Table of Contents
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
x
Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.
For the quarterly period ended March 31, 2014
OR
o
Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the transition period from to .
Commission file number 1-13661
STOCK YARDS BANCORP, INC.
(Exact name of registrant as specified in its charter)
Kentucky
61-1137529
(State or other jurisdiction of
(I.R.S. Employer
incorporation or organization)
Identification No.)
1040 East Main Street, Louisville, Kentucky 40206
(Address of principal executive offices including zip code)
(502) 582-2571
(Registrant’s telephone number, including area code)
S. Y. BANCORP, INC.
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act:
Large accelerated filer
Accelerated filer
Non-accelerated filer (Do not check if a smaller reporting company)
Smaller reporting company
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.). Yes o No x
The number of shares of the registrant’s Common Stock, no par value, outstanding as of April 25, 2014, was 14,661,509.
STOCK YARDS BANCORP, INC. AND SUBSIDIARY
Index
PART I — FINANCIAL INFORMATION
Item 1. Financial Statements
The following consolidated financial statements of Stock Yards Bancorp, Inc. and Subsidiary, Stock Yards Bank & Trust Company, are submitted herewith:
·
Consolidated Balance Sheets March 31, 2014 (Unaudited) and December 31, 2013
Consolidated Statements of Income for the three months ended March 31, 2014 and 2013 (Unaudited)
Consolidated Statements of Comprehensive Income for the three months ended March 31, 2014 and 2013 (Unaudited)
Consolidated Statements of Cash Flows for the three months ended March 31, 2014 and 2013 (Unaudited)
Consolidated Statements of Changes in Stockholders’ Equity for the three months ended March 31, 2014 and 2013 (Unaudited)
Notes to Consolidated Financial Statements
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Item 4. Controls and Procedures
PART II – OTHER INFORMATION
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Item 6. Exhibits
1
Consolidated Balance Sheets
March 31, 2014 and December 31, 2013
(In thousands, except share data)
March 31,
December 31,
2014
2013
(Unaudited)
Assets
Cash and due from banks
$
42,685
34,519
Federal funds sold
40,269
36,251
Mortgage loans held for sale
3,473
1,757
Securities available for sale (amortized cost of $440,104 in 2014 and $493,066 in 2013)
440,184
490,031
Federal Home Loan Bank stock
6,334
Other securities
1,013
Loans
1,728,619
1,721,350
Less allowance for loan losses
28,591
28,522
Net loans
1,700,028
1,692,828
Premises and equipment, net
39,258
39,813
Bank owned life insurance
29,416
29,180
Accrued interest receivable
5,658
5,712
Other assets
45,920
51,824
Total assets
2,354,238
2,389,262
Liabilities and Stockholders’ Equity
Deposits:
Non-interest bearing
436,843
423,350
Interest bearing
1,550,544
1,557,587
Total deposits
1,987,387
1,980,937
Securities sold under agreements to repurchase
52,453
62,615
Federal funds purchased
18,731
55,295
Accrued interest payable
125
128
Other liabilities
24,278
26,514
Federal Home Loan Bank advances
34,288
34,329
Total liabilities
2,117,262
2,159,818
Stockholders’ equity:
Preferred stock, no par value. Authorized 1,000,000 shares; no shares issued or outstanding
—
Common stock, no par value. Authorized 20,000,000 shares; issued and outstanding 14,658,954 and 14,608,556 shares in 2014 and 2013, respectively
9,749
9,581
Additional paid-in capital
34,614
33,255
Retained earnings
192,783
188,825
Accumulated other comprehensive income
(170
)
(2,217
Total stockholders’ equity
236,976
229,444
Total liabilities and stockholders’ equity
See accompanying notes to unaudited consolidated financial statements.
2
Consolidated Statements of Income
For the three months ended March 31, 2014 and 2013 (Unaudited)
(In thousands, except per share data)
Interest income:
19,359
19,049
79
80
31
64
Securities — taxable
1,837
1,370
Securities — tax-exempt
298
272
Total interest income
21,604
20,835
Interest expense:
Deposits
1,140
1,339
Fed funds purchased
6
8
34
35
196
217
Subordinated debentures
773
Total interest expense
1,376
2,372
Net interest income
20,228
18,463
Provision for loan losses
350
2,325
Net interest income after provision for loan losses
19,878
16,138
Non-interest income:
Investment management and trust services
4,568
3,886
Service charges on deposit accounts
2,103
2,000
Bankcard transaction revenue
1,075
961
Mortgage banking revenue
588
1,180
Brokerage commissions and fees
505
615
Bank owned life insurance income
236
252
Other
400
334
Total non-interest income
9,475
9,228
Non-interest expenses:
Salaries and employee benefits
11,118
9,657
Net occupancy expense
1,556
1,231
Data processing expense
1,560
1,356
Furniture and equipment expense
268
291
FDIC insurance expense
342
Gain on other real estate owned
(343
(35
3,043
2,729
Total non-interest expenses
17,544
15,579
Income before income taxes
11,809
9,787
Income tax expense
3,632
3,019
Net income
8,177
6,768
Net income per share:
Basic
0.56
0.49
Diluted
Average common shares:
14,506
13,814
14,701
13,851
3
Consolidated Statements of Comprehensive Income
(In thousands)
Other comprehensive income (loss), net of tax:
Unrealized gains (losses) on securities available for sale:
Unrealized gains (losses) arising during the period (net of tax of $1,091 and ($257), respectively)
2,026
(478
Unrealized gains on hedging instruments:
Unrealized gains arising during the period (net of tax of $12 and $0, respectively)
21
Other comprehensive income (loss)
2,047
Comprehensive income
10,224
6,290
4
Consolidated Statements of Cash Flows
Operating activities:
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation, amortization and accretion, net
1,688
1,465
Deferred income tax provision (benefit)
701
(1,152
Gain on sales of mortgage loans held for sale
(341
(867
Origination of mortgage loans held for sale
(17,617
(47,036
Proceeds from sale of mortgage loans held for sale
16,242
57,374
(236
(252
Gain on the disposal of premises and equipment
(30
Gain on the sale of other real estate
Stock compensation expense
290
531
Excess tax benefits from share-based compensation arrangements
(149
(18
Decrease in accrued interest receivable and other assets
514
1,430
(Decrease) increase in accrued interest payable and other liabilities
(2,090
1,716
Net cash provided by operating activities
7,156
22,249
Investing activities:
Purchases of securities available for sale
(69,855
(106,748
Proceeds from maturities of securities available for sale
123,072
129,192
Net increase in loans
(8,687
(18,649
Purchases of premises and equipment
(509
(350
Proceeds from disposal of equipment
344
Proceeds from sale of other real estate
3,962
1,778
Net cash provided by investing activities
48,327
5,223
Financing activities:
Net increase (decrease) in deposits
6,450
(44,809
Net (decrease) increase in securities sold under agreements to repurchase and federal funds purchased
(46,726
12,103
Proceeds from Federal Home Loan Bank advances
10,000
Repayments of Federal Home Loan Bank advances
(10,041
(10
Issuance of common stock for options and dividend reinvestment plan
463
61
149
18
Common stock repurchases
(519
(286
Cash dividends paid
(3,075
(2,792
Net cash used in financing activities
(43,299
(35,715
Net increase (decrease) in cash and cash equivalents
12,184
(8,243
Cash and cash equivalents at beginning of period
70,770
67,703
Cash and cash equivalents at end of period
82,954
59,460
Supplemental cash flow information:
Income tax payments
Cash paid for interest
1,379
2,398
Supplemental non-cash activity:
Transfers from loans to other real estate owned
1,137
99
5
Consolidated Statements of Changes in Stockholders’ Equity
Accumulated
Common stock
other
Number of
Additional
Retained
comprehensive
shares
Amount
paid-in capital
earnings
income
Total
Balance December 31, 2013
14,609
Other comprehensive income, net of tax
Stock issued for exercise of stock options and dividend reinvestment plan, net of withholdings to satisfy employee tax obligations upon vesting of stock awards
22
75
601
(23
653
Stock issued for non-vested restricted stock
48
160
987
(1,147
Cash dividends, $0.21 per share
Shares repurchased or cancelled
(20
(67
26
(560
Balance March 31, 2014
14,659
Balance December 31, 2012
13,915
7,273
17,731
174,650
5,421
205,075
Other comprehensive loss, net of tax
10
69
55
184
1,083
(1,267
Cash dividends, $0.20 per share
(15
(51
(296
Balance March 31, 2013
13,958
7,416
19,118
177,420
4,943
208,897
(1) Summary of Significant Accounting Policies
The accompanying unaudited consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q and do not include all information and footnotes required by U.S. generally accepted accounting principles (US GAAP) for complete financial statements. The consolidated unaudited financial statements of Stock Yards Bancorp, Inc. (“Bancorp”) and its subsidiary reflect all adjustments (consisting only of adjustments of a normal recurring nature) which are, in the opinion of management, necessary for a fair presentation of financial condition and results of operations for the interim periods.
The unaudited consolidated financial statements include the accounts of Stock Yards Bancorp, Inc. and its wholly-owned subsidiary, Stock Yards Bank & Trust Company (“Bank”). Significant intercompany transactions and accounts have been eliminated in consolidation. In preparing the unaudited consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of certain assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of related revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for loan losses, valuation of other real estate owned, income tax assets, and estimated liabilities and expense.
A description of other significant accounting policies is presented in the notes to the Consolidated Financial Statements for the year ended December 31, 2013 included in Stock Yards Bancorp, Inc.’s Annual Report on Form 10-K. Certain reclassifications have been made in the prior year financial statements to conform to current year classifications.
Interim results for the three month period ended March 31, 2014 are not necessarily indicative of the results for the entire year.
Critical Accounting Policies
Management has identified the accounting policy related to the allowance and provision for loan losses as critical to the understanding of Bancorp’s results of operations and discussed this conclusion with the Audit Committee of the Board of Directors. Since the application of this policy requires significant management assumptions and estimates, it could result in materially different amounts to be reported if conditions or underlying circumstances were to change. Assumptions include many factors such as changes in borrowers’ financial condition which can change quickly or historical loss ratios related to certain loan portfolios which may or may not be indicative of future losses. To the extent that management’s assumptions prove incorrect, the results from operations could be materially affected by a higher or lower provision for loan losses. The accounting policy related to the allowance for loan losses is applicable to the commercial banking segment of Bancorp.
The allowance for loan losses is management’s estimate of probable losses in the loan portfolio. Loan losses are charged against the allowance when management believes the uncollectability of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.
Prior to the third quarter of 2013, management measured the appropriateness of the allowance for loan losses in its entirety using (a) quantitative (historical loss rates) and qualitative factors (management adjustment factors); (b) specific allocations on impaired loans, and (c) an unallocated amount. The unallocated amount was evaluated on the loan portfolio in its entirety and was based on additional factors, such as national and local economic trends and conditions, changes in volume and severity of past due loans, volume of non-accrual loans, volume and severity of adversely classified or graded loans and other
7
factors and trends that affect specific loans and categories of loans, such as a heightened risk in the commercial and industrial loan portfolios. Bancorp utilized the sum of all allowance amounts derived as described above, including a reasonable unallocated allowance, as an indicator of the appropriate level of allowance for loan and lease losses.
