3,386,425) Net loans 280,758,530 269,786,377
Federal Home Loan Bank stock 4,027,300 3,846,500 Bank premises and equipment, net 10,331,618 10,504,904 Interest receivable 3,276,432 3,507,473 Intangible assets 1,367,417 1,405,918 Other assets 584,441 616,556
Total assets $ 419,771,396 $ 397,257,159
LIABILITIES AND STOCKHOLDERS' EQUITY Deposits Non-interest bearing $ 53,366,283 $ 47,622,621 Time deposits, $100,000 and over 46,903,641 41,671,945 Other interest bearing 222,566,031 219,620,618 Total deposits 322,835,955 308,915,184 Repurchase agreements and other borrowings 5,276,695 1,601,982 Federal Home Loan Bank advances 43,937,306 43,597,929 Interest payable 1,844,705 2,814,581 Other liabilities 1,784,893 1,227,102 Total liabilities 375,679,554 358,156,778
Stockholders' equity Preferred stock, 300,000 shares authorized and unissued - - Common stock, no par value; 10,000,000 shares authorized; 2,772,754 and 2,766,917 shares issued and outstanding in 2002 and 2001 6,806,887 6,649,018 Retained earnings 35,435,996 31,703,573 Accumulated other comprehensive income (loss) 1,848,959 747,790 Total stockholders' equity 44,091,842 39,100,381
Total liabilities and stockholders' equity $ 419,771,396 $ 397,257,159
CONSOLIDATED STATEMENTS OF INCOME Years Ended December 31 2002 2001 2000
Interest income Loans, including fees $ 20,632,003 $ 23,658,873 $ 23,681,081 Securities Taxable 2,564,539 2,591,330 2,818,906 Tax exempt 1,254,065 1,124,620 1,059,658 Other 337,397 671,231 647,597 24,788,004 28,046,054 28,207,242 Interest expense Deposits 6,977,969 11,306,963 11,807,823 Repurchase agreements and other borrowings 42,148 131,913 541,550 Federal Home Loan Bank advances 2,257,413 1,857,061 1,158,250 Other 90,000 90,000 90,000 9,367,530 13,385,937 13,597,623
Net interest income 15,420,474 14,660,117 14,609,619 Provision for loan losses 1,204,000 1,068,000 750,000 Net interest income after provision for loan losses 14,216,474 13,592,117 13,859,619
Other income Service charges 3,848,055 3,663,990 2,650,310 Loan service fee income 228,121 257,823 286,704 Trust department income 345,730 346,554 419,728 Securities gains (losses), net 218,604 287,262 (88,169) Gain on sale of mortgage loans 948,369 382,532 132,559 Other 1,000,716 734,043 397,131 6,589,595 5,672,204 3,798,263 Other expenses Salaries and employee benefits 6,728,443 6,019,279 5,538,589 Occupancy expenses 1,908,479 1,890,878 1,538,037 Amortization 429,366 419,486 434,373 Advertising and marketing 330,069 428,229 362,958 Taxes other than payroll, property and income 406,077 370,537 363,957 Other 2,630,321 2,627,444 2,135,581 12,432,755 11,755,853 10,373,495
Income before income taxes 8,373,314 7,508,468 7,284,387 Provision for income taxes 2,470,789 1,983,978 2,031,445
Net income $ 5,902,525 $ 5,524,490 $ 5,252,942
Earnings per share: Basic $ 2.13 $ 1.98 $ 1.87 Diluted 2.10 1.95 1.83
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME Years Ended December 31 2002 2001 2000
Net income $ 5,902,525 $ 5,524,490 $ 5,252,942
Other comprehensive income (loss), net of tax: Unrealized gains (losses) on securities arising during the period 1,245,448 945,748 483,032 Reclassification of realized amount (144,279) (189,593) 58,192 Net change in unrealized gain (loss) on securities 1,101,169 756,155 541,224
Comprehensive income $ 7,003,694 $ 6,280,645 $ 5,794,166
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY Years Ended December 31, 2002, 2001 and 2000
CONSOLIDATED STATEMENTS OF CASH FLOWS Years Ended December 31
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation: The consolidated financial statements include the accounts of Bourbon Bancshares, Inc. (the Company) and its wholly-owned subsidiary, Kentucky Bank (the Bank). Intercompany transactions and balances have been eliminated in consolidation.
Nature of Operations: The Bank operates under a state bank charter and provides full banking services, including trust services, to customers located in Bourbon, Clark, Harrison, Jessamine, Scott, Woodford and adjoining counties in Kentucky. As a state bank, the Bank is subject to regulation by the Kentucky Department of Financial Institutions and the Federal Deposit Insurance Corporation (FDIC). The Company, a bank holding company, is regulated by the Federal Reserve.
Estimates in the Financial Statements: The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The allowance for loan losses and fair value of financial instruments are particularly subject to change.
Cash Flows: For purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks, federal funds sold, and certain short-term investments with maturities of less than three months. Generally, federal funds are sold for one-day periods. Net cash flows are reported for loan, deposit and short-term borrowing transactions.
Securities: The Company is required to classify its securities portfolio into three categories: trading securities, securities available for sale and securities held to maturity. Fair value adjustments are made to the securities based on their classification with the exception of the held to maturity category. The Company has no investments classified as trading.
