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 June 30, 2015
OR
¨ 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)
Not Applicable
(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 ¨
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 ¨
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 o
Accelerated filer x
Non-accelerated filer o
Smaller reporting company o
(Do not check if a 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 ¨ No x
The number of shares of the registrant’s Common Stock, no par value, outstanding as of July 27, 2015, was 14,851,374.
STOCK YARDS BANCORP, INC. AND SUBSIDIARY
Index
Item
Page
PART I — FINANCIAL INFORMATION
Item 1. Financial Statements
The following consolidated financial statements of Stock Yards Bancorp, Inc. and Subsidiary are submitted herewith:
–
Consolidated Balance Sheets
June 30, 2015 (Unaudited) and December 31, 2014
2
Consolidated Statements of Income (Unaudited)
for the three and six months ended June 30, 2015 and 2014
3
Consolidated Statements of Comprehensive Income (Unaudited)
4
Consolidated Statements of Changes in Stockholders’ Equity (Unaudited)
for the six months ended June 30, 2015 and 2014
5
Consolidated Statements of Cash Flows (Unaudited)
6
Notes to Consolidated Financial Statements (Unaudited)
7
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
38
Item 3.
Quantitative and Qualitative Disclosures about Market Risk
56
Item 4.
Controls and Procedures
PART II — OTHER INFORMATION
Unregistered Sales of Equity Securities and Use of Proceeds
Item 6.
Exhibits
57
1
June 30, 2015 and December 31, 2014
(In thousands, except share data)
June 30,
December 31,
2015
2014
(Unaudited)
Assets
Cash and due from banks
$
37,775
42,216
Federal funds sold
20,901
32,025
Cash and cash equivalents
58,676
74,241
Mortgage loans held for sale
8,237
3,747
Securities available-for-sale (amortized cost of $410,242 and $509,276 in 2015 and 2014, respectively)
412,866
513,056
Federal Home Loan Bank stock and other securities
6,347
Loans
1,899,302
1,868,550
Less allowance for loan losses
23,308
24,920
Net loans
1,875,994
1,843,630
Premises and equipment, net
40,199
39,088
Bank owned life insurance
30,554
30,107
Accrued interest receivable
5,950
5,980
Other assets
43,864
47,672
Total assets
2,482,687
2,563,868
Liabilities and Stockholders’ Equity
Deposits:
Non-interest bearing
551,723
523,947
Interest bearing
1,520,042
1,599,680
Total deposits
2,071,765
2,123,627
Securities sold under agreements to repurchase
64,418
69,559
Federal funds purchased
13,290
47,390
Accrued interest payable
125
131
Other liabilities
21,852
26,434
Federal Home Loan Bank advances
38,855
36,832
Total liabilities
2,210,305
2,303,973
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 14,851,554 and 14,744,684 shares in 2015 and 2014, respectively
10,390
10,035
Additional paid-in capital
41,213
38,191
Retained earnings
219,466
209,584
Accumulated other comprehensive income
1,313
2,085
Total stockholders’ equity
272,382
259,895
Total liabilities and stockholders’ equity
See accompanying notes to unaudited consolidated financial statements.
For the three and six months ended June 30, 2015 and 2014
(In thousands, except per share data)
For three months ended
For six months ended
Interest income:
20,612
19,787
41,027
39,146
51
63
119
142
74
43
113
Securities – taxable
1,969
1,824
4,003
3,661
Securities – tax-exempt
294
296
585
594
Total interest income
23,000
22,013
45,847
43,617
Interest expense:
Deposits
938
1,114
1,911
2,254
9
12
15
32
29
69
224
206
440
402
Total interest expense
1,199
1,358
2,432
2,734
Net interest income
21,801
20,655
43,415
40,883
Provision for loan losses
1,350
1,700
Net interest income after provision for loan losses
19,305
39,183
Non-interest income:
Investment management and trust services
4,651
4,755
9,203
9,323
Service charges on deposit accounts
2,199
2,223
4,279
4,326
Bankcard transaction revenue
1,246
1,209
2,368
2,284
Mortgage banking revenue
913
722
1,741
1,310
Loss on sales of securities available for sale
(9
)
Brokerage commissions and fees
499
462
960
967
Bank owned life insurance income
226
234
448
470
Other
485
461
893
861
Total non-interest income
10,219
10,057
19,892
19,532
Non-interest expenses:
Salaries and employee benefits
11,383
10,724
22,483
21,842
Net occupancy expense
1,450
1,453
2,919
3,009
Data processing expense
1,756
1,718
3,210
3,278
Furniture and equipment expense
260
259
507
527
FDIC insurance expense
317
350
614
692
Loss (gain) on other real estate owned
145
(6
165
(349
3,556
3,203
6,748
6,246
Total non-interest expenses
18,867
17,701
36,646
35,245
Income before income taxes
13,153
11,661
26,661
23,470
Income tax expense
4,151
3,627
8,404
7,259
Net income
9,002
8,034
18,257
16,211
Net income per share:
Basic
0.61
0.55
1.24
1.12
Diluted
0.60
1.23
1.10
Average common shares:
14,710
14,545
14,679
14,526
14,936
14,704
14,902
14,714
(In thousands)
Three months ended June 30,
Six months ended June 30,
Other comprehensive income, net of tax:
Unrealized (losses) gains on securities available for sale:
Unrealized (losses) gains arising during the period (net of tax of ($1,417), $663, ($405) and $1,754, respectively)
(2,631
1,232
(751
3,258
Reclassification adjustment for securities losses realized in income (net of tax of $0, $3, $0, and $3, respectively)
Unrealized losses on hedging instruments:
Unrealized losses arising during the period (net of tax of ($1), ($18), ($11) and ($7), respectively)
(2
(34
(21
(13
Other comprehensive (loss) income , net of tax
(2,633
1,204
(772
3,251
Comprehensive income
6,369
9,238
17,485
19,462
For the six months ended June 30, 2015 and 2014
Accumulated
Common stock
other
Number of
Additional
Retained
comprehensive
shares
Amount
paid-in capital
earnings
income (loss)
Total
Balance December 31, 2013
14,609
9,581
33,255
188,825
(2,217
229,444
Other comprehensive income, net of tax
Stock compensation expense
768
Stock issued for exercise of stock options, net of withholdings to satisfy employee tax obligations upon vesting of stock awards
31
104
807
(73
838
Stock issued for non-vested restricted stock
40
132
1,022
(1,154
Stock issued for share-based awards, net of withholdings to satisfy employee tax obligations upon award
18
(111
(93
Cash dividends declared, $0.43 per share
(6,300
Shares repurchased or cancelled
(20
(66
(499
60
(505
Balance June 30, 2014
14,665
9,769
35,242
197,569
1,034
243,614
Balance December 31, 2014
14,745
Other comprehensive loss, net of tax
995
245
1,917
(175
1,987
35
116
1,088
(1,204
61
(397
(128
(464
Cash dividends declared, $0.47 per share
(6,952
(67
(581
84
(564
Balance June 30, 2015
14,852
Operating activities:
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation, amortization and accretion, net
3,374
3,226
Deferred income tax expense (benefit)
1,170
(252
Loss on sale of securities available for sale
Gain on sales of mortgage loans held for sale
(1,133
(769
Origination of mortgage loans held for sale
(63,461
(41,363
Proceeds from sale of mortgage loans held for sale
60,104
39,727
(448
(470
Gain on the disposal of premises and equipment
(5
(30
Loss (gain) on the sale of other real estate
Excess tax benefits from share-based compensation arrangements
(293
(169
Decrease in accrued interest receivable and other assets
387
584
(Decrease) increase in accrued interest payable and other liabilities
(4,303
2,337
Net cash provided by operating activities
14,809
21,160
Investing activities:
Purchases of securities available for sale
(92,730
(124,550
Proceeds from sale of securities available for sale
5,934
7,732
Proceeds from maturities of securities available for sale
184,878
197,397
Net increase in loans
(32,596
(80,407
Purchases of premises and equipment
(2,615
(1,203
Proceeds from disposal of premises and equipment
344
Proceeds from sale of foreclosed assets
1,820
4,303
Net cash provided by investing activities
64,691
3,616
Financing activities:
Net (decrease) increase in deposits
(51,862
6,458
Net decrease in securities sold under agreements to repurchase and federal funds purchased
(39,241
(2,421
Proceeds from Federal Home Loan Bank advances
63,200
21,820
Repayments of Federal Home Loan Bank advances
(61,177
(20,082
Issuance of common stock for options and performance stock units
1,566
626
293
169
Common stock repurchases
(900
(555
Cash dividends paid
(6,944
Net cash used in financing activities
(95,065
(285
Net (decrease) increase in cash and cash equivalents
(15,565
24,491
Cash and cash equivalents at beginning of period
70,770
Cash and cash equivalents at end of period
95,261
Supplemental cash flow information:
Income tax payments
6,774
5,094
Cash paid for interest
2,438
2,729
Supplemental non-cash activity:
Transfers from loans to other real estate owned
232
1,505
(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 available-for sale securities, other real estate owned and income tax assets, and estimated liabilities and expense.
