Kentucky Bancshares Inc. (fka KTYB)

[norweger1979]

3/31/2017 10Q

Summary

The Company recorded net income of $3.1 million, or $1.06 basic earnings and diluted earnings per share for the first three months ended March 31, 2017 compared to $1.8 million or $0.61 basic earnings and diluted earnings per share for the three month period ended March 31, 2016. The first three months net earnings reflect an increase of $1.3 million, or 70.8%, compared to the same time period in 2016. The increase in net earnings is mostly attributed to an increase of $169 thousand, or 2.1%, in net interest income, an increase of $1.6 million, or 58.4%, in non-interest income, a decrease of $142 thousand, or 1.7%, in non-interest expense, and a decrease of $25 thousand, or 6.7%, for the provision for loan losses. The increase in non-interest income is mostly attributed to the sale of a branch building located in Winchester, Kentucky, to a non-banking real estate investor. The sale was solely for the building and not for the loans or deposits associated with the branch. The sale of the building resulted in a pre-tax gain of approximately $1.2 million. Absent the sale of the building, net income would have been up approximately $500 thousand or 27%, compared to the same period last year. For the three months ended March 31, 2017 and compared to the three months ended March 31, 2016, service charges increased $106 thousand, debit card interchange income increased $87 thousand and gains on the sale of loans increased $251 thousand.

For the three months ended March 31, 2017 and compared to the the three months ended March 31, 2016, salaries and benefits expense increased $75 thousand, legal and professional fees decreased $95 thousand, data processing expense decreased $20 thousand, debit card expense increased $56 thousand and other expenses decreased $121 thousand. For the same three month comparision, repossession expense decreased $33 thousand.
Return on average assets was 1.20% for the three months ended March 31, 2017 and 0.74% for the three months ended March 31, 2016. Return on average equity was 13.34% for the three month period ended March 31, 2017 and 8.07% for the three month period ended March 31, 2016.
Securities available for sale increased $28.1 million from $273.8 million at December 31, 2016 to $301.9 million at March 31, 2017. Trading assets increased by $52 thousand, or 0.9%, totaled $5.6 million at both March 31, 2017 and December 31, 2016, and includes income on the investment totaling $34 thousand during the first three months of 2017 compared to $42 thousand for the three months ended March 31, 2016.
Gross Loans increased $1.6 million from $656.0 million on December 31, 2016 to $657.6 million at March 31, 2017. Loans acquired with Madison Financial Corporation had outstanding loan balances of $28.5 million at March 31, 2017 compared to $33.1 million at December 31, 2016. The overall increase in loan balances from December 31, 2016 to March 31, 2017 is comprised of the following: an increase of $3.5 million in 1-4 family residential loans, a decrease of $1.4 million in commercial loans, a decrease of $2.9 million in multi-family residential loans, a decrease of $1.5 million in agricultural loans, an increase of $6.4 million in non-farm and non-residential loans, a decrease of $1.6 million in consumer loans, and a decrease of $912 thousand in real-estate construction loans. Other loan balances decreased $67 thousand from December 31, 2016 to March 31, 2017.
Total deposits increased from $803.0 million on December 31, 2016 to $824.3 million on March 31, 2017, an increase of $21.3 million. Non-interest bearing demand deposit accounts decreased $1.2 million from December 31, 2016 to March 31, 2017 while time deposits $250 thousand and over increased $10 thousand and other interest bearing deposit accounts increased $12.5 million from December 31, 2016 to March 31, 2017. Public fund account balances decreased $18 million from December 31, 2016 to March 31, 2017. Public fund accounts typically decrease during the first three quarters of the year and increase during the last quarter of the year due to tax payments collected during the fourth quarter and then withdrawn from the Bank during the following months. Borrowings from the Federal Home Loan Bank decreased $1.9 million from December 31, 2016 to March 31, 2017, all of which were long-term borrowings, repurchase agreements increased $938 thousand and the note payable decreased $107 thousand.

