KENTUCKY BANCSHARES, INC. This section presents an analysis of the consolidated financial condition of the Company and its wholly-owned subsidiary,Kentucky Bank , atDecember 31, 2020 and 2019, and the consolidated results of operations for each of the years in the two year period endedDecember 31, 2020 . The following discussion and analysis of financial condition and results of operations should be read in conjunction with the 2020 Consolidated Financial Statements and Notes included in Item 8. When necessary, reclassifications have been made to prior years' data throughout the following discussion and analysis for purposes of comparability with 2020 data.
Cautionary Language Regarding Forward-Looking Statements
This document contains statements relating to future results ofKentucky Bancshares that are considered "forward- looking" as defined by Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. The forward-looking statements are principally, but not exclusively, contained in Part II Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations" and Part I Item 1A "Risk Factors." Although the Company believes that the assumptions underlying the forward-looking statements contained herein are reasonable, any of the assumptions could be inaccurate, and therefore, there can be no assurance that the forward-looking statements included herein will prove to be accurate. Factors that could cause actual results to differ from the results discussed in the forward-looking statements include, but are not limited to:
economic conditions (both generally and more specifically in the markets,
? including the tobacco market, the thoroughbred horse industry and the
automobile industry relating to
bank operate);
? competition for the Company's customers from other providers of financial and
mortgage services;
? government legislation, regulation and monetary policy (which changes from time
to time and over which the Company has no control);
? changes in interest rates (both generally and more specifically mortgage
interest rates);
? material unforeseen changes in the liquidity, results of operations, or
financial condition of the Company's customers; and
other risks detailed in Part 1, Item 1A "Risk Factors" in this report and other
? risks detailed in the Company's filings with the Securities and Exchange
Commission, all of which are difficult to predict and many of which are beyond
the control of the Company.
The Company undertakes no obligation to republish revised forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. There is no assurance that any list of risks and uncertainties or risk factors is complete.
Forward-looking statements involve known and unknown risks, uncertainties, and
other factors that may cause actual results, performance, or achievements to be
materially different from future results, performance, or achievements expressed
or implied by the statement. These statements are often, but not always, made
through the use of words or phrases such as "anticipate," "believe," "aim,"
"can," "conclude," "continue," "could," "estimate," "expect," "foresee," "goal,"
"intend," "may," "might," "outlook," "possible," "plan," "predict," "project,"
"potential," "seek," "should," "target," "will," "will likely," "would," or
other similar expressions. These forward-looking statements are not historical
facts and are based on current expectations, estimates and projections about our
industry, management's beliefs and certain assumptions made by management, many
of which, by their nature, are inherently uncertain and beyond our control,
particularly with regard to developments related to the COVID-19 pandemic.
Forward-looking statements detail management's expectations regarding the future
and are based on information known to management only as of the date the
statements are made and management undertakes no obligation to update
forward-looking statements to reflect events or circumstances that occur after
the date forward-looking statements are made, except as required by applicable
law.
19
As previously noted, the Company executed a definitive Agreement and Plan of
Merger ("agreement") dated as of January 27, 2021 , with Stock Yards Bancorp.
This document also contains statements regarding the proposed acquisition
transaction that are not statements of historical fact and are considered
forward-looking statements within the criteria described above. These statements
are likewise subject to various risks and uncertainties that may cause actual
results and outcomes of the proposed transaction to differ, possibly materially,
from the anticipated results or outcomes expressed or implied in these
forward-looking statements. In addition to factors disclosed in reports filed by
Stock Yards and Kentucky Bancshares with the SEC , risks and uncertainties for
Stock Yards, Kentucky Bancshares and the combined company include, but are not
limited to: the possibility that any of the anticipated benefits of the proposed
merger will not be realized or will not be realized within the expected time
period; the risk that integration of Kentucky Bancshares' operations with those
of Stock Yards will be materially delayed or will be more costly or difficult
than expected; the parties' inability to meet expectations regarding the timing,
completion and accounting and tax treatments of the merger; the inability to
complete the merger due to the failure of Kentucky Bancshares' shareholders to
adopt the merger agreement; the failure to satisfy other conditions to
completion of the merger, including receipt of required regulatory and other
approvals; the failure of the proposed transaction to close for any other
reason; diversion of management's attention from ongoing business operations and
opportunities due to the merger; the challenges of integrating and retaining key
employees; the effect of the announcement of the merger on Stock Yards',
Kentucky Bancshares' or the combined company's respective customer and employee
relationships and operating results; the possibility that the merger may be more
expensive to complete than anticipated, including as a result of unexpected
factors or events; dilution caused by Stock Yards' issuance of additional shares
of Stock Yards common stock in connection with the merger; the magnitude and
duration of the COVID-19 pandemic and its impact on the global economy and
financial market conditions and the business, results of operations and
financial condition of Stock Yards, Kentucky Bancshares and the combined
company; and general competitive, economic, political and market conditionsand fluctuations. The merger agreement should not be read alone, but should instead be read in conjunction with the other information regarding Stock Yards Bancorp,Kentucky Bancshares , their respective affiliates or their respective businesses, the merger agreement and the mergers that will be contained in, or incorporated by reference into, the registration statement on Form S-4 that will include a proxy statement ofKentucky Bancshares and a prospectus of Stock Yards Bancorp, as well as in the Forms 10-K, Forms 10-Q, Forms 8-K and other filings that each of Stock Yards Bancorp andKentucky Bancshares make with theSecurities and Exchange Commission ("SEC"). This annual report is not a substitute for the proxy statement/prospectus or registration statement or any other document that Stock Yards Bancorp orKentucky Bancshares may file with theSEC .KENTUCKY BANCSHARES' SHAREHOLDERS ARE ADVISED TO READ THE REGISTRATION STATEMENT ON FORM S-4 AND THE RELATED PROXY STATEMENT/PROSPECTUS, AS WELL AS ANY AMENDMENTS OR SUPPLEMENTS TO THOSE DOCUMENTS AND ANY OTHER RELEVANT DOCUMENTS FILED OR TO BE FILED WITH THE SEC IN CONNECTION WITH THE PROPOSED MERGER TRANSACTION, WHEN THEY BECOME AVAILABLE BECAUSE THEY WILL CONTAIN IMPORTANT INFORMATION ABOUT STOCK YARDS BANCORP,KENTUCKY BANCSHARES AND THE PROPOSED MERGER TRANSACTION. When filed, the registration statement, the definitive proxy statement/prospectus and other documents relating to the merger transaction filed by Stock Yards Bancorp andKentucky Bancshares can be obtained free of charge from theSEC's website at www.sec.gov. These documents also can be obtained free of charge by accessingStock Yard Bancorp's website at www.syb.com under the tab "Investor Relations" and then under "SEC Filings." Alternative, these documents, when available, can be obtained free of charge from Stock Yards Bancorp upon written request to Stock Yards Bancorp, Attention: Chief Financial Officer,1040 East Main Street ,Louisville, Kentucky 40206 or by calling (502) 582-2571, or toKentucky Bancshares , Attention: Chief Financial Officer,339 Main Street ,Paris, Kentucky 40361 or by calling (859) 987-1795. This annual report is not intended to and shall not constitute an offer to sell or the solicitation of an offer to buy securities nor shall there be any sale of securities in any jurisdiction in which such offer, solicitation or sale would be unlawful prior to registration or qualification under the securities laws of such jurisdiction. This annual report is also not a solicitation of any vote in any jurisdiction pursuant to the proposed transactions or otherwise. No offer of securities or solicitation will be made except by means of a prospectus meeting the requirements of Section 10 of the Securities Act of 1933, as amended. 20 Recent Events
Merger with Stock Yards Bancorp, Inc.:
As previously noted, effectiveJanuary 27, 2021 ,Kentucky Bancshares , Stock Yards Bancorp, Inc., aKentucky corporation ("Stock Yards Bancorp "), andH. Meyer Merger Subsidiary, Inc. , aKentucky corporation and a direct, wholly owned subsidiary of Stock Yards Bancorp ("Merger Sub"), entered into an Agreement and Plan of Merger (the "merger agreement"), pursuant to which, on the terms and subject to the conditions set forth therein, Merger Sub will merge with and intoKentucky Bancshares (the "merger"), withKentucky Bancshares as the surviving entity and a wholly owned subsidiary of Stock Yards Bancorp. Following the merger, the surviving company will merge with and into Stock Yards Bancorp (the "combined company"), and thereafterKentucky Bank will merge with and into Stock Yards Bancorp's bank subsidiary,Stock Yards Bank & Trust Company , aKentucky banking corporation ("Stock Yards Bank "), withStock Yards Bank as the surviving banking corporation. The acquisition is expected to close during the second quarter of 2021, subject to customary regulatory approval, approval byKentucky Bancshares' shareholders and completion of other customary closing conditions. Impact of COVID-19 OnJanuary 30, 2020 , theWorld Health Organization ("WHO") announced that the outbreak of the novel coronavirus disease 2019 (COVID-19) constituted a public health emergency of international concern. OnMarch 11, 2020 , WHO declared COVID-19 to be a global pandemic. OnMarch 13, 2020 , the President ofthe United States declared the COVID-19 outbreak a national emergency. The health concerns relating to the COVID-19 outbreak and related governmental actions taken to reduce the spread of the virus have had a significant adverse impact on the economy, the banking industry and the Company. While quarantine and lock-down orders have been lifted and vaccination efforts are underway, COVID-19 has not yet been fully contained and commercial activity has not yet returned to the levels existing prior to the pandemic outbreak. As a result, the demand for the Company's products and services has been, and will continue to be, significantly impacted. OnMarch 27, 2020 , the Coronavirus Aid, Relief and Economic Security Act (the "CARES Act") was signed into law, providing an approximately$2 trillion stimulus package that includes direct payments to individual taxpayers, economic stimulus to significantly impacted industry sectors, emergency funding for hospitals and providers, small business loans, increased unemployment benefits, and a variety of tax incentives. For small businesses, eligible nonprofits and certain others, the CARES Act established a Paycheck Protection Program ("PPP"), which is administered by theSmall Business Administration ("SBA"). OnApril 24, 2020 , the Paycheck Protection Program and Health Care Enhancement Act was enacted. Among other things, this legislation amended the initial CARES Act program by raising the appropriation level for PPP loans from$349 billion to$670 billion . The PPP was further modified onJune 5, 2020 with the adoption of the Paycheck Protection Program Flexibility Act (the "Flexibility Act"), which extended the maturity date for PPP loans from two years to five years for loans disbursed on or after the date of enactment of the Flexibility Act. For PPP loans disbursed prior to such enactment, the Flexibility Act permits the borrower and lender to mutually agree to extend the term of the loan to five years. The vast majority of the Company's PPP loans have two-year maturities. PPP loans earn interest at a fixed rate of 1% and are fully guaranteed by theU.S. government. OnDecember 27, 2020 , a$900 billion COVID-19 relief package, as passed by theU.S. Congress , was signed into law as part of the 2021 Consolidated Appropriations Act ("CAA"). In addition to providing direct stimulus payments to certain individuals, an increase in unemployment insurance benefits, an extension of the eviction moratorium, relief to the healthcare industry, and additional aid to various other businesses, the COVID-19-related provisions of the CAA also established an additional$284 billion in funding for the PPP throughMarch 31, 2021 . The Company is also participating in this phase of
the PPP. As the health and safety of our employees and customers is of primary importance, throughout the COVID-19 pandemic, the Company has enforced mask policies and maintained social distancing precautions for all employees in the office and customer conducting business in our branches, to the fullest extent possible and pursuant to guidance issued by theCenters for Disease Control and state and local authorities. Our management team continues to monitor the ongoing situation related to the COVID-19 pandemic in order to anticipate and respond to ongoing COVID-19 related developments. 21 Critical Accounting Policies Overview. The accounting and reporting policies of the Company and its subsidiary are in accordance with accounting principles generally accepted inthe United States and conform to general practices within the banking industry.Significant accounting policies are listed in Note 1 of the Company's 2020 Consolidated Financial Statements and Notes included in Item 8. Critical accounting and reporting policies include accounting for loans and the allowance for loan losses, goodwill and fair value. Different assumptions in the application of these policies could result in material changes in the consolidated financial position or consolidated results of operations. Allowance for Loan Losses. Loans are stated at the amount of unpaid principal, reduced by an allowance for loan losses. Interest on loans is recognized on the accrual basis, except for those loans on the nonaccrual status. Interest income received on such loans is accounted for on the cash basis or cost recovery method. The allowance for loan losses is a valuation allowance for probable incurred credit losses. Management estimates the allowance balance required using past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions, and other factors. The accounting policies relating to the allowance for loan losses involve the use of estimates and require significant judgments to be made by management. The loan portfolio also represents the largest asset group on the consolidated balance sheets. Additional information related to the allowance for loan losses that describes the methodology and risk factors can be found under the captions "Asset Quality" and "Loan Losses" in this management's discussion and analysis of financial condition and results of operation, as well as Notes 1 and 4 of the Company's 2020 Consolidated Financial Statements and Notes.Goodwill .Goodwill and intangible assets acquired in a purchase business combination and determined to have an indefinite useful life are not amortized, but tested for impairment at least annually. The Company has selectedDecember 31 as the date to perform the annual impairment test. Intangible assets with definite useful lives are amortized over their estimated useful lives to their estimated residual values.Goodwill is the only intangible asset with an indefinite life on our balance sheet. Fair Value of Securities. Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed in Note 18 of the Company's 2020 Consolidated Financial Statements and Notes. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments, and other factors, especially in the absence of broad markets for particular items. Changes in assumptions or in market conditions could significantly affect the estimates. Overview
We conduct our business through our one bank subsidiary,Kentucky Bank , and our one non-bank subsidiaryKBI Insurance Company .Kentucky Bank is engaged in general full-service commercial and consumer banking. A significant part ofKentucky Bank's operating activities include originating loans, approximately 81% of which are secured by real estate atDecember 31, 2020 .Kentucky Bank makes commercial, agricultural and real estate loans to its commercial customers, with emphasis on small-to-medium-sized industrial, service and agricultural businesses. It also makes residential mortgages, installment and other loans to its individual and other non-commercial customers.Kentucky Bank's primary market isBourbon ,Clark ,Elliott ,Fayette ,Harrison ,Jessamine ,Madison ,Rowan ,Scott ,Woodford and surrounding counties inKentucky .KBI Insurance Company is a captive insurance subsidiary and was incorporated in 2014. Net income for the year endedDecember 31, 2020 was$11.7 million , or$1.97 per common share compared to$13.2 million , or$2.21 for 2019. Earnings per share assuming dilution were$1.97 and$2.21 for 2020 and 2019, respectively. For 2020, net income decreased$1.5 million , or 11.1%. Net interest income decreased$567 thousand , provision for loan losses increased$525 thousand , total non-interest income increased$1.7 million , total non-interest expense increased$2.3 million and income tax expense decreased$199 thousand . For 2019, net income increased$723 thousand , or 5.8%. Net interest income increased$719 thousand , the provision for loan losses increased$750 thousand , total non-interest income increased$1.1 million , total non-interest expense increased$926 thousand and income tax expense decreased$577 thousand . 22
Return on average equity was 9.54% in 2020 compared to 11.52% in 2019. Return on average assets was 0.97% in 2020 compared to 1.20% in 2019.