During the third quarter of 2013, Bancorp refined its allowance calculation whereby it allocated the portion of the allowance that was previously deemed to be unallocated allowance based on management’s determination of the appropriate qualitative adjustment. This refined allowance calculation includes specific allowance allocations to loan portfolio segments at March 31, 2014 for qualitative factors including, among other factors, (i) national and local economic and business conditions, (ii) the quality and experience of lending staff and management, (iii) changes in lending policies and procedures, (iv) changes in volume and severity of past due loans, classified loans and non-performing loans, (v) potential impact of any concentrations of credit, (vi) changes in the nature and terms of loans such as growth rates and utilization rates, (vii) changes in the value of underlying collateral for collateral-dependent loans, considering Bancorp’s disposition bias, and (viii) the effect of other external factors such as the legal and regulatory environment. Bancorp may also consider other qualitative factors in future periods for additional allowance allocations, including, among other factors, changes in Bancorp’s loan review process. Changes in the criteria used in this evaluation or the availability of new information could cause the allowance to be increased or decreased in future periods. In addition, bank regulatory agencies, as part of their examination process, may require adjustments to the allowance for loan and lease losses based on their judgments and estimates.
Additionally, management has identified the accounting policy related to accounting for income taxes as critical to the understanding of Bancorp’s results of operations and discussed this conclusion with the Audit Committee of the Board of Directors. The objectives of accounting for income taxes are to recognize the amount of taxes payable or refundable for the current year and deferred tax liabilities and assets for the future tax consequences of events that have been recognized in an entity’s financial statements or tax returns. Judgment is required in assessing the future tax consequences of events that have been recognized in Bancorp’s financial statements or tax returns. Fluctuations in the actual outcome of these future tax consequences, including the effects of periodic IRS and state agency examinations, could materially impact Bancorp’s financial position and its results from operations.
(2) Acquisition
On April 30, 2013, Bancorp completed the acquisition of 100% of the outstanding shares of THE BANCorp, Inc. (“Oldham”), parent company of THE BANK — Oldham County, Inc. As a result of the transaction, THE BANK — Oldham County merged into Stock Yards Bank & Trust Company. Since the acquisition date, results of operations acquired in the Oldham transaction have been included in Bancorp’s financial results.
The Oldham transaction has been accounted for using the acquisition method of accounting and, accordingly, assets acquired, liabilities assumed and consideration transferred were recorded at estimated fair value on the acquisition date. Assets acquired totaled approximately $146.0 million, including $39.8 million of loans and leases. Liabilities assumed totaled $125.1 million, including $120.4 million of deposits. Fair value adjustments resulted in net assets acquired in excess of the consideration paid. Accordingly, a non-taxable gain of $449,000 was recognized.
The following table summarizes the consideration paid and the amounts of assets acquired and liabilities assumed, adjusted for fair value at the acquisition date.
(amounts in thousands)
Purchase price:
Cash
8,297
Equity instruments (531,288 common shares of Bancorp)
12,198
Total purchase price
20,495
Identifiable assets:
Cash and federal funds sold
17,260
Investment securities
81,827
39,755
Premises and equipment
4,008
Core deposit intangible
2,543
605
Total identifiable assets
145,998
Identifiable liabilities:
120,435
Securities sold under agreement to repurchase
2,762
1,857
Total identifiable liabilities
125,054
Net gain resulting from acquisition
449
Acquisition costs (included in other non-interest expenses in Bancorp’s income statement for the year ended December 31, 2013)
1,548
Fair value of the common shares issued as part of the consideration paid was determined based on the closing market price of Bancorp’s common shares on the acquisition date.
Bancorp recorded a core deposit intangible of $2,543,000 which is being amortized over a ten year period using an accelerated method which anticipates the life of the underlying deposits to which the intangible is attributable. At March 31, 2014, the unamortized core deposit intangible was $2,004,000.
In many cases, determining the fair value of acquired assets and assumed liabilities required Bancorp to estimate cash flows expected to result from those assets and liabilities and to discount those cash flows at appropriate rates of interest. The most significant of these determinations related to the valuation of acquired loans.
9
Below is an analysis of the fair value of acquired loans as of March 31, 2014.
(in thousands)
Acquired impaired loans
Acquired non- impaired loans
Total acquired loans
Contractually required principal and interest at acquisition
3,285
37,763
41,048
Contractual cash flows not expected to be collected
(372
(723
(1,095
Expected cash flows at acquisition
2,913
37,040
39,953
Interest component of expected cash flows
(174
(24
(198
Basis in acquired loans at acquisition - estimated fair value
2,739
37,016
Fair values of checking, savings and money market deposit accounts acquired from Oldham were assumed to approximate the carrying value as these accounts have no stated maturity and are payable on demand. Certificate of deposit accounts were valued at the present value of the certificates’ expected contractual payments discounted at market rates for similar certificates.
In connection with the Oldham acquisition, Bancorp incurred expenses related to executing the transaction and integrating and conforming acquired operations with and into Bancorp. Those expenses consisted largely of conversion of systems and/or integration of operations, professional services, costs related to termination of existing contractual arrangements of Oldham to purchase various services; initial marketing and promotion expenses designed to introduce Bancorp to its new customers; and printing, postage, supplies, and other costs of completing the transaction.
(3) Securities
The amortized cost, unrealized gains and losses, and fair value of securities available for sale follow:
Amortized
Unrealized
cost
Gains
Losses
Fair value
March 31, 2014
U.S. Treasury and other U.S. government obligations
40,000
Government sponsored enterprise obligations
156,246
1,665
1,554
156,357
Mortgage-backed securities - government agencies
175,020
1,523
3,263
173,280
Obligations of states and political subdivisions
68,082
1,634
211
69,505
Corporate equity securities
756
286
1,042
Total securities available for sale
440,104
5,108
5,028
December 31, 2013
110,000
138,094
1,623
1,872
137,845
176,524
1,391
5,222
172,693
68,448
1,473
428
69,493
493,066
4,487
7,522
There are no securities classified as held to maturity as of March 31, 2014 or December 31, 2013.
Management has the intent and ability to hold all investment securities available for sale for the foreseeable future. No securities were sold in the first quarter of 2013 or 2014.
Corporate equity securities, included in the available for sale portfolio at March 31, 2014, consist of common stock in a public-traded business development company.
In addition to the available for sale portfolio, investment securities held by Bancorp include certain securities which are not readily marketable, and are carried at cost. This category includes holdings of Federal Home Loan Bank of Cincinnati (FHLB) stock which are required for access to FHLB borrowing availability, and are classified as restricted securities. Other securities consist of a Community Reinvestment Act (CRA) investment which matures in the second quarter of 2014, which is fully collateralized with a government agency security of similar duration, and holdings of stock in a correspondent bank Bancorp utilized for various services. Bancorp reviewed the investment in FHLB stock as of March 31, 2014, considering the FHLB equity position, its continuance of dividend payments, liquidity position, and positive year-to-date net income. Based on this review, Bancorp believes its investment in FHLB stock is not impaired.
A summary of the available for sale investment securities by maturity groupings as of March 31, 2014 is shown below.
Securities available for sale
Amortized cost
Due within 1 year
67,648
67,833
Due after 1 but within 5 years
127,055
128,435
Due after 5 but within 10 years
32,945
33,531
Due after 10 years
36,680
36,063
Mortgage-backed securities
11
Actual maturities may differ from contractual maturities because some issuers have the right to call or prepay obligations. In addition to equity securities, the investment portfolio includes agency mortgage-backed securities, which are guaranteed by agencies such as the FHLMC, FNMA, and GNMA. These securities differ from traditional debt securities primarily in that they may have uncertain principal payment dates and are priced based on estimated prepayment rates on the underlying collateral. Bancorp does not have exposure to subprime originated mortgage-backed or collateralized debt obligation instruments.
Securities with a carrying value of approximately $201.5 million at March 31, 2014 and $243.5 million at December 31, 2013 were pledged to secure accounts of commercial depositors in cash management accounts, public deposits, and cash balances for certain investment management and trust accounts.
Securities with unrealized losses at March 31, 2014 and December 31, 2013, not recognized in income are as follows:
Less than 12 months
12 months or more
Fair
value
losses
77,580
1,161
4,402
393
81,982
85,985
2,089
17,691
1,174
103,676
15,434
186
2,093
25
17,527
Total temporarily impaired securities
178,999
3,436
24,186
1,592
203,185
76,755
1,429
4,353
443
81,108
112,652
4,400
8,752
822
121,404
22,092
405
1,211
23
23,303
211,499
6,234
14,316
1,288
225,815
The applicable dates for determining when securities are in an unrealized loss position are March 31, 2014 and December 31, 2013. As such, it is possible that a security had a market value less than its amortized cost on other days during the past twelve months, but is not in the “Investments with an Unrealized Loss of less than 12 months” category above.
12
Unrealized losses on Bancorp’s investment securities portfolio have not been recognized in income because the securities are of high credit quality, and the decline in fair values is largely due to changes in the prevailing interest rate environment since the purchase date. Fair value is expected to recover as securities reach their maturity date and/or the interest rate environment returns to conditions similar to when these securities were purchased. These investments consist of 123 and 155 separate investment positions as of March 31, 2014 and December 31, 2013, respectively. Because management does not intend to sell the investments, and it is not likely that Bancorp will be required to sell the investments before recovery of their amortized cost bases, which may be maturity, Bancorp does not consider these securities to be other-than-temporarily impaired at March 31, 2014.
(4) Loans
The composition of loans by primary loan portfolio segment follows:
Commercial and industrial
511,247
510,739
Construction and development, excluding undeveloped land
88,108
99,719
Undeveloped land
29,209
29,871
Real estate mortgage
1,066,595
1,046,823
Consumer
33,460
34,198
Total loans
13
The following table presents the balance in the recorded investment in loans and allowance for loan losses by portfolio segment and based on impairment evaluation method as of March 31, 2014 and December 31, 2013.
Type of loan
Construction
and development
Commercial
excluding
and
undeveloped
Undeveloped
Real estate
industrial
land
mortgage
Loans individually evaluated for impairment
7,653
6,988
5,273
82
20,022
Loans collectively evaluated for impairment
502,967
87,021
22,221
1,060,820
33,360
1,706,389
Loans acquired with deteriorated credit quality
627
1,061
502
2,208
Unallocated
Allowance for loan losses
At December 31, 2013
7,644
2,555
5,376
12,604
343
Provision
(145
(628
925
185
Charge-offs
(294
(195
Recoveries
20
178
238
At March 31, 2014
7,508
1,927
6,302
12,515
339
Allowance for loans individually evaluated for impairment
746
439
1,267
Allowance for loans collectively evaluated for impairment
6,762
12,076
257
27,324
Balance: loans acquired with deteriorated credit quality
14
7,579
7,340
7,478
84
22,507
502,535
98,428
22,531
1,038,824
34,095
1,696,413
625
1,265
521
19
2,430
At December 31, 2012
5,949
4,536
14,288
362
6,746
31,881
1,583
(2,119
13,256
490
86
(6,746
6,550
(457
(25
(7,961
(2,758
(763
(11,964
569
163
81
584
658
2,055
762
606
1,452
6,882
11,998
259
27,070
Management uses the following portfolio segments of loans when assessing and monitoring the risk and performance of the loan portfolio:
· Commercial and industrial
· Construction and development, excluding undeveloped land
· Undeveloped land
· Real estate mortgage
· Consumer
Bancorp has loans that were acquired in the Oldham acquisition, for which there was, at acquisition, evidence of deterioration of credit quality since origination and for which it was probable, at acquisition, that all contractually required payments would not be collected. The carrying amount of those loans is included in the balance sheet amounts of loans at March 31, 2014 and December 31, 2013.