A description of other significant accounting policies is presented in the notes to Consolidated Financial Statements for the year ended December 31, 2014 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 and six month periods ended June 30, 2015 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. In the second quarter of 2015, Bancorp extended the historical period used to capture Bancorp’s historical loss ratios from 12 quarters to 24 quarters. Management believes the extension of the look-back period is appropriate to capture the impact of a full economic cycle and more accurately represents the current level of risk inherent in the loan portfolio. 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 inherent in the loan portfolio as of the balance sheet date. 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.
Bancorp’s allowance calculation includes specific allowance allocations to loan portfolio segments at June 30, 2015 for qualitative factors including, among other factors, national and local economic and business conditions, the quality and experience of lending staff and management, changes in lending policies and procedures, changes in volume and severity of past due loans, classified loans and non-performing loans, potential impact of any concentrations of credit, changes in the nature and terms of loans such as growth
rates and utilization rates, changes in the value of underlying collateral for collateral-dependent loans, considering Bancorp’s disposition bias, and 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. Bancorp utilizes the sum of all allowance amounts derived as described above as the appropriate level of allowance for loan and lease losses. 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.
(2) Securities
The amortized cost, unrealized gains and losses, and fair value of securities available-for-sale follow:
(in thousands)
Amortized
Unrealized
June 30, 2015
cost
Gains
Losses
Fair value
U.S. Treasury and other U.S. Government obligations
10,000
Government sponsored enterprise obligations
175,985
1,942
559
177,368
Mortgage-backed securities - government agencies
160,359
1,477
1,510
160,326
Obligations of states and political subdivisions
63,142
1,344
157
64,329
Corporate equity securities
756
87
843
Total securities available for sale
410,242
4,850
2,226
December 31, 2014
70,000
203,531
2,017
562
204,986
173,573
2,042
1,345
174,270
61,416
1,560
62,834
210
966
509,276
5,829
2,049
Corporate equity securities consist of common stock in a publicly-traded business development company.
There were no securities classified as held to maturity as of June 30, 2015 or December 31, 2014.
In the first quarter of 2015, Bancorp sold securities with total fair market value of $5.9 million, generating no gain or loss. These securities consisted of agency and mortgage-backed securities with small remaining balances and agency securities. In the second quarter of 2014, Bancorp sold securities with total fair market value of $7.7 million, generating a net loss of $9 thousand. These securities consisted of mortgage-backed securities with small remaining balances, obligations of state and political subdivisions, and agency securities. These sales were made in the ordinary course of portfolio management. Management has the intent and ability to hold all remaining investment securities available-for-sale for the foreseeable future.
8
A summary of the available-for-sale investment securities by contractual maturity groupings as of June 30, 2015 is shown below.
Securities available-for-sale
Amortized cost
Due within 1 year
26,168
26,253
Due after 1 but within 5 years
123,077
124,852
Due after 5 but within 10 years
18,907
19,263
Due after 10 years
80,975
81,329
Mortgage-backed securities
Total securities available-for-sale
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.
Securities with a carrying value of approximately $258.4 million at June 30, 2015 and $263.1 million at December 31, 2014 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 June 30, 2015 and December 31, 2014, not recognized in the statements of income are as follows:
Less than 12 months
12 months or more
Fair
value
losses
25,363
208
8,793
351
34,156
36,666
394
33,165
1,116
69,831
18,249
124
2,221
33
20,470
Total temporarily impaired securities
80,278
726
44,179
1,500
124,457
36,979
30
26,848
532
63,827
4,038
77
49,325
1,268
53,363
12,655
67
6,297
75
18,952
53,672
174
82,470
1,875
136,142
Applicable dates for determining when securities are in an unrealized loss position are June 30, 2015 and December 31, 2014. As such, it is possible that a security had a market value lower 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.
Unrealized losses on Bancorp’s investment securities portfolio have not been recognized as an expense because the securities are of high credit quality, and the decline in fair values is 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 71 and 80 separate investment positions as of June 30, 2015 and December 31, 2014, 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 June 30, 2015.
FHLB stock and other securities are investments held by Bancorp 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, and are classified as restricted securities.
10
(3) Loans
Composition of loans, net of deferred fees and costs, by primary loan portfolio class follows:
Commercial and industrial
595,584
571,754
Construction and development, excluding undeveloped land
102,274
95,733
Undeveloped land
19,965
21,268
Real estate mortgage:
Commercial investment
484,130
487,822
Owner occupied commercial
342,908
340,982
1-4 family residential
216,864
211,548
Home equity - first lien
42,612
43,779
Home equity - junior lien
65,354
66,268
Subtotal: Real estate mortgage
1,151,868
1,150,399
Consumer
29,611
29,396
Total loans
11
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 June 30, 2015 and December 31, 2014.
Type of loan
Construction
and development
Commercial
excluding
and
undeveloped
Undeveloped
Real estate
industrial
land
mortgage
Loans collectively evaluated for impairment
591,064
101,333
1,146,530
29,537
1,888,429
Loans individually evaluated for impairment
4,440
516
4,844
73
9,873
Loans acquired with deteriorated credit quality
80
425
494
1,000
Unallocated
Allowance for loan losses
At December 31, 2014
11,819
721
1,545
10,541
Provision (credit)
(1,250
655
(471
44
Charge-offs
(1,330
(358
(274
(1,962
Recoveries
14
81
255
At June 30, 2015
9,253
1,376
1,074
11,286
319
Allowance for loans collectively evaluated for impairment
6,807
1,286
10,860
247
20,274
Allowance for loans individually evaluated for impairment
2,446
90
426
72
3,034
Allowance for loans acquired with deteriorated credit quality
564,443
94,603
1,146,212
29,311
1,855,837
7,239
3,720
76
11,551
467
1,162
At December 31, 2013
7,644
2,555
5,376
12,604
343
28,522
4,593
(1,584
(2,244
(1,190
25
(400
(661
(250
(1,753
(993
(587
(4,244
243
166
120
513
1,042
10,790
706
10,285
218
23,544
1,029
256
The considerations by Bancorp in computing its allowance for loan losses are determined based on the various risk characteristics of each loan segment. Relevant risk characteristics are as follows:
· Commercial and industrial loans: Loans in this category are made to businesses. Generally these loans are secured by assets of the business and repayment is expected from the cash flows of the business. A weakened economy, and resultant decreased consumer and/or business spending will have an effect on the credit quality in this loan category.
· Construction and development, excluding undeveloped land: Loans in this category primarily include owner-occupied and investment construction loans and commercial development projects. In most cases, construction loans require only interest to be paid during construction, and then convert to permanent financing in the real estate mortgage segment, requiring principal amortization. Repayment of development loans is derived from sale of lots or units including any pre-sold units. Credit risk is affected by construction delays, cost overruns, market conditions and availability of permanent financing, to the extent such permanent financing is not being provided by Bancorp.
13
· Undeveloped land: Loans in this category are secured by land initially acquired for development by the borrower, but for which no development has yet taken place. Credit risk is affected by market conditions and time to sell lots at an adequate price. Credit risk is also affected by availability of permanent financing, to the extent such permanent financing is not being provided by Bancorp.
· Real estate mortgage: Loans in this category are made to and secured by owner-occupied residential real estate, owner-occupied real estate used for business purposes, and income-producing investment properties. Repayment is dependent on credit quality of the individual borrower. Underlying properties are generally located in Bancorp’s primary market area. Cash flows of income producing investment properties are adversely impacted by a downturn in the economy as evidenced by increased vacancy rates, which in turn, will have an effect on credit quality. Overall health of the economy, including unemployment rates and housing prices, has an effect on credit quality in this loan category.
· Consumer: Loans in this category may be either secured or unsecured and repayment is dependent on credit quality of the individual borrower and, if applicable, sale of collateral securing the loan. Therefore, overall health of the economy, including unemployment rates and housing prices, will have a significant effect on credit quality in this loan category.
