Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
This item discusses the results and operations for Stock Yards Bancorp, Inc. (“Holding Company”), and its wholly-owned subsidiary, Stock Yards Bank & Trust Company (“Bank”) for the three months ended March 31, 2019 and compares this period with the same period of the previous year. All significant inter-company transactions and accounts have been eliminated in consolidation. All companies are collective referred to as “Bancorp” or the “Company.”
Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the consolidated financial statements and accompanying notes presented in Part 1 Item 1 “Financial Statements.”
Stock Yards Bancorp, Inc. is a financial holding company headquartered in Louisville, Kentucky.
The Bank, chartered in 1904, state-chartered non-member financial institution that provides services in the Louisville, Kentucky, Indianapolis, Indiana and Cincinnati, Ohio Metropolitan Statistical Areas (“MSAs”) through 38 full service banking center locations.
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.
Recent Developments
In April 2018, the Kentucky Legislature mandated combined filings for unitary businesses for taxable years beginning on or after January 1, 2019, unless an election is made otherwise. In March 2019, Kentucky legislation was enacted transitioning financial institutions from a capital based franchise tax to the Kentucky corporate income tax beginning in 2021. Therefore, Bancorp will begin filing a Kentucky combined filing in 2021 that will include the Bank unless Bancorp timely elects alternative filing. Bancorp’s holding company historically, by nature of its operations, has generated net operating losses. Bancorp has filed as a separate company in Kentucky and has a Kentucky net operating loss (“NOL”) carryforward.
As of March 31, 2019, Bancorp had not yet concluded whether it would make the election for consolidated filing. During April 2019, HB 458 was enacted which allowed for certain net operating loss carryforwards to be utilized in a combined filing return. Bancorp estimates that based on the default combined filing requirement or if it were to elect for consolidated filing, it would record a state NOL tax benefit, net of federal impact, of approximately $2 million or approximately $0.09 per diluted share for the second quarter 2019.
Issued but Not Yet Effective Accounting Standards Updates (“ASUs”)
For disclosure regarding the impact to Bancorp’s financial statements of issued-but-not-yet-effective ASUs, see Footnote 1 “Basis of Presentation and Summary of Significant Accounting Policies” of Part I Item 1 “Financial Statements.”
Business Segment Overview
As of March 31, 2019, Bancorp was divided into two reportable segments: Commercial banking and Wealth Management & Trust (“WM&T”):
Commercial banking provides a full range of loan and deposit products to individual consumers and businesses through commercial lending, retail lending, deposit services, treasury management services, private banking, online banking, mobile banking, merchant services, workplace banking, international banking, correspondent banking and other banking services. The Bank also offers securities brokerage services via its banking center network through an arrangement with a third party broker-dealer.
WM&T, with approximately $3 billion in assets under management, provides custom-tailored financial planning, investment management, retirement planning and trust and estate services in all markets that Bancorp operates in.
Overview - Three Months Ended March 31, 2019 Compared to the Three Months Ended March 31, 2018
Three months ended March 31,
(In thousands, except per share data)
|
|
2019
|
|
|
2018
|
|
|
$ Change
|
|
|
% Change
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
15,641
|
|
|
$
|
13,404
|
|
|
$
|
2,237
|
|
|
|
16.7
|
%
|
Diluted earnings per share
|
|
$
|
0.68
|
|
|
$
|
0.58
|
|
|
$
|
0.10
|
|
|
|
17.2
|
%
|
Return on average assets
|
|
|
1.94
|
%
|
|
|
1.76
|
%
|
|
18 bps
|
|
|
|
10.2
|
%
|
Return on average equity
|
|
|
17.09
|
%
|
|
|
16.15
|
%
|
|
94 bps
|
|
|
|
5.8
|
%
|
Bancorp completed the first three months of 2019 with record net income of $15.6 million, a 16.7% increase over the comparable period in 2018. The increase is primarily due to higher net interest income driven by year-over-year average loan growth, higher non-interest income led by treasury management fees and debit and credit card income, and a lower effective income tax rate resulting from a Kentucky tax law change enacted in March, 2019. Diluted earnings per share for the first three months of 2019 were a record $0.68, compared to $0.58 for the first three months of 2018.
Key factors affecting Bancorp’s results for the first quarter of 2019 included:
●
|
Average loans increased $96.0 million year over year, contributing to a 17.8% increase in interest income on a comparable quarter basis, while total average deposits increased 7.0% to support loan growth;
|
●
|
Continued strong loan production was offset by a high level of loan payoffs;
|
●
|
Net interest margin rose 10 basis points compared with the same quarter of 2018 consistent with higher yields on loans, loan prepayment penalties and an increase in non-interest bearing deposits;
|
●
|
Credit quality metrics remained strong, as Bancorp experienced its second consecutive quarter of net loan loss recoveries;
|
●
|
The Wealth Management and Trust Group (“WM&T”) posted consistent performance against a strong first quarter last year;
|
●
|
Card income and Treasury Management fees, bolstered by increased usage and expanding customer bases, continue to stand out as diversifying revenue streams; and
|
●
|
Bancorp’s effective income tax rate declined to 10.5% at March 31, 2019 based on Kentucky State legislation requiring financial institutions to transition from a bank franchise tax to the Kentucky corporate income tax beginning in 2021. Associated with this change, during the first quarter of 2019, Bancorp established a Kentucky state deferred tax asset related to existing temporary differences estimated to reverse after the effective date of the law change. Bancorp recorded a corresponding state tax benefit, net of federal impact of $1.3 million, or approximately $0.06 per diluted share for the first quarter 2019.
|
As is the case with most banks, Bancorp’s primary revenue sources are net interest income and fee income 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 corresponding deposits directly impact profitability. New business volume is influenced by economic factors including market interest rates, business spending, consumer confidence and competitive conditions within the marketplace.
Net interest income increased $2.3 million, or 8.6%, for the first three months of 2019, as compared with the same period in 2018. Net interest margin increased to 3.89% for the first three months of 2019, compared with 3.79% for the same period of 2018. Increasing average rates earned on interest earning assets, along with the impact of increased volumes of loans and short-term investments contributed to higher interest income for the first quarter of 2019, as interest income increased $5.3 million, or 17.8%, over the same period in 2018. Higher funding costs on deposits and borrowings, coupled with growth in interest bearing demand deposits and time deposits, resulted in an increase in interest expense of $2.9 million, or 120.6%, year over year. The average balance of time deposits increased $118.9 million, or 50.7% in the first quarter of 2019, as compared with the same period in 2018, as a result of targeted marketing campaigns initiated in 2018 to support loan growth and add liquidity to the balance sheet. The corresponding cost of time deposits increased from 0.77% for the first three months of 2018 to 1.83% for the same period in 2019, as Bancorp aggressively promoted certificate of deposits.
For the three-month period ended March 31, 2019, Bancorp recorded a $600 thousand provision for loan and lease losses (“provision”), compared with $735 thousand for the same period in 2018. The provision represents a charge to earnings necessary to maintain an allowance that, in management’s evaluation, is adequate to provide coverage for the inherent losses on outstanding loans. The provision reflects many factors including trends in the portfolio, as well as changes in quantitative and qualitative factors. Reflecting a moderate increase in classified loans and net recoveries of $330 thousand in the first quarter of 2019, the allowance to total loans was 1.05% as of March 31, 2019, compared with 0.96% as of March 31, 2018. In management’s opinion, the allowance remained adequate to cover potential losses within the portfolio.
Total non-interest income for the first three months of 2019 increased $153 thousand, or 1.4%, compared with the same period in 2018. Non-interest income comprised 27.2% of total revenues, defined as net interest income and non-interest income, as compared with 28.5% for the same period in 2018. Bancorp’s WM&T services comprised 49.2% of Bancorp’s non-interest income, despite a slight reduction in revenue in the first three months of 2019 of 1.1%, or $61 thousand. The stock market recovery in the first quarter of 2019 significantly impacted WM&T income for the quarter. Should positive market trends continue, WM&T is expected to deliver low single digit growth in 2019, however, market volatility could affect near-term results. Debit and credit card revenue, as a result of increasing transaction volumes, increased $236 thousand, or 15.6% in the first three months of 2019, as compared with the same period in 2018. Treasury management fees, a steadily growing source of revenue for Bancorp, increased $110 thousand, or 10.5% in the first quarter of 2019, as compared with the first quarter of 2018. These items offset declines of $164 thousand, or 11.6%, and $94 thousand, or 16.3%, for deposit service charges and mortgage banking income, respectively, for the first three months of 2019, as compared with 2018.
