KENTUCKY BANCSHARES, INC. Forward-Looking Statements
The following discussion provides information about the financial condition and results of operations of the Company and its subsidiaries as of the dates and periods indicated. This discussion and analysis should be read in conjunction with the unaudited consolidated financial statements and Notes thereto appearing elsewhere in this report and the Management's Discussion and Analysis in the Company's Annual Report on Form 10-K for the year endedDecember 31, 2019 . This discussion contains forward-looking statements under the Private Securities Litigation Reform Act of 1995 that involve risks and uncertainties. We intend such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the federal securities laws. These statements are not historical facts, but rather statements based on our current expectations regarding our business strategies and their intended results and our future performance. Forward-looking statements are preceded by terms such as "future", "expects," "believes," "anticipates," "intends," "estimates," "potential," "may," and similar expressions. Forward looking statements are neither historical facts nor assurances of future performance. Instead, they are based on only our current beliefs, expectations and assumptions regarding the future of our business, future plans and strategies, projections, anticipated events and trends, the economy and other future conditions. Although we believe 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. 38
Table of Contents
Factors that could cause actual results to differ from the results discussed in the forward-looking statements include, but are not limited to: economic conditions (both generally and more specifically in the markets in which we operate); negative impacts of current COVID-19 pandemic, current or future volatility in market conditions; competition for our subsidiary'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 we have no control); changes in interest rates (both generally and more specifically mortgage interest rates); ability to successfully gain regulatory approval when required; material unforeseen changes in the liquidity, results of operations, or financial condition of our subsidiary's customers; adequacy of the allowance for losses on loans and the level of future provisions for losses on loans; future acquisitions, changes in technology, information security breaches or cyber security attacks involving the Company, its subsidiaries, or third-party service providers; and other risks detailed in our filings with theSecurities and Exchange Commission , all of which are difficult to predict and many of which are beyond our control. As a result of the uncertainties and the assumptions on which this discussion and the forward-looking statements are based, actual future operations and results in the future may differ materially from those indicated herein. You should not place undue reliance on any forward-looking statements made by us or on our behalf. Our forward-looking statements are made as of the date of the report, and we undertake 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. Policy and Regulatory Developments. Federal, state and local governments and regulatory authorities have enacted and issued a range of policy responses to the COVID-19 pandemic. The descriptions below summarize certain significant government actions taken in response to the COVID-19 pandemic. However, these descriptions are qualified in their entirety by reference to the particular statutory or regulatory provisions or government programs.
The
? basis points on
2020, reaching a current range of 0.0% - 0.25 %.
On
Economic Security Act (CARES Act), which has subsequently been amended several
times. Among other provisions, the CARES Act established an economic stimulus
package, including cash payments to individuals, supplemental unemployment
? insurance benefits and a loan program administered through the
Business Administration (SBA), referred to as the paycheck protection program
(PPP). A second round of funding was authorized during the second quarter. In
addition, the CARES Act provides financial institutions the option to temporarily suspend certain requirements under GAAP related to TDRs for a limited period of time to account for the effects of COVID-19.
On
Statement on Loan Modifications and Reporting for Financial Institutions,
which, among other things, encouraged financial institutions to work prudently
? with borrowers who are or may be unable to meet their contractual payment
obligations because of the effects of COVID-19, and stated that institutions
generally do not need to categorize COVID-19-related modifications as TDRs and
that the agencies will not direct supervised institutions to automatically
categorize all COVID-19 related loan modifications as TDRs.
The
and mid-sized businesses, as well as state and local governments impacted by
COVID-19. The
Program, which establishes two new loan facilities intended to facilitate
lending to small and mid-sized businesses: (1) the Main Street New Loan
Facility, or MSNLF, and (2) the Main Street Expanded Loan Facility, or MSELF.
In addition, the
? support state and local governments with up to
the
appropriated by the CARES Act. The
scope its Primary and Secondary Market Corporate Credit Facilities to support
up to
Reserve announced that its Term Asset-Backed Securities Loan Facility will be
scaled up in scope to include the triple A-rated tranche of commercial
mortgage-backed securities and newly issued collateralized loan obligations.
The size of the facility is$100 billion . 39 Table of Contents
Effects on Our Business. We currently expect that the COVID-19 pandemic and the specific developments referred to above could have a significant impact on our business. The COVID-19 pandemic has resulted in temporary closures or
partial-closures of many businesses and the institution of social distancing and shelter in place requirements, which has
increased unemployment levels and caused extreme volatility in the financial markets. In particular, we anticipate that a significant portion of the Bank's borrowers in various segments will continue to endure significant economic distress, which has caused, and may continue to cause, them to draw on their existing lines of credit and adversely affect their ability to repay existing indebtedness, and is expected to adversely impact the value of collateral.
