Item 1. Business
General
Kentucky Bancshares, Inc. ("Company" or "Kentucky") is a Kentucky corporation organized in 1981 and a bank 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, Cynthiana (Harrison County), Georgetown (Scott County), Morehead (Rowan County), Nicholasville (Jessamine County), North Middletown (Bourbon County), Sandy Hook (Elliott County), Versailles (Woodford County), Wilmore (Jessamine County) and Winchester (Clark 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. Some of the Company's competitors are not subject to the same degree of regulatory review and restrictions that apply to the Company and its subsidiary bank. In addition, the Company must compete with much larger financial institutions that have greater financial resources than the Company.
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 Office 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. 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.
In addition to the laws and regulations discussed above, Kentucky Bank is also subject to certain consumer laws and regulations that are designed to protect consumers in transactions with banks. While the list set forth herein is not exhaustive, these laws and regulations include the Truth in Lending Act, the Truth in Savings Act, the Electronic Funds Transfer Act, the Expedited Funds Availability Act, the Equal Credit Opportunity Act, the Real Estate Settlement Procedures Act, the Fair Housing Act and the Fair and Accurate Transactions Act, among others. These laws and regulations mandate certain disclosure requirements and regulate the manner in which financial institutions must deal with clients when taking deposits or making loans. These laws also limit Kentucky Bank's ability to share information with affiliated and unaffiliated entities. The bank must comply with the applicable provisions of these consumer protection laws and regulations as part of its ongoing business operations.
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. Dividends paid by the subsidiary bank have provided substantially all of the Company's operating funds, and this may reasonably be expected to continue for the foreseeable future.
Employees
At December 31, 2006, the number of full time equivalent employees of the Company was 203.
Item 1A.
Item 1A. Risk Factors
There are factors, many beyond our control, which may significantly change the results or expectations of the Company. Some of these factors are described below in the sections titled financial risk, business risk and operational risk. These risks are not totally independent of each other. Some factors affect more than one type of risk. These include regulatory, economic, and competitive environments. As part of the annual audit plan, our internal risk management department meets with management to assess these risks throughout the Company. Many risks are further addressed in other sections of this Form 10-K document.
The exercise of regulatory power may have negative impact on the Company's results of operations and financial condition. The Company is subject to extensive regulation, supervision and examination by federal and state banking authorities. Any change in applicable regulations or federal or state legislation could have a substantial impact on our operations. Additional legislation and regulations may be enacted or adopted in the future that could significantly affect the Company's powers, authority and operations, which could have a material adverse effect on the financial condition and results of operations. Further, regulators have significant discretion and power to prevent or remedy unsafe or unsound practices or violations of laws by banks and bank holding companies in the performance of their supervisory and enforcement duties.
Significant decline in general economic conditions, locally and nationally, will negatively affect the financial results of the Company's banking operations. The Company's success depends on general economic conditions both locally and nationally. Most of our customers are in the Central Kentucky area. Our customers are directly impacted by the local economy, as well as the national or global economies. Local economic conditions (such as the effect of the tobacco buyout on the agricultural industry) have an impact on the demand of customers for loans, the ability of some borrowers to repay these loans and the value of the collateral securing these loans. Factors influencing general national economic conditions include the change in interest rates (particularly mortgage lending rates), oil prices, inflation, recession and unemployment. As these factors impact the overall business climate, they can have a significant effect on loan demand. Loan growth is critical to our profitability.
The Company faces vigorous competition from banks and other financial institutions. This competition may reduce or limit our margins on banking services, reduce market share and adversely affect results of operations and financial condition. A number of these banks and other financial institutions have substantially greater resources and lending limits, larger branch systems and a wider array of banking services. Additionally, the Company encounters competition from both de novo and smaller community banks entering the markets we are currently in. The Company also competes with other providers of financial services, such as money market mutual funds, brokerage firms, consumer finance companies and insurance companies.
Financial Risk
Financial risk components include, but are not limited to, credit risk, interest rate risk, market risk and liquidity risk. The Company has adopted various policies to minimize potential adverse effects of interest rate, market and liquidity risks. However, even with these policies in place, a change in interest rates could negatively impact the Company's results of operations or financial position.
Defaults in the repayment of loans may negatively impact our business. Credit risk is most closely associated with lending activities at financial institutions. Credit risk is the risk to earnings and capital when a customer fails to meet the terms of any contract or otherwise fails to perform as agreed. Credit risk arises from all activities where the Company is dependent on issuer, borrower, or counterparty performance, not just traditional lending activities. For example, the investment security portfolio has inherent credit risk as do counterparties in derivative contracts. Credit risk encompasses a broad range of financial institution activities and includes items reflected both on and off the balance sheet.
Management makes various assumptions and judgments about the collectibility of the Company's loan portfolio, including the creditworthiness of its borrowers and the value of real estate and other assets serving as collateral for repayment of many of the loans. In determining the size of the allowance for loan losses, management considers, among other factors, the Company's loan loss experience and an evaluation of economic conditions. If these assumptions prove to be incorrect, the current allowance may not be sufficient to cover future loan losses and adjustments may be necessary to allow for different economic conditions or adverse developments in the loan portfolio. Material additions to the Company's allowance would materially decrease our net income.
Fluctuations in interest rates may negatively impact our banking business. Interest rate risk focuses on the impact to earnings and capital arising from movements in interest rates. Interest rate risk focuses on the value implications for accrual portfolios (e.g., held-to-maturity and available- for-sale portfolios) and includes the potential impact to the Company's accrual earnings as well as the economic perspective of the market value of portfolio equity. The interest rate risk is comprised of repricing risk, basis risk, yield curve risk and options risk. Repricing risk represents the risk associated with the differences in timing of cash flows and rate changes with the Company's products. Basis risk represents the risk associated with changing rate relationships among varying yield curves. Yield curve risk is associated with changing rate relationships over the maturity structure. Options risk is associated with interest-related options, which are embedded in our products.
Changes in market factors may negatively affect the value of our investment assets. Market risk focuses on the impact to earnings and capital arising from changes in market factors (e.g., interest rates, market liquidity, volatilities, etc.) that affect the value of traded instruments. Market risk includes items reflected both on and off the balance sheet. Market risk focuses primarily on mark-to-market portfolios (e.g., accounts revalued for financial statement presentation), including trading accounts and certain derivatives.
Our inability to maintain appropriate levels of liquidity may have a negative impact on our results of operations and financial condition. Liquidity risk focuses on the impact to earnings and capital resulting from the Company's inability to meet its obligations as they become due in the normal course of business without incurring significant losses. It also includes the management of unplanned decreases or changes in funding sources as well as managing changes in market conditions, which could affect the ability to liquidate assets in the normal course of business without incurring significant losses. Liquidity risk includes items both on and off the balance sheet.
Business Risk
Business risk is composed mainly of legal (compliance) risk, strategic risk and reputation risk.
Our results of operations and financial condition are susceptible to legal or compliance risks. Legal or compliance risk is the risk to earnings or capital arising from the impact of unenforceable contracts, lawsuits, adverse judgments, violations or nonconformance with laws, rules, regulations, prescribed practices, or ethical standards. The risk also arises in situations where laws or rules governing certain products or activities of our customers may be ambiguous or untested. This risk is not limited to the traditional thinking that legal/compliance risk is only associated with consumer protection laws. It includes the exposure to litigation from all aspects of both traditional and nontraditional financial institution activities.
Incorrect strategic decisions may have a negative impact on our results of operations and financial condition. Strategic risk is the risk to earnings and capital arising from adverse business decisions or improper implementation of those decisions. Strategic risk focuses on more than an analysis of the written strategic plan. Its focus is on how plans, systems and implementation affect franchise value. It also incorporates how management analyzes external factors that affect the Company's strategic direction.
Adverse publicity may have a negative impact on our business. Reputation risk is the risk to earnings and capital arising from negative public opinion. This affects the ability to establish new relationships or services or to continue servicing existing relationships. Examiners will assess reputation risk by recognizing the potential effect the public's opinion could have on the Company's franchise value.
