10-K 1 a14-26847_110k.htm 10-K

Table of Contents

 

 

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 

Form 10-K

 

Annual Report Pursuant to Section 13
or 15(d) of the Securities Exchange Act of 1934

 

For the Fiscal Year Ended

 

Commission File Number

December 31, 2014

 

1-13661

 

STOCK YARDS BANCORP, INC.

1040 East Main Street
Louisville, Kentucky 40206
(502) 582-2571

 

Incorporated in Kentucky

 

I.R.S. No. 61-1137529

 


 

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

 

Title of each class:

 

Name of each exchange on which registered:

Common Stock, no par value

 

NASDAQ

 

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

None

 

Indicate by check mark if the registrant is a well-known seasoned issuer (as defined in Rule 405 of the Securities Act). Yes o No x

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No x

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).Yes x No o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  o

 

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

 

Large accelerated filer o

 

Accelerated filer x

 

 

 

Non-accelerated filer o
(Do not check if a smaller reporting company)

 

Smaller reporting company o

 

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

 

The aggregate market value of registrant’s voting stock (Common Stock, no par value) held by non-affiliates of the registrant as of June 30, 2014 (the last business day of the registrant’s most recently completed second fiscal quarter) was $391,167,000.

 

The number of shares of the registrant’s Common Stock, no par value, outstanding as of February 25, 2015, was 14,738,480.

 

Documents Incorporated By Reference

 

Portions of Registrant’s definitive proxy statement related to Registrant’s Annual Meeting of Shareholders to be held on April 22, 2015 (the “Proxy Statement”), to be filed with the Securities and Exchange Commission, are incorporated by reference into Part III of this Form 10-K.

 

 

 



Table of Contents

 

STOCK YARDS BANCORP, INC.
Form 10-K
Index

 

Part I:

 

 

 

 

 

Item 1.

Business

3

 

 

 

Item 1A.

Risk Factors

5

 

 

 

Item 1B.

Unresolved Staff Comments

8

 

 

 

Item 2.

Properties

8

 

 

 

Item 3.

Legal Proceedings

9

 

 

 

Item 4.

Mine Safety Disclosures

9

 

 

 

Part II:

 

 

 

 

 

Item 5.

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

10

 

 

 

Item 6.

Selected Financial Data

13

 

 

 

Item 7.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

14

 

 

 

Item 7A.

Quantitative and Qualitative Disclosures About Market Risk

42

 

 

 

Item 8.

Financial Statements and Supplementary Data

42

 

 

 

Item 9.

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

94

 

 

 

Item 9A.

Controls and Procedures

94

 

 

 

Item 9B.

Other Information

97

 

 

 

Part III:

 

 

 

 

 

Item 10.

Directors, Executive Officers and Corporate Governance

97

 

 

 

Item 11.

Executive Compensation

97

 

 

 

Item 12.

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

98

 

 

 

Item 13.

Certain Relationships and Related Transactions, and Director Independence

98

 

 

 

Item 14.

Principal Accounting Fees and Services

98

 

 

 

Part IV:

 

 

 

 

 

Item 15.

Exhibits and Financial Statement Schedules

98

 

 

 

Signatures

 

102

 

 

 

Index to Exhibits

 

103

 

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Part I

 

Item 1.                      Business

 

Stock Yards Bancorp, Inc. (“Bancorp” or “Company”), headquartered in Louisville, Kentucky, is the holding company for Stock Yards Bank & Trust Company (“Bank”).  Bancorp, which was incorporated in 1988 in Kentucky, is registered with, and subject to supervision, regulation and examination by the Board of Governors of the Federal Reserve System. The Bank is wholly owned and is a state chartered bank.  Because Bancorp has no significant operations of its own, its business and that of the Bank are essentially the same.  The operations of the Bank are fully reflected in the consolidated financial statements of Bancorp.  Accordingly, references to “Bancorp” in this document may encompass both the holding company and the Bank.  At the annual meeting on April 23, 2014, shareholders approved a resolution to amend Bancorp’s restated articles of incorporation to change its name from S.Y. Bancorp, Inc. to Stock Yards Bancorp, Inc.

 

Stock Yards Bank & Trust Company

 

Stock Yards Bank & Trust Company is the banking subsidiary of Bancorp and was chartered in 1904.  The Bank is headquartered in Louisville, Kentucky and provides commercial and personal banking services in the Louisville, Kentucky, Indianapolis, Indiana and Cincinnati, Ohio metropolitan markets through 35 full service banking offices.  The Bank is chartered under the laws of the Commonwealth of Kentucky.  In addition to traditional commercial and personal banking activities, the Bank has an investment management and trust department offering a wide range of investment management, trust, employee benefit plan and estate administration, and financial planning services.   The Bank also originates and sells single-family residential mortgages. Additionally, the Bank offers securities brokerage services via its branch network through an arrangement with a third party broker-dealer.  See Note 24 to Bancorp’s consolidated financial statements for information relating to the Bank’s business segments and “Item 2. Properties” for information regarding owned and leased properties.

 

On April 30, 2013, Bancorp completed the acquisition of 100% of the outstanding shares of THE BANCorp, Inc. (“Oldham”), parent company of THE BANK — Oldham County, Inc.  As a result of the transaction, THE BANK — Oldham County merged into Stock Yards Bank & Trust Company.  Since the acquisition date, results of operations acquired in the Oldham transaction have been included in Bancorp’s financial results.  The Oldham transaction has been accounted for using the acquisition method of accounting and, accordingly, assets acquired, liabilities assumed and consideration transferred were recorded at estimated fair value on the acquisition date.  See Note 3 to Bancorp’s consolidated financial statements for information relating to the acquisition.

 

At December 31, 2014, Stock Yards Bank & Trust Company had 524 full-time equivalent employees.  Employees of Stock Yards Bank & Trust Company are entitled to participate in a variety of employee benefit programs including a combined employee profit sharing and stock ownership plan (“KSOP”).  Management of Bancorp strives to be an employer of choice and considers the relationship with employees to be good.

