0000835324Stock Yards Bancorp, Inc.false--12-31Q32019000000000002016 2017 2018105010531350,0001200000035Reflects the fair value adjustment for the core deposit intangible asset recorded as a result of the acquisition.Reflects the fair value adjustment based on Bancorp's evaluation of the acquired loan portfolio and to eliminate KSB's recorded allowance.Includes $29.8 million in brokered deposits as of both September 30, 2019 and December 31, 2018.Reflects the fair value adjustment based on Bancorp's evaluation of the premises and equipment acquired.Bancorp's acquisition of KSB closed on May 1, 2019. The fair value adjustments reported are preliminary estimates based on information obtained subsequent to May 1, 2019 and through September 30, 2019. Management is continuing to evaluate each of its estimates and may provide additional recast adjustments in future periods based on this continuing evaluation. To the extent that additional recast adjustments are posted in future periods, the resultant fair values and the amount of goodwill recorded by Bancorp will change.Ratio is computed in relation to average assets.Outside of the scope of ASC 606Reflects the fair value adjustment based on Bancorp's evaluation of the acquired investment portfolio.Consists of land acquired for development by the borrower, but for which no development has yet taken place.Reflects the write-off of a miscellaneous other asset.Reflects the fair value adjustment based on the Company's evaluation of the assumed time deposits.Reflects the fair value adjustment based upon Bancorp's evaluation of the foreclosed real estate acquired.Intrinsic value for SARs is defined as the amount by which the current market price of the underlying stock exceeds the exercise or grant price.Outside of the scope of ASC 606, with the exception of safe deposit fees which were nominal for all periods.Reflects the fair value adjustment based upon Bancorp's evaluation of the assumed FHLB advances.Total loans are presented inclusive of premiums, discounts, and net loan origination fees and costs. Ratio is computed in relation to risk-weighted 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Table of Contents

 

UNITED STATES 

SECURITIES AND EXCHANGE COMMISSION 

Washington, D.C. 20549 

 

FORM 10-Q

  

Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

  

For the quarterly period ended September 30, 2019

  

or 

  

Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

  

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 incorporation or organization)

 

(I.R.S. Employer Identification No.)

   

1040 East Main Street, Louisville, Kentucky

 

40206

(Address of principal executive offices)

 

(Zip Code)

  

Registrant’s telephone number, including area code: (502) 582-2571

  

Securities registered pursuant to Section 12(b) of the Act: 

Title of each class

Trading symbol(s)

Name of each exchange on which registered

Common stock, no par value

SYBT

The NASDAQ Stock Market, LLC

 

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   ☐ No

  

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 such files).  ☒ Yes  ☐ No

  

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer ☒ 

 

Accelerated filer ☐

 

Non-accelerated filer ☐

 

Smaller reporting company ☐ 

Emerging growth company ☐

 

 

 

 

 

 

  

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ◻

  

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  ☐ Yes  ☒ No

 

The number of shares outstanding of the registrant’s Common Stock, no par value, as of October 31, 2019, was 22,597,716.

 

 

 

Stock Yards Bancorp, inc. and subsidiary

 

TABLE OF CONTENTS

 

 

Item   
part I – financial information  
   
Item 1.      Financial Statements.  4
   
Item 2.     Management’s Discussion and Analysis of Financial Condition and Results of Operations. 52
   
Item 3.    Quantitative and Qualitative Disclosures about Market Risk. 76
   
Item 4.    Controls and Procedures. 76
   
   
part II – other information  
   
Item 1.   Legal Proceedings. 76
   
Item 2.   Unregistered Sales of Equity Securities and Use of Proceeds. 76
   
Item 6.   Exhibits. 77
   
SIGNATURES 78

 

 

 

Stock Yards Bancorp, inc. and subsidiary

 

PART I – FINANCIAL INFORMATION

 

 

Glossary of Acronyms and Terms

 

The following listing provides a comprehensive reference of common acronyms and terms used throughout the document:
             

ACH

 

Automated Clearing House

 

FDIC

 

Federal Deposit Insurance Corporation

 

NM

 

Not Meaningful

AFS

 

Available for Sale

 

FFP

 

Federal Funds Purchased

 

OAEM

 

Other Assets Especially Mentioned

Allowance

 

Allowance for Loan and Lease Losses

 

FFS

 

Federal Funds Sold

 

OCI

 

Other Comprehensive Income

AOCI

 

Accumulated Other Comprehensive Income

 

FFTR

 

Federal Funds Target Rate

 

OREO

 

Other Real Estate Owned

ASC

 

Accounting Standards Codification

 

FHA

 

Federal Housing Authority

 

OTTI

 

Other than Temporary Impairment

ASU

 

Accounting Standards Update

 

FHLB

 

Federal Home Loan Bank of Cincinnati

 

PCI

 

Purchased Credit Impaired

AUM

 

Assets Under Management

 

FHLMC

 

Federal Home Loan Mortgage Corporation 

 

Prime

 

The Wall Street Journal Prime Interest Rate

Bancorp / the Company

 

Stock Yards Bancorp, Inc. 

 

FICA

 

Federal Insurance Contributions Act

 

Provision

 

Provision for Loan and Lease Losses

Bank / SYB&T

 

Stock Yards Bank & Trust Company 

 

FNMA

 

Federal National Mortgage Association

 

PSU

 

Performance Stock Unit

BOLI

 

Bank Owned Life Insurance

 

FRB

 

Federal Reserve Bank

 

ROA

 

Return on Average Assets

bps

 

Basis Point - 1/100th of one percent

 

FTE

 

Fully Tax Equivalent

 

ROE

 

Return on Average Equity

C&D

 

Construction and Development

 

GAAP

 

Generally Accepted Accounting Principles in the United States

 

RSA

 

Restricted Stock Award

C&I

 

Commercial and Industrial

 

GNMA

 

Government National Mortgage Association

 

RSU

 

Restricted Stock Unit

CD

 

Certificate of Deposit

 

HB

 

House Bill

 

SAR

 

Stock Appreciation Right

CECL

 

Current Expected Credit Loss

 

HELOC

 

Home Equity Line of Credit

 

SEC

 

Securities and Exchange Commission

CEO

 

Chief Executive Officer

 

KBST

 

King Bancorp Statutory Trust I

 

SSUAR

 

Securities Sold Under Agreements to Repurchase

CFO

 

Chief Financial Officer

 

KSB

 

King Bancorp, Inc. and King Southern Bank

 

TBOC

 

THE Bank Oldham County

COSO

 

Committee of Sponsoring Organizations

 

LIBOR

 

London Interbank Offered Rate

 

TCE

 

Tangible Common Equity

CRA

 

Community Reinvestment Act

 

Loans

 

Loans and Leases

 

TDR

 

Troubled Debt Restructuring

CRE

 

Commercial Real Estate

 

MBS

 

Mortgage Backed Securities

 

TPS

 

Trust Preferred Securities

EPS

 

Earnings Per Share

 

MSA

 

Metropolitan Statistical Area

 

VA

 

U.S. Department of Veterans Affairs

ETR

 

Effective Tax Rate

 

MSRs

 

Mortgage Servicing Rights

 

WM&T

 

Wealth Management and Trust

EVP 

 

Executive Vice President

 

NA  

 

Not Applicable

       

FASB

 

Financial Accounting Standards Board

 

NIM

 

Net Interest Margin

       

 

 

Stock Yards Bancorp, inc. and subsidiary

 

 

Item 1.   Financial Statements

CONSOLIDATED BALANCE SHEETS

September 30, 2019 (unaudited) and December 31, 2018

 

(In thousands, except share data)

 

   

September 30,

   

December 31,

 

 

 

2019

   

2018

 
Assets                

Cash and due from banks

  $ 68,107     $ 51,892  

Federal funds sold and interest bearing due from banks

    68,107       147,047  

Cash and cash equivalents

    136,214       198,939  

Mortgage loans held for sale

    6,329       1,675  

Securities available for sale

    375,601       436,995  

Federal Home Loan Bank stock, at cost

    11,316       10,370  

Loans and leases

    2,856,664       2,548,171  

Allowance for loan and lease losses

    26,877       25,534  

Net loans and leases

    2,829,787       2,522,637  
                 

Premises and equipment, net

    62,386       44,764  

Bank owned life insurance

    32,376       32,273  

Accrued interest receivable

    8,581       8,360  

Goodwill

    12,593       682  

Core deposit intangible

    2,373       1,057  

Other assets

    56,370       45,172  

Total assets

  $ 3,533,926     $ 3,302,924  
                 

Liabilities

               

Deposits:

               

Non-interest bearing

  $ 795,793     $ 711,023  

Interest bearing

    2,150,520       2,083,333  

Total deposits

    2,946,313       2,794,356  
                 

Securities sold under agreements to repurchase

    33,172       36,094  

Federal funds purchased

    9,957       10,247  

Federal Home Loan Bank advances

    81,985       48,177  

Accrued interest payable

    712       762  

Other liabilities

    65,676       46,788  

Total liabilities

    3,137,815       2,936,424  
                 

Commitments and contingent liabilities (note 15)

           
                 

Stockholders’ equity

               

Preferred stock, no par value. Authorized 1,000,000 shares; no shares issued or outstanding

           

Common stock, no par value. Authorized 40,000,000 shares; issued and outstanding 22,597,000 and 22,749,000 shares in 2019 and 2018, respectively

    36,184       36,689  

Additional paid-in capital

    34,607       36,797  

Retained earnings

    323,592       298,156  

Accumulated other comprehensive income (loss)

    1,728       (5,142 )

Total stockholders’ equity

    396,111       366,500  

Total liabilities and stockholders’ equity

  $ 3,533,926     $ 3,302,924  

 

See accompanying notes to unaudited consolidated financial statements.

 

 

 

CONSOLIDATED STATEMENTS OF INCOME  (Unaudited)

For the three and nine months ended September 30, 2019 and 2018

 

   

Three months ended

   

Nine months ended

 

(In thousands, except per share data)

 

September 30,

   

September 30,

 
   

2019

   

2018

   

2019

   

2018

 

Interest income:

                               

Loans and leases

  $ 35,022     $ 30,359     $ 99,985     $ 86,877  

Federal funds sold and interest bearing due from banks

    566       373       2,129       804  

Mortgage loans held for sale

    41       42       121       121  

Securities available for sale

                               

Taxable

    2,239       2,055       7,353       6,298  

Tax-exempt

    105       192       382       669  

Total interest income

    37,973       33,021       109,970       94,769  

Interest expense:

                               

Deposits

    5,316       3,972       16,034       8,723  

Securities sold under agreements to repurchase

    26       55       79       122  

Federal funds purchased and other short-term borrowing

    52       245       176       728  

Federal Home Loan Bank advances

    509       228       1,154       692  

Subordinated debentures

    -             26        

Total interest expense

    5,903       4,500       17,469       10,265  

Net interest income

    32,070       28,521       92,501       84,504  

Provision for loan and lease losses

    400       735       1,000       2,705  

Net interest income after provision

    31,670       27,786       91,501       81,799  

Non-interest income:

                               

Wealth management and trust services

    5,738       5,380       16,839       16,224  

Deposit service charges

    1,444       1,482       4,027       4,340  

Debit and credit card income

    2,102       1,759       6,014       4,956  

Treasury management fees

    1,264       1,151       3,623       3,311  

Mortgage banking income

    834       712       2,112       2,034  

Net investment product sales commissions and fees

    400       444       1,120       1,245  

Bank owned life insurance

    487       186       849       564  

Other

    1,035       312       2,045       1,096  

Total non-interest income

    13,304       11,426       36,629       33,770  

Non-interest expenses:

                               

Compensation

    12,330       11,607       36,846       34,280  

Employee benefits

    2,908       2,501       8,458       7,646  

Net occupancy and equipment

    2,199       1,914       6,033       5,543  

Technology and communication

    1,841       1,595       5,462       4,910  

Debit and credit card processing

    662       588       1,880       1,733  

Marketing and business development

    732       740       2,260       2,191  

Postage, printing and supplies

    402       370       1,218       1,161  

Legal and professional

    524       501       2,581       1,498  

FDIC insurance

    -       238       486       718  

Amortization/impairment of investments in tax credit partnerships

    137       -       241       58  

Capital and deposit based taxes

    993       738       2,864       2,452  

Other

    1,229       989       3,731       2,754  

Total non-interest expenses

    23,957       21,781       72,060       64,944  

Income before income tax expense

    21,017       17,431       56,070       50,625  

Income tax expense

    3,783       3,555       6,652       9,766  

Net income

  $ 17,234     $ 13,876     $ 49,418     $ 40,859  

Net income per share, basic

  $ 0.76     $ 0.61     $ 2.18     $ 1.81  

Net income per share, diluted

  $ 0.76     $ 0.60     $ 2.16     $ 1.78  

Weighted average common shares:

                               

Basic

    22,550       22,636       22,633       22,613  

Diluted

    22,810       22,968       22,901       22,956  

 

See accompanying notes to unaudited consolidated financial statements. 

 

 

 

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)

For the three and nine months ended September 30, 2019 and 2018

 

   

Three months ended

   

Nine months ended

 
   

September 30,

   

September 30,

 

(In thousands)

 

2019

   

2018

   

2019

   

2018

 
                                 

Net income

  $ 17,234     $ 13,876     $ 49,418     $ 40,859  

Other comprehensive income:

                               

Change in unrealized gain (loss) on available for sale debt securities

    946       (2,068 )     9,392       (8,392 )

Change in fair value of derivatives used in cash flow hedges

    (59 )     51       (589 )     543  

Total other comprehensive income (loss), before income tax

    887       (2,017 )     8,803       (7,849 )

Tax effect

    225       (425 )     1,933       (1,649 )

Total other comprehensive income (loss), net of tax

    662       (1,592 )     6,870       (6,200 )

Comprehensive income

  $ 17,896     $ 12,284     $ 56,288     $ 34,659  

 

See accompanying notes to unaudited consolidated financial statements.

 

 

9+

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (Unaudited)

Nine months ended September 30, 2019 and 2018 with quarterly subtotals

 

                                   

Accumulated

         
   

Common stock

   

Additional

           

other

   

Total

 
   

Number of

           

paid-in

   

Retained

   

comprehensive

   

stockholders'

 

(In thousands, except per share data)

 

shares

   

Amount

   

capital

   

earnings

   

income (loss)

   

equity

 
                                                 

Balance, January 1, 2019

    22,749     $ 36,689     $ 36,797     $ 298,156     $ (5,142 )   $ 366,500  
                                                 

Activity for three months ended March 31, 2019:

                                               

Net income

                      15,641             15,641  

Net change in accumulated other comprehensive income

                            2,629       2,629  

Stock compensation expense

                863                   863  

Stock issued for share-based awards, net of witholdings to satisfy employee tax obligations

    74       245       2,254       (4,452 )           (1,953 )

Cash dividends declared, $0.25 per share

                      (5,686 )           (5,686 )

Balance, March 31, 2019

    22,823     $ 36,934     $ 39,914     $ 303,659     $ (2,513 )   $ 377,994  
                                                 

Activity for three months ended June 30, 2019:

                                               
                                                 

Net income

                      16,543             16,543  

Net change in accumulated other comprehensive income

                            3,579       3,579  

Stock compensation expense

                993                   993  

Common stock repurchased

    (107 )     (357 )     (3,308 )                 (3,665 )

Stock issued for share-based awards, net of witholdings to satisfy employee tax obligations

    5       19       182       (363 )           (162 )

Cash dividends declared, $0.26 per share

                      (5,917 )           (5,917 )

Shares cancelled

                (5 )     5              

Balance, June 30, 2019

    22,721     $ 36,596     $ 37,776     $ 313,927     $ 1,066     $ 389,365  
                                                 

Activity for three months ended September 30, 2019:

                                               
                                                 

Net income

                      17,234             17,234  

Net change in accumulated other comprehensive income

                            662       662  

Stock compensation expense

                876                   876  

Common stock repurchased

    (152 )     (504 )     (4,995 )                 (5,499 )

Stock issued for share-based awards, net of witholdings to satisfy employee tax obligations

    29       97       994       (1,744 )           (653 )

Cash dividends declared, $0.26 per share

                      (5,874 )           (5,874 )

Shares cancelled

    (1 )     (5 )     (44 )     49              

Balance, September 30, 2019

    22,597     $ 36,184     $ 34,607     $ 323,592     $ 1,728     $ 396,111  

 

See accompanying notes to unaudited consolidated financial statements.

 

(continued)

 

 

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (Unaudited) (continued)

Nine months ended September 30, 2019 and 2018 with quarterly subtotals

 

                                   

Accumulated

         
   

Common stock

   

Additional

           

other

   

Total

 
   

Number of

           

paid-in

   

Retained

   

comprehensive

   

stockholders'

 

(In thousands, except per share data)

 

shares

   

Amount

   

capital

   

earnings

   

loss

   

Total

 
                                                 

Balance, January 1, 2018

    22,679     $ 36,457     $ 31,924     $ 267,193     $ (1,930 )   $ 333,644  
                                                 

Activity for three months ended March 31, 2018:

                                               

Reclassification adjustment under

                                               

Accounting Standards Update 2018-02

                      506       (506 )      

Net income

                      13,404             13,404  

Net change in accumulated other comprehensive income

                            (3,408 )     (3,408 )

Stock compensation expense

                823                   823  

Stock issued for share-based awards, net of witholdings to satisfy employee tax obligations

    52       174       205       (1,914 )           (1,535 )

Cash dividends declared, $0.23 per share

                      (5,226 )           (5,226 )

Shares cancelled

    (1 )     (4 )     (35 )     39              

Balance, March 31, 2018

    22,730     $ 36,627     $ 32,917     $ 274,002     $ (5,844 )   $ 337,702  
                                                 

Activity for three months ended June 30, 2018:

                                               
                                                 

Net income

                      13,579             13,579  

Net change in accumulated other comprehensive income

                            (1,200 )     (1,200 )

Stock compensation expense

                1,212                   1,212  

Stock issued for share-based awards, net of witholdings to satisfy employee tax obligations

    17       57       618       (1,226 )           (551 )

Cash dividends declared, $0.23 per share

                      (5,227 )           (5,227 )

Shares cancelled

    (1 )     (4 )     (32 )     36              

Balance, June 30, 2018

    22,746     $ 36,680     $ 34,715     $ 281,164     $ (7,044 )   $ 345,515  
                                                 

Activity for three months ended September 30, 2018:

                                               
                                                 

Net income

                      13,876             13,876  

Net change in accumulated other comprehensive income

                            (1,592 )     (1,592 )

Stock compensation expense

                888                   888  

Stock issued for share-based awards, net of witholdings to satisfy employee tax obligations

    2       5       56       (84 )           (23 )

Cash dividends declared, $0.25 per share

                      (5,684 )           (5,684 )

Shares cancelled

    (2 )     (7 )     (61 )     68              

Balance, September 30, 2018

    22,746     $ 36,678     $ 35,598     $ 289,340     $ (8,636 )   $ 352,980  

 

See accompanying notes to unaudited consolidated financial statements.