Net Interest Income

Net interest income is the difference between interest income earned on interest-earning assets and the interest expense paid on interest-bearing liabilities. Net interest income was $8.2 million for the three months ended March 31, 2017 compared to $8.0 million for the three months ended March 31, 2016, an increase of 2.1%. The interest spread, excluding tax equivalent adjustments, was 3.25% for the first three months of 2017 compared to 3.34% for the first three months of 2016. For the first three months in 2017, the yield on assets decreased from 3.88% in 2016 to 3.77% in 2017, excluding tax equivalent adjustments. The yield on loans decreased three basis points compared to the three months ended March 31, 2016 from 4.68% to 4.65% for the three months ended March 31, 2017. The yield on securities, excluding tax equivalent adjustments, decreased five basis points during the first three months of 2017 compared to 2016 from 2.39% in 2016 to 2.34% in 2017. The cost of liabilities was 0.51% for the first three months in 2017 compared to 0.49% in 2016. Year to date average loans, excluding overdrafts, increased $23.4 million, or 3.7% for the three months ended March 31, 2017 compared to the three months ended March 31, 2016. Loan interest income increased $115 thousand during the first three months of 2017 compared to the first three months of 2016. Year to date average total deposits increased from

March 31, 2016 to March 31, 2017 by $50.3 million or 6.5%. Year to date average interest bearing deposits increased $70 thousand, or 10.2%, from March 31, 2016 to March 31, 2017. Deposit interest expense increased $88 thousand for the first three months of 2017 compared to the same period in 2016. Year to date average borrowings, including repurchase agreements, increased $3.9 million, or 3.3%, from March 31, 2016 to March 31, 2017. Interest expense on borrowed funds, including repurchase agreements, increased $21 thousand for the first three months of 2017 compared to the same period in 2016. The volume rate analysis for the three months ended March 31, 2017 indicates that $860 thousand of the increase in loan interest income is attributable to an increase in loan volume and $326 thousand of the increase in securities interest income is attributable to an increase in the volume of our security portfolio. Further, a decrease in loan rates caused a decrease of $745 thousand in interest income and a decrease in rates in our security portfolio contributed a decrease of $231 thousand in securities interest income. The net effect to interest income was an increase of $278 thousand for the first three months of 2017 compared to the same time period in 2016. Also based on the following volume rate analysis for the three months ended March 31, 2017, an increase in demand deposit interest rates resulted in $29 thousand additional interest expense, a decrease in interest rates paid for savings deposits resulted in a reduction of $2 thousand in interest expense, and increases in interest rates paid for time deposits resulted in an addition of $20 thousand in interest expense. The change in volume in deposits and borrowings was responsible for a $75 thousand increase in interest expense, of which an increase in demand deposits resulted in an increase of $39 thousand in interest expense, an increase in time deposits resulted in an increase of $2 thousand in interest expense, a decrease in repurchase agreements resulted in a decrease of $15 thousand in interest expense, and an increase in other borrowings resulted in an increase of $49 thousand in interest expense. The net effect to interest expense was an increase of $109 thousand. As a result, the increase in net interest income for the first three months in 2017 is mostly attributed to growth in the Company’s loan and security portfolios.

Non-Interest Income

Non-interest income increased $1.6 million for the three months ended March 31, 2017, compared to the same period in 2016, to $4.4 million. As previously noted, non-interest income increased $1.6 million for the three months ended March 31, 2017 in comparison to the three months ended March 31, 2016.


Favorable variances to non-interest income for the first three months of 2017 include an increase of $106 thousand in service charges, an increase of $63 thousand in loan net service fee income, an increase of $25 thousand in trust department income, an increase of $9 thousand in brokerage fee income, an increase of $87 thousand in debit card interchange income and an increase of $251 thousand in gains on the sale of loans. The largest favorable variance to non-interest income for the first three months of 2017 is an increase of $1.2 million in gain on bank premises due to the sale of a bank building located in Winchester, Kentucky. Decreases to non-interest income for the three months ended March 31, 2017 compared to the three months ended March 31, 2016 include a decrease of $126 thousand in gains on the sale of securities and a decrease of $23 thousand in gain on trading assets. The gain on the sale of loans increased from $299 thousand during the first three months of 2016 to $550 thousand during the first three months of 2017, an increase of $251 thousand. The volume of loans originated to sell during the first three months of 2017 increased $5.0 million compared to the same time period in 2016. The volume of mortgage loan originations and sales is generally inverse to rate changes. A change in the mortgage loan rate environment can have a significant impact on the related gain on sale of mortgage loans. Loan service fee income, net of amortization and impairment expense, was $114 thousand for the three months ended March 31, 2017 compared to $51 thousand for the three months ended March 31, 2016, an increase of $63 thousand. During the first three months of 2017, the market value adjustment to the carrying value of the mortgage servicing right was a net recovery of prior-writedowns of $39 thousand, as the fair value of this asset increased. During the first three months of 2016, the market value adjustment to the carrying value of the mortgage servicing right asset was a positive valuation adjustment of $3 thousand as the fair value of the mortgage servicing asset increased.