 

Supervision and Regulation

 

Bank holding companies and commercial banks are extensively regulated under both federal and state laws. Changes in applicable laws or regulations may have a material effect on the business and prospects of Bancorp.

 

Bancorp, as a registered bank holding company, is subject to the supervision of and regulation by the Federal Reserve Board under the Bank Holding Company Act of 1956. In addition, Bancorp is subject to the provisions of Kentucky’s banking laws regulating bank acquisitions and certain activities of controlling bank shareholders.

 

Kentucky and federal banking statutes delineate permissible activities for Kentucky state-chartered banks.  Kentucky’s statutes, however, contain a super parity provision for Kentucky banks having one of the top two ratings in its most recent regulatory examination.  This provision allows these state banks to engage in any banking activity in which a national bank in Kentucky, a state bank operating in any other state, or a federally chartered thrift could engage.  The bank must first obtain a legal opinion specifying the statutory or regulatory provisions that permit the activity.

 

The Bank is subject to the supervision of the Kentucky Department of Financial Institutions and the Federal Deposit Insurance Corporation. The Federal Deposit Insurance Corporation (FDIC) insures the deposits of the Bank to the current maximums of $250,000 per depositor.

 

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The Gramm-Leach-Bliley Act (the “GLB Act”) allows for affiliations among banks, securities firms and insurance companies by means of a financial holding company (“FHC”). The GLB Act requires that, at the time of establishment of an FHC, all depository institutions within that corporate group must be “well managed” and “well capitalized” and must have received a rating of “satisfactory” or better under its most recent Community Reinvestment Act examination. Further, non-banking financial firms (for example an insurance company or securities firm) may establish an FHC and acquire a depository institution. While the distinction between banks and non-banking financial firms has been blurring over recent years, the GLB Act makes it less cumbersome for banks to offer services “financial in nature” but beyond traditional commercial banking activities. Likewise, non-banking financial firms may find it easier to offer services that had, heretofore, been provided primarily by depository institutions.  In 2012, management of Bancorp chose to become an FHC after evaluating the benefits and costs.

 

The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”) was signed into law in 2010.  Generally, the Dodd-Frank Act was effective the day after it was signed into law, but different effective dates apply to specific sections of the law.  This new extensive and complex legislation contained many new provisions affecting the banking industry, including:

 

·                  Creation of a new Bureau of Consumer Financial Protection overseeing banks with assets totaling $10 billion or greater while writing and maintaining several regulations that apply to all banks,

·                  Determination of debit card interchange rates by the Federal Reserve Board,

·                  New regulation over derivative instruments,

·                  Phase outs of certain forms of trust preferred debt and hybrids previously included as bank capital, and

·                  Increases to FDIC deposit coverage, revised calculations for assessing bank premiums, and numerous other provisions affecting financial institution regulation, oversight of certain non-banking organizations, investor protection, etc.

 

Uncertainty remains as to the ultimate impact of the Dodd-Frank Act, which we expect will have a continued adverse impact on the financial services industry as a whole and on Bancorp’s business, results of operations and financial condition due to regulatory costs and increased regulatory scrutiny over products and practices.

 

In July 2013, the Federal Reserve Board and the FDIC approved final rules that substantially amend the regulatory risk-based capital rules applicable to Bancorp and Bank. The final rules implement the regulatory capital reforms of the Basel Committee on Banking Supervision reflected in “Basel III: A Global Regulatory Framework for More Resilient Banks and Banking Systems” (Basel III) and changes required by the Dodd-Frank Act. Under these rules, the leverage and risk-based capital ratios of bank holding companies may not be lower than the leverage and risk-based capital ratios for insured depository institutions. The final rules implementing the Basel III regulatory capital reforms became effective for Bancorp and Bank on January 1, 2015, and include new minimum risk-based capital and leverage ratios.  Moreover, these rules refine the definition of what constitutes “capital” for purposes of calculating those ratios, including the definitions of Tier 1 capital and Tier 2 capital.

 

The new minimum capital level requirements applicable to bank holding companies and banks subject to the rules are:

 

·                  a new common equity Tier 1 capital ratio of 4.5%,

·                  a Tier 1 risk-based capital ratio of 6% (increased from 4%),

·                  a total risk-based capital ratio of 8% (unchanged from current rules), and

·                  a Tier 1 leverage ratio of 4% for all institutions.

 

The rules also establish a “capital conservation buffer” of 2.5%, to be phased in over three years, above the new regulatory minimum risk-based capital ratios, and result in the following minimum ratios once the capital conservation buffer is fully phased in:

 

·                  a common equity Tier 1 risk-based capital ratio of 7.0%,

·                  a Tier 1 risk-based capital ratio of 8.5%, and

·                  a total risk-based capital ratio of 10.5%.

 

Management believes that as of December 31, 2014, Bancorp meets the requirements to be considered well-capitalized under the new rules.

 

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The capital conservation buffer requirement is to be phased in beginning in January 2016 at 0.625% of risk-weighted assets and will increase each year until fully implemented in January 2019. An institution will be subject to limitations on paying dividends, engaging in share repurchases and paying discretionary bonuses if capital levels fall below minimum levels plus the buffer amounts. These limitations establish a maximum percentage of eligible retained income that could be utilized for such actions. Under these new rules, Tier 1 capital will generally consist of common stock (plus related surplus) and retained earnings, limited amounts of minority interest in the form of additional Tier 1 capital instruments, and non-cumulative preferred stock and related surplus, subject to certain eligibility standards, less goodwill and other specified intangible assets and other regulatory deductions. The definition of Tier 2 capital is generally unchanged for most banking organizations, subject to certain new eligibility criteria.

 

Common equity Tier 1 capital will generally consist of common stock (plus related surplus) and retained earnings plus limited amounts of minority interest in the form of common stock, less goodwill and other specified intangible assets and other regulatory deductions.