15
The changes in accretable discount related to credit impaired acquired loans are as follows:
Balance at December 31, 2012
Additions due to Oldham acquisition
174
Accretion
(37
Reclassifications from (to) non-accretable difference
Disposals
Balance at December 31, 2013
137
(28
Balance at March 31, 2014
109
16
The following table presents loans individually evaluated for impairment as of March 31, 2014 and December 31, 2013.
Unpaid
Average
Recorded
principal
Related
recorded
investment
balance
allowance
Loans with no related allowance recorded
1,244
1,387
1,037
151
9,675
7,164
3,396
4,086
3,564
Subtotal
11,654
15,299
11,791
Loans with an allowance recorded
6,409
6,579
1,877
2,812
83
8,368
9,474
7,796
7,616
5,963
6,376
23,667
21,265
17
830
974
4,499
54
9,932
3,272
3,731
5,069
5,559
11,927
16,126
13,387
6,749
3,806
7,152
3,747
4,065
3,705
10,580
10,898
14,956
7,723
8,305
313
10,424
9,134
9,264
37
27,024
28,343
Differences between recorded investment amounts and unpaid principal balance amounts are due to partial charge-offs which have occurred over the life of loans and fair value adjustments recorded for loans acquired.
Impaired loans include non-accrual loans and loans accounted for as troubled debt restructurings (TDR), which continue to accrue interest. Non-performing loans include the balance of impaired loans plus any loans over 90 days past due and still accruing interest. Loans past due more than 90 days or more and still accruing interest amounted to $439,000 at March 31, 2014 and $437,000 at December 31, 2013.
The following table presents the recorded investment in non-accrual loans as of March 31, 2014 and December 31, 2013.
884
846
4,843
7,046
12,741
15,258
At March 31, 2014 and December 31, 2013, Bancorp had loans classified as TDR of $7.3 million and $7.2 million, respectively. Bancorp did not modify and classify any loans as TDR during the three months ended March 31, 2014 or March 31, 2013.
The following table presents the recorded investment in loans accounted for as TDR that were restructured and experienced a payment default within the previous 12 months as of March 31, 2014.
(dollars in thousands)
Contracts
Recorded Investment
Commercial & industrial
790
Bancorp did not have any loans that were restructured and experience a payment default within the previous 12 months as of March 31, 2013.
Loans accounted for as TDR include modifications from original terms due to bankruptcy proceedings, modifications of amortization periods or temporary suspension of principal payments due to customer financial difficulties. Loans accounted for as TDR, which have not defaulted, are individually evaluated for impairment and, at March 31, 2014, had a total allowance allocation of $937,000, compared to $942,000 at December 31, 2013.
At March 31, 2014 and December 31, 2013, Bancorp had outstanding commitments to lend additional funds totaling $111,000 and $262,000, respectively, for loans modified as TDR.
The following table presents the aging of loans as of March 31, 2014 and December 31, 2013.
Greater
than
90 days
past due
> 90 days
30-59 days
60-89 days
(includes
non-accrual)
Current
loans
accruing
415
379
917
1,711
509,536
33
244
270
87,838
8,077
2,199
5,249
15,525
1,051,070
406
105
42
147
33,313
8,841
2,620
13,180
24,641
1,703,978
808
201
1,268
2,277
508,462
421
429
455
99,264
4,529
7,062
12,771
1,034,052
110
34,088
5,876
1,381
15,696
22,953
1,698,397
437
Bancorp categorizes loans into credit 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. Pass-rated loans included all risk-rated loans other than those classified as special mention, substandard, and doubtful, which are defined below:
· Special Mention: Loans classified as special mention have a potential weakness that deserves management’s close attention. These potential weaknesses may result in deterioration of repayment prospects for the loan or of Bancorp’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 collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize repayment of the debt. They are characterized by the distinct possibility that Bancorp will sustain some loss if the deficiencies are not corrected.
· Substandard non-performing: Loans classified as substandard-non-performing have all the characteristics of substandard loans and have been placed on non-accrual status or have been accounted for as troubled debt restructurings.
· 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 repayment in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable.
As of March 31, 2014 and December 31, 2013, the risk categories of loans were as follows:
Credit risk profile by internally assigned grade
Grade
Pass
492,970
77,048
21,517
1,040,582
33,296
1,665,413
Special mention
7,104
5,944
540
15,099
28,769
Substandard
3,025
4,682
164
4,745
12,616
Substandard non- performing
8,148
434
6,169
21,821
Doubtful
486,140
87,896
22,366
1,014,216
34,028
1,644,646
12,983
7,091
17,916
38,076
3,616
4,706
165
7,197
15,684
8,000
7,494
22,944
(5) Federal Home Loan Bank Advances
Bancorp had outstanding borrowings of $34.3 million at March 31, 2014, via seven separate advances. For two advances totaling $30 million, both of which are non-callable, interest payments are due monthly, with principal due at maturity. For the remaining advances totaling $4.3 million, principal and interest payments are due monthly based on an amortization schedule.
The following is a summary of the contractual maturities and average effective rates of outstanding advances:
Advance
Rate
0.21
%
2015
20,000
3.34
2020
1,919
2.23
1,931
2021
548
2.12
564
2024
2.40
408
2028
1,416
1.47
1,426
1.46
2.26
Advances from the FHLB are collateralized by certain commercial and residential real estate mortgage loans under a blanket mortgage collateral agreement and FHLB stock. Bancorp views the borrowings as an effective alternative to higher cost time deposits to fund loan growth. At March 31, 2014, the amount of available credit from the FHLB totaled $370.4 million.
(6) Derivative Financial Instruments
Occasionally, Bancorp enters into free-standing interest rate swaps for the benefits of its commercial customers who desire to hedge their exposure to changing interest rates. Bancorp hedges its interest rate exposure on commercial customer transactions by entering into offsetting swap agreements with approved reputable independent counterparties with substantially matching terms. These undesignated derivative instruments are recognized on the consolidated balance sheet at fair value. Because of matching terms of offsetting contracts and the collateral provisions mitigating any non-performance risk, changes in fair value subsequent to initial recognition are expected to have an insignificant effect on earnings. Exchanges of cash flows related to the undesignated interest rate swap agreements for the first quarter of 2014 were offsetting and therefore had no net effect on Bancorp’s earnings or cash flows.
Interest rate swap agreements derive their value from underlying interest rates. These transactions involve both credit and market risk. The notional amounts are amounts on which calculations, payments, and the value of the derivative are based. Notional amounts do not represent direct credit exposures. Direct credit exposure is limited to the net difference between the calculated amounts to be received and paid, if any. Bancorp is exposed to credit-related losses in the event of nonperformance by the counterparties to these agreements. Bancorp controls the credit risk of its financial contracts through credit approvals, limits and monitoring procedures, and does not expect any counterparties to fail their obligations.
At March 31, 2014 and December 31, 2013, Bancorp had outstanding undesignated interest rate swap contracts as follows:
Receiving
Paying
(dollar amounts in thousands)
Notional amount
7,706
5,159
Weighted average maturity (years)
7.4
6.4
(322
(275
322
275
In December 2013, Bancorp entered into an interest rate swap to hedge cash flows of a $10 million floating-rate FHLB borrowing. The interest rate swap involves exchange of Bancorp’s floating rate interest payments on the underlying principal amount. This swap was designated, and qualified, for cash-flow hedge accounting. The term of the swap began December 6, 2013 and ends December 6, 2016. For derivative instruments that are designated and qualify as hedging instruments, the effective portion of gains or losses is reported as a component of other comprehensive income, and is subsequently reclassified into earnings as an adjustment to interest expense in periods in which the hedged forecasted transaction affects earnings. The following table details Bancorp’s derivative position designated as a cash flow hedge, and the fair values as of March 31, 2014 and December 31, 2013.
Notional
Maturity
Receive (variable)
Pay fixed
amount
date
index
swap rate
12/6/2016
US 3 Month LIBOR
0.715
57
24
(7) Goodwill and Intangible Assets
US GAAP requires that goodwill and intangible assets with indefinite useful lives not be amortized, but instead be tested for impairment at least annually. Annual evaluations have resulted in no indication of impairment. Bancorp currently has goodwill in the amount of $682,000 from the 1996 acquisition of an Indiana bank. This goodwill is assigned to the commercial banking segment of Bancorp.
Bancorp recorded a core deposit intangible totaling $2,543,000 arising from the Oldham acquisition. This intangible asset is being amortized over a ten-year period using an accelerated method which anticipates the life of the underlying deposits to which the intangible is attributable. At March 31, 2014, the unamortized core deposit intangible was $2,004,000.
Mortgage servicing rights (MSRs) are initially recognized at fair value when mortgage loans are sold and amortized in proportion to and over the period of estimated net servicing income, considering appropriate prepayment assumptions. MSRs are evaluated quarterly for impairment by comparing carrying value to fair value. The estimated fair values of MSRs at March 31, 2014 and December 31, 2013 were $3,124,000 and $3,953,000, respectively. The total outstanding principal balances of loans serviced for others were $434,930,000 and $435,339,000 at March 31, 2014, and December 31, 2013, respectively.
Changes in the net carrying amount of MSRs for the three months ended March 31, 2014 and 2013 are shown in the following table.
For three months
ended March 31,
Balance at beginning of period
1,832
2,088
Additions for mortgage loans sold
284
Amortization
(233
(234
Balance at March 31
1,679
2,138
(8) Defined Benefit Retirement Plan
Bancorp sponsors an unfunded, non-qualified, defined benefit retirement plan for four key officers (two current, and two retired), and has no plans to increase the number of participants. Benefits vest based on 25 years of service. The actuarially determined pension costs are expensed and accrued over the service period, and benefits are paid from Bancorp’s assets. The net periodic benefits costs, which include interest cost and amortization of net losses, totaled $32,000 and $36,000, for the three months ended March 31, 2014 and 2013, respectively.