Total non-interest expense in the first three months of 2019 increased $1.6 million, or 7.7%, compared with the same period in 2018. Increases in compensation, technology and communication, and other expenses drove the increase. Bancorp's efficiency ratio in the first three months of 2019 was 55.52% compared with 54.89% in the same period in 2018.
Bancorp recorded income tax expense of $1.8 million for the first three months of 2019, compared to $3.1 million for the same period in 2018. The effective rate for the corresponding three month periods was 10.5% and 18.5%, respectively. The decrease in the effective tax rate from 2018 to 2019 related primarily to a Kentucky state tax law change. In March 2019, the Kentucky Legislature passed HB354 requiring financial institutions to transition from a capital based franchise tax to the Kentucky corporate income tax beginning in 2021. Historically, the franchise tax, a component of non-interest expenses, was assessed at 1.1% of net capital and averaged $2.5 million annually over the prior two year-end periods. The Kentucky corporate income tax will be assessed at 5% of Kentucky taxable income and will be included as a component of current and deferred state income tax expense. Associated with this change, during the first quarter of 2019, Bancorp established a Kentucky state deferred tax asset related to existing temporary differences estimated to reverse after the effective date of the law change. Bancorp recorded a corresponding state tax benefit, net of federal impact of $1.3 million, or approximately $0.06 per diluted share for the first quarter 2019. While this is positive in the short-term, Bancorp anticipates an unfavorable impact of approximately $200 thousand per year beginning in 2021.
The ratio of stockholder’s equity to total assets was 11.52% as of March 31, 2019 as compared with 11.10% at December 31, 2018. Total equity increased $11.5 million in the first quarter of 2019 as net income of $15.6 million was offset by dividends declared of $5.7 million. Bancorp’s ratio of tangible common equity (“TCE”) to total tangible assets was 11.47% as of March 31, 2019, compared with 11.05% at December 31, 2018. TCE, a non-Generally Accepted Accounting Principle (“GAAP”) measure, is a measure of a company's capital which is useful in evaluating the quality and adequacy of capital. It consists of a company’s common equity less any preferred equity, less intangible assets. Tangible common equity is divided by tangible assets, which equals total assets less intangible assets. See the Non-GAAP Financial Measures section for details on reconcilement to GAAP measures.
Results of Operations
Net income of $15.6 million for the three months ended March 31, 2019 increased $2.2 million, or 16.4%, from $13.4 million for the comparable 2018 period. Basic net income per share was $0.69 for the first quarter of 2019, an increase of 16.9% from the $0.59 for the first quarter of 2018. Net income per share on a diluted basis was $0.68 for the first quarter of 2019, an increase of 17.2% from the $0.58 for the same period in 2018. See Note 12 for additional information related to net income per share.
Annualized return on average assets and annualized return on average stockholders’ equity were 1.94% and 17.09%, respectively, for the first quarter of 2019, compared with 1.76% and 16.15%, respectively, for the same period in 2018.
Net Interest Income
The following table presents average balance sheets for the three month periods ended March 31, 2019 and 2018 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.
|
|
Three months ended March 31,
|
|
|
|
2019
|
|
|
2018
|
|
|
|
Average
|
|
|
|
|
|
|
Average
|
|
|
Average
|
|
|
|
|
|
|
Average
|
|
(Dollars in thousands)
|
|
balances
|
|
|
Interest
|
|
|
rate
|
|
|
balances
|
|
|
Interest
|
|
|
rate
|
|
Earning assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Federal funds sold and interest bearing due from banks
|
|
$
|
122,189
|
|
|
$
|
733
|
|
|
|
2.43
|
%
|
|
$
|
71,186
|
|
|
$
|
268
|
|
|
|
1.53
|
%
|
Mortgage loans held for sale
|
|
|
1,727
|
|
|
|
37
|
|
|
|
8.69
|
|
|
|
2,098
|
|
|
|
35
|
|
|
|
6.77
|
|
Securities available for sale:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Taxable
|
|
|
409,835
|
|
|
|
2,411
|
|
|
|
2.39
|
|
|
|
373,314
|
|
|
|
2,027
|
|
|
|
2.20
|
|
Tax-exempt
|
|
|
27,784
|
|
|
|
175
|
|
|
|
2.55
|
|
|
|
44,394
|
|
|
|
296
|
|
|
|
2.70
|
|
FHLB stock
|
|
|
10,192
|
|
|
|
157
|
|
|
|
6.25
|
|
|
|
7,687
|
|
|
|
111
|
|
|
|
5.86
|
|
Loans, net of unearned income
|
|
|
2,528,625
|
|
|
|
31,572
|
|
|
|
5.06
|
|
|
|
2,432,659
|
|
|
|
27,100
|
|
|
|
4.52
|
|
Total earning assets
|
|
|
3,100,352
|
|
|
|
35,085
|
|
|
|
4.59
|
|
|
|
2,931,338
|
|
|
|
29,837
|
|
|
|
4.13
|
|
Less allowance for loan losses
|
|
|
26,127
|
|
|
|
|
|
|
|
|
|
|
|
25,063
|
|
|
|
|
|
|
|
|
|
|
|
|
3,074,225
|
|
|
|
|
|
|
|
|
|
|
|
2,906,275
|
|
|
|
|
|
|
|
|
|
Non-earning assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and due from banks
|
|
|
41,653
|
|
|
|
|
|
|
|
|
|
|
|
39,985
|
|
|
|
|
|
|
|
|
|
Premises and equipment, net
|
|
|
45,340
|
|
|
|
|
|
|
|
|
|
|
|
41,891
|
|
|
|
|
|
|
|
|
|
Accrued interest receivable and other assets
|
|
|
110,039
|
|
|
|
|
|
|
|
|
|
|
|
102,740
|
|
|
|
|
|
|
|
|
|
Total assets
|
|
$
|
3,271,257
|
|
|
|
|
|
|
|
|
|
|
$
|
3,090,891
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest bearing liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deposits:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest bearing demand deposits
|
|
$
|
861,020
|
|
|
$
|
1,404
|
|
|
|
0.66
|
%
|
|
$
|
817,567
|
|
|
$
|
623
|
|
|
|
0.31
|
%
|
Savings deposits
|
|
|
157,053
|
|
|
|
96
|
|
|
|
0.25
|
|
|
|
154,607
|
|
|
|
56
|
|
|
|
0.15
|
|
Money market deposits
|
|
|
677,512
|
|
|
|
1,974
|
|
|
|
1.18
|
|
|
|
686,699
|
|
|
|
953
|
|
|
|
0.56
|
|
Time deposits
|
|
|
353,245
|
|
|
|
1,592
|
|
|
|
1.83
|
|
|
|
234,383
|
|
|
|
445
|
|
|
|
0.77
|
|
Securities sold under agreements to repurchase
|
|
|
37,528
|
|
|
|
25
|
|
|
|
0.27
|
|
|
|
71,276
|
|
|
|
33
|
|
|
|
0.19
|
|
Federal funds purchased and other short term borrowings
|
|
|
11,428
|
|
|
|
60
|
|
|
|
2.13
|
|
|
|
26,259
|
|
|
|
90
|
|
|
|
1.39
|
|
FHLB advances
|
|
|
47,962
|
|
|
|
221
|
|
|
|
1.87
|
|
|
|
49,247
|
|
|
|
235
|
|
|
|
1.94
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total interest bearing liabilities
|
|
|
2,145,748
|
|
|
|
5,372
|
|
|
|
1.02
|
|
|
|
2,040,038
|
|
|
|
2,435
|
|
|
|
0.48
|
|
Non-interest bearing liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-interest bearing demand deposits
|
|
|
694,871
|
|
|
|
|
|
|
|
|
|
|
|
669,929
|
|
|
|
|
|
|
|
|
|
Accrued interest payable and other liabilities
|
|
|
59,568
|
|
|
|
|
|
|
|
|
|
|
|
44,354
|
|
|
|
|
|
|
|
|
|
Total liabilities
|
|
|
2,900,187
|
|
|
|
|
|
|
|
|
|
|
|
2,754,321
|
|
|
|
|
|
|
|
|
|
Stockholders’ equity
|
|
|
371,070
|
|
|
|
|
|
|
|
|
|
|
|
336,570
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total liabilities and stockholder's
equity
|
|
$
|
3,271,257
|
|
|
|
|
|
|
|
|
|
|
$
|
3,090,891
|
|
|
|
|
|
|
|
|
|
Net interest income
|
|
|
|
|
|
$
|
29,713
|
|
|
|
|
|
|
|
|
|
|
$
|
27,402
|
|
|
|
|
|
Net interest spread
|
|
|
|
|
|
|
|
|
|
|
3.57
|
%
|
|
|
|
|
|
|
|
|
|
|
3.65
|
%
|
Net interest margin
|
|
|
|
|
|
|
|
|
|
|
3.89
|
%
|
|
|
|
|
|
|
|
|
|
|
3.79
|
%
|
N
otes to the average balance and interest rate tables:
|
●
|
Average balances for loans include the principal balance of non-accrual loans, as well as all loan premiums, discounts, fees and costs, and exclude participation loans accounted for as secured borrowings. These participation loans averaged $10.3 million and $18.0 million, respectively, for the three month periods ended March 31, 2019 and 2018.