Bancorp has loans that were acquired in a 2013 acquisition, for which there was, at acquisition, evidence of deterioration of credit quality since origination and for which it was probable 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 June 30, 2015 and December 31, 2014. Changes in the fair value adjustment for acquired impaired loans are shown in the following table:
Accretable discount
Non- accretable discount
Balance at December 31, 2013
137
369
Accretion
(75
(103
Reclassifications from (to) non-accretable difference
Disposals
Balance at December 31, 2014
62
266
(27
Balance at June 30, 2015
The following table presents loans individually evaluated for impairment as of June 30, 2015 and December 31, 2014.
Unpaid
Average
Recorded
principal
Related
recorded
investment
balance
allowance
Loans with no related allowance recorded
762
3,461
802
26
151
Real estate mortgage
361
110
1,649
2,087
1,587
492
695
27
2,397
3,092
2,491
Subtotal
3,186
6,705
3,319
Loans with an allowance recorded
3,678
6,566
5,438
490
122
118
1,733
274
1,294
592
34
250
2,447
1,666
6,687
9,575
7,668
10,027
6,240
641
483
3,382
3,820
2,881
1,084
945
5,539
4,157
16,280
10,987
896
3,596
996
5,608
198
1,784
1,939
870
782
36
2,803
3,240
2,999
3,725
6,987
9,629
6,343
7,914
6,797
196
640
716
112
704
79
144
651
917
1,995
7,826
9,397
9,068
11,510
7,793
222
235
2,500
2,937
2,643
949
1,433
4,994
16,384
18,697
Differences between recorded investment amounts and unpaid principal balance amounts less related allowance are due to partial charge-offs which have occurred over the life of loans.
16
Impaired loans include non-accrual loans and accruing 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. Bancorp did not have any loans past due more than 90 days and still accruing interest as of June 30, 2015. Loans past due more than 90 days and still accruing interest amounted to $329 thousand at December 31, 2014.
The following table presents the recorded investment in non-accrual loans as of June 30, 2015 and December 31, 2014.
3,420
1,381
2,081
950
3,302
8,781
5,199
At June 30, 2015 and December 31, 2014, Bancorp had accruing loans classified as TDR of $1.1 million and $6.4 million, respectively. Bancorp did not modify and classify any additional loans as TDR during the six months ended June 30, 2015 or 2014.
Bancorp had no loans accounted for as TDR that were restructured and experienced a payment default within the previous 12 months as of June 30, 2015. 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 June 30, 2014.
(dollars in thousands)
June 30, 2014
contracts
Commercial & industrial
790
Loans accounted for as TDR include modifications from original terms such as those due to bankruptcy proceedings, certain modifications of amortization periods or extended 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 June 30, 2015, had a total allowance allocation of $225 thousand, compared to $703 thousand at December 31, 2014.
17
At June 30, 2015, Bancorp did not have any outstanding commitments to lend additional funds to borrowers whose loans have been modified as TDR, compared to $458 thousand at December 31, 2014.
The following table presents the aging of the recorded investment in loans as of June 30, 2015 and December 31, 2014.
90 or more
days past
> 90 days
30-59 days
60-89 days
due (includes)
past due
non-accrual)
Current
loans
accruing
3,598
591,986
101,758
482
70
778
483,352
42
3,642
339,266
2,026
115
3,225
213,639
99
192
42,420
65,189
2,712
446
8,002
1,143,866
29,603
2,884
459
12,124
1,887,178
3,860
1,382
5,245
566,509
757
826
94,907
241
993
249
486,345
1,272
920
4,273
336,709
1,801
285
1,023
3,109
208,439
43,765
78
65,684
4,536
1,532
3,389
9,457
1,140,942
29,335
8,508
1,553
5,528
15,589
1,852,961
329
Consistent with regulatory guidance, 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 include all risk-rated loans other than those classified as special mention, substandard, substandard non-performing 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 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.
19
As of June 30, 2015 and December 31, 2014, the internally assigned risk grades of loans by category were as follows:
Special
Substandard
Pass
mention
non-performing
Doubtful
573,370
13,876
3,898
97,894
3,523
341
18,285
523
1,157
478,381
5,345
178
325,802
11,192
2,532
214,101
1,654
42,532
65,053
98
1,125,869
18,289
2,866
29,538
1,844,956
36,211
8,262
546,582
6,215
11,717
7,240
88,389
4,867
1,720
20,578
530
160
482,415
4,991
181
328,385
6,942
3,156
2,499
209,396
1,129
66,182
50
1,130,143
13,112
3,337
3,807
29,244
1,814,936
24,800
16,934
11,880
20
(4) Securities Sold Under Agreements to Repurchase
Securities sold under agreements to repurchase, which represent excess funds from commercial customers as part of a cash management service, totaled $64.4 million and $69.6 million at June 30, 2015 and December 31, 2014, respectively. Bancorp enters into sales of securities under agreement to repurchase at a specified future date. At June 30, 2015, all of these financing arrangements had overnight maturities and were secured by government sponsored enterprise obligations and government agency mortgage-backed securities which were owned and under the control of Bancorp.
(5) Federal Home Loan Bank Advances
Bancorp had outstanding borrowings of $38.9 million and $36.8 million at June 30, 2015 and December 31, 2014, respectively, via eleven separate fixed-rate 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 $8.9 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
30,000
2.30
%
2020
1,861
2.23
1,885
2021
463
2.12
497
2024
2,966
2.36
3,064
2025
2,200
2.26
2028
1,365
1.47
1,386
2.27
Advances from the FHLB are collateralized by certain commercial and residential real estate mortgage loans totaling $588.6 million under a blanket mortgage collateral agreement and FHLB stock. Bancorp views these borrowings as an effective alternative to higher cost time deposits to fund loan growth. At June 30, 2015, the amount of available credit from the FHLB totaled $405.7 million.
(6) Derivative Financial Instruments
Occasionally, Bancorp enters into free-standing interest rate swaps for the benefit of its commercial customers who desire to hedge their exposure to changing interest rates. Bancorp offsets its interest rate exposure on these transactions by entering into offsetting swap agreements with substantially matching terms with approved reputable independent counterparties. These undesignated derivative instruments are recognized on the consolidated balance sheet at fair value. Because of matching terms of offsetting contracts and 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 undesignated interest rate swap agreements for the first six month of 2015 were offsetting and therefore had no net effect on Bancorp’s earnings or cash flows.
21
Interest rate swap agreements derive their value from underlying interest rates. These transactions involve both credit and market risk. 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 counterparties to these agreements. Bancorp mitigates 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 June 30, 2015 and December 31, 2014, Bancorp had outstanding undesignated interest rate swap contracts as follows:
Receiving
Paying
(dollar amounts in thousands)
Notional amount
8,387
7,217
Weighted average maturity (years)
7.0
6.8
(385
(401
385
401
In 2013, Bancorp entered into an interest rate swap to hedge cash flows of a $10 million rolling fixed-rate three-month FHLB borrowing. For purposes of hedging, the rolling fixed rate advances are considered to be a floating rate liability. The interest rate swap involves exchange of Bancorp’s floating rate interest payments for fixed rate swap payments on the underlying principal amount. This swap was designated, and qualified, for cash-flow hedge accounting. The swap began December 6, 2013 and ends December 6, 2016. For derivative instruments that are designated and qualify as cash flow 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 June 30, 2015 and December 31, 2014.
Notional
Maturity
Receive (variable)
Pay fixed
amount
date
index
swap rate
12/6/2016
US 3 Month LIBOR
0.715
(8
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 thousand from the 1996 acquisition of an Indiana bank. This goodwill is assigned to the commercial banking segment of Bancorp.
In 2013, Bancorp completed the acquisition of THE BANCorp, Inc., parent company of THE BANK — Oldham County, Inc. As a result, Bancorp recorded a core deposit intangible totaling $2.5 million. For money market, savings and interest bearing checking accounts, this intangible asset is being amortized using a straight line method over 15 years. For the remainder of deposits, it is being amortized over a 10-
22
year period using an accelerated method which anticipates the life of the underlying deposits to which the intangible is attributable. At June 30, 2015, the unamortized core deposit intangible was $1.7 million.
Mortgage servicing rights (MSRs) are initially recognized at fair value when mortgage loans are sold with servicing retained. The MSRs are 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. Estimated fair values of MSRs at June 30, 2015 and December 31, 2014 were $2.6 million and $3.4 million, respectively. Total outstanding principal balances of loans serviced for others were $416.8 million and $421.1 million at June 30, 2015, and December 31, 2014, respectively.