These developments, together with economic conditions generally, are also expected to impact our commercial real estate portfolio, particularly with respect to real estate with exposure to these industries, and the value of certain collateral securing our loans. As a result, we anticipate that our financial condition, capital levels and results of operations could be adversely affected, as described in further detail below.
Our Response. We have taken numerous steps in response to the COVID-19 pandemic, including the following:
? We are actively working with loan customers to evaluate prudent loan
modification terms, where necessary.
We continue to promote our digital banking options through our website.
? Customers are encouraged to utilize online and mobile banking tools, and our
customer service and retail departments are fully staffed and available to
assist customers remotely.
We are a participating lender in the PPP. We believe it is our responsibility
as a community bank to assist the SBA in the distribution of funds authorized
? under the CARES Act to our customers and communities, which we are carrying out
in a prudent and responsible manner. As of
for PPP loans included in gross loans on our balance sheet.
We previously limited all branches to drive-up and appointment only services.
However, the Bank implemented a phased re-opening of lobby services, and all
? lobbies are now open during normal business hours. Management has remained
committed to taking all steps to ensure the Bank's employees remain healthy and
available to serve our customers. The Company recorded net income of$4.8 million , or$0.81 basic earnings and diluted earnings per share for the first six months endedJune 30, 2020 compared to$6.0 million or$1.01 basic earnings and diluted earnings per share for the six month period endedJune 30, 2019 . The first six months net earnings reflect a decrease of$1.2 million , or 20.2%, compared to the same time period in 2019. The decrease in net earnings is mostly attributed to an increase of$76 thousand , or 0.4%, in net interest income, an increase of$1.2 million , or 19.4%, in non-interest income, an increase of$1.0 million , or 5.8%, in non-interest expense, and an increase of$1.7 million , or 372.2%, for the provision for loan losses. The increase in non-interest income is mostly attributed to an increase in gain on sale of loans. The earnings for the three months endedJune 30, 2020 were$3.1 million or$0.51 basic and diluted earnings per share compared to$3.2 million or$0.54 basic and diluted earnings per share for the three month period endedJune 30, 2019 . The earnings for the three month period in 2020 reflect a decrease of 5.1% compared to the same time period in 2019.
For the six months ended
$312 thousand , gain on the sale of loans increased$1.5 million , and debit card interchange income increased$34 thousand . Salaries and benefits expense increased$788 thousand , legal and professional fees decreased$145 thousand , debit card expenses decreased$96 thousand and loss on limited partnership expenses increased$38 thousand . For the three months endedJune 30, 2020 and compared to the three months endedJune 30, 2019 , service charges decreased$407 thousand , debit card interchange income increased$12 thousand , and gains on the sale of loans increased$1.1 million . For the three months endedJune 30, 2020 and compared to the three months endedJune 30, 2019 , salaries and benefits expense increased$513 thousand , data processing expense decreased$105 thousand , debit card expense decreased$73 thousand and other expenses increased$202 thousand .
For the same three month comparison, loss on limited partnership expense
increased
expense decreased
40
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Return on average assets was 0.81% for the six months endedJune 30, 2020 and 1.11% for the six months endedJune 30, 2019 . Return on average assets was 1.01% for the three months endedJune 30, 2020 and 1.19% for the three months endedJune 30, 2019 . Return on average equity was 8.02% for the six month period endedJune 30, 2020 and 10.92% for the six month period endedJune 30, 2019 . Return on average equity was 10.27% for the three month period endedJune 30, 2020 and 11.44% for the three month period endedJune 30, 2019 .
Securities available for sale decreased
Gross Loans increased
The overall increase in loan balances fromDecember 31, 2019 toJune 30, 2020 is comprised of the following: an increase of$3.9 million in 1-4 family residential loans, an increase of$45.5 million in commercial loans, an increase of$586 thousand in multi-family residential loans, an increase of$362 thousand in agricultural loans, an increase of$21.6 million in non-farm and non-residential loans, a decrease of$615 thousand in consumer loans and a decrease of$7.1 million in real-estate construction loans. Other loan balances decreased$109 thousand fromDecember 31, 2019 toJune 30, 2020 . The increase in commercial loan balances fromDecember 31, 2019 toJune 30, 2020 was attributed to having$56.8 million in outstanding "PPP" loan balances as ofJune 30, 2020 . The Company received approximately$1.5 million in origination fees for these loans. These fees will be recognized as interest income on a straight-line basis over a two year period from the time the date of loan origination. These fees may be recognized as income sooner if the loans payoff sooner.