Operational Risk
An inability to process transactions may have a negative impact on our business. Operational risk is present on a daily basis through the Company's processing of transactions and is pervasive in all products and services provided to our customers. It can be defined as the impact to earnings and capital from problems encountered in processing transactions. Operational risk is a function of internal controls, operating processes, management information systems, and employee integrity.
Item 1B.
Item 1B. Unresolved Staff Comments
None.
Item 2.
Item 2. Properties
The main banking office of Kentucky Bank, which also serves as the principal office of Kentucky Bancshares, Inc., is located at 339 Main Street, Paris, Kentucky 40361. In addition, Kentucky Bank serves customer needs at 13 other locations. All locations offer a full range of banking services. Kentucky Bank owns all of the properties at which it conducts its business. The Company owns approximately 83,000 square feet of office space.
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 traded on the OTC Bulletin Board under the symbol "KTYB.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 closing sales prices of the Common Stock from the OTC Bulletin Board and the dividends declared thereon, for the periods indicated below:
High Low Dividend
2006 Quarter 4 $32.00 $29.50 $.25 Quarter 3 30.00 26.65 .25 Quarter 2 29.75 27.00 .25 Quarter 1 30.00 29.00 .25
2005 Quarter 4 $30.50 $29.25 $.23 Quarter 3 30.50 29.50 .23 Quarter 2 30.50 28.05 .23 Quarter 1 31.00 29.25 .23
Note 16 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, 2006 the Company had 2,864,586 shares of Common Stock outstanding and approximately 501 holders of record of its Common Stock.
The table below lists issuer purchases of equity securities.
Period (a) Total (b) (c) Total Number (d) Maximum Number Number of Average of Shares (or Units) (or Approximate Dollar Shares (or Price Paid Purchased as Part Value) of Shares (or Units) Per Share of Publicly Units) that May Yet Be Purchased (or Unit) Announced Plans Purchased Under the Or Programs Plans or Programs
10/1/06 - 10/31/06 400 $29.50 400 82,140 shares
11/1/06 - 11/30/06 -0- N/A N/A 82,140 shares
12/1/06 - 12/31/06 350 31.00 350 81,790 shares
Total 750 750 81,790 shares
On October 25, 2000, the Company announced that its Board of Directors approved a stock repurchase program. The Company is authorized to purchase up to 100,000 shares of its outstanding common stock. On November 11, 2002, the Board of Directors approved and authorized the Company's repurchase of an additional 100,000 shares. Shares will be purchased from time to time in the open market depending on market prices and other considerations. Through December 31, 2006, 118,210 shares have been purchased, with the most recent share repurchase under the Board-approved stock repurchase program having occurred on December 20, 2006.
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.
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 2006 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 loans and the allowance for loan losses. Different assumptions in the application of these policies could result in material changes in the consolidated financial position or consolidated results of operations.
Loans are stated at the amount of unpaid principal, reduced by an allowance for loan losses. Interest on loans is recognized on the accrual basis, except for those loans on the nonaccrual status. Interest income received on such loans is accounted for on the cash basis or cost recovery method. The allowance for loan losses is a valuation allowance for probable incurred credit losses. Management estimates the allowance balance required using past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions, and other factors. The accounting policies relating to the allowance for loan losses involve the use of estimates and require significant judgments to be made by management.
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, regulation and monetary policy (which changes from time to time and over which the Company has no control); changes in interest rates (both generally and more specifically mortgage interest rates); material unforeseen changes in the liquidity, results of operations, or financial condition of the Company's customers; 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.
Overview
Net income for the year ended December 31, 2006 was $6.5 million, or $2.35 per common share compared to $5.8 million, or $2.17 for 2005 and $5.8 million, or $2.09 for 2004. Earnings per share assuming dilution were $2.34, $2.16 and $2.07 for 2006, 2005 and 2004, respectively. For 2006, net income increased $666 thousand, or 11%. Net interest income increased $1.7 million, the loan loss provision decreased $33 thousand, other income increased $741 thousand, while total other expenses increased $1.5 million. In July 2006, the Company purchased Peoples Bancorp of Sandy Hook, Inc. (Peoples Bancorp) and its subsidiary, Peoples Bank (Peoples) of Sandy Hook,to strengthen its business and grow its customer base.
For 2005, net income increased $58 thousand, or 1%. Net interest income increased $352 thousand, the loan loss provision decreased $332 thousand, other income decreased $52 thousand, while total other expenses increased $715 thousand.
Return on average equity was 12.8% in 2006 compared to 12.7% in 2005 and 12.6% in 2004. Return on average assets was 1.09% in 2006 compared to 1.08% in 2005 and 1.11% in 2004.
Non-performing loans as a percentage of loans (including held for sale) were 0.59%, 0.26% and 0.58% as of December 31, 2006, 2005 and 2004, respectively.
RESULTS OF OPERATIONS
Net Interest Income
Net interest income, the Company's largest source of revenue, on a tax equivalent basis increased from $17.4 million in 2004 to $17.7 million in 2005 and to $19.5 million in 2006. The taxable equivalent adjustment (nontaxable interest income on state and municipal obligations 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 2005 to 2006. Average earning assets increased $53 million, or 10%. Investment securities increased $15 million primarily due to the Peoples acquisition in July 2006. Loans increased $46 million as a result of the acquisition and improved loan demand. Average interest bearing liabilities increased $44 million, or 10% during this same period. This change was primarily from the acquisition less the loss of some public funds on deposit. The Company continues to actively pursue quality loans and fund these primarily with deposits and FHLB advances.
During the second half of 2004 rates started increasing and this pattern continued into the middle of 2006. Bank prime rates increased 125 basis points during 2004, another 200 basis points in 2005 and another 100 basis points in 2006. As a result of this, the tax equivalent yield on earning assets increased from 5.82% in 2005 to 6.47% in 2006.
The volume rate analysis that follows, during 2006, indicates that $3.4 million of the increase in interest income is attributable to the change in volume, while the higher level of rates contributed to an increase of $3.3 million in interest income. This higher level of rates also caused an increase in the cost of interest bearing liabilities. The average rate of these liabilities increased from 2.82% in 2005 to 3.62% in 2006. In addition, the change in volume contributed to an increase of $1.3 million in interest expense, while the higher level of rates was responsible for a $3.7 million increase in interest expense. As a result, the 2006 net interest income increase is primarily attributed to increases in volume.
The volume rate analysis for 2005 that follows indicates that $1.4 million of the increase in interest income is attributable to the change in volume, while the increase in rates contributed to an increase of $1.7 million in interest income. The rate increase also caused an increase in the cost of interest bearing liabilities. The average rate of these liabilities increased from 2.25% in 2004 to 2.82% in 2005. Based on the volume rate analysis that follows, the change in volume contributed to an increase of $293 thousand to interest expense, while the increase in rates was responsible for a $2.4 million increase in interest expense. As a result, the 2005 net interest income increase is attributed to increases in volume reduced by the negative impact of increases in rates, more on the liability side than the asset side.
In spite of the positive impact on net interest income that may result from the increasing rate environment beginning in 2004 and continued into the first half of 2006, competitive pressures on interest rates will continue and are likely to result in only modest changes in net interest margins.
The accompanying analysis of changes in net interest income in the following table shows the relationships of the volume and rate portions of these changes in 2006 and 2005. 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 $7.2 million in 2006 compared to $6.5 million in 2005 and 2004. In 2006, increasing service charges and increasing trust fees account for the majority of the increase. Similarly, service charges and trust department income increased in 2005, but were offset by a reduction in securities gains in 2005.
Securities gains were $34 thousand in 2006, $64 thousand in 2005 and $289 thousand in 2004. The lower gains in 2006 and 2005 are more normal and primarily attributable to rising interest rates and the related inverse relationship of interest rates and market values. Some equity gains were taken in 2006 and used to offset losses on sales of agency and municipal securities. The gains in 2004 were primarily a result of the Company taking advantage of the inverse relationship of interest rates and market values, and municipal securities being called at premiums before their maturities. In addition, U. S. Treasury securities were sold before maturity to restructure the portfolio and extend out the yield curve.
