EDGAR 10-K Filing

Company CIK: 1000232
Filing Year: 2021
Filename: 1000232_10-K_2021_0001558370-21-002326.json

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ITEM 1. BUSINESS
Item 1. Business
General
Kentucky Bancshares, Inc. (“Company”, “Kentucky Bancshares”, “we”, “our” and “us”) is a financial holding company headquartered in Paris, Kentucky. The Company was organized in 1981 and is registered under the Bank Holding Company Act of 1956, as amended (“BHCA”).
The Company conducts its business in the Commonwealth of Kentucky through one banking subsidiary, Kentucky Bank, and one non-bank subsidiary KBI Insurance Company, Inc.
Kentucky Bank is a commercial bank and trust company organized under the laws of Kentucky. Kentucky Bank has its main office in Paris (Bourbon County), with additional offices in Paris, Cynthiana (Harrison County), Georgetown (Scott County), Lexington (Fayette County), Morehead (Rowan County), Nicholasville (Jessamine County), Richmond (Madison County), Sandy Hook (Elliott County), Versailles (Woodford County), Wilmore (Jessamine County) and Winchester (Clark County). The deposits of Kentucky Bank are insured up to prescribed limits by the Deposit Insurance Fund (“DIF”) of the Federal Deposit Insurance Corporation (“FDIC”). KBI Insurance Company, Inc. is a captive insurance subsidiary and was incorporated in 2014 under the laws of Nevada.
The Company had total assets of $1.2 billion, total deposits of $978.6 million and stockholders’ equity of $128.3 million as of December 31, 2020. The Company’s principal executive office is located at 339 Main Street, Paris, Kentucky 40361, and the telephone number at that address is (859) 987-1795.
Recent Developments
Effective January 27, 2021, Kentucky Bancshares, Stock Yards Bancorp, Inc., a Kentucky corporation (“Stock Yards Bancorp”), and H. Meyer Merger Subsidiary, Inc., a Kentucky 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 into Kentucky Bancshares (the “merger”), with Kentucky 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 thereafter Kentucky Bank will merge with and into Stock Yards Bancorp’s bank subsidiary, Stock Yards Bank & Trust Company, a Kentucky banking corporation (“Stock Yards Bank”), with Stock 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 by Kentucky Bancshares’ shareholders and completion of other customary closing conditions. The combined company will serve customers through 63 branches with total assets of approximately $5.9 billion, $4.3 billion in gross loans, $5.0 billion in deposits and over $4.1 billion in trust assets under management.
Business Strategy
The Company’s current business strategy is to continue operating a well-capitalized, profitable and independent community bank with a significant presence in Central and Eastern Kentucky. Management believes the optimum way to grow the Company is by attracting new loan and deposit customers within its existing markets through its product offerings and premier customer service.
Lending
Kentucky Bank is engaged in general full-service commercial and consumer banking. A significant part of Kentucky Bank’s operating activities include originating loans, approximately 81% of which are secured by real estate at December 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 mortgage, installment and other loans to its individual and other non-commercial customers.
Loan Rates: Kentucky Bank offers variable and fixed rate loans. Loan rates on variable rate loans generally adjust upward or downward based on changes in the loan’s index. Rate adjustments on variable rate loans are made from 1 day to 10 years. Variable rate loans may contain provisions that cap the amount of interest rate increases or decreases over the life of the loan. In addition to the lifetime caps and floors on rate adjustments, loans secured by residential real estate may contain provisions that limit annual increases at a maximum of 200 basis points. There is usually no annual limit applied to loans secured by commercial real estate.
Credit Risk: Commercial lending and real estate construction lending, generally include a higher degree of credit risk than other loans, such as residential mortgage loans. Commercial loans, like other loans, are evaluated at the time of approval to determine the adequacy of repayment sources and collateral requirements. Collateral requirements vary to some degree among borrowers and depend on the borrower’s financial strength, the terms and amount of the loan, and collateral available to secure the loan. Credit risk results from the decreased ability or willingness to pay by a borrower. Credit risk also results when a liquidation of collateral occurs and there is a shortfall in collateral value as compared to a loan’s outstanding balance.
For construction loans, inaccurate initial estimates of a project’s costs and the property’s completed value could weaken the Company’s position and lead to the property having a value that is insufficient to satisfy full payment of the amount of funds advanced for the property. Secured and unsecured consumer loans generally are made for automobiles, boats, and other motor vehicles. In most cases, loans are restricted to Kentucky Bank’s general market area.
Other Products: Kentucky Bank offers its customers a variety of other services, including checking, savings, money market accounts, certificates of deposits, safe deposit facilities, credit cards and other consumer-oriented financial services. Kentucky Bank has Internet banking, including bill payment available to its customers at www.kybank.com. Through its Wealth Management Department, Kentucky Bank provides brokerage services, annuities, life and long term care insurance, personal trust and agency services (including management agency services).
Competition and Market Served
Competition: The banking business is highly competitive. Competition arises from a number of sources, including other bank holding companies and commercial banks, consumer finance companies, thrift institutions, other financial institutions and financial intermediaries. In addition to commercial banks, savings and loan associations, savings banks and credit unions actively compete to provide a wide variety of banking services. Mortgage banking firms, finance companies, insurance companies, brokerage companies, financial affiliates of industrial companies and government agencies provide additional competition for loans and for many other financial services. Kentucky Bank also currently competes for interest-bearing funds with a number of other financial intermediaries, including brokerage firms and mutual funds, which offer a diverse range of investment alternatives. In addition, financial technology, or “FinTech,” companies are emerging in key areas of banking. Some of the Company’s competitors are not subject to the same degree of regulatory review and restrictions that apply to the Company and its subsidiary bank. In addition, the Company must compete with competitors that have greater financial resources than the Company.
Market Served. We primarily conduct our business in the Commonwealth of Kentucky. Our primary market areas consist of Bourbon, Clark, Elliott, Fayette, Harrison, Jessamine, Madison, Rowan, Scott, Woodford and surrounding counties in Kentucky. Per capita personal income for Kentucky during the third quarter increased from $44,078 in 2019 to $45,966 in 2020, according to data published by the Federal Reserve Bank of St. Louis. The Bureau of Labor Statistics reports that the unemployment rate in Kentucky increased from 2019 to 2020. The unemployment rate in Kentucky was 6.0% for December 2020, and 4.3% for December 2019.
Nature of Company’s Business
The business of the Company is not seasonal. The Company’s business does not depend upon a single customer, or a few customers, the loss of any one or more of which would have material adverse effect on the Company. No material portion of the Company’s business is subject to renegotiation of profits or termination of contracts or subcontracts at the election of any governmental entity.
Human Capital Resources
At December 31, 2020, we employed a total of 245 employees, with 236 full-time equivalent team members. The Company respects, values, and invites diversity in our team members, customers, suppliers, marketplace, and community. We seek to recognize the unique contribution each individual brings to our company, and we are fully committed to supporting a rich culture of diversity as a cornerstone to our success. The Company strives to attract, develop and retain talented individuals in every community we serve. We provide professional development opportunities to team members and seek to improve retention, development, and job satisfaction of team members from diverse groups by providing career skills training, peer mentoring, and opportunities to interact with senior leaders. We believe our culture encourages our team to take initiative, accept challenges and achieve goals, all of which enables our team to work efficiently while providing excellent customer service which supports the Company’s strong performance.
Kentucky Bank employees actively share their talents in their communities through volunteer activities in education, economic development, human and health services, and Community Reinvestment. Through our HOME (Helping Our Markets Excel) program we donate resources to programs that strive to improve the quality of life for those living and working in the communities we serve.
We are committed and focused on the health and safety of our team members, customers, and communities. The COVID-19 pandemic presented challenges to maintain team member and customer safety while continuing to be open for business. Accordingly, we launched a proactive response to the escalating COVID-19 outbreak that included managing our pandemic response, providing access to recent safety standards from the Centers for Disease Control and Prevention, the World Health Organization, and other agencies; as well as our workplace guidelines for non-customer and customer environments. In addition, current information is shared through regular emails and other digital communications with our team members and customers facing financial hardships due to COVID-19. Additional actions included adjusting our banking center hours, lobby usage, and encouraging team members to work remotely where possible during the pandemic. We continue to monitor our footprint for areas where there is a resurgence or regression of COVID-19 and adjust our banking center availability accordingly. Our banking centers are still open for business and we continue to lend to qualified businesses for working capital and general business purposes, while our online banking network is continuously available for digital banking transactions. Lastly, the availability of an effective COVID-19 vaccine will drive the re-opening plans of state and local economies in 2021. However, economic uncertainty remains high and bouts of elevated volatility are expected to continue. Despite such continued uncertainty, the health and well-being of our employees and customers will always be our top priority.
Supervision and Regulation
Governing Regulatory Institutions: As a financial holding company, the Company is subject to the regulation and supervision of the Federal Reserve Board. The Company’s subsidiary bank is subject to supervision and regulation by applicable state and federal banking agencies, including the Federal Reserve Board (“Federal Reserve”), the Federal Deposit Insurance Corporation (“FDIC”) and the Kentucky Department of Financial Institutions. Kentucky Bank is also subject to various requirements and restrictions under federal and state law, including requirements to maintain reserves against deposits, restrictions on the types and amounts of loans that may be granted and the interest that may be charged thereon, and limitations on the types of investments that may be made and the types of services that may be offered. In addition to the impact of regulation, Kentucky Bank is affected significantly by the actions of the Federal Reserve Board as it attempts to control the money supply and credit availability in order to influence the economy. The company also has a captive insurance subsidiary which is regulated by the State of Nevada Division of Insurance.
Laws Protecting Deposits: There are a number of obligations and restrictions imposed on bank holding companies and their depository institution subsidiaries by federal law and regulatory policy. These obligations and restrictions are designed to reduce potential loss exposure to the depositors of such depository institutions and to the FDIC insured funds in the event the depository institution becomes in danger of default or is in default. For example, under a policy of the Federal Reserve Board with respect to bank holding company operations, a bank holding company is required to serve as a source of financial strength to its subsidiary depository institutions and commit resources to support such institutions in circumstances where it might not do so absent such policy. In addition, the “cross-guarantee” provisions of federal law require insured depository institutions under common control to reimburse the FDIC for any loss suffered or reasonably anticipated as a result of the default of a commonly controlled insured depository institution or for any assistance provided by the FDIC to a commonly controlled insured depository institution in danger of default.
The federal banking agencies also have broad powers under current federal law to take prompt corrective action to resolve problems of insured depository institutions. The extent of these powers depends upon whether the institutions in question are “well capitalized”, “adequately capitalized”, “undercapitalized”, “significantly undercapitalized” or “critically undercapitalized”, as such terms are defined under uniform regulation defining such capital levels issued by each of the federal banking agencies.
Capital and Liquidity: On July 2, 2013, the Federal Reserve approved final rules known as the “Basel III Capital Rules” substantially revising the risk-based capital and leverage capital requirements applicable to bank holding companies and depository institutions. The Basel III Capital Rules address the components of capital and other issues affecting the numerator in banking institutions’ regulatory capital ratios. Certain of the Basel III Capital Rules came into effect for the Company and Kentucky Bank on January 1, 2015; these rules are subject to a phase-in period which ended on January 31, 2018.
Under the current rules, which were effective January 1, 2015, the Company is subject to additional capital requirements that include: (i) creation of a new required ratio for common equity Tier 1 (“CET1”) capital, (ii) an increase to the minimum Tier 1 Risk-based Capital ratio, (iii) changes to risk-weightings of certain assets for purposes of the risk-based capital ratios, (iv) creation of an additional capital conservation buffer in excess of the required minimum capital ratios, and (v) changes to what qualifies as capital for purposes of meeting these capital requirements.
The Basel III Capital Rules were fully phased in effective January 1, 2019 and require banking organizations to maintain:
● a minimum ratio of CET1 to risk-weighted assets of at least 4.5%, plus a 2.5% “capital conservation buffer” (which is added to the 4.5% CET1 ratio as that buffer is phased-in, effectively resulting in a minimum ratio of CET1 to risk-weighted assets of at least 7.0% upon full implementation);
● a minimum ratio of Tier 1 capital to risk-weighted assets of at least 6.0%, plus the 2.5% capital conservation buffer (which is added to the 6.0% Tier 1 capital ratio as that buffer is phased-in, effectively resulting in a minimum Tier 1 capital ratio of 8.5% upon full implementation);
● a minimum ratio of total capital (that is, Tier 1 plus Tier 2 capital) to risk-weighted assets of at least 8.0%, plus the 2.5% capital conservation buffer (which is added to the 8.0% total capital ratio as that buffer is phased-in, effectively resulting in a minimum total capital ratio of 10.5% upon full implementation); and
● a minimum leverage ratio of 4.0%, calculated as the ratio of Tier 1 capital to adjusted average consolidated assets.
The Basel III Capital Rules also provide for a “countercyclical capital buffer” that is applicable to only certain covered institutions and is not expected to have any current applicability to the Company or Kentucky Bank.
The aforementioned capital conservation buffer is designed to absorb losses during periods of economic stress. Banking institutions with a ratio of CET1 to risk-weighted assets above the minimum but below the conservation buffer will face limitations on the payment of dividends, common stock repurchases and discretionary cash payments to executive officers based on the amount of the shortfall.
The Basel III Capital Rules provides for a number of deductions from and adjustments to CET1. These include, for example, the requirement that mortgage servicing rights, deferred tax assets dependent upon future taxable income and significant investments in non-consolidated financial entities be deducted from CET1 to the extent that any one such category exceeds 10% of CET1 or all such categories in the aggregate exceed 15% of CET1. Under the Basel III Capital Rules, the Company and Kentucky Bank were given a one-time election (“Opt-out Election”) to filter certain accumulated other comprehensive income (“AOCI”) components, comparable to the treatment under the previous general risk-based capital rule. The Company and Kentucky Bank elected to choose the AOCI Opt-out Election.
Implementation of the deductions and other adjustments to CET1 began on January 1, 2015 and are being phased-in over a five-year period (20% per year). The implementation of the capital conservation buffer began on January 1, 2016 at the 0.625% level and is being phased-in over a four-year period (increasing by that amount on each subsequent January 1, until it reaches 2.5% on January 1, 2019). In addition, the Basel III Capital Rules revised the rules for calculating risk-weighted assets to enhance their risk sensitivity. They established a new framework under which mortgage-backed securities and other securitization exposures are subject to risk-weights ranging from 20% to 1,250%.
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 on January 1, 2020. This final rule is applicable to all non-advanced approaches FDIC-supervised institutions with less than $10 billion in total consolidated assets. Highlights of the Community 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 $10 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. 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 FDIC 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 January 1, 2022. The interim final rules also maintain a two-quarter grace period for a qualifying community banking organization whose leverage ratio falls no more than 1 percent below the applicable community bank leverage ratio.
● The final rule adopts tier 1 capital and the existing leverage ratio into the community bank leverage ratio framework. The tier 1 numerator takes into account the modifications made in relation to the capital simplifications and current expected credit losses methodology (CECL) transitions rules as of the compliance dates of those rules.
● A CBLR bank will not be subject to other capital and leverage requirements. It will be deemed to have met the "well capitalized" ratio requirements and be in compliance with the generally applicable capital rule.
● A CBLR may opt out of the framework at any time, without restriction, by reverting to the generally applicable risk-based capital rule.
The rules also establish adjusted risk-weights for credit exposures, including multi-family and commercial real estate exposures that are 90 days or more past due or on non-accrual, are subject to a 150% risk-weight, except in situations where qualifying collateral and/or guarantees are in place. The existing treatment of residential mortgage exposures will remain subject to either a 50% risk-weight (for prudently underwritten owner-occupied first liens that are current or less than 90 days past due) or a 100% risk-weight (for all other residential mortgage exposures including 90 days or more past due exposures). As shown in Note 20, the Company and Kentucky Bank meet all capital adequacy requirements, and management does not anticipate any adverse impact from the implementation of the new capital ratio.
Deposit Insurance: The Company is subject to several deposit insurance assessments, which are described below:
FDIC Assessments. The Company’s subsidiary bank is a member of the FDIC, and its deposits are insured by the FDIC’s Deposit Insurance Fund (“DIF”) up to the amount permitted by law. The Company’s subsidiary bank is thus subject to FDIC deposit insurance assessments. The FDIC utilizes a risk-based assessment system that imposes insurance premiums based upon a risk matrix that takes into account a bank’s capital level and supervisory rating.
The assessment base must, with some possible exceptions, equal average consolidated total assets minus average tangible equity. The FDIC has adopted a DIF restoration plan to ensure that the reserve ratio increases to 1.35% from 1.15% of insured deposits by 2020. The assessment regulations (12 CFR Part 327) provide that after the reserve ratio reaches 1.38 percent (and provided that it remains at least 1.38 percent), the FDIC will automatically apply small bank (total consolidated assets of less than $10 billion) credits to reduce small banks’ regular deposit insurance assessments up to the full amounts of their assessments or the full amount of their credits, whichever is less. Credits will be awarded to any bank, including any small bank affiliate of a large bank, that was a small bank at some point during the credit calculation period (i.e., credit accruing institution). During 2019, the FDIC met target goals pertaining to the DIF. This resulted in the Bank receiving credits totaling $148 thousand that were applied directly to the Company’s FDIC insurance assessment.
Financing Corporation (“FICO”) Assessments. FICO assessment costs were $0 in 2020 and 2019. FICO is a mixed-ownership government corporation established by the Competitive Equality Banking Act of 1987 possessing assessment powers in addition to the FDIC. The FDIC acts as a collection agent for FICO, whose sole purpose is to function as a financing vehicle for the now defunct Federal Savings & Loan Insurance Corporation. Outstanding FICO bonds as of December 31, 2018, which were 30-year noncallable bonds, matured in 2019.
Dodd-Frank Act: On July 21, 2010, financial regulatory reform legislation entitled the “Dodd-Frank Wall Street Reform and Consumer Protection Act” (the “Dodd-Frank Act”) was signed into law. The Dodd-Frank Act significantly restructured the financial regulatory environment in the United States. The Dodd-Frank Act contains numerous provisions that affect all bank holding companies and banks, including Kentucky Bancshares and Kentucky Bank, some of which are described in more detail below. The scope and impact of many of the Dodd-Frank Act provisions were determined and issued over time. The impact of the Dodd-Frank Act on the Company has been substantial. Provisions in the legislation that affect the payment of interest on demand deposits and collection of interchange fees increased the costs associated with certain deposits and placed limitations on certain revenues those deposits generate.
Volcker Rule: On December 10, 2013, the federal bank regulatory agencies adopted final rules that implement a part of the Dodd-Frank Act commonly referred to as the “Volcker Rule.” The Volcker Rule attempts to reduce risk and banking system instability by restricting U.S. banks from investing in or engaging in proprietary trading and speculation and imposing a strict framework to justify exemptions for underwriting, market making and hedging activities. U.S. banks will be restricted from investing in funds with collateral comprised of less than 100% loans that are not registered with the SEC and from engaging in hedging activities that do not hedge a specific identified risk. The Volcker Rule has not had a significant effect on operations of the Company. The roll-back of some Dodd-Frank provisions in 2018 included exempted smaller banks (under $10 billion in assets) from complying with the Volcker rule.
Consumer Regulations: In addition to the laws and regulations discussed above, Kentucky Bank is also subject to certain consumer laws and regulations that are designed to protect consumers in transactions with banks. While the list set forth herein is not exhaustive, these laws and regulations include the Truth in Lending Act, the Truth in Savings Act, the Electronic Funds Transfer Act, the Expedited Funds Availability Act, the Equal Credit Opportunity Act, the Real Estate Settlement Procedures Act, the Fair Housing Act and the Fair and Accurate Transactions Act, among others. These laws and regulations mandate certain disclosure requirements and regulate the manner in which financial institutions must deal with clients when taking deposits or making loans.
These laws also limit Kentucky Bank’s ability to share information with affiliated and unaffiliated entities. The bank must comply with the applicable provisions of these consumer protection laws and regulations as part of its ongoing business operations.
Dividend Restrictions: There are various legal and regulatory limits on the extent to which the Company’s subsidiary bank may pay dividends or otherwise supply funds to the Company. In addition, federal and state regulatory agencies also have the authority to prevent a bank or bank holding company from paying a dividend or engaging in any other activity that, in the opinion of the agency, would constitute an unsafe or unsound practice. Dividends paid by the subsidiary bank have provided substantially all of the Company’s operating funds, and this may reasonably be expected to continue for the foreseeable future.
COVID-19, The CARES Act and Related Legislative and Regulatory Actions: On January 30, 2020, the World Health Organization (“WHO”) announced that the outbreak of the novel coronavirus disease 2019 (COVID-19) constituted a public health emergency of international concern. On March 11, 2020, WHO declared COVID-19 to be a global pandemic and, on March 13, 2020, the President of the 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 significantly impacted the global economy (including the state and local economies in which we operate), disrupted supply chains, lowered equity market valuations and created significant volatility and disruption in financial markets. The outbreak has resulted in authorities implementing numerous measures to try and contain the virus, such as travel bans and restrictions, quarantines, shelter in place or total lock-down orders and business limitations and shutdowns. Such measures significantly contributed to rising unemployment and negatively impacted customer and business spending. While quarantine and lock-down orders have been lifted or reduced and vaccination efforts are underway, COVID-19 has not yet been entirely contained and commercial activity has not yet returned to the levels existing prior to the pandemic. As a result, the demand for some of the Company’s products and services has been, and will continue to be, significantly impacted.
On March 27, 2020, the Coronavirus, Relief and Economic Security Act (the “CARES Act”) was signed into law, providing an approximately $2 trillion stimulus package that included 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 the Small Business Administration (“SBA”). On April 24, 2020, the Paycheck Protection Program and Health Care Enhancement Act was enacted. Among other things, this legislation amends the initial CARES Act program by raising the appropriation level for PPP loans from $349 billion to $670 billion. The PPP was further modified on June 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 the U.S. government. The Company anticipates that the majority of the PPP loans will ultimately be forgiven by the SBA in accordance with the terms of the program. As discussed below under “The 2021 Consolidated Appropriations Act,” an additional $284 billion in funding has been made available under the PPP, with authority to make loans under the program being extended through March 31, 2021. During 2021, Kentucky Bank plans to offer additional PPP loans as authorized under the CAA (as defined below).
On April 7, 2020, the FRB, the Office of the Comptroller of the Currency (the “OCC”), and the Federal Deposit Insurance Corporation (the “FDIC” and, together with the FRB and OCC, the “federal banking regulators”) issued a revised Interagency 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 troubled debt restructurings and that the agencies will not direct supervised institutions to automatically categorize all COVID-19 related loan modifications as troubled debt restructurings. Similarly, under the CARES Act, provisions were included that allow for loan modifications to not be classified as TDRs if certain criteria are met. This TDR exemption, which was set to expire on December 31, 2020, was extended under the CAA to the earlier of (i) 60 days after the national emergency concerning the COVID-19 outbreak terminates, and (ii) January 1, 2022.
The CARES Act, the CAA and certain actions by federal banking regulators have resulted in modifications to, or delays in implementation of, various regulatory capital rules applicable to banking organizations. See “Capital Requirements” above for additional information.
On December 27, 2020, a $900 billion COVID-19 relief package, as passed by the U.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 (i) established an additional $284 billion in funding for the PPP through March 31, 2021, and (ii) further suspended the exception for loan modifications to not be classified as TDRs if certain criteria are met.
Available Information
The Company files annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports with the Securities and Exchange Commission (“SEC”) pursuant to section 13(a) or 15(d) of the Securities Exchange Act of 1934.
The SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC on its website at www.sec.gov. The Company’s website is located at www.kybank.com.