Changes in the net carrying amount of MSRs for the six months ended June 30, 2015 and 2014 are shown in the following table:
For six months
ended June 30,
Balance at beginning of period
1,131
1,832
Additions for mortgage loans sold
216
153
Amortization
(370
Balance at June 30
977
1,515
(8) Defined Benefit Retirement Plan
Bancorp sponsors an unfunded, non-qualified, defined benefit retirement plan for three key officers (two current and one retired), and has no plans to increase the number of or benefits to participants. Benefits vest based on 25 years of service. The retired officer and one current officer are fully vested, and one current officer will be fully vested in 2017. Actuarially determined pension costs are expensed and accrued over the service period, and benefits are paid from Bancorp’s assets. Net periodic benefits costs, which include interest cost and amortization of net losses, totaled $36 thousand and $32 thousand, for the three months ended June 30, 2015 and 2014, respectively. For the six months ended June 30, 2015 and 2014, the net periodic benefit costs totaled $71 thousand and $63 thousand, respectively.
(9) Commitments and Contingent Liabilities
As of June 30, 2015, 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 $548.1 million including standby letters of credit of $11.7 million represent normal banking transactions. Commitments to extend credit were $463.0 million, including letters of credit of $11.0 million, as of December 31, 2014. Commitments to extend credit are agreements to lend to a customer as long as collateral is available and 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
23
management’s credit evaluation of the customer. Collateral held varies but may include accounts receivable, inventory, equipment, and real estate. However, should the commitments be drawn upon and should our customers default on their resulting obligation to us, our maximum exposure to credit loss, without consideration of collateral, is represented by the contractual amount of those instruments. At June 30, 2015, Bancorp has accrued $202 thousand for inherent risks related to unfunded credit commitments.
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 commercial transactions. Standby letters of credit generally have maturities of one to two years.
Also, as of June 30, 2015, 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. At Bancorp’s Annual Meeting of Shareholders held on April 22, 2015, shareholders approved the 2015 Omnibus Equity Compensation Plan and reserved the shares available from the 2005 plan for future awards under the 2015 plan. No additional shares were made available. As of June 30, 2015, there were 363,751 shares available for future awards. The 2005 Stock Incentive Plan expired in April 2015; however, options and SARs granted under this plan expire as late as 2025.
Options, which have not been granted since 2007, generally had a vesting schedule of 20% per year. Stock appreciation rights (“SARs”) granted have a vesting schedule of 20% per year. Options and SARs expire ten years after the grant date unless forfeited due to employment termination.
Restricted shares granted to officers vest over five years. All restricted shares have been granted at a price equal to the market value of common stock at the time of grant. For all grants prior to 2015, grantees are entitled to dividend payments during the vesting period. For grants in 2015, forfeitable dividends are deferred until shares are vested. Fair value of restricted shares is equal to the market value of the shares on the date of grant.
Grants of performance stock units (“PSUs”) 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, fair value of these PSUs is estimated based upon fair value of underlying shares on the date of grant, adjusted for non-payment of dividends.
Grants of restricted stock units (“RSUs”) to directors are time-based and vest 12 months after grant date. Because grantees are entitled to deferred dividend payments at the end of the vesting period, fair value of the RSUs is estimated based on fair value of 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:
Stock-based compensation expense before income taxes
477
Less: deferred tax benefit
(173
(167
(348
(269
Reduction of net income
321
310
647
Bancorp expects to record an additional $1.0 million of stock-based compensation expense in 2015 for equity grants outstanding as of June 30, 2015. As of June 30, 2015, Bancorp has $4.5 million 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 $1.7 million and $626 thousand from the exercise of options during the first six months of 2015 and 2014, respectively.
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. 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
2.97
2.94
Expected volatility
22.81
23.66
Risk free interest rate
1.91
2.22
Expected life of SARs
7.5 years
7.0 years
Dividend yield and expected volatility are based on historical information for Bancorp 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 SARs is based on actual experience of past like-term SARs and 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 six months ended June 30, 2015 follows:
Weighted
Aggregate
average
Options
intrinsic
remaining
and SARs
Exercise
exercise
fair
contractual
price
life (in years)
Vested and exercisable
524
21.03-26.83
23.84
4,981
5.35
3.5
Unvested
194
21.03-29.16
24.83
1,650
4.57
7.7
Total outstanding
718
24.11
6,631
5.14
4.6
Granted
49
34.43
5.95
Exercised
(83
24.26
5.71
Forfeited
508
24.29
7,132
5.20
3.7
176
22.86-34.43
27.93
1,735
4.93
8.2
684
21.03-34.43
26.11
8,867
5.13
4.8
Vested year-to-date
23.77
937
4.66
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 or grant price.
For the periods ending December 31, 2014 and June 30, 2015, Bancorp granted shares of restricted common stock as outlined in the following table:
Grant date
weighted-
Number
average cost
Unvested at December 31, 2013
124,556
22.77
Shares awarded
39,730
29.12
Restrictions lapsed and shares released to employees/directors
(44,724
22.69
Shares forfeited
(5,469
Unvested at December 31, 2014
114,093
24.95
34,990
(40,510
(3,000
28.18
Unvested at June 30, 2015
105,573
28.44
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
2013
20.38
36,792
26.42
25,012
31.54
19,774
In the first quarter of 2015, Bancorp awarded 6,080 RSUs to directors of Bancorp with a grant date fair value of $200 thousand. In the second quarter of 2015, 760 RSUs were cancelled, leaving 5,320 RSUs outstanding with a grant date fair value of $175 thousand.
(12) Net Income Per Share
The following table reflects, for the three and six months ended June 30, 2015 and 2014, net income (numerator) and average shares outstanding (denominator) for basic and diluted net income per share computations:
Three months ended
Six months ended
June 30
Average shares outstanding
Dilutive securities
159
223
188
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.
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 and six month periods ended June 30, 2015 and 2014 follows:
Investment
management
banking
and trust
Three months ended June 30, 2015
21,756
45
All other non-interest income
5,568
Non-interest expense
16,015
2,852
11,309
1,844
Tax expense
3,495
656
7,814
1,188
Three months ended June 30, 2014
5,289
5,302
15,103
2,598
9,448
2,213
2,840
787
6,608
1,426
28
Six months ended June 30, 2015
43,316
10,689
31,206
5,440
22,799
3,862
7,029
1,375
15,770
2,487
Six months ended June 30, 2014
40,793
10,179
10,209
30,065
5,180
19,207
4,263
5,743
1,516
13,464
2,747
(14) Income Taxes
An analysis of the difference between statutory and effective tax rates for the six months ended June 30, 2015 and 2014 follows:
Six months ended June 30
U.S. federal statutory tax rate
35.0
Tax exempt interest income
(1.4
(1.7
Tax credits
(2.5
(1.6
Cash surrender value of life insurance
(0.9
State income taxes
0.9
Other, net
0.4
Effective tax rate
31.5
30.9
US GAAP provides guidance on financial statement recognition and measurement of tax positions taken, or expected to be taken, in tax returns. As of June 30, 2015 and December 31, 2014, the gross amount of unrecognized tax benefits, including penalties and interest, was $48 thousand and $42 thousand, respectively. If recognized, 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 year tax 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 addition or elimination of uncertain tax positions. Federal and state income tax returns are subject to examination for the years after 2011.
(15) Assets and Liabilities Measured and Reported at Fair Value
Bancorp follows the provisions of 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 also 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.
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 derives its own estimates by 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 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 (including mortgage-backed securities), obligations of state and political subdivisions and corporate equity securities. U.S. Treasury and corporate equity securities 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 similar 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 generally based on 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 2015.
Below are the carrying values of assets measured at fair value on a recurring basis.
Fair value at June 30, 2015
Level 1
Level 2
Level 3
Investment securities available for sale
U.S. Treasury and other U.S. government obligations
Total investment securities available for sale
10,843
402,023
Interest rate swaps
413,251
402,408
Liabilities
393
Fair value at December 31, 2014
70,966
442,090
513,481
442,515
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 June 30, 2015 or December 31, 2014.
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 June 30, 2015 and December 31, 2014 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 June 30, 2015 or December 31, 2014. See Note 7 for more information regarding MSRs.