Gains on loans sold were $290 thousand, $334 thousand and $376 thousand in 2006, 2005 and 2004, respectively. Loans held for sale are generally sold after closing to the Federal Home Loan Mortgage Corporation. During 2006, the loan service fee income increased $24 thousand, compared to an increase of $12 thousand in 2005. Proceeds from the sale of loans were $17 million, $18 million and $30 million in 2006, 2005 and 2004, respectively. The volume of loan originations is inverse to rate changes. The volume of loan originations during 2006 was $17 million, comparable to $18 million in 2005, but down from $22 million in 2004.
Other noninterest income excluding security net gains and gain on sale of mortgage loans was $6.9 million in 2006, $6.1 million in 2005 and $5.9 million in 2004. Service charge income, and more particularly overdraft income, is the largest contributor to these numbers. Overdraft income was $4.1 million in 2006, $3.4 million in 2005 and $3.4 million in 2004. The increase in 2006 is primarily attributable to the Peoples acquisition in July 2006. Other income has remained steady with $1.2 million in 2004, $1.1 million in 2005 and $1.1 million in 2006.
Noninterest expense increased $1.5 million in 2006 to $16.7 million, and increased $715 thousand in 2005 to $15.2 million from $14.5 million in 2004. The increases in salaries and benefits from $8.1 million in 2004 to $8.5 million in 2005 and to $9.6 million in 2006 are attributable to normal salary and benefit increases, and in 2006 to the Peoples acquisition. Bonus compensation was $160 thousand higher in 2006 compared to 2005 and $124 thousand higher in 2005 compared to 2004. The 2006 increase is from higher compensation and improved net income, while the 2005 increase is mainly a result of additional sales incentives. Occupancy expense decreased $61 thousand in 2005 to $2.2 million and increased $126 thousand, or 6% in 2006 to $2.3 million. The largest expense, depreciation, decreased $69 thousand to $924 thousand in 2005, but increased $32 thousand to $956 thousand in 2006. Other noninterest expense increased from $4.2 million in 2004 to $4.5 million in 2005 and increased to $4.7 million in 2006. Amortization of core deposits related to the Peoples acquisition was $89 thousand in 2006. See Note 6 in the notes to consolidated financial statements included as Exhibit 13 for more detail of the goodwill and intangible assets.
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) 2006 2005 2004 NON-INTEREST INCOME Service Charges $ 5,224 $ 4,511 $ 4,358 Loan Service Fee Income, net 33 9 (3) Trust Department Income 603 458 299 Investment Securities Gains (Losses),net 34 65 289 Gains on Sale of Mortgage Loans 290 334 376 Other 1,052 1,118 1,228 Total Non-interest Income 7,236 6,495 6,547
NON-INTEREST EXPENSE Salaries and Employee Benefits 9,613 8,548 8,053 Occupancy Expenses 2,320 2,194 2,255 Other 4,749 4,478 4,198 Total Non-interest Expense 16,682 15,220 14,506
Net Non-interest Expense as a Percentage of Average Assets 1.58% 1.62% 1.53%
Income Taxes
The Company had income tax expense of $2.5 million in 2006 and $2.1 million in 2005 and $2.2 million in 2004. This represents an effective income tax rate of 27.6% in 2006, 26.3% in 2005 and 27.8% in 2004. 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 and loans.
Balance Sheet Review
Assets grew from $573 million at December 31, 2005 to $630 million at December 31, 2006. Loan growth was $73 million in 2006. Nearly $51 million was a result of the Peoples acquisition. See Note 15 in the notes to consolidated financial statements included as Exhibit 13 for additional information on the business combination. Deposits grew $37 million and FHLB borrowings grew $13 million. The gain in deposits is primarily from $72 million obtained from the Peoples acquisition. The other decrease is primarily from the loss of public money and a large certificate of deposit customer. Assets at year-end 2005 totaled $573 million compared to $529 million in 2004. In 2005, loan growth was $13 million and deposit growth was $44 million. FHLB borrowings increased $7 million.
Loans
Total loans (including loans held for sale) were $444 million at December 31, 2006 compared to $371 million at the end of 2005 and $358 million in 2004. Loan growth continued to improve in 2006. The increase is mainly attributable to improved loan demand and $51 million from the Peoples acquisition. As of the end of 2006 and compared to the prior year-end, commercial loans increased $2.0 million, real estate construction loans decreased $.8 million, real estate mortgage loans (including loans held for sale) increased $45.0 million, agricultural loans increased $20.3 million and installment loans increased $6.7 million. As of the end of 2005 and compared to the prior year-end, commercial loans increased $7.3 million, real estate construction loans decreased $2.4 million, real estate mortgage loans (including loans held for sale) increased $6.7 million, agricultural loans increased $1.8 million and installment loans decreased $109 thousand.
As of December 31, 2006, the real estate mortgage portfolio comprised 65% of total loans compared to 66% in 2005. Of this, 1-4 family residential property represented 61% in 2006 and 65% in 2005. Agricultural loans comprised 18% in 2006 and 16% in 2005 of the loan portfolio. Approximately 72% of the agricultural loans are secured by real estate in 2006 compared to 82% in 2005. 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 40% in 2006 and 33% in 2005 of the consumer loan portfolio, while the purpose of the remainder of this portfolio is used by customers for purchasing retail goods, home improvement or other personal reasons. The commercial loan portfolio is mainly for capital outlays and business operation. Collateral is requested depending on the creditworthiness of the borrower. Unsecured loans are made to individuals or companies mainly based on the creditworthiness of the customer. Approximately 5% 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. The Company has no foreign loans or highly leveraged transactions in its loan portfolio.
Loans Outstanding At December 31 (in thousands) 2006 2005 2004 2003 2002 Commercial $ 29,335 $ 27,302 $ 19,999 $ 14,278 $ 16,803 Real Estate Construction 29,034 29,822 32,256 14,313 15,514 Real Estate Mortgage 290,324 245,326 238,661 222,342 182,958 Agricultural 79,627 59,328 57,497 56,615 52,188 Installment 15,684 8,954 9,062 12,978 17,134 Other 402 368 991 289 309 Total Loans 444,406 371,100 358,466 320,815 284,906 Less Deferred Loan Fees 256 188 10 54 12 Total Loans, Net of Deferred Loan Fees 444,150 370,912 358,456 320,761 284,894 Less loans held for sale 0 0 175 7,759 740 Less Allowance For Loan Losses 4,991 4,310 4,163 3,820 3,395 Net Loans 439,159 366,602 354,118 309,182 280,759
The following table sets forth the maturity distribution and interest sensitivity of selected loan categories at December 31, 2006. Maturities are based upon contractual term. The total loans in this report represent loans net of deferred loan fees, including loans held for sale but excluding the allowance for loan losses. In addition, deferred loan fees on the above schedule is netted with real estate mortgage loans on the following schedule.
Loan Maturities and Interest Sensitivity
At December 31, 2006 (in thousands) One Year One Through Over Total or Less Five Years Five Years Loans Commercial $ 15,917 $ 10,685 $ 2,733 $ 29,335 Real Estate Construction 23,662 5,290 82 29,034 Real Estate Mortgage 32,213 152,256 105,599 290,068 Agricultural 15,510 45,568 18,549 79,627 Installment 5,339 9,428 917 15,684 Other 402 0 0 402 Total Loans, Net of Deferred Loan Fees 93,043 223,227 127,880 444,150 Fixed Rate Loans 29,972 194,095 41,825 265,892 Floating Rate Loans 63,071 29,132 86,055 178,258 Total Loans, Net of Deferred Loan Fees 93,043 223,227 127,880 444,150
Mortgage Banking
The Company has been in Mortgage Banking since the early 1980's. The activity in origination and sale of these loans fluctuates, mainly due to changes in interest rates. Mortgage loan originations decreased from $22 million in 2004 to $18 million in 2005, to $17 million in 2006. Proceeds from the sale of loans were $17 million, $18 million and $30 million for the years 2006, 2005 and 2004, respectively. Mortgage loans held for sale were zero at December 31, 2006 and December 31, 2005. Loans are generally sold when they are made. The volume of loan originations is inverse to rate changes. The rate environment has been rising, resulting in decreased loan originations in 2006 and 2005. The effect of these changes was also reflected on the income statement. As a result, the gain on sale of mortgage loans was $290 thousand in 2006 compared to $334 thousand in 2005 and $376 thousand in 2004.