|
|
●
|
Interest income on a fully tax equivalent basis includes additional amounts 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 tax-exempt loans has been calculated on a fully tax equivalent basis using a federal income tax rate of 21% for 2019 and 2018. Approximate tax equivalent adjustments to interest income were $56 thousand and $93 thousand, respectively, for the three month periods ended March 31, 2019 and 2018.
|
|
●
|
Interest income includes loan fees of $481 thousand and $217 thousand for the three months ended March 31, 2019, and March 31, 2018, respectively.
|
|
●
|
Net interest income, the most significant component of the Bank's earnings
represents
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 taxable equivalent
rates
ea
rn
ed on interest earning assets less the
cost of
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
impacted
by both interest rate spread and the level of non-interest bearing sources of funds, primarily consisting of demand deposits and stockholders’ equity.
|
Net interest spread and net interest margin were 3.57% and 3.89%, respectively, for the first quarter of 2019, and 3.65% and 3.79%, respectively, for the first quarter of 2018. Fully taxable equivalent net interest income of $29.7 million for the three months ended March 31, 2019 increased $2.3 million, or 8.4%, from $27.4 million for the same period in 2018. Fully taxable equivalent interest income increased $5.2 million or 17.6% for the first quarter of 2019, as compared with the first quarter of 2018, due primarily to increased average loan balances stemming from 2018 loan growth, as well as increased rates earned on loans. Wall Street Journal Prime interest rate was 75 basis points (“bps”) higher in the first quarter of 2019, as compared with 2018, which benefited short-term loan and investment pricing, while new, fixed-rate loans originated during the period benefited from a higher five-year treasury yield curve. Taxable securities, and federal funds sold and interest bearing due from banks average balances also increased in the first quarter of 2019, as compared with 2018, as a result of Bancorp deploying excess liquidity into short-term investments, which earned higher yields year over year. In total, average earning assets increased $169.0 million or 5.77% to $3.1 billion for the first three months of 2019, as compared with the same period in 2018. The average rate on earnings assets increased 46 bps to 4.59%, as Bancorp benefited from a generally higher interest rate environment.
Interest expense increased due primarily to rising deposit costs, and strategic growth in interest bearing demand deposits and time deposits. Average interest bearing liabilities increased $105.7 million, or 5.2%, to $2.1 billion for the first three months of 2019, as compared with the same period in 2018. Growth in average interest bearing demand deposits and time deposits was partially offset by declines in money market deposits, and securities sold under agreements to repurchase. The average cost of interest bearing liabilities increased 54 bps to 1.02% for the first quarter of 2019, as compared with the first quarter of 2018. Bancorp increased rates paid on money market accounts in the first half of 2018 in addition to launching a marketing campaign promoting certificate of deposit accounts. Costs of money market deposit accounts and time deposits increased 62 bps, and 106 bps, respectively, in the first quarter of 2019, as compared with the same period in 2018. The average balance of securities sold under agreements to repurchase (“SSUARs”) decreased $33.7 million, or 47.3%, as customers migrated from lower yielding collateralized products to higher yielding non-collateralized deposits.
Going forward yield curve inversion could pose a significant challenge if loans were to be originated and repriced at a relatively low five-year portion of the treasury yield curve, while deposits and other funding sources priced or re-priced based upon a stagnant or increasing shorter end of the curve.
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 with the goal of optimizing 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 dynamics of interest earning assets and interest bearing liabilities. By estimating effects of interest rate fluctuations, the model can approximate interest rate risk exposure. This 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 may not indicate actual expected results.
The March 31, 2019 simulation analysis, which shows moderate interest rate sensitivity, indicates that increases in interest rates of 100 to 200 basis points would have a positive effect on net interest income, and decreases of 100 to 200 basis points in interest rates would have a negative effect on net interest income. The moderate increase in net interest income in the rising rate scenarios is primarily due to variable rate loans and short-term investments repricing more quickly than deposits and short-term borrowings. Asset balances subject to immediate repricing cause an estimated decline in net interest income in down 100 and 200 basis point rate scenarios, as rates on non-maturity deposits cannot be lowered sufficiently to offset declining interest income. These estimates are summarized below.
|
|
Change in Rates
|
|
|
|
-200
|
|
|
-100
|
|
|
+100
|
|
|
+200
|
|
|
|
Basis Points
|
|
|
Basis Points
|
|
|
Basis Points
|
|
|
Basis Points
|
|
% Change from base net interest income at March 31, 2019
|
|
|
-11.00
|
%
|
|
|
-1.23
|
%
|
|
|
3.03
|
%
|
|
|
6.08
|
%
|
Approximately 60% of Bancorp’s loan portfolio has fixed rates with 40% priced at variable rates. With the Prime rate currently at 5.50%, Bancorp’s variable rate loans are beyond their floors and will reprice as rates change.
Undesignated derivative instruments described in Note 17 to Bancorp’s consolidated financial statements are recognized on the consolidated balance sheet at fair value, with changes in fair value recorded in other non-interest income as interest rates fluctuate. 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 18 to Bancorp’s consolidated financial statements 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 and Lease Losses
The provision reflects results of an allowance methodology that is driven by risk ratings, historical losses, specific loan loss allocations, and qualitative factors. For the three-month period ended March 31, 2019, Bancorp recorded a $600 thousand provision for loan and lease losses (“provision”), compared with $735 thousand for the same period in 2018. The provision represents a charge to earnings necessary to maintain an allowance that, in management’s evaluation, is adequate to provide coverage for the inherent losses on outstanding loans. The provision reflects many factors including trends in the portfolio, as well as changes in quantitative and qualitative factors. Reflecting a moderate increase in classified loans and net recoveries of $330 thousand in the first quarter of 2019, the allowance to total loans was 1.05% as of March 31, 2019, compared with 0.96% as of March 31, 2018. In management’s opinion, the allowance remained adequate to cover potential losses within the portfolio.
Key indicators of loan quality remained consistent with prior years with the exception of increased classified balances which increased $9.9 million during the first quarter of 2019, as compared with December 31, 2018. Also, consistent with Bancorp’s methodology, the historical look-back period was extended from 32 to 36 quarters in the first quarter of 2019 to all classes and segments of the portfolio. Management believes the expansion of the look-back period more accurately represents the current level of risk in the loan portfolio, and captures the effects of a full economic cycle. Based on the look-back period extension, the allowance level increased approximately $2.0 million for the first three months of 2019. Additional information regarding Bancorp’s methodology for evaluating the adequacy of the allowance can be read in the Company’s Annual Report on Form 10K.
Non-performing loans, consisting of TDRs, non-accrual loans, and loans over 90 days past due still accruing, increased to $3.8 million at March 31, 2019 from $3.4 million at December 31, 2018, while decreasing $8.5 million from $12.3 million at March 31, 2018. Bancorp considers the present asset quality metrics to be strong; however, recognizing the cyclical nature of the lending business, this trend is expected to normalize over the long term.