 

 

 

CONSOLIDATED STATEMENTS OF CASHFLOWS (Unaudited)

For the nine months ended September 30, 2019 and 2018

 

(In thousands)

  2019     2018  

Operating activities:

               

Net income

  $ 49,418     $ 40,859  

Adjustments to reconcile net income to net cash provided by operating activities:

               

Provision for loan and lease losses

    1,000       2,705  

Depreciation, amortization and accretion, net

    2,969       3,956  

Deferred income tax (benefit) expense

    (4,924 )     (490 )

Gain on sales of mortgage loans held for sale

    (1,251 )     (1,182 )

Origination of mortgage loans held for sale

    (69,983 )     (58,963 )

Proceeds from sale of mortgage loans held for sale

    66,580       60,576  

Bank owned life insurance income

    (849 )     (564 )

Loss on the disposal of premises and equipment

    6       8  

Income on other investments

    (142 )     -  

Gain on the sale of other real estate owned

    (63 )     (109 )

Stock compensation expense

    2,732       2,923  

Excess tax benefits from share-based compensation arrangements

    (712 )     (527 )

Net change in accrued interest receivable and other assets

    (7,296 )     2,554  

Net change in accrued interest payable and other liabilities

    2,169       (3,466 )

Net cash provided by operating activities

    39,654       48,280  

Investing activities:

               

Purchases of securities available for sale

    (442,220 )     (599,830 )

Proceeds from sales of securities available for sale

    12,427        

Proceeds from maturities and paydowns of securities available for sale

    513,906       614,926  

Purchase of Federal Home Loan Bank stock

          (2,724 )

Proceeds from redemption of Federal Home Loan Bank stock

    591        

Proceeds from redemption of Federal Reserve Bank stock

    490        

Proceeds from redemption of interest bearing due from banks

    1,761        

Net change in loans

    (142,108 )     (128,996 )

Purchases of premises and equipment

    (4,179 )     (4,917 )

Proceeds from sales of premises and equipment

    2,561       230  

Proceeds from surrender of acquired bank bank owned life insurance

    3,431        

Proceeds from bank owned life insurance mortality benefit

    909        

Other investment activities

    (2,766 )     (2,571 )

Proceeds from sales of other real estate owned

    868       2,860  

Cash for acquisition, net of cash acquired

    (24,684 )      

Net cash used in investing activities

    (79,013 )     (121,022 )

Financing activities:

               

Net change in deposits

    26,342       19,743  

Net change in securities sold under agreements to repurchase and federal funds purchased

    (4,778 )     53,402  

Proceeds from Federal Home Loan Bank advances

    90,000       90,000  

Repayments of Federal Home Loan Bank advances

    (99,620 )     (90,958 )

Repayment of acquired bank holding company line of credit

    (2,300 )      

Redemption of acquired bank subordinated debentures

    (3,609 )      

Repurchase of common stock

    (9,164 )      

Stock issued for share-based awards, net of witholdings to satisfy employee tax obligations

    (2,768 )     (2,109 )

Cash dividends paid

    (17,469 )     (16,104 )

Net cash provided by (used in) financing activities

    (23,366 )     53,974  

Net change in cash and cash equivalents

    (62,725 )     (18,768 )

Cash and cash equivalents at beginning of period

    198,939       139,248  

Cash and cash equivalents at end of period

  $ 136,214     $ 120,480  

 

(continued)

 

 

CONSOLIDATED STATEMENTS OF CASHFLOWS (continued) (Unaudited)

For the nine months ended September 30, 2019 and 2018

 

(In thousands)

  2019     2018  

Supplemental cash flow information:

               

Cash paid during the period for:

               

Income tax payments, net of refunds

  $ 9,281     $ 5,512  

Cash paid for interest

    17,519       9,816  

Supplemental non-cash activity:

               

Initital recognition of right-of-use lease assets

  $ 16,747     $  

Initital recognition operating lease liabilities

    18,067        

Transfers from loans to real estate acquired in settlement of loans

          1,715  
                 

Liabilities assumed in conjunction with King Bancorp acquisition:

               

Fair value of assets acquired

  $ 204,613     $  

Cash paid in acqusition

    28,000        

Liabilities assumed

  $ 176,613     $  

 

See accompanying notes to unaudited consolidated financial statements.

 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

 

 

 

(1)

Basis of Presentation and Summary of Significant Accounting Policies

 

Basis of Presentation – The consolidated financial statements include the accounts of Stock Yards Bancorp, Inc. and its wholly-owned subsidiary, SYB&T. All significant inter-company transactions and accounts have been eliminated in consolidation. All companies are collectively referred to as “Bancorp” or the “Company.”

 

The Bank, chartered in 1904, is a Louisville, Kentucky-based, state-chartered non-member financial institution that provides services in the Louisville, Kentucky, Indianapolis, Indiana and Cincinnati, Ohio MSAs through 42 full service banking center locations.

 

As a result of its acquisition of KSB on May 1, 2019, Bancorp became the 100% successor owner of KBST, an unconsolidated finance subsidiary. As permitted under the terms of KBST’s governing documents, Bancorp redeemed the TPS at the par amount of approximately $4 million on June 17, 2019.

 

Bancorp is divided into two reportable segments: Commercial Banking and 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, 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 provides custom-tailored financial planning, investment management, retirement planning and trust and estate services in all markets in which Bancorp operates. 

 

The accompanying unaudited consolidated financial statements have been prepared in accordance with GAAP for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, the financial statements do not include all the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for fair presentation have been included. Operating results for the three and nine months ended September 30, 2019 are not necessarily indicative of the results that may be expected for the year ending December 31, 2019. For further information, refer to the consolidated financial statements and footnotes thereto included in Bancorp’s Annual Report on Form 10-K for the year ended December 31, 2018. Certain reclassifications have been made in the prior year financial statements to conform to current year classifications.

 

Significant Accounting Policies - 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. A description of significant accounting policies is presented in Bancorp’s Annual Report on Form 10-K for the year ended December 31, 2018.

 

Critical Accounting Policies - 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 may continue and future recoveries could occur. Periodically, loans are partially charged off to the net realizable value based upon the evaluation of related underlying collateral, including Bancorp’s expectation of resolution.

 

 

The allowance methodology is driven by risk ratings, historical losses, and qualitative factors. The level of the September 30, 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 to 36 quarters in March of 2019. 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. Based on the look-back period extension, the allowance level increased approximately $2.0 million for 2019. Key indicators of loan quality continued to trend at levels consistent with prior periods, however management recognizes that due to the cyclical nature of local economies, 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 10-K.

 

Accounting Standards Updates Generally, if an issued-but-not-yet-effective ASU with an expected immaterial impact to Bancorp has been disclosed in prior SEC filings, it will not be re-disclosed.

 

The following ASU was issued prior to September 30, 2019 and is considered relevant to Bancorp’s financial statements.

 

In June 2016, FASB issued ASU 2016-13, CECL. This ASU significantly changes the way entities recognize impairment of many financial assets by requiring immediate recognition of estimated credit losses expected to occur over their remaining life. The guidance is effective for annual and interim reporting periods beginning after December 15, 2019. Bancorp expects to recognize a one-time cumulative-effect adjustment to the allowance. Interagency guidance issued in December 2018 allows for a three year phase-in of the cumulative-effect adjustment for regulatory capital reporting.

 

As a result of this ASU, Bancorp expects to increase its allowance. Bancorp has formed a committee to oversee its transition to the CECL methodology. Bancorp has devoted internal resources and purchased a third party software solution to analyze, compute and report upon the CECL disclosure requirements. In addition, Bancorp has analyzed loan-level data and is determining its CECL loan segmentation and initial segment calculation methodologies. Bancorp continues to analyze forecast scenarios and stress test the volatility of the model. The Company expects to quantify the approximate January 1, 2020 impact of this ASU upon its consolidated financial statements in the filing of its 2019 Annual Report on Form 10-K.

 

Recently Adopted Accounting Standards - Bancorp adopted ASU 2016-02, Leases and related amendments using an alternative transition method, effective January 1, 2019 and upon adoption recorded $17 million in right-of-use lease assets and $18 million of operating lease liabilities on its balance sheet. Prior periods have not been restated. The right-of-use lease asset and operating lease liability are recorded in premises and equipment and other liabilities on the consolidated balance sheet. Bancorp elected all applicable practical expedients, including the option to expense short-term leases, which are defined as leases with a term of one year or less. Bancorp also elected not to separate lease components from non-lease components.

 

The adoption of this ASU did not have a meaningful impact on Bancorp's performance metrics, including regulatory capital ratios and ROA. Additionally, Bancorp does not believe that the adoption of this ASU by its clients will have a significant impact on Bancorp's ability to underwrite credit when client financial statements are presented inclusive of the requirements of this ASU. See the Footnote titled “Leases” for additional information on lease activities.

 

 

(2)

Acquisition of King Bancorp, Inc. and its wholly-owned subsidiary King Southern Bank

 

On May 1, 2019, Bancorp completed its acquisition of KSB, for $28 million in cash. The acquisition expands the Company’s market area into nearby Nelson County, Kentucky, while growing its customer base in Louisville, Kentucky.

 

 

The following table provides a summary of the assets acquired and liabilities assumed as recorded by KSB, the previously reported preliminary fair value adjustments necessary to adjust those acquired assets and assumed liabilities to fair value, recast adjustments to those previously reported preliminary fair values, and the fair values of those assets and liabilities as recorded by the Bancorp. As provided for under GAAP, management has up to 12 months following the date of acquisition to finalize the fair values of the acquired assets and assumed liabilities. The preliminary fair value adjustments and the preliminary resultant fair values shown in the following table continue to be evaluated by management and may be subject to further recast adjustments.

 

Acquisition of King Bancorp, Inc.

Summary of Assets Aquired and Liabilities Assumed

 

   

May 1, 2019

 
   

As Recorded

   

Fair Value

     

Recast

     

As Recorded

 

(In thousands)

 

by King

   

Adjustments (1)

     

Adjustments (1)

     

by Bancorp

 

Assets aquired:

                                   
                                     

Cash and due from banks

  $ 3,316     $       $       $ 3,316  

Interest bearing due from banks

    1,761                       1,761  

Available for sale securities

    12,404       23  

a

            12,427  

Loans

    165,744       (1,597 )

b

    (118 )

b

    164,029  

Allowance for loan and lease losses

    (1,812 )     1,812  

b

             

Loans, net

    163,932       215         (118 )       164,029  

Federal Home Loan Bank stock, at cost

    1,517                       1,517  

Federal Reserve Bank stock, at cost

    490                       490  

Premises and equipment, net

    4,358       (1,328 )

c

    351  

c

    3,381  

Core deposit intangible

          1,519  

d

            1,519  

Bank owned life insurance

    3,431                       3,431  

Other real estate owned

    325       (325 )

e

             

Other assets and accrued interest receivable

    867       (36 )

f

            831  
                                     

Total assets acquired

  $ 192,401     $ 68       $ 233       $ 192,702  
                                     

Liabilities assumed:

                                   
                                     

Deposits

                                   

Non-interest bearing

  $ 24,939     $       $       $ 24,939  

Interest bearing

    100,839       (252 )

g

            100,587  

Total deposits

    125,778       (252 )               125,526  
                                     

Federal funds purchased

    1,566                       1,566  

Federal Home Loan Bank advances

    43,718       (419 )

h

            43,299  

Subordinated Note

    3,609                       3,609  

Holding Company line of credit

    2,300                       2,300  

Other liabilities and accrued interest payable

    313                       313  
                                     

Total liabilities assumed

    177,284       (671 )               176,613  
                                     

Net assets acquired

  $ 15,117     $ 739       $ 233       $ 16,089  
                                     

Cash consideration paid

                                (28,000 )
                                     

Goodwill

                              $ 11,911  

 

(1) - Bancorp’s acquisition of KSB closed on May 1, 2019. The fair value adjustments reported are preliminary estimates based on information obtained subsequent to May 1, 2019 and through September 30, 2019. Management is continuing to evaluate each of its estimates and may provide additional recast adjustments in future periods based on this continuing evaluation. To the extent that additional recast adjustments are posted in future periods, the resultant fair values and the amount of goodwill recorded by Bancorp will change.

 

 

Explanation of preliminary fair value adjustments:

 

 

a.

Reflects the fair value adjustment based on Bancorp’s evaluation of the acquired investment portfolio.

 

 

b.

Reflects the fair value adjustment based on Bancorp’s evaluation of the acquired loan portfolio and to eliminate KSB’s recorded allowance.

 

 

c.

Reflects the fair value adjustment based on Bancorp’s evaluation of the premises and equipment acquired.

 

 

d.

Reflects the fair value adjustment for the core deposit intangible asset recorded as a result of the acquisition.

 

 

e.

Reflects the fair value adjustment based upon Bancorp’s evaluation of the foreclosed real estate acquired.

 

 

f.

Reflects the write-off of a miscellaneous other asset.

 

 

g.

Reflects the fair value adjustment based on the Company’s evaluation of the assumed time deposits.

 

 

h.

Reflects the fair value adjustment based upon Bancorp’s evaluation of the assumed FHLB advances.

 

 

Goodwill of approximately $12 million, which is the excess of the acquisition consideration over the fair value of net assets acquired, is expected to be recorded in the KSB acquisition and is the result of expected operational synergies and other factors. This goodwill is all attributable to Bancorp’s Commercial Banking segment and is not expected to be deductible for tax purposes. To the extent that management revises any of the above fair value adjustments as a result of its continuing evaluation, the amount of goodwill recorded in the KSB acquisition will change.

 

Based upon the proximity to existing branch locations, Bancorp closed three acquired full service branch locations in the third quarter of 2019, while retaining the associated customer relationships. The sale of two of these locations was consummated prior to September 30, 2019 with a recast to Goodwill posted. The remaining building is considered held for sale as of September 30, 2019.

 

Prior year pro-forma financial statements are not presented due to the immateriality of the transaction. Revenue (defined as net interest income and non-interest income) attributed to KSB totaled $1.5 million and $2.6 million for the three and nine months ended September 30, 2019.

 

 

 

(3)

Securities Available for Sale

 

All of Bancorp’s securities are classified as AFS. Amortized cost, unrealized gains and losses, and fair value of securities follow:

 

(In thousands)

 

Amortized

   

Unrealized

   

Fair

 

September 30, 2019

  cost    

Gains

   

Losses

    value  
                                 

Government sponsored enterprise obligations

  $ 212,315     $ 2,239     $ (189 )   $ 214,365  

Mortgage backed securities - government agencies

    142,518       1,233       (749 )     143,002  

Obligations of states and political subdivisions

    18,123       113       (2 )     18,234  
                                 

Total securities available for sale

  $ 372,956     $ 3,585     $ (940 )   $ 375,601  
                                 

December 31, 2018

                               
                                 

Government sponsored enterprise obligations

  $ 264,234     $ 156     $ (3,351 )   $ 261,039  

Mortgage backed securities - government agencies

    149,748       282       (3,753 )     146,277  

Obligations of states and political subdivisions

    29,760       107       (188 )     29,679  
                                 

Total securities available for sale

  $ 443,742     $ 545     $ (7,292 )   $ 436,995  

 

At September 30, 2019 and December 31, 2018, there were no holdings of debt securities of any one issuer, other than the U.S. government and its agencies, in an amount greater than 10% of stockholders’ equity.

 

There were no gains or losses on sales or calls of securities for the three-month and nine month periods ending September 30, 2019 and 2018. Securities acquired from KSB, totaling $12 million, were sold immediately following the acquisition with no gain or loss realized in the income statement.

 

A summary of securities AFS by contractual maturity follows:

 

(In thousands)

 

Amortized cost

   

Fair value

 
                 

Due within 1 year

  $ 99,584     $ 99,577  

Due after 1 year but within 5 years

    33,234       33,288  

Due after 5 years but within 10 years

    6,174       6,245  

Due after 10 years

    91,446       93,489  

Mortgage backed securities - government agencies

    142,518       143,002  

Total securities available for sale

  $ 372,956     $ 375,601  

 

Actual maturities may differ from contractual maturities because some issuers have the right to call or prepay obligations with or without prepayment penalties. The investment portfolio includes MBSs, which are guaranteed by agencies such as 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 $295 million and $355 million were pledged at September 30, 2019 and December 31, 2018, to secure accounts of commercial depositors in cash management accounts, public deposits, and uninsured cash balances for WM&T accounts.

 

 

Securities with unrealized losses at September 30, 2019 and December 31, 2018, aggregated by investment category and length of time securities have been in a continuous unrealized loss position follows:

 

(In thousands)

 

Less than 12 months

   

12 months or more

   

Total

 
   

Fair

   

Unrealized

   

Fair

   

Unrealized

   

Fair

   

Unrealized

 

September 30, 2019

 

value

   

losses

   

value

   

losses

   

value

   

losses

 
                                                 

Government sponsored enterprise obligations

  $ 10,347     $ (48 )   $ 51,559     $ (141 )   $ 61,906     $ (189 )

Mortgage-backed securities - government agencies

    28,937       (247 )     40,290       (502 )     69,227       (749 )

Obligations of states and political subdivisions

    4,276       (2 )     135       -       4,411       (2 )
                                                 

Total temporarily impaired securities

  $ 43,560     $ (297 )   $ 91,984     $ (643 )   $ 135,544     $ (940 )
                                                 

December 31, 2018

                                               

Government sponsored enterprise obligations

  $ 96,740     $ (38 )   $ 149,320     $ (3,313 )   $ 246,060     $ (3,351 )

Mortgage-backed securities - government agencies

    3,108       (5 )     120,848       (3,748 )     123,956       (3,753 )

Obligations of states and political subdivisions

    814       (1 )     17,639       (187 )     18,453       (188 )
                                                 

Total temporarily impaired securities

  $ 100,662     $ (44 )   $ 287,807     $ (7,248 )   $ 388,469     $ (7,292 )

 

Applicable dates for determining when securities are in an unrealized loss position are September 30, 2019 and December 31, 2018. 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 “Less than 12 months” category above.

 

Investment securities are evaluated for OTTI on at least a quarterly basis and more frequently when economic or market conditions warrant such an evaluation to determine whether a decline in value below amortized cost is other-than-temporary. The term “other-than-temporary” is not intended to indicate that the decline is permanent, but indicates that the prospects for a near-term recovery of value are not necessarily favorable, or that there is a general lack of evidence to support a realizable value equal to or greater than the carrying value of the investment. Once a decline in value is determined to be other-than-temporary, the value of the security is reduced and a corresponding charge to earnings is recognized for the anticipated credit losses.

 

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 maturity and/or the interest rate environment returns to conditions similar to when these securities were purchased. These investments consist of 52 and 117 separate investment positions as of September 30, 2019 and December 31, 2018. Because management does not intend to sell the securities, and it is not likely that Bancorp will be required to sell the investments before recovery of their amortized cost, which may be at maturity, Bancorp does not consider these securities to be other-than-temporarily impaired at September 30, 2019.

 

FHLB stock represents an investment held by Bancorp which is not readily marketable and is carried at cost adjusted for identified impairment. Impairment is evaluated on an annual basis in the fourth quarter. No impairment has been recorded in the past and not future impairment is expected. Holdings of FHLB stock are required for access to FHLB advances.

 

 

 

(4)

Loans and leases

 

Composition of loans, net of deferred fees and costs, by loan portfolio class follows:

 

(In thousands)

 

September 30, 2019

   

December 31, 2018

 
                 

Commercial and industrial

  $ 876,127     $ 833,524  

Construction and development, excluding undeveloped land(1)

    248,296       225,050  

Undeveloped land

    35,169       30,092  
                 

Real estate mortgage:

               

Commercial investment

    727,531       588,610  

Owner occupied commercial

    470,678       426,373  

1-4 family residential

    331,747       276,017  

Home equity - first lien

    51,015       49,500  

Home equity - junior lien

    72,533       70,947  

Subtotal: Real estate mortgage

    1,653,504       1,411,447  
                 

Consumer

    43,568       48,058  

Total loans(2)

  $ 2,856,664     $ 2,548,171  

 

(1) Consists of land acquired for development by the borrower, but for which no development has yet taken place.

(2) Total loans are presented inclusive of premiums, discounts, and net loan origination fees and costs. 

 

Loans to directors and their related interests, including loans to companies for which directors are principal owners and executive officers totaled $45 million and $53 million, as of September 30, 2019 and December 31, 2018.

 

 

The following table summarizes loans acquired in the Company’s May 1, 2019 KSB acquisition, recasted as of September 30, 2019.

 

   

May 1, 2019

 
   

Contractual

   

Non-accretable

   

Accretable

   

Acquisition-day

 

(In thousands)

 

receivable

   

amount

   

amount

   

fair value

 
                                 

Commercial and industrial

  $ 8,249     $     $ (23 )   $ 8,226  

Construction and development

    10,764             43       10,807  

Raw Land

    7,974             43       8,017  

Real estate mortgage:

                               

Commercial real estate

    84,219             (456 )     83,763  

1-4 family residential

    50,556             322       50,878  

Home equity - first lien

    196             3       199  

Home equity - junior lien

    679             5       684  

Subtotal: Real estate mortgage

    135,650             (126 )     135,524  
                                 

Consumer

    1,528             (73 )     1,455  
                                 

Total loans ASC 310-20

    164,165             (136 )     164,029  
                                 

Commercial and industrial

                               

Construction and development

                       

Raw Land

                       

Real estate mortgage:

                               

Commercial real estate

    1,351       (1,351 )            

1-4 family residential

    228       (228 )            

Home equity - first lien

                       

Home equity - junior lien

                       

Subtotal: Real estate mortgage

    1,579       (1,579 )            
                                 

Consumer

                       
                                 

Total loans ASC 310 purchased- credit-impaired loans

    1,579       (1,579 )            
                                 

Total loans

  $ 165,744     $ (1,579 )   $ (136 )   $ 164,029  

 

Purchased Credit Impaired Loans

 

The Bank acquired PCI loans on May 1, 2019 related to the KSB acquisition and also during 2013 associated with the TBOC acquisition. PCI loans are accounted for under ASC 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality. As provided for under GAAP, management has up to 12 months following the date of acquisition to finalize the fair values of the acquired assets.