Securities available for sale are carried at fair value. The difference between amortized cost and fair value is recorded in stockholders' equity, net of related income tax, under accumulated other comprehensive income. Changes in this difference are recorded as a component of comprehensive income. Amortization of premiums and accretion of discounts are recorded as adjustments to interest income using the constant yield method.
Securities for which the Company has the positive intent and ability to hold to maturity are stated at cost, adjusted for amortization of premiums and accretion of discounts which are recorded as adjustments to interest income using the constant yield method.
Gains or losses on dispositions are based on the net proceeds and the adjusted carrying amount of the securities sold, using the specific identification method.
Loans Held for Sale: Loans held for sale are valued at the lower of cost or market as determined by outstanding commitments from investors or current secondary market prices, calculated on the aggregate loan basis. The Company also provides for any losses on uncovered commitments to lend or sell.
Loans: Loans are stated at the amount of unpaid principal, reduced by an allowance for loan losses. Interest income on loans is recognized on the accrual basis except for those loans on a nonaccrual status. The accrual of interest on impaired loans is discontinued when management believes, after consideration of economic and business conditions and collection efforts, that the borrowers' financial condition is such that collection of interest is doubtful. When interest accrual is discontinued, interest income received on such loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.
Loan origination fees and certain direct origination costs are capitalized and recognized as an adjustment of the yield on the related loan.
Allowance for Loan Losses: The allowance for loan losses is a valuation allowance for probable incurred credit losses, increased by the provision for loan losses and decreased by charge-offs less recoveries. 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. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management's judgment, should be charged-off. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed.
A loan is impaired when full payment under the loan terms is not expected. Impairment is evaluated in total for smaller-balance loans of similar nature such as residential mortgage, consumer, and credit card loans, and on an individual loan basis for other loans. If a loan is impaired, a portion of the allowance is allocated so that the loan is reported, net, at the present value of estimated future cash flows using the loan's existing rate or at the fair value of collateral if repayment is expected solely from the collateral. Large groups of smaller balance homogenous loans, such as consumer and residential real estate loans are collectively evaluated for impairment, and accordingly, they are not separately identified for impairment disclosures.
Mortgage Servicing Rights: The Bank has sold various loans to the Federal Home Loan Mortgage Corporation (FHLMC) 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. The Bank receives a servicing fee from the FHLMC on each loan sold. Servicing rights are capitalized based on the relative fair value of the rights and the loans' estimated lives and are included in intangible assets on the balance sheet and expensed in proportion to, and over the period of, estimated net servicing revenues.
Federal Home Loan Bank Stock: Amount is carried at cost.
Bank Premises and Equipment: Land is carried at cost. Bank premises and equipment are stated at cost less accumulated depreciation. Depreciation is recorded principally by the straight-line method over the estimated useful lives of the bank premises and equipment with useful lives ranging from 3 to 50 years.
Real Estate Acquired Through Foreclosure: Real estate acquired through foreclosure is carried at the lower of the recorded investment in the property or its fair value. The value of the underlying loan is written down to the fair value of the real estate to be acquired by a charge to the allowance for loan losses, if necessary. Any subsequent write-downs are charged to operating expenses. Operating expenses of such properties, net of related income, and gains and losses on their disposition are included in other expenses.
Repurchase Agreements: Substantially all repurchase agreement liabilities represent amounts advanced by various customers. Securities are pledged to cover these liabilities, which are not covered by federal deposit insurance.
Stock Compensation: Employee compensation expense under stock options is reported using the intrinsic value method. No stock-based compensation cost is reflected in net income, as all options granted had an exercise price equal to or greater than the market price of the underlying common stock at date of grant. The following table illustrates the effect on net income and earnings per share if expense was measured using the fair value recognition provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation.
2002 2001 2000 Net income As reported $ 5,902,525 $ 5,524,490 $ 5,252,942
Deduct: Stock-based compensation expense determined under fair value based method (129,172) (76,748) (90,691) Pro forma 5,773,353 5,447,742 5,162,251
Basic earnings per share As reported $ 2.13 $ 1.98 $ 1.87 Pro forma 2.08 1.94 1.84
Diluted earnings per share As reported $ 2.10 $ 1.95 $ 1.83 Pro forma 2.06 1.91 1.80
Weighted averages Fair value of options granted $ 2.43 $ 4.58 $ 6.56 Risk free interest rate 4.30% 4.93% 6.62% Expected life 8 years 8 years 8 years Expected volatility 13.10% 13.10% 11.61% Expected dividend yield 2.72% 2.54% 2.14%
Income Taxes: Income tax expense is the total of the current year income tax due or refundable and the change in deferred tax assets and liabilities. The Company uses the liability method for computing deferred income taxes. Under the liability method, deferred income taxes are based on the change during the year in the deferred tax liability or asset established for the expected future tax consequences of differences in the financial reporting and tax bases of assets and liabilities.
Intangible Assets: Intangible assets include a premium on deposits paid in connection with the acquisition of branches which is being amortized on a straight-line basis over ten or fifteen years and capitalized mortgage servicing rights which are being amortized over the life of the related loans.