(9) Commitments and Contingent Liabilities
As of March 31, 2014, Bancorp had various commitments outstanding that arose in the normal course of business, including standby letters of credit and commitments to extend credit, which are properly not reflected in the consolidated financial statements. In management’s opinion, commitments to extend credit of $459.2 million including standby letters of credit of $13.8 million represent normal banking transactions, and no significant losses are anticipated to result from these commitments as of March 31, 2014. Commitments to extend credit were $469.5 million, including letters of credit of $15.2 million, as of December 31, 2013. Bancorp’s maximum exposure to credit loss in the event of nonperformance by the other party to these commitments is represented by the contractual amount of these instruments. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses. Commitments to extend credit are mainly comprised of commercial lines of credit, construction and home equity credit lines. Since some of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Bancorp uses the same credit and collateral policies in making commitments and conditional guarantees as for on-balance sheet instruments. Bancorp evaluates each customer’s creditworthiness on a case by case basis. The amount of collateral obtained is based on management’s credit evaluation of the customer. Collateral held varies but may include accounts receivable, inventory, equipment, and real estate.
Standby letters of credit and financial guarantees written are conditional commitments issued by Bancorp to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support private borrowing arrangements. Standby letters of credit generally have maturities of one to two years.
Also, as of March 31, 2014, in the normal course of business, there were pending legal actions and proceedings in which claims for damages are asserted. Management, after discussion with legal counsel, believes the ultimate result of these legal actions and proceedings will not have a material adverse effect on the consolidated financial position or results of operations of Bancorp.
(10) Preferred Stock
Bancorp has a class of preferred stock (no par value; 1,000,000 shares authorized), the relative rights, preferences and other terms of which or any series within the class will be determined by the Board of Directors prior to any issuance. None of this stock has been issued to date.
(11) Stock-Based Compensation
The fair value of all awards granted, net of estimated forfeitures, is recognized as compensation expense over the respective service period.
Bancorp currently has one stock-based compensation plan. Initially, in the 2005 Stock Incentive Plan, there were 735,000 shares of common stock reserved for issuance of stock based awards. In 2010, shareholders approved an additional 700,000 shares of common stock for issuance under the plan. As of March 31, 2014, there were 423,424 shares available for future awards. Bancorp’s 1995 Stock Incentive Plan expired in 2005; however, options granted under this plan expire as late as 2015.
Options and stock appreciation rights (SARs) granted generally have been subject to a vesting schedule of 20% per year. Restricted shares generally vest over three to five years. All awards have been granted at an exercise price equal to the market value of common stock at the time of grant; options and SARs expire ten years after the grant date unless forfeited due to employment termination. No stock options have been granted since 2007.
Grants of performance stock units (PSUs) to executive officers vest based upon service and a three-year performance period which begins January 1 of the first year of the performance period. Because grantees are not entitled to dividend payments during the performance period, the fair value of these PSUs is estimated based upon the fair value of the underlying shares on the date of grant, adjusted for non-payment of dividends.
Grants of restricted stock units (RSUs) to directors vest based upon one year of service. Because grantees are entitled to deferred dividend payments at the end of the vesting period, the fair value of the RSUs are estimated based on the fair value of the underlying shares on the date of grant.
Bancorp has recognized stock-based compensation expense, within salaries and employee benefits for employees, and within other non-interest expense for directors, in the consolidated statements of income as follows:
For three months ended
Stock-based compensation expense before income taxes
Less: deferred tax benefit
(102
(186
Reduction of net income
188
345
Bancorp expects to record an additional $1,469,000 of stock-based compensation expense in 2014 for equity grants outstanding as of March 31, 2014. As of March 31, 2014, Bancorp has $4,664,000 of unrecognized stock-based compensation expense that is expected to be recorded as compensation expense over the next five years as awards vest. Bancorp received cash of $463,000 and $61,000 from the exercise of options during the first three months of 2014 and 2013, respectively.
The fair values of Bancorp’s stock options and SARs are estimated at the date of grant using the Black-Scholes option pricing model, a leading formula for calculating the value of stock options and SARs. This model requires the input of subjective assumptions, changes to which can materially affect the fair value estimate. The fair value of restricted shares is determined by Bancorp’s closing stock price on the date of grant. The following assumptions were used in SAR valuations at the grant date in each year:
Dividend yield
2.94%
2.80%
Expected volatility
23.66%
22.54%
Risk free interest rate
2.22%
1.26%
Expected life of SARs
7.0 years
6.6 years
Dividend yield and expected volatility are based on historical information corresponding to the expected life of options and SARs granted. Expected volatility is the volatility of the underlying shares for the expected term on a monthly basis. The risk free interest rate is the implied yield currently available on U.S. Treasury issues with a remaining term equal to the expected life of the options. The expected life of options and SARs is based on actual experience of past like-term options. Bancorp evaluates historical exercise and post-vesting termination behavior when determining the expected life.
A summary of stock option and SARs activity and related information for the three months ended March 31, 2014 follows:
Weighted
Aggregate
average
Options
intrinsic
remaining
and SARs
Exercise
exercise
fair
contractual
price
life (in years)
Vested and exercisable
579
20.25-26.83
23.83
4,685
5.43
3.4
Unvested
218
21.03-24.87
22.70
2,011
4.36
7.7
Total outstanding
797
23.52
6,696
5.14
4.6
Granted
60
29.05
156
5.37
Exercised
23.05
190
5.36
Forfeited
635
23.69
5,045
5.33
3.7
198
21.03-29.05
24.72
1,372
4.56
8.4
833
20.25-29.05
23.93
6,417
5.15
4.8
Vested year-to-date
22.49
734
4.63
Intrinsic value for stock options and SARs is defined as the amount by which the current market price of the underlying stock exceeds the exercise price.
For the periods ending December 31, 2013 and March 31, 2014, Bancorp granted shares of restricted common stock as outlined in the following table:
Grant date
weighted-
Number
average cost
Unvested at December 31, 2012
113,910
22.55
Shares awarded
55,275
22.93
Restrictions lapsed and shares released to employees/directors
(39,909
22.29
Shares forfeited
(4,720
23.45
Unvested at December 31, 2013
124,556
22.77
39,480
29.11
(42,932
22.63
(1,081
23.55
Unvested at March 31, 2014
120,023
24.90
27
Bancorp awarded performance-based restricted stock units (PSUs) to executive officers of Bancorp, the three-year performance period for which began January 1 of the award year. The following table outlines the PSU grants.
Vesting
Expected
Grant
period
shares to
year
in years
be awarded
2012
20.57
22,668
20.38
28,579
26.42
16,675
In the first quarter of 2014, Bancorp awarded 3,920 restricted stock units (RSUs) to directors of Bancorp. The RSUs vest in one year.
(12) Net Income Per Share
The following table reflects, for the three months ended March 31, 2014 and 2013, net income (the numerator) and average shares outstanding (the denominator) for the basic and diluted net income per share computations:
Three months ended
March 31
Average shares outstanding
Dilutive securities
195
Average shares outstanding including dilutive securities
Net income per share, basic
Net income per share, diluted
(13) Segments
Bancorp’s principal activities include commercial banking and investment management and trust. Commercial banking provides a full range of loan and deposit products to individual consumers and businesses. Commercial banking also includes Bancorp’s mortgage origination and securities brokerage activity. Investment management and trust provides wealth management services including investment management, trust and estate administration, and retirement plan services.
28
Financial information for each business segment reflects that which is specifically identifiable or allocated based on an internal allocation method. Income taxes are allocated based on the effective federal income tax rate adjusted for any tax exempt activity. All tax exempt activity and provision for loan losses have been allocated to the commercial banking segment. Measurement of performance of business segments is based on the management structure of Bancorp and is not necessarily comparable with similar information for any other financial institution. Information presented is also not necessarily indicative of the segments’ operations if they were independent entities.
Selected financial information by business segment for the three month periods ended March 31, 2014 and 2013 follows:
Investment
management
banking
and trust
Three months ended March 31, 2014
20,181
47
All other non-interest income
4,890
4,907
Non-interest expense
14,962
2,582
9,759
2,050
Tax expense
2,903
729
6,856
1,321
Three months ended March 31, 2013
18,428
5,325
5,342
13,590
1,989
7,838
1,949
2,331
688
5,507
1,261
29
(14) Income Taxes
An analysis of the difference between the statutory and effective tax rates for the three months ended March 31, 2014 and 2013 follows:
Three months ended March 31,
U.S. federal statutory tax rate
35.0
Tax exempt interest income
(1.7
(2.1
Tax credits
(1.6
(0.7
Cash surrender value of life insurance
(2.0
(2.4
State income taxes
1.0
Other, net
0.1
Effective tax rate
30.8
US GAAP provides guidance on financial statement recognition and measurement of tax positions taken, or expected to be taken, in tax returns. As of March 31, 2014 and December 31, 2013, the gross amount of unrecognized tax benefits was $43,000 and $41,000, respectively. If recognized, the tax benefits would reduce tax expense and accordingly, increase net income. The amount of unrecognized tax benefits may increase or decrease in the future for various reasons including adding amounts for current tax year positions, expiration of open income tax returns due to statutes of limitation, changes in management’s judgment about the level of uncertainty, status of examination, litigation and legislative activity and the addition or elimination of uncertain tax positions.
Bancorp is currently under IRS examination of its 2011 corporate income tax return. Management does not expect that the results of the examination will have a material effect on our financial condition. While management believes tax positions are appropriate, the IRS could challenge Bancorp’s positions as a part of this examination. Federal and state income tax returns are subject to examination for the tax return years after 2009.
Bancorp’s policy is to report interest and penalties, if any, related to unrecognized tax benefits in income tax expense. As of March 31, 2014 and December 31, 2013, the amount accrued for the potential payment of interest and penalties was $3,000 and $2,000, respectively.
(15) Fair Value Measurements
Bancorp follows the provisions of the authoritative guidance for fair value measurements. This guidance is definitional and disclosure oriented and addresses how companies should approach measuring fair value when required by US GAAP. The guidance prescribes various disclosures about financial statement categories and amounts which are measured at fair value, if such disclosures are not already specified elsewhere in US GAAP.
30
The authoritative guidance defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between participants at the measurement date. The guidance also establishes a hierarchy to group assets and liabilities carried at fair value in three levels based upon the markets in which the assets and liabilities trade and the reliability of assumptions used to determine fair value. These levels are:
· Level 1: Valuation is based upon quoted prices for identical instruments traded in active markets.
· Level 2: Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market.
· Level 3: Valuation is generated from model-based techniques that use significant assumptions not observable in the market. These unobservable assumptions would reflect internal estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques could include pricing models, discounted cash flows and other similar techniques.
Authoritative guidance requires maximization of use of observable inputs and minimization of use of unobservable inputs in fair value measurements. Where there exists limited or no observable market data, Bancorp uses its own estimates generally considering characteristics of the asset/liability, the current economic and competitive environment and other factors. For this reason, results cannot be determined with precision and may not be realized on an actual sale or immediate settlement of the asset or liability.
Bancorp’s investment securities available for sale and interest rate swaps are recorded at fair value on a recurring basis. Other accounts including mortgage loans held for sale, mortgage servicing rights, impaired loans and other real estate owned may be recorded at fair value on a non-recurring basis, generally in the application of lower of cost or market adjustments or write-downs of specific assets.