Non-performing and restructured loans as a percentage of loans (including held
for sale) were 0.69% and 0.61% as of
RESULTS OF OPERATIONS Net Interest Income Net interest income, the Company's largest source of revenue, on a tax equivalent basis decreased from$37.1 million in 2019 to$36.7 million in 2020. A significant decrease in interest rates during 2020 contributed to the decline in net interest income. The range for federal funds was 0%-0.25% atDecember 31, 2020 compared to a range of 1.50%-1.75% atDecember 31, 2019 . The prime lending rate was 3.25% atDecember 31, 2020 compared to 4.75% atDecember 31, 2019 . The taxable equivalent adjustment (nontaxable interest income on state and municipal obligations net of the related non-deductible portion of interest expense) is based on our Federal income tax rate of 21% in both 2020 and 2019. Average earning assets increased$91.9 million from 2019 to 2020, or 9.0%. Average investment securities decreased$14.9 million and average loans increased$76.9 million . Average interest bearing liabilities increased$45.7 million , or 6.3% during this same period. Average interest-bearing deposits increased$25.7 million , or 4.2%, average borrowings from theFederal Home Loan Bank increased$23.0 million , or 22.6%, and average repurchase agreements and other borrowings decreased$3.0 million , or 17.5%. The Company continues to actively pursue quality loans and fund these primarily with deposits andFederal Home Loan Bank advances. The bank prime rates decreased 150 basis points fromDecember 2019 toDecember 2020 . The tax equivalent yield on earning assets decreased from 4.52% in 2019 to 3.90% in 2020.
The volume rate analysis for 2020 that follows indicates that$3.8 million of the increase in interest income is attributable to an increase in volume, while the change in rates resulted in a decrease of$6.6 million in interest income. Further, an increase in total interest-bearing liability balances resulted in a$528 thousand increase in interest expense in 2020 compared to 2019 while changes in rates resulted in a reduction in interest expense of$2.8 million over the same period. The average rate of these liabilities decreased from 1.24% in 2019 to 0.87% in 2020. In summary, the decrease in the Company's 2020 net interest income is attributed mostly to a decrease in rates in our loan portfolio. The volume rate analysis for 2019 that follows indicates that$1.5 million of the increase in interest income is attributable to an increase in volume, while the change in rates contributed to an increase of$1.4 million in interest income. Further, a decrease in interest bearing liabilities resulted in a$37 thousand reduction interest expense in 2019 compared to 2018 while changes in rates resulted in additional interest expense of$2.2 million over the same period. The average rate of these liabilities increased from 0.95% in 2018 to 1.24% in 2019. In summary, the increase in the Company's 2019 net interest income is attributed mostly to increases in balances in our loan portfolio. The accompanying analysis of changes in net interest income in the following table shows the relationships of the volume and rate portions of these changes in 2020 vs. 2019 and 2019 vs. 2018. Changes in interest income and expenses due to both rate and volume are allocated on a pro rata basis. 23
Changes in Interest Income and Expense
(in thousands)
2020 vs. 2019 2019 vs. 2018
Increase (Decrease) Due to Change in Increase (Decrease) Due to Change in
(in thousands) Volume Rate Net Change Volume Rate Net Change
INTEREST INCOME
Loans $ 3,803 $ (4,386) $ (583) $ 2,046 $ 930 $ 2,976
Investment Securities (200) (1,482) (1,682) (606) 361 (245)
Other 167 (749) (582) 97 72 169
Total Interest Income 3,770 (6,617) (2,847) 1,537 1,363 2,900
INTEREST EXPENSE
Deposits
Demand 137 (1,477) (1,340) (6) 693 687
Savings 24 (40) (16) (8) 48 40
Negotiable Certificates of Deposit
and Other Time Deposits 14 (579) (565) 219 1,053 1,272
Securities sold under agreements to
repurchase and other borrowings (86) (181) (267) (291) 200 (91)
Federal Home Loan Bank advances 439 (531)
(92) 49 224 273
Total Interest Expense 528 (2,808) (2,280) (37) 2,218 2,181
Net Interest Income $ 3,242 $ (3,809) $ (567) $ 1,574 $ (855) $ 719
24
Average Consolidated Balance Sheets and Net Interest Income Analysis ($ in
thousands)
2020 2019
Average Average Average Average
Balance Interest Rate Balance Interest Rate
ASSETS
Interest-Earning Assets
Securities Available for Sale (1)
U.S. Treasury and Federal Agency
Securities $ 229,691 $ 4,970 2.16 % $ 245,294 $ 6,314 2.57 %
State and Municipal obligations 36,916 944 2.56
36,227 1,287 3.55
Total Investment Securities 266,607 5,914 2.22 281,521 7,601 2.70
Tax Equivalent Adjustment - 251 0.09 - 276 0.10
Tax Equivalent Total 266,607 6,165 2.31 281,521 7,877 2.80Federal Home Loan Bank Stock and Other 7,309 165 2.26 7,303 358 4.90 Federal Funds Sold and Agreements to Repurchase 352 1 0.28 298 7 2.35 Interest-Bearing Deposits with Banks 54,017 149 0.28 24,155 527 2.18 Loans, Net of Deferred Loan Fees (2) Commercial 123,793 4,019 3.25 93,403 4,573 4.90 Real Estate Mortgage 638,814 30,901 4.84
593,505 30,781 5.19
Consumer 21,843 1,536 7.03 20,651 1,685 8.16
Total Loans 784,450 36,456 4.65 707,559 37,039 5.23Tax Equivalent Adjustment - 426 0.05 - 319 0.05 Tax Equivalent Total 784,450 36,882 4.70 707,559 37,358 5.28 Total Interest-Earning Assets 1,112,735 42,685 3.84
1,020,836 45,532 4.46
Tax Equivalent Adjustment - 677 0.06 - 595 0.06
Tax Equivalent Total 1,112,735 43,362 3.90 1,020,836 46,127 4.52
Allowance for Loan Losses (9,832) (8,072)
Cash and Due From Banks 13,919 13,180
Premises and Equipment 20,356 17,932
Other Assets 64,869 50,805
Total Assets $ 1,202,047 $ 1,094,681
LIABILITIES
Interest-Bearing Deposits
Negotiable Order of Withdrawal ("NOW")
and Money Market Investment Accounts $ 310,516 $ 1,457 0.47 % $ 295,337 $ 2,797 0.95 %
Savings 119,338 116 0.10 109,698 132 0.12
Certificates of Deposit and Other
Deposits 201,971 2,746 1.36 201,111 3,311 1.65
Total Interest-Bearing Deposits 631,825 4,319 0.68 606,146 6,240 1.03
Securities sold under agreements to
repurchase and other borrowings 14,143 293 2.07 17,140 560 3.27
Federal Home Loan Bank advances 125,013 2,091 1.67 101,964 2,183 2.14
Total Interest-Bearing Liabilities 770,981 6,703 0.87 725,250 8,983 1.24
Noninterest-Bearing Earning Demand
Deposits 288,225 240,284
Other Liabilities 20,187 15,009
Total Liabilities 1,079,393 980,543
STOCKHOLDERS' EQUITY 122,654 114,138
Total Liabilities and Stockholders'
Equity $ 1,202,047 $ 1,094,681
Average Equity to Average Total Assets 10.20 % 10.43 %
Net Interest Income 35,982 36,549