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ITEM 1A. RISK FACTORS
Item 1A. Risk Factors
There are factors, many beyond our control, which may significantly affect the Company’s financial position and results of operations. Some of these factors are described below in the sections titled financial risk, business risk and operational risk. These risks are not totally independent of each other; some factors affect more than one type of risk. These include regulatory, economic, and competitive environments.
As part of the annual internal audit plan, our risk management department meets with management to assess these risks throughout the Company. Many risks are further addressed in other sections of this Form 10-K document. Additional risks and uncertainties that management is not aware of or focused on or that management currently deems immaterial may also impair the Company’s business operations. This report is qualified in its entirety by these risk factors.
Risks Related to the COVID-19 pandemic
The ongoing COVID-19 pandemic and measures intended to prevent its spread have impacted our business and financial results, and the continued impact depends on future developments, which are still uncertain and cannot be predicted and depend on factors, many of which are outside our control. During 2020, COVID-19 was identified as a pandemic and declared a national emergency in the United States. The pandemic continues to significantly impact the global economy, creating significant volatility and disruption in the financial markets. Measures intended to prevent the spread of COVID-19, including travel bans and restrictions, quarantines, shelter in place and business limitations and shutdowns, have significantly contributed to rising unemployment and negatively impacted consumer and business spending. As a result, demand for certain products and services of Kentucky Bank have been, and will continue to be, significantly impacted. The pandemic has caused, and could continue to influence, the recognition of credit losses in Kentucky Bank’s loan portfolio and increases in the allowance for credit losses. In addition, governmental actions have resulted in decreased interest rates and yields, which may lead to decreases in net interest income and noninterest income. Additionally, the overall impact of any inability of our borrowers to repay loans on a timely basis due to the pandemic cannot fully be determined at this time. COVID-19 has not yet been contained and the extent to which it continues to impact our business, results of operations and financial condition, as well as regulatory capital and liquidity ratios, will depend on future developments, which are highly uncertain and are difficult to predict.
The ongoing COVID-19 pandemic has increased cybersecurity risks. The COVID-19 pandemic introduced additional risk to our information systems and security procedures, controls and policies as a result of employees, contractors and other corporate partners working remotely. Additionally, since the beginning of the pandemic, there has been an increase in cyber criminals utilizing interest in pandemic-related information and the fear and uncertainty caused by the pandemic to increase cybersecurity attacks. If our information technology systems are compromised, our operations could be disrupted, or we may suffer financial loss, loss of customer business or other critical assets, or become exposed to regulatory fines and intervention or civil litigation.
Participation in the Payroll Protection Program (“PPP”), or in other relief programs created in response to the COVID-19 pandemic, may expose us to credit losses as well as litigation and compliance risk. To support our customers, businesses, and communities, the Company has participated in the PPP as a lender. The PPP commenced on April 3, 2020 and was available to qualified borrowers through August 8, 2020. As of December 31, 2020, the Company had originated over 600 loans with balances in excess of $60 million to new and existing customers through the PPP. The Company’s participation in the PPP, and participation in any other relief programs now or in the future, including those under the CARES Act, exposes us to certain credit, compliance, and other risks.
Among other regulatory requirements, PPP loans are subject to forbearance of loan payments for a six-month period to the extent that loans are not eligible for forgiveness. If PPP borrowers fail to qualify for loan forgiveness, including by failing to use the funds appropriately in order to qualify for forgiveness under the program, the Company has a greater risk of holding these loans at unfavorable interest rates. In addition, because of the short time period between the passing of the CARES Act and the implementation of the PPP, there is ambiguity in the laws, rules, and guidance regarding the operation of the PPP, which exposes us to risks relating to noncompliance with the PPP. There is risk that the SBA or another governmental entity could conclude there is a deficiency in the manner in which the Company originated, funded, or serviced PPP loans, which may or may not be related to the ambiguity in the CARES Act or the rules and guidance promulgated by the SBA and the U.S. Treasury regarding the operation of the PPP. In the event of such deficiency, the SBA may deny its liability under the guaranty, reduce the amount of the guaranty, or, if it has already made payment under the guaranty, seek recovery of any loss related to the deficiency from us.
Industry Risk
Industry risk includes risks that affect the entire banking service industry.
Significant decline in general economic conditions will negatively affect the financial results of our banking operations. Kentucky Bank serves both individuals and business customers throughout Central and Eastern Kentucky, unlike larger banks that may be more geographically diverse, the substantial majority of our loan portfolio is to individuals and businesses in these markets. As a result, our financial condition, results of operations and cash flows are affected by local and regional economic conditions. A downturn in these economies could have a negative impact on us and the ability of Kentucky Bank’s customers to repay their loans. The value of the collateral securing loans to borrowers may also decline as the economy declines. As a result, deteriorating economic conditions in these markets could cause a decline in the overall quality of our loan portfolio requiring us to charge-off a higher percentage of loans and/or increase our allowance for loan losses.
Significant declines in U.S. and global markets could have a negative impact on our earnings. The capital and credit markets could experience extreme disruption. These conditions result in less liquidity, greater volatility, widening of credit spreads and a lack of price transparency in certain asset types. In many cases, markets could exert downward pressure on stock prices, security prices and credit capacity for certain issuers without regard to those issuers’ underlying financial strength. Sustained weakness in business and economic conditions in any or all of the domestic or foreign financial markets could result in credit deterioration in investment securities held by us, rating agency downgrades for such securities or other market factors that (such as lack of liquidity for re-sales, absence of reliable pricing information or unanticipated changes in the competitive market) could result in us having to recognize other-than-temporary impairment in the value of such investment securities, with a corresponding charge against earnings. If the markets deteriorate further, these conditions may be material to our ability to access capital and may adversely impact results of operations.
Further, Kentucky Bank’s trust and investment services income could be impacted by fluctuations in the securities market. A portion of this revenue is based on the value of the underlying investment portfolios. If the values of those investment portfolios decline, Kentucky Bank’s revenue could be negatively impacted.
The exercise of regulatory power may have a negative impact on our results of operations and financial condition. We are subject to extensive federal and state regulation, supervision and examination. Banking regulations are primarily intended to protect depositors’ funds, federal deposit insurance funds and the banking system as a whole, rather than corporate shareholders. These regulations affect our lending practices, capital structure, investment practices, dividend policy, operations and growth, among other things. These regulations also impose obligations to maintain appropriate policies, procedure and controls. Congress and federal regulatory agencies continually review banking laws, regulations and policies for possible changes. The Company’s management cannot predict what effect any future changes on such laws, regulations and policies will have on our operations. Changes to statutes, regulations or regulatory policies, including changes in interpretation or implementation of statutes, regulations or policies, could affect us in substantial and unpredictable ways.
Such changes could subject us to additional costs, limit the types of financial services and products that could be offered, and/or increase the ability of non-banks to offer competing financial services and products, among other things. Failure to comply with laws, regulations or policies could result in sanctions by regulatory agencies, civil penalties and/or reputation damage, which could have a material adverse effect on our business, financial condition and result of operations.
Regulation of the Company and our subsidiaries is expected to continue to expand in scope and complexity in the future. These laws are expected to have the effect of increasing our costs of doing business and reducing our revenues, and may limit our ability to pursue business opportunities or otherwise adversely affect our business and financial condition. The Dodd-Frank Act and other laws, as well as rules implementing or related to them, may adversely affect us. Specifically, any governmental or regulatory action having the effect of requiring us to obtain additional capital could reduce earnings and have a material dilutive effect on current shareholders, including the Dodd-Frank Act source of strength requirement that bank holding companies make capital infusions into a troubled subsidiary bank. Legislation and regulation of debit card fees, credit cards and other bank services, as well as changes in our practices relating to those and other bank services, may affect our revenue and other financial results. Additional information about increased regulation is provided in “Item 1. Business” under the heading “Supervision and Regulation.”
We are also subject to tax laws and regulations promulgated by the United States government and the states in which it operates. Changes to these laws and regulations or the interpretations of such laws and regulations by taxing authorities could impact future tax expense and the value of deferred tax assets. In addition, Kentucky Bank’s customers are subject to a wide variety of federal, state and local taxes. Changes in taxes paid by our customers may adversely affect their ability to purchase homes or consumer products, which could adversely affect their demand for loans and deposit products. In addition, negative effects on Kentucky Bank’s customers could result in defaults on the loans made by Kentucky Bank and decrease the value of mortgage-backed securities in which Kentucky Bank has invested. With the Biden Administration taking office in 2021, it is increasingly likely that the federal tax rate for corporations could be increased in 2021 or 2022. The potential enactment of such legislation, or changes in the interpretation of existing tax law, including provisions impacting tax rates, income, expense, credits and exemptions may have a material adverse effect on our business, financial condition and results of operations.
Deposit insurance premiums levied against the Company may increase if the number of bank failures increase or the cost of resolving failed banks increases. The FDIC maintains a Deposit Insurance Fund (“ DIF”) to protect insured depositors in the event of bank failures. The DIF is funded by fees assessed on insured depository institutions including Kentucky Bank. Future deposit premiums paid by Kentucky Bank depend on the level of the DIF and the magnitude and cost of future bank failures. Since the DIF is funded by premiums and assessments paid by insured banks, our FDIC premium could increase in future years depending on the FDIC’s actual loss experience, changes in Kentucky Bank’s financial condition or capital strength and future conditions in the banking industry.
Increased competition from other providers may adversely affect our financial condition and results of operations. We face vigorous competition from banks and other financial institutions. This competition may reduce or limit our margins on banking services, reduce market share and adversely affect results of operations and financial condition.
Many other banks and financial institutions have substantially greater resources and lending limits, larger branch systems and a wider array of banking services.
Additionally, we encounter competition from both de novo and smaller community banks entering the markets we are currently in. We also compete with other providers of financial services, such as money market mutual funds, brokerage firms, consumer finance companies and insurance companies.
Changes in consumer use of banks and changes in consumer spending and saving habits could adversely affect our financial results. Technology and other changes now allow many consumers to complete financial transactions without using banks. For example, consumers can pay bills and transfer funds directly without going through a bank and can access loans through lending groups and other non-regulated entities. This “disintermediation” could result in the loss of fee and interest income, as well as the loss of customer deposits and income generated from those deposits. In addition, changes in consumer spending and saving habits could adversely affect our operations, and we may be unable to timely develop competitive new products and services in response to these changes that are accepted by new and existing customers.
Financial Risk
Financial risk components include, but are not limited to, credit risk, interest rate risk, goodwill impairment, market risk and liquidity risk. We have adopted various policies to minimize potential adverse effects of interest rate, market and liquidity risks. However, even with these policies in place, a change in interest rates could negatively impact our results of operations or financial position.
Defaults in the repayment of loans may negatively impact our business. Credit risk is most closely associated with lending activities at financial institutions. Credit risk is the risk to earnings and capital when a customer fails to meet the terms of any contract or otherwise fails to perform as agreed. Credit risk arises from all activities where the Company is dependent on issuer, borrower, or counterparty performance, not just traditional lending activities. For example, the investment security portfolio has inherent credit risk as do counterparties in derivative contracts. Credit risk encompasses a broad range of financial institution activities and includes items reflected both on and off the balance sheet.
Management makes various assumptions and judgments about the collectability of our loan portfolio, including the creditworthiness of its borrowers and the value of real estate and other assets serving as collateral for repayment of many of the loans. In determining the size of the allowance for loan losses, management considers, among other factors, the Company’s loan loss experience and an evaluation of economic conditions. If these assumptions prove to be incorrect, the current allowance may not be sufficient to cover future loan losses and adjustments may be necessary to allow for different economic conditions or adverse developments in the loan portfolio. Material additions to the Company’s allowance would materially decrease our net income.
Fluctuations in interest rates may negatively impact our banking business. Interest rate risk focuses on the impact to earnings and capital arising from movements in interest rates. Our earnings and cash flows are largely dependent on our net interest income. Interest rates are highly sensitive to many factors that are beyond our control, including general economic conditions, demands for loans, securities and deposits, and policies of various governmental and regulatory agencies and, in particular, the monetary policies of the FRB. Interest rate risk focuses on the value implications for accrual portfolios (e.g., available-for-sale portfolios) and includes the potential impact to the Company’s accrual earnings as well as the economic perspective of the market value of portfolio equity. The interest rate risk is comprised of repricing risk, basis risk, yield curve risk and options risk. Repricing risk represents the risk associated with the differences in timing of cash flows and rate changes with our products. Basis risk represents the risk associated with changing rate relationships among varying yield curves. Yield curve risk is associated with changing rate relationships over the maturity structure. Options risk is associated with interest-related options, which are embedded in our products.
We may be unable to anticipate changes in market interest rates. Any substantial, prolonged change in market interest rates could have a material adverse effect on our financial condition, results of operations, and cash flows.
The replacement of the LIBOR benchmark interest rate may have an impact on our business, financial condition or results of operation. In July 2017, the United Kingdom’s Financial Conduct Authority announced that it intends to stop persuading or compelling banks to submit LIBOR rates after 2021. LIBOR will cease to exist as a published rate after 2021. The expected discontinuation of LIBOR could have a significant impact on the financial markets and market participants. The FRB, through the Alternative Reference Rate Committee, has recommended a replacement benchmark rate, the Secured Overnight Financing Rate. All loan and swap contracts extending beyond 2021 will need to be managed effectively to ensure appropriate benchmark replacements are provided for and adopted. It is uncertain at this time the extent to which those entering into financial contracts will transition to any other particular benchmark. The consequences of a market-wide transition from LIBOR cannot be predicted. However, such consequences may adversely affect the value of, and the return on our financial instruments.
Changes in market factors may negatively affect the value of our investment assets. Market risk focuses on the impact to earnings and capital arising from changes in market factors (e.g., interest rates, market liquidity, volatilities, etc.) that affect the value of traded instruments. Market risk includes items reflected both on and off the balance sheet. Market risk focuses primarily on mark-to-market portfolios (e.g., accounts revalued for financial statement presentation).
Our inability to maintain appropriate levels of liquidity may have a negative impact on our results of operations and financial condition. Liquidity risk focuses on the impact to earnings and capital resulting from our inability to meet our obligations as they become due in the normal course of business without incurring significant losses. It also includes the management of unplanned decreases or changes in funding sources as well as managing changes in market conditions, which could affect the ability to liquidate assets in the normal course of business without incurring significant losses. Liquidity risk includes items both on and off the balance sheet. Although we have historically been able to maintain appropriate levels of liquidity, we may not be able to do so in the future if, among other things, our results of operations or financial condition or market conditions were to change.
We are exposed to risk of environmental liabilities with respect to properties to which we take title. In the course of our business, we may foreclose and take title to real estate, and could be subject to environmental liabilities with respect to these properties. While we will take steps to mitigate this risk, we may be held liable to a governmental entity or to third parties for property damage, personal injury, investigation and clean-up costs incurred by these parties in connection with environmental contamination, or we may be required to investigate or clean-up hazardous or toxic substances, or chemical releases at one or more properties. The costs associated with investigation or remediation activities could be substantial. In addition, while there are certain statutory protections afforded lenders who take title to property through foreclosure on a loan, if we are the owner or former owner of a contaminated site, we may be subject to common law claims by third parties based on damages and costs resulting from environmental contamination emanating from the property. If we become subject to significant environmental liabilities, our business, financial condition, results of operations and prospects could be adversely affected.
Business Risk
Business risk is composed mainly of legal (compliance) risk, strategic risk and reputation risk.
Our results of operations and financial condition are susceptible to legal or compliance risks. Legal or compliance risk is the risk to earnings or capital arising from the impact of unenforceable contracts, lawsuits, adverse judgments, violations or nonconformance with laws, rules, regulations, prescribed practices, or ethical standards. The risk also arises in situations where laws or rules governing certain products or activities of our customers may be ambiguous or untested. This risk is not limited to the traditional thinking that legal/compliance risk is only associated with consumer protection laws. It includes the exposure to litigation from all aspects of both traditional and nontraditional financial institution activities.
Adverse publicity may have a negative impact on our business. Reputation risk is the risk to earnings and capital arising from negative public opinion. This affects the ability to establish new relationships or services or to continue servicing existing relationships. Examiners will assess reputation risk by recognizing the potential effect the public’s opinion could have on our franchise value.
Operational Risk
Because the nature of the financial services business involves a high volume of transactions, we face significant operational risks. Operational risk is the risk of loss resulting from our operations, including, but not limited to, the risk of fraud by employees or persons outside of the Company, the execution of unauthorized transactions by employees, errors relating to transaction processing and technology, breaches of the internal control system and compliance requirements and business continuation and disaster recovery. This risk of loss also includes the potential legal actions that could arise as a result of an operational deficiency or as a result of noncompliance with applicable regulatory standards, adverse business decisions or their implementation, and customer attrition due to potential negative publicity.
In the event of a breakdown in the internal control system, improper operation of systems or improper employee actions, we could suffer financial loss, face regulatory action and suffer damage to its reputation.
Internal controls and procedures may fail or be circumvented. Our management team regularly reviews and updates our internal controls, disclosure controls and procedures, and corporate governance policies and procedures. Any system of controls is based in part on certain assumptions and not provide absolute assurances that the objectives of the system are met. Any failure or circumvention of our controls and procedures or failure to comply with regulations related to controls and procedures could have a material adverse effect on our business, results of operations, cash flows and financial condition.
Adverse weather events could negatively affect our local economies or disrupt our operations, which would have an adverse effect on our business or results of operations. Tornadoes, severe flooding and other adverse weather events can disrupt our operations, result in damage to our properties and negatively affect the local and regional economies in which we operate. In addition, these weather events may result in a decline in value or destruction of properties securing our loans and an increase in delinquencies, foreclosures and loan losses.
Technology Risk
Systems failure, interruption or breach of security may have a negative impact on our business. We rely heavily on communications and information systems to conduct our business. Any failure, interruption or breach in security of these systems, including as a result of cyber-attacks, could result in failures or disruptions in our customer relationship management, deposit, loan, and other systems and also the disclosure or misuse of confidential or proprietary information. While Kentucky Bank has established policies and procedures to prevent or limit the impact of systems failures, interruptions, and security breaches, there can be no assurance that such events will not occur or that they will be adequately addressed if they do. In addition, any compromise of Kentucky Bank’s information security systems could deter customers from using Kentucky Bank’s web site and its internet banking service, both of which involve the transmission of confidential information. The occurrence of any failures, interruption or security breaches of our information system could have a material adverse effect on our business, financial condition and results of operations.
Information security risks for financial institutions have generally increased in recent years, and our technologies, systems, networks, and our customers’ devices may become the target of cyber-attacks or information security breaches that could result in the unauthorized release, gathering, misuse, loss or destruction of our confidential, proprietary and other information, the theft of customer assets through fraudulent transactions or disruption of our, our customers’ or other third parties’ business operations. As cyber threats continue to evolve, we may also be required to expend significant additional resources to continue to modify or enhance our protective measures or to address any information security vulnerabilities.
The business continuity of third-party providers may have a negative impact on our technology operations. Kentucky Bank outsources certain of its data processing to third-party providers. If third-party providers encounter difficulties, or if the Bank has difficulty communicating with them, Kentucky Bank’s ability to adequately process and account for customer transactions could be affected, and its business operations could be adversely impacted. Threats to information security also exist in the processing of customer information through various other vendors and their personnel.
We and our subsidiary bank have addressed technology risks through the use of logon and user access controls, transaction limits, firewalls, antivirus software, intrusion protection monitoring and third party vulnerability scans. Systems failure or interruption has been addressed by adopting a disaster recovery and contingency plan. In addition, for all third-party providers of data processing services, we obtain and review audit reports prepared by independent registered public accounting firms regarding their financial condition and the effectiveness of their internal controls.
The Company cannot predict how changes in technology will impact our business. The banking service industry is increasingly affected by advances in technology, which often occur rapidly. The effective use of technology increases efficiency and enables the banking service industry to better serve customers and to reduce costs. The Company’s ability to compete successfully in the future will depend on whether we can anticipate and respond to technological changes, which will likely require additional capital investments. Many of our competitors have substantially greater resources to invest in technological improvements. Although the Company continually invests in new technology that is appropriate to our operations, we cannot assure that the Company will have sufficient resources or access to the necessary technology to remain competitive in the future.

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ITEM 1B. UNRESOLVED STAFF COMMENTS
Item 1B. Unresolved Staff Comments
None.

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ITEM 2. PROPERTIES
Item 2. Properties
The Company’s corporate headquarters is located at 339 Main Street, Paris, KY 40361, which it owns. The main banking office of Kentucky Bank is located at 401 Main Street, Paris, Kentucky 40361. In addition, Kentucky Bank serves customer needs at 18 other locations. All locations offer a full range of banking services. The Company owns approximately 82,000 square feet of office space and leases approximately 22,000 square feet of office space.
Note 5 and Note 6 to the Company’s audited and consolidated financial statements included in Item 8 (“2020 Consolidated Financial Statements and Notes”) contains additional information relating to amounts invested in premises and equipment and operating leases for which the Company has recorded a right of use asset and liability for.
Kentucky Bank Banking Offices
Owned
401 Main Street, Paris, KY 40361
2021 South Main Street, Paris, KY 40361
1975 By Pass Road, Winchester, KY 40391
50 North Maple Street, Winchester, KY 40391
144 South KY 7, Sandy Hook, KY 41171
939 US Hwy 27 South, Cynthiana, KY 41031
920 North Main Street, Nicholasville, KY 40356
108 East Main Street, Wilmore, KY 40390
400 West First Street, Morehead, KY 40351
1500 Flemingsburg Road, Morehead, KY 40351
260 Blossom Park Drive, Georgetown, KY 40324
103 West Showalter Drive, Georgetown, KY 40324
520 Marsailles Road, Versailles, KY 40383
Leased
4161 Tates Creek Centre Drive, Lexington, KY 40517
1710 Fitzgerald Court, Lexington, KY 40509
360 East Vine Street, Suite 100, Lexington, KY 40507
1001 Gibson Bay Drive, Suite 101, Richmond, KY 40475
680 Dwight Drive Richmond, KY 40475
724 West Main Street, Richmond, KY 40475

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ITEM 3. LEGAL PROCEEDINGS
Item 3. Legal Proceedings
From time to time, the Company or its subsidiaries are subject to legal proceedings and claims in the ordinary course of business. The Company currently is not aware of any such legal proceedings or claims that it believes will have, individually or in the aggregate, a material adverse effect on the business, financial condition, liquidity or operating results of the Company and Kentucky Bank.

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ITEM 4. MINE SAFETY DISCLOSURE
Item 4. Mine Safety Disclosures
Not Applicable
PART II

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ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY
Item 5. Market for Common Equity and Related Stockholder Matters
Market Information
The Company’s Common Stock is not listed on any national securities exchange. However, it is traded on OTCQX under the symbol “KTYB”. Trading in our common stock is less frequent, with trading done directly by a network of brokers. Any over-the-counter market quotations reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not necessarily represent actual transactions.
Holders
As of December 31, 2020 the Company had 5,946,306 shares of Common Stock outstanding and approximately 516 holders of record of its Common Stock.
Dividends
During 2020 and 2019, the Corporation declared quarterly cash dividends aggregating $0.72 and $0.68 per share, respectively. Note 17 to the Company’s 2020 Consolidated Financial Statements and Notes included in Item 8 contains additional information relating to amounts available to be paid as dividends.
Purchases of Equity Securities by the Issuer and Affiliates Purchasers
The table below lists issuer purchases of equity securities.
(c) Total Number
(d) Maximum Number
(a) Total
of Shares (or Units)
(or Approximate Dollar
Number of
(b) Average
Purchased as Part
Value) of Shares (or
Shares (or
Price Paid
of Publicly
Units) that May Yet Be
Units)
Per Share
Announced Plans
Purchased Under the
Period
Purchased
(or Unit)
Or Programs
Plans or Programs
10/1/20 - 10/31/20
-
$
-
-
135,824 shares
11/1/20 - 11/30/20
-
-
-
135,824 shares
12/1/20 - 12/31/20
-
-
-
135,824 shares
Total
-
$
-
-
135,824 shares
On October 25, 2000, the Company announced that its Board of Directors approved a stock repurchase program. The Company was authorized to purchase up to 200,000 shares of its outstanding common stock. On November 11, 2002, the Board of Directors approved and authorized the Company’s repurchase of an additional 200,000 shares. On May 20, 2008, the Board of Directors approved and authorized the purchase of an additional 200,000 shares. On May 17, 2011, the Board of Directors approved and authorized the Company’s repurchase of an additional 200,000 shares. On November 18, 2016, the Board of Directors approved and authorized the Company’s repurchase of an additional 100,000 shares. Shares will be purchased from time to time in the open market depending on market prices and other considerations. Through December 31, 2019, 764,176 shares have been purchased, with the most recent share repurchase under the Board-approved stock repurchase program having occurred on August 23, 2019.
Securities Authorized for Issuance under Equity Compensation Plans
The following table sets forth certain information regarding Company compensations plans under which equity securities of the company are authorized for issuance.
No. of securities
remaining available
Number of securities
for future issuance
to be issued
Weighted average
under equity
upon exercise of
exercise price of
compensation plans
outstanding options,
outstanding options
(excluding securities
Plan category
warrants and rights
warrants and rights
reflected in column 1)
Plans Approved By Stockholders:
2019 Stock Award Plan
-
-
266,528

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ITEM 6. SELECTED FINANCIAL DATA
Item 6. Selected Financial Data (in thousands except per share data)
The following selected financial data should be read in conjunction with the Company’s Consolidated Financial Statements and the accompanying notes presented in Item 8.
At or For the Year ended December 31,
CONDENSED STATEMENT OF INCOME:
Total Interest Income
$
42,685
$
45,532
$
42,632
$
38,659
$
36,554
Total Interest Expense
6,703
8,983
6,802
5,014
4,426
Net Interest Income
35,982
36,549
35,830
33,645
32,128
Provision for Losses
1,775
1,250
1,150
Net Interest Income After Provision for Losses
34,207
35,299
35,330
33,145
30,978
Noninterest Income
15,975
14,239
12,963
13,808
12,149
Noninterest Expense
37,607
35,308
34,209
33,073
33,785
Income Before Income Tax Expense
12,575
14,230
14,084
13,880
9,342
Income Tax Expense
1,077
1,654
3,163
Net Income
11,697
13,153
12,430
10,717
8,569
SHARE DATA:
Basic Earnings per Share (EPS)
$
1.97
$
2.21
$
2.09
$
1.81
$
1.43
Diluted EPS
1.97
2.21
2.09
1.81
1.43
Cash Dividends Declared
0.720
0.680
0.625
0.580
0.540
Book Value
21.58
20.17
17.93
16.88
15.64
Average Common Shares-Basic
5,942
5,953
5,924
5,944
5,982
Average Common Shares-Diluted
5,942
5,953
5,924
5,944
5,982
SELECTED BALANCE SHEET DATA:
Loans, net
$
756,974
$
735,853
$
678,017
$
640,815
$
648,466
Investment Securities
353,494
265,330
315,369
318,177
273,770
Trading Assets
-
-
-
-
5,592
Total Assets
1,239,505
1,110,790
1,086,012
1,053,193
1,028,447
Deposits
978,604
842,653
850,442
815,273
802,981
Repurchase Agreements
9,129
5,994
8,077
19,900
20,873
Federal Home Loan Bank advances
96,532
116,418
100,452
98,732
92,500
Note Payable
-
-
2,718
3,321
4,090
Subordinated Debentures
7,217
7,217
7,217
7,217
7,217
Stockholders’ Equity
128,342
119,263
106,793
100,329
92,972
PERFORMANCE RATIOS:
(Average Balances)
Return on Assets
0.97
%
1.20
%
1.18
%
1.04
%
0.86
%
Return on Stockholders’ Equity
9.54
%
11.52
%
12.36
%
10.93
%
9.10
%
Net Interest Margin (1)
3.29
%
3.64
%
3.70
%
3.60
%
3.61
%
Equity to Assets (annual average)
10.20
%
10.43
%
9.56
%
9.48
%
9.41
%
SELECTED STATISTICAL DATA:
Dividend Payout Ratio
36.60
%
30.75
%
29.96
%
32.16
%
37.68
%
Number of Employees (at period end)
ALLOWANCE COVERAGE RATIOS:
Allowance to Total Loans
1.29
%
1.14
%
1.18
%
1.19
%
1.15
%
Net Charge-offs as a Percentage of Average Loans
0.04
%
0.13
%
0.01
%
0.05
%
0.02
%
(1) Tax equivalent