Total deposits increased from
$101.9 million . Non-interest bearing demand deposit accounts increased$72.9 million fromDecember 31, 2019 toJune 30, 2020 while time deposits$250 thousand and over decreased$7.0 million and other interest bearing deposit accounts increased$36.1 million fromDecember 31, 2019 toJune 30, 2020 . The increase in deposits is largely attributed to funds depositors received through various government stimulus programs during the second quarter (i.e., PPP loans,$1,200 stimulus payments to individuals and additional unemployment insurance payments).
Public fund account balances decreased$17.3 million fromDecember 31, 2019 toJune 30, 2020 . 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 theFederal Home Loan Bank increased$29.0 million fromDecember 31, 2019 toJune 30, 2020 . Long- term borrowings increased$3.5 million while short-term borrowings increased$25.5 million during the six month period. Repurchase agreements decreased$1.7 million for the same six month period.
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$18.1 million for the six months endedJune 30, 2020 compared to$18.0 million for the six months endedJune 30, 2019 , an increase of 0.1%. Net interest income was$9.1 million for the three months endedJune 30, 2020 compared to$9.1 million for the three months endedJune 30, 2019 . The tax equivalent net interest margin was 3.36% for the first six months of 2020 compared to 3.58% for the first six months of 2019. For the first six months in 2020, the tax equivalent yield on interest earning assets decreased from 4.47% in 2019 to 4.08% in 2020. 41 Table of Contents
The yield on loans, excluding tax equivalent adjustments, decreased fourty two basis points for the six months endedJune 30, 2020 compared to the six months endedJune 30, 2019 from 5.20% to 4.78%. The yield on securities, excluding tax equivalent adjustments, decreased twenty two basis points during the first six months of 2020 compared to 2019 from 2.73% in 2019 to 2.51% in 2020. The cost of interest bearing liabilities was 1.01% for the first six months in 2020 compared to 1.24% in 2019.
Year to date average loans, excluding overdrafts, increased$94.8 million , or 13.7% for the six months endedJune 30, 2020 compared to the six months endedJune 30, 2019 . Loan interest income increased$769 thousand during the first six months of 2020 compared to the first six months of 2019. Year to date average total deposits increased fromJune 30, 2019 toJune 30, 2020 by$51.4 million or 6.0%. Year to date average interest bearing deposits increased$22.6 million , or 3.7%, fromJune 30, 2019 toJune 30, 2020 . Deposit interest expense decreased$521 thousand for the first six months of 2019 compared to the same period in 2018. Year to date average borrowings, including repurchase agreements, decreased$1.2 million , or 1.0%, fromJune 30, 2018 toJune 30, 2019 . Interest expense on borrowed funds, including repurchase agreements, decreased$81 thousand , or 5.8%, for the first six months of 2020 compared to the same period in 2019. The volume rate analysis for the six months endedJune 30, 2020 indicates that$4.1 million of the increase in loan interest income is attributable to an increase in loan volume and$680 thousand of the decrease in securities interest income is attributable to a decrease in the volume of our security portfolio. Much of the decrease in loan income is attributed to variable rate loans repricing at lower rates. The decrease in loan rates caused a decrease of$3.3 million in interest income and a decrease in rates in our security portfolio contributed to a decrease of$308 thousand in securities interest income. The net effect to interest income was a decrease of$526 thousand for the first six months of 2020 compared to the same time period in 2019. Also based on the following volume rate analysis for the six months endedJune 30, 2020 , a decrease in demand deposit interest rates resulted in$701 thousand reduced interest expense, interest rates paid for savings deposits remained fairly flat, and decreases in interest rates paid for time deposits resulted in a reduction of$70 thousand in interest expense. The change in volume in deposits and borrowings was responsible for a$777 thousand increase in interest expense, of which a decrease in demand deposits resulted in a decrease of$84 thousand in interest expense, of which an increase in time deposits resulted in an increase of$339 thousand in interest expense, a decrease in repurchase agreements resulted in a decrease of$60 thousand in interest expense, and an increase in other borrowings resulted in an increase of$582 thousand in interest expense. The net effect to interest expense was a decrease of$602 thousand . As a result, the increase in net interest income for the first six months in 2020 is mostly attributed to decreasing rates paid on deposits along with loan growth.