For impaired loans in the table below, fair value is calculated as the carrying value of only loans with a specific valuation allowance, less the specific allowance. Fair value of impaired loans was primarily measured based on the value of the collateral securing these loans. Impaired loans are classified within Level 3 of the fair value hierarchy. Collateral may be real estate and/or business assets including equipment, inventory, and/or accounts receivable. Bancorp determines the value of collateral based on independent appraisals performed by qualified licensed appraisers. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Appraised values are discounted for costs to sell and may be discounted further based on management’s historical knowledge, changes in market conditions from the date of the most recent appraisal, and/or management’s expertise and knowledge of the customer and the customer’s business. Such discounts by management are subjective and are typically significant unobservable inputs for determining fair value. As of June 30, 2015, total impaired loans with a valuation allowance were $6.7 million, and the specific allowance totaled $3.0 million, resulting in a fair value of $3.7 million, compared to total impaired loans with a valuation allowance of $7.8 million, and the specific allowance allocation totaling $1.4 million,
resulting in a fair value of $6.4 million at December 31, 2014. Losses represent the change in the specific allowances for the period indicated.
Other real estate owned (“OREO”), 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 based on appraisals performed by external parties which use judgments and assumptions that are property-specific and sensitive to changes in the overall economic environment. Appraisals are sometimes further discounted based on management’s historical knowledge, and/or changes in market conditions from the date of the most recent appraisal, and/or management’s expertise and knowledge of the customer and the customer’s business. Many of these inputs are not observable and, accordingly, these measurements are classified as Level 3. For OREO in the table below, the fair value is the carrying value of only parcels of OREO which have a carrying value equal to appraised value. Losses represent write-downs which occurred during the period indicated. At June 30, 2015 and December 31, 2014, the carrying value of all other real estate owned was $4.3 million and $6.0 million, respectively.
Below are the carrying values of assets measured at fair value on a non-recurring basis.
Losses for 6 month
period ended
Impaired loans
3,654
(2,524
Other real estate owned
6,991
(2,699
6,449
5,032
11,481
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 other assets and liabilities measured at fair value is such that transfers in and out of any level are expected to be rare. For the three months ended June 30, 2015, there were no transfers between Levels 1, 2, or 3. For Level 3 assets measured at fair value on a non-recurring basis as of June 30, 2015, the significant unobservable inputs used in the fair value measurements are presented below.
Significant
Valuation
unobservable
average of
(Dollars in thousands)
Value
technique
input
Impaired loans - collateral dependent
Appraisal
Appraisal discounts (%)
18.9
9.1
(16) Disclosure of Financial Instruments Not Reported at Fair Value
US GAAP requires disclosure of the fair value of financial assets and liabilities, including those financial assets and financial liabilities that are not measured and reported at fair value on a recurring basis or nonrecurring basis. Carrying amounts, estimated fair values, and placement in the fair value hierarchy of Bancorp’s financial instruments are as follows:
Carrying
Financial assets
Cash and short-term investments
8,475
Loans, net
1,879,004
Financial liabilities
2,072,235
Short-term borrowings
77,708
FHLB advances
38,896
3,876
1,863,568
2,124,904
116,949
37,714
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, carrying amount is a reasonable estimate of fair value as it equals the amount due from FHLB or other issuer at upon redemption.
Mortgage loans held for sale are initially recorded at the lower of cost or market value. The portfolio is comprised of residential real estate loans and fair value 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 an active market (exit price) for trading virtually all 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 (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 creditworthiness of 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 1, common equity Tier 1, and total capital, as defined, to risk weighted assets and Tier 1 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.
In 2013, the Federal Reserve Board and the FDIC approved rules that substantially amend the regulatory risk-based capital rules applicable to Bancorp and Bank. The rules implement the regulatory capital reforms of the Basel Committee on Banking Supervision reflected in “Basel III: A Global Regulatory Framework for More Resilient Banks and Banking Systems” (Basel III) and changes required by the Dodd-Frank Act. The rules implementing the Basel III regulatory capital reforms became effective for Bancorp and Bank on January 1, 2015, and include new minimum risk-based capital and leverage ratios. Capital ratios for December 31, 2014 were calculated using the former rules and for June 30, 2015 ratios were calculated using the new Basel III rules. For Bancorp, key differences under Basel III include risk weighting for commitments under one year and higher risk weighting for certain commercial real estate and construction loans. These differences resulted in higher risk-weighted assets, and therefore, somewhat lower risk-based capital ratios.
Bancorp and the Bank met all capital requirements to which they were subject as of June 30, 2015.
The following table sets forth consolidated Bancorp’s and the Bank’s risk based capital amounts and ratios as of June 30, 2015 and December 31, 2014.
Actual
Minimum for adequately capitalized
Minimum for well capitalized
Ratio
Total risk-based capital (1)
Consolidated
293,459
13.82
169,875
8.00
NA
Bank
286,309
13.50
169,665
212,081
10.00
Common Equity Tier 1 risk-based capital (2)
269,949
12.72
95,501
4.50
262,799
12.39
95,448
127,263
6.00
Tier 1 risk-based capital (1)
127,334
Leverage (3)
10.83
99,704
4.00
10.55
99,639
124,549
5.00
280,228
13.86
161,748
274,345
13.59
161,498
201,873
255,308
12.63
80,858
249,425
12.36
80,720
121,080
10.26
74,651
3.00
10.04
74,529
124,216
(1) Ratio is computed in relation to risk-weighted assets.
(2) Ratio became effective January 2015.
(3) Ratio is computed in relation to average assets.
NA – Not applicable. Regulatory framework does not define well capitalized for holding companies.
37
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
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 and six months ended June 30, 2015 and compares these periods with the same periods 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 six months of 2015 compared to same periods in the year ended December 31, 2014. This discussion should be read in conjunction with the consolidated financial statements and accompanying notes presented in Part 1, Item 1 of this report.
This report contains forward-looking statements under the Private Securities Litigation Reform Act that involve risks and uncertainties. Although Bancorp believes assumptions underlying 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 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 2015 through June 30
Bancorp completed the first six months of 2015 with net income of $18.3 million or 13% more than the comparable period of 2014. The increase is due to higher net interest income, no provision for loan losses, and higher non-interest income. These increases were partially offset by higher non-interest expenses and higher income tax expense. Diluted earnings per share for the first six months of 2015 were $1.23, compared to the first six months of 2014 at $1.10.
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 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 competition, new business acquisition efforts and economic factors including market interest rates, business spending, consumer confidence and competitive conditions within the marketplace.
Net interest income increased $2.5 million, or 6.2%, for the first six months of 2015, compared to the same period in 2014. The positive effects of increased volumes on earning assets and lower costs on time deposits were partially offset by the negative effect of declining interest rates earned. Net interest margin declined to 3.73% for the first six months of 2015, compared to 3.77% for the same period of 2014.
In response to assessment of risk in the loan portfolio, Bancorp did not record a provision for loan losses in the first six months of 2015, compared to a $1.7 million provision in the first six months of 2014. The provision for loan losses represents a charge to earnings necessary to establish an allowance for loan losses that, in management’s evaluation, is adequate to provide coverage for the inherent losses on outstanding loans.
Total non-interest income in the first six months of 2015 increased $360 thousand, or 1.8%, compared to the same period in 2014, and remained consistent at 31% of total revenues. Increases in mortgage banking income
and bankcard transaction revenue contributed to the growth, partially offset by decreases in investment management and trust revenue and service charges on deposit accounts.
Total non-interest expense in the first six months of 2015 increased $1.4 million, or 4.0%, compared to the same period in 2014, due to increases in salaries and benefits, write-downs on foreclosed assets and other non-interest expenses. These were partially offset by decreases in net occupancy, FDIC insurance and data processing expenses. Bancorp’s efficiency ratio in the first six months of 2015 was 57.5% compared with 57.9% in the same period in 2014.
Bancorp’s effective tax rate increased to 31.5% for the first six months of 2015 from 30.9% for the same period in 2014. The increase in the effective tax rate from 2014 to 2015 is the result of proportionally lower nontaxable income from the increase in cash value of life insurance and municipal securities. This was partially offset by the effect of reclassifying amortization of tax credit investments to other non-interest expense in 2015.
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 10.89% as of June 30, 2015, compared to 10.05% at December 31, 2014. 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 $9.0 million for the three months ended June 30, 2015 increased $1.0 million, or 12.0%, from $8.0 million for the comparable 2014 period. Basic net income per share was $0.61 for the second quarter of 2015, an increase of 10.9% from the $0.55 for the second quarter of 2014. Net income per share on a diluted basis was $0.60 for the second quarter of 2015, an increase of 9.1% from the $0.55 for the same period in 2014.
