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 . Results for the prior periods indicated in this report are not necessarily indicative of the results for the year endingDecember 31, 2020 or any future period. 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. 39 Table of Contents 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.
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 due to events beyond our
? control that may have a destabilizing effect on financial markets and the
economy;
? 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 deposit flows;
? 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 the Securities 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.
Recent Developments - COVID-19 Pandemic
Policy and Regulatory Developments. Federal, state and local governments and regulatory authorities have enacted and issued, and may continue to enact and issue, a range of policy responses to the COVID-19 pandemic, which was declared a national emergency inthe United States inMarch 2020 and continues to create disruptions to the global econom, financial markets, businesses, and the lives of individuals. 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).
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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
mid-sized businesses, as well as state and local governments impacted by
COVID-19. The
Program, which established 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 . Effects on Our Business. We continue to 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. Although in various locations certain activity restrictions have been relaxed and business and schools have reopened, in many states and localities the number of COVID-19 diagnoses have increased significantly, which may cause a freezing or, in certain cases, a reversal of previously announced relaxation of activity restrictions and may prompt the need for additional aid and other forms of relief. 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.
During the second and third quarters of 2020 combined, we had approved modifications on approximately$125.3 million of loans. During only the third quarter of 2020, we had approved modifications on approximately$3.7 million . Of the total$125.3 million in approved loan modifications,$3,2 million was still in deferment as of Septemer 30, 2020.
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.
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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
million 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. Summary The Company recorded net income of$8.2 million , or$1.38 basic earnings and diluted earnings per share for the first nine months endedSeptember 30, 2020 compared to$9.7 million or$1.62 basic earnings and diluted earnings per share for the nine month period endedSeptember 30, 2019 . The first nine months net earnings reflect a decrease of$1.5 million , or 15.4%, compared to the same time period in 2019. The decrease in net earnings is mostly attributed to a decrease of$525 thousand , or 1.9%, in net interest income, an increase of$1.3 million , or 12.6%, in non-interest income, an increase of$1.7 million , or 6.6%, in non-interest expense, and an increase of$1.1 million , or 127.3%, 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 endedSeptember 30, 2020 were$3.4 million or$0.57 basic and diluted earnings per share compared to$3.6 million or$0.61 basic and diluted earnings per share for the three month period endedSeptember 30, 2019 . The earnings for the three month period in 2020 reflect a decrease of 7.3% compared to the same time period in 2019. For the nine months endedSeptember 30, 2020 and compared to the nine months endedSeptember 30, 2019 , service charges decreased$630 thousand , gain on the sale of loans increased$2.4 million , and debit card interchange income increased$139 thousand . Salaries and benefits expense increased$924 thousand , legal and professional fees increased$211 thousand , data processing expenses decreased$152 thousand and loss on limited partnership expenses increased
$402 thousand . For the three months endedSeptember 30, 2020 and compared to the three months endedSeptember 30, 2019 , service charges decreased$318 thousand , debit card interchange income increased$105 thousand , and gains on the sale of loans increased$867 thousand . For the three months endedSeptember 30, 2020 and compared to the three months endedSeptember 30, 2019 , salaries and benefits expense increased$136 thousand , data processing expense decreased$25 thousand , debit card expense increased$84 thousand and other expenses increased$283 thousand .
For the same three month comparison, loss on limited partnership expense
increased
expense decreased
Return on average assets was 0.91% for the nine months endedSeptember 30, 2020 and 1.19% for the nine months endedSeptember 30, 2019 . Return on average assets was 1.11% for the three months endedSeptember 30, 2020 and 1.34% for the three months endedSeptember 30, 2019 . Return on average equity was 8.98% for the nine month period endedSeptember 30, 2020 and 11.42% for the nine month period endedSeptember 30, 2019 . Return on average equity was 10.89% for the three month period endedSeptember 30, 2020 and 12.44% for the three month period endedSeptember 30, 2019 .
Securities available for sale increased
Gross Loans increased
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The overall increase in loan balances from December 31, 2019 to September 30,
2020 is comprised of the following: an increase of $2.7 million in 1-4 family
residential loans, an increase of $43.0 million in commercial loans, a decrease
of $640 thousand in multi-family residential loans, a decrease of $3.3 million
in agricultural loans, an increase of $18.7 million in non-farm and
non-residential loans, a decrease of $497 thousand in consumer loans and a
decrease of $16.6 million in real-estate construction loans. Other loan balances
decreased $175 thousand from December 31, 2019 to September 30, 2020 .