Earnings Per Common Share: Basic earnings per common share is net income divided by the weighted average number of common shares outstanding during the period. Diluted earnings per common share include the dilutive effect of additional potential common shares issuable under stock options. Earnings and dividends per share are restated for all stock splits and dividends through the date of issuance of the financial statements.
Comprehensive Income: Comprehensive income consists of net income and other comprehensive income. Other comprehensive income includes unrealized gains and losses on securities available for sale which are also recognized as a separate component of equity.
Derivatives: Beginning January 1, 2001, a new accounting standard requires all derivatives to be recorded at fair value. Unless designated as hedges, changes in these fair values will be recorded in the income statement. Fair value changes involving hedges will generally be recorded by offsetting gains and losses on the hedge and on the hedged item, even if the fair value of the hedged item is not otherwise recorded.
The Company periodically enters into non-exchange traded mandatory forward sales contracts in conjunction with its mortgage banking operation. These contracts, considered derivatives, typically last 60 to 90 days and are used to offset the risk of interest rate changes between the time of the commitment to make a loan to a borrower at a stated rate and when the loan is sold. The Company did not have any mandatory forward sales contracts at December 31, 2002 and 2001.
As allowed in conjunction with the adoption of this standard, the Company transferred its entire securities held to maturity portfolio to available for sale. As a result of this transfer and the corresponding adjustment to fair value, on January 1, 2001 securities increased $407,000, other assets decreased $138,000, and accumulated other comprehensive income increased $269,000.
New Accounting Pronouncements: A new accounting standard requires all business combinations to be recorded using the purchase method of accounting for any transaction initiated after June 30, 2001. Under the purchase method, all identifiable tangible and intangible assets and liabilities of the acquired company must be recorded at fair value at date of acquisition, and the excess of cost over fair value of net assets acquired is recorded as goodwill. Identifiable intangible assets must be separated from goodwill. Identifiable intangible assets with finite useful lives are amortized under the new standard, whereas goodwill, both amounts previously recorded and future amounts purchased, ceased being amortized in 2002. Annual impairment testing is required for goodwill with impairment being recorded if the carrying amount of goodwill exceeds its implied fair value. All recorded acquisition intangibles are identified with specific assets. A subsequent accounting standard also required goodwill on branch acquisitions to cease being amortized separate from core deposit intangible assets which will continue to be amortized. Adoption of this standard on January 1, 2002 did not have a material effect on the Company's financial statements, as there are no intangible assets identified as goodwill.
Newly Issued But Not Yet Effective Accounting Standards: New accounting standards on asset retirement obligations, restructuring activities and exit costs, operating leases, and early extinguishment of debt were issued in 2002. Management determined that when the new accounting standards are adopted in 2003 they will not have a material impact on the Company's financial condition or results of operations.
Industry Segments: While the Company's chief decision makers monitor the revenue streams of the various Company products and services, operations are managed and financial performance is evaluated on a Company-wide basis. Accordingly, all of the Company's operations are considered by management to be aggregated into one reportable operating segment.
NOTE 2 - RESTRICTIONS ON CASH AND DUE FROM BANKS
Included in cash and due from banks are certain non-interest bearing deposits that are held at the Federal Reserve or maintained in vault cash in accordance with average balance requirements specified by the Federal Reserve Board of Governors. The reserve requirement at December 31, 2002 and 2001 was $0 and $123,000.
NOTE 3 - SECURITIES
Year-end securities available for sale are as follows:
Fair Unrealized Unrealized Value Gains Losses U. S. Treasury $ 5,059,063 $ 47,096 $ - U. S. government agencies 6,138,499 147,012 - States and political subdivisions 31,024,014 1,299,516 (6,143) Mortgage-backed 40,321,450 919,850 (57,387) Equity securities 3,747,550 285,695 (15,355) Other 3,218,564 197,169 (15,786)
Total $ 89,509,140 $ 2,896,338 $ (94,671)
Fair Unrealized Unrealized Value Gains Losses U. S. Treasury $ 7,217,500 $ 139,106 $ (1,106) U. S. government agencies 6,117,985 118,507 - States and political subdivisions 19,470,102 574,253 (170,855) Mortgage-backed 9,056,415 350,629 (112,170) Equity securities 10,693,330 255,528 (25,319) Other 3,052,542 32,753 (27,949)
Total $ 75,607,874 $ 1,470,776 $(337,399)
The fair value of securities available for sale at December 31, 2002, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Securities not due at a single maturity are shown separately.
Fair Value
Due in one year or less $ 6,658,310 Due after one year through five years 14,670,456 Due after five years through ten years 8,720,647 Due after ten years 15,390,727 45,440,140
Mortgage-backed 40,321,450 Equity 3,747,550
Total $ 89,509,140
Proceeds from sales of securities during 2002, 2001 and 2000 were $18,838,747, $12,344,139 and $17,045,613. Gross gains of $260,096, $288,105 and $42,704 and gross losses of $41,492, $843 and $103,873, were realized on those sales.
Securities with an approximate carrying value of $70,076,000 and $52,707,000 at December 31, 2002 and 2001, were pledged to secure public deposits, trust funds, securities sold under agreements to repurchase and for other purposes as required or permitted by law.