Reflecting increased net income, annualized return on average assets and annualized return on average stockholders’ equity were 1.45% and 13.30%, respectively, for the second quarter of 2015, compared to 1.37% and 13.35%, respectively, for the same period in 2014.
Net income of $18.3 million for the six months ended June 30, 2015 increased $2.0 million, or 12.6%, from $16.2 million for the comparable 2014 period. Basic net income per share was $1.24 for the first six months of 2015, an increase of 10.7% from the $1.12 for the first six months of 2014. Net income per share on a diluted basis was $1.23 for the first six months of 2015, an increase of 11.8% from the $1.10 for the first six months of 2014.
Reflecting increased net income, annualized return on average assets and annualized return on average stockholders’ equity were 1.47% and 13.73%, respectively, for the first six months of 2015, compared to 1.39% and 13.74%, respectively, for the same period in 2014.
Net Interest Income
The following tables present the average balance sheets for the three and six month periods ended June 30, 2015 and 2014 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.
39
Average Balances and Interest Rates — Taxable Equivalent Basis
Three months ended June 30
balances
Interest
rate
Earning assets:
56,671
0.36
77,386
0.33
7,701
3.85
4,438
3.89
Securities:
Taxable
347,249
1,907
2.20
322,208
1,760
2.19
Tax-exempt
59,605
421
2.83
59,968
424
2.84
FHLB stock and other securities
3.92
6,995
3.61
Loans, net of unearned income
1,879,982
20,719
4.42
1,750,487
19,905
4.56
Total earning assets
2,357,555
23,234
3.95
2,221,482
22,258
4.02
24,693
29,089
2,332,862
2,192,393
Non-earning assets:
37,877
35,896
Premises and equipment
40,148
39,321
Accrued interest receivable and other assets
87,790
90,087
2,498,677
2,357,697
Interest bearing liabilities:
Interest bearing demand deposits
516,765
134
0.10
473,628
0.11
Savings deposits
118,893
0.04
108,360
Money market deposits
634,862
0.20
629,844
324
0.21
Time deposits
287,402
472
0.66
338,531
0.78
58,060
0.22
52,396
Federal funds purchased and other short term borrowings
14,420
0.14
22,109
0.16
41,017
34,886
2.37
Total interest bearing liabilities
1,671,419
0.29
1,659,754
Non-interest bearing liabilities:
Non-interest bearing demand deposits
532,526
431,817
Accrued interest payable and other liabilities
23,255
24,750
2,227,200
2,116,321
Stockholders’ equity
271,477
241,376
22,035
20,900
Net interest spread
3.66
3.69
Net interest margin
3.75
3.77
71,679
87,024
5,678
4.01
3,615
4.13
352,641
3,877
323,045
3,531
59,684
837
59,607
851
2.88
126
7,170
130
1,874,791
41,244
4.44
1,733,924
39,383
4.58
2,370,820
46,316
3.94
2,214,385
44,111
24,950
29,085
2,345,870
2,185,300
37,359
35,664
39,832
39,447
89,079
91,626
2,512,140
2,352,037
508,902
263
477,449
116,650
106,011
654,782
623,819
631
296,821
972
344,051
1,348
0.79
61,185
0.23
56,622
15,142
19,397
38,907
2.28
34,596
2.34
1,692,389
1,661,945
526,423
426,695
25,224
25,397
2,244,036
2,114,037
268,104
238,000
43,884
41,377
3.65
3.73
41
Notes to the average balance and interest rate tables:
· Net interest income, the most significant component of the Bank’s earnings is total interest income less total interest expense. The level of net interest income is determined by 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 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%. Approximate tax equivalent adjustments to interest income were $234 thousand and $245 thousand, respectively, for the three month periods ended June 30, 2015 and 2014 and $469 thousand and $494 thousand, respectively, for the six month periods ended June 30, 2015 and 2014.
· Average balances for loans include the principal balance of non-accrual loans and exclude participation loans accounted for as secured borrowings. These participation loans averaged $7.9 million and $9.2 million, respectively, for the three month periods ended June 30, 2015 and 2014 and $8.0 million and $9.3 million, respectively, for the six month periods ended June 30, 2015 and 2014.
Fully taxable equivalent net interest income of $22.0 million for the three months ended June 30, 2015 increased $1.1 million, or 5.4%, from $20.9 million when compared to the same period last year. Net interest spread and net interest margin were 3.66% and 3.75%, respectively, for the second quarter of 2015 and 3.69% and 3.77%, respectively, for the second quarter of 2014.
Fully taxable equivalent net interest income of $43.9 million for the six months ended June 30, 2015 increased $2.5 million, or 6.1%, from $41.4 million when compared to the same period last year. Net interest spread and net interest margin were 3.65% and 3.73%, respectively, for the first six months of 2015 and 3.69% and 3.77%, respectively, for the first six months of 2014.
Approximately $668 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 $312 million, or 16% of total loans have reached their contractual floor of 4% or higher. Approximately $179 million of variable rate loans have contractual floors below 4%. The remaining $177 million of variable rate loans have no contractual floor. Bancorp attempts 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 increased $156.4 million or 7.1%, to $2.37 billion for the first six months of 2015 compared to 2014, reflecting growth in the loan portfolio and investment securities. Average interest
bearing liabilities increased $30.4 million, or 1.8%, to $1.69 billion for the first six months of 2015 compared to 2014 primarily due to increases in interest bearing demand, savings and money market deposits, FHLB advances and securities sold under agreements to repurchase, partially offset by decreases in time deposits and federal funds purchased.
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.
Bancorp assumes certain correlation rates, often referred to as a deposit “beta” of interest-bearing deposits, wherein the rates paid to customers change at a different pace when compared to changes in benchmark interest rates. Generally, certificates of deposit are assumed to have a high correlation rate, while interest-bearing checking accounts are assumed to have a lower correlation rate. Actual results may differ due to factors including competitive pricing and money supply; however, Bancorp uses its historical experience as well as industry data to inform its assumptions.
The June 30, 2015 simulation analysis, which shows 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
(3.99
)%
Increase 100bp
(3.11
Decrease 100bp
(2.72
Decrease 200bp
N/A
Management expects that net interest margin will remain under pressure over the balance of the year, and any near-term increases in prevailing interest rates will not immediately benefit the Company. Instead, because approximately 65% of its loan portfolio has fixed rates and 16% of its loan portfolio is priced at variable rates with floors of 4% or higher, a rise in rates would have a short-term negative impact on net interest income since rates would have to increase more than 75 bps before the rates on such loans will rise to compensate for higher interest costs. The extent of margin compression also will be affected by the need to respond to competitive pressures on funding sources.
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-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 represents a charge to earnings necessary to establish an allowance for loan losses that, in management’s evaluation, is adequate to provide coverage for inherent losses on outstanding loans. Bancorp did not record a provision for loan losses in the first six months of 2015, compared to a provision of $1.7 million for the same period of 2014. The allowance for loan losses is calculated after considering credit quality factors, and ultimately relies on an overall internal analysis of risk in the loan portfolio. Based on this analysis, the provision for loan losses is determined and recorded. The provision reflects an allowance methodology that is driven by risk ratings, historical losses, and qualitative factors. Levels of non-performing loans continue to decrease, charge-offs remain low and many key indicators of loan quality continue to show improvement.
Management utilizes loan grading procedures which result in specific allowance allocations for 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. 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 June 30, 2015.
An analysis of the changes in the allowance for loan losses and selected ratios for the three and six month periods ended June 30, 2015 and 2014 follows:
Balance at the beginning of the period
24,882
28,591
Loan charge-offs, net of recoveries
(1,574
(180
(1,612
(461
Balance at the end of the period
29,761
Average loans, net of unearned income
1,887,913
1,759,695
1,882,782
1,743,244
Provision for loan losses to average loans (1)
0.00
0.08
Net loan charge-offs to average loans (1)
0.01
0.09
0.03
Allowance for loan losses to average loans
1.69
1.71
Allowance for loan losses to period-end loans
1.65
(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 net realizable value based upon collateral analysis.
An analysis of net charge-offs by loan category for the three and six month periods ended June 30, 2015 and 2014 follows:
Three months
Six months
Net loan charge-offs (recoveries)
1,311
1,316
(37
Real estate mortgage - commercial investment
231
149
Real estate mortgage - owner occupied commercial
(12
(11
85
Real estate mortgage - 1-4 family residential
172
Home equity
64
(3
Total net loan charge-offs
1,574
180
1,612
Non-interest Income and Expenses
The following table sets forth major components of non-interest income and expenses for the three and six month periods ended June 30, 2015 and 2014.