 

Management utilized the following criteria in determining which loans were classified as PCI loans for its KSB acquisition:

 

 

Loans for which management assigned a non-accretable mark

 

●     Loans classified by management as substandard, doubtful or loss

●     Loans classified as non-accrual when acquired

●     Loans past due 90 days or more when acquired

 

The following table reconciles the contractually required and carrying amounts of all PCI loans:

 

In thousands

 

September 30, 2019

   

December 31, 2018

 
                 

Contractually-required principal

  $ 1,575     $ 432  

Non-accretable amount

    (1,575 )      

Accretable amount

    -       (68 )

Carrying value of loans

  $ -     $ 364  

 

The following table presents a rollforward of the accretable amount on all PCI loans:

 

   

Three months ended

   

Nine months ended

 
   

September 30,

   

September 30,

 

(In thousands)

 

2019

   

2018

   

2019

   

2018

 
                                 

Balance, beginning of period

  $ (62 )   $ (95 )   $ (68 )   $ (106 )

Transfers between non-accretable and accretable

                       

Net accretion into interest income on loans, including loan fees

    62       10       68       21  

Balance, end of period

  $ -     $ (85 )   $ -     $ (85 )

 

Credit Quality Indicators

 

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 included all risk-rated loans other than those classified as OAEM, substandard, and doubtful, which are defined below:

 

 

OAEM: Loans classified as OAEM have potential weaknesses requiring management's heightened 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 well-defined weaknesses that jeopardize ultimate repayment of the debt. Default is a distinct possibility 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 TDRs. Loans are placed on non-accrual status when prospects for recovering both principal and accrued interest are considered doubtful or when a default of principal or interest has existed for 90 days or more.

 

 

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.

 

 

Internally assigned risk grades of loans by loan portfolio class classification category follows:

 

(In thousands)

                         

Substandard

           

Total

 

September 30, 2019

 

Pass

   

OAEM

   

Substandard

   

non-performing

   

Doubtful

   

loans

 
                                                 

Commercial and industrial

  $ 838,507     $ 13,924     $ 23,488     $ 208     $     $ 876,127  

Construction and development, excluding undeveloped land

    248,296                               248,296  

Undeveloped land

    35,169                               35,169  
                                                 

Real estate mortgage:

                                               

Commercial investment

    715,432       1,835       8,690       1,574             727,531  

Owner occupied commercial

    456,106       6,825       6,338       1,409             470,678  

1-4 family residential

    329,678       1,690       157       222             331,747  

Home equity - first lien

    51,015                               51,015  

Home equity - junior lien

    72,034       213       18       268             72,533  

Subtotal: Real estate mortgage

    1,624,265       10,563       15,203       3,473             1,653,504  
                                                 

Consumer

    43,568                               43,568  
                                                 

Total

  $ 2,789,805     $ 24,487     $ 38,691     $ 3,681     $     $ 2,856,664  
                                                 
                                                 

December 31, 2018

                                               
                                                 

Commercial and industrial

  $ 803,073     $ 11,516     $ 18,703     $ 232     $     $ 833,524  

Construction and development, excluding undeveloped land

    220,532       4,200             318             225,050  

Undeveloped land

    29,618                   474             30,092  
                                                 

Real estate mortgage:

                                               

Commercial investment

    586,543       1,815       15       237             588,610  

Owner occupied commercial

    411,722       9,030       4,500       1,121             426,373  

1-4 family residential

    273,537       1,544       162       774             276,017  

Home equity - first lien

    49,500                               49,500  

Home equity - junior lien

    70,437       249       19       242             70,947  

Subtotal: Real estate mortgage

    1,391,739       12,638       4,696       2,374             1,411,447  
                                                 

Consumer

    48,058                               48,058  
                                                 

Total

  $ 2,493,020     $ 28,354     $ 23,399     $ 3,398     $     $ 2,548,171  

 

 

The following table presents the activity in the allowance by loan portfolio class:

 

   

Type of loan

         
           

Construction

                                 
           

and development,

                                 

Three months ended

 

Commercial

   

excluding

                                 
   

and

   

undeveloped

   

Undeveloped

   

Real estate

                 

(In thousands)

 

industrial

   

land

   

land

   

mortgage

   

Consumer

   

Total

 
                                                 

Balance, July 1, 2019

  $ 11,858     $ 1,810     $ 601     $ 12,030     $ 117     $ 26,416  

Provision (credit)

    32       (108 )     195       269       12       400  

Charge-offs

    (91 )                       (139 )     (230 )

Recoveries

    154                   46       91       291  

Balance, September 30, 2019

  $ 11,953     $ 1,702     $ 796     $ 12,345     $ 81     $ 26,877  

 

           

Construction

                                 
           

and development,

                                 
   

Commercial

   

excluding

                                 
   

and

   

undeveloped

   

Undeveloped

   

Real estate

                 

(In thousands)

 

industrial

   

land

   

land

   

mortgage

   

Consumer

   

Total

 
                                                 

Balance, July 1, 2018

  $ 12,118     $ 1,938     $ 501     $ 9,914     $ 402     $ 24,873  

Provision (credit)

    (628 )     31       81       1,211       40       735  

Charge-offs

    (451 )                 (14 )     (96 )     (561 )

Recoveries

    62                   51       62       175  

Balance, September 30, 2018

  $ 11,101     $ 1,969     $ 582     $ 11,162     $ 408     $ 25,222  

 

   

Type of loan

         
           

Construction

                                 
           

and development,

                                 

Nine months ended

 

Commercial

   

excluding

                                 
   

and

   

undeveloped

   

Undeveloped

   

Real estate

                 

(In thousands)

 

industrial

   

land

   

land

   

mortgage

   

Consumer

   

Total

 
                                                 

Balance, January 1, 2019

  $ 11,965     $ 1,760     $ 752     $ 10,681     $ 376     $ 25,534  

Provision (credit)

    (178 )     (261 )     44       1,579       (184 )     1,000  

Charge-offs

    (94 )                 (13 )     (383 )     (490 )

Recoveries

    260       203             98       272       833  

Balance, September 30, 2019

  $ 11,953     $ 1,702     $ 796     $ 12,345     $ 81     $ 26,877  

 

           

Construction

                                 
           

and development,

                                 
   

Commercial

   

excluding

                                 
   

and

   

undeveloped

   

Undeveloped

   

Real estate

                 

(In thousands)

 

industrial

   

land

   

land

   

mortgage

   

Consumer

   

Total

 
                                                 

Balance, January 1, 2018

  $ 11,276     $ 1,724     $ 521     $ 11,012     $ 352     $ 24,885  

Provision (credit)

    2,141       245       61       107       151       2,705  

Charge-offs

    (2,390 )                 (14 )     (332 )     (2,736 )

Recoveries

    74                   57       237       368  

Balance, September 30, 2018

  $ 11,101     $ 1,969     $ 582     $ 11,162     $ 408     $ 25,222  

 

 

The considerations by Bancorp in computing its allowance are determined based on the various risk characteristics of each loan segment. Relevant risk characteristics are as follows:

 

 

C&I: Loans in this category are made to businesses. Generally these loans are secured by assets of the business and repayment is expected from cash flows of the business. A decline in the strength of the business or a weakened economy and decreased consumer and/or business spending may have an effect on the credit quality in this loan category.

 

 

C&D, excluding undeveloped land: Loans in this category primarily include owner-occupied and investment C&D loans and commercial development projects. In most cases, C&D loans require only interest to be paid during the construction period. Upon completion or stabilization, C&D loans generally 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. 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.

 

 

Undeveloped land: Loans in this category are secured by land acquired for development by the borrower, but for which no development has yet taken place. Credit risk is primarily dependent upon the financial strength of the borrower, but can also be affected by market conditions and time to sell lots at an adequate price in the future. Credit risk is also affected by availability of permanent financing, including to the end user, 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. Underlying properties are generally located in Bancorp's primary market areas.

 

For owner occupied residential and owner-occupied CRE, repayment is dependent on financial strength of the borrower. For income-producing investment properties, repayment is dependent on financial strength of tenants, and to a lesser extent the borrowers’ financial strength. Cash flows of income producing investment properties may be adversely impacted by a downturn in the economy as reflected by increased vacancy rates, which in turn, will have an effect on credit quality and property values. Overall health of the economy, including unemployment rates and real estate prices, has an effect on credit quality in this overall 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, adequacy of collateral securing the loan. Therefore, overall health of the economy, including unemployment rates, as well as home and securities prices, will have a significant effect on credit quality in this loan category.

 

Impaired loans include non-accrual loans and loans past due 90 days-or-more accruing interest in addition to a nominal amount TDRs, which also continue to accrue interest.

 

 

The following table presents the recorded investment in non-accrual and loans past due 90-days-or-more and still accruing interest:

 

                   

Past Due 90-Days-or-More

 
   

Non-accrual

   

and Still Accruing Interest

 

(In thousands)

 

September 30, 2019

   

December 31, 2018

   

September 30, 2019

   

December 31, 2018

 
                                 

Commercial and industrial

  $ 186     $ 192     $ -     $ 12  

Construction and development, excluding undeveloped land

          318              

Undeveloped land

          474              
                                 

Real estate mortgage:

                               

Commercial investment

    741       138       396       99  

Owner occupied commercial

    1,409       586             535  

1-4 family residential

    137       760       72        

Home equity - first lien

                       

Home equity - junior lien

    249       143       19       99  

Subtotal: Real estate mortgage

    2,536       1,627       487       733  

Consumer

                       

Total loans

  $ 2,722     $ 2,611     $ 487     $ 745  

 

In the course of working with borrowers, Bancorp may elect to restructure the contractual terms of certain loans. TDRs occur when, for economic, legal, or other reasons related to a borrower’s financial difficulties, Bancorp grants a concession to the borrower that it would not otherwise consider. Bancorp did not recognize new TDRs, nor did any TDRs default, in the three and nine months periods ended September 30, 2019 and 2018. Detail of outstanding TDRs included in total non-performing loans follows:

 

   

September 30, 2019

   

December 31, 2018

 

(In thousands)

         

Specific

   

Additional

           

Specific

   

Additional

 
           

reserve

   

commitment

           

reserve

   

commitment

 

TDRs

 

Balance

   

allocation

   

to lend

   

Balance

   

allocation

   

to lend

 
                                                 

Commercial and industrial

  $ 22     $ 22     $     $ 28     $ 28     $  

1-4 family residential

    13       13             14       14        
                                                 

Total TDRs

  $ 35     $ 35     $     $ 42     $ 42     $  

 

As of September 30, 2019 formal foreclosure proceedings were in process on 1-4 family residential mortgage loans with a total recorded investment of $140,000, as compared with $528,000 as of December 31, 2018.

 

 

The following tables present the balance in the recorded investment in loans and by portfolio loan class and based on impairment evaluation method:

 

(In thousands)

 

Loans

   

Allowance

 

September 30, 2019

 

Loans individually evaluated for impairment

   

Loans collectively evaluated for impairment

   

Loans acquired with deteriorated credit quality

   

Total loans

   

Loans individually evaluated for impairment

   

Loans collectively evaluated for impairment

   

Loans acquired with deteriorated credit quality

   

Total allowance

 
                                                                 

Commercial and industrial

  $ 208     $ 875,919     $     $ 876,127     $ 22     $ 11,931     $     $ 11,953  

Construction and development, excluding undeveloped land

          248,296             248,296             1,702             1,702  

Undeveloped land

          35,169             35,169             796             796  

Real estate mortgage

    2,549       1,650,955             1,653,504       13       12,332             12,345  

Consumer

          43,568             43,568             81             81  
                                                                 

Total

  $ 2,757     $ 2,853,907     $     $ 2,856,664     $ 35     $ 26,842     $     $ 26,877  

 

(In thousands)

 

Loans

   

Allowance

 

December 31, 2018

 

Loans individually evaluated for impairment

   

Loans collectively evaluated for impairment

   

Loans acquired with deteriorated credit quality

   

Total loans

   

Loans individually evaluated for impairment

   

Loans collectively evaluated for impairment

   

Loans acquired with deteriorated credit quality

   

Total allowance

 
                                                                 

Commercial and industrial

  $ 220     $ 833,304     $     $ 833,524     $ 28     $ 11,937     $     $ 11,965  

Construction and development, excluding undeveloped land

    318       224,732             225,050             1,760             1,760  

Undeveloped land

    474       29,618             30,092             752             752  

Real estate mortgage

    1,641       1,409,806             1,411,447       14       10,667             10,681  

Consumer

          48,058             48,058             376             376  
                                                                 

Total

  $ 2,653     $ 2,545,518     $     $ 2,548,171     $ 42     $ 25,492     $     $ 25,534  

 

 

The following table’s present loans individually evaluated for impairment by loan portfolio class:

 

   

As of

   

Three months ended

   

Nine months ended

 
   

September 30, 2019

   

September 30, 2019

   

September 30, 2019

 
                                                         
           

Unpaid

           

Average

   

Interest

   

Average

   

Interest

 
   

Recorded

   

principal

   

Related

   

recorded

   

income

   

recorded

   

income

 

(In thousands)

 

investment

   

balance

   

allowance

   

investment

   

recognized

   

investment

   

recognized

 
                                                         

Impaired loans with no related allowance:

                                                       

Commercial and industrial

  $ 186     $ 176     $     $ 136     $     $ 164     $  

Construction and development, excluding undeveloped land

                                  80        

Undeveloped land

                                  119        
                                                         

Real estate mortgage

                                                       

Commercial investment

    741       741             524             376        

Owner occupied commercial

    1,409       1,847             1,427             1,226        

1-4 family residential

    137       137             426             614        

Home equity - first lien

                                         

Home equity - junior lien

    249       249             359             329        

Subtotal: Real estate mortgage

    2,536       2,974             2,736             2,545        
                                                         

Consumer

                                         

Subtotal

  $ 2,722     $ 3,150     $     $ 2,872     $     $ 2,908     $  
                                                         

Impaired loans with an allowance:

                                                       

Commercial and industrial

  $ 22     $ 22     $ 22     $ 28     $     $ 27     $  

Construction and development, excluding undeveloped land

                                         

Undeveloped land

                                         
                                                         

Real estate mortgage

                                                       

Commercial investment

                                         

Owner occupied commercial

                                         

1-4 family residential

    13       13       13       14             14        

Home equity - first lien

                                         

Home equity - junior lien

                                         

Subtotal: Real estate mortgage

    13       13       13       14             14        
                                                         

Consumer

                                         

Subtotal

  $ 35     $ 35     $ 35     $ 42     $     $ 41     $  
                                                         

Total:

                                                       

Commercial and industrial

  $ 208     $ 198     $ 22     $ 164     $     $ 191     $  

Construction and development, excluding undeveloped land

                                  80        

Undeveloped land

                                  119        
                                                         

Real estate mortgage

                                                       

Commercial investment

    741       741             524             376        

Owner occupied commercial

    1,409       1,847             1,427             1,226        

1-4 family residential

    150       150       13       440             628        

Home equity - first lien

                      -             -        

Home equity - junior lien

    249       249             359             329        

Subtotal: Real estate mortgage

    2,549       2,987       13       2,750             2,559        
                                                         

Consumer

                                         

Total impaired loans

  $ 2,757     $ 3,185     $ 35     $ 2,914     $     $ 2,949     $  

 

 

   

As of

   

Three months ended

   

Nine months ended

 
   

December 31, 2018

   

September 30, 2018

   

September 30, 2018

 
                                                         
           

Unpaid

           

Average

   

Interest

   

Average

   

Interest

 
   

Recorded

   

principal

   

Related

   

recorded

   

income

   

recorded

   

income

 

(In thousands)

 

investment

   

balance

   

allowance

   

investment

   

recognized

   

investment

   

recognized

 
                                                         

Impaired loans with no related allowance:

                                                       

Commercial and industrial

  $ 192     $ 707     $     $ 119     $     $ 398     $  

Construction and development, excluding undeveloped land

    318       489             380             524        

Undeveloped land

    474       506             474             474        
                                                         

Real estate mortgage

                                                       

Commercial investment

    138       138                         13        

Owner occupied commercial

    586       1,023             996             2,190        

1-4 family residential

    760       760             1,307             1,461        

Home equity - first lien

          -             -             -        

Home equity - junior lien

    143       143             60             45        

Subtotal: Real estate mortgage

    1,627       2,064             2,363             3,709        
                                                         

Consumer

                                  23        

Subtotal

  $ 2,611     $ 3,766     $     $ 3,336     $     $ 5,128     $  
                                                         

Impaired loans with an allowance:

                                                       

Commercial and industrial

  $ 28     $ 28     $ 28     $ 1,720     $     $ 1,853     $  

Construction and development, excluding undeveloped land

                                         

Undeveloped land

                                  24        
                                                         

Real estate mortgage

                                                       

Commercial investment

                                         

Owner occupied commercial

                      937             897        

1-4 family residential

    14       14       14       14             14        

Home equity - first lien

                                         

Home equity - junior lien

                                         

Subtotal: Real estate mortgage

    14       14       14       951             911        
                                                         

Consumer

                                         

Subtotal

  $ 42     $ 42     $ 42     $ 2,671     $     $ 2,788     $  
                                                         

Total:

                                                       

Commercial and industrial

  $ 220     $ 735     $ 28     $ 1,839     $     $ 2,251     $  

Construction and development, excluding undeveloped land

    318       489             380             524        

Undeveloped land

    474       506             474             498        
                                                         

Real estate mortgage

                                                       

Commercial investment

    138       138                         13        

Owner occupied commercial

    586       1,023             1,933             3,087        

1-4 family residential

    774       774       14       1,321             1,475        

Home equity - first lien

                                         

Home equity - junior lien

    143       143             60             45        

Subtotal: Real estate mortgage

    1,641       2,078       14       3,314             4,620        
                                                         

Consumer

                                  23        

Total impaired loans

  $ 2,653     $ 3,808     $ 42     $ 6,007     $     $ 7,916     $  

 

 

Differences between recorded investment amounts and unpaid principal balance amounts less related allowance are due to partial charge-offs which have occurred over the lives of certain loans.

 

The following table presents the aging of the recorded investment in loans by portfolio class:

 

(In thousands)

                         

90 or more

                 
                           

days past due

                 
           

30-59 days

   

60-89 days

   

(includes all

   

Total

   

Total

 

September 30, 2019

 

Current

   

past due

   

past due

   

non-accrual)

   

past due

   

loans

 
                                                 

Commercial and industrial

  $ 874,576     $ 465     $ 900     $ 186     $ 1,551     $ 876,127  

Construction and development, excluding undeveloped land

    248,296                               248,296  

Undeveloped land

    35,169                               35,169  
                                                 

Real estate mortgage:

                                               

Commercial investment

    723,028       3,352       14       1,137       4,503       727,531  

Owner occupied commercial

    468,699       478       92       1,409       1,979       470,678  

1-4 family residential

    329,140       2,159       239       209       2,607       331,747  

Home equity - first lien

    50,881       134                   134       51,015  

Home equity - junior lien

    72,216       49             268       317       72,533  

Subtotal: Real estate mortgage

    1,643,964       6,172       345       3,023       9,540       1,653,504  
                                                 

Consumer

    43,522       46                   46       43,568  
                                                 

Total

  $ 2,845,527     $ 6,683     $ 1,245     $ 3,209     $ 11,137     $ 2,856,664  
                                                 

December 31, 2018

                                               
                                                 

Commercial and industrial

  $ 832,923     $ 197     $ 200     $ 204     $ 601     $ 833,524  

Construction and development, excluding undeveloped land

    224,732                   318       318       225,050  

Undeveloped land

    29,552       66             474       540       30,092  
                                                 

Real estate mortgage:

                                               

Commercial investment

    586,884       1,382       107       237       1,726       588,610  

Owner occupied commercial

    421,143       2,732       1,377       1,121       5,230       426,373  

1-4 family residential

    274,547       374       336       760       1,470       276,017  

Home equity - first lien

    49,321       179                   179       49,500  

Home equity - junior lien

    70,467       182       56       242       480       70,947  

Subtotal: Real estate mortgage

    1,402,362       4,849       1,876       2,360       9,085       1,411,447  
                                                 

Consumer

    48,058                               48,058  
                                                 

Total

  $ 2,537,627     $ 5,112     $ 2,076     $ 3,356     $ 10,544     $ 2,548,171  

 

27

 

 

(5)

Goodwill and Intangible Assets

 

Goodwill, recorded on the acquisition date of an entity, represents $11.9 million related to the May 1, 2019 KSB acquisition and $682,000 related to the 1996 purchase of a bank in southern Indiana. As provided for under GAAP, management has up to 12 months following the date of acquisition to finalize the fair values of the acquired assets and assumed liabilities. During this measurement period, Bancorp may record subsequent recast adjustments to goodwill for provisional amounts recorded at the acquisition date.

 

GAAP requires that goodwill and intangible assets with indefinite useful lives not be amortized, but instead be tested for impairment at least annually. Impairment exists when a reporting unit’s carrying value of goodwill exceeds its fair value. Bancorp’s annual goodwill impairment test is conducted as of December 31 of each year or more often as situations dictate. The goodwill balance at September 30, 2019 relates entirely to the Commercial Banking segment of Bancorp. At December 31, 2018, Bancorp’s Commercial Banking reporting unit had positive equity and Bancorp elected to perform a qualitative assessment to determine if it was more-likely-than-not that the fair value of the reporting unit exceeded its carrying value, including goodwill. The qualitative assessment indicated that it was not more-likely-than-not that the carrying value of the reporting unit exceeded its fair value. Therefore, Bancorp did not complete the two-step impairment test as of December 31, 2018.