The increase in commercial loan balances from December 31, 2019 to September 30,
2020 was attributed to having $57.6 million in outstanding PPP loan balances as
of September 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$842.7 million onDecember 31, 2019 to$931.2 million onSeptember 30, 2020 , an increase of$88.6 million . Non-interest bearing demand deposit accounts increased$74.4 million fromDecember 31, 2019 toSeptember 30, 2020 while time deposits$250 thousand and over decreased$6.8 million and other interest bearing deposit accounts increased$21.0 million fromDecember 31, 2019 toSeptember 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$33.5 million fromDecember 31, 2019 toSeptember 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 decreased$12.4 million fromDecember 31, 2019 toSeptember 30, 2020 . Long- term borrowings decreased$2.9 million and short-term borrowings decreased$9.5 million during the nine month period. Repurchase agreements decreased$566 thousand for the same nine 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$26.8 million for the nine months endedSeptember 30, 2020 compared to$27.3 million for the nine months endedSeptember 30, 2019 , a decrease of 1.9%. Net interest income was$8.7 million for the three months endedSeptember 30, 2020 compared to$9.3 million for the three months endedSeptember 30, 2019 .
The tax equivalent net interest margin was 3.29% for the first nine months of 2020 compared to 3.69% for the first nine months of 2019. For the first nine months in 2020, the tax equivalent yield on interest earning assets decreased from 4.58% in 2019 to 3.94% in 2020. The yield on loans, excluding tax equivalent adjustments, decreased sixty five basis points for the nine months endedSeptember 30, 2020 compared to the nine months endedSeptember 30, 2019 from 5.31% to 4.66%. The yield on securities, excluding tax equivalent adjustments, decreased thirty eight basis points during the first nine months of 2020 compared to 2019 from 2.73% in 2019 to 2.35% in 2020. The cost of interest bearing liabilities was 0.93% for the first nine months in 2020 compared to 1.25% in 2019. Year to date average loans, excluding overdrafts, increased$88.4 million , or 12.7% for the nine months endedSeptember 30, 2020 compared to the nine months endedSeptember 30, 2019 . Loan interest income increased$27 thousand during the first nine months of 2020 compared to the first nine months of 2019. Year to date average total deposits increased fromSeptember 30, 2019 toSeptember 30, 2020 by$66.3 million or 7.8%. Year to date average interest bearing deposits increased$25.6 million , or 4.3%, fromSeptember 30, 2019 toSeptember 30, 2020 . Deposit interest expense decreased$1.1 million for the first nine months of 2020 compared to the same period in 2019. 43
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Year to date average borrowings, including repurchase agreements, increased$28.3 million , or 23.7%, fromSeptember 30, 2019 toSeptember 30, 2020 . Interest expense on borrowed funds, including repurchase agreements, decreased$201 thousand , or 9.7%, for the first nine months of 2020 compared to the same period in 2019. We anticipate continued pressure on our net interest spread and net interest margin in future periods as our loan yield continues to decline due to
the
The volume rate analysis for the nine months endedSeptember 30, 2020 indicates that$4.8 million of the increase in loan interest income is attributable to an increase in loan volume and$694 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$4.8 million in interest income and a decrease in rates in our security portfolio contributed to a decrease of$768 thousand in securities interest income. The net effect to interest income was a decrease of$1.9 million for the first nine months of 2020 compared to the same time period in 2019. Also based on the following volume rate analysis for the nine months endedSeptember 30, 2020 , a decrease in demand deposit interest rates resulted in$1.1 million 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$327 thousand in interest expense. The change in volume in deposits and borrowings was responsible for a$838 thousand increase in interest expense, of which a decrease in demand deposits resulted in a decrease of$13 thousand in interest expense, of which an increase in time deposits resulted in an increase of$330 thousand in interest expense, a decrease in repurchase agreements resulted in a decrease of$85 thousand in interest expense, and an increase in other borrowings resulted in an increase of$598 thousand in interest expense. The net effect to interest expense was a decrease of$1.3 million . As a result, the decrease in net interest income for the first nine months in 2020 is mostly attributed to lower loan yields. The volume rate analysis for the three months endedSeptember 30, 2020 indicates that the$601 thousand decrease in net interest income is attributable to an increase of$610 thousand due to change in growth in the Company's balance sheet and a decrease of$1.2 million is a result of changes in rates.