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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS
Item 7. Management’s Discussion and Analysis
This section presents an analysis of the consolidated financial condition of the Company and its wholly-owned subsidiary, Kentucky Bank, at December 31, 2020 and 2019, and the consolidated results of operations for each of the years in the two year period ended December 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 of Kentucky 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 Toyota vehicles, in which the Company and its bank operate);
● competition for the Company’s customers from other providers of financial and mortgage services;
● government legislation, regulation and monetary policy (which changes from time to time and over which the Company has no control);
● changes in interest rates (both generally and more specifically mortgage interest rates);
● material unforeseen changes in the liquidity, results of operations, or financial condition of the Company’s customers; and
● other risks detailed in 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.
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 conditions and 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 of Kentucky 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 and Kentucky Bancshares make with the Securities 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 or Kentucky Bancshares may file with the SEC. 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 and Kentucky Bancshares can be obtained free of charge from the SEC’s website at www.sec.gov. These documents also can be obtained free of charge by accessing Stock 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 to Kentucky 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.
Recent Events
Merger with Stock Yards Bancorp, Inc.:
As previously noted, effective January 27, 2021, Kentucky Bancshares, Stock Yards Bancorp, Inc., a Kentucky corporation (“Stock Yards Bancorp”), and H. Meyer Merger Subsidiary, Inc., a Kentucky 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 into Kentucky Bancshares (the “merger”), with Kentucky 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 thereafter Kentucky Bank will merge with and into Stock Yards Bancorp’s bank subsidiary, Stock Yards Bank & Trust Company, a Kentucky banking corporation (“Stock Yards Bank”), with Stock 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 by Kentucky Bancshares’ shareholders and completion of other customary closing conditions.
Impact of COVID-19
On January 30, 2020, the World Health Organization (“WHO”) announced that the outbreak of the novel coronavirus disease 2019 (COVID-19) constituted a public health emergency of international concern. On March 11, 2020, WHO declared COVID-19 to be a global pandemic. On March 13, 2020, the President of the 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.
On March 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 the Small Business Administration (“SBA”). On April 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 on June 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 the U.S. government.
On December 27, 2020, a $900 billion COVID-19 relief package, as passed by the U.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 through March 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 the Centers 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.
Critical Accounting Policies
Overview. The accounting and reporting policies of the Company and its subsidiary are in accordance with accounting principles generally accepted in the United States and conform to general practices within the banking industry.Significant accounting policies are listed in Note 1 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 selected December 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 subsidiary KBI Insurance Company. Kentucky Bank is engaged in general full-service commercial and consumer banking. A significant part of Kentucky Bank’s operating activities include originating loans, approximately 81% of which are secured by real estate at December 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 is Bourbon, Clark, Elliott, Fayette, Harrison, Jessamine, Madison, Rowan, Scott, Woodford and surrounding counties in Kentucky. KBI Insurance Company is a captive insurance subsidiary and was incorporated in 2014.
Net income for the year ended December 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.
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 December 31, 2020 and 2019 respectively.
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% at December 31, 2020 compared to a range of 1.50%-1.75% at December 31, 2019. The prime lending rate was 3.25% at December 31, 2020 compared to 4.75% at December 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 the Federal 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 and Federal Home Loan Bank advances.
The bank prime rates decreased 150 basis points from December 2019 to December 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.
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
$
$
2,976
Investment Securities
(200)
(1,482)
(1,682)
(606)
(245)
Other
(749)
(582)
Total Interest Income
3,770
(6,617)
(2,847)
1,537
1,363
2,900
INTEREST EXPENSE
Deposits
Demand
(1,477)
(1,340)
(6)
Savings
(40)
(16)
(8)
Negotiable Certificates of Deposit and Other Time Deposits
(579)
(565)
1,053
1,272
Securities sold under agreements to repurchase and other borrowings
(86)
(181)
(267)
(291)
(91)
Federal Home Loan Bank advances
(531)
(92)
Total Interest Expense
(2,808)
(2,280)
(37)
2,218
2,181
Net Interest Income
$
3,242
$
(3,809)
$
(567)
$
1,574
$
(855)
$
Average Consolidated Balance Sheets and Net Interest Income Analysis ($ in thousands)
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
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
-
0.09
-
0.10
Tax Equivalent Total
266,607
6,165
2.31
281,521
7,877
2.80
Federal Home Loan Bank Stock and Other
7,309
2.26
7,303
4.90
Federal Funds Sold and Agreements to Repurchase
0.28
2.35
Interest-Bearing Deposits with Banks
54,017
0.28
24,155
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
5.23
Tax Equivalent Adjustment
-
0.05
-
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
-
0.06
-
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
0.10
109,698
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
2.07
17,140
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
(3) Tax equivalent difference represents the nontaxable interest income on state and municipal securities net of the related non-deductible portion of interest expense
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 $2.3 million in 2020 to $37.6 million from $35.3 million in 2019.
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 at December 31, 2019 to 236 at December 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 the Lexington, 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 in FDIC 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 the FDIC 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.
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)
NON-INTEREST INCOME
Service Charges
$
4,602
$
5,368
Loan Service Fee Income (Loss), net
(374)
Trust Department Income
1,441
1,411
Investment Securities Gains (Losses),net
Gains on Sale of Mortgage Loans
4,834
1,552
Brokerage Income
Debit Card Interchange Income
3,742
3,470
Income from Bank-Owned Life Insurance
Other
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
$
35,308
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 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 year ended December 31, 2020, the Company averaged $36.9 million in tax free securities, and $69.2 million in tax free loans. 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, 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.
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 starting in 2021.
As a result of these tax law changes, the Company had a deferred tax asset of $607 thousand during 2020.
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 December 31, 2020, the Company had outstanding loan balances of $41.4 million for loans made as part of the
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 of September 30, 2020 and $56.8 million as of June 30, 2020. These loans are guaranteed by the SBA and required no allowance for loan losses as of December 31, 2020.
As of December 31, 2020, the real estate mortgage portfolio comprised 81% of total loans compared to 82% at December 31, 2019. The real estate mortage portfolio is comprised of real estate construction, 1-4 family residential, multi-family residential, non-farm and non-residential and agricultural loans.
1-4 family residential represented 38% of the total loan portfolio as of December 31, 2020 and 39% as of December 31, 2019. Real estate constructions loans accounted for 2% of the total loan portfolio as of December 31, 2020 and 4% as of December 31, 2019. Multi-family loans represented 6% of the total loan portfolio as of December 31, 2020 and 7% as of December 31, 2019. Non-farm and non-residential loans totaled 29% of the total loan portfolio as of December 31, 2020 and 28% of the total loan portfolio as of December 31, 2019.
Agricultural loans comprised 7% of the total loan portfolio at December 31, 2020 and 8% of total loans at December 31, 2019. Approximately 90% of the agricultural loans are secured by real estate at December 31, 2020 and 88% at December 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.
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
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
Total Loans
772,434
746,764
687,623
650,086
657,043
Less Deferred Loan Fees
1,136
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
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
Total
Loan 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
-
-
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
$
151,880
$
392,562
$
227,992
$
772,434
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 at December 31, 2020 and $2.1 million at December 31, 2019. Fixed rate residential mortgage loans are generally sold when they are made. The volume of loan originations is inverse to rate changes.
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 the Federal 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 $1.6 million at both December 31, 2020 and December 31, 2019.
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 ended December 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 at December 31, 2020, of which $130 million were interest bearing.
The table below provides information on the maturities of time deposits of $100,000 or more at December 31, 2020:
At December 31, 2020
Maturity of Time Deposits of $100,000 or More
(in thousands)
Maturing 3 Months or Less
$
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.
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
Federal Funds Purchased:
Balance at Year end
$
-
$
-
Average Balance During the Year
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
Lease payments on premises
5,539
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.
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
Non-accrual Loans
$
4,051
$
3,081
$
1,141
$
1,193
$
4,566
Accruing Loans which are Contractually past due over 89 days
1,499
1,182
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
2,148
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
%
%
%
%
%
(1) Net of deferred loan fees
Total nonperforming assets at December 31, 2020 were $6.1 million compared to $6.7 million at December 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 at December 31, 2020, of which, $354 thousand were income producing properties. Total nonperforming loans were $5.3 million and $4.6 million at December 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.
At December 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 of December 31, 2020 was $3.6 million compared to $1.4 million as of December 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.
At December 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.
At December 31, 2019, impaired loan balances of $1.5 million had specific impairment allocations of $52 thousand. An additional $3.0 million in loan balances were individually reviewed for impairment but resulted in no specific impairment allocation.
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 on December 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 of December 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.
On March 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 beginning March 1, 2020 until the earlier of December 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 of the United States under the National Emergencies Act (50 U.S.C. 1601 et seq.) terminates. The Interagency Statement was subsequently revised in April 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 of December 31, 2020, approved modifications were approximately $130.1 million of loan balances, of which, an approximate $1.7 million was still in deferment as of December 31, 2020. Modifications were $125.3 million as of September 30, 2020 and $115.0 million as of June 30, 2020.
At December 31, 2020, the Company has one loan totaling $1.1 million classified as a troubled debt restructure. As of December 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. At December 31, 2019, the Company did not have any loans designated as troubled debt restructurings.
For the years ending December 31, 2020 and 2019, no loans modified as troubled debt restructurings defaulted on payment.
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)
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
Real Estate Construction
-
-
-
Real Estate Mortgage
1-4 Family Residential
Multi-Family Residential
-
Non-Farm & Non-Residential
-
-
-
Agricultural
Consumer and other
Total Recoveries
1,167
1,081
1,400
Net Charge-offs
(338)
(917)
(93)
(321)
(130)
Provision for Loan Losses
1,775
1,250
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.
The provision for loan losses increased $525 thousand from 2019 to 2020. The allowance for loan losses increased $1.4 million from December 31, 2019 to December 31, 2020.
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 December 31, 2020, the allowance for loan losses was 1.28% of loans outstanding compared to 1.13% at year-end 2019. Management believes the allowance for loan losses at the year-end 2020 is adequate to cover probable incurred credit losses within the portfolio.
The following tables set forth an allocation for the allowance for loan losses and loans by category. 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)
Commercial
$
$
1,003
$
1,265
$
1,069
$
Real Estate Construction
Real Estate Mortgage:
1-4 Family Residential
3,427
3,162
2,843
2,538
2,515
Multi-family Residential
Non-farm & Non-residential
3,146
1,791
1,799
1,704
1,315
Agricultural
Consumer and other
Total
$
9,897
$
8,460
$
8,127
$
7,720
$
7,541
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
0.02
%
0.04
%
0.03
%
0.03
%
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):
Unused lines of credit
$
146,200
$
117,265
Commitments to make loans
42,834
28,743
Letters of credit
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
In August 2018, the Federal 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 of December 31, 2020 and December 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 the Basel Committee on Banking Supervision’s capital guidelines for US banks (Basel III rules) became effective for the Company on January 1, 2015 with full compliance with all of the requirements being phased in over a multi-year schedule, and was fully phased in on January 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 on January 1, 2020. This final rule is applicable to all non-advanced approaches FDIC-supervised institutions with less than $10 billion in total consolidated assets.
The Bank has elected to use the CBLR framework. At December 31, 2020, the Bank’s CBLR was 9.0%. Management believes as of December 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.
At December 31, 2020 and at December 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 December 31, 2020 and December 31, 2019:
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
$
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 at December 31, 2019 to $353.5 million at December 31, 2020. Federal funds sold totaled $395 thousand at December 31, 2020 and $260 thousand at December 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 of December 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 of December 31, 2020.
Securities Available for Sale at Fair Value
For the Year ended December 31,
(in thousands)
Investment Securities (at fair value)
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
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
10,669
10,589
2,034
-
23,298
States and political subdivisions
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
%
%
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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ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Item 8. Financial Statements
The management of the Company has the responsibility for preparing the accompanying consolidated financial statements and for their integrity and objectivity. The statements were prepared in accordance with generally accepted accounting principles in the United States of America. The consolidated financial statements include amounts that are based on management’s best estimates and judgments. Management also prepared other information in the annual report and is responsible for its accuracy and consistency with the financial statements.
The Company’s 2020 consolidated financial statements have been audited by Crowe LLP, an independent registered public accounting firm.
Crowe LLP
Independent Member Crowe Global
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Shareholders and the Board of Directors of
Kentucky Bancshares, Inc.
Paris, Kentucky
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of Kentucky Bancshares, Inc. (the "Company") as of December 31, 2020 and 2019, the related consolidated statements of income, comprehensive income, stockholders’ equity, and cash flows for the years then ended, and the related notes (collectively referred to as the "financial statements"). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2020 and 2019, and the results of its operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.
Basis for Opinion
These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) ("PCAOB") and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
Critical Audit Matter
The critical audit matter communicated below is a matter arising from the current period audit of the financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of the critical audit matter does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.
Allowance for Loan Losses - Qualitative Factors
As more fully described in Note 1 to the consolidated financial statements, the Company’s allowance for loan losses is a valuation allowance for probable incurred credit losses. The allowance for loan losses consists of a general component for collectively evaluated loans and a specific component for impaired loans. The general component is initially determined based on historical loss factors as applied to each loan segment and then adjusted for qualitative factors.
Adjustments are made to the historical loss experience ratios based on the qualitative factors consistent with regulatory guidance. Management estimates the allowance balance required using past due loan loss experience, trends in non-accrual loans, the nature and volume of the portfolio composition, information about specific borrower situations and estimated collateral values, economic condition, and other factors. The allowance for loan losses is evaluated at the portfolio segment level using the same methodology for each segment. The recent historical actual net losses are the basis for the general reserve for each segment which is then adjusted for qualitative factors specifically evaluated at individual segment levels.
The principal consideration for our determination that auditing the allowance for loan losses qualitative factors applied to adjust historical loss experience (qualitative factors) is a critical audit matter is the high degree of subjectivity involved in management’s assessment of the adjustment associated with each qualitative factor.
Our audit procedures related to the allowance loan losses qualitative factors included the following procedures to address the critical audit matter.
● We substantively tested management’s qualitative factors by evaluating the relevance and reliability of the underlying objective data used to derive the qualitative factors. Based on the underlying data, we evaluated the reasonableness of management’s determination of the resulting adjustment to the historical loss experience.
● We substantively tested the accuracy of the mathematical application of the qualitative factors to adjust the historical loss experience.
● We performed analytical review procedures to determine if the overall result was consistent with trends in the loan portfolio and economic conditions.
/s/ Crowe LLP
Crowe LLP
We have served as the Company's auditor since 1998.
Louisville, Kentucky
March 3, 2021
KENTUCKY BANCSHARES, INC.
Paris, Kentucky
CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2020 and December 31, 2019
CONSOLIDATED BALANCE SHEETS
As of December 31,
(Dollar amounts in thousands except per share data)
12/31/2020
12/31/2019
ASSETS
Cash and due from banks
$
38,579
$
21,922
Federal funds sold
Cash and cash equivalents
38,974
22,182
Interest bearing time deposits
2,470
2,375
Securities available for sale
353,494
265,330
Loans held for sale
4,427
2,144
Loans
766,871
744,313
Allowance for loan losses
(9,897)
(8,460)
Net loans
756,974
735,853
Federal Home Loan Bank stock
7,072
7,034
Real estate owned, net
2,148
Bank premises and equipment, net
20,375
19,429
Interest receivable
5,227
4,166
Mortgage servicing rights
1,612
1,573
Goodwill
14,001
14,001
Other intangible assets
Bank owned life insurance
18,713
18,165
Operating lease right of use asset
7,670
8,195
Other assets
7,558
8,059
Total assets
$
1,239,505
$
1,110,790
LIABILITIES AND STOCKHOLDERS’ EQUITY
Deposits
Non-interest bearing
$
313,285
$
235,268
Time deposits, $250,000 and over
36,192
43,345
Other interest bearing
629,127
564,040
Total deposits
978,604
842,653
Repurchase agreements
9,129
5,994
Short-term Federal Home Loan Bank advances
10,500
25,000
Long-term Federal Home Loan Bank advances
86,032
91,418
Subordinated debentures
7,217
7,217
Interest payable
1,170
Operating lease liability
7,850
8,350
Other liabilities
11,056
9,725
Total liabilities
1,111,163
991,527
Commitments and Contingencies - See Note 19
Stockholders’ equity
Preferred stock, 300,000 shares authorized and unissued
-
-
Common stock, no par value; 20,000,000 shares authorized; 5,946,306 and 5,913,922 shares issued and outstanding at December 31, 2020 and December 31, 2019
21,996
21,447
Retained earnings
104,319
96,903
Accumulated other comprehensive income
2,027
Total stockholders’ equity
128,342
119,263
Total liabilities and stockholders’ equity
$
1,239,505
$
1,110,790
See accompanying notes.
CONSOLIDATED STATEMENTS OF INCOME
Years Ended December 31,
(Dollar amounts in thousands except per share data)
(in thousands, except per share data)
Interest income
Loans, including fees
$
36,456
$
37,039
Securities
Taxable
4,976
6,564
Tax exempt
1,037
Other
42,685
45,532
Interest expense
Deposits
4,319
6,240
Repurchase agreements and other borrowings
Federal Home Loan Bank advances
2,091
2,183
Note payable
-
Subordinated debentures
6,703
8,983
Net interest income
35,982
36,549
Provision for loan losses
1,775
1,250
Net interest income after provision for loan losses
34,207
35,299
Other income
Service charges
4,602
5,368
Loan service fee income (expense), net
(374)
Trust department income
1,441
1,411
Securities gains (losses), net
Gain on sale of loans
4,834
1,552
Brokerage income
Debit card interchange income
3,742
3,470
Income from bank-owned life insurance
Other
15,975
14,239
Other expenses
Salaries and employee benefits
20,897
19,187
Occupancy expense
4,118
4,066
Legal and professional fees
1,345
1,183
Data processing
2,267
2,425
Debit card expenses
1,989
1,996
Advertising and marketing
Taxes other than payroll, property and income
1,412
1,314
Loss on limited partnership
1,170
Other
3,846
3,678
37,607
35,308
Income before income taxes
12,575
14,230
Provision for income taxes
1,077
Net income
$
11,697
$
13,153
Earnings per share:
Basic
$
1.97
$
2.21
Diluted
1.97
2.21
See accompanying notes.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Years Ended December 31,
(Dollar amounts in thousands except per share data)
Net income
$
11,697
$
13,153
Other comprehensive income (loss)
Unrealized gains (losses) on securities arising during the period
3,628
6,357
Reclassification of realized amount
(345)
(857)
Net change in unrealized gain (loss) on securities
3,283
5,500
Less: Tax impact
(828)
(1,155)
Net of tax
2,455
4,345
Unrealized gains (losses) on cashflow hedges arising during the period
(1,955)
Reclassification of realized amount
-
Net change in unrealized gain (loss) on cash flow hedges
(1,771)
Less: Tax impact
-
Net of tax
(1,341)
Total other comprehensive income
1,114
4,391
.
Comprehensive income
$
12,811
$
17,544
See accompanying notes.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
(Dollar amounts in thousands except per share data)
Accumulated
Other
Total
Common Stock
Retained
Comprehensive
Stockholders’
Shares
Amount
Earnings
Income (Loss)
Equity
Balances, January 1, 2019
5,955,242
$
21,170
$
89,101
$
(3,478)
$
106,793
Common stock issued (employee stock grants of 21,856 shares, net of 1,524 shares forfeited, and director stock grants of 2,824 shares)
24,680
-
-
Stock compensation expense
-
-
-
Common stock purchased and retired
(66,000)
(238)
(1,306)
-
(1,544)
Other comprehensive loss
-
-
-
4,391
4,391
Net income
-
-
13,153
-
13,153
Dividends declared - $0.68 per share
-
-
(4,045)
-
(4,045)
Balances, December 31, 2019
5,913,922
$
21,447
$
96,903
$
$
119,263
Common stock issued (employee stock grants of 28,850 shares, net of 590 shares forfeited and 890 shares withheld in lieu of income tax, and director stock grants of 3,834 shares)
32,384
-
-
Stock compensation expense
-
-
-
Other comprehensive income
-
-
-
1,114
1,114
Net income
-
-
11,697
-
11,697
Dividends declared - $0.72 per share
-
-
(4,281)
-
(4,281)
Balances, December 31, 2020
5,946,306
$
21,996
$
104,319
$
2,027
$
128,342
See accompanying notes.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31,
(Dollar amounts in thousands except per share data)
(in thousands)
Cash flows from operating activities
Net income
$
11,697
$
13,153
Adjustments to reconcile net income to net cash from operating activities:
Depreciation and amortization
1,343
1,206
Amortization (accretion), net
(384)
Provision for loan losses
1,775
1,250
Securities amortization, net
1,289
Securities (gains) losses, net
(345)
(857)
Net increase in cash surrender value of bank-owned life insurance
(548)
(467)
Originations of loans held for sale
(128,017)
(71,240)
Proceeds from sale of loans
130,568
71,851
Gain on sale of loans
(4,834)
(1,552)
Stock based compensation expense
Losses (gain) on disposal of fixed assets
-
(12)
Losses (gain) on other real estate
(74)
Write-downs of other real estate, net
Deferred taxes
(699)
(366)
Changes in:
Interest receivable
(1,061)
(16)
Other assets
(882)
Interest payable
(395)
Other liabilities
(10)
Net cash from operating activities
$
11,608
$
13,227
Cash flows from investing activities
Net change in interest bearing time deposits
(95)
(200)
Purchases of securities, available for sale
(183,070)
(101,829)
Proceeds from sales of securities, available for sale
17,096
79,561
Purchase of Federal Home Loan Bank stock
(38)
-
Purchase of bank-owned life insurance
-
(7,500)
Proceeds from principal payments and maturities of securities
80,148
77,903
Net change in loans
(23,200)
(60,021)
Purchases of bank premises and equipment
(2,289)
(3,291)
Capitalized expenditures for other real estate
-
(135)
Proceeds from sale of other real estate
1,450
Proceeds from sale of bank premises and equipment
-
Net cash from investing activities
$
(109,998)
$
(15,228)
Cash flows from financing activities
Net change in deposits
135,951
(7,789)
Net change in repurchase agreements and other borrowings
3,135
(2,083)
Net change in short-term advances from Federal Home Loan Bank
(14,500)
13,400
Long-term FHLB advances
15,000
18,500
Payments on long-term FHLB advances
(20,386)
(15,934)
Payments on note payable
-
(2,718)
Proceeds from issuance of common stock, including options and grants, including tax benefits
Purchase of common stock
-
(1,544)
Dividends paid
(4,281)
(4,045)
Net cash from financing activities
$
115,182
$
(1,918)
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31,
(Dollar amounts in thousands except per share data)
Net change in cash and cash equivalents
$
16,792
$
(3,919)
Cash and cash equivalents at beginning of year
22,182
26,101
Cash and cash equivalents at end of year
$
38,974
$
22,182
Supplemental disclosures of cash flow information Cash paid during the year for:
Interest expense
$
7,098
$
8,706
Income taxes
1,450
Supplemental schedules of non-cash investing activities
Real estate acquired through foreclosure
$
$
1,430
In conjunction with the adoption of ASU 2016-02, as detailed in Note 6 of the consolidated financial statements, a net operating lease asset and a related lease liability was recognized at 1/1/2019
-
6,373
Lease liability arising from obtaining right of use asset
-
2,669
See accompanying notes.
Notes to Consolidated Financial Statements
(Dollar amounts in thousands except per share data)
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation: The consolidated financial statements include the accounts of Kentucky Bancshares, Inc. (the Company), its wholly-owned subsidiaries, Kentucky Bank (the Bank) and KBI Insurance Company, Inc., a captive insurance subsidiary, and the Bank’s wholly-owned subsidiary, KB Special Assets Unit, LLC. Intercompany transactions and balances have been eliminated in consolidation.
Nature of Operations: The Bank operates under a state bank charter and provides full banking services, including trust services, to customers located in Bourbon, Clark, Elliot, Fayette, Harrison, Jessamine, Madison, Rowan, Scott, Woodford and adjoining counties in Kentucky. As a state bank, the Bank is subject to regulation by the Kentucky Department of Financial Institutions and the Federal Deposit Insurance Corporation (FDIC). The Company, a bank holding company, is regulated by the Federal Reserve. KBI Insurance Company, Inc., a captive insurance subsidiary, is regulated by the State of Nevada Division of Insurance.
Estimates in the Financial Statements: The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
COVID-19: The impact of the COVID-19 pandemic is fluid and continues to evolve. The potential financial impact continues to be unknown at this time. However, actions that have been taken or will be taken in response may adversely impact several industries within our geographic footprint and impair the ability of our customers to fulfill their contractual obligations to the Company. This could cause Kentucky Bancshares to experience a material adverse effect on our business operations, asset valuations, financial condition, and results of operations. Material adverse impacts may include all or a combination of valuation impairments on Kentucky Bancshares’s intangible assets, investments, loans, loan servicing rights, deferred tax assets, or counter-party risk derivatives.
Cash Flows: For purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks, federal funds sold, and certain short-term investments with maturities of less than three months. Generally, federal funds are sold for one-day periods. Net cash flows are reported for loan, deposit and short-term borrowing transactions.
Interest Bearing Time Deposits: Interest bearing time deposits in other financial institutions have original maturities between one and three years and are carried at cost.
Securities: The Company is required to classify its securities portfolio into one of three categories: trading securities, securities available for sale and securities held to maturity. Fair value adjustments are made to the securities based on their classification with the exception of the held to maturity category. The Company has no investments classified as trading securities or held to maturity. Securities available for sale are carried at fair value. Unrealized holding gains and losses for securities which are classified as available for sale are reported in other comprehensive income, net of deferred tax.
Interest income includes amortization of purchase premium or discount. Premiums and discounts on securities are amortized on the level-yield method without anticipating prepayments, except for mortgage backed securities where prepayments are anticipated. Premiums on purchased callable debt securities are amortized to the earliest call date. Gains and losses on sales are recorded on the settlement date and determined using the specific identification method.
Equity investments with readily determinable fair values are included in other assets with changes in fair value recorded in other income.
Management evaluates securities for other-than-temporary impairment (“OTTI”) at least on a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. For securities in an unrealized loss position, management considers the extent and duration of the unrealized loss, and the financial condition and near-term prospects of the issuer. Management also assesses whether it intends to sell, or it is more likely than not that it will be required to sell, a security in an unrealized loss position before recovery of its amortized cost basis.
Notes to Consolidated Financial Statements
(Dollar amounts in thousands except per share data)
If either of the criteria regarding intent or requirement to sell is met, the entire difference between amortized cost and fair value is recognized as impairment through earnings.