The volume rate analysis for the three months endedJune 30, 2020 indicates that the$23 thousand increase in net interest income is attributable to an increase of$1.1 million due to change in growth in the Company's balance sheet and a decrease of$1.1 million is a result of changes in rates. 42 Table of Contents
Changes in Interest Income and Expense
Six Months Ended
2020 vs. 2019
Increase (Decrease) Due to Change in
(in thousands) Volume Rate Net Change
INTEREST INCOME
Loans $ 4,078 $ (3,309) $ 769
Investment Securities (680) (308) (988)
Other 516 (823) (307)
Total Interest Income 3,914
(4,440) (526)
INTEREST EXPENSE
Deposits
Demand (84) (701) (785)
Savings - (5) (5)
Negotiable Certificates of Deposit and Other Time
Deposits 339 (70) 269
Securities sold under agreements to repurchase and
other borrowings (60) (74) (134)
Federal Home Loan Bank advances 582 (529) 53
Total Interest Expense 777 (1,379) (602)
Net Interest Income $ 3,137 $ (3,061) $ 76
Three Months Ended
2020 vs. 2019
Increase (Decrease) Due to Change in
Volume Rate Net Change
INTEREST INCOME
Loans $ 1,651 $ (1,462) $ 189
Investment Securities (423) (50) (473)
Other 370 (568) (198)
Total Interest Income 1,598
(2,080) (482)
INTEREST EXPENSE
Deposits
Demand (29) (458) (487)
Savings - (3) (3)
Negotiable Certificates of Deposit and Other Time
Deposits 190 (152) 38
Securities sold under agreements to repurchase and
other borrowings (17) (50) (67)
Federal Home Loan Bank advances 368
(354) 14
Total Interest Expense 512 (1,017) (505)
Net Interest Income $ 1,086 $ (1,063) $ 23
Non-Interest Income
Non-interest income increased $1.2 million for the six months ended June 30,
2020 , compared to the same period in 2019, to $7.6 million . Non-interest income
increased $664 thousand for the three months ended June 30, 2020 , compared to
the three months ended June 30 2019, to $4.0 million .
Favorable variances to non-interest income for the six months ended June 30,
2020 compared to the six months ended June 30, 2019 include an increase of $27
thousand in trust department income, an increase of $230 thousand in gains on
the sale of securities, an increase of $34 thousand in debit card interchange
income, an increase of $1.5 million in gains on the sale of loans, and an
increase of $153 thousand in other income, which is primarily attributed to
gains on bank owned life insurance.
Decreases to non-interest income for the six months ended June 30, 2020 compared
to the six months ended June 30, 2019 include a decrease of $312 thousand in
service charge income, a $391 thousand decrease in loan servicing fees, and a
decrease of $49 thousand in brokerage income.
43
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The gain on the sale of loans increased from$528 thousand during the first six months of 2019 to$2.1 million during the first six months of 2020, an increase of$1.5 million . For the three months endedJune 30 , the gain on the sale of loans increased from$321 thousand in 2019 to$1.4 million in 2020. The volume of loans originated to sell during the first six months of 2020 increased$37.7 million compared to the same time period in 2019. The volume of mortgage loan originations and sales is generally inverse to rate changes. A change in the mortgage loan rate environment can have a significant impact on the related gain on sale of mortgage loans. Loan service fee income, net of amortization and impairment expense, was$(287) thousand for the six months endedJune 30, 2020 compared to$104 thousand for the six months endedJune 30, 2019 , a decrease of$391 thousand . During the first six months of 2020, the market value adjustment to the carrying value of the mortgage servicing right was a net write- down of$336 thousand , as the fair value of this asset decreased. During the six months endedJune 30 2019 , the market value adjustment to the carrying value of the mortgage servicing right asset was a net write-down of$41 thousand . Non-Interest Expense Total non-interest expense increased$1.0 million , or 5.8%, for the six month period endedJune 30, 2020 compared to the same period in 2019. Total non-interest expense increased$560 thousand for the three month period endedJune 30, 2020 compared to the three months endedJune 30, 2019 . 