% Change
-2.2
-1.3
-1.1
3.1
26.5
32.9
-100.0
8.0
-0.7
-3.4
-4.7
5.2
1.6
1.8
6.1
2.9
-0.2
-3.0
2.2
-2.1
-3.8
-9.4
-11.3
*
-147.3
11.0
6.6
4.0
* Percent change exceeds 500%
Total non-interest income increased $162 thousand, or 1.6%, for the second quarter of 2015 and $360 thousand, or 1.8% for the first six months of 2015, compared to the same periods in 2014.
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. Trust assets under management totaled $2.29 billion at June 30, 2015, compared to $2.36 billion at June 30, 2014. Investment management and trust revenue, which constitutes an average of 46% of non-interest income at June 30, 2015, decreased $104 thousand, or 2.2%, in the second quarter of 2015, and $120 thousand, or 1.3% for the first six months, as compared to the same periods in 2014. Recurring fees, which generally comprise over 95% of the investment management and trust revenue, increased $173 thousand, or 2%, for the first six months of 2015, compared to the same period of 2014. However, one-time executor and other non-recurring fees decreased $293 thousand for the first six months of 2015, compared to the same period in 2014. 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 directly with the overall stock market, as accounts usually contain fixed income and equity asset classes. 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. Management
46
expects to encounter slower growth of our investment management and trust revenue in 2015 as some revenue that boosted 2014 results is not expected to recur at the same level in 2015. Still, management believes the investment management and trust department will continue to factor significantly in financial results and provide strategic diversity to revenue streams.
Service charges on deposit accounts decreased $24 thousand, or 1.1%, in the second quarter of 2015, and $47 thousand, or 1.1%, for the first six months of 2015, as compared to the same periods in 2014. Service charge income is driven by transaction volume, which can fluctuate throughout the year. A significant component of service charges is related to fees earned on overdrawn checking accounts. Management expects this source of revenue to decline slightly in 2015 due to anticipated changes in customer behavior and increased regulatory restrictions.
Bankcard transaction revenue increased $37 thousand, or 3.1%, in the second quarter of 2015, and $84 thousand, or 3.7% for the first six months of 2015, compared to the same periods in 2014, and primarily represents income the Bank derives from customers’ use of debit cards. The increase in 2015 primarily reflects an increase in the volume of transactions, partially offset by a decrease in interchange rates received. 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 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 merchants gravitate to lower cost interchanges. Volume, which is dependent on consumer behavior, is expected to continue to increase slowly. However, management expects interchange rates to decrease, resulting in income from this source to remain consistent with levels experienced in 2014.
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 increased $191 thousand, or 26.5%, in the second quarter of 2015, and $431 thousand or 32.9%, for the first six months of 2015, as compared to the same periods in 2014. Market rates for mortgage loans decreased in the first half of 2015, resulting in increased refinance activity compared to the same period in 2014. This was coupled with an increase in home purchase activity in the first half of 2015, an indicator of improving consumer confidence.
In 2015, Bancorp sold securities with total fair market value of $5.9 million, generating no gain or loss. These securities consisted of agency and mortgage-backed securities with small remaining balances and agency securities. In 2014, Bancorp sold securities with total fair market value of $7.7 million, generating a net loss of $9 thousand. These securities consisted of mortgage-backed securities with small remaining balances, obligations of state and political subdivisions, and agency securities. These sales were made in the ordinary course of portfolio management.
Brokerage commissions and fees increased $37 thousand, or 8.0%, in the second quarter of 2015, and decreased $7 thousand or 0.7% for the first six months of 2015, as compared to the same periods in 2014, 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 are based on a percentage of assets. Bancorp deploys its brokers primarily through its branch network
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via an arrangement with a third party broker-dealer, while larger managed accounts are serviced in the investment management and trust department.
Bank Owned Life Insurance (BOLI) income totaled $226 thousand and $234 thousand for the second quarter of 2015 and 2014, respectively, and totaled $448 thousand and $470 thousand for the first six months of 2015 and 2014, respectively. 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 $24 thousand, or 5.2%, in the second quarter of 2015, and $32 thousand, or 3.7%, in the first six months of 2015, as compared to the same periods in 2014, due to a variety of other factors, none of which are individually significant.
Total non-interest expenses increased $1.2 million, or 6.6%, for the second quarter of 2015, and $1.4 million, or 4.0%, for the first six months of 2015, as compared to the same periods in 2014.
Salaries and employee benefits increased $659 thousand, or 6.1%, for the second quarter of 2015, and $641 thousand, or 2.9% for the first six months of 2015, as compared to the same periods of 2014, largely due to increased staffing levels, normal increases in salaries, higher health insurance costs and higher stock-based compensation expense, partially offset by decreased bonus accruals. Increased staffing levels included senior staff with higher per capita salaries in investment management and trust and lending functions. The increase in stock-based compensation is primarily due to the effect of a first quarter 2014 expense adjustment related to performance stock units, which decreased stock-based compensation by $185 thousand in that quarter. At June 30, 2015, Bancorp had 538 full-time equivalent employees compared to 528 at June 30, 2014.
Net occupancy expense decreased $3 thousand, or 0.2%, in the second quarter of 2015, and decreased $90 thousand, or 3.0% in the first six months of 2015, as compared to the same periods of 2014. The decrease for the first six months of 2015 is largely due to unusually high maintenance costs in 2014 related to the severe winter.
Data processing expense increased $38 thousand, or 2.2% in the second quarter of 2015, and decreased $68 thousand, or 2.1% for the first six months of 2015, compared to the same periods of 2014. The decrease for the first six months of 2015 is largely due to decreases in expenses for bank card processing/reissuance. This category includes ongoing computer software amortization and maintenance related to investments in new technology needed to maintain and improve the quality of delivery channels and internal resources.
Furniture and equipment expense was unchanged for the second quarter of 2015, and decreased $20 thousand, or 3.8% for the first six months of 2015, as compared to the same periods in 2014. These fluctuations relate to a variety of factors, none of which were 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.
FDIC insurance expense decreased $33 thousand, or 9.4%, for the second quarter of 2015, and $78 thousand or 11.3% for the first six months of 2015, as compared to the same periods in 2014. 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.
Loss on other real estate owned (OREO) increased $151 thousand for the second quarter of 2015, as compared to the same period of 2014. Net losses on OREO totaled $165 thousand for the first six months
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of 2015 compared to gains totaling $349 thousand for the same period in 2014. Bancorp liquidated several properties at prices greater than their carrying values in the first quarter of 2014 resulting in gains.
Other non-interest expenses increased $353 thousand or 11.0% in the second quarter of 2015, and $502 thousand or 8.0% for the first six months of 2015, as compared to the same periods in 2014. The increases are largely due to tax credit amortization of $158,000 for the second quarter and $317,000 for the first six months of 2015, that was formerly recorded as income tax expense in 2014. Also included in 2015 was a $202 thousand expense to establish a reserve for estimated losses on unfunded credit commitments. This category also includes MSR amortization, legal and professional fees, advertising, printing, mail and telecommunications, none of which had individually significant variances.
Income Taxes
In the second quarter of 2015, Bancorp recorded income tax expense of $4.2 million, compared to $3.6 million for the same period in 2014. The effective rate for the three month period was 31.6% in 2015 and 31.1% in 2014. Bancorp recorded income tax expense of $8.4 million for the first six months of 2015, compared to $7.3 million for the same period in 2014. The effective rate for the six month period was 31.5% in 2015 and 30.9% in 2014. The increase in the effective tax rate from 2014 to 2015 is the result of proportionally lower nontaxable income from the increase in cash value of life insurance and municipal securities, due to higher total pre-tax income. This was partially offset by the effect of amortization of tax credit investments which was recorded in other non-interest expense in 2015 and a component of tax expense in 2014.
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, 2014, 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 $81.2 million, or 3.2%, from $2.56 billion on December 31, 2014 to $2.48 billion on June 30, 2015. The most significant contributor to the decrease was securities available for sale, which decreased $100.2 million in the first six months of 2015 largely as a result of maturing short-term securities. 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 $10 million and $95 million for June 30, 2015 and December 31, 2014, respectively. Cash and cash equivalents decreased $15.6 million. Loans increased $30.8 million, while mortgage loans held for sale increased $4.5 million. Other assets decreased $3.8 million, driven primarily by a $1.7 million decline in other real estate owned and a $755 thousand decrease in deferred tax assets.