The portfolio of investment securities available for sale is comprised of U.S. Treasury and other U.S government obligations, debt securities of U.S. government-sponsored corporations, mortgage-backed securities, obligations of state and political subdivisions and corporate equity securities. Corporate equity securities, included in the 2014 table, are priced using quoted prices of identical securities in an active market. These measurements are classified as Level 1 in the hierarchy above. All other securities are priced using standard industry models or matrices with various assumptions such as yield curves, volatility, prepayment speeds, default rates, time value, credit rating and market prices for the instruments. These assumptions are generally observable in the market place and can be derived from or supported by observable data. These measurements are classified as Level 2 in the hierarchy above.
Interest rate swaps are valued using primarily Level 2 inputs. Fair value measurements are obtained from an outside pricing service. Prices obtained are generally based on dealer quotes, benchmark forward yield curves, and other relevant observable market data. For purposes of potential valuation adjustments to derivative positions, Bancorp evaluates the credit risk of its counterparties as well as its own credit risk. To date, Bancorp has not realized any losses due to a counterparty’s inability to perform and the change in value of derivative assets and liabilities attributable to credit risk was not significant during 2014.
Below are the carrying values of assets measured at fair value on a recurring basis.
Fair value at March 31, 2014
Level 1
Level 2
Level 3
Investment securities available for sale
Total investment securities available for sale
439,142
Interest rate swaps
440,563
439,521
Liabilities
Fair value at December 31, 2013
299
490,330
32
Bancorp did not have any financial instruments classified within Level 3 of the valuation hierarchy for assets and liabilities measured at fair value on a recurring basis at March 31, 2014 or December 31, 2013.
MSRs are recorded at fair value upon capitalization, are amortized to correspond with estimated servicing income, and are periodically assessed for impairment based on fair value at the reporting date. Fair value is based on a valuation model that calculates the present value of estimated net servicing income. The model incorporates assumptions that market participants would use in estimating future net servicing income. These measurements are classified as Level 3. At March 31, 2014 and December 31, 2013 there was no valuation allowance for the mortgage servicing rights, as the fair value exceeded the cost. Accordingly, the MSRs are not included in either table below for March 31, 2014 or December 31, 2013.
Mortgage loans held for sale are recorded at the lower of cost or market value. The portfolio is comprised of residential real estate loans and fair value is based on specific prices of underlying contracts for sales to investors. These measurements are classified as Level 2. Because the fair value of the loans held for sale exceeded carrying value, mortgage loans held for sale are not included in either table below for March 31, 2014 or December 31, 2013.
Other real estate owned, which is carried at the lower of cost or fair value, is periodically assessed for impairment based on fair value at the reporting date. Fair value is determined from external appraisals using judgments and estimates of external professionals. Many of these inputs are not observable and, accordingly, these measurements are classified as Level 3. At March 31, 2014 and December 31, 2013, the carrying value of other real estate owned was $2,933,000 and $5,590,000, respectively. Other real estate owned is not included in either table below, as the fair value of the properties exceeded their carrying value at March 31, 2014 and December 31, 2013.
For impaired loans in the table below, the fair value is calculated as the carrying value of only loans with a specific valuation allowance, less the specific allowance. As of March 31, 2014, total impaired loans with a valuation allowance were $8.4 million, and the specific allowance totaled $1.3 million, resulting in a fair value of $7.1 million, compared to total impaired loans with a valuation allowance of $10.6 million, and the specific allowance allocation totaling $1.5 million, resulting in a fair value of $9.1 million at December 31, 2013. The losses represent the change in the specific allowances for the period indicated.
Below are the carrying values of assets measured at fair value on a non-recurring basis.
Losses for 3 month
period ended
Impaired loans
7,102
(180
March 31, 2013
9,128
(928
In the case of the securities portfolio, Bancorp monitors the valuation technique utilized by pricing agencies to ascertain when transfers between levels have occurred. The nature of the remaining assets and liabilities is such that transfers in and out of any level are expected to be rare. For the three months ended March 31, 2014, there were no transfers between Levels 1, 2, or 3.
(16) Fair Value of Financial Instruments
The following table presents the carrying amounts, estimated fair values, and placement in the fair value hierarchy of financial instruments not measured at fair value on a recurring or non-recurring basis at March 31, 2014 and December 31, 2013.
Carrying
Fair Value
Financial assets
Cash and short-term investments
3,600
Federal Home Loan Bank stock and other securities
7,347
Loans, net
1,713,562
Financial liabilities
1,989,147
Short-term borrowings
71,184
FHLB advances
35,077
1,817
1,703,291
1,983,029
117,910
35,166
Management used the following methods and assumptions to estimate the fair value of each class of financial instrument for which it is practicable to estimate the value.
Cash, short-term investments, accrued interest receivable/payable and short-term borrowings
For these short-term instruments, carrying amount is a reasonable estimate of fair value.
For these securities without readily available market values, the carrying amount is a reasonable estimate of fair value.
The fair value of mortgage loans held for sale is determined by market quotes for similar loans based on loan type, term, rate, size and the borrower’s credit score.
US GAAP prescribes the exit price concept for estimating fair value of loans. Because there is not a liquid market (exit price) for trading predominant types of loans in Bancorp’s portfolio, fair value of loans is estimated by discounting future cash flows using current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities (e.g. entrance price).
Fair value of demand deposits, savings accounts, and certain money market deposits is the amount payable on demand at the reporting date. Fair value of fixed-rate certificates of deposits is estimated by discounting future cash flows using the rates currently offered for deposits of similar remaining maturities.
Fair value of FHLB advances is estimated by discounting future cash flows using estimates of current market rate for instruments with similar terms and remaining maturities.
Commitments to extend credit and standby letters of credit
Fair values of commitments to extend credit are estimated using fees currently charged to enter into similar agreements and the creditworthiness of the customers. Fair values of standby letters of credit are based on fees currently charged for similar agreements or estimated cost to terminate them or otherwise settle obligations with counterparties at the reporting date. Fair value of commitments to extend credit, letters of credit and lines of credit is not presented since management believes the fair value to be insignificant.
Limitations
Fair value estimates are made at a specific point in time based on relevant market information and information about financial instruments. Because no market exists for a significant portion of Bancorp’s financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Therefore, calculated fair value estimates in many instances cannot be substantiated by comparison to independent markets and, in many cases, may not be realizable in a current sale of the instrument. Changes in assumptions could significantly affect estimates.
(17) Regulatory Matters
Bancorp and the Bank are subject to various capital requirements prescribed by banking regulations and administered by state and federal banking agencies. Under these requirements, Bancorp and the Bank must
meet minimum amounts and percentages of Tier I and total capital, as defined, to risk weighted assets and Tier I capital to average assets. Risk weighted assets are determined by applying certain risk weightings prescribed by the regulations to various categories of assets and off-balance sheet commitments. Capital and risk weighted assets may be further subject to qualitative judgments by regulators as to components, risk weighting and other factors. Failure to meet the capital requirements can result in certain mandatory, and possibly discretionary, corrective actions prescribed by the regulations or determined to be necessary by the regulators, which could materially affect the unaudited consolidated financial statements. Bancorp and the Bank met all capital requirements to which they were subject as of March 31, 2014.
The following table sets forth consolidated Bancorp’s and the Bank’s risk based capital amounts and ratios as of March 31, 2014 and December 31, 2013.
Actual
Minimum for adequately capitalized
Minimum for well capitalized
(Dollars in thousands)
Ratio
Total risk-based capital (1)
Consolidated
258,026
13.72
150,452
8.00
NA
Bank
248,296
13.24
150,028
187,535
10.00
Tier I risk-based capital (1)
234,459
12.47
75,207
4.00
224,796
11.99
74,994
112,492
6.00
Leverage (2)
70,338
3.00
9.61
70,176
116,959
5.00
252,171
13.54
148,993
239,577
12.90
148,575
185,719
228,827
12.29
74,476
219,299
11.65
75,296
112,944
9.75
70,408
9.24
71,201
118,668
(1) Ratio is computed in relation to risk-weighted assets.
(2) Ratio is computed in relation to average assets.
NA — Not applicable. Regulatory framework does not define well capitalized for holding companies.
36
This item discusses the results of operations for Stock Yards Bancorp, Inc. (“Bancorp” or “Company”), and its subsidiary, Stock Yards Bank & Trust Company (“Bank”) for the three months ended March 31, 2014 and compares this period with the same period of the previous year. Unless otherwise indicated, all references in this discussion to the Bank include Bancorp. In addition, the discussion describes the significant changes in the financial condition of Bancorp and the Bank that have occurred during the first three months of 2014 compared to the year ended December 31, 2013. This discussion should be read in conjunction with the unaudited consolidated financial statements and accompanying notes presented in Part 1, Item 1 of this report.
At the annual meeting on April 23, 2014, shareholders approved a resolution to amend Bancorp’s restated articles of incorporation to change its name from S.Y. Bancorp, Inc. to Stock Yards Bancorp, Inc. The primary reason for the name change was to better align the identity of Bancorp with its subsidiary bank, Stock Yards Bank & Trust Company.
This report contains forward-looking statements under the Private Securities Litigation Reform Act that involve risks and uncertainties. Although Bancorp believes the assumptions underlying the forward-looking statements contained herein are reasonable, any of these assumptions could be inaccurate. Factors that could cause actual results to differ from results discussed in forward-looking statements include, but are not limited to the following: economic conditions both generally and more specifically in the markets in which Bancorp and the Bank operate; competition for Bancorp’s customers from other providers of financial services; government legislation and regulation which change from time to time and over which Bancorp has no control; changes in interest rates; material unforeseen changes in liquidity, results of operations, or financial condition of Bancorp’s customers; and other risks detailed in Bancorp’s filings with the Securities and Exchange Commission, all of which are difficult to predict and many of which are beyond the control of Bancorp.
Overview of 2014 through March 31
Bancorp completed the first quarter of 2014 with record net income of $8.18 million or 21% more than the comparable period of 2013. The increase is primarily due to a lower provision for loan losses, higher net interest income and slightly higher non-interest income, partially offset by higher non-interest expenses and resultant higher income tax expense. Diluted earnings per share for the first quarter of 2014 were $0.56, compared to the first quarter of 2013 at $0.49. Included in the results for the first quarter of 2014 was a $343,000 net gain on sale of foreclosed assets.
As is the case with most banks, the primary source of Bancorp’s revenue is net interest income and fees from various financial services provided to customers. Net interest income is the difference between interest income earned on loans, investment securities and other interest earning assets less interest expense on deposit accounts and other interest bearing liabilities. Loan volume and the interest rates earned on those loans are critical to overall profitability. Similarly, deposit volume is crucial to funding loans and rates paid on deposits directly impact profitability. Business volumes are influenced by overall economic factors including market interest rates, business spending, consumer confidence and competitive conditions within the marketplace.
Net interest income increased $1,765,000, or 9.6%, for the first three months of 2014, compared to the same period in 2013. The net interest margin declined to 3.76% for the first quarter of 2014, compared to 3.83% for the same period in 2013. The negative effect of declining interest rates earned somewhat offset the positive effect of increased volumes on earning assets. In the fourth quarter of 2013, Bancorp redeemed $30 million of subordinated debentures which carried a rate of 10.00%; this accounted for the majority of the interest expense savings. To a lesser extent, interest expense declined due to lower costs on deposits and FHLB borrowings arising from lower interest rates and a more favorable deposit mix.