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. Our most recent expansion involved constructing a new branch inLexington, KY in Tates Creek Centre. The branch opened inJuly 2020 . For the comparable six month periods, salaries and employees benefits expense increased$788 thousand , an increase of 8.4%. The number of full-time employee equivalent employees increased from 232 atJune 30, 2019 to 236 atJune 30, 2020 , an increase of four full-time employee equivalent employees. For the three months endedJune 30, 2020 compared to the three months endedJune 30, 2019 , salaries and employee benefits expense increased$513 thousand , or 11.0%. Occupancy expense increased$67 thousand to$2.1 million for the first six months of 2020 compared to the same time period in 2019. Occupancy expense was$1.0 million for the three months endedJune 30, 2020 compared to$1.1 million for the three months endedJune 30, 2019 . Debit card expenses decreased$96 thousand for the six months endedJune 30, 2020 compared to the first six months of 2019 and decreased$73 thousand for the three months endedJune 30, 2020 compared to the three months endedJune 30, 2019 . The year to date decrease in debit card expense is attributed to a decrease in debit card interchange activity. Data processing expenses decreased$127 thousand for the six months endedJune 30, 2020 compared to the first six months of 2019 and decreased$105 thousand for the three months endedJune 30, 2020 compared to the three months ended
June 30, 2019 . Loss on limited partnership expense increased$267 thousand for the six months endedJune 30, 2020 compared to the same time period in 2019. The increase is attributed to accelerating the amortization of one of our tax credit investments. However, this was offset through reduced income tax expense. Income Taxes The effective tax rate for the six months endedJune 30, 2020 was 2.4% compared to 4.61% in 2019. These effective tax rates are less than the statutory rate of 21% as a result of the Company investing in tax-free 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. The effective tax rate was lower for the six months endedJune 30, 2020 when compared to the six months endedJune 30, 2019 due to tax credits associated with low income housing investments increasing from$276 thousand for the six months endedJune 30, 2019 to$607 thousand for the six months endedJune 30, 2020 ; an increase of$331 thousand . 44
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Tax- exempt income increased$207 thousand for the first six months of 2020 compared to the first six months of 2019. Further, income before income taxes for the six months endedJune 30, 2020 decreased$1.4 million when compared to the six months endedJune 30, 2019 . 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 theCommonwealth of Kentucky . In making these investments, the Company considers the overall impact to managing our net interest margin, credit worthiness of the underlying issuer and the favorable impact on our tax position. For the six months endedJune 30, 2020 , the Company averaged$25.9 million in tax free securities and$56.5 million in tax free loans. As ofJune 30, 2020 , the weighted average remaining maturity for tax free securities is 61 months, while the weighted average remaining maturity for the tax free loans is 167 months.
For the year endedDecember 31, 2019 , the Company averaged$36.3 million in tax free securities, and$42.8 million in tax free loans. As ofDecember 31, 2019 , the weighted average remaining maturity for the tax free securities was 103 months, while the weighted average remaining maturity for the tax free loans was 131 months. OnMarch 26, 2019 ,Governor Bevin signed House Bill 354 into law which, among other things, repealed the bank franchise tax structure inKentucky . The capital based franchise tax structure will be replaced with the state-wide corporate income tax structure starting in 2021.Kentucky Bancshares, Inc. has historically filed a separate return inKentucky , and has generated aKentucky net operating loss ("NOL") carryforward, given the nature of its operations. Given House Bill 354,Kentucky Bancshares, Inc. will file a combined return in 2021, unless the Company decides to timely elect to file on a consolidated basis. OnApril 9, 2019 ,Governor Bevin signed House Bill 458 into law which, among other things, allows a taxpayer to utilize certain net operating loss ("NOL") carryforwards to offset other members in the combined filing group starting
in 2021.