NOTE 4 - LOANS
Loans at year-end were as follows:
2002 2001
Commercial $ 16,802,888 $ 18,617,714 Real estate construction 15,513,702 12,301,704 Real estate mortgage 182,206,697 166,322,768 Agricultural 52,187,812 53,640,436 Consumer 17,133,717 21,951,943 Other 308,789 338,237
$ 284,153,605 $ 273,172,802
Activity in the allowance for loan losses was as follows:
2002 2001 2000
Beginning balance $ 3,386,425 $ 3,388,380 $ 3,102,800 Charge-offs (1,329,218) (1,145,942) (558,552) Recoveries 133,868 75,987 94,132 Provision for loan losses 1,204,000 1,068,000 750,000
Ending balance $ 3,395,075 $ 3,386,425 $ 3,388,380
Impaired loans totaled $1,573,000 and $964,000 at December 31, 2002 and 2001. The average recorded investment in impaired loans during 2002, 2001 and 2000 was $1,441,000, $457,000 and $224,000. The total allowance for loan losses related to these loans was $675,000 and $249,000 at December 31, 2002 and 2001. Interest income on impaired loans of $8,000, $31,000 and $11,000 was recognized for cash payments received in 2002, 2001 and 2000.
Nonperforming loans were as follows: 2002 2001 2000 Loans past due over 90 days still on accrual $ 789,000 $ 1,278,000 $ 1,365,000 Nonaccrual loans 1,573,000 935,000 307,000
Nonperforming loans include impaired loans and smaller balance homogeneous loans, such as residential mortgage and consumer loans, that are collectively evaluated for impairment.
Mortgage loans serviced for others are not included in the accompanying consolidated balance sheets. The unpaid principal balances of mortgage loans serviced for others was approximately $93,530,000 and $86,527,000 at December 31, 2002 and 2001. Custodial escrow balances maintained in connection with the foregoing loan servicing, and included in demand deposits, were approximately $714,000 and $683,000 at December 31, 2002 and 2001.
Changes in mortgage servicing rights were as follows:
2002 2001 2000
Beginning balance $ 463,067 $ 521,467 $ 606,487 Additions 390,865 81,619 69,885 Amortization (149,898) (140,019) (154,905)
Ending balance $ 704,034 $ 463,067 $ 521,467
Certain directors and executive officers of the Company and companies in which they have beneficiary ownership were loan customers of the Bank during 2002 and 2001. Such loans were made in the ordinary course of business at the Bank's normal credit terms and interest rates. An analysis of the activity with respect to all director and executive officer loans is as follows:
2002 2001
Balance, beginning of year $ 1,529,000 $ 1,478,000 Additions, including loans now meeting disclosure requirements 1,346,000 1,514,000 Amounts collected, including loans no longer meeting disclosure requirements (1,249,000) (1,463,000)
Balance, end of year $ 1,626,000 $ 1,529,000
NOTE 5 - PREMISES AND EQUIPMENT
Year-end premises and equipment were as follows:
2002 2001
Land and buildings $ 10,790,642 $ 10,773,183 Furniture and equipment 8,001,811 7,941,210 Construction in process 534,659 - 19,327,112 18,714,393 Less accumulated depreciation (8,995,494) (8,209,489)
$ 10,331,618 $ 10,504,904
Depreciation expense was $989,839, $960,661 and $812,453 in 2002, 2001, and 2000.
NOTE 6 - INTANGIBLE ASSETS
Acquired intangible assets were as follows at year-end:
Gross Carrying Accumulated Amount Amortization Amortized intangible assets: Core deposit intangibles $ 2,890,382 $ 2,226,999
Aggregate amortization expense was $279,468, $279,468 and $279,468 for 2002, 2001 and 2000.
Estimated amortization expense for each of the next five years:
2003 $ 279,468 2004 198,895 2005 19,140 2006 19,140 2007 19,140
NOTE 7 - DEPOSITS
At December 31, 2002, the scheduled maturities of time deposits are as follows:
2003 $ 111,613,815 2004 20,857,153 2005 2,460,136 2006 21,315,832 2007 6,462,416
Certain directors and executive officers of the Company and companies in which they have beneficiary ownership are deposit customers of the Bank. The amount of these deposits was approximately $1,178,000 and $861,000 at December 31, 2002 and 2001.
NOTE 8 - REPURCHASE AGREEMENTS
Repurchase agreements generally mature within one to 35 days from the transaction date. The securities underlying the agreements are maintained in a third-party custodian's account under a written custodial agreement. Information concerning repurchase agreements for 2002 and 2001 is summarized as follows:
2002 2001
Average daily balance during the year $ 2,097,456 $ 3,303,000 Average interest rate during the year 1.22% 3.35% Maximum month-end balance during the year $ 3,504,562 $ 5,164,000
NOTE 9 - FEDERAL HOME LOAN BANK ADVANCES
The Bank owns stock of the Federal Home Loan Bank (FHLB) of Cincinnati, Ohio. This stock allows the Bank to borrow advances from the FHLB. At December 31, 2002 and 2001, $43,937,306 and $43,597,929 represented the balance due on advances from the FHLB. All advances are paid either on a monthly basis or at maturity, over remaining terms of one month to fourteen years, with fixed interest rates ranging from 1.83% to 7.23%. The Bank also has letters of credit from the FHLB totaling $2,000,000 at December 31, 2002 for the purpose of securing trust deposits. Advances and letters of credit are secured by the FHLB stock and substantially all first mortgage loans.