Net Interest Income (tax equivalent)
(3) 36,659 37,144
Net Interest Spread (tax equivalent)
(3) 3.03 3.28
Net Interest Margin (tax equivalent)
(3) 3.29 3.64
(1) Averages computed at amortized cost
(2) Includes loans on a nonaccrual status and loans held for sale
Tax equivalent difference represents the nontaxable interest income on state
(3) and municipal securities net of the related non-deductible portion of
interest expense
25
Noninterest Income and Expenses
Noninterest income was$16.0 million in 2020 and$14.2 million in 2019. In 2020, increases in gains on the sale of loans and debit card interchange income were offset by reductions in service charges and loan service fees, net. In 2019, increases in gains on available for sale securities and debit card interchange income were offset by reductions in brokerage income and loan service fee income. Securities gains were$345 thousand in 2020 and$857 thousand in 2019. The net gains recognized in both 2020 and 2019 are attributed to selling securities which had gains in market value due to declining market interest rates and the related inverse relationship of interest rates and market values. Management evaluates the structure of the portfolio, periodically, and may strategically sell securities to diversify the portfolio. Additionally, the securities available for sale portfolio is a source of liquidity for the Company; therefore securities may be sold to generate cash. Gains on loans sold were$4.8 million in 2020 and$1.6 million in 2019. Loans held for sale are generally sold after closing to the Federal Home Loan Mortgage Corporation or other government agencies. During 2020, the loan service fee income, net of amortization expense for the mortgage servicing right asset, decreased$514 thousand , compared to a decrease of$93 thousand in 2019. In 2020, the mortgage servicing right asset had net write-downs of$414 thousand compared to net write-downs of$71 thousand in 2019. Proceeds from the sale of loans were$131 million and$72 million in 2020 and 2019, respectively. The volume of loan originations is inverse to rate changes with historic low rates spurring activity. The volume of loan originations during 2020 was$128 million and$71 million in 2019. Other noninterest income, excluding net security gains (losses) and the sale of mortgage loans, was$10.8 million in 2020 and$11.8 million in 2019. Service charge income, and more particularly overdraft income, is the largest contributor to these numbers. Overdraft income was$1.8 million in 2020 and$2.5 million in 2019. Debit card interchange income was the second largest contributor to noninterest income. Debit card interchange income was$3.7 million in 2020 and$3.5 million in 2019. Other income was$253 thousand in
2020 and$459 thousand in 2019.
Noninterest expense increased
Salaries and benefits, the largest contributor to total non-interest expense, increased$1.7 million from$19.2 million in 2019 to$20.9 million in 2020 due to normal staff merit increases. Full-time equivalent employees increased from 233 atDecember 31, 2019 to 236 atDecember 31, 2020 . The largest component of occupancy expense, depreciation expense, increased$100 thousand from$1.2 million in 2019 to$1.3 million in 2020. Building rent expense, included in occupancy expense, decreased$17 thousand from 2019 to 2020. The decrease in expense was attributed to the Company not renewing a lease for additional office space. The majority of the rent expense is related to lease expense for the new branches that opened in 2020 in theLexington, Kentucky market. Total noninterest expense, excluding salaries and benefits expense and occupancy expense, increased from$12.1 million in 2019 to$12.6 million in 2020. Legal and professional fees increased$162 thousand from$1.2 million in 2019 to$1.3 million in 2020. Other non-interest expense increased$168 thousand from 2019 to 2020. This increase is attributable primarily to an increase of$213 thousand inFDIC insurance expense from 2019 to 2020.FDIC insurance expense increased from 2019 to 2020 mostly due to additional credits received in 2019 that were used to offset expense. The credits were issued by theFDIC as a result of meeting goals for the insurance fund. Amortization expense of core deposits was$74 thousand in 2020 and$102 thousand in 2019. See Note 7 in the Company's Consolidated Financial Statements and Notes included in Item 8 for more detail of the goodwill and intangible assets. 26 The following table is a summary of noninterest income and expense for the two year period indicated. For the Year ended December 31, (in thousands) 2020 2019 NON-INTEREST INCOME Service Charges $ 4,602 $ 5,368 Loan Service Fee Income (Loss), net (374) 140 Trust Department Income 1,441 1,411 Investment Securities Gains (Losses),net 345 857 Gains on Sale of Mortgage Loans 4,834 1,552 Brokerage Income 464 543 Debit Card Interchange Income 3,742 3,470 Income from Bank-Owned Life Insurance 668 439 Other 253 459 Total Non-interest Income$ 15,975 $ 14,239 NON-INTEREST EXPENSE Salaries and Employee Benefits$ 20,897 $ 19,187 Occupancy Expense 4,118 4,066 Other 12,592 12,055 Total Non-interest Expense $
37,607
Net Non-interest Expense as a Percentage of Average Assets 1.80 % 1.92 % Income Taxes
As part of normal business,Kentucky 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 year endedDecember 31, 2020 , the Company averaged$36.9 million in tax free securities, and$69.2 million in tax free loans. 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, 2020 , the weighted average remaining maturity for the tax free securities is 62 months, while the weighted average remaining maturity for the tax free loans is 158 months. The Company had income tax expense of$878 thousand in 2020 and$1.1 million in 2019. This represents an effective income tax rate of 7.0% in 2020 and 7.6% in 2019. The difference between the effective tax rate and the statutory federal rate of 21% in both 2020 and 2019 is primarily due to tax exempt income on certain investment securities and loans. In addition, the Company had additional tax credits which also contributed to the lower effective income tax rates. The Company had tax credits totaling$899 thousand in 2020 and$553 thousand in 2019 for investments made in affordable housing project investments. 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 tax asset of
27
Balance Sheet Review
Assets increased slightly from $1.1 billion at December 31, 2019 to $1.2 billion
at December 31, 2020 . Securities available for sale increased $88.2 million
during 2020, outstanding loan balances increased $21.1 million during 2020 and
deposits increased $136.0 million during 2020.