 

The final rules allow banks and their holding companies with less than $250 billion in assets a one-time opportunity to opt-out of a requirement to include unrealized gains and losses in accumulated other comprehensive income in their capital calculation. Bancorp expects that it will opt-out of this requirement.

 

Available Information

 

Bancorp files reports with the SEC including the Annual Report on Form 10-K, quarterly reports on Form 10-Q, current event reports on Form 8-K, and proxy statements, as well as any amendments to those reports. The public may read and copy any materials the Registrant files with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an internet site that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC at http://www.sec.gov.  Bancorp’s Annual Report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to section 13(a) or 15(d) of the Exchange Act are also accessible at no cost on Bancorp’s web site at http://www.syb.com after they are electronically filed with the SEC.

 

Item 1A.             Risk Factors

 

Investment in Bancorp’s common stock involves risk, and Bancorp’s profitability and success may be affected by a number of factors including those discussed below.

 

Financial condition and profitability depend significantly on local and national economic conditions.

 

Our success depends on general economic conditions both locally and nationally.  Most of Bancorp’s customers are in the Louisville, Indianapolis, and Cincinnati metropolitan areas.  Compared to regional or national financial institutions, we are less able to spread the risks of unfavorable local economic conditions across a large number of diversified economies. Some of Bancorp’s customers are directly impacted by the local economy while others have more national or global business dealings. Some of the factors influencing general economic conditions include tepid economic recovery, unemployment, and government regulation. Poor economic conditions have an unfavorable impact on the demand of customers for loans and the ability of some borrowers to repay these loans.  Deterioration in the quality of the credit portfolio could have a material adverse effect on financial condition, results of operations, and ultimately capital.

 

Financial condition and profitability depend on real estate values in our market area.

 

Bancorp offers a variety of secured loans, including commercial lines of credit, commercial term loans, real estate, construction, home equity, consumer and other loans. Over half of Bancorp’s loans are secured by real estate (both residential and commercial) in Bancorp’s market area. In instances where borrowers are unable to repay their loans from us and there has been deterioration in the value of the loan collateral, Bancorp could experience higher loan losses which could have a material adverse effect on financial condition, results of operations, and ultimately capital.

 

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If actual loan losses are greater than Bancorp’s assumption for loan losses, earnings could decrease.

 

Bancorp’s loan customers may not repay their loans according to the terms of these loans, the collateral securing the payment of these loans may be insufficient to ensure repayment and the wealth of guarantors providing guarantees to support these loans may be insufficient to aid in the repayment of these loans.  Accordingly, Bancorp may experience significant credit losses which could have a material adverse effect on operating results.  Bancorp makes various assumptions and judgments about the collectability of the loan portfolio, including the creditworthiness of borrowers and the value of real estate and other assets serving as collateral for repayment of many loans.  In determining the adequacy of the allowance for loan losses, Bancorp considers, among other factors, an evaluation of economic conditions and Bancorp’s loan loss experience.  If Bancorp’s assumptions prove to be incorrect or economic problems are worse than projected, the current allowance may not be sufficient to cover loan losses and adjustments may be necessary to allow for different economic conditions or adverse developments in the loan portfolio.  Such additions to the allowance, if necessary, could have a material adverse impact on financial results.

 

In addition, federal and state regulators periodically review Bancorp’s allowance for loan losses and may require an increase in the provision for loan losses or loan charge-offs. If the regulatory agencies require any increase in the provision for loan losses or loan charge-offs for which Bancorp had not allocated, it would have a negative effect on net income.

 

Fluctuations in interest rates could reduce profitability.

 

Our primary source of income is from the net interest spread, the difference between interest earned on loans and investments and the interest paid on deposits and borrowings.  Bancorp expects to periodically experience “gaps” in the interest rate sensitivities of Bancorp’s assets and liabilities, meaning that either interest-bearing liabilities will be more sensitive to changes in market interest rates than interest-earning assets, or vice versa.  In either event, if market interest rates should move contrary to Bancorp’s position, this “gap” will work against Bancorp and earnings will be negatively affected.

 

Many factors affect the fluctuation of market interest rates, including, but not limited to the following:

 

·                  inflation or deflation

·                  recession

·                  a rise in unemployment

·                  tightening money supply

·                  international disorder and instability in foreign financial markets

·                  the Federal Reserve’s actions to control interest rates

 

Bancorp’s interest rate sensitivity analysis indicates an increase in interest rates of up to 2% would decrease net interest income, primarily because the majority of Bancorp’s variable rate loans have floors of 4% or higher, and are indexed to the prime rate.  Since the prime rate is currently 3.25%, rates would have to increase more than 75 bp before the rates on such loans will rise.  This effect negatively impacts the effect of rising rates.  Deposit rates generally do not reprice as quickly as loans which negatively affects earnings as rates decline.  Bancorp’s asset-liability management strategy, which is designed to mitigate risk from changes in market interest rates, may not be able to prevent changes in interest rates from having a material adverse effect on Bancorp’s results of operations and financial condition.  Bancorp’s most recent earnings simulation model estimating the impact of changing interest rates on earnings indicates net interest income will decrease approximately 1.3% if interest rates immediately decrease 100 basis points for the next 12 months and decrease approximately 3.2% if rates increase 100 basis points.  Prevailing interest rates are at historically low levels, and current indications are that the Federal Reserve will likely maintain the low rates at least through the first half of 2015.

 

Significant stock market volatility could negatively affect Bancorp’s financial results.

 

Capital and credit markets experience volatility and disruption from time to time.  These conditions place downward pressure on credit availability, credit worthiness and customers’ inclinations to borrow.  Prolonged volatility or a significant disruption could negatively impact customers’ ability to seek new loans or to repay existing loans.  The personal wealth of many borrowers and guarantors has historically added a source of financial strength to certain loans

 

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and would be negatively impacted by severe market declines.  Sustained reliance on their personal assets to make loan payments would result in deterioration of their liquidity, and could result in loan defaults.