Bancorp’s loan portfolio is diversified with no significant concentrations of credit. Geographically, most loans are extended to borrowers in the metropolitan areas of Louisville, Indianapolis and Cincinnati. The adequacy of the allowance is monitored on an ongoing basis and it is the opinion of management that the balance of the allowance at March 31, 2019 is adequate to absorb probable losses inherent in the loan portfolio as of the financial statement date.
An analysis of the changes in the allowance and selected ratios follows:
(Dollars in thousands)
|
|
Three months ended March 31,
|
|
|
|
|
|
|
|
|
|
|
2019
|
|
|
2018
|
|
|
|
|
|
|
|
|
|
|
Balance at the beginning of the period
|
|
$
|
25,534
|
|
|
$
|
24,885
|
|
Provision
|
|
|
600
|
|
|
|
735
|
|
Total charge-offs
|
|
|
99
|
|
|
|
1,528
|
|
Total recoveries
|
|
|
(429
|
)
|
|
|
(111
|
)
|
Net loan charge-offs (recoveries)
|
|
|
(330
|
)
|
|
|
1,417
|
|
Balance at the end of the period
|
|
$
|
26,464
|
|
|
$
|
24,203
|
|
Average loans, net of unearned income
|
|
$
|
2,528,625
|
|
|
$
|
2,432,659
|
|
Provision to average loans and leases (1)
|
|
|
0.02
|
%
|
|
|
0.03
|
%
|
Net loan charge-offs (recoveries) to average loans and leases (1)
|
|
|
(0.01
|
)%
|
|
|
0.06
|
%
|
Allowance to average loans and leases
|
|
|
1.05
|
%
|
|
|
0.99
|
%
|
Allowance to period-end loans and leases
|
|
|
1.05
|
%
|
|
|
0.96
|
%
|
(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 and collection status. One commercial loan was charged off to its net realizable value in the first quarter of 2018, which resulted in increased net charge offs for the three month period ending March 31, 2018. The increase in the allowance in the first quarter of 2019 was mainly due to qualitative considerations, increased classified loan balances in the first quarter of 2019, offset by net recoveries of $330 thousand. At March 31, 2019, and December 31, 2018, the allowance remained adequate to cover potential losses in the loan portfolio, in management’s opinion.
An analysis of net charge-offs (recoveries) by loan portfolio segment follows:
|
|
Three months
|
|
(In thousands)
|
|
ended March 31,
|
|
|
|
2019
|
|
|
2018
|
|
|
|
|
|
|
|
|
|
|
Commercial and industrial
|
|
$
|
(99
|
)
|
|
$
|
1,399
|
|
Construction and development, excluding undeveloped land
|
|
|
(203
|
)
|
|
|
-
|
|
Undeveloped land
|
|
|
-
|
|
|
|
-
|
|
Real estate mortgage - commercial investment
|
|
|
(20
|
)
|
|
|
(1
|
)
|
Real estate mortgage - owner occupied commercial
|
|
|
-
|
|
|
|
-
|
|
Real estate mortgage - 1-4 family residential
|
|
|
-
|
|
|
|
-
|
|
Home equity
|
|
|
-
|
|
|
|
(3
|
)
|
Consumer
|
|
|
(8
|
)
|
|
|
22
|
|
Total net loan charge-offs (recoveries)
|
|
$
|
(330
|
)
|
|
$
|
1,417
|
|
Non-interest Income and Expenses
The following table sets forth major components of non-interest income and expenses.
|
|
Three months ended March 31,
|
|
(In thousands)
|
|
2019
|
|
|
2018
|
|
|
$ Change
|
|
|
% Change
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-interest income:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Wealth management and trust services
|
|
$
|
5,439
|
|
|
$
|
5,500
|
|
|
$
|
(61
|
)
|
|
|
(1.1
|
)%
|
Deposit service charges
|
|
|
1,247
|
|
|
|
1,411
|
|
|
|
(164
|
)
|
|
|
(11.6
|
)
|
Debit and credit card income
|
|
|
1,744
|
|
|
|
1,508
|
|
|
|
236
|
|
|
|
15.6
|
|
Treasury management fees
|
|
|
1,157
|
|
|
|
1,047
|
|
|
|
110
|
|
|
|
10.5
|
|
Mortgage banking income
|
|
|
482
|
|
|
|
576
|
|
|
|
(94
|
)
|
|
|
(16.3
|
)
|
Net investment product sales commissions and fees
|
|
|
356
|
|
|
|
404
|
|
|
|
(48
|
)
|
|
|
(11.9
|
)
|
Bank owned life insurance
|
|
|
178
|
|
|
|
187
|
|
|
|
(9
|
)
|
|
|
(4.8
|
)
|
Other
|
|
|
459
|
|
|
|
276
|
|
|
|
183
|
|
|
|
66.3
|
|
Total non-interest income
|
|
$
|
11,062
|
|
|
$
|
10,909
|
|
|
$
|
153
|
|
|
|
1.4
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-interest expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Compensation
|
|
$
|
11,801
|
|
|
$
|
10,970
|
|
|
$
|
831
|
|
|
|
7.6
|
%
|
Employee benefits
|
|
|
2,642
|
|
|
|
2,633
|
|
|
|
9
|
|
|
|
0.3
|
|
Net occupancy and equipment
|
|
|
1,858
|
|
|
|
1,818
|
|
|
|
40
|
|
|
|
2.2
|
|
Technology and communication
|
|
|
1,773
|
|
|
|
1,630
|
|
|
|
143
|
|
|
|
8.8
|
|
Debit and credit card processing
|
|
|
587
|
|
|
|
566
|
|
|
|
21
|
|
|
|
3.7
|
|
Marketing and business development
|
|
|
625
|
|
|
|
646
|
|
|
|
(21
|
)
|
|
|
(3.3
|
)
|
Postage, printing, and supplies
|
|
|
406
|
|
|
|
391
|
|
|
|
15
|
|
|
|
3.8
|
|
Legal and professional
|
|
|
534
|
|
|
|
493
|
|
|
|
41
|
|
|
|
8.3
|
|
FDIC insurance
|
|
|
238
|
|
|
|
242
|
|
|
|
(4
|
)
|
|
|
(1.7
|
)
|
Amortization/impairment of investment in tax credit partnerships
|
|
|
52
|
|
|
|
-
|
|
|
|
52
|
|
|
|
100.0
|
|
Capital and deposit based taxes
|
|
|
904
|
|
|
|
852
|
|
|
|
52
|
|
|
|
6.1
|
|
Other
|
|
|
1,219
|
|
|
|
786
|
|
|
|
433
|
|
|
|
55.1
|
|
Total non-interest expenses
|
|
$
|
22,639
|
|
|
$
|
21,027
|
|
|
$
|
1,612
|
|
|
|
7.7
|
%
|
The largest component of non-interest income is WM&T revenue. The magnitude of WM&T revenue distinguishes Bancorp from other community banks of similar asset size. Trust assets under management totaled $2.97 billion at March 31, 2019, a 3.03% increase compared with $2.88 billion at March 31, 2018, and a 7.41% increase from $2.76 billion at December 31, 2018. AUM are stated at market value. WM&T revenue, which represents 49% of non-interest income, decreased $61 thousand, or 1.1%, for the three months ended March 31, 2019 compared with the same period in 2018, as stock market declines experienced in the fourth quarter of 2018 negatively impacted first quarter 2019 revenue. Recurring fees earned for managing accounts are based on a percentage of market value of AUM and are typically assessed on a monthly basis. Recurring fees, which generally comprise over 98% of the WM&T revenue, decreased $83 thousand, or 1.5%, in the first quarter of 2019, compared with the same time period in 2018. Some revenues of the WM&T 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, and is also based on the market value of AUM. Total non-recurring fees increased $22 thousand or 21.8% in the first quarter of 2019 compared with the first quarter of 2018. Contracts between WM&T and their clients do not permit performance based fees and accordingly, none of the fees earned by WM&T are performance based. Management believes the WM&T department will continue to factor significantly in Bancorp’s financial results and provide strategic diversity to revenue streams. Based upon the stock market recovery in the first quarter of 2019, WM&T is expected to deliver low single digit growth in 2019, provided positive market trends continue, however market volatility could affect near-term results.