Loans
Total loans (including loans held for sale) were $771 million at December 31,
2020 compared to $746 million at December 31, 2019 . As of December 31, 2020 and
compared to the prior year-end, commercial loans increased $30.9 million , real
estate construction loans decreased $17.6 million , 1-4 family residential
property loans increased $1.7 million , multi-family residential property loans
decreased $768 thousand , non-farm & non-residential property loans increased
$14.1 million , agricultural loans decreased $4.9 million and consumer loans and
other loans decreased $779 thousand .
As of
Paycheck Protection Program (PPP) established under the CARES Act which were included in commercial loans in the
table below. The balances were$57.6 million as ofSeptember 30, 2020 and$56.8 million as ofJune 30, 2020 . These loans are guaranteed by the SBA and required no allowance for loan losses as ofDecember 31, 2020 .
As of
1-4 family residential represented 38% of the total loan portfolio as ofDecember 31, 2020 and 39% as ofDecember 31, 2019 . Real estate constructions loans accounted for 2% of the total loan portfolio as ofDecember 31, 2020 and 4% as ofDecember 31, 2019 . Multi-family loans represented 6% of the total loan portfolio as ofDecember 31, 2020 and 7% as ofDecember 31, 2019 . Non-farm and non-residential loans totaled 29% of the total loan portfolio as ofDecember 31, 2020 and 28% of the total loan portfolio as ofDecember 31, 2019 . Agricultural loans comprised 7% of the total loan portfolio atDecember 31, 2020 and 8% of total loans atDecember 31, 2019 . Approximately 90% of the agricultural loans are secured by real estate atDecember 31, 2020 and 88% atDecember 31, 2019 . The remainder of the agricultural portfolio is used to purchase livestock, equipment and other capital improvements and for general operation of the farm. Generally, a secured interest is obtained in the capital assets, equipment, livestock or crops. Automobile loans account for 27% of the consumer loan portfolio in 2020 and 20% in 2019. The purpose of the remainder of this portfolio is used by customers for purchasing retail goods, home improvement or other personal reasons. The commercial loan portfolio is mainly for capital outlays and business operation.
Collateral is requested depending on the creditworthiness of the borrower. Unsecured loans are made to individuals or companies mainly based on the creditworthiness of the customer. Approximately 7% of the loan portfolio is unsecured. Management is not aware of any significant concentrations that may cause future material risks, which may result in significant problems with future income and capital requirements.
28
The following table represents a summary of the Company's loan portfolio by category for each of the last five years. There is no concentration of loans (greater than 5% of the loan portfolio) in any industry. The Company has no foreign loans or highly leveraged transactions in its loan portfolio.
December 31, (in thousands)
Loans Outstanding 2020 2019 2018 2017 2016
Commercial $ 117,425 $ 86,552 $ 86,149 $ 80,070 $ 77,436
Real Estate Construction 14,571 32,219 24,254 20,816 29,169
Real Estate Mortgage:
1-4 Family Residential 298,699 293,870 253,797 239,672 245,674
Multi-Family Residential 47,854 48,622 46,403 39,926 47,199
Non-Farm & Non-Residential 218,998 204,908 196,674 192,074 176,024
Agricultural 52,239 57,166 60,049 59,176 62,491
Consumer 22,532 23,122 20,089 18,182 18,867
Other 116 305 208 170 183
Total Loans 772,434 746,764 687,623 650,086 657,043
Less Deferred Loan Fees 1,136 307 276 320 312
Total Loans, Net of Deferred Loan Fees 771,298 746,457 687,347 649,766 656,731
Less loans held for sale 4,427 2,144 1,203 1,231 724
Less Allowance for Loan Losses 9,897 8,460 8,127 7,720 7,541
Net Loans $ 756,974 $ 735,853 $ 678,017 $ 640,815 $ 648,466
The following table sets forth the maturity distribution and interest
sensitivity of selected loan categories at December 31, 2020 . Maturities are
based upon contractual term. The total loans in this report represent loans net
of deferred loan fees, including loans held for sale but excluding the allowance
for loan losses. In addition, deferred loan fees on the above table are netted
with real estate mortgage loans on the following table.
December 31, 2020 (in thousands)
One Year One Through Over TotalLoan Maturities and Interest Sensitivity or Less Five Years
Five Years Loans Commercial$ 25,378 $ 70,931 $ 21,116 $ 117,425 Real Estate Construction 2,618 9,676 2,277 14,571 Real Estate Mortgage: 1-4 Family Residential 88,637 108,422 101,640 298,699 Multi-Family Residential 2,318 27,117 18,419 47,854 Non-Farm & Non-Residential 15,449 130,952 72,597 218,998 Agricultural 12,248 29,865 10,126 52,239 Consumer 5,116 15,599 1,817 22,532 Other 116 - - 116
Total Loans, Net of Deferred Loan Fees 151,880 392,562
227,992 772,434 Fixed Rate Loans 19,592 146,896 168,128 334,616 Floating Rate Loans 132,288 245,666
59,864 437,818
Total Loans, Net of Deferred Loan Fees
Mortgage Banking The Company has been in mortgage banking since the early 1980's. The activity in origination and sale of these loans fluctuates, mainly due to changes in interest rates. Mortgage loan originations increased from$71 million in 2019 to$128 million in 2020. Proceeds from the sale of loans were$72 million and$131 million for 2019 and 2020, respectively. Mortgage loans held for sale were$4.4 million atDecember 31, 2020 and$2.1 million atDecember 31, 2019 . Fixed rate residential mortgage loans are generally sold when they are made. The volume of loan originations is inverse to rate changes. 29 During 2020, declining mortgage rates resulted in additional loan volume due to an increased number of borrowers who chose to refinance their existing mortgages. The gain on sale of loans increased$3.3 million from$1.6 million in 2019 to$4.8 million in 2020. The Bank has sold various loans to the Federal Home Loan Mortgage Corporation (FHLMC) and theFederal Home Loan Bank (FHLB) while retaining the servicing rights. Gains and losses on loan sales are recorded at the time of the cash sale, which represents the premium or discount paid by the FHLMC and FHLB. The Bank receives a servicing fee from the FHLMC and FHLB on each loan sold. Servicing rights are carried using the amortized cost method and are capitalized based on the relative fair value of the rights and the expected life of the loan and are expensed in proportion to, and over the period of, estimated net servicing revenues.
Mortgage servicing rights were
Amortization of mortgage servicing rights was$1.0 million (including$414 thousand for negative fair value adjustments) and$403 thousand (including$71 thousand for positive fair value adjustments) for the years endedDecember 31, 2020 and 2019, respectively. See Note 4 in the Company's 2020 Consolidated Financial Statements and Notes included in Item 8 for additional information. Deposits For 2020, total deposits increased$136.0 million to$978.6 million . Noninterest bearing deposits increased$78.0 million , time deposits of$250 thousand and over decreased$7.2 million , and other interest bearing deposits increased$65.1 million . Public fund balances totaled$177 million atDecember 31, 2020 , of which$130 million were interest bearing.