 

Changes in the carrying value of goodwill follows:

 

   

Three months ended

   

Nine months ended

 
   

September 30,

   

September 30,

 

(In thousands)

 

2019

   

2018

   

2019

   

2018

 

Balance at beginning of period

  $ 12,826     $ 682     $ 682     $ 682  

Goodwill acquired

                12,144        

Recast adjustments

    (233 )           (233 )      

Impairment

                       

Balance at end of period

  $ 12,593     $ 682     $ 12,593     $ 682  

 

The Company recorded core deposit intangible assets of $1.5 million and $2.5 million in association with its May 1, 2019 KSB and 2013 TBOC acquisitions. See the Footnote titled “Acquisition of King Bancorp, Inc.” for further details.

 

Changes in the net carrying amount of core deposit intangibles follow:

 

   

Three months ended

   

Nine months ended

 
   

September 30,

   

September 30,

 

(In thousands)

 

2019

   

2018

   

2019

   

2018

 

Balance at beginning of period

  $ 2,461     $ 1,139     $ 1,056     $ 1,225  

Core deposit intangible acquired

                1,519        

Amortization

    (88 )     (41 )     (202 )     (127 )

Balance at end of period

  $ 2,373     $ 1,098     $ 2,373     $ 1,098  

 

MSRs, a component of other assets, 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 September 30, 2019 and December 31, 2018 were $3 million and $4 million.

 

 

Changes in the net carrying amount of MSRs follows:

 

   

Three months ended

   

Nine months ended

 
   

September 30,

   

September 30,

 

(In thousands)

 

2019

   

2018

   

2019

   

2018

 

Balance at beginning of period

  $ 1,168     $ 898     $ 1,022     $ 875  

Additions for mortgage loans sold

    124       125       338       220  

Amortization

    (40 )     (40 )     (108 )     (112 )

Balance at end of period

  $ 1,252     $ 983     $ 1,252     $ 983  

 

Total outstanding principal balances of loans serviced for others were $324 million and $328 million at September 30, 2019, and December 31, 2018.

 

 

(6)

Income Taxes

 

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 $200,000 per year beginning in 2021.

 

In April 2019, the Kentucky legislature passed HB458 allowing banks and their holding companies to be combined together for Kentucky tax return filings. The combined filing will allow Bancorp’s holding company net operating losses to offset against net revenue generated by the Bank and reduce Bancorp’s tax liability. Bancorp recorded a state tax benefit associated with this change of $2.4 million in the second quarter of 2019, or approximately $0.11 per diluted share for the second quarter of 2019.

 

Components of income tax expense (benefit) from operations follow:

 

   

Three months ended

   

Nine months ended

 
   

September 30,

   

September 30,

 

(In thousands)

 

2019

   

2018

   

2019

   

2018

 

Current income tax expense:

                               

Federal

  $ 4,524     $ 3,888     $ 11,022     $ 9,750  

State

    224       196       554       506  

Total current income tax expense

    4,748       4,084       11,576       10,256  
                                 

Deferred income tax expense (benefit) :

                               

Federal

    (768 )     (502 )     21       (456 )

State

    (201 )     (27 )     (4,969 )     (34 )

Total deferred income tax expense

    (969 )     (529 )     (4,948 )     (490 )

Change in valuation allowance

    4             24        

Total income tax expense

  $ 3,783     $ 3,555     $ 6,652     $ 9,766  

 

 

An analysis of the difference between statutory and effective income tax rates follows:

 

   

Three months ended

   

Nine months ended

 
   

September 30,

   

September 30,

 
   

2019

   

2018

   

2019

   

2018

 

U.S. federal statutory income tax rate

    21.0

%

    21.0

%

    21.0

%

    21.0

%

Kentucky state income tax enactments

    (0.7 )           (6.9 )      

Excess tax benefits from stock-based compensation arrangements

    (1.5 )           (1.2 )     (1.0 )

Increase in cash surrender value of life insurance

    (0.8 )     (0.7 )     (0.9 )     (0.6 )

Tax credits

    (0.5 )     (0.2 )     (0.6 )     (0.4 )

Tax exempt interest income

    (0.3 )     (0.4 )     (0.3 )     (0.5 )

State income taxes, net of federal benefit

    0.7       0.8       0.7       0.7  

Other, net

    (0.1 )     (0.1 )     0.1       0.1  

Effective income tax rate

    17.9

%

    20.4

%

    11.9

%

    19.3

%

 

Currently, state income tax expense represents tax owed to the state of Indiana. Kentucky and Ohio state bank taxes are currently based on capital levels, and are recorded as other non-interest expense. See preceding section regarding 2019 changes in Kentucky tax law.

 

GAAP provides guidance on financial statement recognition and measurement of tax positions taken, or expected to be taken, in tax returns. 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. As of September 30, 2019 and December 31, 2018, the gross amount of unrecognized tax benefits was immaterial to the consolidated financial statements of the Company. Federal and state income tax returns are subject to examination for the years after 2015.

 

 

(7)

Deposits

 

The composition of the Bank’s deposits follows:

 

(In thousands)

 

September 30, 2019

   

December 31, 2018

 
                 

Non-interest bearing demand deposits

  $ 795,793     $ 711,023  
                 

Interest bearing deposits:

               

Interest bearing demand

    854,175       892,867  

Savings

    168,067       155,007  

Money market

    698,318       688,744  
                 

Time deposits of $250 thousand or more

    69,210       55,182  

Other time deposits(1)

    360,750       291,533  

Total time deposits

    429,960       346,715  
                 

Total interest bearing deposits

    2,150,520       2,083,333  
                 

Total deposits

  $ 2,946,313     $ 2,794,356  

 

 

(1)

Includes $29.8 million in brokered deposits as of both September 30, 2019 and December 31, 2018.

 

Deposits totaling $125.5 million were acquired on May 1, 2019, associated with the KSB acquisition.

 

 

 

(8)

Securities Sold Under Agreements to Repurchase

 

SSUAR represent a funding source of Bancorp and are primarily used by commercial customers in conjunction with collateralized corporate cash management accounts. Such repurchase agreements are considered financing agreements and mature within one business day from the transaction date. At September 30, 2019, 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 controlled by Bancorp.

 

Information concerning SSUAR follows:

 

(Dollars in thousands)

 

September 30, 2019

   

December 31, 2018

 

Outstanding balance at end of period

  $ 33,172     $ 36,094  

Weighted average interest rate at end of period

    0.24

%

    0.24

%

 

   

Three months ended

   

Nine months ended

 
   

September 30,

   

September 30,

 

(Dollars in thousands)

 

2019

   

2018

   

2019

   

2018

 
                                 

Average outstanding balance during the period

  $ 37,705     $ 67,381     $ 38,402     $ 66,869  

Average interest rate during the period

    0.27

%

    0.32

%

    0.28

%

    0.24

%

Maximum outstanding at any month end during the period

  $ 38,362     $ 73,057     $ 43,160     $ 74,725  

 

 

 

(9)

Federal Home Loan Bank Advances

 

Bancorp had outstanding 57 separate advances totaling $82 million as of September 30, 2019, as compared with 14 separate advances totaling $48 million as of December 31, 2018. As a result of the KSB acquisition, Bancorp assumed 46 advances totaling $43 million, with maturities ranging from 2019 to 2028. These advances were discounted to fair value as of the acquisition date. See the Footnote titled “Acquisition of King Bancorp, Inc.” for further details. As of September 30, 2019, for 15 advances totaling $50 million, all of which are non-callable, interest payments are due monthly, with principal due at maturity. For the remaining advances, 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:

 

(In thousands)

 

September 30, 2019

   

December 31, 2018

 

Maturity

         

Weighted average

           

Weighted average

 

Year

 

Advance

   

Fixed Rate

   

Advance

   

Fixed Rate

 

2019

  $ 29,926       2.09

%

  $ 30,000       2.54

%

2020

    20,218       2.38       1,691       2.23  

2021

    2,481       2.49       215       2.12  

2023

    489       1.00              

2024

    2,077       2.36       2,240       2.36  

2025

    3,896       2.41       4,626       2.42  

2026

    8,358       1.95       8,185       1.99  

2027

    8,346       1.75              

2028

    6,194       2.38       1,220       1.49  
                                 

Total

  $ 81,985       2.16

%

  $ 48,177       2.39

%

 

FHLB advances are collateralized by certain commercial and residential real estate mortgage loans under a blanket mortgage collateral pledge agreement and FHLB stock. Bancorp views these advances to be an effective alternative to brokered deposits to fund loan growth. At September 30, 2019, and December 31, 2018, the amount of available credit from the FHLB totaled $511 million and $537 million. The Company also had $105 million in FFP lines available from correspondent banks at both September 30, 2019, and December 31, 2018.

 

 

 

(10)

Other Comprehensive Income (Loss)

 

The following tables illustrate activity within the balances in AOCI by component:

 

   

Net unrealized

   

Net unrealized

   

Minimum

         
   

gains (losses)

   

gains (losses)

   

pension

         

Three months ended September 30, 2019

 

on securities

   

on cash

   

liability

         

(In thousands)

 

available for sale

   

flow hedges

   

adjustment

   

Total

 
                                 

Balance, beginning of period

  $ 1,291     $ (14 )   $ (211 )   $ 1,066  

Net current period other comprehensive income (loss)

    719       (55 )     (2 )     662  

Balance, end of period

  $ 2,010     $ (69 )   $ (213 )   $ 1,728  
                                 

Three months ended September 30, 2018

                               

Balance, beginning of period

  $ (7,274 )   $ 623     $ (393 )   $ (7,044 )

Net current period other comprehensive income (loss)

    (1,632 )     40             (1,592 )

Balance, end of period

  $ (8,906 )   $ 663     $ (393 )   $ (8,636 )

 

   

Net unrealized

   

Net unrealized

   

Minimum

         
   

gains (losses)

   

gains (losses)

   

pension

         

Nine months ended September 30, 2019

 

on securities

   

on cash

   

liability

         

(In thousands)

 

available for sale

   

flow hedges

   

adjustment

   

Total

 
                                 

Balance, beginning of period

  $ (5,330 )   $ 408     $ (220 )   $ (5,142 )

Net current period other comprehensive income (loss)

    7,340       (477 )     7       6,870  

Balance, end of period

  $ 2,010     $ (69 )   $ (213 )   $ 1,728  
                                 

Nine months ended September 30, 2018

                               

Balance, beginning of period

  $ (1,781 )   $ 193     $ (342 )   $ (1,930 )

Net current period other comprehensive income (loss)

    (6,629 )     429             (6,200 )

Reclassification adjustment for adoption of ASU 2018-02

    (496 )     41       (51 )     (506 )

Balance, end of period

  $ (8,906 )   $ 663     $ (393 )   $ (8,636 )

 

 

(11)

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.

 

 

 

(12)

Net Income Per Share

 

The following table reflects net income (numerator) and average shares outstanding (denominator) for basic and diluted net income per share computations:

 

   

Three months ended

   

Nine months ended

 
   

September 30,

   

September 30,

 

(In thousands, except per share data)

 

2019

   

2018

   

2019

   

2018

 

Net income

  $ 17,234     $ 13,876     $ 49,418     $ 40,859  
                                 

Weighted average shares outstanding - basic

    22,550       22,636       22,633       22,613  

Dilutive securities

    260       332       268       343  

Weighted average shares outstanding- diluted

    22,810       22,968       22,901       22,956  
                                 

Net income per share, basic

  $ 0.76     $ 0.61     $ 2.18     $ 1.81  

Net income per share, diluted

    0.76       0.60       2.16       1.78  

 

Certain SARs that were excluded from the EPS calculation because their impact was antidilutive follows:

 

   

Three months ended

   

Nine months ended

 

(In thousands)

 

September 30,

   

September 30,

 
   

2019

   

2018

   

2019

   

2018

 

Antidilutive SARs

    199       94       199       94  

 

These shares while antidilutive, could however, be dilutive to EPS in the future.

 

 

(13)

Defined Benefit Plan

 

Bancorp sponsors an unfunded, non-qualified, defined benefit retirement plan for three key officers (one current and two retired), and has no plans to increase the number of or benefits to participants. All participants are fully vested. Actuarially determined pension costs are expensed and accrued over the service period, and benefits are paid from Bancorp’s assets. Bancorp maintains life insurance policies, for which it is the beneficiary, for the defined benefit plan participants. Income from these policies is utilized to offset costs of benefits. Net periodic benefit cost was immaterial for all respective periods.

 

 

(14)

Stock-Based Compensation

 

The fair value of all stock-based awards granted, net of estimated forfeitures, is recognized as compensation expense over the respective service period.

 

At Bancorp's 2015 Annual Meeting of Shareholders, shareholders approved the 2015 Omnibus Equity Compensation Plan and authorized the shares available from the expiring 2005 plan for future awards under the 2015 plan. In 2018 shareholders approved an additional 500,000 shares for issuance under the plan. As of September 30, 2019, there were 795,000 shares available for future awards.

 

 

Stock OptionsBancorp had no stock options outstanding as of September 30, 2019 and December 31, 2018.

 

SARs SARs granted have a vesting schedule of 20% per year and expire ten years after the grant date unless forfeited due to employment termination.

 

Fair values of SARs are estimated at the date of grant using the Black-Scholes option pricing model, a leading formula for calculating such value. This model requires the input of assumptions, changes to which can materially affect the fair value estimate. The following assumptions were used in SAR valuations at the grant date in each year:

 

   

2019

   

2018

 
                 

Dividend yield

    2.54 %     2.56 %

Expected volatility

    20.39 %     20.17 %

Risk free interest rate

    2.52 %     2.96 %

Expected life of SARs (years)

    7.2       7.0  

 

Dividend yield and expected volatility are based on historical information for Bancorp corresponding to the expected life of 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 awards. The expected life of SARs is based on past experience of similar-life SARs. Bancorp evaluates historical exercise and post-vesting termination behavior when determining the expected life.

 

RSA Grants – RSAs granted to officers vest over five years. For all grants prior to 2015, grantees are entitled to dividend payments during the vesting period. For grants in 2015 and forward, forfeitable dividends are deferred until shares are vested. Fair value of RSAs is equal to the market value of the shares on the date of grant.

 

PSU Grants – 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, the fair value of these PSUs is estimated based upon the market value of the underlying shares on the date of grant, adjusted for non-payment of dividends. Grants require a one year post-vesting holding period and the fair value of such grants incorporates a liquidity discount related to the holding period of 4.1%, 4.3% and 5.1% for 2019, 2018, and 2017.

 

RSU Grants – RSUs are only granted to non-employee 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 equals market value of underlying shares on the date of grant.

 

Bancorp utilized cash of $272,000 during the first nine months of 2019 for the purchase of shares upon the vesting of RSUs. This compares with cash used of $154,000 during the first nine months of 2018 for the purchase of shares.

 

In the first quarter of 2019, Bancorp awarded 9,834 RSUs to non-employee directors of Bancorp with a grant date fair value of $330,000.

 

 

Bancorp has recognized stock-based compensation expense for SARs, RSAs, and PSUs within compensation expense, and RSUs for directors within other non-interest expense, as follows:

 

   

Three months ended September 30, 2019

 

(In thousands)

 

Stock Appreciation Rights

   

Restricted Stock Awards

   

Restricted Stock Units

   

Performance Stock Units

   

Total

 
                                         

Expense

  $ 88     $ 292     $ 82     $ 414     $ 876  

Deferred tax benefit

    (18 )     (65 )     (17 )     (109 )     (209 )

Total net expense

  $ 70     $ 227     $ 65     $ 305     $ 667  

 

   

Three months ended September 30, 2018

 

(In thousands)

 

Stock Appreciation Rights

   

Restricted Stock Awards

   

Restricted Stock Units

   

Performance Stock Units

   

Total

 
                                         

Expense

  $ 79     $ 280     $ 62     $ 467     $ 888  

Deferred tax benefit

    (16 )     (59 )     (13 )     (103 )     (191 )

Total net expense

  $ 63     $ 221     $ 49     $ 364     $ 697  

 

   

Nine months ended September 30, 2019

 

(In thousands)

 

Stock Appreciation Rights

   

Restricted Stock Awards

   

Restricted Stock Units

   

Performance Stock Units

   

Total

 
                                         

Expense

  $ 258     $ 891     $ 246     $ 1,337     $ 2,732  

Deferred tax benefit

    (54 )     (186 )     (52 )     (281 )     (573 )

Total net expense

  $ 204     $ 705     $ 194     $ 1,056     $ 2,159  

 

   

Nine months ended September 30, 2018

 

(In thousands)

 

Stock Appreciation Rights

   

Restricted Stock Awards

   

Restricted Stock Units

   

Performance Stock Units

   

Total

 
                                         

Expense

  $ 229     $ 831     $ 186     $ 1,677     $ 2,923  

Deferred tax benefit

    (48 )     (175 )     (39 )     (356 )     (618 )

Total net expense

  $ 181     $ 656     $ 147     $ 1,321     $ 2,305  

 

 

As of September 30, 2019, Bancorp has $5.8 million of unrecognized stock-based compensation expense estimated to be recorded as follows:

 

(In thousands)

Year ended

 

Stock Appreciation Rights

   

Restricted Stock Awards

   

Restricted Stock Units

   

Performance Stock Units

   

Total

 
                                         

Remainder of 2019

  $ 88     $ 296     $ 83     $ 381     $ 848  

2020

    306       1,037       2       853       2,198  

2021

    248       819             462       1,529  

2022

    193       550                   743  

2023

    118       304                   422  

2024

    11       24                   35  

Total estimated expense

  $ 964     $ 3,030     $ 85     $ 1,696     $ 5,775  

 

The following table summarizes SARs activity and related information:

 

                                             

Weighted

 
                     

Weighted

           

Weighted

   

average

 
                     

average

   

Aggregate

   

average

   

remaining

 
           

Exercise

   

exercise

   

intrinsic

   

fair

   

contractual

 

(In thousands, except per share data)

 

SARs

   

price

   

price

   

value(1)

   

value

   

life (in years)

 
                                                   

Outstanding, January 1, 2018

    704     $14.02 - $40.00     $ 19.51     $ 12,923     $ 3.47       5.1  

Granted

    100     35.90 - 39.32       37.75             6.07          

Exercised

    (73 )   14.02 - 19.37       15.32       1,654       3.43          

Forfeited

          -         -                      

Outstanding, December 31, 2018

    731     $14.02 - $40.00     $ 22.42     $ 8,422     $ 3.83       5.2  
                                                   

Outstanding, January 1, 2019

    731     $14.02 - $40.00     $ 22.42     $ 8,422     $ 3.83          

Granted

    53     36.65 - 38.18       37.01       2       6.24          

Exercised

    (125 )   14.02 - 22.96       16.05       2,574       3.53          

Forfeited

          -         -                      

Outstanding, September 30, 2019

    659     $14.02 - $40.00     $ 24.80     $ 8,146     $ 4.08       5.4  
                                                   

Vested and exercisable

    447     $14.02 - $40.00     $ 19.89     $ 7,575     $ 3.36       4.1  

Unvested

    212     22.96 - 40.00       35.15       571       5.58       8.2  

Outstanding, September 30, 2019

    659     $14.02 - $40.00     $ 24.80     $ 8,146     $ 4.08       5.4  
                                                   

Vested at September 30, 2019

    80     $19.37  - $40.00     $ 27.41     $ 780     $ 4.55          

 

(1) - Intrinsic value for SARs is defined as the amount by which the current market price of the underlying stock exceeds the exercise or grant price.

 

 

The following table summarizes activity for RSAs granted to officers:

 

           

Grant date

 
           

weighted

 

(In thousands, except per share data)

 

RSAs

   

average cost

 
                 

Unvested at January 1, 2018

    119     $ 27.62  

Shares awarded

    40       35.89  

Restrictions lapsed and shares released

    (44 )     23.62  

Shares forfeited

    (5 )     31.35  

Unvested at December 31, 2018

    110     $ 32.09  
                 

Unvested at January 1, 2019

    110     $ 32.09  

Shares awarded

    40       34.88  

Restrictions lapsed and shares released

    (40 )     28.72  

Shares forfeited

    (2 )     35.37  

Unvested at September 30, 2019

    108     $ 34.30  

 

Shares expected to be awarded for PSUs granted to executive officers of Bancorp, the three-year performance period for which began January 1 of the award year are as follows:

 

   

Vesting

           

Expected

 

Grant

 

period

   

Fair

   

shares to

 

year

 

in years

   

value

   

be awarded

 

2017

    3     $ 35.66       61,893  

2018

    3       31.54       50,352  

2019

    3       32.03       43,603  

 

 

(15)

Commitments and Contingent Liabilities

 

As of September 30, 2019 and December 31, 2018, Bancorp had various commitments outstanding that arose in the normal course of business, such as unused commitments or lines of credit and commitments made to lend in the future, which are properly not reflected in the consolidated financial statements. Total off balance sheet commitments to extend credit follows:

 

(In thousands)

 

September 30, 2019

   

December 31, 2018

 

Commercial and industrial

  $ 384,038     $ 309,920  

Construction and development

    251,984       179,364  

Home equity

    151,800       147,907  

Credit cards

    25,606       20,003  

Overdrafts

    22,083       21,751  

Letters of credit

    22,827       20,891  

Other

    43,910       33,369  

Future loan commitments

    179,843       101,399  
                 

Total off balance sheet commitments to extend credit

  $ 1,082,091     $ 834,604  

 

Commitments to extend credit are an agreement to lend to a customer as long as collateral is available as agreed upon and there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses. Since some of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Bancorp uses the same credit and collateral policies in making commitments and conditional guarantees as for on-balance sheet instruments. Bancorp evaluates each customer’s creditworthiness on a case by case basis. The amount of collateral obtained is based on management’s credit evaluation of the customer. Collateral held varies but may include accounts receivable, inventory, securities, 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 September 30, 2019 and December 31, 2018, Bancorp had accrued $350,000 in other liabilities for its estimate of inherent risks related to unfunded credit commitments.