For debt securities that do not meet the aforementioned criteria, the amount of impairment is split into two components as follows: 1) OTTI related to credit loss, which must be recognized in the income statement and 2) OTTI related to other factors, which is recognized in other comprehensive income. The credit loss is defined as the difference between the present value of the cash flows expected to be collected and the amortized cost basis.
Loans Held for Sale: Loans held for sale are carried at the lower of cost or fair value as determined by outstanding commitments from investors or current secondary market prices, calculated on the aggregate loan basis. The Company also provides for any losses on uncovered commitments to lend or sell. The Company sells loans with servicing rights retained.
Loans: Loans that management has the intent and ability to hold for the foreseeable future or until maturity are stated at the amount of unpaid principal, net of deferred loan origination fees and costs and acquired purchase premiums and discounts, reduced by an allowance for loan losses. Interest income on loans is recognized on the accrual basis except for those loans on a nonaccrual status. Interest income on real estate mortgage (1-4 family residential and multi-family residential) and consumer loans is discontinued at the time the loan is 90 days delinquent, and interest income on real estate construction, non-farm and non-residential mortgage, agricultural and commercial loans is discontinued at the time the loan is 120 days delinquent, unless the loan is well-secured and in process of collection. Past due status is based on the contractual terms of the loan. In all cases, loans are placed on nonaccrual or charged-off at an earlier date if collection of principal or interest is considered doubtful. Nonaccrual loans and loans past due 90 days still on accrual include both smaller balance homogeneous loans that are collectively evaluated for impairment and individually classified impaired loans. Loan origination fees and certain direct origination costs are capitalized and recognized as an adjustment of the yield on the related loan. Recorded investment is the outstanding loan balance, excluding accrued interest receivable. When interest accrual is discontinued, interest income received on such loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.
Typically, the Company seeks to establish a payment history of at least six consecutive payments made on a timely basis before returning a loan to accrual status. Consumer and credit card loans are typically charged off no later than 120 days past due. Loans are placed on nonaccrual or charged-off at an earlier date if collection of principal or interest is considered doubtful.
Concentration of Credit Risk: Most of the Company’s business activity is with customers located within Bourbon, Clark, Elliott, Fayette, Harrison, Jessamine, Madison, Rowan, Scott, Woodford and surrounding counties located in Kentucky. Therefore, the Company’s exposure to credit risk is significantly affected by changes in the economy in these counties.
Allowance for Loan Losses: The allowance for loan losses is a valuation allowance for probable incurred credit losses. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.
Adjustments are made to the historical loss experience ratios based on the qualitative factors as outlined in the regulatory Interagency Policy Statement on the Allowance for Loan and Lease Losses. These qualitative factors include the nature and volume of portfolio, economic and business conditions, classification, past due and non-accrual trends.
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. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management’s judgment, should be charged off.
The allowance for loan losses is evaluated at the portfolio segment level using the same methodology for each segment. The recent historical actual net losses are the basis for the general reserve for each segment which is then adjusted for qualitative factors as outlined above (i.e., nature and volume of portfolio, economic and business conditions, classification, past due and non-accrual trends) specifically evaluated at individual segment levels.
Notes to Consolidated Financial Statements
(Dollar amounts in thousands except per share data)
The allowance consists of specific and general components. The specific component relates to loans that are individually classified as impaired. The general component covers non-classified loans and is based on historical loss experience adjusted for current factors for non-classified loans and a migration analysis for classified loans.
A loan is impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Loans, for which the terms have been modified, and for which the borrower is experiencing financial difficulties and has been granted a concession, are considered troubled debt restructurings and classified as impaired.
Loans are charged off when available information confirms that loans, or portions thereof, are uncollectible. While management considers the number of days a loan is past due in its evaluation process, we also consider a variety of other factors.
Factors considered by management in evaluating the charge-off decision include collateral value, availability of current financial information for both borrower and guarantor, and the probability of collecting contractual principal and interest payments. These considerations may result in loans being charged off before they are 90 days or more past due. This evaluation framework for determining charge-offs is consistently applied to each segment.
From time to time, the Company will charge-off a portion of impaired and non-performing loans. Loans that meet the criteria under ASC 310 are evaluated individually for impairment. Management considers payment status, collateral value, availability of current financial information for the borrower and guarantor, actual and expected cash flows, and probability of collecting amounts due. If a loan’s collection status is deemed to be collateral dependent or foreclosure is imminent, the loan is charged down to the fair value of the collateral, less selling costs. In circumstances where the loan is not deemed to be collateral dependent, but we believe, after completing our evaluation process, that probable loss has been incurred, we will provide a specific allocation on that loan.
The impact of recording partial charge-offs is a reduction of gross loans and a reduction of the loan loss reserve. The net loan balance is unchanged in instances where the loan had a specific allocation as a component of the allowance for loan losses. The allowance as a percentage of total loans may be lower as the allowance no longer needs to include a component for the loss, which has now been recorded, and net charge-off amounts are increased as partial charge-offs are recorded.
Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed.
Commercial and real estate construction and real estate mortgage loans (multi-family residential, and non-farm and non-residential mortgage) over $200 thousand are individually evaluated for impairment. If a loan is impaired, a portion of the allowance is allocated so that the loan is reported, net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral. Large groups of smaller balance homogeneous loans, such as consumer and 1-4 family residential real estate loans, are collectively evaluated for impairment, and accordingly, they are not separately identified for impairment disclosures. Troubled debt restructurings are separately identified for impairment disclosures and are measured at the present value of estimated future cash flows using the loan’s effective rate at inception.
If a troubled debt restructuring is considered to be a collateral dependent loan, the loan is reported, net, at the fair value of the collateral. For troubled debt restructurings that subsequently default, the Company determines the amount of reserve in accordance with the accounting policy for the allowance for loan losses.
The general component covers non-impaired loans and is based on historical loss experience adjusted for current factors. The historical loss experience is determined by portfolio segment and is based on the actual loss history experienced by the Company over the most recent 5 years. This actual loss experience is supplemented with other economic factors based on the risks present for each portfolio segment.
Notes to Consolidated Financial Statements
(Dollar amounts in thousands except per share data)
These economic factors include consideration of the following: levels of and trends in delinquencies and impaired loans; levels of and trends in charge-offs and recoveries; trends in volume and terms of loans; effects of any changes in risk selection and underwriting standards; other changes in lending policies, procedures, and practices; experience, ability, and depth of lending management and other relevant staff; national and local economic trends and conditions; industry conditions; and effects of changes in credit concentrations.
A “portfolio segment” is defined as the level at which an entity develops and documents a systematic methodology to determine its allowance for loan losses. The Company has identified the following portfolio segments: commercial, real estate construction, real estate mortgage, agricultural, consumer (credit cards and other consumer) and other (overdrafts).
Commercial: These loans to businesses do not have real estate as the underlying collateral. Instead of real estate, collateral could be business assets such as equipment or accounts receivable or the personal guarantee of one or more guarantors. These loans generally present a higher level of risk than loans secured by commercial real estate because in the event of default by the borrower, the business assets must be liquidated and/or guarantors pursued for deficit funds. Business assets are worth more while they are in use to produce income for the business and worth significantly less if the business is no longer in operation. Within the commercial portfolio, risk analysis is performed primarily based on the individual loan type.
Real estate construction: Real estate construction consists of loans secured by real estate for additions or alterations to existing structures, as well as constructing new structures. They include fixed and floating rate loans. Real estate construction loans generally present a higher level of risk than loans secured by 1-4 family residential real estate primarily because of the length of the construction period, potential change in prices of construction, the incomplete status of the collateral and economic cycles. Because of these factors, real estate construction loans generally have higher qualitative adjustments.
Real Estate Mortgage:
1-4 family residential: Loans secured by 1-4 family residential real estate represent the lowest risk of loans for the Company. They include fixed and floating rate loans as well as loans for commercial purposes or consumer purposes. The Company generally does not hold subprime residential mortgages. Borrowers with loans in this category, whether for commercial or consumer purposes, tend to make their payments timely as they do not want to risk foreclosure and loss of property.
Multifamily residential: Loans secured by multifamily residential real estate consist primarily of loans secured by apartment buildings and can be either fixed or floating rate loans. Multi-family residential real estate loans generally present a higher level of risk than loans secured by 1-4 family residential real estate because the borrower’s repayment ability typically comes from rents from tenants. Local economic and employment fluctuations impact rent rolls and potentially the borrower’s repayment ability.
Non-farm & non-residential: Loans secured by non-farm non-residential real estate consist of loans secured by commercial real estate that is not owner occupied. These loans generally consist of loans collateralized by property whereby rents received from commercial tenants of the borrower are the source of repayment. These loans generally present a higher level of risk than loans secured by owner occupied commercial real estate because repayment risk is expanded to be dependent on the success of multiple businesses which are paying rent to the borrower. If multiple businesses fail due to deteriorating economic conditions or poor business management skills, the borrower may not have enough rents to cover their monthly payment. Repayment risk is also increased depending on the level of surplus available commercial lease space in the local market area.
Agricultural: These loans to agricultural businesses do not have real estate as the underlying collateral. Instead of real estate, collateral could be assets such as equipment or accounts receivable or the personal guarantee of one or more guarantors. These loans generally present a higher level of risk than loans secured by real estate because in the event of default by the borrower, the assets must be liquidated and/or guarantors pursued for deficit funds. Farm assets are worth more while they are in use to produce income and worth significantly less if the farm is no longer in operation.
Notes to Consolidated Financial Statements
(Dollar amounts in thousands except per share data)
Consumer: Consumer loans are generally loans to borrowers for non-business purposes. They can be either secured or unsecured. Consumer loans are generally small in the individual amount of principal outstanding and are repaid from the borrower’s private funds earned from employment. Consumer lending risk is very susceptible to local economic trends. If there is a consumer loan default, any collateral that may be repossessed is generally not well maintained and has a diminished value. For this reason, consumer loans tend to have higher overall interest rates to cover the higher cost of repossession and charge-offs. However, due to their smaller average balance per borrower, consumer loans are collectively evaluated for impairment in determining the appropriate allowance for loan losses.
Other: All other loan types are aggregated together for credit risk evaluation due to the varying nature but small number of the remaining types of loans in the Company’s loan portfolio. Loans in this segment include but are not limited to overdrafts. Due to their smaller balance, other loans are collectively evaluated for impairment in determining the appropriate allowance for loan losses.
Due to the overall high level of real estate mortgage loans within the loan portfolio as a whole, as compared to other portfolio segments, for risk assessment and allowance purposes this segment was segregated into more granular pools by collateral property type.
The non-farm non-residential and the multi-family real estate mortgage loan portfolio segments had the next highest level of qualitative adjustments due to the effects of local markets and economies on the underlying collateral property values, as well as for industry concentrations and risks related to the this type of property.
Derivatives: At the inception of a derivative contract, the Company designates the derivative as one of three types based on the Company’s intentions and belief as to likely effectiveness as a hedge. These three types are (1) a hedge of the fair value of a recognized asset or liability or of an unrecognized firm commitment (“fair value hedge”), (2) a hedge of a forecasted transaction or the variability of cash flows to be received or paid related to a recognized asset or liability (“cash flow hedge”), or (3) an instrument with no hedging designation (“stand-alone derivative”). For a fair value hedge, the gain or loss on the derivative, as well as the offsetting loss or gain on the hedged item, are recognized in current earnings and included in interest and fee income on loans as fair value changes.
For a cashflow hedge, the gain or loss on the derivative is reported in other comprehensive income and is reclassified into earnings and included in interest and fee income on loans in the same periods during which the hedged transaction affects earnings. Changes in the fair value of derivatives that do not qualify for hedge accounting are reported currently in earnings, as non-interest income.
Net cash settlements on derivatives that qualify for hedge accounting are recorded in interest income or interest expense, based on the item being hedged. Net cash settlements on derivatives that do not qualify for hedge accounting are reported in non-interest income. Cash flows on hedges are classified in the cash flow statement the same as the cash flows of the items being hedged.
The Company formally documents the relationship between derivatives and hedged items, as well as the risk-management objective and the strategy for undertaking hedge transactions at the inception of the hedging relationship. This documentation includes linking both fair value hedges and cash flow hedges to specific assets and liabilities on the balance sheet or to specific firm commitments or forecasted transactions.
The Company also formally assesses, both at the hedge’s inception and on an ongoing basis, whether the derivative instruments that are used are highly effective in offsetting changes in fair values or cash flows of the hedged items. The Company discontinues hedge accounting when it determines that the derivative is no longer effective in offsetting changes in the fair value or cash flows of the hedged item, the derivative is settled or terminates, a hedged forecasted transaction is no longer probable, a hedged firm commitment is no longer firm, or treatment of the derivative as a hedge is no longer appropriate or intended.
When hedge accounting is discontinued, subsequent changes in fair value of the derivative are recorded as non-interest income. When a fair value hedge is discontinued, the hedged asset or liability is no longer adjusted for changes in fair value and the existing basis adjustment is amortized or accreted over the remaining life of the asset or liability. When a cash flow hedge is discontinued but the hedged cash flows or forecasted transactions are still expected to occur, gains or losses that were accumulated in other comprehensive income are amortized into earnings over the same periods which the hedged transactions will affect earnings.
Notes to Consolidated Financial Statements
(Dollar amounts in thousands except per share data)
Mortgage Banking Derivatives: Commitments to fund mortgage loans (interest rate locks) to be sold into the secondary market and forward commitments for the future delivery of these mortgage loans are accounted for as free standing derivatives. The fair value of the interest rate lock is recorded at the time the commitment to fund the mortgage loan is executed and is adjusted for the expected exercise of the commitment before the loan is funded. In order to hedge the change in interest rates resulting from its commitments to fund the loans, the Company enters into forward commitments for the future delivery of the mortgage loans when interest rate locks are entered into. Fair values of these mortgage derivatives are estimated based on changes in mortgage interest rates from the date the interest on the loan is locked. Changes in the fair values of these derivatives are included in net gains on the sales of loans.
Mortgage Servicing Rights: The Bank has sold certain residential mortgage loans to the Federal Home Loan Mortgage Corporation (FHLMC) while retaining the servicing rights. Servicing rights are recognized separately when they are acquired through sales of loans. When mortgage loans are sold, servicing rights are initially recorded at fair value with the income statement effect recorded in gain on sale of mortgage loans. Fair value is based on market prices for comparable mortgage servicing contracts, when available, or alternatively, is based on a valuation model that calculates the present value of estimated future net servicing income.
The valuation model incorporates assumptions that market participants would use in estimating future net servicing income, such as the cost to service, the discount rate, the custodial earnings rate, an inflation rate, ancillary income, prepayment speeds and default rates and losses. All classes of servicing assets are subsequently measured using the amortization method which requires servicing rights to be amortized into loan service fee income, net, included in non-interest income in proportion to, and over the period of, the estimated future net servicing income of the underlying loans.
Servicing assets are evaluated for impairment based upon the fair value of the rights as compared to carrying amount. Impairment is determined by stratifying rights into groupings based on predominant risk characteristics, such as interest rate, loan type and investor type. Impairment is recognized through a valuation allowance for an individual grouping, to the extent that fair value is less than the carrying amount. If the Company later determines that all or a portion of the impairment no longer exists for a particular grouping, a reduction of the allowance may be recorded as an increase to income. The fair values of servicing rights are subject to significant fluctuations as a result of changes in estimated and actual prepayment speeds and default rates and losses.
Servicing fee income, which is reported on the income statement as loan service income, net, is recorded for fees earned for servicing loans. The fees are based on a contractual percentage of the outstanding principal or a fixed amount per loan and are recorded as income when earned. The amortization of mortgage servicing rights and valuation allowance are netted against loan servicing fee income. Servicing fees totaled $630 thousand and $543 thousand for the years ended December 31, 2020 and 2019 and are included in loan service fee income, net in the income statement. Late fees and ancillary fees related to loan servicing are not material.
Federal Home Loan Bank (FHLB) Stock: The Bank is a member of the FHLB system. Members are required to own a certain amount of stock based on the level of borrowings and other factors, and may invest in additional amounts. FHLB stock is carried at cost, classified as a restricted security, and periodically evaluated for impairment based on ultimate recovery of par value. Both cash and stock dividends are reported as income.
Bank-Owned Life Insurance: The Company has purchased life insurance policies on certain key employees. Bank- owned life insurance is recorded at the amount that can be realized under the insurance contract at the balance sheet date, which is the cash surrender value adjusted for other charges or other amounts due that are probable at settlement.
Bank Premises and Equipment: Land is carried at cost. Bank premises and equipment are stated at cost less accumulated depreciation. Buildings and related components are depreciated using the straight-line method with useful lives ranging from 5 to 40 years. Furniture, fixtures and equipment are depreciated using the straight-line (or accelerated) method with useful lives ranging from 3 to 10 years.
Real Estate Owned: Physical possession of residential real estate property collateralizing a consumer mortgage loan occurs when legal title is obtained upon completion of foreclosure or when the borrower conveys all interest in the property to satisfy the loan through completion of a deed in lieu of foreclosure or similar legal agreement. Real estate acquired through foreclosure is initially recorded at fair value less costs to sell when acquired, establishing a new cost basis. These assets are subsequently accounted for at the lower of cost or fair value less estimated costs to sell.
Notes to Consolidated Financial Statements
(Dollar amounts in thousands except per share data)
The value of the underlying loan is written down to the fair value of the real estate to be acquired by a charge to the allowance for loan losses, if necessary. Any subsequent write-downs are charged to operating expenses. Operating expenses of such properties, net of related income, and gains and losses on their disposition are included in other expenses.
Investments in Limited Partnerships: Investments in limited partnerships represent the Company’s investments in affordable housing projects for the primary purpose of available tax benefits. The Company is a limited partner in these investments and as such, the Company is not involved in the management or operation of such investments. These investments are amortized over the period that the Company expects to receive the tax benefits. These investments are evaluated for impairment when events indicate the carrying amount may not be recoverable.
The investment recorded at December 31, 2020 was $3.1 million, compared to $4.2 million at December 31, 2019, and is included with other assets in the balance sheet. During the years ended December 31, 2020 and 2019, the Company recognized amortization expense of $1.2 million and $635 thousand, respectively, which was included within other noninterest expense on the consolidated statements of income.
Leases: Lessees are required to recognize assets and liabilities on the balance sheet for leases with lease terms greater than 12 months. The Company recorded an operating lease right of use asset of $7.7 million and an operating lease liability of $7.9 million, as of December 31, 2020, as a result of recording operating lease contracts where the Company is lessee.
Repurchase Agreements: Substantially all repurchase agreement liabilities represent amounts advanced by various customers. Securities are pledged to cover these liabilities, which are not covered by federal deposit insurance.
Stock-Based Compensation: Compensation cost is recognized for stock options and restricted stock awards issued to employees, based on the fair value of these awards at the date of grant. A Black-Scholes model is utilized to estimate the fair value of stock options, while the market price of the Company’s common stock at the date of grant is used for restricted stock awards. Compensation cost is recognized over the required service period, generally defined as the vesting period. For awards with graded vesting, compensation cost is recognized on a straight-line basis over the requisite service period for the entire award.
Revenue Recognition: The Company’s services that fall within the scope of ASC 606 are presented within Non-Interest Income and are recognized as revenue as the Company satisifies its obligation to the customer. Services within the scope of ASC 606 include trust department income, service charges, debit card interchange income and brokerage income.
Income Taxes: Income tax expense is the total of the current year income tax due or refundable and the change in deferred tax assets and liabilities. Deferred tax assets and liabilities are the expected future tax amounts for the temporary differences between carrying amounts and tax bases of assets and liabilities, computed using enacted tax rates. A valuation allowance, if needed, reduces deferred tax assets to the amount expected to be realized.
A tax position is recognized as a benefit only if it is “more likely than not” that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being realized on examination. For tax positions not meeting the “more likely than not” test, no tax benefit is recorded. The Company recognizes interest related to income tax matters as interest expense and penalties related to income tax matters as other expense.
Retirement Plans: Employee 401(k) and profit sharing plan expense is the amount of matching contributions.
Goodwill and Intangible Assets: 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 selected December 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. Management concluded that that the current decline in macroeconomic conditions is a triggering event and performed a goodwill impairment test as of December 31, 2020.
Despite the recent economic downturn associated with the COVID-19 pandemic, management determined no impairment exists to Goodwill as of December 31, 2020.
Notes to Consolidated Financial Statements
(Dollar amounts in thousands except per share data)
Intangible assets consist of core deposit intangible assets arising from whole bank and branch acquisitions. They are initially measured at fair value and then are amortized on either an accelerated or straight-line basis, over 10 or 15 years.
Loan Commitments and Related Financial Instruments: Financial instruments include off-balance sheet credit instruments, such as commitments to make loans and commercial letters of credit, issued to meet customer financing needs. The face amount for these items represents the exposure to loss, before considering customer collateral or ability to repay. Such financial instruments are recorded when they are funded.
Earnings Per Common Share: Basic earnings per common share is net income divided by the weighted average number of common shares outstanding during the period. Diluted earnings per common share include the dilutive effect of additional potential common shares issuable under stock options. Earnings and dividends per share have been adjusted in all periods presented to give effect to all stock splits and dividends through the date of issuance of the financial statements.
Comprehensive Income (Loss): Comprehensive income consists of net income and other comprehensive income. Other comprehensive income (loss) includes unrealized gains and losses on securities available for sale, and unrealized gains and losses on cash flow hedges, which are also recognized as a separate component of equity.
Fair Value of Financial Instruments: Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed in a separate note. 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.
Operating Segments: While the Company’s chief decision makers monitor the revenue streams of the various Company products and services, operations are managed and financial performance is evaluated on a Company-wide basis. Accordingly, all of the Company’s operations are considered by management to be aggregated into one reportable operating segment: banking.
Reclassifications: Some items in the prior year financial statements were reclassified to conform to the current presentation. Reclassifications had no effect on prior year net income or stockholders’ equity.
Adoption of New Accounting Standards
FASB ASC 326, 815, and 825 - In April 2019, the FASB issued ASU No. 2019-04, Codification Improvements to Topic 326, Financial Instruments-Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments. The improvements and clarifications related to Topic 815 address partial-term fair value hedges of interest-rate risk, amortization, and disclosure of fair value hedge basis adjustments and consideration of hedged contractually specified interest rate under the hypothetical method and became effective for the annual reporting period beginning January 1, 2020. The amendments related to Topic 825 contain various improvements to ASU 2016-01, including scope; held-to-maturity debt securities fair value disclosures; and remeasurement of equity securities at historical exchange rates and became effective for fiscal years and interim periods beginning after December 15, 2019. The amendments related to Topic 326 address accrued interest, transfers between classifications or categories for loans and debt securities, recoveries, vintage disclosures, and contractual extensions and renewal options and became effective for annual periods and interim periods within those annual periods beginning after December 15, 2019 for those entities who have adopted ASC 326. The amendments in this update did not have a material impact on the financial statements
FASB ASC 350 - In January 2017, the FASB issued ASU No. 2017-04, Intangibles: Goodwill and Other: Simplifying the Test for Goodwill Impairment. To simplify the subsequent measurement of goodwill, the amendments eliminate Step 2 from the goodwill impairment test. The annual, or interim, goodwill impairment test is performed by comparing the fair value of a reporting unit with its carrying amount. An impairment charge should be recognized for the amount by which the carrying amount exceeds the reporting unit’s fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. In addition, the income tax effects of tax deductible goodwill on the carrying amount of the reporting unit should be considered when measuring the goodwill impairment loss, if applicable.
Notes to Consolidated Financial Statements
(Dollar amounts in thousands except per share data)
The amendments also eliminate the requirements for any reporting unit with a zero or negative carrying amount to perform Step 2 of the goodwill impairment test. An entity still has the option to perform the qualitative assessment for a reporting unit to determine if the quantitative impairment test is necessary. The amendments should be applied on a prospective basis. The nature of and reason for the change in accounting principle should be disclosed upon transition. The amendments in this update became effective for annual or any interim goodwill impairment tests in fiscal years beginning after December 15, 2019 and did not have a material impact on the financial statements.
FASB ASC 820 - In August 2018, the FASB issued ASU No. 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement. The updated guidance improves the disclosure requirements on fair value measurements. The ASU removes certain disclosures required by Topic 820 related to transfers between Level 1 and Level 2 of the fair value hierarchy; the policy for timing of transfers between levels; the valuation processes for Level 3 fair value measurements; and for nonpublic entities, the changes in unrealized gains and losses for the period included in earnings for recurring Level 3 fair value measurements held at the end of the reporting period.