The table below provides information on the maturities of time deposits of
At December 31, 2020 Maturity of Time Deposits of
$ 28,800
Maturing over 3 Months through 6 Months 10,334
Maturing over 6 Months through 12 Months 33,485
Maturing over 12 Months 21,545
Total $ 94,164
Borrowings
The Company utilizes both long-term and short-term borrowings. Long-term
borrowing at the Bank is primarily from the Federal Home Loan Bank (FHLB). This
borrowing is mainly used to fund longer term, fixed rate mortgages, as part of a
leverage strategy and to assist in asset/liability management. Advances are
either paid monthly or at maturity. As of December 31, 2020 , $96.5 million was
borrowed from FHLB, a decrease of $19.9 million from December 31, 2019 .
Throughout 2020, the Bank had a net decrease of $14.5 million in short-term
borrowings from the FHLB which were outstanding at December 31, 2020 . As of
December 31, 2019 , $25.0 million in short-term borrowings from the FHLB were
outstanding. FHLB advances classified as short-term have an original maturity of
less than 1 year. Also, during 2020, the Bank had a net decrease of $5.4 million
in long-term advances due to normal monthly paydowns and maturities. There were
no prepayment penalties associated with the decrease in FHLB advances. These
advances each had an original maturity of more than 1 year.
30
The following table depicts relevant information concerning our short term
borrowings.
As of and for the year ended
December 31, (in thousands)
Short Term Borrowings 2020 2019
Federal Funds Purchased:
Balance at Year end $ - $ -
Average Balance During the Year 153 618
Maximum Month End Balance - 16,365
Year end rate - -
Average annual rate 0.65 % 2.91
Repurchase Agreements:
Balance at Year end $ 9,129 $ 5,994
Average Balance During the Year 6,773 6,996
Maximum Month End Balance 10,924 8,947
Year end rate 0.26 % 0.50
Average annual rate 0.36 % 0.53
Federal Home Loan Bank Advances:
Balance at Year end $ 10,500 $ 25,000
Average Balance During the Year 33,396 12,880
Maximum Month End Balance 55,500 25,000
Year end rate 0.44 % 1.80
Average annual rate 0.67 % 2.24
Contractual Obligations
The Bank has required future payments for time deposits and long-term debt.
The
other required payments are the approximate future minimum lease payments due
under the aforementioned operating leases for their base term and are as
follows:
Payments due by period (in thousands)
Less More
than 1 1-3 3-5 than 5
Contractual Obligations Total year years years years
Federal Home Loan Bank advances $ 96,532 $ 20,894 $ 34,482 $ 25,351 $ 15,805
Subordinated debentures 7,217 - - - 7,217
Time deposits 151,221 112,510 29,154 9,442 115
Lease payments on premises 5,539 521 1,058 1,054 2,906
Asset Quality
With respect to asset quality, management considers three categories of assets
to merit close scrutiny. These categories include: loans that are currently
nonperforming, other real estate, and loans that are currently performing but
which management believes require special attention.
During periods of economic slowdown, the Company may experience an increase in nonperforming loans.
The Company discontinues the accrual of interest on loans that become 90 days
past due as to principal or interest unless reasons for delinquency are
documented such as the loan being well collateralized and in the process of
collection. A loan remains in a non-accrual status until factors indicating
doubtful collection no longer exist. A loan is classified as a restructured loan
when the interest rate is materially reduced or the term is extended beyond the
original maturity date because of the inability of the borrower to service the
interest payments at market rates. Other real estate is initially recorded at
fair value less estimated costs to sell. These assets are subsequently accounted
for at the lower of cost or fair value, less costs to sell.
31
A summary of the components of nonperforming assets, including several ratios using period-end data, is shown as follows.
Year Ended December 31,
Nonperforming Assets 2020 2019 2018 2017 2016
Non-accrual Loans $ 4,051 $ 3,081 $ 1,141 $ 1,193 $ 4,566
Accruing Loans which are Contractually
past due over 89 days 75 1,499 1,182 231 927
Accruing Troubled Debt Restructurings 1,145 - - - 2,063
Total Nonperforming and Restructured
Loans 5,271 4,580 2,323 1,424 7,556
Other Real Estate 876 2,148 830 2,404 1,824
Total Nonperforming and Restructured
Loans and Other Real Estate $ 6,147 $ 6,728 $ 3,153 $ 3,828 $ 9,380
Nonperforming and Restructured Loans as
a Percentage of Loans (including loans
held for sale) (1) 0.69 % 0.61 % 0.34 % 0.22 % 1.15 %
Nonperforming and Restructured Loans
and Other Real Estate as a Percentage
of Total Assets 0.50 % 0.61 % 0.29 % 0.36 % 0.91 %
Allowance as a Percentage of
Non-performing and Restructured Loans
and Other Real Estate 161 % 126 % 258 % 202 % 80 %
(1) Net of deferred loan fees
Total nonperforming assets atDecember 31, 2020 were$6.1 million compared to$6.7 million atDecember 31, 2019 . The decrease from 2019 to 2020 is mostly attributed to the sale of other real estate. Total other real estate properties totaled$876 thousand atDecember 31, 2020 , of which,$354 thousand were income producing properties. Total nonperforming loans were$5.3 million and$4.6 million atDecember 31, 2020 and 2019, respectively. The increase in restructured loans during 2020 is attributed to a single note. No restructured notes were held in 2019. Total net loan charge offs in 2020 were$338 thousand . The amount of lost interest on our non-accrual loans was$382 thousand for
2020 and$65 thousand for 2019. AtDecember 31, 2020 , loans currently performing but which management believes requires special attention were$18.3 million , with 45% being non-farm and non-residential, 18% being agriculturual, 13% being 1-4 family residential, 3% being multi-family and 21% being commercial. The Company continues to follow its long-standing policy of not engaging in international lending and not concentrating lending activity in any one industry. The carrying amount of impaired loans as ofDecember 31, 2020 was$3.6 million compared to$1.4 million as ofDecember 31, 2019 . These amounts are generally included in the total nonperforming and restructured loans presented in the table above. See Note 18 in the Company's 2020 Consolidated Financial Statements and Notes included in Item 8 herein. A loan is considered impaired when, based on current information and events, it is probable that a creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement. All amounts due according to the contractual terms means that both the contractual interest payments and the contractual principal payments of a loan will be collected as scheduled in
the loan agreement. Nonaccrual loans are loans for which payments in full of principal or interest is not expected or which principal or interest has been in default for a period of 90 days or more unless the asset is both well secured and in the process of collection. Impaired loans may be loans showing signs of weakness or interruptions in cash flow, but ultimately are current or less than 90 days past due with respect to principal and interest and for which we anticipate full payment of principal and interest through collateral liquidation. Additional factors considered by management in determining impairment and non-accrual status include payment status, collateral value, availability of current financial information, and the probability of collecting all contractual principal and interest payments. AtDecember 31, 2020 , loans individually evaluated for impairment totaled$8.4 million . Of this,$3.9 million in balances had specific impairment allocations of$1.0 million . The remaining$4.5 million in impaired loan balances did not have a specific impairment allocation. 32
At
The allowance for loan losses on impaired loans is determined using one of two methods. Either the present value of estimated future cash flows of the loan, discounted at the loan's effective interest rate or the fair value of the underlying collateral. The entire change in present value of expected cash flows is reported as a provision for loan losses in the same manner in which impairment initially was recognized or as a reduction in the amount of provision for loan losses that otherwise would be reported. The total allowance for loan losses related to these loans was$1.0 million and$52 thousand onDecember 31, 2020 and 2019, respectively.Kentucky Bank has a "Problem Loan Committee" that meets at least quarterly to review problem loans, including past due and non-performing loans, and other real estate. When analyzing the problem loans and the loan quality as ofDecember 31, 2020 , the following factors have been considered:
Changes in lending policies and procedures, including changes in underwriting
? standards and collection, charge-off and recovery practices not considered
elsewhere in estimating credit losses.