Scheduled principal payments due on advances during the years subsequent to December 31, 2002 are as follows:
2003 $ 14,519,457 2004 15,645,814 2005 5,153,194 2006 5,160,971 2007 159,546 Thereafter 3,298,324 $ 43,937,306
NOTE 10 - INCOME TAXES
Income tax expense was as follows: 2002 2001 2000
Current $ 2,189,931 $ 1,878,784 $ 1,782,641 Deferred 280,858 105,194 248,804
$ 2,470,789 $ 1,983,978 $ 2,031,445
Year-end deferred tax assets and liabilities were due to the following. No valuation allowance for the realization of deferred tax assets is considered necessary.
2002 2001 Deferred tax assets Allowance for loan losses $ 889,158 $ 952,005 Core deposit intangibles 245,154 215,651 Other 181 62,610
Deferred tax liabilities Unrealized gain on securities (952,708) (385,587) Bank premises and equipment (251,461) (234,934) FHLB stock (687,803) (626,331) Mortgage servicing rights (239,372) (157,443) Other (105,546) (80,389)
Net deferred tax asset (liability) $ (1,102,397) $ (254,418)
Effective tax rates differ from federal statutory rates applied to financial statement income due to the following: 2002 2001 2000
U. S. federal income tax rate 34.0% 34.0% 34.0%
Changes from the statutory rate Tax-exempt investment income (5.7) (5.2) (5.9) Non-deductible interest expense related to carrying tax-exempt investments .6 .6 .8 Rehabilitation tax credit - (2.1) - Other .6 (.9) (1.0)
29.5% 26.4% 27.9%
NOTE 11 - EARNINGS PER SHARE
The factors used in the earnings per share computation follow:
2002 2001 2000 Basic Earnings Per Share Net income $ 5,902,525 $ 5,524,490 $ 5,252,942 Weighted average common shares outstanding 2,770,282 2,790,238 2,811,565 Basic earnings per share $ 2.13 $ 1.98 $ 1.87
Diluted Earnings Per Share Net income $ 5,902,525 $ 5,524,490 $ 5,252,942 Weighted average common shares outstanding 2,770,282 2,790,238 2,811,565 Add dilutive effects of assumed exercise of stock options 35,836 47,080 56,600 Weighted average common and dilutive potential common shares outstanding 2,806,118 2,837,318 2,868,165 Diluted earnings per share $ 2.10 $ 1.95 $ 1.83
Stock options for 3,050 and 14,300 shares common stock were excluded from 2002 and 2001 diluted earnings per share because their impact was antidilutive.
NOTE 12 - RETIREMENT PLANS
The Company has a defined benefit pension plan covering substantially all of its employees. The Company's funding policy is to contribute annually the maximum amount that can be deducted for federal income tax purposes. Benefits are based on one percent of employee average earnings for the previous five years times years of credited service.
Information about the pension plan was as follows:
2002 2001 Change in benefit obligation: Beginning benefit obligation $ 3,583,257 $ 3,130,826 Service cost 299,744 240,644 Interest cost 245,253 219,979 Actuarial adjustment 323,543 51,306 Benefits paid (66,230) (59,498) Ending benefit obligation 4,385,567 3,583,257
Change in plan assets, at fair value: Beginning plan assets 3,279,471 3,118,137 Actual return (176,162) (68,643) Employer contribution 360,139 289,475 Benefits paid (66,230) (59,498) Ending plan assets 3,397,218 3,279,471
Funded status (988,349) (303,786) Unrecognized net actuarial (gain) loss 1,236,596 486,520 Unrecognized prior transition asset (2,229) (2,601)
Net pension prepaid benefit $ 246,018 $ 180,133
Net periodic pension cost include the following components:
2002 2001 2000
Service cost $ 299,744 $ 240,644 $ 221,305 Interest cost 245,253 219,979 191,676 Expected return on plan assets (255,964) (246,285) (233,428) Amortization 5,221 (372) (372)
Net periodic cost $ 294,254 $ 213,966 $ 179,181
Discount rate on benefit obligation 7% 7% 7% Long-term expected rate of return on plan assets 8% 8% 8% Rate of compensation increase 5% 5% 5%
The Company also has a qualified profit sharing plan which covers substantially all employees and includes a 401(k) provision. Profit sharing contributions, excluding the 401(k) provision, are at the discretion of the Company's Board of Directors. Expense recognized in connection with the plan was $270,348, $237,661 and $224,106 in 2002, 2001 and 2000.
NOTE 13 - STOCK OPTION PLAN
The Company grants certain officers and key employees stock option awards which vest and become fully exercisable at the end of five years. The Company also grants certain directors stock option awards which vest and become fully exercisable immediately. The exercise price of each option, which has a ten year life, was equal to the market price of the Company's stock on the date of grant; therefore, no compensation expense was recognized.