Changes in Interest Income and Expense
Nine Months Ended
2020 vs. 2019
Increase (Decrease) Due to Change in
(in thousands) Volume Rate Net Change
INTEREST INCOME
Loans $ 4,830 $ (4,803) $ 27
Investment Securities (694) (768) (1,462)
Other 449 (868) (419)
Total Interest Income 4,585 (6,439) (1,854)
INTEREST EXPENSE
Deposits
Demand (13) (1,112) (1,125)
Savings 8 (14) (6)
Negotiable Certificates of Deposit and Other Time
Deposits 330 (327) 3
Securities sold under agreements to repurchase and
other borrowings (85) (121) (206)
Federal Home Loan Bank advances 598 (593) 5 Total Interest Expense 838 (2,167) (1,329) Net Interest Income$ 3,747 $ (4,272) $ (525) Non-Interest Income Non-interest income increased$1.3 million for the nine months endedSeptember 30, 2020 , compared to the same period in 2019, to$11.7 million . Non-interest income increased$85 thousand for the three months endedSeptember 30, 2020 , compared to the three months ended September 30 2019, to$4.1 million . 44 Table of Contents Favorable variances in non-interest income for the nine months endedSeptember 30, 2020 compared to the nine months endedSeptember 30, 2019 include an increase of$25 thousand in trust department income, an increase of$139 thousand in debit card interchange income, an increase of$2.4 million in gains on the sale of loans, and an increase of$42 thousand in other income, which is mostly attributed to an increase of$233 thouand in income from bank owned life insurance partially offset by a net decrease of$162 thousand in the gain on the sale of other real estate. Favorable variances in non-interest income for the three months endedSeptember 30, 2020 compared to the three months endedSeptember 30, 2019 include an increase of$117 thousand in loan servicing fee income, net, an increase of$867 in the gain on sale of loans and an increase of$105 thousand in debit card interchange income. Decreases in non-interest income for the nine months endedSeptember 30, 2020 compared to the nine months endedSeptember 30, 2019 include a decrease of$630 thousand in service charge income, a$274 thousand decrease in loan servicing fees, a decrease of$346 thousand in gains on the sale of securities and a decrease of$46 thousand in brokerage income. The decrease of$630 thousand in service charge income is mostly attributed to a decrease of$559 thousand in overdraft fees due to a decrease in overdraft activity we have experienced since the COVID-19 pandemic began. The gain on the sale of loans increased from$1.1 million during the first nine months of 2019 to$3.5 million during the first nine months of 2020, an increase of$2.4 million . For the three months endedSeptember 30 , the gain on the sale of loans increased from$541 thousand in 2019 to$1.4 million in 2020. The volume of loans originated to sell during the first nine months of 2020 increased$45.0 million compared to the same time period in 2019. The volume of mortgage loan originations and sales is generally inverse to rate changes. A change in the mortgage loan rate environment can have a significant impact on the related gain on sale of mortgage loans. Loan service fee income, net of amortization and impairment expense, was$(265) thousand for the nine months endedSeptember 30, 2020 compared to$9 thousand for the nine months endedSeptember 30, 2019 , a decrease of$274 thousand . During the first nine months of 2020, the market value adjustment to the carrying value of the mortgage servicing right was a net write- down of$330 thousand , as the fair value of this asset decreased. During the nine months endedSeptember 30, 2019 , the market value adjustment to the carrying value of the mortgage servicing right asset was a net write-down of$155 thousand . Non-Interest Expense Total non-interest expense increased$1.7 million , or 6.6%, for the nine month period endedSeptember 30, 2020 compared to the same period in 2019. Total non-interest expense increased$706 thousand for the three month period endedSeptember 30, 2020 compared to the three months endedSeptember 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 nine month periods, salaries and employees benefits expense increased$924 thousand , an increase of 6.5%. The number of full-time employee equivalent employees increased from 232 atSeptember 30, 2019 to 239 atSeptember 30, 2020 , an increase of seven full-time employee equivalent employees. For the three months endedSeptember 30, 2020 compared to the three months endedSeptember 30, 2019 , salaries and employee benefits expense increased$136 thousand , or 2.8%.
Occupancy expense increased
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Debit card expenses decreased $12 thousand for the nine months ended September
30, 2020 compared to the first nine months of 2019 and increased $84 thousand
for the three months ended September 30, 2020 compared to the three months ended
September 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 $152 thousand for the nine months ended
September 30, 2020 compared to the first nine months of 2019 and decreased $25
thousand for the three months ended September 30, 2020 compared to the three
months ended September 30, 2019 .