As a result of these tax law changes, the Company had a deferred state tax asset
of
Liquidity and Funding Liquidity is the ability to meet current and future financial obligations. The Company's primary sources of funds consist of deposit inflows, loan repayments, maturities and sales of investment securities andFederal Home Loan Bank borrowings. Liquidity risk is the possibility that we may not be able to meet our cash requirements in an orderly manner. Management of liquidity risk includes maintenance of adequate cash and sources of cash to fund operations and to meet the needs of borrowers, depositors and creditors. Excess liquidity may have a negative impact on earnings as a result of the lower yields on short-term assets. Cash and cash equivalents were$104.3 million as ofJune 30, 2020 compared to$22.2 million atDecember 31, 2019 . The increase in cash and cash equivalents is attributed to an increase of$82.0 million in cash and due from banks. In addition to cash and cash equivalents, the securities portfolio provides an important source of liquidity. Securities available for sale totaled$251.6 million atJune 30, 2020 compared to$265.3 million atDecember 31, 2019 . The decrease of$13.7 million , fromDecember 31, 2019 toJune 30, 2020 in our available for sale security portfolio had minimal impact on available liquidity. The securities available for sale are available to meet liquidity needs on a continuing basis. However, we expect our customers' deposits to be adequate to meet our funding demands. Generally, we rely upon net cash inflows from financing activities, supplemented by net cash inflows from operating activities, to provide cash used in our 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. Our primary investing activities include purchasing investment securities and loan originations. 45 Table of Contents For the first six months of 2020, deposits increased$101.9 million compared toDecember 31, 2019 . The Company's borrowed funds from theFederal Home Loan Bank increased$29.0 million fromDecember 31, 2019 toJune 30, 2020 , federal funds purchased remained at zero, and total repurchase agreements decreased$1.7 million fromDecember 31, 2019 toJune 30, 2020 . Management is aware of the challenge of funding sustained loan growth. Therefore, in addition to deposits, other sources of funds, such asFederal Home Loan Bank advances, may be used. We rely onFederal Home Loan Bank advances for both liquidity and asset/liability management purposes. These advances are used primarily to fund long- term fixed rate residential mortgage loans. As ofJune 30, 2020 , we have sufficient collateral to borrow an additional$83.9 million from theFederal Home Loan Bank . In addition, as ofJune 30, 2020 ,$31 million is available in overnight borrowing through various correspondent banks and$270 million is available in brokered deposits. In light of this, management believes there is sufficient liquidity to meet all reasonable borrower, depositor and creditor needs in the present economic environment. In addition, theFederal Reserve has implemented a liquidity facility available to financial institutions participating in the PPP. As such, the Bank believes it has sufficient liquidity sources to fund all pending PPP loans and to continue to provide this important service to local businesses. Capital Requirements InAugust 2018 , theFederal Reserve Board issued an interim final ruling that holding companies with assets less than$3 billion are not subject to minimum capital requirements. As a result, only Bank capital data and capital ratios are presented as ofJune 30, 2020 andDecember 31, 2019 . The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possible additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank's assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Bank capital amounts and classifications are also subject to qualitative judgments by regulators about components, risk weightings, and other factors. The final rules implementing theBasel Committee on Banking Supervision's capital guidelines for US banks (Basel III rules) became effective for the Company onJanuary 1, 2015 with full compliance with all of the requirements being phased in over a multi-year schedule, and was fully phased in onJanuary 1, 2019 . The net unrealized gain or loss on available for sale securities and holding gains or losses on cash flow hedges are not included in computing regulatory capital. The federal banking agencies jointly issued a final rule that provides for an optional, simplified measure of capital adequacy, the community bank leverage ratio framework, for qualifying community banking organizations, consistent with Section 201 of the Economic Growth, Regulatory Relief, and Consumer Protection Act. The final rule became effective onJanuary 1, 2020 . This final rule is applicable to all non-advanced approachesFDIC -supervised institutions with less than$10 billion in total consolidated assets. Highlights of theCommunity Bank Leverage Ratio Framework follow:
The community bank leverage ratio (CBLR) final rule will be effective on
? calculate a leverage ratio to measure capital adequacy. Banks opting into the
CBLR framework (CBLR banks) will not be required to calculate or report risk-based capital.
A qualifying community banking organization is defined as having less than
billion in total consolidated assets, a leverage ratio greater than 9% as of
or less of total consolidated assets, and trading assets and liabilities of 5%
? or less of total consolidated assets. It also cannot be an advanced approaches
institution. Under the interim final rules, the community bank leverage ratio
will be 8 percent beginning in the second quarter and for the remainder of
calendar year 2020, 8.5 percent for calendar year 2021, and 9 percent
thereafter.
46
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The interim final rules also maintain a two-quarter grace period for a qualifying community banking organization whose leverage ratio falls no more than 1 percent below the applicable community bank leverage ratio.
The final rule adopts tier 1 capital and the existing leverage ratio into the
community bank leverage ratio framework. The tier 1 numerator takes into
? account the modifications made in relation to the capital simplifications and
current expected credit losses methodology (CECL) transitions rules as of the
compliance dates of those rules.
A CBLR bank will not be subject to other capital and leverage requirements. It
? will be deemed to have met the "well capitalized" ratio requirements and be in
compliance with the generally applicable capital rule.
? A CBLR may opt out of the framework at any time, without restriction, by
reverting to the generally applicable risk-based capital rule.
Management believes as ofJune 30, 2020 , the Bank meets all capital adequacy requirements to which it is subject. Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the following table) and Tier I capital (as defined in the regulations) to average assets (as defined).