 

 

Standby letters of credit are conditional commitments issued by Bancorp to guarantee the performance of a customer to a first party beneficiary. Those guarantees are primarily issued to support commercial transactions. Standby letters of credit generally have maturities of one to two years.

 

As of September 30, 2019, 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.

 

 

(16)

Assets and Liabilities Measured and Reported at Fair Value

 

Fair value represents the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. There are three levels of inputs that may be used to measure fair values:

 

 

Level 1: Valuation is based upon quoted (unadjusted) 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 AFS securities portfolio and interest rate swaps are recorded at fair value on a recurring basis.

 

All AFS 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 observable in the market place and can be derived from or supported by observable data. These measurements are classified as Level 2.

 

Fair value measurements for interest rate swaps are 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 counterparty’s inability to perform and the change in value of derivative assets and liabilities attributable to credit risk was not significant during the reporting period. Interest rate swaps are valued using primarily Level 2 inputs.

 

MSRs, impaired loans and OREO are 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.

 

 

Carrying values of assets measured at fair value on a recurring basis follows:

 

(In thousands)

 

Fair value at September 30, 2019

 

Assets

 

Total

   

Level 1

   

Level 2

   

Level 3

 

Securities available for sale:

                               
                                 

Government sponsored enterprise obligations

  $ 214,365     $     $ 214,365     $  

Mortgage backed securities - government agencies

    143,002             143,002        

Obligations of states and political subdivisions

    18,234             18,234        
                                 
                                 

Total Securities available for sale

    375,601             375,601        
                                 

Interest rate swaps

    3,708             3,708        
                                 

Total assets

  $ 379,309     $     $ 379,309     $  
                                 

Liabilities

                               
                                 

Interest rate swaps

  $ 3,802     $     $ 3,802     $  

 

(In thousands)

 

Fair value at December 31, 2018

 

Assets

 

Total

   

Level 1

   

Level 2

   

Level 3

 

Securities available for sale:

                               

Government sponsored enterprise obligations

  $ 261,039     $     $ 261,039     $  

Mortgage backed securities - government agencies

    146,277             146,277        

Obligations of states and political subdivisions

    29,679             29,679        
                                 
                                 

Total Securities available for sale

    436,995             436,995        
                                 

Interest rate swaps

    1,035             1,035        
                                 

Total assets

  $ 438,030     $     $ 438,030     $  
                                 

Liabilities

                               
                                 

Interest rate swaps

  $ 543     $     $ 543     $  

 

For the securities portfolio, Bancorp monitors the valuation technique used 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 and nine months ended September 30, 2019, there were no transfers between Levels 1, 2, or 3.

 

Bancorp had no financial instruments classified within Level 3 of the valuation hierarchy for assets and liabilities measured at fair value on a recurring basis at September 30, 2019 or December 31, 2018.

 

 

Discussion of assets measured at fair value on a non-recurring basis follows:

 

MSRs – On at least a quarterly basis, MSRs are evaluated for impairment based upon the fair value of the MSRs as compared to carrying amount. 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 September 30, 2019 and December 31, 2018, there was no valuation allowance for MSRs, as the fair value exceeded the cost. Accordingly, the MSRs are not included in the following tabular disclosure for September 30, 2019 or December 31, 2018.

 

Impaired loans – Collateral-dependent impaired loans generally include loans that have received partial charge-downs or specific reserve allocations needed to record the loan at fair value. Fair value is commonly based on recent real estate appraisals or other sources of valuations based upon the underlying collateral. Fair value of impaired loans was primarily measured based on the value of 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 typically determines the value of real estate 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. For other assets, Bancorp relies on both internal and third party assessments of asset value, based on information provided by the borrower, following methodologies similar to those described for real estate. As of September 30, 2019, total impaired collateral dependent loans charged down to their fair value and impaired loans with a valuation allowance were $383,000 and the specific allowance totaled $35,000, resulting in a fair value of $348,000, compared with total collateral dependent loans charged down to their fair value and impaired loans with a valuation allowance of $967,000, and the specific allowance allocation totaling $42,000, resulting in a fair value of $925,000 at December 31, 2018. Losses represent charge offs and changes in specific allowances for the periods indicated.

 

OREO – Assets acquired through or instead of loan foreclosure are initially recorded at fair value less costs to sell when acquired, establishing a new cost basis. These assets are subsequently accounted for at lower of cost or fair value less estimated costs to sell. Fair value is commonly based on recent real estate appraisals or valuations performed by internal or external parties which use judgments and assumptions that are property-specific and sensitive to changes in the overall economic environment. Appraisals may be further discounted based on management’s historical knowledge and/or changes in market conditions from the date of the most recent appraisal. Many of these inputs are not observable and, accordingly, these measurements are classified as Level 3. For OREO in the following table, 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 September 30, 2019 and December 31, 2018, carrying value of OREO was $563,000 and $1.0 million.

 

 

Below are the carrying values of assets measured at fair value on a non-recurring basis.

 

(In thousands)

 

Fair value at September 30, 2019

   

Losses recorded:

 
                                   

Three months

   

Nine months

 
                                   

ended

   

ended

 
   

Total

   

Level 1

   

Level 2

   

Level 3

   

September 30, 2019

   

September 30, 2019

 

Impaired loans

  $ 348     $     $     $ 348     $     $  

Other real estate owned

    239                   239              

 

(In thousands)

 

Fair value at December 31, 2018

   

Losses recorded:

 
                                   

Three months

   

Nine months

 
                                   

ended

   

ended

 
   

Total

   

Level 1

   

Level 2

   

Level 3

   

September 30, 2018

   

September 30, 2018

 

Impaired loans

  $ 925     $     $     $ 925     $     $ 874  

Other real estate owned

    239                   239              

 

For Level 3 assets measured at fair value on a non-recurring basis, the significant unobservable inputs used in the fair value measurements are presented below.

 

September 30, 2019

   

Fair

 

Valuation

 

Unobservable

 

(weighted

 

(Dollars in thousands)

 

value

 

technique

 

inputs

 

average)

 
                       

Impaired loans - collateral dependent

  $ 348  

Appraisal

 

Appraisal discounts

    10.0

%

Other real estate owned

    239  

Appraisal

 

Appraisal discounts

    22.0  

 

December 31, 2018

 
   

Fair

 

Valuation

 

Unobservable

 

(weighted

 

(Dollars in thousands)

 

value

 

technique

 

inputs

 

average)

 
                       

Impaired loans - collateral dependent

  $ 925  

Appraisal

 

Appraisal discounts

    9.9

%

Other real estate owned

    239  

Appraisal

 

Appraisal discounts

    22.0  

 

42

 

 

(17)

Disclosure of Financial Instruments Not Reported at Fair Value

 

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:

 

(In thousands)

 

Carrying

                                 

September 30, 2019

 

amount

   

Fair value

   

Level 1

   

Level 2

   

Level 3

 
                                         

Assets

                                       

Cash and cash equivalents

  $ 136,214     $ 136,214     $ 136,214     $     $  

Mortgage loans held for sale

    6,329       6,464             6,464        

Federal Home Loan Bank stock

    11,316       11,316             11,316        

Loans, net

    2,829,787       2,841,414                   2,841,414  

Accrued interest receivable

    8,581       8,581       8,581              
                                         

Liabilities

                                       

Non-interest bearing deposits

  $ 795,793     $ 795,793     $ 795,793     $     $  

Transaction deposits

    1,720,560       1,720,560             1,720,560        

Time deposits

    429,960       433,232             433,232        

Securities sold under agreement to repurchase

    33,172       33,172             33,172        

Federal funds purchased

    9,957       9,957             9,957        

FHLB advances

    81,985       83,505             83,505        

Accrued interest payable

    712       712       712              

 

(In thousands)

 

Carrying

                                 

December 31, 2018

 

amount

   

Fair value

   

Level 1

   

Level 2

   

Level 3

 
                                         

Assets

                                       

Cash and cash equivalents

  $ 198,939     $ 198,939     $ 198,939     $     $  

Mortgage loans held for sale

    1,675       1,743             1,743        

Federal Home Loan Bank stock

    10,370       10,370             10,370        

Loans, net

    2,522,637       2,508,587                   2,508,587  

Accrued interest receivable

    8,360       8,360       8,360              
                                         

Liabilities

                                       

Non-interest bearing deposits

  $ 711,023     $ 711,023     $ 711,023     $     $  

Transaction deposits

    1,736,618       1,736,618             1,736,618        

Time deposits

    346,715       345,273             345,273        

Securities sold under agreement to repurchase

    36,094       36,094             36,094        

Federal funds purchased

    10,247       10,247             10,247        

FHLB advances

    48,177       47,227             47,227        

Accrued interest payable

    762       762       762              

 

 

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.

 

 

(18)

Derivative Financial Instruments

 

Periodically, Bancorp enters into interest rate swap transactions with borrowers who desire to hedge exposure to rising interest rates, while at the same time entering into an offsetting interest rate swap, with substantially matching terms, with another approved independent counterparty. These are undesignated derivative instruments and are recognized on the 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 have an insignificant effect on earnings. Exchanges of cash flows related to undesignated interest rate swap agreements were offsetting and therefore had no effect on Bancorp’s earnings or cash flows.

 

Interest rate swap agreements derive their value from underlying interest rates. These transactions involve both credit and market risk. 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, collateral, and monitoring procedures, and does not expect any counterparties to fail their obligations.

 

Bancorp had outstanding undesignated interest rate swap contracts as follows:

 

(Dollars in thousands)

 

Receiving

   

Paying

 
   

September 30,

   

December 31,

   

September 30,

   

December 31,

 
   

2019

   

2018

   

2019

   

2018

 

Notional amount

  $ 83,144     $ 55,505     $ 83,144     $ 55,505  

Weighted average maturity (years)

    7.9       8.0       7.9       8.0  

Fair value

  $ 3,708     $ 519     $ 3,729     $ 543  

 

In 2015, Bancorp entered into an interest rate swap to hedge cash flows of a $20 million rolling fixed-rate three-month FHLB borrowing. The swap began December 9, 2015 and matures December 6, 2020. In 2016, Bancorp entered into an interest rate swap to hedge cash flows of a $10 million rolling fixed-rate three-month FHLB borrowing. The swap began December 6, 2016 and ends December 6, 2021. For purposes of hedging, rolling fixed rate advances are considered to be floating rate liabilities. Interest rate swaps involve exchange of Bancorp’s floating rate interest payments for fixed rate swap payments on underlying principal amounts. These swaps were designated, and qualified, for cash-flow hedge accounting. 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 OCI, 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 September 30, 2019 and December 31, 2018.

 

(Dollars in thousands)

                       
                     

Fair value

 

Notional

 

Maturity

 

Receive (variable)

 

Pay fixed

   

assets (liabilities)

 

amount

 

date

 

index

 

swap rate

   

September 30, 2019

   

December 31, 2018

 
$ 10,000  

12/6/2021

 

US 3 Month LIBOR

    1.89 %   $ (65 )   $ 193  
  20,000  

12/6/2020

 

US 3 Month LIBOR

    1.79 %     (8 )     323  
$ 30,000             1.82 %   $ (73 )   $ 516  

 

 

(19)

Regulatory Matters

 

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.

 

 

The following table sets forth consolidated Bancorp’s and the Bank’s risk based capital amounts and ratios:

 

(Dollars in thousands)

 

Actual

   

Minimum for adequately

capitalized

   

Minimum for well

capitalized

 

September 30, 2019

 

Amount

   

Ratio

   

Amount

   

Ratio

   

Amount

   

Ratio

 
                                                 

Total risk-based capital (1)

                                               

Consolidated

  $ 407,160       12.53

%

  $ 259,900       8.00

%

    0       0  

Bank

    385,910       11.91       259,300       8.00     $ 324,125       10.00

%

                                                 

Common equity tier 1 risk-based capital

                                               

Consolidated

    379,933       11.69       146,194       4.50       0       0  

Bank

    358,683       11.07       145,856       4.50       210,861       6.50  
                                                 

Tier 1 risk-based capital (1)

                                               

Consolidated

    379,933       11.69       194,925       6.00       0       0  

Bank

    358,683       11.07       194,475       6.00       259,300       8.00  
                                                 

Leverage (2)

                                               

Consolidated

    379,933       10.90       139,437       4.00       0       0  

Bank

    358,683       10.60       135,316       4.00       169,145       5.00  

 

(Dollars in thousands)

 

Actual

   

Minimum for adequately

capitalized

   

Minimum for well

capitalized

 

December 31, 2018

 

Amount

   

Ratio

   

Amount

   

Ratio

   

Amount

   

Ratio

 
                                                 

Total risk-based capital (1)

                                               

Consolidated

  $ 396,019       13.91

%

  $ 227,714       8.00

%

    0       0  

Bank

    385,637       13.56       227,462       8.00     $ 284,327       10.00

%

                                                 

Common equity tier 1 risk-based capital

                                               

Consolidated

    370,135       13.00       128,089       4.50       0       0  

Bank

    359,753       12.65       127,947       4.50       184,813       6.50  
                                                 

Tier 1 risk-based capital (1)

                                               

Consolidated

    370,135       13.00       170,785       6.00       0       0  

Bank

    359,753       12.65       170,596       6.00       227,462       8.00  
                                                 

Leverage (2)

                                               

Consolidated

    370,135       11.33       130,698       4.00       0       0  

Bank

    359,753       11.02       130,569       4.00       163,211       5.00  

 

 

(1)

Ratio is computed in relation to risk-weighted assets.

 

(2)

Ratio is computed in relation to average assets.

 

46

 

 

(20)

Segments

 

Bancorp’s principal activities include commercial banking and WM&T. 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 investment products sales activity. WM&T provides financial 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 have been allocated fully 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.

 

Principally, all of the net assets of Bancorp are involved in the commercial banking segment. Goodwill of $12.6 million, of which $682,000 relates to a bank acquisition in 1996 and $11.9 million related to the May 2019 KSB acquisition, has been assigned to the commercial banking segment. Assets assigned to WM&T primarily consist of net premises and equipment.

 

Selected financial information by business segment follows: 

 

           

Wealth

         
   

Commercial

   

Management

         

(In thousands)

 

Banking

   

and Trust

   

Total Company

 
                         

Three months ended September 30, 2019

                       

Net interest income

  $ 31,995     $ 75     $ 32,070  

Provision

    400             400  

Wealth management and trust services

          5,738       5,738  

All other non-interest income

    7,566             7,566  

Non-interest expenses

    20,822       3,135       23,957  

Income before income tax expense

    18,339       2,678       21,017  

Income tax expense

    3,202       581       3,783  

Net income

  $ 15,137     $ 2,097     $ 17,234  
                         

Segment assets

  $ 3,530,198     $ 3,728     $ 3,533,926  
                         

Three months ended September 30, 2018

                       

Net interest income

  $ 28,462     $ 59     $ 28,521  

Provision

    735             735  

Wealth management and trust services

          5,380       5,380  

All other non-interest income

    6,046             6,046  

Non-interest expenses

    18,774       3,007       21,781  

Income before income tax expense

    14,999       2,432       17,431  

Income tax expense

    3,027       528       3,555  

Net income

  $ 11,972     $ 1,904     $ 13,876  
                         

Segment assets

  $ 3,320,838     $ 3,959     $ 3,324,797  

 

 

           

Wealth

         
   

Commercial

   

management

         

(In thousands)

 

Banking

   

and Trust

   

Total Company

 
                         

Nine months ended September 30, 2019

                       

Net interest income

  $ 92,266     $ 235     $ 92,501  

Provision

    1,000             1,000  

Wealth management and trust services

          16,839       16,839  

All other non-interest income

    19,790             19,790  

Non-interest expenses

    62,725       9,335       72,060  

Income before income tax expense

    48,331       7,739       56,070  

Income tax expense

    4,973       1,679       6,652  

Net income

  $ 43,358     $ 6,060     $ 49,418  
                         

Segment assets

  $ 3,530,198     $ 3,728     $ 3,533,926  
                         

Nine months ended September 30, 2018

                       

Net interest income

  $ 84,312     $ 192     $ 84,504  

Provision

    2,705             2,705  

Wealth management and trust services

          16,224       16,224  

All other non-interest income

    17,546             17,546  

Non-interest expenses

    55,572       9,372       64,944  

Income before income tax expense

    43,581       7,044       50,625  

Income tax expense

    8,237       1,529       9,766  

Net income

  $ 35,344     $ 5,515     $ 40,859  
                         

Segment assets

  $ 3,320,838     $ 3,959     $ 3,324,797  

 

48

 

 

(21)

Revenue from Contracts with Customers

 

All of Bancorp’s revenue from contracts with customers in the scope of ASC 606 is recognized within non-interest income. The table below presents Bancorp’s sources of non-interest income with items outside the scope of ASC 606 noted as such:

 

   

Three months ended September 30, 2019

   

Three months ended September 30, 2018

 
                                                 

(Dollars in thousands)

 

Commercial

   

WM&T

   

Total

   

Commercial

   

WM&T

   

Total

 

Wealth management and trust services

  $     $ 5,738     $ 5,738     $     $ 5,380     $ 5,380  

Deposit service charges

    1,444             1,444       1,482             1,482  

Debit and credit card income

    2,102             2,102       1,759             1,759  

Treasury management fees

    1,264             1,264       1,151             1,151  

Mortgage banking income(1)

    834             834       712             712  

Net investment product sales commissions and fees

    400             400       444             444  

Bank owned life insurance(1)

    487             487       186             186  

Other(2)

    1,035             1,035       312             312  

Total non-interest income

  $ 7,566     $ 5,738     $ 13,304     $ 6,046     $ 5,380     $ 11,426  

 

   

Nine months ended September 30, 2019

   

Nine months ended September 30, 2018

 
                                                 

(Dollars in thousands)

 

Commercial

   

WM&T

   

Total

   

Commercial

   

WM&T

   

Total

 

Wealth management and trust services

  $     $ 16,839     $ 16,839     $     $ 16,224     $ 16,224  

Deposit service charges

    4,027             4,027       4,340             4,340  

Debit and credit card income

    6,014             6,014       4,956             4,956  

Treasury management fees

    3,623             3,623       3,311             3,311  

Mortgage banking income(1)

    2,112             2,112       2,034             2,034  

Gain on sale of securities

                                   

Net investment product sales commissions and fees

    1,120             1,120       1,245             1,245  

Bank owned life insurance(1)

    849             849       564             564  

Other(2)

    2,045             2,045       1,096             1,096  

Total non-interest income

  $ 19,790     $ 16,839     $ 36,629     $ 17,546     $ 16,224     $ 33,770  

 

(1) Outside of the scope of ASC 606.

(2) Outside of the scope of ASC 606, with the exception of safe deposit fees which were nominal for all periods.

 

Revenue sources within the scope of ASC 606 are discussed below:

 

Bancorp earns fees from its deposit customers for transactions-based, account management, and overdraft services. Transaction-based fees, which include services such as ATM use fees, stop payments fees, and ACH fees, are recognized at the time the transaction is executed as that is when the company fulfills the performance obligation. Account management fees are earned over the course of a month and charged in the month in which the services are provided. Overdraft fees are recognized at the point in time that the overdraft occurs. Deposit service charges are withdrawn from customer’s account balances.

 

Treasury management transaction fees are recognized at the time the transaction is executed as that is when the company fulfills the performance obligation. Account management fees are earned over the course of a month and charged in the month in which the services are provided. Treasury management fees are withdrawn from customer’s account balances.

 

 

WM&T provides customers fiduciary and investment management services as agreed upon in asset management contracts. The contracts require WM&T to provide a series of distinct services for which fees are earned over time. The contracts are cancellable upon demand with fees typically based upon the asset value of investments. Revenue is accrued and recognized monthly based upon month-end asset values and collected from the customer predominately in the following month except for a small percentage of fees collected quarterly. Incentive compensation related to WM&T activities is considered a cost of obtaining the contract. Contracts between WM&T and clients do not permit performance based fees and accordingly, none of the fees earned by WM&T are performance based. Trust fees receivable as of September 30, 2019 were $2.1 million compared with $1.9 million as of December 31, 2018.