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 expected 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 $746 thousand at December 31, 2006, $802 thousand at December 31, 2005 and $876 thousand at December 31, 2004. Amortization of mortgage servicing rights was $235 thousand, $254 thousand and $249 thousand for the years ended December 31, 2006, 2005 and 2004, respectively. See Note 4 in the notes to consolidated financial statements included as Exhibit 13 for additional information.
Deposits
Total deposits increased to $469 million in 2006, up $37 million from 2005. Noninterest bearing deposits increased $15 million, time deposits of $100 thousand and over increased $6 million, and other interest bearing deposits increased $16 million. Public funds totaled $60 million at the end of 2006 ($59 million were interest bearing), a decrease of $25 million from the end of 2005.
For 2005, total deposits increased $44 million to $432 million. Noninterest bearing deposits decreased $2 million, while time deposits of $100 thousand and over increased $2 million, and other interest bearing deposits decreased $44 million. Public funds totaled $85 million at the end of 2005 ($84 million were interest bearing).
The table below provides information on the maturities of time deposits of $100,000 or more at December 31, 2006:
Maturity of Time Deposits of $100,000 or More
At December 31, 2006 (in thousands) Maturing 3 Months or Less $14,408 Maturing over 3 Months through 6 Months 16,958 Maturing over 6 Months through 12 Months 23,400 Maturing over 12 Months 12,489
Total $67,255
Borrowings
The Company utilizes both long and short term borrowing. Long term borrowing at the Bank is mainly from the Federal Home Loan Bank (FHLB). This borrowing is mainly used to fund longer term, fixed rate mortgages, as part of a leverage strategy and to assist in asset/liability management. Advances are either paid monthly or at maturity. As of December 31, 2006, $80 million was borrowed from FHLB, an increase of $13 million from 2005. In 2006, $83 million of FHLB advances were paid, and advances were made for an additional $90 million. The remaining $7 million was obtained in the Peoples acquisition. FHLB advances were $67 million at December 31, 2005. During 2005, $8 million of FHLB borrowing was paid, and advances were made for an additional $15 million. The 2005 advances were obtained mainly to fund fixed rate loans, 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) 2006 2005 2004 Federal Funds Purchased: Balance at Year end $ - $ 1,470 $ 6,383 Average Balance During the Year 8,616 3,001 3,706 Maximum Month End Balance 27,723 15,919 11,306 Year end rate 0.00% 4.25% 2.50% Average annual rate 5.37% 2.95% 1.52% Repurchase Agreements: Balance at Year end $ 9,628 $14,346 $18,314 Average Balance During the Year 15,661 16,014 18,398 Maximum Month End Balance 18,372 18,072 21,947 Year end rate 3.83% 3.18% 2.94% Average annual rate 3.79% 3.19% 1.90% Other Borrowed Funds: Balance at Year end $ 1,699 $ 1,021 $ 896 Average Balance During the Year 1,719 457 343 Maximum Month End Balance 8,508 1,021 1,011 Year end rate 5.90% 4.00% 1.87% Average annual rate 6.15% 3.10% 1.51%
Contractual Obligations
The Bank has required future payments for a defined benefit retirement plan, time deposits and long-term debt. See Note 13 in the notes to consolidated financial statements included as Exhibit 13 for further information on the defined benefit retirement plan. The other required payments under such commitments at December 31, 2006 are as follows:
Payments due by period (in thousands) Less More than 1 1-3 3-5 than 5 Contractual Obligations Total year years years years
FHLB advances $ 79,980 $ 15,909 $52,201 $ 7,181 $ 4,689 Subordinated debentures 7,217 - - - 7,217 Time deposits 229,277 193,592 33,931 1,754 -
Asset Quality
With respect to asset quality, management considers three categories of assets to merit close scrutiny. These categories include: loans that are currently nonperforming, other real estate, and loans that are currently performing but which management believes require special attention.
During periods of economic slowdown, the Company may experience an increase in nonperforming loans.
The Company discontinues the accrual of interest on loans that become 90 days past due as to principal or interest unless reasons for delinquency are documented such as the loan being well collateralized and in the process of collection. A loan remains in a non-accrual status until factors indicating doubtful collection no longer exist. A loan is classified as a restructured loan when the interest rate is materially reduced or the term is extended beyond the original maturity date because of the inability of the borrower to service the interest payments at market rates. Other real estate is recorded at fair 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) 2006 2005 2004 2003 2002 Non-accrual Loans $2,379 $ 774 $1,781 $1,844 $1,573 Accruing Loans which are Contractually past due 90 days or more 253 206 308 779 789 Restructured Loans 0 0 0 0 0 Total Nonperforming Loans 2,632 980 2,089 2,623 2,362 Other Real Estate 411 141 676 375 172 Total Nonperforming Assets 3,043 1,121 2,765 2,998 2,534 Total Nonperforming Loans as a Percentage of Loans (including loans held for sale) (1) 0.59% 0.26% 0.58% 0.82% 0.83% Total Nonperforming Assets as a Percentage of Total Assets 0.48% 0.20% 0.52% 0.60% 0.60% Allowance to nonperforming assets 1.64 3.84 1.51 1.27 1.34
(1) Net of deferred loan fees
Total nonperforming assets at December 31, 2006 were $3.0 million compared to $1.1 million at December 31, 2005 and $2.8 million at December 31, 2004. The increase from 2005 to 2006 is attributable to the increase in various loans being put on non-accrual and additions to other real estate. Total nonperforming loans were $2.6 million, $1.0 million, and $2.1 million at December 31, 2006, 2005 and 2004, respectively. The non-accrual loan increase from 2005 to 2006 is mainly attributable to 6 loans secured by real estate greater than $100,000, but less than $325,000. The amount of lost interest on our non-accrual loans is immaterial. At December 31, 2006, 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, 2006 were $2.4 million compared to $800 thousand in 2005 and $1.8 million in 2004. 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 $553 thousand, $240 thousand and $416 thousand on December 31, 2006, 2005 and 2004, 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) 2006 2005 2004 2003 2002 Balance at Beginning of Year $ 4,310 $ 4,163 $ 3,820 $ 3,395 $ 3,386 Balance of Allowance for Loan Losses of Acquired Bank at Acquisition Date 775 0 0 363 0 Amounts Charged-off: Commercial 15 146 197 569 536 Real Estate Construction 28 0 0 0 18 Real Estate Mortgage 232 134 110 276 69 Agricultural 3 21 88 24 5 Consumer 365 225 293 529 701 Total Charged-off Loans 643 526 688 1,398 1,329 Recoveries on Amounts Previously Charged-off: Commercial 2 3 10 11 15 Real Estate Mortgage 2 11 42 1 19 Agricultural 21 16 21 21 10 Consumer 49 135 118 127 90 Total Recoveries 74 165 191 160 134 Net Charge-offs 569 361 497 1,238 1,195 Provision for Loan Losses 475 508 840 1,300 1,204 Balance at End of Year 4,991 4,310 4,163 3,820 3,395 Total Loans (1) Average 408,131 361,732 338,465 290,502 281,105 At December 31 444,150 370,912 358,456 320,761 284,894 As a Percentage of Average Loans (1): Net Charge-offs 0.14% 0.10% 0.15% 0.43% 0.43% Provision for Loan Losses 0.12% 0.14% 0.25% 0.45% 0.43% Allowance as a Percentage of Year-end Loans (1) 1.12% 1.16% 1.16% 1.19% 1.19% Beginning Allowance as a Multiple of Net Charge-offs 7.6 11.5 7.7 2.7 2.8 Ending Allowance as a Multiple of Nonperforming Assets 1.64 3.84 1.51 1.27 1.34
(1) Including loans held for sale, 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 2006 was $475 thousand compared to $508 thousand in 2005 and $840 thousand in 2004. Net charge-offs were $569 thousand in 2006, $361 thousand in 2005 and $497 thousand in 2004. Net charge-offs to average loans were 0.14%, 0.10% and 0.15% in 2006, 2005 and 2004, respectively. Based on the quality of the loan portfolio, the loan loss provision decreased $33 thousand from 2005 to 2006 and decreased $332 thousand from 2004 to 2005. In evaluating the allowance for loan losses, management considers the composition of the loan portfolio, the historical loan loss experience, the overall quality of the loans and an assessment of current economic conditions. The recent improvement in the economy along with management's emphasis on improving the lending process resulted in fewer loan losses, lower loan loss provision and improved loan quality numbers over the past 3 years. At December 31, 2006, the allowance for loan losses was 1.12% of loans outstanding compared to 1.16% at year-end 2005 and 1.16% at year-end 2004. Management believes the allowance for loan losses at the end of 2006 is adequate to cover probable incurred 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
Off-balance Sheet Arrangements
Some financial instruments, such as loan commitments, credit lines, letters of credit, and overdraft protection, are issued to meet customer financing needs. These are agreements to provide credit or to support the credit of others, as long as conditions established in the contract are met, and usually have expiration dates. Commitments may expire without being used. Off-balance sheet risk to credit loss exists up to the face amount of these instruments, although material losses are not anticipated. The same credit policies are used to make such commitments as are used for loans, including obtaining collateral at exercise of the commitment.