Change in international, national, regional and local economic and business
? conditions and developments that affect the collectability of the portfolio,
including the condition of various market segments.
? Changes in the nature and volume of the portfolio and in the terms of loans.
? Changes in the experience, ability and depth of lending management and other
relevant staff.
? Changes in the volume and severity of past due loans; the volume of non-accrual
loans, and the volume and severity of adversely classified or graded loans.
? Changes in the quality of the Bank's loan review system.
? Changes in the value of underlying collateral for collateral-dependent loans.
? The existence and effect of any concentrations of credit, and changes in the
level of such concentrations.
The effect of other external factors such as competition and legal and
? regulatory requirements on the level of estimated credit losses in the Bank's
existing portfolio. Management periodically reviews renewals and modifications of previously identified troubled debt restructurings (TDR), for which there was no principal forgiveness, to consider if it is appropriate to remove the TDR classification. If the borrower is no longer experiencing financial difficulty and the renewal/modification did not contain a concessionary interest rate or other concessionary terms, management considers the potential removal of the TDR classification. If deemed appropriate based upon current underwriting, the TDR classification is removed as the borrower has complied with the terms of the loan at the date of renewal/modification and there was a reasonable expectation that the borrower will continue to comply with the terms of the loan after the date of the renewal/modification. Additionally, TDR classification can be removed in circumstances in which the Company performs a non-concessionary re-modification of the loan at terms considered to be at market for loans with comparable risk and management expects the borrower will continue to perform under the re-modified terms based on the borrower's past history of performance. OnMarch 22, 2020 , the Interagency Statement was issued by our banking regulators that encourages financial institutions to work prudently with borrowers who are or may be unable to meet their contractual payment obligations due to the effects of COVID-19. Additionally, Section 4013 of the CARES Act further provides that a qualified loan modification is exempt by law from classification as a TDR as defined by GAAP, from the period beginningMarch 1, 2020 until the earlier ofDecember 31, 2020 or the date that is 60 days after the date on which the national emergency concerning the COVID-19 outbreak declared by the President ofthe United States under the National Emergencies Act (50 U.S.C.1601 et seq.) terminates. The Interagency Statement was subsequently revised inApril 2020 to clarify the interaction of the original guidance with Section 4013 of the CARES Act, as well as setting forth the banking regulators' views on consumer protection considerations. In accordance with such guidance, we made modifications in response to COVID-19 impacted borrowers who were not past due and met criteria for modification. The majority of the loan modifications we made for customers involved three to six month forbearance payments which were added to the end of the note. As ofDecember 31, 2020 , approved modifications were approximately$130.1 million of loan balances, of which, an approximate$1.7 million was still in deferment as ofDecember 31, 2020 . Modifications were$125.3 million as ofSeptember 30, 2020 and$115.0 million as ofJune 30, 2020 . 33 AtDecember 31, 2020 , the Company has one loan totaling$1.1 million classified as a troubled debt restructure. As ofDecember 31, 2020 , the Company had no specific allowance for loan loss for this loan and had not committed to lend any additional funds to this loan customer. Modifications to this loan included capitalizing interest and closing costs and modifying the payment schedule from annual principal only payments to interest only. AtDecember 31, 2019 , the Company did not have any loans designated as troubled debt restructurings.
For the years ending
Loan Losses
The following table is a summary of the Company's loan loss experience for each
of the past five years.
For the Year ended December 31, (in thousands)
2020 2019 2018 2017 2016
Balance at Beginning of Year $ 8,460 $ 8,127 $ 7,720 $ 7,541 $ 6,521
Amounts Charged-off:
Commercial (25) (260) (23) (35) (5)
Real Estate Construction - - - - -
Real Estate Mortgage:
1-4 Family Residential (37) (168) (98) (249) (126)
Multi-Family Residential - - - - -
Non-Farm & Non-Residential - (17) (31) (42) -
Agricultural - - - - (193)
Consumer and other (1,087) (1,298) (1,108) (1,076) (1,206)
Total Charged-off Loans (1,149) (1,743) (1,260) (1,402) (1,530)
Recoveries on Amounts Previously
Charged-off:
Commercial 17 21 10 19 39
Real Estate Construction - - - 1 15
Real Estate Mortgage
1-4 Family Residential 40 19 272 20 19
Multi-Family Residential - 15 10 181 12
Non-Farm & Non-Residential 5 - - - 454
Agricultural 8 8 191 57 50
Consumer and other 741 763 684 803 811
Total Recoveries 811 826 1,167 1,081 1,400
Net Charge-offs (338) (917) (93) (321) (130)
Provision for Loan Losses 1,775 1,250 500 500 1,150
Balance at End of Year 9,897 8,460 8,127 7,720 7,541
Total Loans (1)
Average 788,450 710,728 670,063 651,668 647,278
At December 31 771,298 746,457 687,347 649,766 656,731
As a Percentage of Average Loans
(1):
Net Charge-offs 0.04 % 0.13 % 0.01 % 0.05 % 0.02 %
Provision for Loan Losses 0.23 % 0.18 % 0.07 % 0.08 % 0.18 %
Allowance as a Percentage of
Year-end Loans (1) 1.28 % 1.13 % 1.18 % 1.19 % 1.15 %
Beginning Allowance as a Multiple
of Net Charge-offs 25.0 8.9 83.0 23.5 50.2
Ending Allowance as a Multiple of
Nonperforming Assets 1.61 1.26 2.58 2.02 0.80
(1) Net of deferred loan fees and includes loans held for sale
Loans are typically charged-off when the collection of principal is considered doubtful, and would be well documented and approved by the appropriate responsible party or committee. The provision for loan losses for 2020 was$1.8 million compared to$1.3 million in 2019. Net charge-offs were$338 thousand in 2020 and$917 thousand in 2019. Net charge-offs to average loans were 0.04% and 0.13% in 2020 and 2019, respectively. 34
The provision for loan losses increased
In evaluating the allowance for loan losses, management considers the composition of the loan portfolio, the historical loan loss experience, the overall quality of the loans and an assessment of current economic conditions.