The ASU modifies certain disclosures required by Topic 820 related to disclosure of transfers into and out of Level 3 of the fair value hierarchy and purchases and issues of Level 3 assets and liabilities for nonpublic entities; the requirement to disclose the timing of liquidation of an investee’s assets and the date when restrictions from redemption might lapse only if the investee has communicated the timing to the entity or announced the timing publicly for investments in certain entities that calculate net asset value; and clarification that the measurement uncertainty disclosure is to communicate information about the uncertainty in measurement as of the reporting date. The ASU adds certain disclosure requirements related to changes in unrealized gains and losses for the period included in other comprehensive income for recurring Level 3 fair value measurements held at the end of the reporting period and the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements. For certain unobservable inputs, an entity may disclose other quantitative information in lieu of the weighted average if the entity determines that other quantitative information would be a more reasonable and rational method to reflect the distribution of unobservable inputs used to develop Level 3 fair value measurements. The amendments in this update became effective for fiscal years, and interim periods within those fiscal years beginning after December 15, 2019 and did not have a material impact on the financial statements.
FIL-36-2020 - On March 22, 2020, the federal banking agencies issued an “Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus”, which was subsequently clarified and revised by an interagency statement issued on April 7, 2020. This guidance encourages financial institutions to work prudently with borrowers that may be unable to meet their contractual obligations because of the effects of COVID-19. The guidance goes on to explain that in consultation with the FASB staff that the federal banking agencies conclude that short-term modifications (e.g. six months) made on a good faith basis to borrowers who were current as of the implementation date of a relief program are not Troubled Debt Restructurings (“TDRs”). The Coronavirus Aid, Relief and Economic Security Act (CARES Act) was signed into law on March 27, 2020 and has subsequently been amended several times. Section 4013 of the CARES Act also addressed COVID-19 related modifications and specified that COVID-19 related modifications on loans that were current as of December 31, 2019 are not TDRs. Modifications were executed in the second and third quarters of 2020. 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 of December 31, 2020, approved modifications were approximately $130.1 million of loan balances, of which, an approximate $1.7 million was still in deferment as of December 31, 2020. Modifications were $125.3 million as of September 30, 2020 and $115.0 million as of June 30, 2020.
Accounting Standards Issued But Not Yet Adopted
ASU 2016-13, “Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.” Issued in June 2016, ASU 2016-13 added Financial Accounting Standards Board “FASB” ASC Topic 326, “Financial Instruments-Credit Losses” and finalized amendments to FASB ASC Subtopic 825-15, “Financial Instruments-Credit Losses.” The amendments of ASU 2016-13 are intended to provide financial statement users with more decision-useful information related to expected credit losses on financial instruments and other commitments to extend credit by replacing the current incurred loss impairment methodology with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to determine credit loss estimates.
Notes to Consolidated Financial Statements
(Dollar amounts in thousands except per share data)
The amendment requires the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Financial institutions and other organizations will now use forward-looking information to enhance their credit loss estimates. The amendment requires enhanced disclosures to help investors and other financial statement users better understand significant estimates and judgments used in estimating credit losses, as well as the credit quality and underwriting standards of an organization’s portfolio. In addition, the ASU amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration.
As previously disclosed, the Company formed a steering committee to oversee the adoption of the ASU at the effective date. Appropriate members of Senior Management have developed a plan focused on understanding the ASU, researching issues, identifying data needs for modeling inputs, technology requirements, and modeling considerations. The Company is focused on the completion of its model, refining assumptions, and continued review of the model. Concurrent with this, the Company is also focused on researching and resolving interpretive accounting issues in the ASU, contemplating various related accounting policies, developing processes and related controls, and considering various reporting disclosures.
As of the beginning of the first reporting period in which the new standard is effective, the Company expects to recognize a one-time cumulative effect adjustment increasing the allowance for loan losses, if any, since the ASU covers credit losses over the expected life of a loan as well as considering future changes in macroeconomic conditions. The magnitude of any such one-time adjustment or the overall impact of the new guidance on the consolidated financial statements cannot yet be reasonably estimated, however, we expect to run multiple parallel models before finalizing the adjustment.
In December 2018, the OCC, the Board of Governors of the Federal Reserve System, and the FDIC approved a final rule to address changes to credit loss accounting under GAAP, including banking organizations’ implementation of CECL. The final rule provides banking organizations the option to phase in over a three-year period the day-one adverse effects on regulatory capital that may result from the adoption of the new accounting standard.
In 2019, the Financial Accounting Standards Board approved a delay for the implementation of the current expected credit loss standard until January 2023 for certain companies. The delay would apply to smaller reporting companies (as defined by the SEC), non-SEC public companies and private companies. The delayed implementation date of January 2023 applies to Kentucky Bancshares and the Company does not intend to early adopt.
ASU 2019-12 Income Taxes (Topic 740), Simplifying the Accounting for Income Taxes: In December 2019, the FASB issued this Update as part of its Simplification Initiative. The amendments in this Update affect entities within the scope of Topic 740, Income Taxes. The amendments in this Update simplify the accounting for income taxes by removing certain exceptions to the general principles in Topic 740. The amendments also improve consistent application of and simplify GAAP for other areas of Topic 740 by clarifying and amending existing guidance.
The amendments in this Update related to separate financial statements of legal entities that are not subject to tax should be applied on a retrospective basis for all periods presented. The amendments related to changes in ownership of foreign equity method investments or foreign subsidiaries should be applied on a modified retrospective basis through a cumuluative-effect adjustment to retained earnings as of the beginning of the fiscal year of adoption. The amendments related to franchise taxes that are partially based on income should be applied on either a retrospective basis for all periods presented or a modified retrospective basis through a cumulative-effect adjustment to retained earnings as of the beginning of the fiscal year of adoption. All other amendments should be applied on a prospective basis.
These amendments are effective for public business entities for fiscal years beginning after December 15, 2020, and interim periods within those fiscal years. Early adoption is perfmitted. The adoption of this standard is not expected to have a material effect on the Company’s operating results or financial condition.
Notes to Consolidated Financial Statements
(Dollar amounts in thousands except per share data)
NOTE 2 - RESTRICTIONS ON CASH AND DUE FROM BANKS
Included in cash and due from banks are certain interest bearing deposits that are held at the Federal Reserve or maintained in vault cash in accordance with average balance requirements specified by the Federal Reserve Board of Governors. The reserve requirement was $0 at December 31, 2020 and $4.5 million at December 31, 2019.
NOTE 3 - SECURITIES AVAILABLE FOR SALE
The following table summarizes the amortized cost and fair value of the securities at December 31, 2020 and 2019 and the corresponding amounts of gross unrealized gains and losses recognized in accumulated other comprehensive income (loss) were as follows:
Gross
Gross
Amortized
Unrealized
Unrealized
Fair
Cost
Gains
Losses
Value
Available for Sale
December 31, 2020
U.S. treasury notes
$
9,075
$
$
-
$
9,188
U.S. government agencies
23,185
(31)
23,298
States and political subdivisions
65,665
1,977
(3)
67,639
Mortgage-backed - residential
124,941
1,728
(187)
126,482
Mortgage-backed - commercial
73,573
1,179
(201)
74,551
Asset-backed
51,676
(455)
51,311
Other
1,000
-
1,025
Total
$
349,115
$
5,256
$
(877)
$
353,494
December 31, 2019
U.S. treasury notes
$
9,165
$
$
-
$
9,168
U.S. government agencies
23,716
(41)
23,735
States and political subdivisions
31,950
(22)
32,589
Mortgage-backed - residential
113,629
(272)
113,991
Mortgage-backed - commercial
50,092
(147)
50,351
Asset-backed
35,682
(241)
35,496
Total
$
264,234
$
1,819
$
(723)
$
265,330
The amortized cost and fair value of securities at December 31, 2020, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Securities not due at a single maturity are shown separately.
Amortized
Fair
Cost
Value
Due in one year or less
$
5,191
$
5,239
Due after one year through five years
20,130
20,358
Due after five years through ten years
35,646
36,526
Due after ten years
37,958
39,027
98,925
101,150
Mortgage-backed - residential
124,941
126,482
Mortgage-backed - commercial
73,573
74,551
Asset-backed
51,676
51,311
Total
$
349,115
$
353,494
Proceeds from sales of securities during 2020 and 2019 were $17.1 million and $79.6 million. Gross gains of $388 thousand and $896 thousand and gross losses of $43 thousand and $39 thousand, were realized on those sales, respectively. The tax provision related to these realized gains and losses was $72 thousand and $180 thousand, respectively.
Notes to Consolidated Financial Statements
(Dollar amounts in thousands except per share data)
Securities with an approximate carrying value of $223.6 million and $190.7 million at December 31, 2020 and 2019, were pledged to secure public deposits, trust funds, securities sold under agreements to repurchase and for other purposes as required or permitted by law.
Securities with unrealized losses at year end 2020 and 2019 not recognized in income are as follows:
December 31, 2020
Less than 12 Months
12 Months or More
Total
Fair
Unrealized
Fair
Unrealized
Fair
Unrealized
Description of Securities
Value
Loss
Value
Loss
Value
Loss
U.S. government agencies
$
8,432
$
(18)
$
$
(13)
$
9,283
$
(31)
States and political subdivisions
(3)
-
-
(3)
Mortgage-backed - residential
32,440
(187)
-
-
32,440
(187)
Mortgage-backed - commercial
19,852
(189)
5,087
(12)
24,939
(201)
Asset-backed
15,948
(236)
22,565
(219)
38,513
(455)
Total temporarily impaired
$
77,005
$
(633)
$
28,503
$
(244)
$
105,508
$
(877)
December 31, 2019
Less than 12 Months
12 Months or More
Total
Fair
Unrealized
Fair
Unrealized
Fair
Unrealized
Description of Securities
Value
Loss
Value
Loss
Value
Loss
U.S. government agencies
$
6,171
$
(18)
$
4,396
$
(23)
$
10,567
$
(41)
States and political subdivisions
(3)
1,199
(19)
2,058
(22)
Mortgage-backed - residential
32,718
(129)
14,583
(143)
47,301
(272)
Mortgage-backed - commercial
5,760
(25)
10,625
(122)
16,385
(147)
Asset-backed
21,786
(150)
6,962
(91)
28,748
(241)
Total temporarily impaired
$
67,294
$
(325)
$
37,765
$
(398)
$
105,059
$
(723)
The Company evaluates securities for other than temporary impairment at least on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. In analyzing an issuer’s financial condition, the Company may consider whether the securities are issued by the federal government or its agencies, whether downgrades by bond rating agencies have occurred, and the results of reviews of the issuer’s financial condition.
Unrealized losses on securities have not been recognized into income because the issues are of high credit quality, management does not intend to sell and it is more likely than not that management would be required to sell the securities prior to their anticipated recovery, and the decline in fair value is largely due to changes in interest rates. The fair value is expected to recover as the securities approach maturity.
At December 31, 2020, four U.S. government agency securities have unrealized losses of 0.3% from their amortized cost, eight commercial mortgage backed securities have unrealized losses of 0.8% from their amortized cost basis, fifteen residential mortgage backed securities have unrealized losses of 0.6% from their amortized cost basis, one state and municipal has unrealized losses of 0.8% from its amortized cost basis and seventeen asset-backed securities which has an unrealized loss of 1.2%. Management believes the declines in fair value from these and other securities are largely due to changes in interest rates. The Company believes there is no other-than-temporary impairment and does not have the intent to sell these securities and it is likely that it will not be required to sell the securities before their anticipated recovery.
Notes to Consolidated Financial Statements
(Dollar amounts in thousands except per share data)
NOTE 4 - LOANS
Loans at year-end were as follows:
Commercial
$
117,425
$
86,552
Real estate construction
14,571
32,219
Real estate mortgage:
1-4 family residential
293,136
291,419
Multi-family residential
47,854
48,622
Non-farm & non-residential
218,998
204,908
Agricultural
52,239
57,166
Consumer
22,532
23,122
Other
Total
$
766,871
$
744,313
As of December 31, 2020, the Company had outstanding loan balances of $41.4 million for loans made as part of the Paycheck Protection Program (PPP) established under the CARES Act which were included in commercial loans in the table above. The balances were $57.6 million as of September 30, 2020 and $56.8 million as of June 30, 2020. These loans required no allowance for loan losses as of December 31, 2020 because they are fully guaranteed by the SBA. At December 31, 2020, deferred fee income for PPP loans totaled $744 thousand. During 2020, $894 thousand for fees for PPP loans was recognized as income.
The following table presents the activity in the allowance for loan losses by portfolio segment for the years ending December 31, 2020 and 2019:
Beginning
Ending
December 31, 2020
Balance
Charge-offs
Recoveries
Provision
Balance
Commercial
$
$
(25)
$
$
$
Real estate Construction
-
-
(274)
Real estate mortgage:
1-4 family residential
2,901
(37)
3,210
Multi-family residential
-
-
Non-farm & non-residential
1,643
-
1,298
2,946
Agricultural
-
Consumer
(325)
Other
(762)
Unallocated
-
-
(70)
$
8,460
$
(1,149)
$
$
1,775
$
9,897
Beginning
Ending
December 31, 2019
Balance
Charge-offs
Recoveries
Provision
Balance
Commercial
$
1,159
$
(260)
$
$
-
$
Real estate Construction
-
-
Real estate mortgage:
1-4 family residential
2,605
(168)
2,901
Multi-family residential
-
Non-farm & non-residential
1,649
(17)
-
1,643
Agricultural
-
(39)
Consumer
(397)
Other
(901)
Unallocated
-
-
$
8,127
$
(1,743)
$
$
1,250
$
8,460
Notes to Consolidated Financial Statements
(Dollar amounts in thousands except per share data)
The following tables present the balance in the allowance for loan losses and the recorded investment (excluding accrued interest receivable amounting to $4.1 million and $3.1 million) in loans by portfolio segment and based on impairment method as of December 31, 2020 and December 31, 2019:
Individually
Collectively
Evaluated for
Evaluated for
As of December 31, 2020
Impairment
Impairment
Total
Allowance for Loan Losses:
Commercial
$
-
$
$
Real estate construction
-
Real estate mortgage:
1-4 family residential
3,205
3,210
Multi-family residential
Non-farm & non-residential
2,046
2,946
Agricultural
Consumer
-
Other
-
Unallocated
-
$
1,030
$
8,867
$
9,897
Loans:
Commercial
$
-
$
117,425
$
117,425
Real estate construction
-
14,571
14,571
Real estate mortgage:
1-4 family residential
292,332
293,136
Multi-family residential
1,292
46,562
47,854
Non-farm & non-residential
3,654
215,344
218,998
Agricultural
3,759
48,480
52,239
Consumer
-
22,532
22,532
Other
-
Total
$
9,509
$
757,362
$
766,871
Notes to Consolidated Financial Statements
(Dollar amounts in thousands except per share data)
Individually
Collectively
Evaluated for
Evaluated for
As of December 31, 2019
Impairment
Impairment
Total
Allowance for Loan Losses:
Commercial
$
-
$
$
Real estate construction
-
Real estate mortgage:
1-4 family residential
2,899
2,901
Multi-family residential
Non-farm & non-residential
-
1,643
1,643
Agricultural
-
Consumer
-
Other
-
Unallocated
-
$
$
8,408
$
8,460
Loans:
Commercial
$
-
$
86,552
$
86,552
Real estate construction
31,845
32,219
Real estate mortgage:
1-4 family residential
291,217
291,419
Multi-family residential
1,292
47,330
48,622
Non-farm & non-residential
1,799
203,109
204,908
Agricultural
56,324
57,166
Consumer
-
23,122
23,122
Other
-
Total
$
4,509
$
739,804
$
744,313
The following table presents loans individually evaluated for impairment by class of loans as of December 31, 2020:
Unpaid
Allowance for
Average
Interest
Cash Basis
Principal
Recorded
Loan Losses
Recorded
Income
Interest
(in thousands):
Balance
Investment
Allocated
Investment
Recognized
Recognized
With no related allowance recorded:
Real estate mortgage:
Non-farm and non-residential
$
1,855
$
1,855
$
-
$
$
$
Agricultural
3,709
3,709
-
2,276
With an allowance recorded:
Real estate mortgage:
1-4 family residential
$
$
$
$
$
$
Multi-family residential
1,292
1,292
1,292
-
-
Non-farm and non-residential
1,799
1,799
1,799
-
-
Agricultural
-
-
Total
$
9,509
$
9,509
$
1,030
6,823
$
The recorded investment in loans excludes accrued interest receivable and loan origination fees, net due to immateriality.
Notes to Consolidated Financial Statements
(Dollar amounts in thousands except per share data)
The following table presents loans individually evaluated for impairment by class of loans as of December 31, 2019:
Unpaid
Allowance for
Average
Interest
Cash Basis
Principal
Recorded
Loan Losses
Recorded
Income
Interest
(in thousands):
Balance
Investment
Allocated
Investment
Recognized
Recognized
With no related allowance recorded:
Real estate construction
$
$
$
-
$
$
-
$
-
Real estate mortgage:
Non-farm & non-residential
1,799
1,799
-
1,013
Agricultural
-
1,003
With an allowance recorded:
Real estate mortgage
1-4 family residential
Multi-family residential
1,292
1,292
Total
$
4,509
$
4,509
$
$
3,639
$
$
The recorded investment in loans excludes accrued interest receivable and loan origination fees, net due to immateriality.
Nonperforming loans include impaired loans and smaller balance homogeneous loans, such as residential mortgage and consumer loans, that are collectively evaluated for impairment.
Nonaccrual loans secured by real estate make up 98.2% of the total nonaccrual loans.
Loans on non-accrual or more than 89 days past due are not individually evaluated for specific allowances unless certain criteria are met. Further, loans more than 89 days past due maybe be individually evaluated but determined to be not impaired.
The following tables present the recorded investment in nonaccrual loans, loans past due over 89 days still accruing, and troubled debt restructurings by class of loans as of December 31, 2020 and 2019:
Loans Past Due
Over 89 Days
Still
Troubled Debt
As of December 31, 2020
Nonaccrual
Accruing
Restructurings
Commercial
$
$
$
-
Real estate construction
-
-
Real estate mortgage:
1-4 family residential
-
-
Multi-family residential
1,292
-
-
Non-farm & non-residential
1,813
-
-
Agricultural
-
1,145
Consumer
-
Total
$
4,051
$
$
1,145
Loans Past Due
Over 89 Days
Still
Troubled Debt
As of December 31, 2019
Nonaccrual
Accruing
Restructurings
Real estate construction
$
$
-
$
-
Real estate mortgage:
1-4 family residential
-
Multi-family residential
-
1,292
-
Non-farm & non-residential
1,799
-
Agricultural
-
-
Consumer
-
Total
$
3,081
$
1,499
$
-
Notes to Consolidated Financial Statements
(Dollar amounts in thousands except per share data)
The following tables present the aging of the recorded investment in past due and non-accrual loans as of December 31, 2020 and 2019 by class of loans:
December 31, 2020
30-59
60-89
Greater than
Total
Days
Days
89 Days
Past Due &
Loans Not
(in thousands)
Past Due
Past Due
Past Due
Non-accrual
Non-accrual
Past Due
Commercial
$
$
$
$
$
$
116,967
Real estate construction
-
-
-
14,447
Real estate mortgage:
1-4 family residential
1,360
-
2,857
290,279
Multi-family residential
-
-
-
1,292
1,292
46,562
Non-farm & non-residential
-
1,813
2,114
216,884
Agricultural
-
-
51,926
Consumer
22,304
Other
-
-
-
-
-
Total
$
2,249
$
1,011
$
$
4,051
$
7,386
$
759,485
December 31, 2019
30-59
60-89
Greater than
Total
Days
Days
89 Days
Past Due &
Loans Not
(in thousands)
Past Due
Past Due
Past Due
Non-accrual
Non-accrual
Past Due
Commercial
$
$
$
-
$
-
$
$
86,201
Real estate construction
-
-
-
31,845
Real estate mortgage:
1-4 family residential
2,734
3,900
287,519
Multi-family residential
-
-
1,292
-
1,292
47,330
Non-farm & non-residential
1,799
2,241
202,667
Agricultural
-
-
56,455
Consumer
22,852
Other
-
-
-
-
-
Total
$
4,224
$
$
1,499
$
3,081
$
9,139
$
735,174
Troubled Debt Restructurings:
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.
On March 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 beginning March 1, 2020 until the earlier of December 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 of the United States under the National Emergencies Act (50 U.S.C. 1601 et seq.) terminates. The Interagency Statement was subsequently revised in April 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.
Notes to Consolidated Financial Statements
(Dollar amounts in thousands except per share data)
This ability to exclude COVID-19-related modifications as troubled debt restructurings, which was set to expire on December 31, 2020, was extended under the Consolidated Appropriations Act 2021 to the earlier of 60 days after the national emergency concerning the COVID-19 outbreak terminates, or, January 1, 2022.
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. During 2020, approved modifications were approximately $130.1 million of loan balances, of which, an approximate $1.7 million was still in deferment as of December 31, 2020. Modifications were $125.3 million as of September 30, 2020 and $115.0 million as of June 30, 2020.
At December 31, 2020, the Company has one loan totaling $1.1 million classified as a troubled debt restructure. As of December 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. At December 31, 2019, the Company did not have any loans designated as troubled debt restructurings.
For the years ending December 31, 2020 and 2019, no loans modified as troubled debt restructurings defaulted on payment. A loan is considered in default once it is 30 days contractually past due under the modified terms of the agreement.
Credit Quality Indicators:
The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. The Company analyzes loans individually by classifying the loans as to credit risk. This analysis includes primarily non-homogeneous loans with an outstanding balance greater than $200 thousand such as commercial and commercial real estate loans. This analysis is performed on a quarterly basis. The Company uses the following definitions for risk ratings:
Special Mention. Loans classified as special mention have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution’s credit position at some future date.
Substandard. Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.
Doubtful. Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.
Notes to Consolidated Financial Statements
(Dollar amounts in thousands except per share data)
Loans not meeting the criteria above that are analyzed individually as part of the above described process are considered to be pass rated loans. The following tables present the risk category of loans by class of loans, based on the most recent analysis performed, as of December 31, 2020 and 2019:
December 31, 2020
Special
(in thousands)
Pass
Mention
Substandard
Doubtful
Commercial
$
113,402
$
3,896
$
$
-
Real estate construction
14,447
-
-
Real estate mortgage:
1-4 family residential
286,925
2,309
3,902
-
Multi-family residential
45,974
1,292
-
Non-farm & non-residential
207,050
8,261
1,888
1,799
Agricultural
45,649
3,288
3,302
-
Total
$
713,447
$
18,342
$
10,635
$
1,799
December 31, 2019
Special
(in thousands)
Pass
Mention
Substandard
Doubtful
Commercial
$
83,515
$
2,785
$
$
-
Real estate construction
30,462
1,363
-
Real estate mortgage:
1-4 family residential
283,048
3,435
4,932
Multi-family residential
43,193
4,137
1,292
-
Non-farm & non-residential
195,800
7,169
1,939
-
Agricultural
51,352
4,459
1,355
-
Total
$
687,370
$
23,348
$
10,164
$
For consumer loans, the Company evaluates the credit quality based on the aging of the recorded investment in loans, which was previously presented. Non-performing consumer loans are loans which are greater than 89 days past due or on non-accrual status, and total $46 thousand at December 31, 2020 and $95 thousand at December 31, 2019.
Non-consumer loans with an outstanding balance less than $200 thousand are evaluated similarly to consumer loans. Loan performance is evaluated based on delinquency status. Both are reviewed at least quarterly and credit quality grades are updated as needed.
Certain directors and executive officers of the Company and companies in which they have beneficial ownership were loan customers of the Bank during 2020 and 2019. An analysis of the activity with respect to all director and executive officer loans is as follows:
Balance, beginning of year
$
1,333
$
New loans
Effect of change in composition of related parties
-
Repayments
(610)
(416)
Balance, end of year
$
1,095
$
1,333
Loan Servicing
Mortgage loans serviced for others are not included in the accompanying consolidated balance sheets. The unpaid principal balances of mortgage loans serviced for others were approximately $269.9 million and $227.2 million at
Notes to Consolidated Financial Statements
(Dollar amounts in thousands except per share data)
December 31, 2020 and 2019. Custodial escrow balances maintained in connection with the foregoing loan servicing, and included in demand deposits, were approximately $1.2 million and $1.3 million at December 31, 2020 and 2019.
Activity for mortgage servicing rights and the related valuation allowance follows:
Servicing Rights:
Beginning balance
$
1,573
$
1,536
Additions
1,043
Amortization
(590)
(333)
Change in valuation allowance
(414)
(71)
Ending balance
$
1,612
$
1,573
Valuation Allowance:
Beginning balance
$
$
Additions expensed
Reductions credited to operations
(6)
(84)
Ending balance
$
$
The fair value of servicing rights was $1.9 million at December 31, 2020 and $2.0 million at December 31, 2019. Fair value at year-end 2020 was determined using a discount rate of 12.0%, prepayment speeds ranging from 12.0% to 29.1%, depending on the stratification of the specific right, and default rates ranging from 0.1% to 0.9%.
Fair value at year-end 2019 was determined using a discount rate of 12.0%, prepayment speeds ranging from 8.8% to 19.9%, depending on the stratification of the specific right, and default rates ranging from 0.1% to 0.9%.
The weighted average amortization period is 23.0 years. Estimated amortization expense for each of the next five years is:
$
NOTE 5 - PREMISES AND EQUIPMENT
Year-end premises and equipment were as follows:
Land and buildings
$
25,748
$
22,780
Furniture and equipment
21,283
20,028
Construction in process
-
1,934
47,031
44,742
Less accumulated depreciation
(26,656)
(25,313)
$
20,375
$
19,429
Depreciation expense was $1.3 million and $1.2 million in 2020 and 2019.
Certain premises, not included in premises and equipment above, are leased under operating leases. Please refer to Note 6 for information pertaining to the Company’s operating leases.
Notes to Consolidated Financial Statements
(Dollar amounts in thousands except per share data)
NOTE 6 - LEASES
As of December 31, 2020, the Company is obligated under six operating leases, two of which are for building leases and four of which are for land leases, with terms extending through 2078. The Company's lease agreements include options to renew at the Company's discretion. The extensions are reasonably certain to be exercised. The lease agreements with options that we are reasonably certain will be exercised were considered in the calculation of the ROU asset and lease liability.
Statement of
Consolidated
Balance Sheet
12/31/2020
12/31/2019
(in thousands)
Operating Lease Right of Use Asset:
Gross Carrying Amount
$
8,631
$
8,857
Accumulated Amortization
(961)
(662)
Net Book Value
Operating lease right of use asset
$
7,670
$
8,195
Operating Lease Liabilities
Right of use lease obligations
Operating lease liability
$
7,850
$
8,350
As of December 31, 2020, the weighted-average remaining lease term for operating leases was 34.7 years compared to 35.4 years at December 31, 2019 and the weighted- average discount rate used in the measurement of operating lease liabilities was 4.14%. The Company utilized the FHLB fixed rate advance rate as of December 31, 2018 for the term most closely aligning with the remaining lease term for lease obligations in existence as of December 31, 2018. The Company utilized the FHLB fixed rate advance rate of 4.50% as of April 30, 2019 as a basis for determing the discount rate for one contract which was entered into during April 2019.
Year Ended
12/31/2020
12/31/2019
(in thousands)
Lease Cost:
Operating lease cost
$
$
Total lease cost
$
$
Other information
Cash paid for amounts included in the measurement of lease liabilities:
Operating cash flows from operating leases
$
$
Maturity analysis of liabilities under operating leases with terms longer than 12 months, are as follows at December 31, 2020:
(in thousands)
Twelve months ended December 31,
$
Thereafter
18,339
Total undiscounted lease payments
$
20,972
Amounts representing interest
(13,122)
Lease liability
$
7,850
Notes to Consolidated Financial Statements
(Dollar amounts in thousands except per share data)
NOTE 7 - GOODWILL AND INTANGIBLE ASSETS
The change in balance for goodwill during the year is as follows:
Beginning of year
$
14,001
$
14,001
Impairment
-
-
End of year
$
14,001
$
14,001
Goodwill is not amortized but instead evaluated periodically for impairment.
Impairment exists when a reporting unit’s carrying value of goodwill exceeds its fair value. At December 31, 2020, the Company’s reporting unit had positive equity and the Company elected to perform a qualitative assessment to determine if it was more likely than not that the fair value of the reporting unit exceeded it carrying value, including goodwill. The qualitative assessment indicated that it was more likely than not that the fair value of the reporting unit exceeded its carrying value, resulting in no impairment.
.
Acquired intangible assets were as follows at year-end:
Gross
Gross
Carrying
Accumulated
Carrying
Accumulated
Amount
Amortization
Amount
Amortization
Amortized intangible assets:
Core deposit intangibles
$
$
$
$
Aggregate amortization expense was $74 thousand and $102 thousand 2020 and 2019.
Estimated amortization expense for each of the next five years:
$
-
-
-
NOTE 8 - DEPOSITS
Time deposits of $250 thousand or more were $36.2 million and $43.3 million at year-end 2020 and 2019, respectively.
At December 31, 2020, the scheduled maturities of time deposits for the next five years are as follows:
$
132,510
21,479
7,675
5,693
3,749
Certain directors and executive officers of the Company and companies in whom they have beneficial ownership are deposit customers of the Bank. These deposits totaled approximately $2.5 million and $2.8 million at December 31, 2020 and 2019.
NOTE 9 - REPURCHASE AGREEMENTS
Repurchase agreements are secured by U.S. Government agency securities with a total carrying amount of $14.7 million and $12.1 million at December 31, 2020 and 2019.
Notes to Consolidated Financial Statements
(Dollar amounts in thousands except per share data)
Repurchase agreements range in maturities from 1 day to 5 months. The securities underlying the agreements are maintained in a third-party custodian’s account under a written custodial agreement. Information concerning repurchase agreements for 2020 and 2019 is summarized as follows:
Average daily balance during the year
$
6,773
$
6,996
Average interest rate during the year
0.36
%
0.53
%
Maximum month-end balance during the year
$
10,924
$
8,947
Weighted average interest rate at year end
0.26
%
0.50
%
NOTE 10 - FEDERAL HOME LOAN BANK ADVANCES
At year-end, advances from the Federal Home Loan Bank were as follows:
Short-Term Advances
Maturities in February 2021, fixed rates from 0.24% to 0.65% with a weighted-average rate of 0.44% as of 12/31/20 and 1.80% as of 12/31/19
$
10,500
$
25,000
Long-Term Advances
Maturities range from June 2021 through November 2028, fixed rates from 0.79% to 5.37%, with a weighted-average rate of 1.99% as of 12/31/20 and 2.13% as of 12/31/19
86,032
91,418
Advances are paid either on a monthly basis or at maturity. All advances require a prepayment penalty, and are secured by the Federal Home Loan Bank stock and substantially all 1-4 family first-mortgage residential, multi-family and farm real estate loans under a blanket lien arrangement at December 31, 2020 and 2019. Based on this collateral and the Company’s holding of Federal Home Loan Bank stock, the Company is eligible to borrow up to an additional $110.1 million at December 31, 2020.
Scheduled principal payments due on advances during the years subsequent to December 31, 2020 are as follows:
$
29,743
23,493
19,438
18,792
2,630
Thereafter
2,436
$
96,532
NOTE 11 - SUBORDINATED DEBENTURES
In August 2003, the Company formed Kentucky Bancshares, Statutory Trust I (“Trust”). The Trust issued $217 thousand of common securities to the Company and $7 million of trust preferred securities as part of a pooled offering of such securities. The Company issued $7.2 million subordinated debentures to the Trust in exchange for the proceeds of the offering, which debentures represent the sole asset of the Trust. The debentures paid interest quarterly at 7.06% for the first 5 years. Starting September 2008, the rate converted to three-month LIBOR plus 3.00% adjusted quarterly, which was 3.23% at year-end 2020. The Company is not considered the primary beneficiary of this Trust (variable interest entity), therefore the trust is not consolidated in the Company’s financial statements, but rather the subordinated debentures are shown as a liability.