Financial instruments with off-balance sheet risk were as follows at year-end:
2006 2005
Unused lines of credit $ 67,921,443 $ 56,354,000 Commitments to make loans 658,000 156,000 Letters of credit 639,538 183,000
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 5.625% to 6.125% with maturities ranging from 15 to 30 years and are intended to be sold.
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, 2006 increased $3.8 million to $48.4 million. During 2006, the Company purchased 12,901 shares of its stock for $378 thousand. These repurchases partially offset the $6.5 million in net income for 2006. Stockholders' equity, excluding accumulated other comprehensive income, was $56.6 million at December 31, 2006. Included in Tier I capital is $7 million of trust preferred securities issued in August 2003. The disallowed amount of stockholders' equity is mainly attributable to the goodwill and core deposit intangible, resulting from the Peoples acquisition in 2006 and the Kentucky First acquisition in 2003(see Note 6 in the notes to consolidated financial statements included as Exhibit 13 for more information on the goodwill and core deposit intangible assets). 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) 2006 2005 Change Stockholders' Equity (1) $ 56,595 $ 47,479 9,116 Trust Preferred Securities 7,000 7,000 0 Less Disallowed Amount 15,175 9,877 5,298 Tier I Capital 48,420 44,602 3,818 Allowance for Loan Losses 5,067 4,385 682 Other 5 143 (138) Tier II Capital 5,072 4,528 544 Total Capital 53,492 49,130 4,362 Total Risk Weighted Assets 426,900 366,393 60,507 Ratios: Tier I Capital to Risk-weighted Assets 11.3% 12.2% -0.8% Total Capital to Risk-weighted Assets 12.5% 13.4% -0.9% Leverage 7.8% 8.0% -0.2%
(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, 2006, 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, classified as available for sale, decreased from $160.7 million at December 31, 2005 to $127.9 million at December 31, 2006. The decrease is mainly attributable to a short term decrease in deposits. Federal funds sold totaled $4.1 million at December 31, 2006 and $2.7 million at December 31, 2005.
Per Company policy, fixed rate asset backed securities will not have an average life exceeding seven years, but final maturity may be longer. Adjustable rate securities shall adjust within three years per Company policy. As of December 31, 2006, the Company held no adjustable rate mortgage backed securities. Of the $1.4 million of adjustable asset backed securities held on December 31, 2005, $303 thousand were repriceable monthly and the remaining $1.1 million were 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, 2006.
Investment Securities at market value At December 31 (in thousands) 2006 2005 2004 Available for Sale U.S. treasury $ 0 $ 2,974 $ 2,984 U.S. government agencies 31,492 67,033 39,031 States and political subdivisions 44,130 37,463 35,160 Mortgage-backed Fixed - GNMA, FNMA, FHLMC Passthroughs 38,262 33,566 35,013 GNMA, FNMA, FHLMC CMO's 13,720 17,390 11,335 Total 51,982 50,956 46,348 Variable - GNMA, FNMA, FHLMC Passthroughs 0 1,081 1,623 GNMA, FNMA, FHLMC CMO's 0 303 649 Total 0 1,384 2,272 Total mortgage-backed 51,982 52,340 48,620 Other 287 842 972 Total 127,891 160,652 126,767
Maturity Distribution of Securities
Impact of Inflation and Changing Prices
The majority of the Company's assets and liabilities are monetary in nature. Therefore, the Company differs greatly from most commercial and industrial companies that have significant investments in nonmonetary assets and inventories. However, inflation does have an important impact on the growth of assets in the banking industry and the resulting need to increase equity capital at higher than normal rates in order to maintain an appropriate equity to assets ratio. Inflation also affects other expenses, which tend to rise during periods of inflation.
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, 2006 the projected net interest income percentages are within the Board of Directors limits. The projected net interest income report summarizing the Company's interest rate sensitivity as of December 31, 2006 and December 31, 2005 is as follows:
Projected Net Interest Income (December 31, 2006)
Projected Net Interest Income (December 31, 2005)
The numbers in 2006 show more fluctuation when compared to 2005. In 2006, year one reflected a decrease in net interest income of 3.1% compared to 2.2% projected decrease from 2005 with a 100 basis point decline. The 300 basis point increase in rates reflected a 7.3% increase in net interest income in 2006 compared to a 4.0% increase in 2005. The risk is more in 2006 due to the current status of existing interest rates and their effect on rate sensitive assets and rate sensitive liabilities. Based on the model, an increase in rates should 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 meet the needs of borrowers, depositors and creditors. Excess liquidity generally 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 $33.0 million at December 31, 2006. Additionally, securities available-for- sale with maturities greater than one year totaled $113.9 million at December 31, 2006. The available for sale securities are available to meet liquidity needs on a continuing basis.
The Company 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, 2006 these balances totaled $67.3 million, approximately 14% 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 $28 million from the FHLB at December 31, 2006.
Generally, the Company 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 2006 2005 2004 Average Loans (including loans held for sale)/Average Deposits 93.6% 90.4% 88.3% Average Securities sold under agreements to repurchase and other borrowings/Average Assets 5.6% 4.9% 5.7%
This chart shows that the loan to deposit ratio increased in 2006 and increased in 2005. The increase in the ratio in 2006 compared to 2005, and in 2005 compared to 2004 is mainly attributable to a larger increase in loans compared to deposits.
Item 8.
Item 8. Financial Statements
The consolidated financial statements of the Company together with the notes thereto and report of independent registered public accountants are contained in the Company's 2006 Annual Report to Stockholders included as Exhibit 13, and are incorporated herein by reference. No other portion of the 2006 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
None
Item 9A.
Item 9A. Controls and Procedures
The Company's management, with participation of the Company's Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Company's disclosure controls and procedures as of December 31, 2006. Based on the evaluation, the Company's Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures were effective as of December 31, 2006. There was no change in the Company's internal control over financial reporting during the fourth quarter of 2006 that has materially affected, or is reasonably likely to materially affect, such internal control over financial reporting.
Item 9B.
Item 9B. Other Information
None
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 2007:
William Arvin, age 67, is an attorney. He has been a director of Kentucky Bank and the Company since 1995.
B. Proctor Caudill, age 57, is Special Projects Manager of Kentucky Bank. He was President and Chief Executive Officer of the Peoples Bancorp from 1981 to 2006, and President from 1999 to 2006 and Chief Executive Officer from 1981 to 2006 of Peoples Bank. He has been a director of Kentucky Bank and the Company since 2006.
Louis Prichard, age 53, is President and Chief Executive Officer of Kentucky Bank. He was President and Chief Operating Officer of Kentucky Bank from 2003 to 2004. He has been a director of Kentucky Bank and the Company since 2003. Since 1983, he was in banking in Danville and was the Chairman and Chief Executive Officer of Boyle Bancshares, Inc. and their banking subsidiary, Farmers Bank for 7 years before joining the Company in 2003.
Woodford Van Meter, age 53, is an ophthalmologist. He has been a director of Kentucky Bank and the Company since 2004.