At
The following tables set forth an allocation for the allowance for loan losses and loans by category. In making the allocation, management evaluates the risk in each category, current economic conditions and charge-off experience. An allocation for the allowance for loan losses is an estimate of the portion of the allowance that represents probable incurred losses in each loan category, but it does not preclude any portion of the allowance allocated to one type of loan being used to absorb losses of another loan type. Allowance for Loan Losses (in thousands) 2020 2019 2018 2017 2016 Commercial$ 989 $ 1,003 $ 1,265 $ 1,069 $ 862 Real Estate Construction 296 601 451 507 616 Real Estate Mortgage: 1-4 Family Residential 3,427 3,162 2,843 2,538 2,515 Multi-family Residential 951 880 800 702 635 Non-farm & Non-residential 3,146 1,791 1,799 1,704 1,315 Agricultural 480 424 458 542 935 Consumer and other 608 599 511 658 663 Total$ 9,897 $ 8,460 $ 8,127 $ 7,720 $ 7,541 2020 2019 2018 2017 2016 Loans (in thousands) Dollars Percentage Dollars Percentage Dollars Percentage Dollars Percentage Dollars Percentage Commercial$ 117,425 15.31 %$ 86,552 11.63 %$ 86,149 12.56 %$ 80,070 12.35 %$ 77,436 11.80 % Real Estate Construction 14,571 1.90 % 32,219 4.33 % 24,254 3.54 % 20,816 3.21 % 29,169 4.45 % Real Estate Mortgage: 1-4 Family Residential 293,136 38.22 % 291,419 39.15 % 252,318 36.77 % 238,121 36.72 % 244,638 37.29 % Multi-family Residential 47,854 6.24 % 48,622 6.53 % 46,403 6.76 % 39,926 6.16 % 47,199 7.19 % Non-farm & Non-residential 218,998 28.56 % 204,908 27.53 % 196,674 28.66 % 192,074 29.62 % 176,024 26.83 % Agricultural 52,239 6.81 % 57,166 7.68 % 60,049 8.75 % 59,176 9.12 % 62,491 9.53 % Consumer 22,532 2.94 % 23,122 3.11 % 20,089 2.93 % 18,182 2.80 % 18,867 2.88 % Other 116 0.02 % 305 0.04 % 208 0.03 % 170 0.03 % 183 0.03 % Total, Net (1)$ 766,871 100.00 %$ 744,313 100.00 %$ 686,144 100.00 %$ 648,535 100.00 %$ 656,007 100.00 %
(1) Net of deferred loan fees
Off-balance Sheet Arrangements
Some financial instruments, such as loan commitments, credit lines, letters of
credit, and overdraft protection, are issued to meet customer financing needs.
These are agreements to provide credit or to support the credit of others, as
long as conditions established in the contract are met, and usually have
expiration dates. Commitments may expire without being used. Off-balance sheet
risk to credit loss exists up to the face amount of these instruments, although
material losses are not anticipated. The same credit policies are used to make
such commitments as are used for loans, including obtaining collateral at
exercise of the commitment.
Financial instruments with off-balance sheet risk were as follows at year-end
(in thousands):
2020 2019
Unused lines of credit $ 146,200 $ 117,265
Commitments to make loans 42,834 28,743
Letters of credit 402 461
35
Unused lines of credit are substantially all at variable rates. Commitments to make loans are generally made for a period of 60 days or less and are primarily fixed at current market rates ranging from 1.88% to 5.13% with maturities ranging up to 30 years. Capital 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 ofDecember 31, 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. The Bank has elected to use the CBLR framework. AtDecember 31, 2020 , the Bank's CBLR was 9.0%. Management believes as ofDecember 31, 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.
AtDecember 31, 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, exclusive of the capital conservation
buffer, are presented below as of
36
To Be Well
Capitalized
Under Prompt
For Capital Corrective
Actual Adequacy Purposes Action Provisions
Amount Ratio Amount Ratio Amount Ratio
(Dollars in Thousands)
December 31, 2020
Bank Only
Tier I Capital (to Average Assets) $ 107,805 9.0 $ 96,258 8.0
December 31, 2019 Bank Only Total Capital (to Risk-Weighted Assets)$ 111,294 14.7 %$ 60,584 8.0 %$ 75,731 10.0 %Tier I Capital (to Risk-Weighted Assets) 102,759 13.6 45,438 6.0 60,584 8.0 Common Equity Tier 1 Capital (to Risk-Weighted Assets) 102,759 13.6 34,079 4.5 49,225 6.5 Tier I Capital (to Average Assets) 102,759 9.3 44,164
4.0 55,206 5.0
Securities and Federal Funds Sold
Securities, classified as available for sale, increased from$265.3 million atDecember 31, 2019 to$353.5 million atDecember 31, 2020 . Federal funds sold totaled$395 thousand atDecember 31, 2020 and$260 thousand atDecember 31, 2019 . Per Company policy, fixed rate asset backed securities will not have an average life exceeding seven years, but final maturity may be longer. Adjustable rate securities shall adjust within three years per Company policy. As ofDecember 31, 2020 and 2019, the Company held$56 million and$38 million in adjustable-rate mortgage backed securities, respectively. Unrealized gains (losses) on investment securities are temporary and change inversely with movements in interest rates. In addition, some prepayment risk exists on mortgage-backed securities and prepayments are likely to increase with decreases in interest rates. The following tables present the investment securities for each of the past two years and the maturity and yield characteristics of securities as ofDecember 31, 2020 .
Securities Available for Sale at Fair Value
For the Year ended December 31,
(in thousands)
Investment Securities (at fair value) 2020 2019
Available for Sale
U.S. treasury notes $ 9,188 $ 9,168
U.S. government agencies 23,298 23,735
States and political subdivisions 67,639 32,589
Mortgage-backed
GNMA, FNMA, FHLMC Passthroughs 79,751 54,470 GNMA, FNMA, FHLMC CMO's 121,282 109,872 Total mortgage backed 201,033 164,342 Asset-backed 51,311 35,496 Other 1,025 - Total$ 353,494 $ 265,330 37
Maturity Distribution of Securities Available for Sale
December 31, 2020 (in thousands)
Over One Over Five
Year Years
One Year Through Through Over Asset & Mortgage
or Less Five Years Ten Years Ten Years Backed Total
Available for Sale
U.S. treasury note $ 5,081 $ 4,106 $ - $ - $ - $ 9,188
U.S. government agencies 6 10,669 10,589 2,034 - 23,298
States and political
subdivisions 152 5,583 24,912 36,993 - 67,639
Mortgage-backed - - - - 201,033 201,033
Asset-backed - - - - 51,311 51,311
Other - - 1,025 - - 1,025
Total 5,239 20,358 36,526 39,027 252,344 353,494
Percent of Total 1.5 % 5.8 % 10.3 % 11.0 % 71.4 % 100 %
Weighted Average Yield 1.57 % 1.23 % 1.88 % 2.32 % 2.31 % 2.19 %
Impact of Inflation and Changing Prices
The majority of the Company's assets and liabilities are monetary in nature. Therefore, the Company differs greatly from most commercial and industrial companies that have significant investments in nonmonetary assets and inventories. However, inflation does have an important impact on the growth of assets in the banking industry and the resulting need to increase equity capital at higher than normal rates in order to maintain an appropriate equity to assets ratio. Inflation also affects other expenses, which tend to rise during periods of inflation.
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