 

Income from investment management and trust services constitutes approximately 47% of non-interest income. Trust assets under management are expressed in terms of market value, and a significant portion of fee income is based upon those values. While investment management and trust fees are based on market values, they typically do not fluctuate directly with the overall stock market.  Accounts typically contain fixed income and equity asset classes, which generally react to market fluctuations inversely to each other.

 

Competition with other financial institutions could adversely affect profitability.

 

Bancorp operates in a highly competitive industry that could become even more competitive as a result of legislative, regulatory and technological changes and continued consolidation. Bancorp faces vigorous competition from banks and other financial institutions. A number of these banks and other financial institutions have substantially greater resources and lending limits, larger branch systems and a wider array of banking services. Additionally, Bancorp encounters competition from smaller community banks in Bancorp’s markets.  Bancorp also competes with other non-traditional providers of financial services, such as brokerage firms and insurance companies.  As internet-based financial services continue to grow in acceptance, Bancorp must remain relevant as a place where consumers and businesses value personal service while our competition offers these services without human interaction. These sources of competition may reduce or limit margins on banking services, reduce market share and adversely affect results of operations and financial condition.

 

Credit unions continue to grow in popularity and size, and their expansion into business lending is growing.  Because credit unions are not subject to federal income tax, and Bancorp pays federal income tax at a marginal rate of 35%, these companies have a significant competitive advantage over Bancorp.  This advantage may have a negative impact on Bancorp’s growth and resultant financial results as these credit unions continue to expand.

 

An extended disruption of vital infrastructure or a security breach could negatively impact Bancorp’s business, results of operations, and financial condition.

 

Bancorp’s operations depend upon, among other things, infrastructure, including equipment and facilities.  Extended disruption of vital infrastructure by fire, power loss, natural disaster, telecommunications failure, information systems breaches, terrorist activity or the domestic and foreign response to such activity, or other events outside of Bancorp’s control could have a material adverse impact on the financial services industry as a whole and on Bancorp’s business, results of operations and financial condition. Bancorp’s business continuity plan may not work as intended or may not prevent significant interruption of operations.  The occurrence of any failures, interruptions, or security breaches of information systems could damage Bancorp’s reputation, result in the loss of customer business, subject us to additional regulatory scrutiny, or expose us to civil litigation and possible financial liability, any of which could have an adverse effect on Bancorp’s financial condition and results of operation.

 

Bancorp’s assets which are at risk for cyber-attacks include financial assets and non-public information belonging to customers. Bancorp utilizes several third-party vendors who have access to our assets via electronic media.  Certain cyber security risks arise due to this access, including cyber espionage, blackmail, ransom, and theft.  Bancorp employs many preventive and detective controls to protect its assets, and provides mandatory recurring information security training to all employees. Bancorp requires third parties to have similar or superior controls in place.  Bancorp did not suffer a material incident in the years reported herein.  Bancorp maintains certain insurance coverage to prevent material financial loss from cyber-attacks.

 

Bancorp’s accounting policies and methods are critical to how Bancorp reports its financial condition and results of operations. They require management to make estimates about matters that are uncertain.

 

Accounting policies and methods are fundamental to how Bancorp records and reports its financial condition and results of operations. Bancorp must exercise judgment in selecting and applying these accounting policies and methods so they comply with United States generally accepted accounting principles (US GAAP).

 

Bancorp has identified certain accounting policies as being critical because they require management’s judgment to ascertain the valuations of assets, liabilities, commitments and contingencies. A variety of factors could affect the

 

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ultimate value that is obtained either when earning income, recognizing an expense, recovering an asset, or reducing a liability. Bancorp has established detailed policies and control procedures that are intended to ensure these critical accounting estimates and judgments are well controlled and applied consistently. In addition, the policies and procedures are intended to ensure that the process for changing methodologies occurs in an appropriate manner. Because of the uncertainty surrounding Bancorp’s judgments and the estimates pertaining to these matters, there can be no assurances that actual results will not differ from those estimates. See the “Critical Accounting Policies” in the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for more information.

 

Bancorp operates in a highly regulated environment and may be adversely affected by changes in federal, state and local laws and regulations.

 

Bancorp is subject to extensive regulation, supervision and examination by federal and state banking authorities.  Any change in applicable regulations or federal or state legislation could have a substantial impact on Bancorp and its operations.  Additional legislation and regulations may be enacted or adopted in the future that could significantly affect Bancorp’s powers, authority and operations, which could have a material adverse effect on Bancorp’s financial condition and results of operations.  The exercise of regulatory power may have negative impact on Bancorp’s results of operations and financial condition.

 

We need to stay current on technological changes in order to compete and meet customer demands.

 

The financial services industry is undergoing rapid technological changes, with frequent introductions of new technology-driven products and services. The future success of Bancorp will depend, in part, upon its ability to address the needs of its customers by using technology to provide products and services that will satisfy customer demands for convenience, as well as to create additional operational efficiencies and greater privacy and security protection for customers and their personal information. Many of Bancorp’s competitors have substantially greater resources to invest in technological improvements. Bancorp may not be able to effectively implement new technology-driven products and services as quickly as competitors or be successful in marketing these products and services to its customers. Failure to successfully keep pace with technological change affecting the financial services industry could impair Bancorp’s ability to effectively compete to retain or acquire new business and could have an adverse impact on its business, financial position, results of operations and liquidity.

 

We may not be able to attract and retain skilled people.

 

Our success depends, in large part, on our ability to attract and retain key people. Competition for the best people in the industry and the markets in which we engage can be intense, and we may not be able to retain or hire the people we want or need. In order to attract and retain qualified employees, we must compensate them at market levels. If we are unable to continue to attract and retain qualified employees, or do so at rates necessary to maintain our competitive position, our performance, including our competitive position, could suffer, and, in turn, adversely affect our business, financial condition or results of operations.