Notes to Consolidated Financial Statements
(Dollar amounts in thousands except per share data)
The Company may redeem the subordinated debentures, in whole or in part, beginning September 2008 at a price of 100% of face value. The subordinated debentures must be redeemed no later than 2033. The Company has the option to defer interest payments on the subordinated debentures from time to time for a period not to exceed five consecutive years.
The subordinated debentures may be included in Tier I capital (with certain limitations applicable) under current regulatory guidelines and interpretations.
NOTE 12 - REVENUE FROM CONTRACTS WITH CUSTOMERS
The Company’s revenue from contracts with customers in the scope of Topic 606 is recognized within noninterest income. The consolidated statements of income include all categories of noninterest income. The following table reflects only the categories of noninterest income that are within the scope of Topic 606:
Year Ended
12/31/2020
12/31/2019
Service charges
$
4,602
$
5,368
Trust department income
1,441
1,411
Brokerage income
Debit card interchange income
3,742
3,470
Total
$
10,249
$
10,792
Notes to Consolidated Financial Statements
(Dollar amounts in thousands except per share data)
Trust department income: We earn wealth management fees based upon asset custody, investment management, trust, and estate services provided to customers. Most of these customers receive monthly billings for services rendered based upon the market value of assets and/or income generated. Fees that are transaction based are recognized at the point in time that the transaction is executed
Service charges: We earn fees from our deposit customers for transaction-based, account maintenance, and overdraft services. Transaction-based fees and overdraft fees are recognized at a point in time, since the customer generally has a right to cancel the depository arrangement at any time. The arrangement is considered a day-to-day contract with ongoing renewals and optional purchases, so the duration of the contract does not extend beyond the services already performed. Account maintenance fees, which relate primarily to monthly maintenance, are earned over the course of a month, representing the period over which we satisfy our performance obligation.
Debit card interchange income: As with the transaction-based fees on deposit accounts, debit card interchange income is recognized at the point in time that we fulfill the customer’s request. We earn interchange fees from cardholder transactions processed through card association networks. Interchange rates are generally set by the card associations based upon purchase volumes and other factors. Interchange fees represent a percentage of the underlying transaction value and are recognized daily, concurrently with the transaction processing services provided to the cardholder
Brokerage income: Brokerage income fees are the commissions and fees received from a registered broker/dealer and investment adviser that provide those services to our customers. We act as an agent in arranging the relationship between the customer and the third-party service provider. These fees are recognized monthly from the third-party broker based upon services already performed.
NOTE 13 - INCOME TAXES
Income tax expense was as follows:
Current Expense
Federal
$
1,147
$
1,443
Deferred Expense
Federal
(303)
State
(606)
$
$
1,077
Notes to Consolidated Financial Statements
(Dollar amounts in thousands except per share data)
Year-end deferred tax assets and liabilities were due to the following.
Deferred tax assets
Allowance for loan losses
$
2,488
$
2,129
Other real estate owned
Nonaccrual loan interest
Accrued expenses
Acquisition market value adjustments
-
Low income housing investments
Unearned income
Net operating loss
Derivative from cash flow hedge
-
Operating lease liability
1,959
2,083
Other
6,305
5,272
Deferred tax liabilities
Bank premises and equipment
(1,048)
(619)
FHLB stock
(960)
(960)
Prepaid expenses
(518)
(495)
Mortgage servicing rights
(402)
(383)
Core deposit intangibles
(15)
(31)
Unrealized gain on securities
(1,093)
(265)
Operating lease right of use asset
(1,959)
(2,083)
Other
(17)
(10)
(6,012)
(4,846)
Valuation Allowance
-
(5)
Net Deferred Tax Asset
$
$
Effective tax rates differ from federal statutory rates applied to financial statement income due to the following:
U. S. federal income tax rate
21.0
%
21.0
%
Changes from the statutory rate
State deferred tax benefit
0.3
(4.3)
Tax-exempt interest income
(4.3)
(3.3)
Tax-exempt BOLI income
(0.9)
(0.7)
Historic and low income tax credits
(7.1)
(3.9)
Insurance captive
(1.5)
(1.1)
Non-deductible interest expense related to carrying tax-exempt investments
0.2
0.2
Other
(0.7)
(0.3)
7.0
%
7.6
%
Federal income tax laws provided the First Federal Savings Bank, acquired by the Company in 2003, with additional bad debt deductions through 1987, totaling $1.3 million. Accounting standards do not require a deferred tax liability to be recorded on this amount, which otherwise would total a $323 thousand liability at December 31, 2020. The Company’s acquisition of First Federal Savings Bank did not require the recapture of the bad debt reserve. However, if Kentucky Bank was liquidated or otherwise ceased to be a bank, or if tax laws were to change, the $323 thousand would be recorded as expense.
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.
Notes to Consolidated Financial Statements
(Dollar amounts in thousands except per share data)
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 up to 50% of other members’ Kentucky taxable income in the combined filing group starting in 2021.
As a result of these tax law changes, the Company had a deferred tax asset of $607 thousand as of December 31, 2020. Most of the benefit of recording the deferred tax asset was recorded during 2019 as a reduction to income tax expense.
Unrecognized Tax Benefits
The Company does not have any unrecognized tax benefit. The Company does not expect the total amount of unrecognized tax benefits to significantly increase or decrease in the next twelve months.
There were no interest and penalties recorded in the income statement or accrued for the years ended December 31, 2020 and 2019.
The Company and its subsidiaries file a consolidated U.S. Corporation income tax return and a corporate income tax return in the state of Kentucky. The Company is no longer subject to examination by taxing authorities for years before 2017.
NOTE 14 - EARNINGS PER SHARE
The factors used in the earnings per share computation follow:
Basic and Diluted Earnings Per Share
Net income
$
11,697
$
13,153
Weighted average common shares outstanding
5,942
5,953
Basic and diluted earnings per share
$
1.97
$
2.21
Restricted stock grants for 2020 and 2019 were excluded in shares outstanding for purposes of computing basic and diluted earnings per share and were anti-dilutive.
NOTE 15 - RETIREMENT PLAN
The Company has a qualified profit sharing plan which covers substantially all employees and includes a 401(k) provision. Profit sharing contributions, excluding the 401(k) provision, are at the discretion of the Company’s Board of Directors. Expense recognized in connection with the plan was $970 thousand and $899 thousand in 2020 and 2019.
NOTE 16 - STOCK BASED COMPENSATION
The Company has two share based compensation plans as described below. Total compensation cost that has been charged against income for those plans was $286 thousand and $220 thousand for 2020 and 2019.
2005 Restricted Stock Grant Plan
Under the Company’s expired 2005 Restricted Stock Grant Plan, total shares issuable under the plan were 100,000. There were no shares issued during 2020 and 2019. There were 0 shares forfeited during 2020 and 90 shares forfeited during 2019. The plan is now expired and no additional restricted stock share awards will be issued.
Notes to Consolidated Financial Statements
(Dollar amounts in thousands except per share data)
A summary of changes in the Company’s nonvested shares for the year follows:
Weighted-Average
Grant-Date
Fair Value
Nonvested Shares
Shares
Fair Value
Per Share
Nonvested at January 1, 2020
1,580
$
21,606
$
13.67
Vested
(1,580)
(21,606)
13.67
Nonvested at December 31, 2020
-
$
-
$
-
As of December 31, 2020, there was no unrecognized compensation cost related to nonvested shares granted under the 2005 Restricted Stock Grant Plan due to their being no nonvested shares outstanding.
2009 Stock Award Plan
On May 13, 2009, the Company’s stockholders approved a stock award plan that provides for the granting of both incentive and nonqualified stock options, restricted stock share awards and other share based awards. Total shares issuable under the plan are 300,000. There were 0 shares issued during 2020 and 23,380 shares issued during 2019. There were 300 shares forfeited during 2020 and 1,434 shares forfeited during 2019. The plan is now expired and no additional restricted stock share awards will be issued from the 2009 Stock Award Plan.
A summary of changes in the Company’s nonvested shares for the year follows:
Weighted-Average
Fair
Grant-Date
Value
Nonvested Shares
Shares
Fair Value
Per Share
Nonvested at January 1, 2020
38,482
$
825,935
$
21.46
Vested
(14,995)
(318,074)
21.21
Forfeited
(300)
(6,410)
21.37
Nonvested at December 31, 2020
23,187
$
501,451
$
21.63
As of December 31, 2020, there was $280 thousand unrecognized compensation cost related to nonvested shares granted under the 2009 Stock Award Plan. The cost is expected to be recognized over a weighted-average period of 2.6 years. The total grant-date fair value of shares vested during the years ended December 31, 2020 and 2019 was $318 thousand and $176 thousand.
2019 Stock Award Plan
On May 21, 2019, the Company’s stockholders approved a stock award plan that provides for the granting of both incentive and nonqualified stock options and other share based awards. Total shares issuable under the plan are 300,000. There were 30,030 shares issued during 2020 and 0 shares were issued during 2019. There were 290 shares forfeited 2020 and 0 shares forfeited in 2019.
Weighted-Average
Fair
Grant-Date
Value
Nonvested Shares
Shares
Fair Value
Per Share
Nonvested at January 1, 2020
-
$
-
$
-
Granted
30,030
693,993
23.11
Vested
(2,410)
(55,695)
23.11
Forfeited
(290)
(6,702)
23.11
Nonvested at December 31, 2020
27,330
$
631,596
$
23.11
As of December 31, 2020, there was $399 thousand unrecognized compensation cost related to nonvested shares granted under the 2019 Stock Award Plan. The cost is expected to be recognized over a weighted-average period of 4.2 years. The total grant-date fair value of shares vested during the years ended December 31, 2020 and 2019 was $56 thousand and $0.
Notes to Consolidated Financial Statements
(Dollar amounts in thousands except per share data)
NOTE 17 - LIMITATION ON BANK DIVIDENDS
The Company’s principal source of funds is dividends received from the Bank. Banking regulations limit the amount of dividends that may be paid by the Bank without prior approval of regulatory agencies. Under these regulations, the amount of dividends that may be paid in any calendar year is limited to the current year’s net profits, as defined, combined with the retained net profits of the preceding two years. During 2020 the Bank could, without prior approval, declare dividends on any 2021 net profits retained to the date of the dividend declaration plus $9.6 million.
NOTE 18 - FAIR VALUE
Fair value is the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. There are three levels of inputs that may be used to measure fair values:
Level 1 - Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.
Level 2 - Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.
Level 3 - Significant unobservable inputs that reflect a company’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.
The Company used the following methods and significant assumptions to estimate the fair value:
Securities Available for Sale: The fair values for investment securities are determined by quoted market prices, if available (Level 1). For securities where quoted prices are not available, fair values are calculated based on market prices of similar securities (Level 2).
For securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows or other market indicators (Level 3).
Impaired Loans: The fair value of impaired loans with specific allocations of the allowance for loan losses is generally based on recent real estate appraisals. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value.
Non-real estate collateral may be valued using an appraisal, net book value per the borrower’s financial statements, or aging reports, adjusted or discounted based on management’s historical knowledge, changes in market conditions from the time of the valuation, and management’s expertise and knowledge of the client and client’s business, resulting in a Level 3 fair value classification. Impaired loans are evaluated on a quarterly basis for additional impairment and adjusted in accordance with the allowance policy.
Other Real Estate Owned: Assets acquired through, or instead of, loan foreclosure are initially recorded at fair value less costs to sell when acquired, establishing a new cost basis. These assets are subsequently accounted for at lower of cost or fair value less estimated costs to sell. Fair value is commonly based on recent real estate appraisals which are updated no less frequently than annually. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach.
Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value. Real estate owned properties are evaluated on a quarterly basis for additional impairment and adjusted accordingly.
Notes to Consolidated Financial Statements
(Dollar amounts in thousands except per share data)
Loan Servicing Rights: Fair value is based on market prices for comparable mortgage servicing contracts, when available, or alternatively based on a valuation model that calculates the present value of estimated future net servicing income, resulting in a Level 3 classification.
Assets and Liabilities Measured on a Recurring Basis
Available for sale investment securities,equity securities and derivatives which are in included in other assets on the Company’s balance sheet,are the Company’s only balance sheet item that meet the disclosure requirements for instruments measured at fair value on a recurring basis. Disclosures are as follows in the tables below.
Fair Value Measurements at December 31, 2020 Using :
Quoted Prices
In Active
Markets for
Significant Other
Significant
Identical
Observable
Unobservable
Carrying
Assets
Inputs
Inputs
Description
Value
(Level 1)
(Level 2)
(Level 3)
Financial Assets
U.S. treasury notes
$
9,188
$
-
$
9,188
$
-
U. S. government agencies
23,298
-
23,298
-
States and political subdivisions
67,639
-
67,639
-
Mortgage-backed - residential
126,482
-
126,482
-
Mortgage-backed-commercial
74,551
-
74,551
-
Asset-backed
51,311
-
51,311
-
Other
1,025
1,025
Derivatives
-
-
Equity Securities
-
-
Total
$
354,293
$
$
353,995
$
-
Financial Liabilities
Derivatives
$
2,350
$
-
$
2,350
$
-
Notes to Consolidated Financial Statements
(Dollar amounts in thousands except per share data)
Fair Value Measurements at December 31, 2019 Using :
Quoted Prices
In Active
Markets for
Significant Other
Significant
Identical
Observable
Unobservable
Carrying
Assets
Inputs
Inputs
Description
Value
(Level 1)
(Level 2)
(Level 3)
U.S. treasury notes
$
9,168
$
-
$
9,168
$
-
U. S. government agencies
23,735
-
23,735
-
States and political subdivisions
32,589
-
32,589
-
Mortgage-backed - residential
113,991
-
113,991
-
Mortgage-backed - commercial
50,351
-
50,351
-
Asset-backed
35,496
-
35,496
-
Derivatives
Equity Securities
-
-
Total
$
265,670
$
$
265,378
$
-
Financial Liabilities
Derivatives
$
$
-
$
$
-
Assets measured at fair value on a non-recurring basis are summarized below:
Fair Value Measurements at December 31, 2020 Using :
Quoted Prices
In Active
Markets for
Significant Other
Significant
Identical
Observable
Unobservable
Carrying
Assets
Inputs
Inputs
(In thousands)
Value
(Level 1)
(Level 2)
(Level 3)
Description
Impaired loans:
Real estate mortgage:
1-4 family residential
$
$
-
$
-
$
Multi-family residential
1,217
-
-
1,217
Non-farm residential
-
-
Agricultural
-
-
Other real estate owned, net:
Real estate mortgage:
1-4 family residential
-
-
Commercial
-
-
Agricultural
-
-
Mortgage servicing rights
1,459
-
-
1,459
Notes to Consolidated Financial Statements
(Dollar amounts in thousands except per share data)
Fair Value Measurements at December 31, 2019 Using :
Quoted Prices
In Active
Markets for
Significant Other
Significant
Identical
Observable
Unobservable
Carrying
Assets
Inputs
Inputs
(In thousands)
Value
(Level 1)
(Level 2)
(Level 3)
Description
Impaired loans:
Real Estate Mortgage:
1-4 family residential
$
$
-
$
-
$
Multi-family residential
1,242
-
-
1,242
Other real estate owned, net:
Real Estate Mortgage:
1-4 family residential
-
-
Commercial
-
-
Agriculturual
-
-
Mortgage servicing rights
1,107
-
-
1,107
Impaired loans measured for impairment using the fair value of the collateral had a net carrying amount of $3.6million, with a valuation allowance of $1.0million at December 31, 2020. During 2020, four new loans became impaired resulting in an additional provision for loan losses of $955 thousand. The total allowance for specific impaired loans increased $978 thousand for the year ending December 31, 2020. There was one loan with an outstanding balance of $1.8 million and classified as non-farm and non-residential as of December 31, 2020, for which a specific valuation allowance of $900 thousand was deemed necessary as of December 31, 2020.
At December 31, 2019, impaired loans measured for impairment using the fair value of the collateral had a net carrying amount of $1.4million, with a valuation allowance of $52 thousand. During 2019, two new loans became impaired resulting in an additional provision for loan losses of $50 thousand. The total allowance for specific impaired loans decreased $149 thousand for the year ending December 31, 2019.
Other real estate owned measured at fair value less costs to sell, had a net carrying amount of $451 thousand, which is made up of the outstanding balance of $928 thousand, net of a valuation allowance of $477 thousand at December 31, 2020. Fair value adjustments of other real estate were a net write-down of $32 thousand for the year ended December 31, 2020. At December 31, 2019, other real estate owned measured at fair value less costs to sell, had a net carrying amount of $519 thousand, which was made up of the outstanding balance of $980 thousand, net of a valuation allowance of $461 thousand at December 31, 2019. Fair value adjustments of other real estate were a net write-down of $54 thousand for the year ended December 31, 2019.
Certain impaired loan servicing rights, which are carried at lower of cost or fair value, were carried at their fair value of $1.5 million, which is made up of the outstanding balance of $2.0 million, net of a valuation allowance of $524 thousand at December 31, 2020. Fair value adjustments for the loan servicing were net write-downs of $414 thousand for the year ended December 31, 2020. At December 31, 2019, impaired loan servicing rights were carried at their fair value of $1.1 million, which was made up of the outstanding balance of $1.2 million, net of a valuation allowance of $110 thousand at December 31, 2019. Fair value adjustments were net write-downs of $71 thousand for the year ended December 31, 2019.
Notes to Consolidated Financial Statements
(Dollar amounts in thousands except per share data)
The following table presents quantitative information about level 3 fair value measurements for financial instruments measured at fair value on a non-recurring basis at December 31, 2020 and 2019:
Range
December 31, 2020
Fair
Valuation
Unobservable
(Weighted
(In thousands)
Value
Technique(s)
Input(s)
Average)
Impaired loans
Real estate mortgage:
1-4 family residential
$
sales comparison
adjustment for differences between the comparable sales
15%-15%
(15%)
Multi-family residential
1,217
income approach
capitalization rate
7% - 7%
(7)%
Non-farm residential
sales comparison
adjustment for differences between the comparable sales
50% -50%
(50)%
Agricultural
sales comparison
adjustment for differences between the comparable sales
100% - 100%
(100)%
Other real estate owned:
Real estate mortgage:
1-4 family residential
sales comparison
adjustment for differences between the comparable sales
23% - 27%
(30)%
Commercial
sales comparison
adjustment for differences between the comparable sales
15%-15%
(15%)
Agricultural
sales comparison
adjustment for differences between the comparable sales
0% - 26%
(14)%
Mortgage servicing rights
1,459
discounted cash flow
constant prepayment rates
12% - 29%
(19)%
Range
December 31, 2019
Fair
Valuation
Unobservable
(Weighted
(In thousands)
Value
Technique(s)
Input(s)
Average)
Impaired loans
Real estate mortgage:
1-4 family residential
$
sales comparison
adjustment for differences between the comparable sales
(1)% - 21%
(1)%
Multi-family residential
1,242
income approach
capitalization rate
7% - 7%
(7)%
Other real estate owned:
Real estate mortgage:
1-4 family residential
sales comparison
adjustment for differences between the comparable sales
(4%) - 11%
(29%)
Commercial
sales comparison
capitalization rate
(6%) - 8%
(62)%
Agriculturual
sales comparison
adjustment for differences between the comparable sales
0% - 26%
(14)%
Mortgage servicing rights
1,107
discounted cash flow
constant prepayment rates
9% - 20%
(12)%
Notes to Consolidated Financial Statements
(Dollar amounts in thousands except per share data)
Fair Value of Financial Instruments
The carrying amounts and estimated fair values of financial instruments, at December 31, 2020 and December 31, 2019 are as follows:
December 31, 2020:
Carrying
(in thousands)
Value
Level 1
Level 2
Level 3
Total
Financial assets
Cash and cash equivalents
$
38,974
$
38,974
$
-
$
-
$
38,974
Interest bearing time deposits
2,470
2,470
-
-
2,470
Securities available for sale
353,494
-
353,494
-
353,494
Loans held for sale
4,427
-
4,532
-
4,532
Net Loans
756,974
-
-
763,914
763,914
Federal Home Loan Bank stock
7,072
-
-
-
N/A
Interest receivable
5,227
-
1,057
4,170
5,227
Derivative and financial instruments
-
-
Equity securities
-
-
Financial liabilities
Total deposits
$
978,604
$
807,383
$
171,892
$
-
$
979,275
Repurchase agreements
9,129
-
9,129
-
9,129
Short-term Federal Home Loan Bank advances
10,500
-
10,500
-
10,500
Long-term Federal Home Loan Bank advances
86,032
-
88,332
-
88,332
Subordinated debentures
7,217
-
-
7,214
7,214
Interest payable
-
Derivative and financial instruments
2,350
-
2,350
-
2,350
Notes to Consolidated Financial Statements
(Dollar amounts in thousands except per share data)
December 31, 2019:
Carrying
(in thousands)
Value
Level 1
Level 2
Level 3
Total
Financial assets
Cash and cash equivalents
$
22,182
$
22,182
$
-
$
-
$
22,182
Interest bearing time deposits
2,375
2,375
-
-
2,375
Securities available for sale
265,330
-
265,330
-
265,330
Loans held for sale
2,144
-
2,171
-
2,171
Net Loans
735,853
-
-
735,060
735,060
Federal Home Loan Bank stock
7,034
-
-
-
N/A
Interest receivable
4,166
-
1,035
3,131
4,166
Derivatives
-
-
Equity securities
-
-
Financial liabilities
Total deposits
$
842,653
$
630,948
$
210,892
$
-
$
841,840
Repurchase agreements
5,994
-
5,993
-
5,993
Short-term Federal Home Loan Bank advances
25,000
-
25,000
-
25,000
Long-term Federal Home Loan Bank advances
91,418
-
91,397
-
91,397
Subordinated debentures
7,217
-
-
7,213
7,213
Interest payable
1,170
-
1,156
1,170
Derivatives and financial instruments
-
-
NOTE 19 - OFF-BALANCE SHEET ACTIVITIES AND COMMITMENTS
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:
12/31/2020
12/31/2019
Fixed Rate
Variable Rate
Fixed Rate
Variable Rate
Unused lines of credit
$
-
$
146,200
$
-
$
117,265
Commitments to make loans
25,052
17,782
1,810
26,933
Letters of credit
-
-
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 originated at current market rates ranging from 1.88% to 5.25% with maturities ranging up to 30 years.
Notes to Consolidated Financial Statements
(Dollar amounts in thousands except per share data)
NOTE 20 - CAPITAL REQUIREMENTS
In August 2018, the Federal 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 of December 31, 2020 and December 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.
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.
In 2019, 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 (CBLR 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 on January 1, 2020 and was elected by the Bank as of December 31, 2020. In April 2020, the federal banking agencies issued an interim final rule that makes temporary changes to the CBLR framework, pursuant to section 4012 of the Coronavirus Aid, Relief, and Economic Security (CARES) Act, and a second interim final rule that provides a graduated increase in the community bank leverage ratio requirement after the expiration of the temporary changes implemented pursuant to section 4012 of the CARES Act.
The community bank leverage ratio removes the requirement for qualifying banking organizations to calculate and report risk-based capital but rather only requires a Tier 1 to average assets (leverage) ratio. Qualifying banking organizations that elect to use the community bank leverage ratio framework and that maintain a leverage ratio of greater than required minimums will be considered to have satisfied the generally applicable risk based and leverage capital requirements in the agencies’ capital rules (generally applicable rule) and, if applicable, will be considered to have met the well capitalized ratio requirements for purposes of section 38 of the Federal Deposit Insurance Act. Under the interim final rules the community bank leverage ratio minimum requirement is 8% as of December 31, 2020, 8.5% for calendar year 2021, and 9% for calendar year 2022 and beyond. The interim rules allows for a two-quarter grace period to correct a ratio that falls below the required amount, provided that the bank maintains a leverage ratio of 7% as of December 31, 2020, 7.5% for calendar year 2021, and 8% for calendar year 2022 and beyond.
Notes to Consolidated Financial Statements
(Dollar amounts in thousands except per share data)
Under the final rule, an eligible banking organization can opt out of the CBLR framework and revert back to the risk-weighting framework without restriction. As of December 31, 2020, both the Company and Bank were qualifying community banking organizations as defined by the federal banking agencies and elected to measure capital adequacy under the CBLR framework.
The Bank’s actual amounts and ratios, exclusive of the capital conservation buffer for 2019, are presented below as of December 31, 2020 and December 31, 2019:
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
$
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
NOTE 21 - DERIVATIVES AND FINANCIAL INSTRUMENTS
As part of our overall interest rate risk management, the Company uses derivative instruments, including interest rate swaps. The notional amount does not represent amounts exchanged by the parties. The amount exchanged is determined by reference to the notional amount and the other terms of the individual agreements.
Cash Flow Hedges: Interest rate swaps with notional amounts totaling $23 million and $10 million as of December 31, 2020 and 2019, were designated as cash flow hedges of certain rolling three month term FHLB advances and/or brokered deposits and were determined to be effective during all periods presented. The Company expects the hedges to remain effective during the remaining terms of the swaps. The carrying value of the cash flow hedge liability was $1.725 million and an asset of $46 thousand as of December 31, 2020 and 2019 and included in other assets or other liabilities on the Company’s Consolidated Balance Sheet. Changes in the value of cash flow hedges resulted in a reduction of other comprehensive income, net of tax, of $1.3 million and an increase of $46 thousand for the years ended December 31, 2020 and 2019. Changes in the value of cash flow hedges had no impact on the Company’s income statement as of December 31, 2020 or 2019.
Fair Value Hedges: Interest rate swaps with notional amounts totaling $7 million and $7 million as of December 31, 2020 and 2019, were designated as fair value last of layer hedges of certain fixed rate prepayable loans. The hedges were determined to be effective during all periods presented. The Company expects the hedges to remain effective during the remaining terms of the swaps. The carrying value of the fair value hedge was a $626 thousand asset and a $169 thousand liability as of December 31, 2020 and 2019 and was included in loan balances on the Company’s balance sheet. Changes in the value of fair value hedges had an immaterial impact on the Company's income statement as of December 31, 2020 and 2019.
Derivatives Not Designated as Hedges: Commitments to fund mortgage loans (interest rate locks) to be sold into the secondary market commitments for the future delivery of these mortgage loans are accounted for as free standing derivatives. The fair value of the interest rate lock is recorded at the time the commitment to fund the mortgage loan is executed and is adjusted for the expected exercise of the commitment before the loan is funded. Fair values of these mortgage derivatives are estimated based on changes in mortgage interest rates from the date the interest on the loan is locked. Changes in the fair values of these derivatives are included in net gains on the sales of loans. The notional amounts of these transactions as of December 31, 2020 and 2019 were $24.2 million and $7.4 million. The carrying value of the fair value asset was $501 thousand and $48 thousand as of December 31, 2020 and 2019 and was included in other assets on the Company’s balance sheet.``````````````````````````````````````
Notes to Consolidated Financial Statements
(Dollar amounts in thousands except per share data)
NOTE 22 - PARENT COMPANY FINANCIAL STATEMENTS
Condensed Balance Sheets
As of December 31,
(In Thousands)
ASSETS
Cash on deposit with subsidiaries
$
8,804
$
6,048
Investment in subsidiaries
126,125
119,804
Other assets
Total assets
$
135,569
$
126,494
LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities
Subordinated debentures
$
7,217
$
7,217
Other Liabilities
Stockholders’ equity
Preferred stock
-
-
Common stock
21,996
21,447
Retained earnings
104,319
96,903
Accumulated other comprehensive income
2,027
Total liabilities and stockholders’ equity
$
135,569
$
126,494
Notes to Consolidated Financial Statements
(Dollar amounts in thousands except per share data)
Condensed Statements of Income and Comprehensive Income
Years Ended December 31,
(In Thousands)
Income
Dividends from subsidiary
$
7,425
$
8,140
Securities gains (losses), net
-
-
Total income
7,425
8,140
Expenses
Interest expense
Other expenses
Total expenses
Income before income taxes and equity in undistributed income of subsidiary
6,785
7,344
Applicable income tax benefits
Income before equity in undistributed income of subsidiary
6,950
7,913
Equity in undistributed income of subsidiaries
4,747
5,240
Net income
$
11,697
$
13,153
Comprehensive income (loss)
$
12,811
$
17,544
Notes to Consolidated Financial Statements
(Dollar amounts in thousands except per share data)
Condensed Statements of Cash Flows
Years Ended December 31,
(In Thousands)
Cash flows from operating activities
Net income
$
11,697
$
13,153
Adjustments to reconcile net income to net cash from operating activities
Equity in undistributed earnings of subsidiary
(4,747)
(5,240)
Change in other assets
(414)
Change in other liabilities
(4)
(2)
Net cash from operating activities
6,948
7,497
Cash flows from financing activities
Payments on note payable
-
(2,718)
Dividends paid
(4,281)
(4,045)
Proceeds from issuance of common stock
Purchase of common stock
-
(1,544)
Net cash from financing activities
(4,192)
(8,242)
Net change in cash
2,756
(745)
Cash at beginning of year
6,048
6,793
Cash at end of year
$
8,804
$
6,048
NOTE 23 - QUARTERLY FINANCIAL DATA (UNAUDITED)
Interest
Net Interest
Net
Earnings Per Share
Income
Income
Income
Basic
Fully Diluted
First quarter
$
11,135
$
8,992
$
1,751
$
0.30
$
0.30
Second quarter
10,878
9,082
3,073
0.51
0.51
Third quarter
10,184
8,709
3,352
0.57
0.57
Fourth quarter
10,488
9,199
3,521
0.59
0.59
First quarter
$
11,179
$
8,939
$
2,811
$
0.47
$
0.47
Second quarter
11,360
9,059
3,237
0.54
0.54
Third quarter
11,512
9,310
3,616
0.61
0.61
Fourth quarter
11,481
9,241
3,489
0.59
0.59
NOTE 24 - SUBSEQUENT EVENTS
Announcement of Merger between Kentucky Bank and Stock Yards Bancorp
On January 27, 2021, the Company and Stock Yards Bancorp announced the execution of an Agreement and Plan of Merger (the “merger agreement”), providing for the merger of the Company and Stock Yards, subject to the terms and conditions set forth therein. Under the terms of the merger agreement, which was unanimously approved by the Boards of Directors of both companies, the Company’s shareholders will receive 0.64 shares of Stock Yards common stock and cash of $4.75 for each share of Kentucky Bank common stock they own. The transaction is expected to close in the second quarter of 2021 subject to customary closing conditions, including receipt of all applicable regulatory approvals and shareholder approval of Kentucky Bancshares.
Unaudited
The combined company will operate under the Stock Yards Bancorp name and will trade under the Stock Yards ticker symbol SYBT on the Nasdaq stock market. The company will be headquartered in Louisville, Kentucky. Stock Yards Bancorp is a bank holding company headquartered in Louisville, Kentucky. Stock Yards’ bank subsidiary Stock Yards Bank & Trust operates 44 banking locations in Kentucky, Indiana and Ohio. Stock Yards reported total assets of $4.6 billion, total loans of $3.5 billion and total deposits of $4.0 billion as of December 31, 2020.