Trust Assets Under Management by Account Type
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
March 31, 2019
|
|
|
March 31, 2018
|
|
(In thousands)
|
|
Managed
|
|
|
Non-
managed
(1)
|
|
|
Managed
|
|
|
Non-
managed
(1)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investment advisory accounts
|
|
$
|
1,209,859
|
|
|
$
|
19,446
|
|
|
$
|
1,095,159
|
|
|
$
|
18,290
|
|
Personal trust accounts
|
|
|
565,951
|
|
|
|
86,494
|
|
|
|
577,803
|
|
|
|
77,303
|
|
Personal individual retirement acounts
|
|
|
375,940
|
|
|
|
2,535
|
|
|
|
352,105
|
|
|
|
1,806
|
|
Corporate retirement accounts
|
|
|
48,390
|
|
|
|
381,859
|
|
|
|
53,935
|
|
|
|
403,879
|
|
Foundation and endowment accounts
|
|
|
207,910
|
|
|
|
1,176
|
|
|
|
193,258
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total accounts
|
|
$
|
2,408,050
|
|
|
$
|
491,510
|
|
|
$
|
2,272,260
|
|
|
$
|
501,278
|
|
Custody and safekeeping accounts
|
|
|
-
|
|
|
|
70,482
|
|
|
|
-
|
|
|
|
109,047
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Totals
|
|
$
|
2,408,050
|
|
|
$
|
561,992
|
|
|
$
|
2,272,260
|
|
|
$
|
610,325
|
|
Total managed and non-managed assets
|
|
$
|
2,970,042
|
|
|
|
|
|
|
$
|
2,882,585
|
|
|
|
|
|
(1) Non-managed assets represent those for which WM&T does not have investment discretion.
The table above provides information regarding assets under management (“AUM”) by WM&T. This table demonstrates that:
• Approximately 81% of AUM are actively managed.
• Corporate retirement plan accounts consist primarily of participant directed assets.
• The amount of custody and safekeeping accounts is insignificant, and
• The majority of managed assets are in personal trust, agency, and investment advisory accounts.
Managed Trust Assets by Class of Investment
|
|
|
|
|
|
|
|
|
|
|
March 31,
|
|
(In thousands)
|
|
2019
|
|
|
2018
|
|
|
|
|
|
|
|
|
|
|
Interest bearing deposits
|
|
$
|
130,599
|
|
|
$
|
116,146
|
|
US Treasury and government agency obligations
|
|
|
57,856
|
|
|
|
44,265
|
|
State, county and municipal obligations
|
|
|
130,570
|
|
|
|
136,972
|
|
Money market mutual funds
|
|
|
6,516
|
|
|
|
8,409
|
|
Equity mutual funds
|
|
|
575,471
|
|
|
|
561,059
|
|
Other mutual funds - fixed, balanced, and municipal
|
|
|
299,217
|
|
|
|
306,731
|
|
Other notes and bonds
|
|
|
169,565
|
|
|
|
135,634
|
|
Common and preferred stocks
|
|
|
912,755
|
|
|
|
837,903
|
|
Real estate mortgages
|
|
|
347
|
|
|
|
365
|
|
Real estate
|
|
|
50,432
|
|
|
|
50,710
|
|
Other miscellaneous assets (1)
|
|
|
74,722
|
|
|
|
74,066
|
|
|
|
|
|
|
|
|
|
|
Total managed assets
|
|
$
|
2,408,050
|
|
|
$
|
2,272,260
|
|
(1) Includes client directed instruments including rights, warrants, annuities, insurance policies, unit investment trusts, and oil and gas rights.
The table above presents data regarding WM&T managed assets by class of investment. Managed assets are invested in instruments for which market values can be readily determined, the majority of which are sensitive to market fluctuations. This table demonstrates that:
|
•
|
The composition of managed assets is divided approximately 60% in equities and 40% in fixed income securities, and this composition is relatively consistent from year to year, and
|
|
•
|
WM&T has no proprietary mutual funds.
|
Fiduciary and Related Trust Services Income
|
|
|
|
|
|
|
|
|
|
|
Three months ended March 31,
|
|
(In thousands)
|
|
2019
|
|
|
2018
|
|
|
|
|
|
|
|
|
|
|
Investment advisory accounts
|
|
$
|
2,131
|
|
|
$
|
2,079
|
|
Personal trust accounts
|
|
|
1,804
|
|
|
|
1,918
|
|
Personal individual retirement accounts
|
|
|
890
|
|
|
|
873
|
|
Corporate retirement accounts
|
|
|
327
|
|
|
|
379
|
|
Foundation and endowment accounts
|
|
|
133
|
|
|
|
151
|
|
Custody and safekeeping accounts
|
|
|
31
|
|
|
|
56
|
|
Brokerage and insurance services
|
|
|
25
|
|
|
|
23
|
|
Other
|
|
|
98
|
|
|
|
21
|
|
|
|
|
|
|
|
|
|
|
Total WM&T services
|
|
$
|
5,439
|
|
|
$
|
5,500
|
|
The table above provides information regarding fee income earned by Bancorp’s WM&T department. It demonstrates that WM&T fee revenue is earned most significantly from personal trust and investment advisory accounts. Fees are based on AUM and tailored for individual accounts and/or relationships. WM&T uses a fee structure that is tailored based on account type and other factors. For example, fee structures are in place for investment management, irrevocable trusts, revocable trusts, IRA accounts, and accounts holding only fixed income securities. There are also fee structures for estate settlements, which are non-recurring, and retirement plan services which typically consist of a one-time conversion fee with recurring AUM fees to follow. All fees are based on the market value of each account and are tiered based on account size, with larger relationships paying a lower percentage of AUM in fees. Fees are agreed upon at the time the account is opened and these and any subsequent revisions are communicated in writing to the customer. Fees earned are not performance based nor are they based on investment strategy or transactions.
Additional sources of non-interest income
Deposit service charges decreased $164 thousand, or 11.6%, for the first three months of 2019, as compared with the same period in 2018. Service charge income is driven by transaction volume, which can fluctuate throughout the year. The first quarter decrease is consistent with the decline in fees earned on overdrawn checking accounts. While management expects this source of revenue to slowly decline due to anticipated changes in customer behavior, including reduced check volume, and ongoing regulatory restrictions, the decline is anticipated to be less significant than what was experienced in the first quarter of 2019.
Debit and credit card revenue increased $236 thousand, or 15.6%, in the first three months of 2019, as compared with the same period in 2018. The increase in the first quarter of 2019 reflected increased volume resulting from continued growth in the commercial credit cards customer base. Volume, which is dependent on customer behavior and new accounts, is expected to continue to increase. Credit card interchange income and ancillary credit card fees increased $148 thousand, or 45%, and debit card interchange increased $88 thousand or 7.46%, in the first three months of 2019, as compared with the same period in 2018. Bancorp expects to experience a slight decrease in interchange rates as service providers gravitate to lower cost options within the market, however, growth in accounts is anticipated to offset the decline in rates.
Treasury management fees primarily consists of fees earned for cash management services provided to commercial customers. This category has been a growing source of revenue for Bancorp including an increase in the first three months of 2019 of $110 thousand or 10.5% over the same period in 2018. Bancorp continues to expect growth in this income category in 2019 based upon an expanding customer base and as more existing customers take advantage of offered services.
Mortgage banking income 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, Veterans Administration (“VA”) and Federal Housing Authority (“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 department. Mortgage banking revenue decreased $94 thousand, or 16.3%, for the first three months of 2019, as compared with the same periods in 2018, due to lower transaction volume. In Bancorp’s primary market of Louisville, Kentucky, the housing inventory continued to be relatively low, contributing to this decline. Refinancing activity, which slowed in 2018 as a result of rising interest rates, could increase if mortgage rates decline in 2019.
Net investment product sales commissions and fees decreased $48 thousand, or 11.9%, for the three-month period ended March 31, 2019, as compared with the same period in 2018. The decrease corresponds primarily to overall brokerage volume. Managed account balances were down in the first quarter of 2019 as a result of the stock market decline in the fourth quarter of 2018. 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 via an arrangement with a third party broker-dealer, while larger managed accounts are serviced in the Bank’s WM&T department.