 

Item 1B.             Unresolved Staff Comments

 

Bancorp has no unresolved SEC staff comments.

 

Item 2.                      Properties

 

The principal offices of Bancorp are located at 1040 East Main Street, Louisville, Kentucky. Bancorp’s operations center is at a separate location. In addition to the main office complex and the operations center, Bancorp owned 19 branch properties at December 31, 2014, two of which are located on leased land.  At that date, Bancorp also leased 15 branch facilities.  Of the 34 banking locations, 28 are located in the Louisville Metropolitan Statistical Area (“MSA”), three are located in the Indianapolis MSA and three are located in the Cincinnati MSA.  See Notes 6 and 18 to Bancorp’s consolidated financial statements for the year ended December 31, 2014, for additional information relating to amounts invested in premises and equipment and lease commitmentsIn the first quarter of 2015, Bancorp opened an additional branch in the Indianapolis MSA.

 

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Item 3.                      Legal Proceedings

 

See Note 18 to Bancorp’s consolidated financial statements for the year ended December 31, 2014, for information relating to legal proceedings.

 

Item 4.                      Mine Safety Disclosures

 

Not applicable.

 

Executive Officers of the Registrant

 

The following table lists the names and ages as of December 31, 2014 of all current executive officers of Bancorp and the Bank. Each executive officer is appointed by Bancorp’s Board of Directors to serve at the discretion of the Board. There is no arrangement or understanding between any executive officer of Bancorp or the Bank and any other person(s) pursuant to which he/she was or is to be selected as an officer.

 

Name and Age
of Executive Officer

 

Position and Offices
with Bancorp and/or the Bank

David P. Heintzman
Age 55

 

Chairman of the Board of Directors and Chief Executive Officer of Bancorp and the Bank

James A. Hillebrand
Age 46

 

President and Director of Bancorp and the Bank

Kathy C. Thompson
Age 53

 

Senior Executive Vice President and Director of Bancorp and the Bank

Nancy B. Davis
Age 59

 

Executive Vice President, Secretary, Treasurer and Chief Financial Officer of Bancorp and the Bank

William M. Dishman III
Age 51

 

Executive Vice President and Chief Risk Officer of the Bank

Philip S. Poindexter
Age 48

 

Executive Vice President and Chief Lending Officer of the Bank

T. Clay Stinnett
Age 41

 

Executive Vice President and Chief Strategic Officer of Bancorp and the Bank

Michael J. Croce
Age 45

 

Executive Vice President and Director of Retail Banking of the Bank

 

Mr. Heintzman was appointed Chairman and Chief Executive Officer in January 2006.  Prior thereto, he served as President of Bancorp and the Bank since 1992. Mr. Heintzman joined the Bank in 1985.

 

Mr. Hillebrand was appointed President in July 2008.  Prior thereto, he served as Executive Vice President and Director of Private Banking of the Bank since 2005. From 2000 to 2004, he served as Senior Vice President of Private Banking.  Mr. Hillebrand joined the Bank in 1996.

 

Ms. Thompson was appointed Senior Executive Vice President in January 2006.   Prior thereto, she served as Executive Vice President of Bancorp and the Bank. She joined the Bank in 1992 and is Manager of the Investment Management and Trust Department.

 

Ms. Davis was appointed Executive Vice President of Bancorp and the Bank in 1999 and Chief Financial Officer in 1993.  She joined the Bank in 1991.

 

Mr. Dishman joined the Bank and was appointed Executive Vice President and Chief Risk Officer in February 2009.  Prior thereto, he served as Executive Vice President and Chief Credit Officer for National City Bank’s Kentucky and Tennessee markets from 2004 to 2009.

 

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Mr. Poindexter was appointed Chief Lending Officer in July 2008.  Prior thereto, he served as Executive Vice President and Director of Commercial Banking.  Mr. Poindexter joined the Bank in 2004.

 

Mr. Stinnett was appointed Executive Vice President and Chief Strategic Officer in February 2011.  Prior thereto, he served as Senior Vice President and Chief Strategic Officer since 2005.  Mr. Stinnett joined the Bank in 2000.

 

Mr. Croce was appointed Executive Vice President and Director of Retail Banking in July 2014.  Prior thereto, he served as Senior Vice President and Division Manager of Business Banking.  Mr. Croce joined the Bank in 2004.

 

Part II

 

Item 5.                      Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

 

Bancorp’s common stock is traded on the NASDAQ Global Select Market under the ticker symbol SYBT.  The table below sets forth the quarterly high and low market closing prices of Bancorp’s common stock and dividends declared per share. The payment of dividends by the Bank to Bancorp is subject to the restriction described in Note 17 to the consolidated financial statements. Management believes that Bancorp will continue to generate adequate earnings to continue to pay dividends on a quarterly basis.  On December 31, 2014, Bancorp had approximately 1,507 shareholders of record, and approximately 4,400 non-objecting beneficial owners holding shares in nominee or “street” name.

 

 

 

2014

 

2013

 

Quarter

 

High

 

Low

 

Cash dividends
declared

 

High

 

Low

 

Cash dividends
declared

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

First

 

$

32.14

 

$

27.92

 

$

0.21

 

$

23.29

 

$

22.10

 

$

0.20

 

Second

 

32.04

 

27.44

 

0.22

 

24.99

 

21.51

 

0.20

 

Third

 

30.75

 

28.62

 

0.22

 

28.46

 

24.99

 

0.20

 

Fourth

 

34.16

 

30.07

 

0.23

 

33.77

 

27.23

 

0.21

 

 

The following table shows information relating to the repurchase of shares of common stock by Bancorp during the three months ended December 31, 2014.