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ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
Item 9. Changes In and Disagreements with Accountants on Accounting and Financial Disclosure
None

---

ITEM 9A. CONTROLS AND PROCEDURES
Item 9A. Controls and Procedures
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
Kentucky Bancshares’ management is responsible for establishing and maintaining effective disclosure controls and procedures, as defined under Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934. As of December 31, 2020, an evaluation was carried out by Kentucky Bancshares’ management, with the participation of our Chief Executive Officer and our Chief Financial Officer of the effectiveness of the design and operation of our disclosure controls and procedures. Based on this evaluation, management concluded that disclosure controls and procedures as of December 31, 2020 were effective in ensuring material information required to be disclosed in this annual report on Form 10-K was recorded, processed, summarized, and reported on a timely basis.
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING
There were no changes in Kentucky Bancshares’ internal control over financial reporting that occurred during the year ended December 31, 2020 that have materially affected, or are reasonably likely to materially affect, Kentucky Bancshares internal control over financial reporting.
MANAGEMENT REPORT ON INTERNAL CONTROL
We, as management of Kentucky Bancshares, Inc. and its subsidiaries, are responsible for establishing and maintaining adequate internal control over financial reporting. Pursuant to the rules and regulations of the Securities and Exchange Commission, internal control over financial reporting is a process designed by, or under the supervision of, the company’s principal executive and principal financial officers, or persons performing similar functions, and effected by the company’s board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles and includes those policies and procedures that:
● Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the company;
● Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the Company; and
● Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements.
All internal control systems, no matter how well designed, have inherent limitations, including the possibility of human error and the circumvention of overriding controls. Accordingly, even effective internal control can provide only reasonable assurance with respect to financial statement preparation. Further, because of changes in conditions, the effectiveness of internal control may vary over time.
Because of the inherent limitations, any system of internal control over financial reporting, no matter how well designed, may not prevent or detect misstatements due to the possibility that a control can be circumvented or overridden or that misstatements due to error or fraud may occur that are not detected. Also, projections of the effectiveness to future periods are subject to the risk that the internal controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies and procedures included in such controls may deteriorate.
Management has evaluated the effectiveness of its internal control over financial reporting as of December 31, 2020 based on the control criteria in the 2013 COSO Framework issued by the Committee of Sponsoring Organizations (“COSO”) of the Treadway Commission. Based on such evaluation, we have concluded that Kentucky Bancshares’ internal control over financial reporting is effective as of December 31, 2020.

---

ITEM 9B. OTHER INFORMATION
Item 9B. Other Information
None
PART III

---

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Item 10. Directors and Executive Officers and Corporate Governance
Set forth below is information about our executive officers who do not serve as Directors, including their business experience for at least the past five years and their ages as of February 28, 2021.
Name
Age
Position with the Company
James B. Braden
Executive Vice President, Chief Operations
Officer. Previously Chief Administration Officer from 2013 to 2017 and Director of Risk Management
from 2010 to 2012. Also, previously a Senior Manager
at a national public accounting firm serving
financial institutions.
Brenda S. Bragonier
Senior Vice President, Director of Marketing
since 1999.
Carol Caskey
Senior Vice President, Director of Human Resources
since 2011. Previously an Associate Relations
Consultant at a national health insurance
carrier.
Gregory J. Dawson
Senior Vice President, Chief Financial Officer
since 1989.
Shane Foley
Excecutive Vice President, Director of Retail Banking. Previously Vice President of Mortgage Lending from 2004 -2007 and Vice President of Commercial Lending from 2007-2019.
Norman J. Fryman
Executive Vice President, Chief Credit Officer
since 2010. Director of Sales and Service
from 2004 to 2009.
Christopher Gorley
Senior Vice President, Director of Operations
since 2013. Previously a Vice President and
Chief Operations Officer with a community bank.
Director Compensation.
We use a combination of cash and equity-based incentive compensation to attract and retain qualified candidates to serve on our Board of Directors. Additionally, each director of the Company is also a director of Kentucky Bank, our operating subsidiary. In setting director compensation, we consider the significant amount of time directors expend in fulfilling their duties to the Company as well as the skill-level required by the Company to be an effective member of the Board.
The form and amount of director compensation is reviewed by the Compensation Committee, which makes recommendations to the full Board.
Cash Compensation. Each Director receives an annual fee of $18,000 ($12,000 to be paid in stock-see below) and a fee of $800 for attending each Kentucky Bank board meeting, including $800 for one paid absence per year. The
Chairman of the Board receives an additional $7,000 retainer per year. The Audit Committee Chair receives an additional annual fee of $7,500 and the Compensation Committee Chair receives an additional annual fee of $5,000. Each other Committee Chair receives an additional annual fee of $2,500. Audit Committee members receive $700 for each committee meeting.
Non-employee Directors receive a fee of $250 for attending each Loan Committee meeting of Kentucky Bank and a fee of $500 for all other committee meetings (excluding Audit Committee meetings) of the Company and of Kentucky Bank that he or she attends (for which he or she is a member).
Equity-Based Compensation. Prior to July 2015, non-employee Directors received equity-based compensation in the form of restricted stock under our 2009 Stock Award Plan following each year in which Kentucky Bank had a return on assets of one percent (1%) or greater. Twenty percent of each grant vests annually on the anniversary date of the grant (assuming the recipient is still a director). Vesting expires 90 days after termination of directorship and one (1) year after death, disability or retirement. Upon a change of control, any restriction period will expire immediately and the director will hold the restricted stock free of any restrictions. In 2020, no shares were granted under this formula.
Non-employee Directors receive equity-based compensation in the form of stock under our 2019 Stock Award Plan equivalent to approximately $12,000 for part of their annual retainer. For service on the board in 2020, we granted 580 shares of stock to each of our Directors, except Mr. Prichard.
2020 Director Summary Compensation Table
The table below summarizes the total compensation paid to or earned by our non-employee Directors and Mr. Caudill (employee) during 2020. The compensation of Mr. Prichard is reflected in the Summary Compensation Table under Executive Compensation.
Fees Earned
or Paid
Stock
Option
All Other
Name of Director
in Cash (1)
Awards (2)
Awards
Compensation (3)
Total
Shannon B. Arvin
$
19,000
$
10,011
-
$
-
$
29,011
B. Proctor Caudill, Jr.
30,050
10,011
-
-
$
40,061
Henry Hinkle
26,850
10,011
-
-
36,861
Mary McDowell Hoskins
21,050
10,011
-
-
31,061
Ted McClain
25,850
10,011
-
-
35,861
Jack W. Omohundro
32,500
10,011
-
-
42,511
Edwin S. Saunier
40,950
10,011
-
-
50,961
Robert G. Thompson
41,500
10,011
-
-
51,511
Woodford Van Meter
24,500
10,011
-
6,000
40,511
(1) Includes fees paid for serving as a director of Kentucky Bank and attending committee meetings of Kentucky Bank of which he or she is a committee member.
(2) The amounts under this column represent the aggregate grant date fair value of the shares of our common stock that we granted each Director as partial payment for their director fees computed in accordance with FASB ASC Topic 718. The aggregate number of shares granted to each of director, except Mr. Prichard, in 2020 is as follow: Mmes. Arvin and Hoskins, and Messrs. Caudill, Hinkle, McClain, Omohundro, Saunier, Thompson, and Van Meter - 426 each.
(3) As described in “Transactions with Related Persons,” Mr. McClain is a partial owner of The Hopewell Company, Inc., which in 2020 received $393,149 from the Company. The amounts attributed to premium payments are directly passed through to insurance companies that issued the insurance policies we bought. The amount retained by the company for services was less than $200,000. Because these fees are not paid directly to Mr. McClain, we have not included them in the table. The amount paid to Mr. Van Meter reflects the amount we paid him for parking lot rent.
Directors.
Classified Board. Under our Amended and Restated Articles of Incorporation, our Board of Directors consists of three different classes (Class I, Class II, and Class III) as nearly equal in number as the then total number of directors constituting the Board permits.
Term; Vacancies. The directors in each class serve for a term of three years, and one class is elected annually. Any vacancies that occur after the directors are elected may be filled by the Board of Directors in accordance with law for the remainder of the full term of the vacant directorship.
Independence of Directors. In accordance with rules of NASDAQ, all of the nominees for director, and all continuing directors listed below, fully meet the NASDAQ definition of “independent” except for Mrs. Arvin, and Messrs. Caudill and Prichard (see discussion below under “Corporate Governance - Board and Committee Independence”).
Director Qualifications. Our Board of Directors currently consists of ten members who are well-qualified to serve on our board and represent our shareholders’ best interests. The Company does not have a formal policy with respect to diversity; however, the Board believes that it is essential that the Board members represent diverse viewpoints. Our directors are selected with a view of establishing a board of directors that meet the criteria for qualified candidates that is set forth above under the caption “Corporate Governance - General Director Qualifications.” We believe that each of the directors bring these qualifications to our Board of Directors. Our directors provide our Board with a diverse complement of specific business skills, experience and perspectives, including: extensive financial and accounting expertise, knowledge of the commercial banking industry, experience with companies that serve the same communities that our various bank subsidiaries serve, and extensive operational and strategic planning experience. The following describes the key qualifications, business skills, experience, and perspectives that each of our directors brings to the Board of Directors, in addition to the general director qualifications under “Corporate Governance - General Director Qualifications” and information included in the biographical summaries provided below for each director. We believe that each individual’s skills and perspectives strengthen our Board’s collective qualifications, skills and experience.
Name
Qualifications
Shannon B. Arvin
Extensive executive management and financial experience as a former member attorney of a law practice and current president and CEO of an internationally known Thoroughbred racecourse and auction house; extensive knowledge of local communities including service on numerous local boards of various civic and professional organizations.
B. Proctor Caudill, Jr.
Extensive banking career beginning in 1973; significant executive management experience in banking industry; knowledge of local communities including service on numerous local boards of various civic and professional organizations; in-depth knowledge of the Company’s business, strategy and management team.
Henry Hinkle
Extensive executive management and financial experience as owner and president of a paving and construction company; extensive knowledge of local communities including service on numerous local boards of various civic and professional organizations; in-depth knowledge of the Company’s business, strategy and management team from serving as a director of Kentucky Bank since 1989.
Mary McDowell Hoskins
Extensive executive management and financial experience as president of an architect and engineer business; extensive knowledge of local communities including service on numerous local boards of various civic and professional organizations.
Ted McClain
Extensive risk management, financial and operations skills and general business experience through ownership of an insurance company.
Jack W. Omohundro
Extensive financial, operational and general business skills as a Certified Public Accountant (CPA), MBA and degree in accounting; extensive knowledge of local communities including service on numerous local boards of various civic and professional organizations.
Louis Prichard
Extensive banking career beginning in 1977; significant executive management experience in banking industry; knowledge of local communities including service on numerous local boards of various civic and professional organizations; in-depth knowledge of the Company’s business, strategy and management team.
Edwin S. Saunier
Extensive executive management and financial experience as owner and president of a moving and storage business; degree in accounting; extensive knowledge of local communities including service on numerous local boards of various civic and professional organizations.
Robert G. Thompson
Extensive management, financial, operational and general business skills as a business entrepreneur in the farming and thoroughbred industry; extensive knowledge of local communities including service on numerous local boards of various civic and professional organizations; in-depth knowledge of the Company’s business, strategy and management team from serving as a director of Kentucky Bank since 1991.
Woodford Van Meter
Comprehensive business management experience as a managing physician of an ophthalmology practice; extensive analytical and planning skills as a Professor of Ophthalmology for a medical school; in-depth knowledge of the Company’s business, strategy and management team.
Name of Director
Age
Principal Occupations, Other Public
Directorships and Positions with the Company (1)
Year
First Elected
a Director
Class I
Directors Whose Terms Expire 2021
Shannon B. Arvin
President and CEO of Keeneland Association, Inc., Director of Kentucky Bank since 2020.
Ted McClain
Insurance agent and partial owner of The Hopewell Company, Inc. Director of Kentucky Bank since 2002.
Edwin S. Saunier
President of Saunier North American, Inc., a moving and storage company. Director of Kentucky Bank since 2007.
Class II
Directors Whose Terms Expire 2022
B. Proctor Caudill, Jr.
Special Projects Manager of the Company since 2006. President and CEO of Peoples Bancorp of Sandy Hook, Inc. from 1981 to 2006 and President from 1999 to 2006. CEO of Peoples Bank, (Sandy Hook, Kentucky) from 1981 to 2006.
Louis Prichard
President and CEO of the Company and Kentucky Bank since 2004. President and Chief Operating Officer of the Company and Kentucky Bank from 2003 to 2004. Director of Kentucky Bank since 2003.
Woodford Van Meter
Ophthalmologist. Director of Kentucky Bank since 2004.
Class III
Directors Whose Terms Expire in 2023
Henry Hinkle
CEO/Treasurer of Hinkle Holding Company, LLC. Director of Kentucky Bank since 1989.
Mary McDowell Hoskins
President of Gray Architects & Engineers, PSC, Director of Kentucky Bank since 2019.
Jack W. Omohundro
Secretary/Treasurer of The Allen Company. Director of Kentucky Bank since 2016.
Robert G. Thompson
Farmer and thoroughbred horse breeder. Director of Kentucky Bank since 1991.
(1) Kentucky Bank is our operating subsidiary. We acquired Peoples Bancorp of Sandy Hook Inc. and Peoples Bank, (Sandy Hook, Kentucky) in 2006.
None of the nominees or continuing directors is a director of any company with a class of securities registered with the Securities and Exchange Commission pursuant to Section 12 of the Securities Exchange Act of 1934 or subject to the requirements of Section 15(d) of that Act, or any company registered as an investment company under the Investment Company Act of 1940.
Corporate Governance.
Code of Ethics. Ethical business conduct is a shared value of our Board of Directors, management and employees. Our Code of Ethics applies to our employees and officers, including the principal executive officer and principal financial officer.
Our Code of Ethics covers all areas of professional conduct including, but not limited to, conflicts of interest, disclosure obligations, insider trading and confidential information, as well as compliance with all laws, rules and regulations applicable to our business. We encourage all employees, officers and directors to promptly report any violations of the Code of Ethics to the appropriate persons identified in the Code of Ethics. A copy of our Code of Ethics is available at our website www.kybank.com in the section entitled “About Us” under “Investor Relations” in the “Corporate Information - Governance Documents” subsection.
Board Structure and Committees. As of February 26, 2021, our Board of Directors consists of ten (10) members. Our Board of Directors held eight meetings during 2020, consisting of eight regularly scheduled meetings. All directors, except Mrs. Arvin, Mr. Hinkle, and Mrs. Hoskins, attended at least 75% of the total number of board meetings and the meetings of the committees to which they belonged. Our Board of Directors does not have a specific policy for director attendance at our Annual Meeting of shareholders. Three of our directors attended our 2020 Annual Meeting of shareholders.
Our Board of Directors has a standing Compensation Committee and Audit Committee but does not have a standing nominating committee.
Compensation
Committee Members
Functions of the Committee
Meetings
in 2020
Edwin S. Saunier
(Chairman)
Henry Hinkle
Ted McClain
Determines compensation of our executive officers and oversees our assessment of whether our compensation practices are reasonably likely to expose the Company to material risks
Audit
Committee Members *
Functions of the Committee
Meetings
in 2020
Robert G. Thompson
(Chairman)
Jack W. Omohundro
Edwin S. Saunier
Monitors the integrity of our financial reporting processing and systems of internal controls regarding finance, accounting, and legal compliance
Selects our independent auditor and determines such auditor’s compensation
Monitors the independence and performance of the independent auditor, management, and the internal audit department
Provides an avenue of communication among the independent auditors, management, the internal audit department, and the Board of Directors
Pre-approves, if appropriate, all related party transactions
Oversees ethical and regulatory compliance
Committee Charters. Our Audit Committee and Compensation Committee have charters, which are available at our website www.kybank.com in the section entitled “About Us” under “Investor Relations” in the “Corporate Information - Governance Documents” subsection.
The Board of Directors does not limit the number of audit committees for other corporations on which its audit committee members may serve. None of the committee members currently serves on another audit committee for a publicly-held entity.
Board and Committee Independence. The Board has determined that each of its members is fully independent as defined by the rules of NASDAQ except for the current directors: Mr. Caudill, Mr. Prichard, and Mrs. Arvin. While our Board determined that Mr. McClain and Mr. Van Meter are each independent under the rules of NASDAQ, it did have to consider the Company’s payments to their companies. Mr. McClain owns 40% of The Hopewell Company, Inc.,
which is a family business. The aggregate amount the Company paid to The Hopewell Company, Inc. for property or services during each of 2020, 2019 and 2018 did not exceed the greater of $200,000 or 5% of Hopewell Insurance Company’s consolidated gross revenues for the applicable fiscal year. Mr. Van Meter is the sole owner of a company that rents parking space to us. The aggregate amount the Company paid to Mr. Van Meter’s company was below the $120,000 threshold set by NASDAQ. Respecting Mrs. Arvin, the Company also considered the Company’s payments to Stoll Keenon Ogden PLLC, a law firm in which Mrs. Arvin previously was a member. Since Mrs. Arvin was previously a member (i.e. partner) of Stoll Keenon Ogden PLLC, which received payments during 2020 from the Company for legal services rendered, Mrs. Arvin was ineligible to serve on the Company’s audit committee. However, in determining whether Mrs. Arvin was considered independent for purposes other than the audit committee, the Company looked to whether payments made to Stoll Keenon Ogden PLLC in 2020 exceeded the greater of $200,000 or 5% of Stoll Keenon Ogden PLLC’s gross revenues.
Audit Committee Financial Expert. Our Board of Directors has determined that each of the members of the Audit Committee is independent as defined by the rules of NASDAQ for audit committee members. Further, our Board of Directors has determined (in accordance with Securities and Exchange Commission Regulation S-K 407(d)) that Mr. Jack W. Omohundro satisfies the qualifications of financial expert and Mr. Omohundro accordingly has been designated as the Audit Committee financial expert.
General Director Qualifications. Board members must possess the acumen, education and experience to make a significant contribution to the Board, and bring a diverse range of skills and perspectives to satisfy the perceived needs of the Board at a particular time. Board members must have the highest ethical standards, a strong sense of professionalism, independence and an understanding of our business. Additionally, Board members must have the aptitude and experience to fully appreciate the legal responsibilities of a director and the governance processes of a public company, a willingness to commit, as well as have, sufficient time to discharge their duties to the Board and such other factors as the independent members of the Board of Directors determine are relevant in light of the needs of the Board and the Company.
Communications with the Board. Our Board of Directors has established a process for shareholders to communicate with the Board or an individual director. Shareholders may contact the Board or an individual director by writing to the attention of one or more directors at our principal executive offices at Kentucky Bancshares, Inc., 339 Main Street, Paris, Kentucky 40361, Attention: Gregory J. Dawson, Secretary. Each communication intended for the Board of Directors or an individual director will be forwarded to the specified party.
Board Leadership Structure and Role in Risk Oversight. We are a financial holding company effective June 26, 2014 (previously a bank holding company) that was formed in 1981 under the Bank Holding Company Act of 1956, as amended. We are the parent company of Kentucky Bank, a separately chartered commercial state bank, and KBI Insurance Company, Inc., a captive insurance company.
Our Board is comprised of seven independent directors, one employee director, and two directors who are not independent. We are committed to a strong, independent Board and believe that objective oversight of the performance of our management is a critical aspect of effective governance. Accordingly, the role of Chairman of the Board and Chief Executive Officer (“CEO”) are held by different individuals. Our Chairman has the following duties:
● Chair and preside at Board meetings;
● Coordinate with our CEO in establishing the agenda and topic items for Board meetings;
● Advise on the quality, quantity, and timeliness of the flow of information from management to the Board;
● Act as principal liaison between management and the Board on sensitive issues;
● Retain independent advisors on behalf of the Board as the Board may determine is necessary or appropriate;
● Assist the Compensation Committee with the annual evaluation of the performance of the CEO; and
● Provide an important communication link between the Board and shareholders, as appropriate.
Our Board of Directors, together with the Audit and Compensation Committees of the Board, coordinate with each other to provide enterprise-wide oversight of our management and handling of risk. These committees report regularly to the entire Board of Directors on risk-related matters and provide our Board of Directors with integrated insight about our management of strategic, credit, interest rate, financial reporting, technology, liquidity, compliance, operational, and reputational risks.
In addition Kentucky Bank has its own board of directors, audit, IT and asset liability management committees, which provide risk management. Our CEO serves on the board of Kentucky Bank. One of the key responsibilities of the subsidiary board is to manage strategic, credit, interest rate, financial reporting, technology, liquidity, compliance, operational, and reputational risks. While we have not developed an enterprise-wide risk statement, our Board of Directors believes that sound credit underwriting to manage credit risk, and a conservative investment portfolio to manage liquidity, and interest rate risk contribute to an effective oversight of the Company’s risk, and we require our subsidiaries to follow this philosophy.