Also favorably impacting 2014 results, Bancorp’s provision for loan losses was $350 thousand in the first quarter compared to $2.3 million in the first quarter of 2013, in response to Bancorp’s assessment of risk in the loan portfolio. The provision for loan losses is calculated after considering credit quality factors, and ultimately relies on an overall internal analysis of the risk in the loan portfolio. Bancorp’s allowance for loan losses was 1.65% of total loans at March 31, 2014, compared to 1.66% of total loans at December 31, 2013, and 2.00% at March 31, 2013.
Total non-interest income in the first quarter of 2014 increased $247,000 compared to the same period in 2013, and remained consistent at 32% of total revenues. Increases in investment management and trust services and service charges on deposit accounts contributed to the growth, partially offset by a decrease in mortgage banking revenue and brokerage commissions.
Total non-interest expense in the first quarter of 2014 increased $1,965,000, or 12.6%, compared to the same period in 2013 due to increases in salaries and benefits, net occupancy, data processing and other non-interest expenses. These increases were partially offset by gains on sale of foreclosed assets. Bancorp’s efficiency ratio in the first quarter of 2014 was 56.00% compared with 55.76% in the first quarter last year.
Tangible common equity (TCE), a non-GAAP measure, is a measure of a company’s capital which is useful in evaluating the quality and adequacy of capital. The ratio of tangible common equity to total tangible assets was 9.96% as of March 31, 2014, compared to 9.50% at December 31, 2013. See the Non-GAAP Financial Measures section for details on reconcilement to US GAAP measures.
The following sections provide more details on subjects presented in this overview.
a) Results Of Operations
Net income of $8,177,000 for the three months ended March 31, 2014 increased $1,409,000, or 20.8%, from $6,768,000 for the comparable 2013 period. Both basic and diluted net income per share was $0.56 for the first quarter of 2014, an increase of 14.3% from the $0.49 for the first quarter of 2013. Basic and diluted net income per share did not increase at the same rate as net income due to the issuance of 531,288 shares in the second quarter of 2013 for the Oldham transaction. Also, Bancorp’s higher stock price in the first quarter of 2014 as compared to 2013 is the primary factor for more dilutive shares. See Note 12 for additional information related to net income per share.
Reflecting increased net income, annualized return on average assets and annualized return on average stockholders’ equity were 1.41% and 14.14%, respectively, for the first quarter of 2014, compared to 1.30% and 13.18%, respectively, for the same period in 2013.
Net Interest Income
The following tables present the average balance sheets for the three month periods ended March 31, 2014 and 2013 along with the related calculation of tax-equivalent net interest income, net interest margin and net interest spread for the related periods. See the notes following the tables for further explanation.
38
Average Balances and Interest Rates — Taxable Equivalent Basis
Three months ended March 31
balances
Interest
rate
Earning assets:
96,770
0.33
110,472
0.29
2,783
4.52
7,851
3.31
Securities:
Taxable
323,892
1,770
2.22
229,938
1,311
2.31
Tax-exempt
59,242
426
2.92
47,293
389
FHLB stock and other securities
67
3.70
6,180
59
3.87
Loans, net of unearned income
1,717,175
19,480
4.60
1,577,394
19,180
4.93
Total earning assets
2,207,209
21,853
4.02
1,979,128
21,083
4.32
29,082
32,850
2,178,127
1,946,278
Non-earning assets:
35,430
31,686
39,573
36,434
Accrued interest receivable and other assets
93,184
91,598
2,346,314
2,105,996
Interest bearing liabilities:
Interest bearing demand deposits
481,313
131
0.11
337,844
85
0.10
Savings deposits
103,637
0.04
86,295
Money market deposits
617,727
307
0.20
561,506
0.22
Time deposits
349,633
692
0.80
375,704
946
1.02
60,895
0.23
57,335
0.25
Fed funds purchased and other short term borrowings
16,654
0.15
19,643
0.17
34,302
2.32
31,876
2.76
Long-term debt
30,900
10.15
Total interest bearing liabilities
1,664,161
0.34
1,501,103
0.64
Non-interest bearing liabilities:
Non-interest bearing demand deposits
421,517
371,598
Accrued interest payable and other liabilities
26,049
25,094
2,111,727
1,897,795
Stockholders’ equity
234,587
208,201
20,477
18,711
Net interest spread
3.68
Net interest margin
3.76
3.83
39
Notes to the average balance and interest rate tables:
· Net interest income, the most significant component of Bancorp’s earnings, is total interest income less total interest expense. The level of net interest income is determined by the mix and volume of interest earning assets, interest bearing deposits and borrowed funds, and changes in interest rates.
· Net interest spread is the difference between the taxable equivalent rate earned on interest earning assets less the rate expensed on interest bearing liabilities.
· Net interest margin represents net interest income on a taxable equivalent basis as a percentage of average interest earning assets. Net interest margin is affected by both the interest rate spread and the level of non-interest bearing sources of funds, primarily consisting of demand deposits and stockholders’ equity.
· Interest income on a fully tax equivalent basis includes the additional amount of interest income that would have been earned if investments in certain tax-exempt interest earning assets had been made in assets subject to federal taxes yielding the same after-tax income. Interest income on municipal securities and loans have been calculated on a fully tax equivalent basis using a federal income tax rate of 35%. The approximate tax equivalent adjustments to interest income were $249,000 and $248,000, respectively, for the three month periods ended March 31, 2014 and 2013.
· Average balances for loans include the principal balance of non-accrual loans and exclude participation loans accounted for as secured borrowings.
Fully taxable equivalent net interest income of $20.5 million for the three months ended March 31, 2014 increased $1.8 million, or 9.4%, from $18.7 million when compared to the same period last year. Net interest spread and net interest margin were 3.68% and 3.76%, respectively, for the first quarter of 2014 and 3.68% and 3.83%, respectively, for the first quarter of 2013.
Net interest income for the first quarter of 2014 included approximately $140 thousand for accretion of fair value adjustments related to the Oldham transaction. Adjusting for this additional income, Bancorp’s more normalized or core net interest margin was 3.72% for the first quarter of 2014. The table below shows the most recent five quarters of net interest margin and core net interest margin. See the Non-GAAP Financial Measures section for details on reconciliation to US GAAP measures. Management believes these core margins better reveal the pressure of a low interest rate environment and a highly competitive loan market, and it expects margin compression to diminish in 2014.
3/31/2014
12/31/2013
9/30/2013
6/30/2013
3/31/2013
3.61
3.79
3.72
Prepayment penalties / late charges
-0.01
-0.06
-0.04
Interest adjustment on non-accrual loan
-0.07
Accretion of fair value adjustments
-0.03
-0.02
Core net interest margin
3.53
3.63
3.66
3.77
Approximately $611 million, or 35%, of Bancorp’s loans are variable rate; most of these loans are indexed to the prime rate and may reprice as that rate changes. However, approximately $329 million of variable rate loans have reached their contractual floor of 4% or higher. Approximately $117 million of variable rate loans have contractual floors below 4%. The remaining $165 million of variable rate loans have no
40
contractual floor. Bancorp intends to establish floors whenever possible upon acquisition of new customers. Bancorp’s variable rate loans are primarily comprised of commercial lines of credit and real estate loans. At inception, most of Bancorp’s fixed rate loans are priced in relation to the five year Treasury bond.
Average earning assets for the first three months of 2014 increased $228.1 million, or 11.5% to $2.21 billion, compared to $1.98 billion for the same period of 2013, reflecting growth in the loan portfolio and investment securities. Average interest bearing liabilities for the first three months of 2014 increased $163.0 million, or 10.9% to $1.66 billion compared to $1.50 billion for the same period of 2013, primarily due to increases in interest bearing demand and money market deposit accounts.
Asset/Liability Management and Interest Rate Risk
Managing interest rate risk is fundamental for the financial services industry. The primary objective of interest rate risk management is to neutralize effects of interest rate changes on net income. By considering both on and off-balance sheet financial instruments, management evaluates interest rate sensitivity while attempting to optimize net interest income within the constraints of prudent capital adequacy, liquidity needs, market opportunities and customer requirements.
Interest Rate Simulation Sensitivity Analysis
Bancorp uses an earnings simulation model to estimate and evaluate the impact of an immediate change in interest rates on earnings in a one year forecast. The simulation model is designed to reflect the dynamics of interest earning assets, interest bearing liabilities and off-balance sheet financial instruments. By estimating the effects of interest rate increases and decreases, the model can reveal approximate interest rate risk exposure. The simulation model is used by management to gauge approximate results given a specific change in interest rates at a given point in time. The model is therefore a tool to indicate earnings trends in given interest rate scenarios and does not indicate actual expected results.
The March 31, 2014 simulation analysis, which shows very little interest rate sensitivity, indicates that an increase in interest rates of 100 to 200 basis points would have a negative effect on net interest income, and a decrease of 100 basis points in interest rates would also have a negative impact. These estimates are summarized below.
Net interest income change
Increase 200bp
(5.72
)%
Increase 100bp
(4.03
Decrease 100bp
(2.11
Decrease 200bp
N/A
Loans indexed to the prime rate, with floors of 4% or higher, comprise approximately 19% of total loans. Since the prime rate is currently 3.25%, rates would have to increase more than 75 bp before the rates on such loans will rise. This effect, captured in the simulation analysis above, negatively impacts the effect of rising rates.
The scenario of rates decreasing 200 bp is not reasonably possible given current low rates for short-term instruments and most deposits.
Undesignated derivative instruments described in Note 6 are recognized on the consolidated balance sheet at fair value, with changes in fair value, due to changes in prevailing interest rates, recorded in other non-
41
interest income. Because of matching terms of offsetting contracts, in addition to collateral provisions which mitigate the impact of non-performance risk, changes in fair value subsequent to initial recognition have a minimal effect on earnings, and are therefore not included in the simulation analysis results above.
Derivatives designated as cash flow hedges described in Note 6 are recognized on the consolidated balance sheet at fair value, with changes in fair value, due to changes in prevailing interest rates, recorded net of tax in other comprehensive income.
Provision for Loan Losses
The provision for loan losses was $350 thousand for the first three months of 2014 compared to $2.3 million for the same period in 2013. The allowance for loan losses is calculated after considering credit quality factors, and ultimately relies on an overall internal analysis of the risk in the loan portfolio. Based on this analysis, provisions for loan losses are determined and recorded. The provision reflects an allowance methodology that is driven by risk ratings, historical losses, and qualitative factors. The levels of non-performing, special mention and substandard loans continue to decrease and many key indicators of loan quality continue to show improvement. Bancorp intends to continue with its historically conservative stance toward credit quality, remaining cautious in assessing the potential risk in the loan portfolio.
Management utilizes loan grading procedures which result in specific allowance allocations for the estimated inherent risk of loss. For all loans graded, but not individually reviewed, a general allowance allocation is computed using factors typically developed over time based on actual loss experience. The specific and general allocations plus consideration of qualitative factors represent management’s best estimate of probable losses contained in the loan portfolio at the evaluation date. Although the allowance for loan losses is comprised of specific and general allocations, the entire allowance is available to absorb any credit losses. Based on this detailed analysis of credit risk, management considers the allowance for loan losses adequate to cover probable losses inherent in the loan portfolio at March 31, 2014.