Terms expiring in 2008:
Henry Hinkle, age 55, is President of Hinkle Construction Company. He has been a director of Kentucky Bank and the Company since 1989.
Theodore Kuster, age 63, 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 57, is a farmer and thoroughbred horse breeder. He has been a director of Kentucky Bank and the Company since 1991.
Terms expiring in 2009:
Betty J. Long, age 59, is retired President and CEO of First Federal, Cynthiana. She has been a director of Kentucky Bank since 2006 and the Company since 2003.
Ted McClain, age 55, is an insurance agent with Hopewell Insurance Company. He has been a director of Kentucky Bank since 2002 and the Company since 2003.
Edwin S. Saunier, age 49, is President of Saunier North American, Inc. He has been a director of Kentucky Bank and the Company since 2007.
Buckner Woodford, age 62, is Chairman of the Board of Kentucky Bancshares, Inc. and Kentucky Bank. He was President and Chief Executive Officer of the Company from 1991 to 2004, and President and Chief Executive Officer of the Kentucky Bank from 1984 to 2004. He has been a director of Kentucky Bank since 1971 and the Company since inception.
The Company's other executive officers are Norman J. Fryman, age 57, Gregory J. Dawson, age 46 and Darren M. Henry, age 44. Mr. Fryman is the Vice President of Sales and Service of Kentucky Bank and has been with the Company since 1977. Mr. Dawson is the Chief Financial Officer and has been with the Company since 1985. Mr. Henry is Vice President, Director of Commercial Lending and has been with the Company since 2002.
The Company has adopted a code of ethics for its Chief Executive Officer and its Chief Financial Officer. A copy of the code of ethics may be obtained, without charge, by contacting the CFO.
The Company has named Betty J. Long of the audit committee as its financial expert and she is independent as that term is used in Item 7(d)(3)(iv) of Schedule 14A under the Securities Exchange Act of 1934.
Item 11.
Item 11. Compensation Discussion and Analysis
EXECUTIVE COMPENSATION Compensation Discussion and Analysis Overview of Compensation Program The Compensation Committee ("Committee") of the Board has responsibility for establishing, implementing and continually monitoring adherence with the Company's compensation philosophy. The Committee ensures that the total compensation paid is fair, reasonable and competitive. The individuals who served as the Company's Chief Executive Officer and Chief Financial Officer during fiscal 2006, as well as the other individuals included in the Summary Compensation Table, are referred to as the "named executive officers". Compensation Philosophy and Objectives The Committee believes that the most effective executive compensation program is one that is designed to reward the achievement of specific annual, long- term and strategic goals by the Company, and which aligns executives' interests with those of the stockholders by rewarding performance above established corporate and individual goals, with the ultimate objective of improving stockholder value. The Committee evaluates both performance and compensation to ensure that the Company maintains its ability to attract and retain superior employees in key positions and that compensation provided to key employees remains competitive relative to the compensation paid to similarly situated executives of our peer companies. To that end, the Committee believes executive compensation packages provided by the Company to its executives, including the named executive officers, should include both cash and stock-based compensation that reward performance as measured against established goals. The Committee, and the President and Chief Executive Officer ("CEO"), evaluate the information in the annual Kentucky Bankers Association Financial Institution Compensation Survey ("KBA Survey") and then use their subjective judgment to determine a percentage increase in the Company's total base pay. Each manager, based on this aggregate percentage increase, is allocated a pool of funds to allocate increases among the employees the manager supervises. Role of Executive Officers in Compensation Decisions The Committee makes all compensation decisions for the CEO and approves recommendations regarding equity awards to all officers of the Company. Decisions regarding the non-equity compensation of other executive officers are made by the CEO, in his discretion using the pool of funds allocated to the other executive officers based on the overall corporate percentage increase. Setting Executive Compensation Based on the foregoing objectives, the Committee has structured the Company's annual and long-term incentive-based cash and non-cash executive compensation to motivate executives to achieve the business goals set by the Company and reward the executives for achieving such goals. A significant percentage of total compensation is allocated to incentives. The Committee reviews relevant market data and alternatives when making compensation decisions for the CEO. Up to 40% of base compensation may be earned in performance-based incentive compensation as a result of the performance of the Company, compared to established goals. 2006 Executive Compensation Components
For the fiscal year ended December 31, 2006, the principal components of compensation for named executive officers were base salary, performance-based incentive compensation, long-term equity incentive compensation, and retirement and other benefits.
Base Salary The Company provides named executive officers and other employees with base salary to compensate them for services rendered during the fiscal year. Base salary ranges for named executive officers are determined for each executive based on his or her position and responsibility. Salary levels are typically considered annually as part of the Company's performance review process as well as upon a promotion or other change in job responsibility. The Committee and the CEO primarily use the annual KBA Survey in setting salary ranges on an annual basis. Every five years, the Committee recalibrates salary ranges based on the overall value of each job by comparing current market rates of bench mark jobs and assigning all jobs to salary grades, after considering their market value and internal value. During his review of base salaries for other executives, the CEO primarily focuses on the individual's performance. Performance-Based Incentive Compensation The Management Incentive Plan ("MIP") was created to promote high performance by officers of the Company by achievement of corporate goals and encouragement of growth of stockholder value. The Company currently has approximately 61 officers (including the named executive officers) who are eligible to receive cash awards under MIP. The MIP provides guidelines for the calculation of annual non-equity incentive based compensation, subject to Committee oversight and modification. Annually, the Committee considers whether any changes should be made with the MIP. The MIP includes various incentive levels based on the participant's accountability and impact on Company operations, with target award opportunities that are established as a percentage of base salary. These maximum targets range from 20% of base salary to 40% of base salary for the Company's named executive officers. For fiscal 2006, 50-100% of a named executive officer's MIP award was based upon achievement of corporate financial objectives relating to Company earnings on a quarterly basis, with goals set for threshold, target and maximum levels. The remaining percentage of an executive's MIP award was based upon individual performance goals (such as investment yield, net interest spread, loan volume, loan margin) also with threshold, target and maximum levels, determined by the CEO. Only the CEO's MIP award was based on 100% of the Company's earnings. The remaining executive's MIP awards were either 50% or 75% based on Company's earnings. Payment of awards under the MIP are based upon the achievement of such objectives for the current year. Named executive officers participating in the MIP receive: 50% of the maximum award if threshold levels are met, 75% of the maximum award if target levels are met and 100% of the maximum award if maximum levels are met. Generally, the Committee sets the target level for earnings at the Company's earnings objective for the current year. Threshold and maximum levels are set below and above the target level (generally five to seven percentage points, as applicable). In making the annual determination of the threshold, target and maximum levels, the Committee may consider the specific circumstances facing the Company during the coming year. In 2006, the established targets for each quarter were: Threshold Target Maximum Actual 1st quarter $ 1,391,000 $ 1,464,000 $ 1,566,000 $ 1,474,000 2nd quarter 1,587,000 1,671,000 1,788,000 1,780,000 3rd quarter 1,812,000 1,907,000 2,041,000 1,880,000 4th quarter 1,820,000 1,916,000 2,050,000 1,830,000
This plan has been in place for the last two years. The payout percentages for the Company's earnings over these two years have been between 43% and 63% of the participant's maximum. Generally, the Committee sets the threshold, target and maximum levels such that the relative difficulty of achieving the target level is consistent from year to year. Awards made to named executive officers under the MIP for performance in 2006 are reflected in column (g) of the Summary Compensation Table.