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ITEM 11. EXECUTIVE COMPENSATION
Item 11. Executive Compensation
Executive Compensation.
The Company qualifies as a Smaller Reporting Company under SEC rules. As a Smaller Reporting Company, we are permitted to provide reduced disclosure in this annual report, including those relating to executive compensation. Accordingly, we have omitted certain disclosures on those matters. Among other things, we are no longer required to have a Compensation Discussion and Analysis. However, we recognize the importance of transparency and, in some cases, have chosen to provide many of the compensation-related disclosures required for larger public companies and that we historically provided.
Compensation of Named Executive Officers.
Summary Compensation Table
The table below summarizes the total compensation paid to or earned by our CEO, and the next two (2) most highly compensated executive officer other than the CEO, and these individuals are collectively referred to as the “Named Executive Officers.“
Summary Compensation Table
Non-Equity
Incentive
Stock
Plan
All Other
Name & Position
Year
Salary
Bonus
Awards (1)
Compensation (2)
Compensation (3)
Total
Louis Prichard
$
375,767
$
-
$
62,397
$
111,377
$
47,598
$
597,139
President, CEO
349,569
-
21,150
129,288
44,758
544,765
James B. Braden
228,050
-
38,132
51,995
16,136
334,313
Exec VP, Chief Operating Officer
199,309
-
12,925
56,703
15,103
284,040
Norman J. Fryman
221,752
-
38,132
50,559
39,534
349,977
Exec VP, Chief Credit Officer
207,300
-
12,925
58,977
40,574
319,776
(1) The amounts under this column represent the aggregate grant date fair value of the restricted stock that we granted each of our Named Executive Officers computed in accordance with FASB ASC Topic 718. The restricted stock will vest ratably over a five-year period. The grant date fair value of each restricted stock awarded in 2018 was $23.025, in 2019 was $23.50 and in 2020 was $23.11.
(2) Represents cash payments from satisfaction of the performance goals under the MIP plan. See discussion under “Performance-Based Incentive Compensation”.
(3) The amounts reflected in this column for the Named Executive Officers include premiums paid for life insurance, a car allowance for Mr. Prichard, the Company’s matching contributions of the first 6% of voluntarily deferred salary contribution into his 401(k) plan (which was $26,000 for Mr. Prichard), director fees of $15,600 for Mr. Prichard, and the transition credit amounts from the termination of the pension plan for Mr. Fryman. For a discussion of the transition credit payment see “Long-Term Incentive Compensation: Profit Sharing (401k) Plan”.
Base Salary. We provide our Named Executive Officers and other employees with base salary to compensate them for services rendered during the fiscal year. Base salary ranges for Named Executive Officers are determined for each executive based on his or her position and responsibility. Salary levels are typically considered annually as part of our performance review process as well as upon a promotion or other change in job responsibility.
Performance-Based Incentive Compensation. The Management Incentive Plan (“MIP”) was created to promote continual high performance by officers of the Company through achievement of corporate goals and encouragement of growth of shareholder value. The MIP includes various incentive levels based on the participant’s accountability and impact on our operations, with target award opportunities that are established as a percentage of base salary. These maximum targets range from 50% of base salary to 65% of base salary for the Named Executive Officers.
Long-Term Incentive Compensation:
2019 Stock Award Plan. The 2019 Stock Award Plan, approved by the Company’s stockholders on May 21, 2019, is intended to help us enhance the link between the creation of shareholder value and long-term executive incentive compensation, to provide an opportunity for increased equity ownership by executives and to maintain competitive levels of total compensation. Under this plan, our Board and the Committee have the ability to issue stock options, stock appreciation rights, restricted stock and other stock-based awards.
Twenty percent of each grant vests annually on the anniversary date of the grant (assuming the recipient is still in our employ). Upon a change of control, death, disability or retirement (assuming the individual has reached the age of 65 or greater when he or she retires) any restriction period will expire immediately and the employee will hold the restricted stock free of any restrictions. Upon any other termination of employment, nonvested awards are immediately forfeited.
These awards are reflected in the Summary Compensation Table for our Named Executive Officers.
2009 Stock Award Plan. The 2009 Stock Award Plan, which expired in May 2019, was intended to help us enhance the link between the creation of shareholder value and long-term executive incentive compensation, to provide an opportunity for increased equity ownership by executives and to maintain competitive levels of total compensation. Under this plan, our Board and the Committee have the ability to issue stock options, stock appreciation rights, restricted stock and other stock-based awards.
Twenty percent of each grant vests annually on the anniversary date of the grant (assuming the recipient is still in our employ). Upon a change of control, death, disability or retirement (assuming the individual has reached the age of 65 or greater when he or she retires) any restriction period will expire immediately and the employee will hold the restricted stock free of any restrictions. Upon any other termination of employment, nonvested awards are immediately forfeited.
These awards are reflected in the Summary Compensation Table for our Named Executive Officers.
Retirement Plan & Trust. The Retirement Plan & Trust (the “Plan”) was terminated at December 31, 2008. The Company made distributions under the Plan and the distribution amounts made to Plan participants were based upon amendments made to the Pension Protection Act of 2006 and the Internal Revenue Code of 1986, as amended. In connection with the termination of the Plan, employees had the choice of choosing to receive their distributions as a rollover to their 401(k) plans or to IRAs, or they could choose to receive cash or an annuity. Additionally, employees who had more than 50 years of combined age plus years of service as of December 31, 2008 received additional distribution credits (“transition credit amounts”), which have been and will continue to be paid through the 401k Plan. Finally, Plan participants also had the option to rollover their additional $1.5 million Plan termination distributions to a 401(k) or IRA, or to receive cash.
Profit Sharing (401k) Plan. Our Profit Sharing (401k) Plan is available to all employees, including the Named Executive Officers. We match 100% of the first 6% of pay that is contributed by an employee to the plan. All employee contributions to the plan are fully-vested upon contribution, and matching contributions are vested after 3 years of service. We may, at our discretion, make a profit sharing contribution to the plan. We have not made a profit sharing contribution since we added the 401(k) feature to the plan. Due to the termination of the Retirement Plan mentioned
above, transition credits will be earned by employees who have more than 50 years of combined age plus years of service as of December 31, 2008 and this will be paid through the 401k Plan.
Outstanding Equity Awards Table
Outstanding Equity Awards at December 31, 2020
Stock Awards (1)
Market Value of
Number of Shares
Shares or
Grant
Or units of stock
Or units of stock
Name
Date
That have not vested
That have not vested
Louis Prichard
3/1/20
5,490
$
113,643
3/1/19
2,465
51,026
1/2/18
8,694
1/3/17
5,796
1/4/16
2,898
James B. Braden
3/1/20
2,630
54,441
3/1/19
19,872
1/2/18
4,099
1/3/17
2,732
1/4/16
1,366
Norman J. Fryman
3/1/20
2,280
47,196
3/1/19
15,836
1/2/18
4,099
1/3/17
2,732
1/4/16
1,366
(1) The shares of restricted common stock vest ratably over a five-year period for grants prior to 2019. For 2020 and 2019 grants, a portion of the shares of restricted common stock vest ratably over a two-year period . The shares that vest over the two-year period are as follows: Mr. Prichard - 2,790 shares for 2020 and 1,745 shares for 2019, Mr. Braden - 980 shares for 2020 and 520 shares for 2019, and Mr. Fryman - 630 shares for 2020 and 325 shares for 2019. In the event of a change in control of the Company, any restrictions will expire immediately and the employee will thereafter hold the shares of common stock without any restrictions.

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ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Stock Ownership of Directors and Executive Officers.
We believe it is important for our Directors and executive officers to align their interests with the long-term interests of our shareholders. Although we have encouraged stock accumulation through the grant of equity incentives to our directors and executive officers, we have not historically required our directors and executive officers to own shares of our common stock. With our revised director compensation plan, our Directors have begun receiving shares of our common stock as part of their annual compensation.
See Part II, Item 5, for information about securities authorized for issuance under the Company’s equity compensation plans.
Except as otherwise indicated below, the table below shows the amount of our common stock each of our Directors and Named Executive Officers (as defined in the Executive Compensation section below) owned on February 26, 2021. Unless otherwise indicated, all shares shown are held with sole voting and investment power.
Number of
Number of
Shares
Total Number
Shares Not
Subject to
of Shares
Subject to
Exercisable
Beneficially
Percent of
Name of Beneficial Owner
Options
Options (1)
Owned (2)
Class (3)
Shannon B. Arvin
1,006
-
1,006
*
James B. Braden
9,260
-
5,692
*
B. Proctor Caudill, Jr.(4)
242,556
-
242,556
4.1
%
Norman J. Fryman
4,940
-
1,987
*
Henry Hinkle (5)
94,463
-
94,463
1.6
%
Mary McDowell Hoskins (6)
3,006
-
3,006
*
Ted McClain (7)
34,221
-
34,221
*
Jack W. Omohundro
4,206
-
4,206
*
Louis Prichard (8)
21,559
-
14,124
*
Edwin S. Saunier (9)
8,423
-
8,423
*
Robert G. Thompson (10)
14,623
-
14,623
*
Woodford Van Meter (11)
72,181
-
72,181
1.2
%
Other Executive Officers
55,940
-
39,634
*
Directors and Executive Officers as a group
565,463
-
540,442
9.1
%
*
Ownership is less than 1.0%
(1) Shares of common stock attributed to a named person by virtue of options exercisable currently or within sixty days of March 2, 2021.
(2) Total number of shares beneficially owned does not include the following non-vested shares of restricted stock:
Number of Shares of
Name of Beneficial Owner
Restricted Common Stock
Executive Officers
James B. Braden
3,568
Norman J. Fryman
2,953
Louis Prichard
7,435
Executive Officers as a group
25,021
(3) Based on 5,961,376 shares of our common stock outstanding as of February 26, 2021.
(4) Includes 39,450 shares held of record by Mr. Caudill’s wife, as to which Mr. Caudill’s disclaims beneficial ownership.
(5) Includes 360 shares held by Mr. Hinkle’s wife, as to which Mr. Hinkle disclaims beneficial ownership. Includes 84,560 shares held of record by Hinkle Holding Company, LLC, as to which Mr. Hinkle, as president, has shared voting power.
(6) Includes 2,000 shares held by a trust, as to which Mrs. Hoskins disclaims beneficial ownership.
(7) Includes 2,000 shares held of record by The Hopewell Company, Inc., as to which Mr. McClain, as a 40% owner and officer, has voting power.
(8) Includes 5,174 shares held by a trust, as to which Mr. Prichard disclaims beneficial ownership.
(9) Includes 1,600 shares held in a retirement account.
(10) Includes 800 shares held of record by Mr. Thompson’s wife, as to which Mr. Thompson disclaims beneficial ownership.
(11) Includes 6,400 shares held of record by Mr. Van Meter’s wife, as to which Mr. Van Meter disclaims beneficial ownership.

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ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Item 13. Certain Relationships and Related Transactions, and Director Independence
Transactions with Related Persons.
Our operating subsidiary, Kentucky Bank, has had and expects in the future to have banking transactions in the ordinary course of business with our directors and executive officers and their affiliates. All loans to and deposits from such persons or their affiliates have been on substantially the same terms, including interest rates and collateral on loans, as those prevailing at the same time for comparable transactions with other persons not related to the lender, and, in the opinion of management, have not involved more than the normal risk of collectability or other unfavorable features.
Additional information concerning transactions with related persons is hereby incorporated by reference to Note 4 and Note 8 of our December 31, 2020 audited consolidated financial statements filed on Form 10-K.
Our practice has been that any transaction that would require disclosure under Item 404 of Regulation S-K of the rules and regulations of the Securities and Exchange Commission, with respect to a director or executive officer, must be reviewed and approved, or ratified, annually by the Board of Directors. Any such related party transactions will only be approved or ratified if the Board determines that such transaction will not impair the involved person’s service to, and exercise of judgment on behalf of, the Company, or otherwise create a conflict of interest that would be detrimental to the Company. The transaction relating to Mr. McClain described below have been reviewed and approved or ratified by our Board.
The Company paid The Hopewell Company, Inc., a Kentucky corporation, $393,149 in 2020 and $216,286 in 2019. The amounts attributed to premium payments are directly passed through to the insurance companies that issued the insurance policies we bought. Mr. McClain owns 40% of The Hopewell Company, Inc. and is also a director of the company. The aggregate amount retained by The Hopewell Company, Inc. for property or services during each of 2020 and 2019 did not exceed the lesser of $120,000 or 1% of the Company’s total assets at year-end.

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ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
Item 14. Principal Accountant Fees and Services
Fees of Independent Registered Public Accounting Firm.
Preapproval Policies and Procedures. The Audit Committee’s policy is to approve in advance all audit fees and terms and non-audit services permitted by law to be provided by the external auditors. In accordance with that policy, the committee annually pre-approves a list of specific services and categories of services, including audit, audit-related and non-audit services described below, for the upcoming or current fiscal year, subject to specified cost levels. Other services include:
● Consultation regarding financial accounting and reporting standards;
● Discussions related to accounting for proposed acquisitions;
● Discussions regarding regulatory requirements;
● Consultation concerning tax planning strategies; and
● Audits of benefit plans.
Since the May 2003 effective date of the SEC rules stating that an auditor is not independent of an audit client if the services it provides to the client are not appropriately approved, each service provided by our independent registered public accounting firm has been approved in advance by the Audit Committee. None of those services required use of the de minimis exception to preapproval contained in the SEC’s rules.
Fees and Related Disclosures for Accounting Services. The aggregate fees we incurred for professional services rendered by Crowe were as follows:
Audit fees - Fees for the consolidated financial statement audit, review of the Company's Form 10-Q's and HUD audit were $275,000 for 2020 and $250,000 for 2019.
Audit related fees - Aggregate fees for all assurance and related services were $15,000 for 2020 and $14,500 for 2019. These fees were incurred for audits of benefit plans in 2020 and 2019.
Tax fees - Fees related to tax compliance, advice and planning were $50,425 for 2020 and $25,600 for 2019.
All services provided by Crowe in 2020 and 2019 were approved by the Audit Committee. All fees were approved in accordance with the preapproval policy. The Audit Committee has determined that the provision of the services described above is compatible with maintaining the independence of the external auditors.
Part IV

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ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
Item 15.Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a)(1) Financial Statements
The following financial statements are included in Item 8 of this Form 10-K.
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets
Consolidated Statements of Income
Consolidated Statements of Comprehensive Income
Consolidated Statements of Changes in Stockholders’ Equity
Consolidated Statements of Cash Flow
Notes to Consolidated Financial Statements
(a)(2) Financial Statement Schedules.
All financial statement schedules have been omitted as the required information is inapplicable or the required information has been included in the Consolidated Financial statements or notes thereto.
(a)(3) Exhibits
Reference is made to the Exhibit Index beginning on Page E-1 hereof.
Kentucky Bancshares, Inc.
Exhibit Index
2.1
Agreement and Plan of Merger with Peoples Bancorp of Sandy Hook is incorporated by reference to Exhibit 2.1 of the Registrant’s Current Report on Form 8-K dated February 24, 2006.
2.2
Agreement and Plan of Share Exchange with Madison Financial Corporation is incorporated by reference to Exhibit 99.1 of the Registrant’s Current Report on Form 8-K dated January 21, 2015.
2.3
Agreement and Plan of Merger with Stock Yards Bancorp, Inc. is incorporated by reference to Exhibit 2.1 of the Registrant’s Current Report on Form 8-K dated January 27, 2021.
3.1
Amended and Restated Articles of Incorporation of the Registrant are incorporated by reference to Exhibit 3.1 of the Registrant’s Quarterly Report on Form 10-Q for the quarterly period ending March 31, 2000.
3.2
Bylaws of the Registrant are incorporated by reference to Exhibit 3.1 of the Registrant’s Current Report on Form 8-K dated November 21, 2007.
3.3
Articles of Amendment to Amended and Restated Articles of Incorporation of the Registrant are incorporated by reference to Exhibit 3.3 of the Registrant’s Annual Report on Form 10-K for the period ending December 31, 2005 and filed March 29, 2006.
3.4
Second Amended and Restated Articles of Incorporation of the Registrant are incorporated by reference to Exhibit 3.1 of the Registrant’s Current Report on Form 8-K filed dated December 4, 2019.
4.1
Description of Kentucky Bancshares capital stock.
10.1
Kentucky Bancshares, Inc. 1993 Non-Employee Directors Stock Ownership Incentive Plan is incorporated by reference to Exhibit 10.3 of the Registrant’s Registration Statement on Form S-4 (File No. 33-96358).
10.3
Employment Agreement for Louis Prichard as incorporated by reference to the Registrant’s Current Report on Exhibit 10.1 of the Registrant’s Current Report on Form 8-K dated April 3, 2008.
10.4
2005 Restricted Stock Grant Plan, including form of Award Agreement, as incorporated by reference to Exhibit 10.1 of the Registrant’s Current Report on Form 8-K dated February 22, 2005.
10.5
2009 Stock Award Plan, as incorporated by reference to Exhibit 10.1 of the Registrant’s Quarterly Report on Form 10-Q for the quarterly period ending June 30, 2009.
10.6
2019 Stock Award Plan, as incorporated by reference to Exhibit 4.1 of the Registrant’s on Form S-8 filed on December 20, 2019.
10.7
Prichard Agreement with Louis Prichard as incorporated by reference to the Registrant’s Current Report on Exhibit 10.1 of the Registrant’s Current Report on Form 8-K dated February 23, 2021.
Computation of earnings per share - See Note 14 in the notes to the consolidated financial statements included in Item 8.
Subsidiaries of Registrant
Consent of Crowe LLP
31.1
Certification of Chief Executive Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, as amended.
31.2
Certification of Chief Financial Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, as amended.
32.1
Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2
Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101 INS
Inline XBRL Instance Document
101 SCH
Inline XBRL Taxonomy Extension Scheme Document
101 CAL
Inline XBRL Taxonomy Extension Calculation Linkbase Document
101 DEF
Inline XBRL Taxonomy Extension Definition Linkbase Document
101 LAB
Inline XBRL Taxonomy Extension Label Linkbase Document
101 PRE
Inline XBRL Taxonomy Extension Presentation Linkbase Document
Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101)