Prompt corrective action regulations provide five classifications: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized, although these terms are not used to represent overall financial condition. If adequately capitalized, regulatory approval is required to accept brokered deposits. If undercapitalized, capital distributions are limited, as is asset growth and expansion, and capital restoration plans are required.
AtJune 30, 2020 and atDecember 31, 2019 , the most recent regulatory notifications categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Bank must maintain minimum Tier I leverage ratios as set forth in the following table. There are no conditions or events since that notification that management believes have changed the institution's category. The Bank's actual amounts and ratios are presented in the following table:
To Be Well
Capitalized
Under Prompt
For Capital Corrective
Actual Adequacy Purposes Action Provisions
Amount Ratio Amount Ratio Amount Ratio
(Dollars in Thousands)
June 30, 2020
Bank Only
Tier I Capital (to Average Assets) 105,145 8.6 97,791 8.0 97,791 8.0
December 31, 2019 Bank Only Tier I Capital (to Average Assets) 102,759 9.3 44,164
4.0 55,206 5.0
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Non-Performing Assets
As of June 30, 2020 , our non-performing assets totaled $6.7 million or 0.54% of
assets compared to $6.7 million or 0.61% of assets at December 31, 2019 . The
Company experienced an increase of $1.5 million in non-accrual loans from
December 31, 2019 to June 30, 2020 . As of June 30, 2020 , non-accrual loans
include $903 thousand in loans secured by 1-4 family properties, $374 thousand
in loans secured by real estate construction, $2.0 million in loans secured by
non-farm and non-residential properties, $1.3 million in loans secured by
multi-family properties and $38 thousand in consumer loans.
Loans secured by real estate composed 99.2% of the non-performing, non-accrual
loans as of June 30, 2020 and 97.8% as of December 31, 2019 . Forgone interest
income on non-accrual loans totaled $195 thousand for the first six months of
2020 compared to forgone interest of $41 thousand for the same time period in
2019. Accruing loans that are contractually 90 days or more past due as of June
30, 2020 totaled $264 thousand compared to $1.5 million at December 31, 2019 , a
decrease of $1.2 million .
Total nonperforming loans increased$242 thousand fromDecember 31, 2019 toJune 30, 2020 . The ratio of nonperforming loans as a percentage of loans decreased one basis point to 0.60% fromDecember 31, 2019 toJune 30, 2020 . In addition, the amount the Company has recorded as other real estate owned decreased$269 thousand fromDecember 31, 2019 toJune 30, 2020 . As ofJune 30, 2020 , the amount recorded as other real estate owned totaled$1.9 million compared to$2.1 million atDecember 31, 2019 . During the first six months of 2020, no new additions were added to other real estate properties while$231 thousand in other real estate properties were sold. Write-downs totaling$38 thousand were also recorded during the six months endedJune 30, 2020 . The allowance as a percentage of non-performing and restructured loans and other real estate owned increased from 126% atDecember 31, 2019 to 155% at June
30, 2020. The economic downturn experienced as a result of the COVID-19 pandemic is expected to result in increased non-performing assets. Loan modifications executed during 2020 totaled approximately$115 million . The majority of these modifications involved three to six month forbearance payments which were added to the end of the note. These modification and economic stimulus packages offered by the government are expected to help loan customers meet debt obligations but it is unknown to what extent at this time.
Nonperforming and Restructured Assets
6/30/2020 12/31/2019
(in thousands)
Non-accrual Loans $ 4,558 $ 3,081
Accruing Loans which are Contractually past due over 89
days 264 1,499
Accruing Troubled Debt Restructurings - - Total Nonperforming and Restructured Loans 4,822
4,580
Other Real Estate 1,879
2,148
Total Nonperforming and Restructured Loans and Other Real Estate$ 6,701
0.60
% 0.61 %
Nonperforming and Restructured Loans and
0.54 % 0.61 %
Allowance as a Percentage of Period-end Loans 1.29 % 1.14 %
Allowance as a Percentage of Non-performing and
Restructured Loans and Other Real Estate 155
% 126 %
We maintain a "watch list" of agricultural, commercial, real estate mortgage,
and real estate construction loans and review those loans at least quarterly but
more often if needed. Generally, assets are designated as "watch list" loans to
ensure more frequent monitoring. If we determine that there is serious doubt as
to performance in accordance with original terms of the contract, then the loan
is generally downgraded and often placed on non-accrual status. We review and
evaluate nonaccrual loans, past due loans, and loans graded substandard or worse
on a regular basis to determine if the loan should be evaluated for impairment
and whether specific allocations are needed.