Loss on limited partnership expense increased $402 thousand for the nine months
ended September 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 nine months ended September 30, 2020 was 5.0%
compared to 8.9% 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 nine months ended September 30, 2020
when compared to the nine months ended September 30, 2019 due to tax credits
associated with historical and low income housing investments increasing from
$415 thousand for the nine months ended September 30, 2019 to $674 thousand for
the nine months ended September 30, 2020 ; an increase of $259 thousand . Tax-
exempt income increased $152 thousand for the first nine months of 2020 compared
to the first nine months of 2019. Further, income before income taxes for the
nine months ended September 30, 2020 decreased $2.0 million when compared to the
nine months ended September 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 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 nine months ended September 30, 2020 , the Company averaged
$32.2 million in tax free securities and $56.7 million in tax free loans. As of
September 30, 2020 , the weighted average remaining maturity for tax free
securities is 68 months, while the weighted average remaining maturity for the
tax free loans is 165 months.
For the year ended December 31, 2019 , the Company averaged $36.3 million in tax
free securities, and $42.8 million in tax free loans. As of December 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.
On March 26, 2019 , Governor Bevin signed House Bill 354 into law which, among
other things, repealed the bank franchise tax structure in Kentucky . 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 in Kentucky , and has generated a Kentucky
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.
On April 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 startingin 2021.
As a result of these tax law changes, the Company had a deferred state tax asset of$473 thousand as ofSeptember 30, 2020 and$606 thousand as of December
31,
2019.
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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$41.3 million as ofSeptember 30, 2020 compared to$22.2 million atDecember 31, 2019 . The increase in cash and cash equivalents is attributed to an increase of$19.0 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$291.9 million atSeptember 30, 2020 compared to$265.3 million atDecember 31, 2019 . The increase of$26.5 million , fromDecember 31, 2019 toSeptember 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. For the first nine months of 2020, deposits increased$88.6 million compared toDecember 31, 2019 . The Company's borrowed funds from theFederal Home Loan Bank decreased$12.4 million fromDecember 31, 2019 toSeptember 30, 2020 , federal funds purchased remained at zero, and total repurchase agreements decreased$566 thousand fromDecember 31, 2019 toSeptember 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 ofSeptember 30, 2020 , we have sufficient collateral to borrow an additional$110.1 million from theFederal Home Loan Bank . In addition, as ofSeptember 30, 2020 ,$45 million is available in overnight borrowing through various correspondent banks and$266 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. , including as a result of the COVID-19 pandemic. 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 ofSeptember 30, 2020 andDecember 31, 2019 . 47 Table of Contents
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 became effective on January
1, 2020, and allows qualifying community banking organizations to 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, off-balance sheet exposures of 25% or
less of total consolidated assets, and trading assets and liabilities of 5% or
less of total consolidated assets, all as of the most recent quarter It also
cannot be an advanced approaches institution. A bank that elects to use the
CBLR framework will generally be considered well-capitalized and to have met
? the risk-based and leverage capital requirements of the capital regulations if
it has a leverage ratio greater than 9%. As required by the CARES Act, the
temporarily lowered the CBLR to 8% beginning in the second quarter of 2020
through the end of the year. Beginning in 2021, the CBLR will increase to 8.5%
for that calendar year. The CBLR will return to 9% on
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.
The Bank has elected to use the CBLR framework. AtSeptember 30, 2020 , the Bank's CBLR was 8.7%. Management believes as ofSeptember 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.
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AtSeptember 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)
September 30, 2020
Bank Only
Tier I Capital (to Average Assets) $ 106,408 8.7 $ 97,326 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
(1) Amounts reported for capital adequacy purposes do not include capital
conservation buffer
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Non-Performing Assets
As ofSeptember 30, 2020 , our non-performing assets totaled$6.0 million or 0.50% of assets compared to$6.7 million or 0.61% of assets atDecember 31, 2019 . The Company experienced an increase of$1.2 million in non-accrual loans fromDecember 31, 2019 toSeptember 30, 2020 . As ofSeptember 30, 2020 , non-accrual loans include$684 thousand in loans secured by 1-4 family properties,$374 thousand in loans secured by real estate construction,$1.8 million in loans secured by non-farm and non-residential properties,$1.3 million in loans secured by multi-family properties,$56 thousand in commercial loans,$82 thousand in agricultural loans and$27 thousand in consumer loans. Loans secured by real estate composed 91.5% of the non-performing, non-accrual loans as ofSeptember 30, 2020 and 97.8% as ofDecember 31, 2019 . Forgone interest income on non-accrual loans totaled$313 thousand for the first nine months of 2020 compared to forgone interest of$55 thousand for the same time period in 2019. Accruing loans that are contractually 90 days or more past due as ofSeptember 30, 2020 totaled$983 thousand compared to$1.5 million atDecember 31, 2019 , a decrease of$516 thousand .