Bank owned life insurance (“BOLI”) assets represent the cash surrender value of life insurance policies on certain key employees who have provided consent for Bancorp to be the beneficiary of a portion of such policies. The related change in cash surrender value and any death benefits received under the policies are recorded as non-interest income. This income helps offset the cost of various employee benefits. Income related to BOLI decreased to $178 thousand in the first quarter of 2019 compared with $187 thousand for the same time period in 2018, as a result of decreasing crediting rates on investments.
Other non-interest income increased $183 thousand, or 66.3%, for the first quarter of 2019 compared with the same period in 2018. In the first quarter of 2019 Bancorp recognized income of $126 thousand related to incentive received to relocate a banking center location.
Non-interest expenses
Compensation, which includes salaries, incentives, bonuses, and stock based compensation, increased $831 thousand, or 7.6%, for the first quarter of 2019, compared with the same period in 2018. Personnel additions related to Bancorp’s growth along with annual salary increases drove the increase. At March 31, 2019, Bancorp had 596 full-time equivalent employees compared with 589 at March 31, 2018.
Employee benefits consists of all personnel related expense not included in compensation, with the most significant items being health insurance, payroll taxes, and retirement plan contributions. Employee benefits were flat year over year. The directional inconsistency when comparing to compensation is attributable to lower health insurance claims during the first quarter of 2019 compared to the same period in 2018.
Net occupancy and equipment expense increased $40 thousand, or 2.2%, in the first quarter of 2019, as compared with the same period in 2018. This category primarily includes rent, depreciation, and maintenance, variances for which were not 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.
Technology and communications expense increased $143 thousand, or 8.8% in the first quarter of 2019 compared with the same period in 2018 due largely to increases in computer infrastructure upgrades and maintenance costs. These expenses include ongoing computer software amortization, equipment depreciation, and expenditures related to investments in technology needed to maintain and improve the quality of customer delivery channels, information security, and internal resources.
Bancorp outsources processing for debit and credit card operations, which generate significant revenue. These expenses increase as transaction volume increases, offsetting a portion of corresponding revenue growth. Debit and credit card processing increased $21 thousand, or 3.7% in the first three months of 2019, as compared with the same period in 2018, as a result of rising transaction volume.
Marketing and business development expenses include all costs associated with promoting Bancorp, community investment, retaining customers, and acquiring new business. Expenses decreased $21 thousand, or 3.3% in the first quarter of 2019 compared with the first quarter of 2018. A general increase in travel, meals, and entertainment expense, was more than offset by a decline in contribution expense.
Postage, printing and supplies expenses increased $15 thousand, or 3.8% in the first quarter of 2019 compared with the same time period in 2018.
Legal and professional fees increased $41 thousand, or 8.3% to $534 thousand in the first quarter of 2019 from $493 thousand in the first quarter of 2018. Costs associated with CECL engagements drove the increase.
FDIC insurance expense was flat year over year. The assessment is calculated by the FDIC, and any fluctuation in expense is directly related to changes in Bancorp’s balance sheet.
Amortization/impairment of investments in tax credit partnerships increased $52 thousand for the first quarter of 2019 compared with the same period of 2018, as Bancorp did not record any expense in the first quarter of 2018. These partnerships generate federal income tax credits. For each of Bancorp’s investments in tax credit partnerships, the tax benefit compared with related expenses results in a positive effect on net income. Amounts of credits and corresponding expenses can vary widely depending upon timing and magnitude of the investments. See the Income Taxes section below for details on amortization and income tax impact for these credits.
Other non-interest expenses increased $433 thousand, or 55.1% in the first quarter of 2019 compared with the same period in 2018. The increase for 2019 was largely due to director compensation increasing $260 thousand, primarily due to market-tied deferred compensation, gains on the sale of other real estate declining $87 thousand, and fraud related losses increasing $74 thousand.
Income Taxes
Bancorp recorded income tax expense of $1.8 million for the first three months of 2019, compared to $3.1 million for the same period in 2018. The effective rate for the corresponding three month periods was 10.5% and 18.5%, respectively. The decrease in the effective tax rate from 2018 to 2019 related primarily to a Kentucky state tax law change. In March 2019, the Kentucky Legislature passed HB354 requiring financial institutions to transition from a capital based franchise tax to the Kentucky corporate income tax beginning in 2021. Historically, the franchise tax, a component of non-interest expenses, was assessed at 1.1% of net capital and averaged $2.5 million annually over the prior two year-end periods. The Kentucky corporate income tax will be assessed at 5% of Kentucky taxable income and will be included as a component of current and deferred state income tax expense. Associated with this change, during the first quarter of 2019, Bancorp established a Kentucky state deferred tax asset related to existing temporary differences estimated to reverse after the effective date of the law change. Bancorp recorded a corresponding state tax benefit, net of federal impact of $1.3 million, or approximately $0.06 per diluted share for the first quarter 2019. While this is positive in the short-term, Bancorp anticipates an unfavorable impact of approximately $200 thousand per year beginning in 2021.
Commitments
As detailed in the Commitments footnote, 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.
Other commitments discussed in Bancorp’s Annual Report on Form 10-K for the year ended December 31, 2018, have not materially changed since that report was filed, relative to qualitative and quantitative disclosures of fixed and determinable contractual obligations.
Financial Condition
Balance Sheet
Total assets remained level at $3.3 billion at both March 31, 2019 and December 31, 2018. In the first three months of 2019 decreases in loans, federal funds sold and interest bearing due from banks, were offset by increased available for sale securities. Gross loans decreased $22.5 million, or less than 1%, primarily as a result of elevated commercial and industrial loan and commercial real estate (CRE) loan payoffs mainly attributable to underlying collateral sales. Securities available for sale increased $70.1 million, or 16.0%, over the first three months of 2019, as excess liquidity was deployed into short-term securities. The increase also included market value improvement in the portfolio with net unrealized losses at March 31, 2019 of $3.3 million as compared with $6.7 million at December 31, 2018. Other assets increased $16.8 million or 35.7%, primarily the result establishing a right of use lease asset upon adopting ASU 2016-02,
Leases
in the first quarter of 2019.
Total liabilities also remained level at $2.9 billion at both March 31, 2019 and December 31, 2018. Total deposits decreased $41.8 million or 1.5%, consistent with expected seasonal decreases experienced in both non-interest bearing deposits, $12.2 million, or 1.7%, and interest bearing demand deposit accounts, $45.6 million, or 5.1%. Savings accounts increased $6.0 million, or 3.9%, and time deposits increased $9.7 million or 2.8%. Securities sold under agreements to repurchase decreased $1.5 million, or 4.0%, due to normal cyclical activity, and the continuation of customers migrating to higher-yielding, non-collateralized deposits. Federal funds purchased and other short-term borrowing increased $2.0 million, or 19.2%, period to period. Bancorp uses short-term lines of credit to manage its overall liquidity position. Other liabilities increased $8.2 million, or 17.7%, largely due to the addition of ASU 2016-02,
Leases
, in the first quarter of 2019.
Loan Portfolio Composition
Composition of loans, net of deferred fees and costs, by primary loan portfolio class follows:
(In thousands)
|
|
March 31, 2019
|
|
|
December 31, 2018
|
|
|
|
|
|
|
|
|
|
|
Commercial and industrial
|
|
$
|
827,747
|
|
|
$
|
833,524
|
|
Construction and development, excluding undeveloped land (1)
|
|
|
216,115
|
|
|
|
225,050
|
|
Undeveloped land
|
|
|
28,433
|
|
|
|
30,092
|
|
|
|
|
|
|
|
|
|
|
Real estate mortgage
|
|
|
|
|
|
|
|
|
Commercial investment
|
|
|
586,648
|
|
|
|
588,610
|
|
Owner occupied commercial
|
|
|
428,163
|
|
|
|
426,373
|
|
1-4 family residential
|
|
|
277,847
|
|
|
|
276,017
|
|
Home equity - first lien
|
|
|
48,656
|
|
|
|
49,500
|
|
Home equity - junior lien
|
|
|
66,837
|
|
|
|
70,947
|
|
Subtotal: Real estate mortgage
|
|
|
1,408,151
|
|
|
|
1,411,447
|
|
|
|
|
|
|
|
|
|
|
Consumer
|
|
|
45,263
|
|
|
|
48,058
|
|
Total loans
|
|
$
|
2,525,709
|
|
|
$
|
2,548,171
|
|
(1) Consists of land 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 participation loans sold, Bancorp has retained effective control of the loans, typically by restricting the participating institutions from pledging or selling their share ownership 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 portfolio segments, and a corresponding liability is recorded in other liabilities. At March 31, 2019 and December 31, 2018, the total participated portions of loans of this nature were $10.2 million and $10.5 million, respectively.