Loan production for the first six months of 2015 has been very strong, but loan payoffs and diminished line of credit usage have continued to hamper the overall growth of the loan portfolio. This high level of prepayments reflected not only low prevailing interest rates, but also heightened competitive conditions.
Total liabilities decreased $93.7 million, or 4.1%, from $2.30 billion December 31, 2014 to $2.21 billion on June 30, 2015. The most significant component of the decrease was deposits, which decreased $51.9 million or 2.4% as seasonal deposits declined in the second quarter of 2015. Federal funds purchased decreased $34.1 million, or 72.0%, while Federal Home Loan Bank advances increased $2.0 million or 5.5%. Bancorp utilizes short-term lines of credit to manage its overall liquidity position. Securities sold under agreement to repurchase decreased $5.1 million or 7.4%, and other liabilities decreased $4.6 million or 17.3%.
Elements of Loan Portfolio
The following table sets forth the major classifications of the loan portfolio.
Loans by Type
Undeveloped land (1)
Total Loans
(1) Undeveloped land consists of land initially acquired for development by the borrower, but for which no development has yet 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 June 30, 2015 and December 31, 2014, the total participated portions of loans of this nature were $7.3 million and $8.1 million, respectively.
Non-performing Loans and Assets
Information summarizing non-performing assets, including non-accrual loans follows:
Non-accrual loans
Troubled debt restructuring
1,092
6,352
Loans past due 90 days or more and still accruing
Non-performing loans
Foreclosed real estate
4,296
5,977
Non-performing assets
14,169
17,857
Non-performing loans as a percentage of total loans
0.52
0.64
Non-performing assets as a percentage of total assets
0.57
0.70
The following table sets forth the major classifications of non-accrual loans:
Non-accrual loans by type
Home equity and consumer loans
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. Management believes it has the ability to increase deposits at any time by offering rates slightly higher than 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 $20.9 million at June 30, 2015. 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 $412.9 million at June 30, 2015. The portfolio includes maturities of approximately $26.2 million over the next twelve months, including $10 million of short-term securities which matured in July 2015. 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 June 30, 2015, total investment securities pledged for these purposes comprised 63% of the available-for-sale investment portfolio, leaving $154.5 million of unpledged securities.
Bancorp has a large base of core customer deposits, defined as demand, savings, and money market deposit accounts. At June 30, 2015, such deposits totaled $1.79 billion and represented 86% 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 June 30, 2015, Bancorp had only $498 thousand or 0.02% of total deposits, in brokered deposits.
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 June 30, 2015, available credit from the FHLB totaled $405.7 million. Additionally, Bancorp had available federal funds purchased lines with correspondent banks totaling $70 million.
Bancorp’s principal source of cash revenues is dividends paid to it as sole shareholder of the Bank. At June 30, 2015, the Bank may pay up to $46.3 million in dividends to Bancorp without regulatory approval subject to the ongoing capital requirements of the Bank.
d) Capital Resources
At June 30, 2015, stockholders’ equity totaled $272.4 million, an increase of $12.5 million since December 31, 2014. See the Consolidated Statement of Changes in Stockholders’ Equity for further detail of the changes in equity since the end of 2014. One component of equity is accumulated other comprehensive income 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 income was $1.3 million at June 30, 2015 compared to a $2.1 million at December 31, 2014. The $772 thousand decrease is primarily a reflection of the negative effect of the changing interest rate environment during the first six months of 2015 on the valuation of Bancorp’s portfolio of securities available-for-sale.
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The following table sets forth Bancorp’s and the Bank’s risk based capital ratios as of June 30, 2015 and December 31, 2014.
Common equity tier 1 risk-based capital (1) (2)
(1) Under the banking agencies risk-based capital guidelines, assets and credit-equivalent amounts of derivatives and off-balance sheet exposures are assigned to broad risk categories. The aggregate dollar amount in each risk category is multiplied by the associated risk weight of the category. The resulting weighted values are added together, resulting in the Bancorp’s total risk-weighted assets. These ratios are computed in relation to average assets.
(2) The rules described herein established common equity tier 1 capital effective January 1, 2015. The ratio was not prescribed in prior years. For Bancorp, this is equal to tier 1 capital, and therefore, the ratio is equal to the tier 1 risk-based capital ratio.
(3) Ratio is computed in relation to average assets
In 2013, the Federal Reserve Board and the FDIC approved rules that substantially amend the regulatory risk-based capital rules applicable to Bancorp and Bank. The rules implement the regulatory capital reforms of the Basel Committee on Banking Supervision reflected in “Basel III: A Global Regulatory Framework for More Resilient Banks and Banking Systems” (Basel III) and changes required by the Dodd-Frank Act. Rules implementing the Basel III regulatory capital reforms became effective for Bancorp and Bank on January 1, 2015, and include new minimum risk-based capital and leverage ratios. The new minimum capital level requirements applicable to bank holding companies and banks subject to the rules are:
· a new common equity Tier 1 capital ratio of 4.5%,
· a Tier 1 risk-based capital ratio of 6% (increased from 4%),
· a total risk-based capital ratio of 8% (unchanged from current rules), and
· a Tier 1 leverage ratio of 4% for all institutions.
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The rules also establish a “capital conservation buffer” of 2.5%, to be phased in over three years, above the new regulatory minimum risk-based capital ratios, and result in the following minimum ratios once the capital conservation buffer is fully phased in:
· a common equity Tier 1 risk-based capital ratio of 7.0%,
· a Tier 1 risk-based capital ratio of 8.5%, and
· a total risk-based capital ratio of 10.5%.
The rules allowed banks and their holding companies with less than $250 billion in assets a one-time opportunity to opt-out of a requirement to include unrealized gains and losses in accumulated other comprehensive income in their capital calculation. Bancorp opted out of this requirement.
For Bancorp, the key differences under Basel III include risk weighting for commitments under one year and higher risk weighting for certain commercial real estate and construction loans. These differences resulted in higher risk-weighted assets, and therefore, somewhat lower risk-based capital ratios. Bancorp estimates the effect of these key differences decreased the Tier 1 risk-based capital ratio 0.30% and the total risk based-capital ratio 0.34%.
Management believes that as of June 30, 2015, Bancorp meets the requirements to be considered well-capitalized under the new rules.
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 measures to amounts reported under US GAAP.
(in thousands, except per share data)
Total equity
Less core deposit intangible
(1,706
(1,820
Less goodwill
(682
Tangible common equity
269,994
257,393
Total tangible assets
2,480,299
2,561,366
Total shareholders’ equity to total assets
10.97
10.14
Tangible common equity ratio
10.89
10.05
Number of outstanding shares
Book value per share
18.34
17.63
Tangible common equity per share
18.18
17.46
f) Recently Issued Accounting Pronouncements
In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers, which outlines a single comprehensive model for use in accounting for revenue arising from contracts with customers, and supersedes most current revenue recognition guidance. The ASU was originally effective for fiscal years and interim periods beginning after December 15, 2016. In July 2015, FASB voted to delay the effective date. The effective date will be annual reporting periods beginning after December 15, 2017, and the interim periods within that year. Bancorp is still evaluating the potential impact of adoption of ASU 2014-09.
In April 2015, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2015-03, Interest — Imputation of Interest, which changes the presentation of debt issuance costs in financial statements. Under the ASU, an entity presents such costs in the balance sheet as a direct deduction from the related debt liability rather than as an asset. Amortization of the costs is reported as interest expense. The ASU is effective for fiscal years and interim periods beginning after December 15, 2016. The adoption of ASU 2015-03 is not expected to have a significant impact on Bancorp’s operations or financial statements.
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Item 3. Quantitative and Qualitative Disclosures about Market Risk
Information required by this item is included in Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
Item 4. Controls and Procedures
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 June 30, 2015 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.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
The following table shows information relating to the repurchase of shares of common stock by Bancorp during the three months ended June 30, 2015.
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
April 1 - April 30
1,103
35.66
May 1 - May 31
596
35.21
June 1 - June 30
1,699
35.50
(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.
Item 6. Exhibits
The following exhibits are filed or furnished as a part of this report:
Exhibit
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. June 30, 2015 Quarterly Report on Form 10-Q, filed on August 4, 2015, formatted in eXtensible Business Reporting Language (XBRL):
(1)
(2)
Consolidated Statements of Income
(3)
Consolidated Statements of Comprehensive Income
(4)
Consolidated Statements of Changes in Stockholders’ Equity
(5)
Consolidated Statements of Cash Flows
(6)
Notes to Consolidated Financial Statements
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: August 4, 2015
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
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