Total nonperforming loans increased
In addition, the amount the Company has recorded as other real estate owned decreased$1.5 million fromDecember 31, 2019 toSeptember 30, 2020 . As ofSeptember 30, 2020 , the amount recorded as other real estate owned totaled$673 thousand compared to$2.1 million atDecember 31, 2019 . During the first nine months of 2020, no new additions were added to other real estate properties while$1.4 million in other real estate properties were sold. Write-downs totaling$38 thousand were also recorded during the nine months endedSeptember 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 169% atSeptember 30, 2020 .
The economic downturn experienced as a result of the COVID-19 pandemic has resulted and is expected to continue to result in increased non-performing assets. Loan modifications executed during 2020 totaled approximately$125.3 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. Of the approximate$125.3 million in loan balances originally modified, only$3.2 million remain in deferment.
Nonperforming and Restructured Assets
9/30/2020 12/31/2019
(in thousands)
Non-accrual Loans $ 4,328 $ 3,081
Accruing Loans which are Contractually past due over 89
days 983 1,499
Accruing Troubled Debt Restructurings 1,127 - Total Nonperforming and Restructured Loans 6,438
4,580
Other Real Estate 673
2,148
Total Nonperforming and Restructured Loans and Other Real Estate$ 7,111
0.82
% 0.61 %
Nonperforming and Restructured Loans and
0.59 % 0.61 %
Allowance as a Percentage of Period-end Loans 1.28 % 1.14 %
Allowance as a Percentage of Non-performing and
Restructured Loans and Other Real Estate 142
% 126 %
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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.
Provision for Loan Losses
The loan loss provision for the first nine months of 2020 was$1.9 million compared to$825 thousand for the first nine months of 2019. The increase in the total loan loss provision during the first nine 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 second quarter of 2020 for one loan which had an an outstanding balance$1.8 million , not accruing interest and classified as non-farm and non-residential. The specific reserve was still carried atSeptember 30, 2020 . The specific reserve of$900 thousand was offset by declines in loan balances in other segments, resulting in a decrease of$250 thousand provision expense for the three months endedSeptember 30, 2020 . The allowance for loan losses as a percentage of loans was 1.28% atSeptember 30, 2020 compared to 1.14% atDecember 31, 2019 . The allowance for loan losses as a percentage of loans, excluding PPP loans for which no allowance for loan losses was needed as ofSeptember 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$731 thousand fromDecember 31, 2019 to$5.3 million atSeptember 30, 2020 . The Company recorded net charge-offs of$241 thousand for the nine months endedSeptember 30, 2020 compared to net charge-offs of$686 thousand for the nine months endedSeptember 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 atDecember 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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Nine Months Ended September 30 ,
(in thousands)
2020 2019Balance at Beginning of Period $ 8,460
$ 8,127
Amounts Charged-Off:
Commercial 25 191
1-4 family residential 37 149
Non-farm & non-residential - 17
Consumer and other 827 920
Total Charged-off Loans 889 1,277
Recoveries on Amounts Previously Charged-off:
Commercial 15 14
1-4 family residential 24 15
Non-farm & non-residential 5 -
Agricultural 6 6
Consumer and other 598 541
Total Recoveries 648 591
Net Charge-offs (Recoveries) 241 686
Provision for Loan Losses 1,875 825
Balance at End of Period 10,094 8,266
Loans
Average 791,387 701,505
At September 30, 787,447 732,267
As a Percentage of Average Loans:
Net Charge-offs for the period 0.03 % 0.10 %
Provision for Loan Losses for the period 0.24 % 0.12 %
Allowance as a Multiple of Net Charge-offs annualized 31.4
9.0
Three Months Ended September 30 ,
(in thousands)
2020 2019Balance at Beginning of Period: $ 10,389
$ 8,076
Amounts Charged-Off:
Commercial - -
1-4 family residential - 45
Non-farm & non-residential - -
Consumer and other 214 340
Total Charged-off Loans 216 385
Recoveries on Amounts Previously Charged-off:
Commercial 3 4
1-4 family residential 6 3
Multi-family residential - 15
Agricultural 3 2
Consumer and other 154 176
Total Recoveries 171 200
Net Charge-offs 45 185
Provision for Loan Losses (250) 375
Balance at End of Period 10,094 8,266
Loans
Average 803,638 721,676
At September 30, 787,447 732,267
As a Percentage of Average Loans:
Net Charge-offs (Recoveries) for the period 0.01 % 0.03 %
Provision for Loan Losses for the period (0.03) % 0.05 %
Allowance as a Multiple of Net Charge-offs annualized 56.1
11.2
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