An analysis of the changes in the allowance for loan losses and selected ratios for the three month periods ended March 31, 2014 and 2013 follows:
Balance at the beginning of the period
Loan charge-offs, net of recoveries
(281
(2,184
Balance at the end of the period
32,022
Average loans, net of unearned income
1,726,610
1,585,326
Provision for loan losses to average loans (1)
0.02
Net loan charge-offs to average loans (1)
0.14
Allowance for loan losses to average loans
1.66
2.02
Allowance for loan losses to period-end loans
1.65
2.00
(1) Amounts not annualized
Loans are charged off when deemed uncollectible and a loss is identified or after underlying collateral has been liquidated; however, collection efforts may continue and future recoveries may occur. Periodically, loans are partially charged off to the net realizable value based upon collateral analysis.
An analysis of net charge-offs by loan category for the three month periods ended March 31, 2014 and 2013 follows:
Three months
ended March 31
Net loan charge-offs (recoveries)
(9
(164
Real estate mortgage - commercial investment
(13
Real estate mortgage - owner occupied commercial
94
Real estate mortgage - 1-4 family residential
143
251
Home equity
(1
45
(2
Total net loan charge-offs
281
2,184
43
Non-interest Income and Expenses
The following table sets forth the major components of non-interest income and expenses for the three month periods ended March 31, 2014 and 2013.
Change
682
17.6
103
5.2
114
11.9
(592
-50.2
(110
-17.9
(16
-6.3
66
19.8
247
2.7
1,461
15.1
325
26.4
204
15.0
-7.9
(8
-2.3
(308
*
314
11.5
1,965
12.6
(*) - Amount exceeds 100%
Total non-interest income increased 247,000, or 2.7%, in the first quarter of 2014 compared to the same period in 2013.
The largest component of non-interest income is investment management and trust revenue. The magnitude of investment management and trust revenue distinguishes Bancorp from other community banks of similar asset size. Along with the effects of improving investment market conditions in 2013 and 2014, this area of Bancorp continued to grow through attraction of new business and retention of existing business. Trust assets under management totaled $2.28 billion at March 31, 2014, compared to $2.01 billion at March 31, 2013. Investment management and trust services income, which constitutes an average of 40% of non-interest income, increased $682,000, or 17.6%, for the first quarter of 2014 compared to the same period in 2013, primarily due to an increased market value of assets under management, net new business, and an increase in one-time executor fees. Recurring fees, which generally comprise over 95% of the investment management and trust revenue, increased 14% for the first quarter of 2014, compared to the first quarter of 2013. Most recurring fees earned for managing accounts are based on a percentage of market value on a monthly basis. While fees are based on market values, they typically do not fluctuate
44
directly with the overall stock market, as accounts usually contain fixed income and equity asset classes, which generally react inversely to each other. Some revenues of the investment management and trust department, most notably executor, insurance, and some employee benefit plan-related fees, are non-recurring in nature and the timing of these revenues corresponds with the related administrative activities. Non-recurring fees increased $152,000 for the first three months of 2014, compared to the same period of 2013.
Service charges on deposit accounts increased $103,000, or 5.2%, in the first quarter of 2014, as compared to the same period in 2013. Service charge income is driven by transaction volume, which can fluctuate throughout the year, increased in 2014 due to addition of accounts in the Oldham transaction. A significant component of service charges is related to fees earned on overdrawn checking accounts. While this source of income has experienced a modest increase, management expects it to decline slightly in 2014 due to anticipated changes in customer behavior and increased regulatory restrictions.
Bankcard transaction revenue increased $114,000, or 11.9%, for the first quarter of 2014, as compared to the same period in 2013 and primarily represents income Bancorp derives from customers’ use of debit cards. This category reflects a change in the manner in which bankcard revenue and expense are received and recorded by Bancorp, related to the selection of a new bankcard processor. Bancorp’s new processor provides more detailed information regarding related income and expense. As a result, beginning in mid-2013, information previously recorded as net revenue has been grossed up to more accurately reflect income and expense. This more detailed information is not available for prior periods and thus impacts the comparability of the information on an absolute basis for revenue and expense. It is, however, comparable on a net basis. Bankcard income, net of bankcard expenses which are recorded in data processing expenses, was $632,000 for the first quarter of 2014, compared to $660,000 for the same period of 2013. The net decrease in 2014 primarily reflects a decrease in the interchange rates received, partially offset by increased volume of transactions. Most of this revenue is interchange income based on rates set by service providers in a competitive market. Beginning in October 2011, this rate was set by the Federal Reserve Board for banks with over $10 billion in assets. While this threshold indicates Bancorp will not be directly affected, this change has affected Bancorp and other similarly sized institutions as vendors gravitate to lower cost interchanges. While there are many uncertainties about its effect or ultimately when these changes may take place, the Dodd-Frank legislation will negatively affect this source of income. Volume, which is dependent on consumer behavior, is expected to increase slowly. However, management expects interchange rates to decrease, resulting in income from this source to remain consistent with levels experienced in 2013.
Mortgage banking revenue primarily includes gains on sales of mortgage loans. Bancorp’s mortgage banking department originates residential mortgage loans to be sold in the secondary market. Interest rates on the loans sold are locked with the borrower and investor prior to closing the loans, thus Bancorp bears no interest rate risk related to these loans. The department offers conventional, VA and FHA financing, for purchases and refinances, as well as programs for first time home buyers. Interest rates on mortgage loans directly impact the volume of business transacted by the mortgage banking division. Mortgage banking revenue decreased $592,000, or 50.2%, in the first quarter of 2014 compared to the same period of 2013. Market rates for mortgage loans increased since the first quarter of 2013, resulting in 88% lower volume of refinance activity in 2014 compared to 2013. Declines in refinance activity reflect national trends, as fewer borrowers remain in the marketplace with incentive to refinance. Lower purchase volume due in part to severe winter conditions also dampened home-buying activity throughout most of the first quarter.
Brokerage commissions and fees decreased $110,000, or 17.9%, in the first quarter of 2014 compared to the same period of 2013, corresponding to overall brokerage volume. Brokerage commissions and fees earned consist primarily of stock, bond and mutual fund sales as well as wrap fees on accounts. Wrap fees
are charges for investment programs that bundle together a suite of services, such as brokerage, advisory, research, and management, and based on a percentage of assets. In the second quarter of 2013, the departure of two brokers resulted in a decline of accounts, many of which included wrap fees. However, after consideration of related expenses, the decline in net income for the first quarter of 2014 was approximately $16,000 compared to the same period of 2013. Bancorp deploys its brokers primarily through its branch network, while larger managed accounts are serviced in the investment management and trust department.
Bank owned life insurance (BOLI) income totaled $236,000 for the first three months of 2014, compared to $252,000 for the same period in 2013. BOLI represents the cash surrender value for life insurance policies on certain key employees who have provided consent for Bancorp to be the beneficiary of a portion of such policies. Any proceeds received under the policies and the related change in cash surrender value are recorded as non-interest income. This income helps offset the cost of various employee benefits.
Other non-interest income increased $66,000, or 19.8%, in the first quarter of 2014 as compared to the same period in 2013, due to a variety of other factors, none of which are individually significant.
Total non-interest expenses increased $1,965,000, or 12.6%, for the first quarter of 2014 as compared to the same period in 2013.
Salaries and benefits are the largest component of non-interest expenses and increased $1,461,000 or 15.1% for the first quarter of 2014 compared to the same period of 2013, largely due to increased staffing levels, higher bonus accruals, normal increases in salaries and higher health insurance costs, partially offset by lower stock-based compensation expense. In the first quarter of 2014, Bancorp recorded an adjustment to expense related to performance stock units, decreasing stock-based compensation by $185,000. Increased staffing levels included senior staff with higher per capita salaries in investment management and trust, lending and operational functions as well as staff increases resulting from the Oldham transaction. At March 31, 2014, Bancorp had 522 full-time equivalent employees compared to 488 at March 31, 2013.
Net occupancy expense increased $325,000, or 26.4%, in the first quarter of 2014, as compared to the same period of 2013, largely due to a $150,000 non-recurring rent refund on a leased facility which lowered rent expense in the first quarter of 2013, increases in rent and depreciation expense attributable to four additional locations as a result of the Oldham transaction, and unusually high maintenance costs in 2014 related to the severe winter.
Data processing expense increased $204,000 or 15.0% in the first quarter of 2014, as compared to the same period of 2013. As noted above during 2013, Bancorp began recording bank card revenue and expense gross; this information was previously conveyed net. The reported expense related to bank card activity increased $141,000 for the first quarter of 2014 compared to the same period in 2013 due to this change. This category also includes ongoing computer equipment maintenance costs related to investments in new technology needed to improve the pace of delivery channels and internal resources.
Furniture and equipment expense was $268,000 in the first quarter of 2014, compared to $291,000 for the same period in 2013, due to a variety of factors, none of which is individually significant. Costs of capital asset additions flow through the statement of income over the lives of the assets in the form of depreciation expense.
46
FDIC insurance expense was $342,000 in the first quarter of 2014, compared to $350,000 for the same period in 2013. The assessment is calculated by the FDIC and adjusted quarterly. The decline in expense is due primarily to a reduction in the assessment rate, which was driven by improved credit metrics in 2013.
Gains on other real estate owned (OREO) totaled $343,000 for the first quarter of 2014, compared to $35,000 for the same period in 2013. Bancorp liquidated several properties at prices greater than their carrying values in the first quarter of 2014 resulting in gains on foreclosed assets.
Other non-interest expenses increased $314,000 or 11.5% in the first quarter of 2014, as compared to the same period in 2013, due largely to increases of $147,000 in core deposit intangible amortization, $85,000 in losses related to debit cards, and $74,000 in bank franchise taxes. This category also includes legal and professional fees, advertising, printing, mail and telecommunications, none of which had individually significant variances.
Income Taxes
In the first quarter of 2014, Bancorp recorded income tax expense of $3,632,000, compared to $3,019,000 for the same period in 2013. The effective rate for the three month periods ended March 31, 2014 and 2013 were both 30.8%.
Commitments
Bancorp uses a variety of financial instruments in the normal course of business to meet the financial needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. A discussion of Bancorp’s commitments is included in Note 9.
Other commitments discussed in Bancorp’s Annual Report on Form 10-K for the year ended December 31, 2013, have not materially changed since that report was filed, relative to qualitative and quantitative disclosures of fixed and determinable contractual obligations.
b) Financial Condition
Balance Sheet
Total assets decreased $35.0 million, or 1.5%, from $2.389 billion on December 31, 2013 to $2.354 billion on March 31, 2014. The most significant contributor to the decrease was securities available for sale, which decreased $49.8 million in the first quarter as a result of maturing short-term securities. These were matched with short-term seasonal deposits which also decreased in the first quarter of 2014. Bancorp invests excess funds in short-term investment securities at each quarter end as part of a state tax minimization strategy. These securities, with maturities of 30 days or less, totaled $55 million and $110 million for March 31, 2014 and December 31, 2013, respectively. Loans increased $7.3 million, while mortgage loans held for sale increased $1.7 million. Cash and due from banks increased $8.2 million, and federal funds sold increased $4.0 million. Other assets decreased $5.9 million, driven primarily by a $2.7 million decline in other real estate owned.