Summary of stock option transactions are as follows:
Options outstanding at year-end 2002 were as follows:
NOTE 14 - LIMITATION ON BANK DIVIDENDS
The Company's principal source of funds is dividends received from the Bank. Banking regulations limit the amount of dividends that may be paid by the Bank without prior approval of regulatory agencies. Under these regulations, the amount of dividends that may be paid in any calendar year is limited to the current year's net profits, as defined, combined with the retained net profits of the preceding two years. During 2003 the Bank could, without prior approval, declare dividends of approximately $4,605,000 plus any 2003 net profits retained to the date of the dividend declaration.
NOTE 15 - DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
The fair values of the Company's financial instruments at December 31, 2002 and 2001 are as follows:
2002 2001 Carrying Carrying Amount Fair Value Amount Fair Value (In Thousands) Financial assets Cash and cash equivalents $ 29,176 $ 29,176 $ 29,638 $ 29,638 Securities 89,509 89,509 75,608 75,608 Mortgage loans held for sale 740 740 2,343 2,392 Loans, net 280,759 287,447 269,786 274,929 FHLB stock 4,027 4,027 3,847 3,847 Interest receivable 3,276 3,276 3,507 3,507
Financial liabilities Deposits $322,836 $325,454 $308,915 $311,191 Securities sold under agreements to repurchase and other borrowings 5,277 5,277 1,602 1,602 FHLB advances 43,937 45,343 43,598 44,752 Interest payable 1,845 1,845 2,815 2,815
Carrying amount is the estimated fair value for cash and cash equivalents, short-term borrowings, Federal Home Loan Bank stock, accrued interest receivable and payable, demand deposits, short-term debt, and variable rate loans or deposits that reprice frequently and fully. Security fair values are based on market prices or dealer quotes, and if no such information is available, on the rate and term of the security and information about the issuer. For fixed rate loans or deposits and for variable rate loans or deposits with infrequent repricing or repricing limits, fair value is based on discounted cash flows using current market rates applied to the estimated life and credit risk. Fair values for impaired loans are estimated using discounted cash flow analysis or underlying collateral values. Fair value of debt is based on current rates for similar financing. The fair value of commitments to extend credit and standby letters of credit is not considered material.
NOTE 16 - OFF-BALANCE SHEET ACTIVITIES AND COMMITMENTS
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:
2002 2001
Unused lines of credit $ 44,943,000 $ 42,252,000 Commitments to make loans - 2,049,000 Letters of credit 345,000 495,000
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 5.75% to 7.00% with maturities ranging from 15 to 30 years and are intended to be sold.
NOTE 17 - CONTINGENT LIABILITIES
The Bank is a defendant in legal actions arising from normal business activities. Management believes these actions are without merit or that the ultimate liability, if any, resulting from them will not materially affect the Company's consolidated financial position or results of operations.
NOTE 18 - CAPITAL REQUIREMENTS
Regulatory Matters: The Company and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possible additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of the Company's and the Bank's assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Company and Bank capital amounts and classifications are also subject to qualitative judgments by regulators about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (set forth in the following table) of Total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital to average assets (as defined). Management believes, as of December 31, 2002 and 2001, that the Company and the Bank meet all capital adequacy requirements to which they are subject.
The most recent notification from the Federal Deposit Insurance Corporation categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Bank must maintain minimum Total risk-based, Tier I risk-based and Tier I leverage ratios as set forth in the following table. There are no conditions or events since that notification that management believes have changed the institution's category.
The Company's and the Bank's actual amounts and ratios are presented in the table below:
NOTE 19 - PARENT COMPANY FINANCIAL STATEMENTS
Condensed Balance Sheets December 31
2002 2001 (In Thousands) ASSETS Cash on deposit with subsidiary $ 5,609 $ 3,510 Investment in subsidiary 37,425 33,931 Securities available for sale 1,169 1,759 Total assets $ 44,203 $ 39,200
LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities $ 111 $ 100 Stockholders' equity Preferred stock - - Common stock 6,807 6,649 Retained earnings 35,436 31,703 Accumulated other comprehensive income 1,849 748
Total liabilities and stockholders' equity $ 44,203 $ 39,200
Condensed Statements of Income and Comprehensive Income Years Ended December 31
2002 2001 2000 (In Thousands) Income Dividends from subsidiary $ 3,400 $ 3,280 $ 3,160 Securities gains (losses), net 145 72 (17) Interest income 32 44 61 Total income 3,577 3,396 3,204
Expenses Other expenses 55 39 39
Income before income taxes and equity in undistributed income of subsidiary 3,522 3,357 3,165
Applicable income tax (expense) benefits (29) (26) 46
Income before equity in undistributed income of subsidiary 3,493 3,331 3,211
Equity in undistributed income of subsidiary 2,410 2,193 2,042
Net income 5,903 5,524 5,253