 

Investment products sales commissions and fees represent the Bank’s share of transaction fees and wrap fees resulting from investment services and programs provided through an agent relationship with a third party broker-dealer. Transaction fees are assessed at the time of the transaction. Those fees are collected and recognized on a monthly basis. Trailing fees are based upon market value and are assessed, collected, and recognized on a quarterly basis. Because the Bank acts as an agent in arranging the relationship between the customer and third party provider, and does not control the services rendered, investment product sales commissions and fees are reported net of related costs, including nominal incentive compensation, and trading activity charges of $391,000 and $403,000 for the nine month periods ended September 30, 2019 and 2018.

 

Debit and credit card revenue primarily consists of debit and credit card interchange income. Interchange income represents fees assessed within the payment card system for acceptance of card based transactions. Interchange fees are assessed as the performance obligation is satisfied, which is at the point in time the card transaction is authorized. Revenue is collected and recognized daily through the payment network settlement process.

 

Bancorp did not establish any contract assets or liabilities as a result of adopting ASC 606, nor were any recognized during 2019.

 

Bancorp’s revenue on the consolidated statement of income is categorized by product type, which effectively depicts how the nature, timing, and extent of cash flows are affected by economic factors.

 

 

(22)

Leases

 

Bancorp has operating leases for various branch locations with terms remaining from three months to 14 years, some of which include options to extend the leases in five year increments. Options reasonably expected to be exercised are included in determination of the right of use asset. Bancorp elected the practical expedient to expense short-term lease expense associated with leases with original terms 12 months or less. Bancorp elected not to separate non-lease components from lease components for its operating leases. The right-of-use lease asset and operating lease liability are recorded in premises and equipment and other liabilities on the consolidated balance sheet.

 

 

Balance sheet, income statement, and cash flow detail regarding operating leases follows:

 

(In thousands)

         
           

Balance Sheet

 

September 30, 2019

   
           

Operating lease right-of-use assets

  $ 15,741  

included in premises and equipment

Operating lease liabilities

    17,060  

included in other liabilities

           

Weighted average remaining lease term (yrs)

    11.88    

Weighted average discount rate

    3.61 %  
           

Maturities of lease liabilities:

         

One year or less

  $ 1,974    

Year 2

    1,917    

Year 3

    1,920    

Year 4

    1,968    

Year 5

    1,858    

Greater than 5 years

    11,454    

Total lease payments

  $ 21,091    

Less imputed interest

    4,031    

Total

  $ 17,060    

 

(In thousands)

 

Three months ended

   

Nine months ended

 

Income Statement

 

September 30, 2019

   

September 30, 2019

 

Components of lease expense:

               

Operating lease cost

  $ 501     $ 1,498  

Variable lease cost

    38       101  

Less sublease income

    14       41  

Total lease cost

  $ 525     $ 1,558  

 

(In thousands)

         

Nine months ended

 

Cash flow Statement

         

September 30, 2019

 

Supplemental cash flow information:

               

Operating cash flows from operating leases

          $ 1,051  

 

As of September 30, 2019 Bancorp had not entered into any lease agreements that had yet to commence.

 

 

 

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. and its wholly-owned subsidiary, SYB&T for the three and nine months ended September 30, 2019 and compares these periods with the same periods of the previous year. All significant inter-company transactions and accounts have been eliminated in consolidation. All companies are collectively referred to as “Bancorp” or the “Company.”

 

Stock Yards Bancorp, Inc. is a financial holding company headquartered in Louisville, Kentucky.

 

The Bank, chartered in 1904, is a state-chartered non-member financial institution that provides services in the Louisville, Kentucky, Indianapolis, Indiana and Cincinnati, Ohio MSAs through 42 full service banking center locations.

 

As a result of its acquisition of KSB on May 1, 2019, Bancorp became the 100% successor owner of KBST, an unconsolidated finance subsidiary. As permitted under the terms of KBST’s governing documents, Bancorp redeemed the TPS at the par amount of approximately $4 million on June 17, 2019.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the consolidated financial statements and accompanying Footnotes presented in Part 1 Item 1 “Financial Statements.”

 

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.

 

Acquisition of King Bancorp, Inc. and its wholly-owned subsidiary King Southern Bank

 

On May 1, 2019, Bancorp completed its acquisition of KSB, for $28 million in cash. The acquisition expands the Company’s market area into nearby Nelson County, Kentucky, while expanding the customer base in Louisville, Kentucky. At May 1, 2019, KSB reported approximately $192 million in total assets, approximately $164 million in loans, and approximately $126 million in deposits. As a result of the acquisition, goodwill totaling $12 million was recorded during the second quarter of 2019 with nominal recast adjustments posted during the third quarter.

 

As a result of the completion of the acquisition, Bancorp incurred pre-tax transaction charges totaling $1.3 million during the second quarter of 2019. Net income from the KSB acquisition is expected to be accretive to Bancorp’s overall operating results on a quarterly basis going forward.

 

Issued but Not Yet Effective Accounting Standards Updates

 

For disclosure regarding the impact to Bancorp’s financial statements of issued-but-not-yet-effective ASUs, see the Footnote titled “Basis of Presentation and Summary of Significant Accounting Policies” of Part I Item 1 “Financial Statements.”

 

 

Business Segment Overview

 

Bancorp is divided into two reportable segments: Commercial Banking and 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, 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 provides custom-tailored financial planning, investment management, retirement planning and trust and estate services in all markets in which Bancorp operates. The magnitude of WM&T revenue distinguishes Bancorp from other community banks of similar asset size.

 

Overview - Three and Nine Months Ended September 30, 2019 Compared to the Same Periods in the Prior Year

 

Three months ended September 30, (In thousands, except per share data)

 

2019

   

2018

   

$ Change

   

% Change

 
                                 

Net income

  $ 17,234     $ 13,876     $ 3,358       24 %

Diluted earnings per share

  $ 0.76     $ 0.60     $ 0.16       27 %

Annualized return on average assets

    1.95 %     1.75 %     20 bps       11 %

Annualized return on average equity

    17.41 %     15.67 %     174 bps       11 %

 

General highlights for the quarter ended September 30, 2019 compared to the same period in 2018:

 

NIM improved 7 bps to 3.86% for the three months ended September 30, 2019 compared to the same period in 2018.

The FRB lowered the FFTR 25 bps on two separate occasions effective August 1st and September 19th with Prime ending the period at 5.00%.

Net interest income increased $3.5 million, or 12%, for the three months ended September 30, 2019.

Consistent with the lowering of Prime, Bancorp lowered the stated rate of most interest-bearing deposit account types during the third quarter of 2019.

Average loans increased $260 million, or 10%, for the three months ended September 30, 2019 compared to the same period in 2018. The benefit of the first full quarter from the May 1st KSB acquisition was complemented by strong organic loan production and net loan growth.

Average deposits increased $322 million, or 12%, for the three months ended September 30, 2019 compared to the same period in 2018.

Sustained sound credit metrics and minimal net charge-offs led to a low provision of $400,000 for the three months ended September 30, 2019 compared to $735,000 for the same period in 2018.

The allowance to total loans was 0.94% as of September 30, 2019 compared to 1.00% at both September 30, 2018 and December 31, 2018.

Non-interest income increased $1.9 million, or 16%, for the three months ended September 30, 2019 compared to 2018 based on the following:

 

o

Strong market returns, new business generation, and growth in corporate retirement plans led to higher WM&T income.

 

o

Debit and credit card revenue continues to benefit from increasing transaction volumes and incentives paid by card processors.

 

o

Other non-interest income benefited from non-recurring swap fees collected, gain on sale of Visa Class B common stock and proceeds received from a life insurance policy.

Non-interest expenses increased $2.2 million, or 10%, for the three months ended September 30, 2019 compared to 2018 based on the following:

 

o

Compensation reflects increases for both the KSB acquisition and full time equivalent employee additions.

 

o

In addition to the full time equivalent employee additions mentioned above, employee benefits expense also reflects higher health insurance claims experienced and increased 401(k) expense.

 

 

The ETR decreased from 20.39% for the three months ended September 30, 2018 to 18.00% for the same period in 2019.

 

Nine months ended September 30, (In thousands, except per share data)

 

2019

   

2018

   

$ Change

   

% Change

 
                                 

Net income

  $ 49,418     $ 40,859     $ 8,559       21 %

Diluted earnings per share

  $ 2.16     $ 1.78     $ 0.38       21 %

Annualized return on average assets

    1.94 %     1.75 %     19 bps       11 %

Annualized return on average equity

    17.31 %     15.92 %     139 bps       9 %

 

General highlights for the nine months ended September 30, 2019 compared to the same period in 2018:

 

NIM improved 3 bps to 3.85% for the nine months ended September 30, 2019 compared to the same period in 2018.

The FRB lowered the FFTR on two separate occasions by 25 bps twice during with Prime ending the period at 5.00%.

Net interest income increased $8.0 million, or 9%, for the nine months ended September 30, 2019.

Consistent with the lowering of Prime, Bancorp lowered the stated rate of most interest-bearing deposit account types during 2019.

Average loans increased $164 million, or 7%, for the nine months ended September 30, 2019 compared to the same period in 2018. Bancorp benefited from the May 1st KSB acquisition in addition to strong organic loan production and net loan growth.

Average deposits increased $275 million, or 11%, for the nine months ended September 30, 2019 compared to same period in 2018.

Sustained sound credit metrics, including net loan loss recoveries for the first nine months of 2019, lead to reduced provision of $1.0 million compared with $2.7 million for the same period in 2018.

Non-interest income increased $2.9 million, or 8%, for the nine months ended September 30, 2019 compared to 2018 based on the following:

 

o

Strong market returns, new business generation, and growth in corporate retirement plans led to higher WM&T income.

 

o

Debit and credit card revenue continues to benefit from increasing transaction volumes and incentives paid by card processors.

 

o

Other non-interest income benefited from non-recurring swap fees collected, gain on sale of Visa Class B common stock and proceeds received from a life insurance policy.

Non-interest expenses increased $7.1 million, or 11%, for the nine months ended September 30, 2019 compared to 2018 based on the following:

 

o

Compensation reflects increases for both the KSB acquisition and full time equivalent employee additions.

 

o

In addition to the full time equivalent employee additions mentioned above, employee benefits expense also reflects higher health insurance claims experienced and increased 401(k) expense.

Bancorp's efficiency ratio, calculated on a FTE basis, in the first nine months of 2019 was 55.7% compared with 54.8% in the same period in 2018.

The ETR decreased from 19.29% for the nine months ended September 30, 2018 to 11.86% for the same period in 2019 primarily due to two Kentucky state tax law changes that occurred during the first six months of 2018.

 

Total stockholder’s equity to total assets was 11.21% as of September 30, 2019 compared to 11.10% at December 31, 2018 and 10.62% at September 30, 2018. Total equity increased $30 million in the first nine months of 2019, as net income of $49 million was offset by dividends declared of $17 million, stock repurchases totaling $9 million, changes in AOCI and various stock based compensation.

 

TCE is a measure of a company's capital which is useful in evaluating the quality and adequacy of capital. Bancorp’s ratio of TCE to total tangible assets was 10.83% as of September 30, 2019, compared with 11.05% at December 31, 2018, and 10.57% at September 30, 2018, with the decline attributable to the second quarter KSB acquisition. See the Non-GAAP Financial Measures section for details on reconcilement to GAAP measures.

 

 

The following sections provide more details on subjects presented in this overview.

 

Results of Operations - Three and Nine Months Ended September 30, 2019 Compared to September 30, 2018

 

Net Interest Income

 

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 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.

 

 

Total Company Average Balance Sheets and Interest Rates - Three Month Comparison

 

   

Three months ended September 30,

 
   

2019

   

2018

 
   

Average

           

Average

   

Average

           

Average

 

(Dollars in thousands)

 

balance

   

Interest

   

rate

   

balance

   

Interest

   

rate

 

Interest earning assets:

                                               

Federal funds sold and interest bearing due from banks

  $ 98,569     $ 566       2.28

%

  $ 73,196     $ 373       2.02

%

Mortgage loans held for sale

    3,887       41       4.18       2,980       42       5.59  

Securities available for sale:

                                               

Taxable

    376,186       2,113       2.23       337,707       1,922       2.26  

Tax-exempt

    20,500       125       2.42       34,544       230       2.64  

Federal Home Loan Bank stock

    11,317       126       4.42       10,370       133       5.09  

Loans, net of unearned income

    2,791,389       35,063       4.98       2,531,604       30,390       4.76  

Total interest earning assets

    3,301,848       38,034       4.57       2,990,401       33,090       4.39  

Less allowance for loan losses

    27,168                       25,124                  
      3,274,680                       2,965,277                  

Non-earning assets:

                                               

Cash and due from banks

    45,343                       43,599                  

Premises and equipment, net

    64,573                       43,137                  

Bank Owned Life Insurance

    32,697                       32,492                  

Accrued interest receivable and other assets

    84,974                       68,901                  

Total assets

  $ 3,502,267                     $ 3,153,406                  
                                                 

Interest bearing liabilities:

                                               

Deposits:

                                               

Interest bearing demand deposits

  $ 837,796     $ 1,207       0.57

%

  $ 776,770     $ 1,168       0.60

%

Savings deposits

    170,300       65       0.15       156,471       98       0.25  

Money market deposits

    687,794       1,763       1.02       642,013       1,612       1.00  

Time deposits

    431,879       2,281       2.10       299,599       1,094       1.45  

Total interest bearing deposits

    2,127,769       5,316       0.99       1,874,853       3,972       0.84  
                                                 

Securities sold under agreements to repurchase

    37,705       26       0.27       67,381       55       0.32  

Federal funds purchased

    10,671       52       1.93       48,906       245       1.99  

Federal Home Loan Bank advances

    83,386       509       2.42       48,612       228       1.86  

Subordinated debt

                                   
                                                 
                                                 

Total interest bearing liabilities

    2,259,531       5,903       1.04       2,039,752       4,500       0.88  

Non-interest bearing liabilities:

                                               

Non-interest bearing demand deposits

    784,862                       715,303                  

Accrued interest payable and other liabilities

    65,034                       46,975                  

Total liabilities

    3,109,427                       2,802,030                  

Stockholders’ equity

    392,840                       351,376                  

Total liabilities and stockholder's equity

  $ 3,502,267                     $ 3,153,406                  

Net interest income

          $ 32,131                     $ 28,590          

Net interest spread

                    3.53

%

                    3.51

%

Net interest margin

                    3.86

%

                    3.79

%

 

 

Total Company Average Balance Sheets and Interest Rates - Nine Month Comparison

 

   

Nine months ended September 30,

 
   

2019

   

2018

 
   

Average

           

Average

   

Average

           

Average

 

(Dollars in thousands)

 

balance

   

Interest

   

rate

   

balance

   

Interest

   

rate

 

Interest earning assets:

                                               

Federal funds sold and interest bearing due from banks

  $ 119,210     $ 2,129       2.39

%

  $ 60,463     $ 804       1.78

%

Mortgage loans held for sale

    3,144       121       5.15       2,687       121       6.02  

Securities available for sale:

                                               

Taxable

    398,617       6,919       2.32       356,423       5,946       2.23  

Tax-exempt

    24,465       462       2.52       40,520       813       2.68  

Federal Home Loan Bank stock

    10,704       434       5.42       9,004       352       5.23  

Loans, net of unearned income

    2,660,328       100,077       5.03       2,496,267       86,980       4.66  

Total interest earning assets

    3,216,468       110,142       4.58       2,965,364       95,016       4.28  

Less allowance for loan losses

    26,832                       24,874                  
      3,189,636                       2,940,490                  

Non-earning assets:

                                               

Cash and due from banks

    43,664                       41,410                  

Premises and equipment, net

    63,586                       42,347                  

Bank Owned Life Insurance

    32,690                       32,303                  

Accrued interest receivable and other assets

    74,504                       69,275                  

Total assets

  $ 3,404,080                     $ 3,125,825                  
                                                 

Interest bearing liabilities:

                                               

Deposits:

                                               

Interest bearing demand deposits

  $ 847,443     $ 4,019       0.63

%

  $ 795,361     $ 2,630       0.44

%

Savings deposits

    165,794       270       0.22       156,553       214       0.18  

Money market deposits

    685,124       5,816       1.13       661,817       3,772       0.76  

Time deposits

    398,384       5,929       1.99       257,815       2,107       1.09  

Total interest bearing deposits

    2,096,745       16,034       1.02       1,871,546       8,723       0.62  
                                                 

Securities sold under agreements to repurchase

    38,402       79       0.28       66,869       122       0.24  

Federal funds purchased

    11,288       176       2.08       54,531       728       1.78  

Federal Home Loan Bank advances

    68,075       1,154       2.27       48,927       692       1.89  

Subordinated debt

    643       26       5.41                    
                                                 
                                                 

Total interest bearing liabilities

    2,215,153       17,469       1.05       2,041,873       10,265       0.67  

Non-interest bearing liabilities:

                                               

Non-interest bearing demand deposits

    745,105                       695,791                  

Accrued interest payable and other liabilities

    62,079                       44,913                  

Total liabilities

    3,022,337                       2,782,577                  

Stockholders’ equity

    381,743                       343,248                  

Total liabilities and stockholder's equity

  $ 3,404,080                     $ 3,125,825                  

Net interest income

          $ 92,673                     $ 84,751          

Net interest spread

                    3.53

%

                    3.61

%

Net interest margin

                    3.85

%

                    3.82

%

 

 

Total Company Average Balance Sheets and Interest Rates - Supplemental Information

 

 

Average loan balances 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. Participation loans averaged $9 million and $16 million for the three month periods ended September 30, 2019 and 2018, and $10 million and $17 million for the nine month periods ended September 30, 2019 and 2018.

 

 

Interest income on a FTE 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 FTE basis using a federal income tax rate of 21% for 2019 and 2018. Approximate tax equivalent adjustments to interest income were $61,000 and $69,000 for the three month periods ended September 30, 2019 and 2018, and $172,000 and $247,000 for the nine month periods ended September 30, 2019 and 2018.

 

 

Interest income includes loan fees of $481,000 and $184,000 for the three months ended September 30, 2019, and 2018 and $1.3 million and $722,000 for the nine month periods ended September 30, 2019 and 2018.

 

 

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 earned on interest earning assets less the cost of interest bearing liabilities.

 

 

NIM represents net interest income on a taxable equivalent basis as a percentage of average interest earning assets. NIM 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 Income – Overview

 

During the third quarter of 2019, the FRB lowered the FFTR 25 bps twice; effective on August 1st and later during the quarter effective September 19th. At September 30, 2019, Prime was 5.00% compared to 5.50% at December 31, 2018 and 5.25% at September 30, 2018. In response to the August FFTR reduction, Bancorp immediately lowered the stated rate of most interest-bearing deposit account types, in addition to lowering all CD offering rates. With regard to the September FFTR reduction, Bancorp immediately lowered stated rates on most personal money market and larger sweep customers in addition to CD offering rates. Bancorp was able to fully offset the loss in revenue, with the first FFTR move not impacting overall NIM. As discussed throughout, future FFTR declines would likely result in margin compression, as additional reductions in deposit rates may not be sufficient to offset the potential loss in revenue.

 

Beginning in the second quarter of 2019, with the flattening/inverting of the treasury curve, Bancorp began to experience loan pricing pressure. In addition to continued intense loan pricing competition, protracted yield curve inversion is a concern, with recent fixed rate loan production at yields closer to 4.50%, while the overall portfolio yielded 4.98% for the three months ended September 30, 2019.

 

In the first half of 2018, Bancorp raised stated rates paid on money market accounts in addition to launching a targeted CD marketing campaign within its Louisville market to support loan growth in addition to increasing liquidity. The campaign generated over $100 million in CD growth in 2018. In addition, the deposit portfolio assumed from KSB in the second quarter was and remains concentrated in higher costing time deposits. While the Company has not aggressively pursued deposits since mid-2018, nor has it significantly raised rates, deposit balances have continued to migrate from non-interest bearing accounts to interest bearing accounts during the period.

 

In general, net interest income and NIM have been favorably impacted by elevated loan prepayment fees collected in 2019 with a much lighter impact experienced in the prior year. Also, the KSB portfolio mix of earning assets and interest bearing liabilities added during 2019 has slightly impacted NIM in a negative manner.