Allowance for Loan and Lease Losses
An allowance has been established to provide for probable losses on loans that may not be fully repaid. The allowance is increased by provisions charged to expense and decreased by charge-offs, net of recoveries. Loans are typically charged off when management deems them uncollectible and after underlying collateral has been liquidated; however, collection efforts continue and future recoveries may occur. Periodically, loans are partially charged off to the net realizable value based upon evaluation of related underlying collateral, including Bancorp’s proclivity for resolution.
The allowance methodology is driven by risk ratings, historical losses, and qualitative factors. The level of the March 31, 2019 allowance reflected a number of factors, including credit quality metrics which were generally consistent with prior periods, and expansion of the historical look-back period from 32 quarters to 36 quarters. This expansion of the historical period was applied to all classes and segments of the portfolio. Expansion of the look-back period for historical loss rates used in the quantitative allocation caused review of the overall methodology for qualitative factors to ensure we were appropriately capturing risk not addressed in the quantitative historical loss rate. Management believes extension of the look-back period is appropriate to ensure capture of the impact of a full economic cycle and more accurately represents the current level of risk inherent in the loan portfolio. Key indicators of loan quality continued to trend at levels consistent with prior periods, however management recognizes that due to the cyclical nature of the lending business, these trends will likely normalize over the long term. Additional information regarding Bancorp’s methodology for evaluating the adequacy of the allowance can be read in Bancorp’s Annual Report on Form 10K.
As of March 31, 2019 the allowance was $26.5 million, a $930 thousand increase from the December 31, 2018 balance of $25.5 million. For the comparative periods, the allowance as a percent of average loans was 1.05% and 1.01%, respectively. The allowance as a percent of period end loans, as of each period end, 1.05% and 1.00%, respectively. The increase in the first quarter of 2019 reflects a moderate increase in classified balances and net recoveries of $330 thousand. As of March 31, 2019, and December 31, 2018, the allowance remained adequate to cover potential losses in the loan portfolio, in management’s opinion.
Non-performing Loans and Assets
Information summarizing non-performing assets, including non-accrual loans follows:
(Dollars in thousands)
|
|
March 31, 2019
|
|
|
December 31, 2018
|
|
|
|
|
|
|
|
|
|
|
Non-accrual loans (1)
|
|
$
|
3,273
|
|
|
$
|
2,611
|
|
Troubled debt restructuring
|
|
|
39
|
|
|
|
42
|
|
Loans past due 90 days or more and still accruing
|
|
|
454
|
|
|
|
745
|
|
|
|
|
|
|
|
|
|
|
Total non-performing loans
|
|
|
3,766
|
|
|
|
3,398
|
|
|
|
|
|
|
|
|
|
|
Other real estate owned
|
|
|
878
|
|
|
|
1,018
|
|
|
|
|
|
|
|
|
|
|
Total non-performing assets
|
|
$
|
4,644
|
|
|
$
|
4,416
|
|
|
|
|
|
|
|
|
|
|
Non-performing loans as a percentage of total loans
|
|
|
0.15
|
%
|
|
|
0.13
|
%
|
Non-performing assets as a percentage of total assets
|
|
|
0.14
|
%
|
|
|
0.13
|
%
|
(1) No TDRs previously accruing were moved to non-accrual during the three month periods ending March 31, 2019. No TDRs were on non-accrual as of March 31, 2019 or December 31, 2018.
In total, non-performing assets as of March 31, 2019 were comprised of 29 loans, ranging in amount from $1 thousand to $667 thousand, two accruing TDRs, and foreclosed real estate held for sale. Foreclosed real estate held at March 31, 2019 included a 1-4 family residential property and two commercial real estate properties.
The following table sets forth the major classifications of non-accrual loans:
(In thousands)
|
|
March 31, 2019
|
|
|
December 31, 2018
|
|
|
|
|
|
|
|
|
|
|
Commercial and industrial
|
|
$
|
193
|
|
|
$
|
192
|
|
Construction and development, excluding undeveloped land
|
|
|
-
|
|
|
|
318
|
|
Undeveloped land
|
|
|
-
|
|
|
|
474
|
|
|
|
|
|
|
|
|
|
|
Real estate mortgage
|
|
|
|
|
|
|
|
|
Commercial investment
|
|
|
317
|
|
|
|
138
|
|
Owner occupied commercial
|
|
|
1,466
|
|
|
|
586
|
|
1-4 family residential
|
|
|
843
|
|
|
|
760
|
|
Home equity - first lien
|
|
|
-
|
|
|
|
-
|
|
Home equity - junior lien
|
|
|
454
|
|
|
|
143
|
|
Subtotal: Real estate mortgage
|
|
|
3,080
|
|
|
|
1,627
|
|
Consumer
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
Total loans
|
|
$
|
3,273
|
|
|
$
|
2,611
|
|
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 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, federal funds sold and interest bearing due from accounts with banks. Federal funds sold and interest bearing due from bank accounts totaled $67.3 million at March 31, 2019. These investments normally have overnight maturities and are used for general daily liquidity purposes.
Available for sale securities totaled $507.1 million, at March 31, 2019, with $205.4 million in securities expected to mature over the next 12 months. Combined with federal funds sold and interest bearing due from bank accounts, these offer substantial resources to meet either new loan demand or reductions in Bancorp’s deposit funding base. Bancorp pledges portions of the securities portfolio to secure public fund deposits, cash balances of certain WM&T accounts, and securities sold under agreements to repurchase. At March 31, 2019, total investment securities pledged for these purposes comprised 70% of the available for sale investment portfolio, leaving approximately $151.5 million of unpledged securities.
Bancorp has a significant base of non-maturity customer deposits, defined as demand, savings, money market deposit accounts and time deposits less than or equal to $250,000 (excluding brokered deposits). At March 31, 2019, such deposits totaled $2.7 billion and represented 97% of Bancorp’s total deposits, as compared with $2.7 billion, or 97% of total deposits at December 31, 2018. Because these 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. As market conditions continue to improve, these balances may decrease, putting strain on Bancorp’s liquidity position. Bancorp began adding liquidity to the balance sheet in 2018 sheet through targeted certificate of deposit marketing campaigns. The campaigns generated $111 million in certificate of deposit growth in 2018.
As of March 31, 2019, and December 31, 2018, Bancorp had brokered deposits of $29.8 million.
Included in total deposit balances at March 31, 2019 is $191.3 million of public funds deposits generally comprised of accounts from local government agencies and public school districts in the markets Bancorp operates within. As a result of property tax collections in the latter part of each year these accounts provide seasonal excess balances that originate with tax payments and decline leading into the next tax season. While this excess liquidity is maintained in low-yielding short-term investments and consequently negatively impacts net interest margin, it has a positive impact on net interest income.
Other sources of funds available to meet daily needs include the sales of securities under agreement to repurchase. As a member of the FHLB of Cincinnati, Bancorp has access to credit products offered by the FHLB. Bancorp views these borrowings as a low cost alternative to brokered deposits. At March 31, 2019, available credit from the FHLB totaled $523.7 million, as compared with $537.0 million as of December 31, 2018. Additionally, Bancorp had available federal funds purchased lines with correspondent banks totaling $105.0 million at both March 31, 2019, and December 31, 2018.
Bancorp’s principal source of cash is dividends paid to it as sole shareholder of the Bank. At March 31, 2019, the Bank could pay up to $68.4 million in dividends to Bancorp without regulatory approval subject to the ongoing capital requirements of the Bank. The Bank will pay the Holding Company a $28 million dividend in April, 2019, to consummate the acquisition of King Bancorp, Inc. This will not significantly hamper the Bank’s ability to pay dividends in the future.