Other comprehensive income (loss), net of tax: Unrealized gains (losses) on securities Arising during the period 1,245 946 483 Reclassification of realized amount (144) (189) 58
Net change in unrealized gain (loss) on securities 1,101 757 541
Comprehensive income $ 7,004 $ 6,281 $ 5,794
Condensed Statements of Cash Flows Years Ended December 31
2002 2001 2000 (In Thousands) Cash flows from operating activities Net income $ 5,903 $ 5,524 $ 5,253 Adjustments to reconcile net income to net cash from operating activities Equity in undistributed earnings of Subsidiary (2,410) (2,193) (2,042) Securities (gains) losses, net (145) (72) 17 Change in other assets (100) 72 (37) Change in other liabilities 103 - - Net cash from operating activities 3,351 3,331 3,191
Cash flows from investing activities Purchase of securities available for sale (109) (311) (1,071) Proceeds from sales of securities available for sale 869 820 638 Net cash from investing activities 760 509 (433)
Cash flows from financing activities Dividends paid (1,885) (1,673) (1,463) Proceeds from issuance of common stock 188 344 173 Purchase of common stock (315) (1,711) (364) Net cash from financing activities (2,012) (3,040) (1,654)
Net change in cash 2,099 800 1,104
Cash at beginning of year 3,510 2,710 1,606
Cash at end of year $ 5,609 $ 3,510 $ 2,710
NOTE 20 - QUARTERLY FINANCIAL DATA (UNAUDITED)
Interest Net Interest Net Earnings Per Share Income Income Income Basic Fully Diluted First quarter $ 6,233 $ 3,626 $ 1,296 $ .47 $ .46 Second quarter 6,104 3,695 1,221 .44 .44 Third quarter 6,141 3,932 1,625 .59 .58 Fourth quarter 6,310 4,167 1,761 .63 .62
First quarter $ 7,289 $ 3,627 $ 1,281 $ .46 $ .45 Second quarter 7,181 3,713 1,438 .51 .50 Third quarter 6,982 3,706 1,360 .49 .48 Fourth quarter 6,594 3,614 1,445 .52 .52
REPORT OF INDEPENDENT AUDITORS
Board of Directors Bourbon Bancshares, Inc. Paris, Kentucky
We have audited the accompanying consolidated balance sheets of Bourbon Bancshares, Inc. as of December 31, 2002 and 2001, and the related consolidated statements of income, comprehensive income, changes in stockholders' equity and cash flows for each of the three years in the period ended December 31, 2002. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Bourbon Bancshares, Inc. as of December 31, 2002 and 2001, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2002, in conformity with accounting principles generally accepted in the United States of America.
As disclosed in Note 1 to the consolidated financial statements, on January 1, 2001 the Company changed its method of accounting for derivative instruments and hedging activities to comply with new accounting guidance.
Crowe, Chizek and Company LLP
Lexington, Kentucky January 17, 2003
MEET OUR OFFICERS. BOURBON COUNTY. PARIS SENIOR MANAGEMENT Buckner Woodford - Chairman and CEO Louis Prichard - President and COO Norman J. Fryman - Sr. Vice President, Director of Lending James P. Shipp, Jr. - Sr. Vice President, Director of Branch Administration Brenda Bragonier - Vice President, Director of Marketing 	and Human Resources Hugh Crombie - Vice President, Director of Operations Greg Dawson - Vice President, Chief Financial Officer
OFFICERS Heather Barger - Auditor Brenda Berry - Accountant Wallis Brooks - Branch Manager Patty Carpenter - Assistant Vice President, Loan Operations Officer R.W. Collins, Jr. - Vice President, Agricultural Lender Cynthia Criswell - Data Processing Officer Nancye Fightmaster - Vice President, Loan Officer Shane Foley - Mortgage Operations Manager David Foster - Vice President, Agricultural Lender Janice Hash - Accountant and Purchasing Agent Lisa Highley - Personal Trust Officer Cathy Hill - Vice President, Director of Collections Perry Ingram - Assistant Vice President, Network Manager Gary Linville - Assistant Vice President, Collections Negotiator Jane Mogge - Head Deposit Operations Mary Moreland - Assistant Vice President, Loan Officer Donald Roe - Assistant Vice President, Sr. Data Processing Officer Rowena Ruff - Investment Advisor Lydia Sosby - Corporate and Automated Products Officer Judy Taylor - Assistant Vice President, Human Resource Manager Rick Wagner - Maintenance Supervisor Lisa Watkins - Compliance Officer George Wilder - Vice President, Loan Officer Buck Woodford, V. - Management Intern Martha Woodford - Assistant Vice President, Corporate and Automated Products Manager Jan Worth - Assistant Vice President, Sr. Personal Trust Officer
Lexington Road Branch Susan A. Lemons - Assistant Vice President, Branch Manager/Loan Officer
Pleasant Street Branch Philip Hurst - Assistant Branch Manager
CLARK COUNTY. WINCHESTER Rita Bugg - Vice President, Regional Manager Darren Henry, Vice President, Loan Officer Kathy Newkirk - Branch Manager, Loan Officer Teresa Shimfessel - Assistant Vice President, Loan Officer Rebecca Taulbee - Vice President, Loan Officer Carolyn Wilkins - Overdraft Management Officer
HARRISON COUNTY. CYNTHIANA Ken DeVasher - Vice President, Regional Manager Paul Clift - Assistant Vice President, Loan Officer
JESSAMINE COUNTY. NICHOLASVILLE Michael Lovell - Vice President, Regional Manager Rick Walling - Assistant Vice President, Loan Officer
SCOTT COUNTY. Georgetown Ben Sargent - Vice President, Branch Manager
WOODFORD COUNTY. VERSAILLES Duncan Gardner - Vice President, Regional Manager A.J. Gullett - Assistant Vice President, Loan Officer
Board of Directors Kentucky Bank
Buckner Woodford Chairman, Chief Executive Officer
William M. Arvin Attorney
James L. Ferrell Physician
K. Bruce Florence Director, Licking Valley College
Henry Hinkle President, Hinkle Contracting Company
Mike Hockensmith Owner and President, The Hockensmith Agency, Inc.