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Provision for Loan Losses
The loan loss provision for the first six months of 2020 was $2.1 million
compared to $450 thousand for the first six months of 2019. The increase in the
total loan loss provision during the first six months of 2020 compared to the
same time period in 2019 was attributed mostly to uncertainties surrounding the
COVID-19 pandemic. It is possible the Company will have additional provision for
loan losses expense in future quarters as a result of the economic downturn
associated with the COVID-19 pandemic. In addition, we recorded a specific
reserve of $900 thousand during the three months ended June 30, 2020 for one
loan which had an an outstanding balance $1.8 million , not accruing interest and
classified as non-farm and non-residential at June 30, 2020 . The specific
reserve of $900 thousand was offset by declines in loan balances in other
segments only requiring $500 thousand provision expense for the three months
ended June 30, 2020 . The allowance for loan losses as a percentage of loans was
1.29% at June 30, 2020 compared to 1.14% at June 30, 2019 . The allowance for
loan losses as a percentage of loans, excluding PPP loans for which no allowance
for loan losses was needed as of June 30, 2020 , was 1.38%.
Management evaluates the loan portfolio by reviewing the historical loss rate
for each respective loan type and assigns risk multiples to certain categories
to account for qualitative factors including current economic conditions. The
average loss rates are reviewed for trends in the analysis, as well as
comparisons to peer group loss rates.
Management makes allocations within the allowance for loan losses for
specifically classified loans regardless of loan amount, collateral or loan
type. Loan categories are evaluated utilizing subjective factors in addition to
the historical loss calculations to determine a loss allocation for each of
those types. As this analysis, or any similar analysis, is an imprecise measure
of loss, the allowance is subject to ongoing adjustments. Therefore, management
will often take into account other significant factors that may be necessary or
prudent in order to reflect probable incurred losses in the total loan
portfolio.
Nonperforming loans increased $242 thousand from December 31, 2019 to $4.8
million at June 30, 2020 . The Company recorded net charge-offs of $196 thousand
for the six months ended June 30, 2020 compared to net charge-offs of $501
thousand for the six months ended June 30, 2019 . During the first quarter of
2019, a single note balance of $191 thousand was charged-off. The note had a
specific reserve of $191 thousand at December 31, 2018 ; thus, this charged-off
balance did not result in additional loan loss provision expense. Future levels
of charge-offs will be determined by the particular facts and circumstances
surrounding individual loans.
Based on the above information, management believes the current loan loss allowance is sufficient to meet probable incurred loan losses.
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Six Months Ended June 30 ,
(in thousands)
2020 2019Balance at Beginning of Period$ 8,460
$ 8,127 Amounts Charged-Off: Commercial 25 191 1-4 family residential 35 104 Non-farm & non-residential - 17 Consumer and other 613 580 Total Charged-off Loans 673 892 Recoveries on Amounts Previously Charged-off: Commercial 12 10 1-4 family residential 18 12 Agricultural 3 4 Consumer and other 444 365 Total Recoveries 477 391 Net Charge-offs (Recoveries) 196 501 Provision for Loan Losses 2,125 450 Balance at End of Period 10,389 8,076 Loans Average 786,236 691,399 At June 30, 808,467 707,982 As a Percentage of Average Loans: Net Charge-offs for the period 0.02 % 0.07 % Provision for Loan Losses for the period 0.27 % 0.07 % Allowance as a Multiple of Net Charge-offs annualized 26.5
8.1
Three Months Ended June 30,
(in thousands)
2020 2019
Balance at Beginning of Period: $ 9,916 $ 7,882
Amounts Charged-Off:
1-4 family residential - 5
Consumer and other 266 278
Total Charged-off Loans 266 283
Recoveries on Amounts Previously Charged-off:
Commercial 6 3
1-4 family residential 3 4
Agricultural 1 3
Consumer and other 229 142
Total Recoveries 239 152
Net Charge-offs 27 131
Provision for Loan Losses 500 325
Balance at End of Period 10,389 8,076
Loans
Average 810,478 697,381
At June 30, 808,467 707,982
As a Percentage of Average Loans:
Net Charge-offs (Recoveries) for the period 0.00 % 0.02 %
Provision for Loan Losses for the period 0.06 % 0.05 %
Allowance as a Multiple of Net Charge-offs annualized 96.2 15.4
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