 

 

Net Interest Income – Three months ended September 30, 2019 compared to September 30, 2018

 

Net interest spread and NIM increased to 3.53% and 3.86%, for the three months ended September 30, 2019 compared to 3.51% and 3.79% for the same periods in 2018. Net interest income (FTE) of $32.1 million for the three months ended September 30, 2019 increased $3.5 million, or 12%, from $28.6 million for the same period in 2018 led by earning asset growth, primarily loans. Total average earning assets increased $311 million, or 10%, to $3.3 billion for the three month period ended September 30, 2019, as compared with the same period in 2018, with the average rate earned on earnings assets increasing 18 bps to 4.57%. Average loans increased $260 million, or 10%, for the three months ended September 30, 2019 compared to the same period in 2018, with the KSB acquisition contributing $156 million, or 60% of the total increase. The remaining increase stemmed from strong organic loan production experienced across all markets. Average balances of FFS and interest bearing due from banks and taxable securities increased $64 million in total for the third quarter of 2019, as compared with 2018, as excess liquidity was deployed into short-term investments earning higher period over period yields.

 

Total interest income (FTE) increased $4.9 million, or 15%, for the third quarter of 2019, as compared with the third quarter of 2018, to $38.0 million. Approximately $4.7 million of the total increase related to the increased interest income on loans (FTE), with changes in volume driving most of the increase.

 

Total average interest bearing liabilities increased $220 million, or 11%, to $2.3 billion for the three month period ended September 30, 2019, as compared with the same period in 2018, with the average cost increasing 16 bps to 1.04%. Interest bearing liabilities assumed in the KSB acquisition (deposits and FHLB advances) represented $122 million, or 56%, of the total increase. Average interest bearing deposits increased $253 million, or 13%, for the three months ended September 30, 2019 compared to the same period in 2018, with time deposits representing 52% of the increase. KSB assumed interest bearing liabilities represented $86 million of the third quarter 2019 average interest bearing deposit balance and concentrated in the time deposit category.

 

Total interest expense increased $1.4 million, or 31%, for the three months ended September 30, 2019 compared to 2018 with the vast majority of the increase associated with total interest bearing deposits – predominantly time deposits. The cost of time deposits increased from 1.45% for the three months ended September 30, 2018 to 2.10% for the same period in 2019, while the average balance increased $132 million, or 44%. The change in time deposits was impacted equally by both changes in rates and volume. The average balance of SSUAR decreased $30 million, or 44%, for the three months ended September 30, 2019 as compared to the same period in 2018, as a significant number of commercial customers migrated from lower yielding collateralized products to higher yielding non-collateralized deposits. Average FHLB advances increased $35 million, or 72%, for the three months ended September 30, 2019 compared to 2018 based on advances assumed from the KSB acquisition. These advances were retained by Bancorp based upon favorable rates and terms in the overall execution of the Company’s asset liability management strategy.

 

 

Net Interest Income – Nine months ended September 30, 2019 compared to September 30, 2018

 

Net interest spread and NIM were 3.53% and 3.85%, for the nine months ended September 30, 2019 compared to 3.61% and 3.82% for the same periods in 2018. Net interest income (FTE) of $92.7 million for the nine months ended September 30, 2019 increased $7.9 million, or 9%, from $84.8 million for the same period in 2018, led by growth in average interest earning assets, primarily loans. Total average earning assets increased $251 million, or 8%, to $3.2 billion for the nine month period ended September 30, 2019, as compared with the same period in 2018, with the average rate earned on earnings assets increasing 30 bps to 4.58%. Average loans increased $164 million, or 7%, for the nine months ended September 30, 2019 compared to the same period in 2018, with the KSB acquisition contributing $89 million, or 54% of the total average increase. The remaining increase stemmed from record year to date organic loan production experienced across all markets. Average balances of FFS, interest bearing due from banks and taxable securities increased $101 million in total for the nine month period ended September 30, 2019, as compared with 2018, as excess liquidity was deployed into short-term investments earning higher period over period yields.

 

Total interest income (FTE) increased $15.1 million, or 16%, for the nine months ended September 30, 2019, as compared with the same period in 2018, to $110.1 million. Approximately $100.1 million of the total increase related to loans (FTE), with changes in rate driving just over half of the increase.

 

Total average interest bearing liabilities increased $173 million, or 8%, to $2.2 billion for the nine month period ended September 30, 2019, as compared with the same period in 2018, with the average cost increasing 38 bps to 1.05%. Interest bearing liabilities assumed in the KSB acquisition (deposits and FHLB advances) represented $71 million, or 41%, of the total increase. Average interest bearing deposits increased $225 million, or 12%, for the nine months ended September 30, 2019 compared to the same period in 2018, with approximately $50 million attributable to the KSB acquisition and concentrated in the time deposits category.

 

Total interest expense increased $7.2 million, or 70%, for the nine months ended September 30, 2019 compared to the same period in 2018 and was concentrated within interest bearing deposits. Approximately 75% of the combined time deposits, money market accounts and demand deposits change was attributable to rate with fluctuations as follows:

 

The cost of time deposits increased from 1.09% to 1.99%, while the average balance increased $141 million, or 55%

 

The cost of money markets increased from 0.76% to 1.13%, while the average balance increased $23 million, or 4%

 

The cost of demand deposits increased from 0.44% 0.63%, while the average balance increased $52 million, or 7%.

 

The average balance of SSUAR decreased $28 million, or 43%, for the nine months ended September 30, 2019 compared to the same period in 2018, as a significant number of commercial customers migrated from lower yielding collateralized products to higher yielding non-collateralized deposits. Average FHLB advances increased $19 million, or 39%, for nine months ended September 30, 2019 compared to 2018 based on advances assumed from the KSB acquisition. These advances were retained by Bancorp based upon favorable rates and terms in the overall execution of the Company’s asset liability management strategy. As a result of the KSB acquisition, Bancorp assumed a $4 million subordinated note that was redeemed at par prior to the end of the second quarter of 2019.

 

 

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 or expected results.

 

The September 30, 2019 simulation analysis, which shows interest rate sensitivity, indicates that increases in interest rates of 100 to 200 BPs would have a positive effect on net interest income, and decreases of 100 to 200 BPs in interest rates would have a negative effect on net interest income. The mix of assets and liabilities acquired in the KSB transaction slightly increased Bancorp’s exposure to falling rates. The overall 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 BP 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 September 30, 2019

    -8.45 %     -3.27 %     2.56 %     5.19 %

 

Approximately 60% of Bancorp’s loan portfolio has fixed rates with 40% priced at variable rates. Bancorp’s variable rate loans are above their floors and will reprice as rates change.

 

Undesignated derivative instruments, as described in the Footnote titled “Disclosure of Financial Instruments Not Reported at Fair Value,” 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 as described in the Footnote titled “Derivative Financial Instruments,” 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 OCI.

 

 

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. 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.

 

Bancorp recorded provision of $400,000 and $1.0 million for the three and nine month periods ended September 30, 2019, as compared with $735,000 and $2.7 million for the same periods in 2018. Continued strong credit metrics and net recoveries of $61,000 and $343,000 for the three and nine months ended September 30, 2019 resulted in an allowance to total loans of 0.94% as of September 30, 2019, compared with 1.00% as of both December 31, 2018 and September 30, 2018. The loans acquired in the KSB acquisition were marked to market on the acquisition date and as such did not receive an allowance.

 

Key indicators of loan quality remained consistent with the prior year with the exception of increased classified balances, defined as OAEM, Substandard, and non-performing loans, which increased $11 million as of September 30, 2019, as compared with December 31, 2018. While classified loan levels remained historically low, Substandard loans increased approximately $15 million in 2019 primarily due to the downgrade of three commercial relationships.

 

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 during the first quarter 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 10-K.

 

Non-performing loans, consisting of TDRs, non-accrual loans, and loans over 90 days past due still accruing, declined to $3.2 million at September 30, 2019 from $3.4 million at December 31, 2018 and $5.0 million at September 30, 2018. Bancorp considers the present asset quality metrics to be exceptional; however, recognizing the cyclical nature of local economies, 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 MSAs 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 September 30, 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:

 

   

Three months ended

   

Nine months ended

 

(Dollars in thousands)

 

September 30,

   

September 30,

 
   

2019

   

2018

   

2019

   

2018

 
                                 

Balance at the beginning of the period

  $ 26,416     $ 24,873     $ 25,534     $ 24,885  

Provision

    400       735       1,000       2,705  

Total charge-offs

    (230 )     (561 )     (490 )     (2,736 )

Total recoveries

    291       175       833       368  

Total net loan charge-offs (recoveries)

    61       (386 )     343       (2,368 )

Balance at the end of the period

  $ 26,877     $ 25,222     $ 26,877     $ 25,222  

Average loans, net of unearned income

  $ 2,791,389     $ 2,531,604     $ 2,660,328     $ 2,496,267  

Provision to average loans (1)

    0.01 %     0.03 %     0.04 %     0.11 %

Net loan charge-offs (recoveries) to average loans (1)

    0.00 %     -0.02 %     0.01 %     -0.09 %

Allowance to average loans

    0.96 %     1.00 %     1.01 %     1.01 %

Allowance to total loans

    0.94 %     1.00 %     0.94 %     1.00 %

 

(1) Amounts not annualized

 

Loans are charged off when deemed uncollectible and a loss is identified or after underlying collateral has been liquidated; however, collection efforts may continue and future recoveries may occur. Periodically, loans are partially charged off to net realizable value based upon collateral analysis and collection status. One significant C&I loan relationship totaling $1.3 million was charged off to its net realizable value in the first quarter of 2018, which resulted in increased net charge offs for the nine month period ending September 30, 2018.

 

An analysis of net charge-offs (recoveries) by loan portfolio segment follows:

 

   

Three months ended

   

Nine months ended

 

(In thousands)

 

September 30,

   

September 30,

 
   

2019

   

2018

   

2019

   

2018

 
                                 

Commercial and industrial

  $ (63 )   $ 389     $ (166 )   $ 2,316  

Construction and development, excluding undeveloped land

                (203 )      

Undeveloped land

                       

Real estate mortgage - commercial investment

    (3 )     (1 )     (4 )     (3 )

Real estate mortgage - owner occupied commercial

          14       (20 )     14  

Real estate mortgage - 1-4 family residential

    (42 )           (59 )      

Home equity

    (1 )     (50 )     (2 )     (54 )

Consumer

    48       34       111       95  

Total net loan charge-offs (recoveries)

  $ (61 )   $ 386     $ (343 )   $ 2,368  

 

 

Non-interest Income and Non-interest Expenses

 

   

Three months ended September 30,

   

Nine months ended September 30,

 

(Dollars in thousands)

 

2019

   

2018

   

$ Change

   

% Change

   

2019

   

2018

   

$ Change

   

% Change

 

Non-interest income:

                                                               

Wealth management and trust services

  $ 5,738     $ 5,380     $ 358       7

%

  $ 16,839     $ 16,224     $ 615       4

%

Deposit service charges

    1,444       1,482       (38 )     (3 )     4,027       4,340       (313 )     (7 )

Debit and credit card income

    2,102       1,759       343       19       6,014       4,956       1,058       21  

Treasury management fees

    1,264       1,151       113       10       3,623       3,311       312       9  

Mortgage banking income

    834       712       122       17       2,112       2,034       78       4  

Net investment product sales commissions and fees

    400       444       (44 )     (10 )     1,120       1,245       (125 )     (10 )

Bank owned life insurance

    487       186       301       162       849       564       285       51  

Other

    1,035       312       723       232       2,045       1,096       949       87  

Total non-interest income

  $ 13,304     $ 11,426     $ 1,878       16

%

  $ 36,629     $ 33,770     $ 2,859       8

%

                                                                 

Non-interest expenses:

                                                               

Compensation

  $ 12,330     $ 11,607     $ 723       6

%

  $ 36,846     $ 34,280     $ 2,566       7

%

Employee benefits

    2,908       2,501       407       16       8,458       7,646       812       11  

Net occupancy and equipment

    2,199       1,914       285       15       6,033       5,543       490       9  

Technology and communication

    1,841       1,595       246       15       5,462       4,910       552       11  

Debit and credit card processing

    662       588       74       13       1,880       1,733       147       8  

Marketing and business development

    732       740       (8 )     (1 )     2,260       2,191       69       3  

Postage, printing, and supplies

    402       370       32       9       1,218       1,161       57       5  

Legal and professional

    524       501       23       5       2,581       1,498       1,083       72  

FDIC insurance

          238       (238 )     (100 )     486       718       (232 )     (32 )

Amortization/impairment of investment in tax credit partnerships

    137             137       100       241       58       183       316  

Capital and deposit based taxes

    993       738       255       35       2,864       2,452       412       17  

Other

    1,229       989       240       24       3,731       2,754       977       35  

Total non-interest expenses

  $ 23,957     $ 21,781     $ 2,176       10

%

  $ 72,060     $ 64,944     $ 7,116       11

%

 

Non-interest Income

 

Total non-interest income increased $1.9 million, or 16%, and $2.9 million, or 8%, for the three and nine month periods ended September 30, 2019 compared to the same periods in 2018. Non-interest income comprised 29.3% and 28.3% of total revenues, defined as net interest income and non-interest income, for the three and nine month periods ended September 30, 2019 compared to 28.6% and 28.5% for the same periods in 2018. WM&T services comprised 43.1% and 46.0% of Bancorp’s total non-interest income for the three and nine month periods ended September 30, 2019 compared to 47.1% and 48.0% for the same periods in 2018. Debit and credit card income comprised 15.8% and 16.4% of Bancorp’s non-interest income for the three and nine month periods ended September 30, 2019 compared to 15.4% and 14.7% for the same periods in 2018.

 

The magnitude of WM&T revenue distinguishes Bancorp from other community banks of similar asset size. Trust AUM, stated at market value, totaled $3.12 billion at September 30, 2019, a 5% increase compared with $2.97 billion at September 30, 2018, and a 13% increase from $2.77 billion at December 31, 2018. WM&T revenue increased $358,000, or 7%, and $615,000, or 4% for the three and nine month periods ended September 30, 2019, as compared with the same periods in 2018 consistent with increased new business generation, the second consecutive quarter of strong market returns and growth in corporate retirement plans.

 

 

Recurring fees earned for managing trust 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 97% of the WM&T revenue, increased $263,000, or 5%, and $432,000, or 3% for the three and nine month periods ended September 30, 2019, as compared with the same periods in 2018. A portion of the WM&T revenue, 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 $95,000, or 72%, and $182,000, or 52%, for the three and nine month periods ended September 30, 2019, as compared with the same periods in 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.

 

Detail of WM&T Service Income by Account Type:

 

   

Three months ended September 30,

   

Nine months ended September 30,

 

(In thousands)

 

2019

   

2018

   

2019

   

2018

 
                                 

Investment advisory

  $ 2,319     $ 2,121     $ 6,696     $ 6,270  

Personal trust

    1,701       1,730       5,399       5,512  

Personal individual retirement

    978       903       2,799       2,645  

Corporate retirement

    517       353       1,160       1,093  

Foundation and endowment

    143       134       416       419  

Custody and safekeeping

    32       42       93       128  

Brokerage and insurance services

    11       12       49       42  

Other

    37       85       227       115  
                                 

Total WM&T services income

  $ 5,738     $ 5,380     $ 16,839     $ 16,224  

 

The table above demonstrates that WM&T fee revenue is concentrated within investment advisory and personal trust accounts. WM&T fees are based on AUM and tailored for individual accounts and/or relationships with fee structures customized based on account type and other factors with larger relationships paying a lower percentage of AUM in fees. For example, fee structures are in place for investment management, irrevocable trusts, revocable trusts, individual IRAs, 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. Fees are agreed upon at the time the account is opened and any subsequent revisions are communicated via writing to the customer. Fees earned are not performance based nor are they based on investment strategy or transactions.

 

Deposit service charges decreased $38,000, or 3%, and $313,000, or 7%, for the three and nine month periods ended September 30, 2019, as compared with the same periods in 2018. Deposit service charge income is primarily driven by changes in customers and transaction volume which can fluctuate from period to period. Both the quarterly and year-to-date decreases are consistent with the general decline in fees earned on overdrawn checking accounts. While management expects this source of revenue to continue its slow 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 part of 2019.

 

Debit and credit card income consists of interchange income, ancillary fees and incentives received from card processors. Debit and credit card revenue increased $343,000, or 19%, and $1.1 million, or 21%, for the three and nine month periods ended September 30, 2019, as compared with the same periods in 2018. The increases in both comparisons reflected increased volume resulting from continued growth in the customer bases. Total debit card income increased $86,000, or 6%, and $467,000, or 12% for the three and nine month periods ended September 30, 2019, while credit card income increased $257,000, or 64%, and $591,000, or 55%, for the same periods. Third quarter 2019 credit card income included a $47,000 non-recurring fee from its card processor for reaching activity incentive thresholds. This was the first such payment received since the Bank launched this product in mid-2015. Second quarter 2019 debit card revenue included a similar non-recurring fee of $174,000. No similar non-recurring debit or credit card incentives were received in 2018. Both debit and credit card volume, which is dependent on customer behavior and new accounts, is expected to continue to increase.

 

 

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 increases in the third quarter of 2019 of $113,000, or 10%, and $312,000, or 9%, for the first nine months of 2019, as compared with the same periods in 2018. Bancorp anticipates this income category will continue to increase based upon continued customer base growth and the expanding suite of services offered.

 

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, primarily to the FNMA. Interest rates on the loans sold to FNMA are locked with the borrower and investor prior to closing the loans, thus Bancorp bears no interest rate risk related to loans sold. 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 department. Mortgage banking revenue increased $122,000, or 17%, and $78,000, or 4%, for the three and nine month periods ended September 30, 2019, as compared with the same periods in 2018. Mortgage transaction volume began to increase in the second quarter and to a larger extent into the third quarter of 2019, as mortgage rates declined, spurring the increase in refinancing activity. During the third quarter, the ten year treasury rate/ yield curve began a steep decline leading to the lowest mortgage rates in several years. Bancorp anticipates refinancing activity to remain steady into the fourth quarter, provided mortgage rates continue to remain attractive.

 

Net investment product sales commissions and fees are generated primarily on stock, bond and mutual fund sales, as well as wrap fees on brokerage 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. Net investment product sales commissions and fees decreased $44,000, or 10%, and $125,000, or 10%, for the three and nine month periods ended September 30, 2019, as compared with the same periods in 2018. Overall, brokerage volume has been impacted by advisor turnover and market volatility that has somewhat discouraged investment activity in 2019.

 

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 serves to offset the cost of various employee benefits. BOLI income increased $301,000 and $285,000 for the three and nine month periods ended September 30, 2019, as compared with the same time periods in 2018, as a result of life insurance proceeds received, offset slightly by lower crediting rates on investments.

 

Other non-interest income increased $723,000 and $949,000 for the three and nine months ended September 30, 2019, as compared with the same period in 2018 primarily due to the following non-recurring items:

 

 

Interest rate swap fees on loans of $374,000 and $483,000 were recognized during the three and nine months ended September 30, 2019 compared to $1,000 and $109,000 for the same periods in 2018.

 

Approximately $142,000 in life insurance proceeds (outside of the traditional BOLI program) were recognized in the third quarter of 2019. Similarly, $112,000 was recognized in the second quarter of 2018.

 

Approximately $212,000 was realized during the third quarter of 2019 when Bancorp sold a nominal amount of Visa Class B stock, an illiquid $0 basis investment that was acquired in the TBOC acquisition.

 

In the first quarter of 2019, Bancorp recognized $126,000 related to banking center re-location incentivization.

 

In the second quarter of 2019, $130,000 was received related to a historic tax-credit investment tax distribution.

 

The impact of KSB on non-interest income has been and is expected to continue to be nominal in 2019.

 

 

Non-interest Expenses

 

Total non-interest expenses increased $2.2 million, or 10%, and $7.1 million, or 11%, for the three and nine month periods ended September 30, 2019 compared to the same periods in 2018. Salaries and employee benefits comprised 63.6% and 62.9% of Bancorp’s non-interest expenses for the three and nine month periods ended September 30, 2019, compared to 64.8% and 64.6% for the same periods in 2018.

 

Compensation, which includes salaries, incentives, bonuses, and stock based compensation, increased $723,000, or 6%, and $2.6 million, or 7%, for the three and nine month periods ended September 30, 2019, as compared with the same periods in 2018. The increase related to an overall increase in full time equivalent employee’s led by the Company’s efforts to add loan production talent to support strategic growth initiatives in addition to the May 2019 KSB acquisition. In addition, non-recurring severance and employee retention expense of $487,000 was recorded in the second quarter of 2019 as a result of the KSB acquisition. At September 30, 2019, Bancorp had 622 full time equivalent employees including 25 employees added from the KSB acquisition, as compared with 593 at September 30, 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 increased $407,000, or 16%, and $812,000, or 11%, for the three and nine month periods ended September 30, 2019, as compared with the same periods in 2018. Growth in full time equivalent employees, increased 401(k) matching contributions, higher health insurance claims, increased FICA expense associated with the growth in compensation and higher employee recruiting costs resulted in the increases.