James Kay Businessman, Farmer
Theodore Kuster Farmer and Thoroughbred Breeder, West View Equine
Ted McClain Agent, Hopewell Insurance Company, Inc.
Jonah Mitchell President, Johan Mitchell Real Estate and Auction Company
Donald Pace Executive Director of Central Kentucky Educational Co-op with UK
Louis Prichard President, COO
William R. Stamler Chairman, Signal Investments, Inc.
Robert G. Thompson Executive Director, Paris-Bourbon County YMCA
Gerald M. Whalen President, Whalen and Company
REGIONAL BOARD OF DIRECTORS CLARK COUNTY
Mary Beth Hendricks Director of Clark County Child Support Services
Donald Pace Executive Director of Central Kentucky Educational Co-op with UK
John G. Roche Optician
Ed Saunier President, Saunier North American, Inc.
James Taulbee Farmer
REGIONAL BOARD OF DIRECTORS HARRISON COUNTY
K. Bruce Florence Director, Licking Valley College
Brad Marshall Farmer
Joel Techau CEO, Techau Inc.
Gerald M. Whalen President, Whalen and Company
REGIONAL BOARD OF DIRECTORS JESSAMINE COUNTY
William M. Arvin Attorney
Dan Brewer Bluegrass RECC
Tom Buford Kentucky Senator
Eva McDaniel Jessamine County Clerk
Jonah Mitchell President, Jonah Mitchell Real Estate and Auction Company
REGIONAL BOARD OF DIRECTORS SCOTT COUNTY
Dr. Gus Bynum Physician
Mike Hockensmith Owner and President, The Hockensmith Agency, Inc.
R.C. Johnson, Jr. Owner and President, Johnson's Funeral Home
George Lusby County Judge Executive
Everette Varney Mayor, Georgetown
REGIONAL BOARD OF DIRECTORS WOODFORD COUNTY
Loren Carl Director, Kentucky Attorney General's Office
Dr. William J. Graul Physician
James Kay Businessman, Farmer
Tricia Kittinger Woodford Circuit Clerk
Bourbon Bancshares, Inc. Board of Directors
Buckner Woodford President and Chief Executive Officer, Bourbon Bancshares, Inc. Class of 2003
William R. Stamler Chairman, Signal Investments, Inc. Class of 2003
Henry Hinkle President, Hinkle Contracting Corporation Class of 2005
Robert G. Thompson Executive Director, Paris/Bourbon County YMCA; Snow Hill Farm Class of 2005
Theodore Kuster Farmer and Thoroughbred Breeder, West View Farm Class of 2005
James L. Ferrell, M.D. Physician; Chairman, Bourbon Bancshares, Inc. Class of 2004
William M. Arvin Attorney, William M. Arvin Associates Class of 2004
Exhibit 21 Subsidiaries of Registrant
Bourbon Bancshares, Inc.'s Subsidiary
Kentucky Bank
EXHIBIT 23
CONSENT OF INDEPENDENT AUDITORS
We hereby consent to the incorporation by reference in the Form S-8 Registration Statement No. 333-92725 of Bourbon Bancshares, Inc., of our report dated January 17, 2003 on the consolidated financial statements of Bourbon Bancshares, Inc. as of December 31, 2002 and 2001 and for each of the three years in the period ended December 31, 2002 as included in the registrant's annual report on Form 10-K.
/s/Crowe, Chizek and Company LLP Crowe, Chizek and Company LLP
Lexington, Kentucky March 28, 2003
Exhibit 99.1 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 Annual Report of Bourbon Bancshares, Inc. (the "Company") on Form 10-K for the period ended December 31, 2002 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Buckner Woodford, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes- Oxley Act of 2002, that to my knowledge:
(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 result of operations of the Company.
___/s/ Buckner Woodford_____ Chief Executive Officer
March 31, 2003
A signed original of this written statement required by Section 906 has been provided to Bourbon Bancshares, Inc. and will be retained by Bourbon Bancshares, Inc. and furnished to the Securities and Exchange Commission or its staff upon request.
Exhibit 99.2 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 Annual Report of Bourbon Bancshares, Inc. (the "Company") on Form 10-K for the period ended December 31, 2002 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Gregory J. Dawson, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes- Oxley Act of 2002, that to my knowledge:
(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 result of operations of the Company.
___/s/ Gregory J. Dawson____ Chief Financial Officer
March 31, 2003
A signed original of this written statement required by Section 906 has been provided to Bourbon Bancshares, Inc. and will be retained by Bourbon Bancshares, Inc. and furnished to the Securities and Exchange Commission or its staff upon request.
BOURBON BANCSHARES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2000, 1999 and 1998
42.
74. BOURBON BANCSHARES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2002, 2001 and 2000