 

 

 

Total number of
shares
purchased (1)

 

Average price
paid per share

 

Total number of
shares purchased as
part of publicly
announced plan (2)

 

Maximum number
of shares that may
yet be purchased
under the plan

 

October 1-October 31

 

122

 

$

33.04

 

 

 

November 1-November 30

 

 

 

 

 

December 1-December 31

 

1,505

 

31.76

 

 

 

Total

 

1,627

 

$

31.86

 

 

 

 


(1)                                 Activity represents shares of stock withheld to pay the exercise price of stock options or to pay taxes due upon the exercise of stock appreciation rights. This activity has no impact on the number of shares that may be purchased under a Board-approved plan.

 

(2)                                 Since 2008, there has been no active share buyback plan.

 

The following performance graph and data shall not be deemed filed for purposes of Section 18 of the Securities Exchange Act of 1934 or otherwise subject to the liabilities of that section, nor shall it be deemed soliciting material or subject to Regulation 14A of the Exchange Act or incorporated by reference in any filing under the Exchange Act or the Securities Act of 1933, except as shall be expressly set forth by specific reference in such filing.

 

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Table of Contents

 

The first graph below compares the performance of Bancorp Common Stock to the Russell 2000 index, the SNL NASDAQ Bank index and the SNL Midwest Bank index for Bancorp’s last five fiscal years. The graph assumes the value of the investment in Bancorp Common Stock and in each index was $100 at December 31, 2009 and that all dividends were reinvested.

 

The ten-year period is presented in addition to the five-year period required by the SEC because it provides additional perspective, and Bancorp management believes that longer-term performance is of greater interest to Bancorp shareholders. In 2008 and 2009, Bancorp did not experience a decline in value as precipitous as illustrated by the referenced bank indices, nor did it decrease or suspend cash dividends. Accordingly, Bancorp’s stock price increases since 2008 have not been as steep as the referenced bank indices. The ten-year graph assumes the value of the investment in Bancorp Common Stock and in each index was $100 at December 31, 2004 and that all dividends were reinvested.

 

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Table of Contents

 

 

 

 

Period Ending

 

Index

 

12/31/09

 

12/31/10

 

12/31/11

 

12/31/12

 

12/31/13

 

12/31/14

 

Stock Yards Bancorp, Inc.

 

100.00

 

118.35

 

102.29

 

115.58

 

169.75

 

182.48

 

Russell 2000

 

100.00

 

126.86

 

121.56

 

141.43

 

196.34

 

205.95

 

SNL Midwest Bank

 

100.00

 

124.18

 

117.30

 

141.18

 

193.28

 

210.12

 

SNL Bank NASDAQ

 

100.00

 

117.98

 

104.68

 

124.77

 

179.33

 

185.73

 

 

 

 

 

Period Ending

 

Index

 

12/31/04

 

12/31/05

 

12/31/06

 

12/31/07

 

12/31/08

 

12/31/09

 

12/31/10

 

12/31/11

 

12/31/12

 

12/31/13

 

12/31/14

 

Stock Yards Bancorp, Inc.

 

100.00

 

105.90

 

127.15

 

111.52

 

131.65

 

105.34

 

124.67

 

107.76

 

121.75

 

178.81

 

192.22

 

Russell 2000

 

100.00

 

104.55

 

123.76

 

121.82

 

80.66

 

102.58

 

130.12

 

124.69

 

145.08

 

201.40

 

211.26

 

SNL Midwest Bank

 

100.00

 

96.36

 

111.38

 

86.81

 

57.11

 

48.40

 

60.10

 

56.77

 

68.33

 

93.55

 

101.70

 

SNL Bank NASDAQ

 

100.00

 

96.95

 

108.85

 

85.45

 

62.06

 

50.34

 

59.40

 

52.70

 

62.81

 

90.28

 

93.51

 

 

12


 


Table of Contents

 

Item 6.                      Selected Financial Data

 

Selected Consolidated Financial Data

 

(Amounts in thousands except

 

Years ended December 31

 

per share data and ratios)

 

2014

 

2013

 

2012

 

2011

 

2010

 

 

 

 

 

 

 

 

 

 

 

 

 

Income statement data

 

 

 

 

 

 

 

 

 

 

 

Interest income

 

$

89,087

 

$

86,464

 

$

86,901

 

$

86,039

 

$

86,146

 

Interest expense

 

5,330

 

9,166

 

12,951

 

15,307

 

19,267

 

Net interest income

 

83,757

 

77,298

 

73,950

 

70,732

 

66,879

 

(Credit) provision for loan losses

 

(400

)

6,550

 

11,500

 

12,600

 

11,469

 

Non-interest income

 

39,155

 

39,002

 

38,457

 

33,244

 

33,739

 

Non-interest expenses

 

73,209

 

71,352

 

65,472

 

59,581

 

57,131

 

Income before income taxes

 

50,103

 

38,398

 

35,435

 

31,795

 

32,018

 

Income tax expense

 

15,281

 

11,228

 

9,634

 

8,191

 

9,065

 

Net income

 

$

34,822

 

$

27,170

 

$

25,801

 

$

23,604

 

$

22,953

 

 

 

 

 

 

 

 

 

 

 

 

 

Per share data

 

 

 

 

 

 

 

 

 

 

 

Net income, basic

 

$

2.39

 

$

1.91

 

$

1.86

 

$

1.71

 

$

1.68

 

Net income, diluted

 

2.36

 

1.89

 

1.85

 

1.71

 

1.67

 

Cash dividends declared

 

0.88

 

0.81

 

0.77

 

0.72

 

0.69

 

Book value

 

17.63

 

15.71

 

14.74

 

13.58

 

12.37

 

Market value

 

33.34

 

31.92

 

22.42

 

20.53

 

24.55

 

Weighted average common and common equivalent shares - diluted

 

14,762

 

14,353

 

13,932

 

13,834

 

13,779

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance Sheet data

 

 

 

 

 

 

 

 

 

 

 

Total assets

 

$

2,563,868

 

$

2,389,262

 

$

2,148,262

 

$

2,053,097

 

$

1,902,945

 

Loans

 

1,868,550

 

1,721,350

 

1,584,594

 

1,544,845

 

1,508,425

 