Capital Resources
At March 31, 2019, stockholders’ equity totaled $378.0 million, an increase of $11.5 million since December 31, 2018. See the Consolidated Statement of Changes in Stockholders’ Equity for further detail of changes in equity since the end of 2018. One component of equity is accumulated other comprehensive income (loss) which, for Bancorp, consists of net unrealized gains or losses on securities available for sale and hedging instruments, as well as a minimum pension liability, each net of income taxes. Accumulated other comprehensive loss was $2.5 million at March 31, 2019 compared with a loss of $5.1 million on December 31, 2018. The $2.6 million increase is primarily a reflection of the effect of the changing interest rate environment during the first three months of 2019 on the valuation of Bancorp’s portfolio of available for sale securities.
The following table sets forth Bancorp’s and the Bank’s risk based capital ratios:
|
|
March 31,
|
|
|
December 31,
|
|
|
|
2019
|
|
|
2018
|
|
|
|
|
|
|
|
|
|
|
Total risk-based capital (1)
|
|
|
|
|
|
|
|
|
Consolidated
|
|
|
14.04
|
%
|
|
|
13.91
|
%
|
Bank
|
|
|
13.74
|
|
|
|
13.56
|
|
|
|
|
|
|
|
|
|
|
Common equity tier 1 risk-based capital (1)
|
|
|
|
|
|
|
|
|
Consolidated
|
|
|
13.11
|
|
|
|
13.00
|
|
Bank
|
|
|
12.82
|
|
|
|
12.65
|
|
|
|
|
|
|
|
|
|
|
Tier 1 risk-based capital (1)
|
|
|
|
|
|
|
|
|
Consolidated
|
|
|
13.11
|
|
|
|
13.00
|
|
Bank
|
|
|
12.82
|
|
|
|
12.65
|
|
|
|
|
|
|
|
|
|
|
Leverage (2)
|
|
|
|
|
|
|
|
|
Consolidated
|
|
|
11.57
|
|
|
|
11.33
|
|
Bank
|
|
|
11.31
|
|
|
|
11.02
|
|
|
(1)
|
Under 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.
W
eighted values are added together, resulting in
Bancorp's total risk-weighted assets. These ratios are computed in relation to average assets.
|
|
(2)
|
Ratio is computed in relation to average assets
.
|
Bancorp and the Bank are subject to capital regulations in accordance with Basel III, as administered by banking regulators. Regulatory agencies measure capital adequacy within a framework that makes capital requirements, in part, dependent on the individual risk profiles of financial institutions. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on Bancorp’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Holding Company and the Bank must meet specific capital guidelines that involve quantitative measures of Bancorp’s assets, liabilities and certain off-balance sheet items, as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators regarding components, risk weightings and other factors.
Banking regulators have categorized the Bank as well-capitalized. For prompt corrective action, the regulations in accordance with Basel III define “well capitalized” as a 6.5% Common Equity Tier 1 Risk-Based Capital ratio, an 8.0% Tier 1 Risk-Based Capital ratio, a 10.0% Total Risk-Based Capital ratio and a 5.0% Tier 1 Leverage ratio. Additionally, in order to avoid limitations on capital distributions, including dividend payments and certain discretionary bonus payments to executive officers, Bancorp and Bank must hold a capital conservation buffer composed of Common Equity Tier 1 Risk-Based Capital above their minimum risk-based capital requirements. The capital conservation buffer phased in from 2016 to 2019 on the following schedule: a capital conservation buffer of 0.625% effective January 1, 2016; 1.25% effective January 1, 2017; 1.875% effective January 1, 2018; and a fully phased in capital conservation buffer of 2.5% on January 1, 2019.
Bancorp continues to exceed the regulatory requirements for Total Risk Based Capital, Common Equity Tier I Risk Based, Tier I Risk Based Capital and Tier I Leverage Capital. Bancorp and the Bank intend to maintain a capital position that meets or exceeds the “well-capitalized” requirements as defined by the FRB and the FDIC, in addition to the Capital Conservation Buffer.
Non-GAAP Financial Measures
The following table provides a reconciliation of total stockholders’ equity in accordance with GAAP to tangible stockholders’ equity in accordance with applicable regulatory requirements, a non-GAAP disclosure. Bancorp provides the tangible book value per share, a non-GAAP measure, in addition to those defined by banking regulators, because of its widespread use by investors as a means to evaluate capital adequacy.
The following table reconciles Bancorp’s calculation of tangible common equity to amounts reported under GAAP.
(In thousands, except per share data)
|
|
March 31, 2019
|
|
|
December 31, 2018
|
|
|
|
|
|
|
|
|
|
|
Total stockholders equity - GAAP
|
|
$
|
377,994
|
|
|
$
|
366,500
|
|
Less: core deposit intangible
|
|
|
(1,015
|
)
|
|
|
(1,057
|
)
|
Less: goodwill
|
|
|
(682
|
)
|
|
|
(682
|
)
|
Tangible common equity - Non-GAAP
|
|
$
|
376,297
|
|
|
$
|
364,761
|
|
|
|
|
|
|
|
|
|
|
Total assets - GAAP
|
|
$
|
3,281,016
|
|
|
$
|
3,302,924
|
|
Less: core deposit intangible
|
|
|
(1,015
|
)
|
|
|
(1,057
|
)
|
Less: goodwill
|
|
|
(682
|
)
|
|
|
(682
|
)
|
Tangible assets - Non-GAAP
|
|
$
|
3,279,319
|
|
|
$
|
3,301,185
|
|
|
|
|
|
|
|
|
|
|
Total shareholders' equity to total assets - GAAP
|
|
|
11.52
|
%
|
|
|
11.10
|
%
|
Tangible common equity to tangible assets - Non-GAAP
|
|
|
11.47
|
|
|
|
11.05
|
|
|
|
|
|
|
|
|
|
|
Number of outstanding shares
|
|
|
22,823
|
|
|
|
22,749
|
|
|
|
|
|
|
|
|
|
|
Book value per share - GAAP
|
|
$
|
16.56
|
|
|
$
|
16.11
|
|
Tangible common equity per share - Non-GAAP
|
|
|
16.49
|
|
|
|
16.03
|
|
In addition to the efficiency ratio normally presented, Bancorp considers an adjusted efficiency ratio. Bancorp believes excluding amortization of investments in tax credit partnerships from non-interest expense in this ratio is important because it provides a meaningful comparison to both prior periods, since amortization expense can fluctuate widely between periods depending upon timing of tax credits, and to other companies who do not invest in these partnerships.
The following table reconciles Bancorp’s calculation of adjusted efficiency ratios to the ratio reported under GAAP.
|
|
Three months ended
|
|
|
|
March 31,
|
|
(Dollars in thousands)
|
|
2019
|
|
|
2018
|
|
Non-interest expenses
|
|
$
|
22,639
|
|
|
$
|
21,027
|
|
|
|
|
|
|
|
|
|
|
Net interest income (tax-equivalent)
|
|
|
29,713
|
|
|
|
27,402
|
|
Non-interest income
|
|
|
11,062
|
|
|
|
10,909
|
|
Total revenue
|
|
$
|
40,775
|
|
|
$
|
38,311
|
|
|
|
|
|
|
|
|
|
|
Efficiency ratio - GAAP
|
|
|
55.52
|
%
|
|
|
54.89
|
%
|
(amounts in thousands)
|
|
2019
|
|
|
2018
|
|
Non-interest expense
|
|
$
|
22,639
|
|
|
$
|
21,027
|
|
Less: amortization of investments in tax credit partnerships
|
|
|
(52
|
)
|
|
|
-
|
|
Adjusted non-interest expense
|
|
|
22,587
|
|
|
|
21,027
|
|
|
|
|
|
|
|
|
|
|
Net interest income (tax-equivalent)
|
|
|
29,713
|
|
|
|
27,402
|
|
Non-interest income
|
|
|
11,062
|
|
|
|
10,909
|
|
Total revenue
|
|
$
|
40,775
|
|
|
$
|
38,311
|
|
|
|
|
|
|
|
|
|
|
Adjusted efficiency ratio - Non-GAAP
|
|
|
55.39
|
%
|
|
|
54.89
|
%
|