Long-Term Incentive Compensation Stock Grant Plan The Stock Grant Plan encourages participants to focus on long-term Company performance and provides an opportunity for executives and other officers to increase their stake in the Company through grants of the Company's Common Stock. Starting in 2006, the Committee utilized the Stock Grant Plan to compensate executives and other officers for sustained increases in the Company's stock performance. Twenty percent of each grant vests annually on anniversary date of the grant. Upon a change of control while an employee is employed by the Company, any restriction period will expire immediately and the employee will hold the restricted stock free of any restrictions. Based on its subjective judgment, the Committee annually establishes the awards to the executive officers under the Stock Grant Plan based on the salary level of each employee. These awards are reflected in the Summary Compensation Table and the Grants of Plan Based Awards Table. Stock Option Plan The Employee Stock Option Plan assists the Company to enhance the link between the creation of stockholder value and long-term executive incentive compensation, provide an opportunity for increased equity ownership by executives and maintain competitive levels of total compensation. Since the establishment of the Stock Grant Plan in 2006, the Committee has not awarded any stock options. Currently, the committee anticipates that stock option awards for officers will be primarily used for newly hired or promoted executives. Options are awarded at the current closing price of the Company's Common Stock on the date of the grant. The options granted by the Committee vest at a rate of 20% per year over the first five years of the ten-year option term. Vesting and exercise rights expire 90 days after termination of employment, except in the case of death (subject to a one year limitation), disability or retirement. Prior to the exercise of an option, the holder has no rights as a stockholder with respect to the shares subject to such option, including voting rights and the right to receive dividends or dividend equivalents. In the event of a change of control of the Company, each outstanding option will become fully vested and immediately exercisable.
Retirement and Other Benefits All employees of the Company are eligible to participate in the Pension Plan and the Profit Sharing (401k) Plan. Pension Plan Under the Retirement Plan, full or part-time employees working for the Company who have completed five continuous years of employment with the Company, including the named executive officers, earn the right to receive certain benefits upon retirement at the normal retirement age of 65 or upon early retirement on or after age 55. Retirement benefits are calculated as the product of 1% times the years of service multiplied by the final average eligible pay for the five highest consecutive years. If the employee retires between the ages of 55 and 64, the amount of benefits is reduced such that if the associate retires at age 55, he or she will be entitled to 50% of the accrued benefits. Of the named executive officers, Mr. Woodford and Mr. Fryman are eligible for early retirement benefits under the Retirement Plan. Profit Sharing (401k) Plan The Profit Sharing (401k) Plan is available to all employees, including the named executive officers. The Company will match 100% of the first 6% of pay that is contributed to the Savings. All employee contributions to the Savings Plan are fully-vested upon contribution, and matching contributions are vested after 3 years of service. The Company may, at its discretion, make a profit sharing contribution to the plan. This has not been done since the 401k feature was added to the plan. Stock Gift Program The Company provides stock gifts to full time Company employees, including the named executive officers, who have completed at least 15 years of service. Under the Stock Gift Program, participants may be awarded an increasing number of shares of the Company's Common Stock for each five year anniversary starting with 15 years for their continued dedicated service to the Company
Tax and Accounting Implications
Accounting for Stock-Based Compensation Beginning on January 1, 2006, the Company began accounting for stock- based payments including its Stock Option Program, Long-Term Stock Grant Program, Restricted Stock Program and Stock Award Program in accordance with the requirements of FASB Statement 123(R).
The following table sets forth information with respect to the compensation of the Chairman of the Board (Buckner Woodford), President and Chief Executive Officer (Louis Prichard), Vice President of Sales and Service (Norman J. Fryman), Chief Financial Officer (Gregory J. Dawson) and Vice President Director of Commercial Lending (Darren M. Henry) of the Company (the "Named Executive Officers") for the fiscal year ended December 31, 2006. No other executive officer earned total compensation in excess of $100,000.
Summary Compensation Table
(1) Represents compensation for work done on special project (2) Represents the value from stock grants issued in 2006 (3) Represents cash incentives based on bank and/or individual performance (4) Represents change in value of pension benefits (5) Represents the Company's matching contribution to the qualified profit sharing plan that includes a 401(k) provision
The following table contains information regarding the grant of stock options under the Company's stock option plan to the Named Executive Officers during the year ended December 31, 2006.
Grants of Plan Based Awards
(1) Represents incentive compensation from MIP plan (2) Represents the shares granted from stock grant plan (3) Represents the value of stock grant on grant date
Outstanding Equity Awards at Fiscal Year-end
(1) Represents stock options granted under the stock option plan (2) Represents grants of stock under the stock grant plan
The following table sets forth certain information regarding options exercised by the Named Executive Officers during calendar year 2006.
Option Awards Number of Shares Value Realized Name Acquired on Exercise on Exercise Gregory J. Dawson 600 $11,100
The table below shows the present value of accumulated benefits payable to each of the named executive officers, including the number of years of service credited to each such named executive officer, under the Pension Plan determined using interest rate and mortality rate assumptions consistent with those used in the Company's financial statements.
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 highest 5 years. The years of service are 35 years for Mr. Woodford, 3 years for Mr. Prichard, 22 years for Mr. Fryman, 21 years for Mr. Dawson and 4 years for Mr. Henry. The normal benefit is a life annuity based on the 1984 Unisex Pension pre-retirement mortality table and a pre-retirement interest rate of 7%. The benefits are not subject to a deduction for Social Security or other offset amounts.
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 ($400 for one paid absence per year) and non-employee Company directors are paid $100 for each Kentucky Bank committee meeting attended. Each Company Director is paid an annual retainer of $1,500 plus the audit committee chairman is paid an additional annual retainer of $2,000. Thos compensation is shown in the table below as fees earned or paid in cash. Non-employee Directors of Kentucky Bank are also granted a 10-year option (shown under options awards in the table below) to purchase 100 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.
Fees Earned or Paid Option Name in Cash Awards Total William Arvin $12,200 $ 497 $ 12,697 Henry Hinkle 8,300 497 8,797 Theodore Kuster 13,400 497 13,897 Betty J. Long 12,300 497 12,797 Ted McClain 12,100 497 12,597 Edward Saunier 2,500 497 2,997 Robert G. Thompson 14,200 497 14,697 Woodford Van Meter 10,300 497 10,797
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION The compensation committee of the Board is comprised of Messrs. Arvin, Hinkle and Kuster, each a non-employee director of the Company. None of our executive officers serve on the compensation committee or board of directors of any other company of which any members of our compensation committee or any of our directors is an executive officer.
REPORT OF THE COMPENSATION COMMITTEE The Compensation Committee of the company has reviewed and discussed the Compensation Discussion and Analysis required by Item 402(b) of Regulation S-K with management and, based on such review and discussions, the Compensation Committee recommended to the Board that the Compensation Discussion and Analysis be included in this proxy statement. Members of the Compensation Committee: William Arvin Henry Hinkle Theodore Kuster
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, 2006.
Name Shares Beneficially Owned(1) Number Percentage
William Arvin (2) 30,271 1.0%
B. Proctor Caudill (3) 177,010 6.0
Gregory J. Dawson (4) 8,762 *
Norman J. Fryman (5) 3,935 *
Darren M. Henry (6) 1,100 *
Henry Hinkle (7) 38,135 1.3%
Theodore Kuster (8) 18,105 *
Betty J. Long (9) 1,700 *
Ted McClain (10) 2,575 *
Louis Prichard (11) 7,410 *
Edwin S. Saunier (12) 700 *
Robert G. Thompson (13) 6,250 *
Woodford Van Meter (14) 32,500 1.1%
Buckner Woodford (15) 250,429 8.5%
All directors and officers (14 persons) as a group (consisting of those persons named above)(16) 578,882 19.7%
* 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, 11,968 shares held of record by Mr. Arvin's wife, as to which Mr. Arvin disclaims beneficial ownership, 5,465 shares held jointly with his wife and 750 shares that Mr. Arvin may acquire upon exercise of outstanding stock options. 3) Includes 19,725 shares held of record by Mr. Caudill's wife, as to which Mr. Caudill's disclaims beneficial ownership and 165 shares from future vesting of stock grants. 4) Includes 2,710 shares that Mr. Dawson may acquire upon exercise of outstanding stock options and 297 shares from future vesting of stock grants. 5) Includes 2,200 shares that Mr. Fryman may acquire upon exercise of outstanding stock options and 297 shares from future vesting of stock grants. 6) Includes 900 shares that Mr. Henry may acquire upon exercise of outstanding stock options and 180 shares from future vesting of stock grants. 7) Includes 1,000 shares held by his wife and 2,545 shares held by relatives, as to which Mr. Hinkle disclaims beneficial ownership. Includes 31,875 shares held of record by Hinkle Contracting Company, as to which Mr. Hinkle, as president, has shared voting power. Also includes 750 shares that Mr. Hinkle may acquire upon exercise of outstanding stock options. 8) Includes 6,250 shares held of record by Mr. Kuster's wife, as to which Mr. Kuster disclaims beneficial ownership. Also includes 5,500 shares held in a retirement account and 550 shares that Mr. Kuster may acquire upon exercise of outstanding stock options. 9) Includes 1,600 shares held in a retirement account and 100 shares that Ms. Long may acquire upon exercise of outstanding stock options. 10) Includes 1,000 shares held of record by Hopewell Company, as to which Mr. McClain, as a 1/3 owner, has voting power. Also includes 400 shares that Mr. McClain may acquire upon exercise of outstanding stock options. 11) Includes 2,110 shares held jointly with his wife and 4,600 shares that Mr. Prichard may acquire upon exercise of outstanding stock options and 630 shares from future vesting of stock grants. 12) Includes 200 shares that Mr. Saunier may acquire upon exercise of outstanding stock options. 13) Includes 200 shares held of record by Mr. Thompson's wife, as to which Mr. Thompson disclaims beneficial ownership. Includes 750 shares that Mr. Thompson may acquire upon exercise of outstanding stock options. 14) Includes 2,200 shares held of record by Mr. Van Meter's wife, as to which Mr. Van Meter disclaims beneficial ownership. Includes 200 shares that Mr. Van Meter may acquire upon exercise of outstanding stock options. 15) Includes 8,000 shares held by his wife, as to which Mr. Woodford disclaims beneficial ownership. Also 6,900 shares that Mr. Woodford may acquire upon exercise of outstanding stock options and 297 shares from future vesting of stock grants. 16) Includes 21,010 shares that may be acquired upon exercise of outstanding stock options and 1,866 shares from future vesting of stock grants.