Total liabilities decreased $42.6 million, or 1.97%, from $2.160 billion December 31, 2013 to $2.117 billion on March 31, 2014. The most significant component of the decrease was federal funds purchased, which decreased $36.6 million, or 66.1%. Bancorp utilizes short-term lines of credit to manage its overall liquidity position. Deposits increased $6.5 million or 0.33%. Securities sold under agreement to repurchase decreased $10.2 million or 16.2%, and other liabilities decreased $2.2 million or 8.4%.
Elements of Loan Portfolio
The following table sets forth the major classifications of the loan portfolio.
Loans by Type
Undeveloped land (1)
Real estate mortgage:
Commercial investment
448,255
430,047
Owner occupied commercial
329,260
329,422
1-4 family residential
185,775
183,700
Home equity - first lien
40,700
40,251
Home equity - junior lien
62,605
63,403
Subtotal: Real estate mortgage
Total Loans
(1) Undeveloped land consists of land initially acquired for development by the borrower, but for which
no development has taken place.
Bancorp occasionally enters into loan participation agreements with other banks to diversify credit risk. For certain sold participation loans, Bancorp has retained effective control of the loans, typically by restricting the participating institutions from pledging or selling their share of the loan without permission from Bancorp. US GAAP requires the participated portion of these loans to be recorded as secured borrowings. These participated loans are included in the commercial and industrial and real estate mortgage loan totals above, and a corresponding liability is recorded in other liabilities. At March 31, 2014 and December 31, 2013, the total participated portions of loans of this nature were $9.2 million and $9.4 million, respectively.
Non-performing Loans and Assets
Information summarizing non-performing assets, including non-accrual loans follows:
Non-accrual loans
Troubled debt restructuring
7,280
7,249
Loans past due 90 days or more and still accruing
Non-performing loans
20,460
Foreclosed real estate
2,935
5,592
Non-performing assets
23,395
28,536
Non-performing loans as a percentage of total loans
1.18
1.33
Non-performing assets as a percentage of total assets
0.99
1.19
The following table sets forth the major classifications of non-accrual loans:
Non-accrual loans by type
847
1,921
2,141
1,741
2,391
Home equity and consumer loans
152
Bancorp has one relationship in its primary market which accounts for $6.7 million or 53% of total non-accrual loans at March 31, 2014. Each of the loans in this relationship is secured predominantly by undeveloped land, and management estimates minimal loss exposure after consideration of collateral. The remaining balance of non-accrual loans, totaling $6.0 million, is comprised of a larger number of borrowers with smaller balances. Each non-accrual loan is individually evaluated for impairment in conjunction with the overall allowance methodology.
c) Liquidity
The role of liquidity management is to ensure funds are available to meet depositors’ withdrawal and borrowers’ credit demands while at the same time maximizing profitability. This is accomplished by balancing changes in demand for funds with changes in the supply of those funds. Liquidity is provided by short-term liquid assets that can be converted to cash, investment securities available for sale, various lines of credit available to Bancorp, and the ability to attract funds from external sources, principally deposits.
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Management believes it has the ability to increase deposits at any time by offering rates slightly higher than the market rate.
Bancorp’s most liquid assets are comprised of cash and due from banks, available for sale marketable investment securities and federal funds sold. Federal funds sold totaled $40.3 million at March 31, 2014. These investments normally have overnight maturities and are used for general daily liquidity purposes. The fair value of the available for sale investment portfolio was $440.2 million at March 31, 2014. The portfolio includes maturities of approximately $67.8 million over the next twelve months, including $55 million of short-term securities which matured in April 2014. Combined with federal funds sold, these offer substantial resources to meet either new loan demand or reductions in Bancorp’s deposit funding base. Bancorp pledges portions of its investment securities portfolio to secure public fund deposits, cash balances of certain investment management and trust accounts, and securities sold under agreements to repurchase. At March 31, 2014, total investment securities pledged for these purposes comprised 46% of the available for sale investment portfolio, leaving $238.7 million of unpledged securities.
Bancorp has a large base of core customer deposits, defined as demand, savings, and money market deposit accounts. At March 31, 2014, such deposits totaled $1.644 billion and represented 83% of Bancorp’s total deposits. Because these core deposits are less volatile and are often tied to other products of Bancorp through long lasting relationships they do not put heavy pressure on liquidity. However, many of Bancorp’s overall deposit balances are historically high. When market conditions improve, these balances will likely decrease, putting some strain on Bancorp’s liquidity position. As of March 31, 2014, Bancorp had only $4.3 million or 0.2% of total deposits, in brokered deposits, which are predominantly comprised of Certificate of Deposit Account Registry Service (CDARs) deposits, a program which allows Bancorp to offer FDIC insurance up to $50 million in deposits per customer through reciprocal agreements with other network participating banks.
Other sources of funds available to meet daily needs include the sales of securities under agreements to repurchase. Also, Bancorp is a member of the FHLB of Cincinnati. As a member of the FHLB, Bancorp has access to credit products of the FHLB. Bancorp views these borrowings as a low cost alternative to other time deposits. At March 31, 2014, the amount of available credit from the FHLB totaled $370.4 million. Additionally, Bancorp had available federal funds purchased lines with correspondent banks totaling $85 million.
Bancorp’s principal source of cash revenues is dividends paid to it as the sole shareholder of the Bank. At March 31, 2014, the Bank may pay up to $28.4 million in dividends to Bancorp without regulatory approval subject to the ongoing capital requirements of the Bank.
d) Capital Resources
At March 31, 2014, stockholders’ equity totaled $237.0 million, an increase of $7.5 million since December 31, 2013. See the Consolidated Statement of Changes in Stockholders’ Equity for further detail of the changes in equity since the end of 2013. One component of equity is accumulated other comprehensive income (loss) which, for Bancorp, consists of net unrealized gains or losses on securities available for sale and hedging instruments, as well as a minimum pension liability, each net of taxes. Accumulated other comprehensive loss was ($170,000) and ($2,217,000) at March 31, 2014 and December 31, 2013, respectively. The $2,047,000 increase is primarily a reflection of the effect of the changing interest rate environment during the first quarter of 2014 on the valuation of Bancorp’s portfolio of securities available for sale.
Bank holding companies and their subsidiary banks are required by regulators to meet risk based capital standards. These standards, or ratios, measure the relationship of capital to a combination of balance sheet
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and off-balance sheet risks. The values of both balance sheet and off-balance sheet items are adjusted to reflect credit risks. To be categorized as well capitalized, the Bank must maintain a total risk-based capital ratio of at least 10%; a Tier 1 ratio of at least 6%; and a leverage ratio of at least 5%.
The following table sets forth Bancorp’s and the Bank’s risk based capital ratios as of March 31, 2014 and December 31, 2013.
Bancorp intends to maintain capital ratios at these historically high levels at least until such time as the economy demonstrates sustained improvement and implications of newly proposed Basel III capital rules become definitive, and to remain well positioned to pursue expansion and other opportunities that may arise.
e) Non-GAAP Financial Measures
In addition to capital ratios defined by banking regulators, Bancorp considers various ratios when evaluating capital adequacy, including tangible common equity to tangible assets, and tangible common equity per share, all of which are non-GAAP measures. Bancorp believes these ratios are important because of their widespread use by investors as means to evaluate capital adequacy, as they reflect the level of capital available to withstand unexpected market conditions. Because US GAAP does not include capital ratio measures, there are no US GAAP financial measures comparable to these ratios.
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The following table reconciles Bancorp’s calculation of the measures to amounts reported under US GAAP.
(in thousands, except per share data)
Total equity
Less core deposit intangible
(2,004
(2,151
Less goodwill
(682
Tangible common equity
234,290
226,611
Total tangible assets
2,351,552
2,386,429
Total shareholders’ equity to total assets
10.07
9.60
Tangible common equity ratio
9.96
9.50
Number of outstanding shares
Book value per share
16.17
15.71
Tangible common equity per share
15.98
15.51
The following table provides a reconciliation of net interest margin in accordance with US GAAP to core net interest margin. Bancorp provides this information to illustrate the trend in quarterly net interest margin sequentially during 2013 and 2014 and to show the impact of prepayment fees, late charges and accretion on net interest margin.
f) Recently Issued Accounting Pronouncements
At March 31, 2014, no recently issued accounting pronouncements were identified that would affect the financial statements of Bancorp.
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Information required by this item is included in Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
Bancorp maintains disclosure controls and procedures designed to ensure that it is able to collect the information it is required to disclose in reports it files with the Securities and Exchange Commission (“SEC”), and to record, process, summarize and report this information within the time periods specified in the rules and forms of the SEC. Based on their evaluation of Bancorp’s disclosure controls and procedures as of the end of the quarterly period covered by this report, the Chief Executive and Chief Financial Officers believe that these controls and procedures are effective to ensure that Bancorp is able to collect, process and disclose the information it is required to disclose in reports it files with the SEC within the required time periods.
Based on the evaluation of Bancorp’s disclosure controls and procedures by the Chief Executive and Chief Financial Officers, there were no significant changes during the quarter ended March 31, 2014 in Bancorp’s internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, Bancorp’s internal control over financial reporting.
PART II — OTHER INFORMATION
The following table shows information relating to the repurchase of shares of common stock by Bancorp during the three months ended March 31, 2014.
Total number of shares purchased (1)
Average price paid per share
Total number of shares purchased as part of publicly announced plan (2)
Maximum number of shares that may yet be purchased under the plan
January 1 - January 31
30.38
February 1 - February 28
12,386
28.65
March 1 - March 31
6,540
31.19
19,009
29.53
(1) Activity represents shares of stock withheld to pay taxes due upon exercise of stock appreciation rights or vesting of restricted stock. This activity has no impact on the number of shares that may be purchased under a Board-approved plan.
(2) Since 2008, there has been no active share buyback plan
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The following exhibits are filed or furnished as a part of this report:
Exhibit Number
Description of exhibit
31.1
Certifications pursuant to Section 302 of the Sarbanes-Oxley Act by David P. Heintzman
31.2
Certifications pursuant to Section 302 of the Sarbanes-Oxley Act by Nancy B. Davis
Certifications pursuant to 18 U.S.C. Section 1350
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The following financial statements from the Stock Yards Bancorp, Inc. March 31, 2014 Quarterly Report on Form 10-Q, filed on May 7, 2014, formatted in eXtensible Business Reporting Language (XBRL):
(1)
(2)
(3)
(4)
(5)
Consolidated Statement of Changes in Stockholders’ Equity
(6)
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Date: May 7, 2014
By:
/s/ David P. Heintzman
David P. Heintzman, Chairman
and Chief Executive Officer
/s/ Nancy B. Davis
Nancy B. Davis, Executive Vice President,
Treasurer and Chief Financial Officer