Allowance for loan losses

 

24,920

 

28,522

 

31,881

 

29,745

 

25,543

 

Available for sale securities

 

513,056

 

490,031

 

386,440

 

352,185

 

245,352

 

Deposits

 

2,123,627

 

1,980,937

 

1,781,693

 

1,617,739

 

1,493,468

 

Federal Home Loan Bank advances

 

36,832

 

34,329

 

31,882

 

60,431

 

60,442

 

Subordinated debentures

 

 

 

30,900

 

40,900

 

40,900

 

Stockholders’ equity

 

259,895

 

229,444

 

205,075

 

187,686

 

169,861

 

 

 

 

 

 

 

 

 

 

 

 

 

Average balances

 

 

 

 

 

 

 

 

 

 

 

Stockholders’ equity

 

$

245,425

 

$

220,107

 

$

197,551

 

$

179,638

 

$

163,572

 

Assets

 

2,398,430

 

2,232,868

 

2,070,967

 

1,959,609

 

1,847,452

 

Federal Home Loan Bank advances

 

35,709

 

32,518

 

60,113

 

60,436

 

69,159

 

Long-term debt

 

 

30,477

 

31,474

 

40,900

 

40,901

 

 

 

 

 

 

 

 

 

 

 

 

 

Selected ratios

 

 

 

 

 

 

 

 

 

 

 

Return on average assets

 

1.45

%

1.22

%

1.25

%

1.20

%

1.24

%

Return on average stockholders’ equity

 

14.19

 

12.34

 

13.06

 

13.14

 

14.03

 

Average stockholders’ equity to average assets

 

10.23

 

9.86

 

9.54

 

9.17

 

8.85

 

Net interest rate spread

 

3.67

 

3.59

 

3.74

 

3.79

 

3.74

 

Net interest rate margin, fully tax-equivalent

 

3.75

 

3.74

 

3.94

 

3.99

 

3.99

 

Efficiency ratio

 

59.09

 

60.82

 

57.38

 

56.47

 

56.01

 

Non-performing loans to total loans

 

0.64

 

1.33

 

1.90

 

1.51

 

1.28

 

Non-performing assets to total assets

 

0.70

 

1.19

 

1.74

 

1.51

 

1.30

 

Net charge offs to average loans

 

0.18

 

0.60

 

0.60

 

0.55

 

0.40

 

Allowance for loan losses to total loans

 

1.33

 

1.66

 

2.01

 

1.93

 

1.69

 

 

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Table of Contents

 

Item 7.       Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Financial Section Summary

 

The financial section of this Form 10-K includes management’s discussion and analysis, consolidated financial statements, and the notes to those financial statements. Bancorp has prepared the following summary to assist in your review of the financial section. It is designed to give you an overview of Stock Yards Bancorp, Inc. and summarize some of the more important activities and events that occurred during 2014.

 

The financial section includes the following:

 

Management’s discussion and analysis, or MD&A — provides information as to the analysis of the consolidated financial condition and results of operations of Bancorp.  It contains management’s view about industry trends, risks, uncertainties, accounting policies that Bancorp views as critical in light of its business, results of operations including discussion of the key performance drivers, financial position, cash flows, commitments and contingencies, important events, transactions that have occurred over the last three years, and forward-looking information, as appropriate.

 

Financial statements — include Consolidated Balance Sheets as of the end of the last two years, and Consolidated Statements of Income, Comprehensive Income, Changes in Stockholders’ Equity, and Cash Flows, for each of the last three years.  Bancorp’s financial statements are prepared in accordance with US GAAP.

 

Notes to the financial statements — provide insight into, and are an integral part of, the financial statements. The notes contain explanations of significant accounting policies, details about certain captions on the financial statements, information about significant events or transactions that have occurred, discussions about legal proceedings, commitments and contingencies, and selected financial information relating to business segments. The notes to the financial statements also are prepared in accordance with US GAAP.

 

Reports related to the financial statements and internal control over financial reporting — include the following:

 

·                  A report from KPMG LLP, an independent registered public accounting firm, which includes their opinion on the presentation of Bancorp’s consolidated financial statements in conformity with US GAAP based on their audits;

·                  A report from management indicating Bancorp’s responsibility for financial reporting and the financial statements;

·                  A report from management indicating Bancorp’s responsibility for the system of internal control over financial reporting,  including an assessment of the effectiveness of those controls; and

·                  A report from KPMG LLP, which includes their opinion on the effectiveness of Bancorp’s internal control over financial reporting.

 

Our Business

 

Stock Yards Bancorp, Inc. (“Bancorp”), incorporated in 1988, and its business is substantially the same as that of its wholly owned subsidiary, Stock Yards Bank & Trust Company (“the Bank”).  The Bank has operated continuously since it opened in 1904. The Bank conducted business at one location for 85 years and began branching in 1989. At December 31, 2014, the Bank had 28 full service banking locations in the Louisville MSA, three full service banking locations in the Indianapolis MSA, and three full service banking locations in the Cincinnati MSA. In the first quarter of 2015, Bancorp opened an additional full-service branch in the Indianapolis MSA. Bancorp’s focus on flexible, attentive customer service has been key to its growth and profitability. The wide range of services added by investment management and trust, securities brokerage, and mortgage origination helps support the corporate philosophy of capitalizing on full service customer relationships.

 

Forward-Looking Statements

 

This report contains forward-looking statements under the Private Securities Litigation Reform Act that involve risks and uncertainties. These forward-looking statements may be identified by the use of words such as “expect”, “anticipate”, “plan”, “foresee”, “believe” or other words with similar meaning.  Although Bancorp believes the assumptions underlying the forward-looking statements contained herein are reasonable, any of these assumptions could be inaccurate. Factors that could cause actual results to differ from results discussed in forward-looking statements include, but are not limited to: economic conditions both generally and more specifically in the markets in which

 

14



Table of Contents

 

Bancorp and its subsidiaries 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, deterioration in the real estate market, results of operations or financial condition of Bancorp’s customers; or other risks detailed in Bancorp’s filings with the Securities and Exchange Commission and Item 1A of this Form 10-K, all of which are difficult to predict and many of which are beyond the control of Bancorp.