Non-Interest Expense

Total non-interest expense decreased $142 thousand for the three month period ended March 31, 2017 compared to the same period in 2016. Management continues to consider opportunities for branch expansion, and will also consider acquisition opportunities that help advance its strategic objectives, which would result in additional future non-interest expense. For the comparable three month periods, salaries and employees benefits expense increased $75 thousand, an increase of 1.7%. The number of full-time employee equivalent employees decreased from 247 at March 31, 2016 to 243 at March 31, 2017, a decrease of four full-time employee equivalent employees. Occupancy expense increased $47 thousand to $965 thousand for the first three months of 2017 compared to the same time period in 2016. Building rent expense increased $30 thousand mostly due to rent expense being lower in 2016 due to the Company recovering $20 thousand in accrued expense for a former branch leased in Richmond, KY. Depreciation expense decreased $37 thousand for the three months ended March 31, 2017 compared to March 31, 2016. Expenses incurred for assets not depreciated increased $30 thousand during the first three months of 2017 compared to the first three months of 2016. This increase is attributed to purchasing additional equipment during the first quarter of 2017 and increasing the threshold for which we depreciate assets. Building repairs and maintenance decreased $42 thousand due to fewer maintetenance projects in 2017. Legal and professional fees decreased $95 thousand for the three months ended March 31, 2017 compared to the first three months in 2016. The reduction in legal and professional fees is attributed to expenses being higher for the three months ended March 31, 2016 due to the Company incurring $195 thousand in additional expense related to acquiring the services of an outside firm to help the Company identify ways to become more efficient and profitable. Debit card expenses increased $56 thousand for the three months ended March 31, 2017 compared to the first three months of 2016. The increase in debit card expense is attributed to an increase in debit card interchange activity which also resulted in increases in debit card interchange income as shown on the income statement. Repossession expense decreased $33 thousand for the first three months ended March 31, 2017 compared to the same time period in 2016. Repossession expenses are reported net of rental income earned on repossessed properties. Net repossession expenses were lower during the first three months of 2017 when compared to 2016 due to net write-downs totaling $0 in 2017 compared to net write-downs of $85 thousand in 2016.


Income Taxes

The effective tax rate for the three months ended March 31, 2017 was 21.4% compared to 10.5% in 2016. The effective tax rate is higher in 2017 due to taxable income increasing, largely due to the $1.2 million gain on the sale of the branch building. These effective tax rates are less than the statutory rate as a result of the Company investing in taxfree securities, loans and other investments which generate tax credits for the Company. The Company also has a captive insurance subsidiary which contributes to reducing taxable income. Income tax expense increased $639 thousand for the three months ended March 31, 2017 compared to the first three months in 2016. Tax-exempt interest income increased $27 thousand for the first three months of 2017 compared to the first three months of 2016. Further, for the first three months of 2017, the Company had tax credits totaling $154 thousand for investments made in low income housing projects compared to similar tax credits of $172 for the first three months of 2016. As part of normal business, the Bank typically makes tax free loans to select municipalities in our market and invests in selected tax free securities, primarily in the Commonwealth of Kentucky. In making these investments, the Company considers the overall impact to managing our net interest margin, credit worthiness of the underlying issuer and the favorable impact on our tax position. For the three months ended March 31, 2017, the Company averaged $86.9 million in tax free securities and $40.7 million in tax free loans. As of March 31, 2017, the weighted average remaining maturity for the tax free securities is 98 months, while the weighted average remaining maturity for the tax free loans is 141 months.

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