 

Net occupancy and equipment expense primarily includes depreciation, rent, property taxes, utilities 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. Net occupancy increased $285,000, or 15%, and $490,000, or 9%, for the three and nine month periods ended September 30, 2019, as compared with the same periods in 2018. Bancorp opened one branch location during the third quarter of 2019 in Mt. Washington, Kentucky and added five branch locations associated with the KSB acquisition during the second quarter. The KSB locations added $175,000 of additional expense for the nine month period ended September 30, 2019. Bancorp closed three of the acquired branch locations in Louisville during the third quarter of 2019 due to their proximity to existing Bancorp branches and two buildings were sold resulting in positive adjustments to goodwill.

 

Technology and communications expense 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. Technology expense increased $246,000, or 15%, and $552,000, or 11%, for the three and nine month periods ended September 30, 2019, as compared with the same periods in 2018 due largely to increases in computer infrastructure upgrades and maintenance costs. KSB related one-time non-recurring expenses totaled $104,000 for the nine month period ended September 30, 2019.

 

Bancorp outsources processing for debit and credit card operations, which generate significant revenue for the Company. These expenses increase as transaction volume increases, offsetting a portion of corresponding revenue growth. Debit and credit card processing expense increased $74,000, or 13%, and $147,000, or 8%, for the three month and nine month periods ended September 30, 2019, as compared with the same periods in 2018, as a result of a growing customer base and increased transaction volume.

 

Marketing and business development expenses include all costs associated with promoting Bancorp, community support, retaining customers, and acquiring new business. Marketing and business development expenses decreased $8,000, or 1%, in the third quarter of 2019, as compared with the third quarter of 2018 while increasing $69,000, or 3%, for the nine months ended September 30, 2019. The increase for the nine months ended September 30, 2019 compared 2018 was largely due to increased community support expenses, which can fluctuate between periods due to the nature and timing of the expense, but is expected to trend to historical annual levels over the remainder of 2019.

 

Postage, printing and supplies expenses increased $32,000, or 9%, and $57,000, or 5%, for the three and nine month periods ended September 30, 2019, as compared with the same time periods in 2018, primarily due to the KSB acquisition.

 

Legal and professional fees increased $23,000, or 5%, and $1.1 million, or 72%, for the three and nine month periods ended September 30, 2019 compared to the same periods in 2018. One-time costs associated with the KSB acquisition totaled nearly $900,000 for the nine months ended September 30, 2019. Additional costs associated with consulting engagements also contributed to the period increases.

 

 

No FDIC insurance expense was recorded for the third quarter of 2019, as the national FDIC Reserve Ratio reached 1.38%, triggering the FDIC to release credits to small institutions (less than $10 billion in total consolidated assets). This change was announced in 2016 and it took approximately 3 years for the threshold to be met and the corresponding credits issued. It is also expected that no FDIC insurance expense will be recorded in the fourth quarter of 2019.

 

Tax credit partnerships generate federal income tax credits, and 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.

 

Other non-interest expenses increased $240,000, or 24%, for the three months ended September 30, 2019, as compared to 2018 primarily due to the following:

 

 

Director compensation increased $67,000.

 

Expense associated with Bancorp’s growing credit card program, mainly rebates/ rewards increased $117,000.

 

Core deposit intangible amortization increased $47,000 as a result of the KSB acquisition.

 

Other non-interest expenses increased $977,000, or 35%, for the nine months ended September 30, 2019, as compared to 2018 primarily due to the following:

 

 

Director compensation increased $290,000.

 

Expense associated with Bancorp’s growing credit card program, mainly rebates/ rewards increased $256,000.

 

Core deposit intangible amortization increased $75,000 as a result of the KSB acquisition.

 

Miscellaneous losses, most notably fraudulent check losses increased $153,000.

 

Gain on sales of OREO decreased $46,000.

 

Income Taxes

 

Bancorp recorded income tax expense of $3.8 million and $6.7 million for the three and nine month periods ended September 30, 2019, compared with $3.6 million and $9.8 million for the same periods in 2018. The ETR for the corresponding three and nine month periods in 2019 were 18.0% and 11.9% and 20.4% and 19.3% for the same periods in 2018. The decline in the ETR from 2018 to 2019 related primarily to the following two Kentucky state tax law changes:

 

 

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 recorded a state tax benefit, net of federal impact of $1.3 million in the first quarter of 2019, or approximately $0.06 per diluted share for the first nine months of 2019. While this is favorable in the short-term, Bancorp anticipates an unfavorable impact of approximately $200,000 per year beginning in 2021.

 

 

In April 2019, the Kentucky Legislature passed HB458 allowing banks and their holding companies to be combined together for Kentucky tax return filings beginning in 2021. The combined filing will allow Bancorp’s Holding Company net operating losses to offset against net revenue generated by the Bank and reduce Bancorp’s tax liability. Bancorp recorded a state tax benefit, net of federal impact of $2.4 million in the second quarter of 2019, or approximately $0.11 per diluted share for the first nine months of 2019. 

 

 

Financial Condition – September 30, 2019 Compared to December 31, 2018

 

Balance Sheet

 

Total assets increased $231 million, or 7%, to $3.5 billion at September 30, 2019, from $3.3 billion at December 31, 2018. In the first nine months of 2019, increases in loans, premises and equipment, and other assets were offset by decreases in cash and cash equivalents, and AFS securities. Bancorp acquired total assets of approximately $192 million on May 1, 2019 in connection with the KSB acquisition and recognized goodwill of approximately $12 million.

 

Cash and cash equivalents decreased $63 million, or 32%, as excess liquidity was used to fund loan growth and the KSB acquisition. AFS securities decreased $61 million, or 14%, during the first nine months of 2019, as maturing security cash flows were not reinvested but held in the form of short-term liquidity. This decline was offset by $9 million of market value improvement in the portfolio, shifting to a $3 million net unrealized gain position at September 30, 2019 from a $6 million unrealized loss position at December 31, 2018.

 

Premises and equipment increased $18 million, or 39%, primarily the result of establishing a right of use lease asset upon adopting ASU 2016-02, Leases in the first quarter of 2019 and the addition of KSB branches.

 

Gross loans increased $308 million, or 12%, including $152 million in loans acquired from KSB. Strong loan production in the second and third quarters of 2019 contributed to non-acquisition, or legacy, loan growth of $156 million, or 6%, for the nine months ended September 30, 2019.

 

Total liabilities increased $201 million, or 7%, to $3.1 billion as of September 30, 2019, from $2.9 billion as of December 31, 2018. Bancorp assumed $177 million in liabilities in connection with the KSB acquisition as of May 1, 2019.

 

For the nine month period ending September 30, 2019, non-interest bearing demand deposits increased $85 million, or 12%, while interest bearing deposits increased $67 million, or 3%. SSUAR decreased $3 million, or 8%, as customers continued to migrate to higher-yielding, non-collateralized deposits. FHLB advances increased $34 million, or 70%, as Bancorp retained the fixed rate long term advances assumed from KSB. These advances were retained by Bancorp based upon favorable rates and terms in the overall execution of the Company’s asset liability management strategy. Other liabilities increased $19 million, or 40%, largely due to the adoption of ASU 2016-02, Leases, in the first quarter of 2019.

 

 

Trust Assets Under Management

 

Trust AUM (not included on balance sheet) grew from $2.77 billion at December 31, 2018 to $3.12 billion at September 30, 2019.

 

Trust Assets Under Management by Account Type

 

   

September 30, 2019

   

December 31, 2018

 

(In thousands)

 

Managed

   

Non-managed (1)

   

Managed

   

Non-managed (1)

 

Investment advisory

  $ 1,258,074     $ 19,582     $ 1,077,904     $ 34,214  

Personal trust

    582,783       89,391       532,254       80,167  

Personal individual retirement

    409,791       2,714       344,900       2,363  

Corporate retirement

    43,625       402,457       47,884       390,619  

Foundation and endowment

    224,572       1,236       187,492       1,020  
                                 

Total accounts

  $ 2,518,845     $ 515,380     $ 2,190,434     $ 508,383  

Custody and safekeeping

          81,348             66,058  
                                 
    $ 2,518,845     $ 596,728     $ 2,190,434     $ 574,441  

Total managed and non-managed assets

  $ 3,115,573             $ 2,764,875          

 

(1) Non-managed assets represent those for which WM&T does not have investment discretion.

 

As of September 30, 2019, approximately 81% of AUM were actively managed. The majority of managed assets are in investment advisory, personal trust and agency accounts. Corporate retirement plan accounts primarily consist of participant directed asset and the amount of custody and safekeeping accounts are insignificant.

 

Managed Trust Assets Under Management by Class of Investment

 

(In thousands)

 

September 30, 2019

   

December 31, 2018

 
                 

Interest bearing deposits

  $ 113,658     $ 139,779  

US Treasury and government agency obligations

    48,720       53,513  

State, county and municipal obligations

    138,087       128,057  

Money market mutual funds

    5,755       8,627  

Equity mutual funds

    609,282       485,961  

Other mutual funds - fixed, balanced, and municipal

    326,375       290,352  

Other notes and bonds

    180,799       155,701  

Common and preferred stocks

    969,157       801,690  

Real estate mortgages

    328       352  

Real estate

    49,954       49,840  

Other miscellaneous assets (1)

    76,730       76,562  
                 

Total managed assets

  $ 2,518,845     $ 2,190,434  

 

(1) Includes client directed instruments including rights, warrants, annuities, insurance policies, unit investment trusts, and oil and gas rights.

 

Managed assets are invested in instruments for which market values can be readily determined, the majority of which are sensitive to market fluctuations, and consist of approximately 63% in equities and 37% in fixed income securities. This composition is relatively consistent from period to period and WM&T has no proprietary mutual funds.

 

 

Loan Portfolio Composition

 

Composition of loans, net of deferred fees and costs, by primary loan portfolio class follows:

 

(In thousands)

 

September 30, 2019

   

December 31, 2018

 
                 

Commercial and industrial

  $ 876,127     $ 833,524  

Construction and development, excluding undeveloped land(1)

    248,296       225,050  

Undeveloped land

    35,169       30,092  
                 

Real estate mortgage:

               

Commercial investment

    727,531       588,610  

Owner occupied commercial

    470,678       426,373  

1-4 family residential

    331,747       276,017  

Home equity - first lien

    51,015       49,500  

Home equity - junior lien

    72,533       70,947  

Subtotal: Real estate mortgage

    1,653,504       1,411,447  
                 

Consumer

    43,568       48,058  

Total loans(2)

  $ 2,856,664     $ 2,548,171  

 

(1) Consists of land acquired for development by the borrower, but for which no development has yet taken place.

(2) Total loans are presented inclusive of premiums, discounts, and net loan origination fees and costs. 

 

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 ownership share of the loan without permission from Bancorp. GAAP requires the participated portion of these loans to be recorded as secured borrowings. These participated loans are included in the C&I, C&D and CRE mortgage loan portfolio segments with a corresponding liability recorded in other liabilities. At September 30, 2019 and December 31, 2018, the total participated portion of loans of this nature were $9 million and $11 million.

 

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 may continue and future recoveries could occur. Periodically, loans are partially charged off to the net realizable value based upon the evaluation of related underlying collateral, including Bancorp’s expectation of resolution.

 

The allowance methodology is driven by risk ratings, historical losses, and qualitative factors. The level of the September 30, 2019 allowance reflected a number of factors, including credit quality metrics which were generally consistent with those experienced in the preceding 12 months, 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 local economies, 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 10-K.

 

The allowance increased $1.3 million from December 31, 2018 to $27 million at September 30, 2019. The allowance as a percent of total loans declined to 0.94% at September 30, 2019 from 1.00% at December 31, 2018, primarily due to the KSB acquisition. The loans acquired in the KSB acquisition were marked to market on the acquisition date and as such did not receive an allowance. The allowance balance is reflective of continued strong credit metrics and net recoveries of $343,000 for the first nine months of 2019. As of September 30, 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)

 

September 30, 2019

   

December 31, 2018

 
                 

Non-accrual loans

  $ 2,722     $ 2,611  

Troubled debt restructurings

    35       42  

Loans past due 90 days or more and still accruing

    487       745  
                 

Total non-performing loans

    3,244       3,398  
                 

Other real estate owned

    563       1,018  
                 

Total non-performing assets

  $ 3,807     $ 4,416  
                 

Non-performing loans to total loans

    0.11 %     0.13 %

Non-performing assets to total assets

    0.11 %     0.13 %


In total, non-performing assets as of September 30, 2019 were comprised of 22 loans, ranging in amount from $1,000 to $500,000, two accruing TDRs, and foreclosed real estate held for sale. Foreclosed real estate held at September 30, 2019 included a 1-4 family residential property and a CRE property.

 

The following table sets forth the major classifications of non-accrual loans:

 

(In thousands)

 

September 30, 2019

   

December 31, 2018

 
                 

Commercial and industrial

  $ 186     $ 192  

Construction and development, excluding undeveloped land

          318  

Undeveloped land

          474  
                 

Real estate mortgage

               

Commercial investment

    741       138  

Owner occupied commercial

    1,409       586  

1-4 family residential

    137       760  

Home equity - first lien

           

Home equity - junior lien

    249       143  

Subtotal: Real estate mortgage

    2,536       1,627  

Consumer

           

Total non-accrual loans

  $ 2,722     $ 2,611  

 

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. 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.

 

See the Footnote titled “Commitments and Contingent Liabilities” for additional detail.

 

 

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 such funds. Liquidity is provided by short-term liquid assets that can be converted to cash, AFS securities, 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, AFS marketable investment securities, FFS and interest bearing due from accounts with banks. FFS and interest bearing due from bank accounts totaled $68 million at September 30, 2019. These investments normally have overnight maturities and are used for general daily liquidity purposes.

 

AFS securities totaled $376 million at September 30, 2019, with $100 million in securities expected to mature over the next 12 months. Combined with FFS 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 SSUAR. At September 30, 2019, total investment securities pledged for these purposes comprised 79% of the AFS securities portfolio, leaving approximately $80 million of unpledged AFS 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 September 30, 2019, such deposits totaled $2.8 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 significant pressure on liquidity.  Bancorp began adding liquidity to the balance sheet in 2018 through targeted CD marketing campaigns. The campaigns generated over $100 million in CD growth in 2018.

 

As of September 30, 2019 and December 31, 2018, Bancorp had brokered deposits of $30 million.

 

Included in total deposit balances at September 30, 2019 is $140 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 subsequent tax season. While this excess liquidity is maintained in low-yielding short-term investments and consequently negatively impacts NIM, it has a positive impact on net interest income.

 

Other sources of funds available to meet daily needs include the sales of SSUAR and FHLB advances. As a member of the FHLB, Bancorp has access to credit products offered by the FHLB. Bancorp views these borrowings as a low cost alternative to brokered deposits. At September 30, 2019 and December 31, 2018, available credit from the FHLB totaled $511 million and $537 million. Additionally, Bancorp had unsecured available FFP lines with correspondent banks totaling $105 million at both September 30, 2019, and December 31, 2018.

 

Bancorp’s principal source of cash is dividends received from the Bank. The Bank paid the Holding Company an $18.5 million dividend during the third quarter of 2019 to support the share repurchase program. Also, during the second quarter of 2019, the Bank paid the Holding Company a $28 million dividend to consummate the KSB acquisition. At September 30, 2019, the Bank could pay up to $42 million in dividends to Bancorp without regulatory approval subject to the ongoing capital requirements of the Bank.

 

Capital Resources

 

At September 30, 2019, stockholders’ equity totaled $396 million, an increase of $30 million, or 8%, since December 31, 2018. See the Consolidated Statement of Changes in Stockholders’ Equity for further detail of changes in equity since 2018. One component of equity is AOCI which, for Bancorp, consists of net unrealized gains or losses on AFS securities and hedging instruments, as well as a minimum pension liability, each net of income taxes. AOCI was $2 million at September 30, 2019 compared with a loss of $5 million on December 31, 2018. The fluctuation in OCI is reflective of the changing interest rate environment during 2019 and corresponding impact upon the valuation of Bancorp’s AFS securities portfolio.

 

 

The following table sets forth Bancorp’s and the Bank’s risk based capital ratios:

 

   

September 30,

   

December 31,

 
   

2019

   

2018

 
                 

Total risk-based capital(1)

               

Consolidated

    12.53

%

    13.91

%

Bank

    11.91       13.56  
                 

Common equity tier 1 risk-based capital(1)

               

Consolidated

    11.69       13.00  

Bank

    11.07       12.65  
                 

Tier 1 risk-based capital(1)

               

Consolidated

    11.69       13.00  

Bank

    11.07       12.65  
                 

Leverage(2)

               

Consolidated

    10.90       11.33  

Bank

    10.60       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. Weighted 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% 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: 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 capital, tier I risk-based capital and 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, 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.

 

(In thousands, except per share data)

 

September 30, 2019

   

December 31, 2018

 
                 

Total stockholders' equity - GAAP

  $ 396,111     $ 366,500  

Less: Goodwill

    (12,593 )     (682 )

Less: Core deposit intangible

    (2,373 )     (1,057 )

Tangible common equity - Non-GAAP

  $ 381,145     $ 364,761  
                 

Total assets - GAAP

  $ 3,533,926     $ 3,302,924  

Less: Goodwill

    (12,593 )     (682 )

Less: Core deposit intangible

    (2,373 )     (1,057 )

Tangible assets - Non-GAAP

  $ 3,518,960     $ 3,301,185  
                 

Total stockholders' equity to total assets - GAAP

    11.21 %     11.10 %

Tangible common equity to tangible assets - Non-GAAP

    10.83 %     11.05 %
                 

Total shares outstanding

    22,597       22,749  
                 

Book value per share - GAAP

  $ 17.53     $ 16.11  

Tangible common equity per share - Non-GAAP

    16.87       16.03  

 

 

Item 3.      Quantitative and Qualitative Disclosures about Market Risk.

 

Information required by this item is included in Part I Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

 

Item 4.      Controls and Procedures.

 

As of the end of the period covered by this report, an evaluation was carried out by Stock Yards Bancorp, Inc.’s management, with the participation of its CEO and CFO, of the effectiveness of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934). Based upon that evaluation, the Company’s CEO and CFO concluded that these disclosure controls and procedures were effective as of the end of the period covered by this report. In addition, no change in the Company’s internal control over financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934) occurred during the fiscal quarter covered by this report that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

PART II – OTHER INFORMATION

 

Item 1.      Legal Proceedings.

 

In the ordinary course of operations, Bancorp and the Bank are defendants in various legal proceedings. There is no proceeding pending or, to the knowledge of management, threatened in which an adverse decision could result in a material adverse change in the business or consolidated financial position of Bancorp or the Bank.

 

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 September 30, 2019.

 

   

Total number of shares purchased(1)

   

Average price paid per share

   

Total number of shares purchased as part of publicly announced plans or programs

   

Average price paid per share

   

Maximum number of shares that may yet be purchased under the plans or programs

 
                                         

July 1 - July 31

    1,505     $ 37.52           $          

August 1 - August 31

    122,155       36.39       119,814       36.39          

September 1 - September 30

    45,131       36.53       31,652       35.99          

Total

    168,791     $ 36.44       151,466     $ 36.31       741,196  

 

(1)

Activity includes 17,325 shares of stock withheld to pay taxes due upon exercise of SARs and vesting of RSUs and PSUs.

 

Effective May 22, 2019, Bancorp’s Board of Directors approved a share repurchase program authorizing the repurchase of 1,000,000 shares, or approximately 4% of the Company’s total common shares outstanding. Stock repurchases are expected to be made from time to time on the open market or in privately negotiated transactions, subject to applicable securities law. The plan, which will expire in two years unless otherwise extended or completed at an earlier date, does not obligate the Company to repurchase any specific dollar amount or number of shares prior to the plan’s expiration. As of September 30, 2019, Bancorp had 741,196 shares that could be repurchased under its current share repurchase program.

 

There were no equity securities of the registrant sold without registration during the quarter covered by this report.

 

 

Item 6.      Exhibits.

 

The following exhibits are filed or furnished as a part of this report:

 

Exhibit

 

Number Description of exhibit
31.1  Certification of Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act
31.2 Certification of Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act

32

Certification of Principal Executive Officer and Principal Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 902 of the Sarbanes-Oxley Act

 

101

The following materials from Stock Yards Bancorp Inc.’s Form 10-Q Report for the quarterly period ended September 30, 2019, formatted in inline XBRL: (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Income, (iii) the Consolidated Statements of Comprehensive Income, (iv) the Consolidated Statements of Changes in Shareholders’ Equity, (v) the Consolidated Statements of Cash Flows, and (vi) the Notes to Consolidated Financial Statements.

 

104

The cover page from Stock Yards Bancorp Inc.’s Form 10-Q Report for the quarterly period ended September 30, 2019, formatted in inline XBRL and contained in Exhibit 101.

 

 

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.

 

 

STOCK YARDS BANCORP, INC.

(Registrant)

   
   
   

Date: November 8, 2019

By:         /s/ James A. Hillebrand

James A. Hillebrand,

              Chief Executive Officer

 

Date: November 8, 2019

/s/ T. Clay Stinnett

T. Clay Stinnett, Executive Vice President,

Treasurer and Chief Financial Officer (Principal Financial Officer)

 

78

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