The following table sets forth as of December 31, 2006 the only persons 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 notes 3 and 15 in the preceding table for further information.
Name and Address Shares Beneficially of Beneficial Owner Owned Percentage
Buckner Woodford 250,429 8.5% 340 Stoner Avenue Paris, Kentucky 40361
B. Proctor Caudill 177,010 6.0 2075 Rice Road Morehead, KY 40351
The following table sets forth as of December 31, 2006 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, 2006. 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 $4.7 million as of December 31, 2006 and as of December 31, 2005. See Note 4 in the notes to consolidated financial statements included as Exhibit 13. The Company purchased various types of insurance with aggregate premiums amounting to $256 thousand in 2006 from Hopewell Insurance Company. Director Ted McClain owns 33% of this company and is one of their insurance agents.
Item 14.
Item 14. Principal Accountant Fees and Services
The Audit Committee has pre-approved that management of the Company may consult with the primary independent auditor concerning certain additional services outside of the audit work that was specifically approved in the engagement letter for those services. Included were services such as:
1. Discussions related to accounting for mergers and acquisitions, 2. Tax return preparation 3. Discussions concerning loan review, 4. Discussions regarding regulatory requirements, 5. Data processing and retirement plan audits, and 6. Profit enhancement and other consulting.
The fees for services provided by the primary independent auditor, Crowe Chizek and Company LLC for 2006 and for 2005 were as follows:
Audit fees - Fees for the financial statement audit, and the review of the Company's Form 10-Q's were $115,000 for 2006 and $92,050 for 2005.
Audit related fees - Aggregate fees for all assurance and related services were $14,450 for 2006 and $14,600 for 2005. These fees were incurred for audits of benefit plans. The 2006 and 2005 amounts were preapproved by the audit committee.
Tax fees - Fees related to tax compliance, advice and planning were $16,000 for 2006 and $14,450 for 2005. The 2006 and 2005 amounts were preapproved by the audit committee.
All other fees - Consulting fees related to acquisitions, profitability and risk management were $16,120 for 2006 and $14,400 for 2005. The 2006 and 2005 amounts were preapproved by the audit committee.
All services provided by the Corporation's primary independent auditor in 2006 and 2005 were approved by the Audit Committee.
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:
2.1 Agreement and Plan of Merger with Peoples Bancorp of Sandy Hook is incorporated by reference to Exhibit 2.1 of the Registrant's Current Report on Form 8-K dated February 24, 2006 (File No. 33-96358).
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).
3.3 Articles of Amendment to Amended and Restated Articles of Incorporation of the Registrant are incorporated by reference to Exhibit 3.3 of the Registrant's Annual Report on Form 10-K for the period ending December 31, 2005 (File No. 33-96358).
10.1 Kentucky Bancshares, Inc. 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 Kentucky Bancshares, Inc. 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 Kentucky 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.*
10.4 Schedule of 2006 Compensation Arrangements for Named Executive Officers is incorporated by reference to the Registrant's Current Report on Form 8-K dated December 20, 2005 (File No. 33-96358).*
10.5 2005 Restricted Stock Grant Plan, including form of Award Agreement, as incorporated by reference to Exhibit 10.1 of the Registrant's Current Report on Form 8-K dated February 15, 2005 (File No. 33-96358).*
11 Computation of earnings per share - See Note 12 in the notes to consolidated financial statements included as Exhibit 13.
13 Kentucky Bancshares, Inc. 2006 Annual Report and Proxy Statement, including 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 LLC
31.1 Certification of Chief Executive Officer pursuant to Rule 13a- 14(a) and Rule 15d-14(a) of the Securities Exchange Act, as amended.
31.2 Certification of Chief Financial Officer pursuant to Rule 13a- 14(a) and Rule 15d-14(a) of the Securities Exchange Act, as amended.
32.1 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.
32.2 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.
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.
Kentucky Bancshares, Inc. By: ___/s/Louis Prichard __ Louis Prichard, President and Chief Executive Officer, Director March 30, 2007
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/Louis Prichard__ _______ March 30, 2007 Louis Prichard, President and Chief Executive Officer, Director
/s/Gregory J. Dawson_________ March 30, 2007 Gregory J. Dawson, Chief Financial and Accounting Officer
/s/Buckner Woodford__________ March 30, 2007 Buckner Woodford, Chairman of the Board, Director
_____________________________ March __, 2007 William Arvin, Director
/s/B. Proctor Caudill________ March 30, 2007 B. Proctor Caudill, Director
/s/Henry Hinkle___ _ __ ____ March 30, 2007 Henry Hinkle, Director
_____________________________ March __, 2007 Theodore Kuster, Director
/s/Betty J. Long_____________ March 30, 2007 Betty J. Long, Director
/s/Ted McClain______________ March 30, 2007 Ted McClain, Director
_____________________________ March __, 2007 Edwin S. Saunier, Director
/s/Robert G. Thompson________ March 30, 2007 Robert G. Thompson, Director
_____________________________ March __, 2007 Woodford Van Meter, 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.
INDEX TO EXHIBITS
Exhibit Number Description of Document
2.1 Agreement and Plan of Merger with Peoples Bancorp of Sandy Hook is incorporated by reference to Exhibit 2.1 of the Registrant's Current Report on Form 8-K dated February 24, 2006 (File No. 33-96358).
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).
3.3 Articles of Amendment to Amended and Restated Articles of Incorporation of the Registrant are incorporated by reference to Exhibit 3.3 of the Registrant's Annual Report on Form 10-K for the period ending December 31, 2005 (File No. 33-96358).
10.1 Kentucky Bancshares, Inc. 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 Kentucky Bancshares, Inc. 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 Kentucky 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.*
10.4 Schedule of 2006 Compensation Arrangements for Named Executive Officers is incorporated by reference to the Registrant's Current Report on Form 8-K dated December 20, 2005 (File No. 33-96358).*
10.5 2005 Restricted Stock Grant Plan, including form of Award Agreement, as incorporated by reference to Exhibit 10.1 of the Registrant's Current Report on Form 8-K dated February 15, 2005 (File No. 33-96358).*
11 Computation of earnings per share - See Note 10 in the notes to consolidated financial statements included as Exhibit 13.
13 Kentucky Bancshares, Inc. 2006 Annual Report and Proxy Statement, including 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 LLC
31.1 Certification of Chief Executive Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, as amended.
31.2 Certification of Chief Financial Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, as amended.
32.1 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.
32.2 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.
BOURBON BANCSHARES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2000, 1999 and 1998