 

Critical Accounting Policies

 

Bancorp has prepared the consolidated financial information in this report in accordance with US GAAP.  In preparing the consolidated financial statements in accordance with US GAAP, Bancorp makes estimates and assumptions that affect the reported amount of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expenses during the reporting period.  There can be no assurances that actual results will not differ from those estimates.

 

Management has identified the accounting policy related to the allowance and provision for loan losses as critical to the understanding of Bancorp’s results of operations and discussed this conclusion with the Audit Committee of the Board of Directors.  Since the application of this policy requires significant management assumptions and estimates, it could result in materially different amounts to be reported if conditions or underlying circumstances were to change.  Assumptions include many factors such as changes in borrowers’ financial condition which can change quickly or historical loss ratios related to certain loan portfolios which may or may not be indicative of future losses.  To the extent that management’s assumptions prove incorrect, the results from operations could be materially affected.   The impact and any associated risks related to this policy on Bancorp’s business operations are discussed in the “Allowance for Loan Losses” section below.

 

The allowance for loan losses is management’s estimate of probable losses in the loan portfolio as of the balance sheet date. Loan losses are charged against the allowance when management believes the uncollectability of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.

 

Prior to 2013, management measured the appropriateness of the allowance for loan losses in its entirety using (a) quantitative (historical loss rates) and qualitative factors (management adjustment factors); (b) specific allocations on impaired loans, and (c) an unallocated amount.  The unallocated amount was evaluated on the loan portfolio in its entirety and was based on additional factors, such as national and local economic trends and conditions, changes in volume and severity of past due loans, volume of non-accrual loans, volume and severity of adversely classified or graded loans and other factors and trends that affect specific loans and categories of loans, such as a heightened risk in the commercial and industrial loan portfolios.  Bancorp utilized the sum of all allowance amounts derived as described above, including a reasonable unallocated allowance, as an indicator of the appropriate level of allowance for loan and lease losses.

 

During 2013, Bancorp refined its allowance calculation to allocate the portion of allowance that was previously deemed to be unallocated to instead be included in management’s determination of appropriate qualitative factors. This refined allowance calculation includes specific allowance allocations for qualitative factors including, among other factors, (i) national and local economic conditions, (ii) the quality and experience of lending staff and management, (iii) changes in lending policies and procedures, (iv) changes in volume and severity of past due loans, classified loans and non-performing loans, (v) potential impact of any concentrations of credit, (vi) changes in the nature and terms of loans such as growth rates and utilization rates, (vii) changes in the value of underlying collateral for collateral-dependent loans, considering Bancorp’s disposition bias, and (viii) the effect of other external factors such as the legal and regulatory environment.  Bancorp may also consider other qualitative factors for additional allowance allocations, including changes in Bancorp’s loan review process.   Changes in the criteria used in this evaluation or the availability of new information could cause the allowance to be increased or decreased in future periods. In addition, bank regulatory agencies, as part of their examination process, may require adjustments to the allowance for loan losses based on their judgments and estimates.

 

Additionally, management has identified the accounting policy related to accounting for income taxes as critical to the understanding of Bancorp’s results of operations and discussed this conclusion with the Audit Committee of the Board of Directors.  The objectives of accounting for income taxes are to recognize the amount of taxes payable or refundable for the current year and deferred tax liabilities and assets for the future tax consequences of events that have been recognized in an entity’s financial statements or tax returns.  Judgment is required in assessing the future tax

 

15



Table of Contents

 

consequences of events that have been recognized in Bancorp’s financial statements or tax returns. Fluctuations in the actual outcome of these future tax consequences, including the effects of IRS examinations and examinations by other state agencies, could materially impact Bancorp’s financial position and its results from operations.  Additional information regarding income taxes is discussed in the “Income Taxes” section below.

 

Overview of 2014

 

The following discussion should be read in conjunction with Bancorp’s consolidated financial statements and accompanying notes and other schedules presented elsewhere in this report.

 

In 2014, Bancorp completed a year of earnings, asset and deposit growth with net income totaling $34.8 million, an increase of 28% over 2013.  This marked the fourth consecutive year of record earnings per diluted share.  Increased profitability was primarily due to an increase in net interest income, a significant reduction in provision for loan losses which resulted in a net release of reserves for loan losses, and a slight increase in non-interest income.  These increases were partially offset by higher non-interest expenses and higher income tax expense. Diluted earnings per share for 2014 increased 25% over 2013 to $2.36.

 

As is the case with most banks, the primary source of Bancorp’s revenue is net interest income and fees from various financial services provided to customers.  Net interest income is the difference between interest income earned on loans, investment securities and other interest earning assets less interest expense on deposit accounts and other interest bearing liabilities.  Loan volume and the interest rates earned on those loans are critical to overall profitability. Similarly, deposit volume is crucial to funding loans and rates paid on deposits directly impact profitability.  Business volumes are influenced by economic factors including market interest rates, business spending, consumer confidence and competitive conditions within the marketplace.

 

Bancorp’s loan portfolio increased $147 million, or 9%, during 2014 to $1.9 billion.  Record loan production of approximately $537 million was largely offset by loan payoffs, including amortization and the effects of loan maturities.  Increased volume of loans and investments contributed to higher interest income in 2014; this was partially offset by declining interest rates on loans. As a result, interest income for 2014 increased $2.6 million over 2013.  Even with significant deposit growth, interest expense declined due to lower funding costs on deposits and borrowings, largely due to the redemption of the trust preferred securities in December 2013.  Rates on liabilities decreased slightly more than the rates on earning assets, resulting in an increased net interest spread and net interest margin compared to 2013.  Net interest margin in 2014 increased slightly to 3.75% compared to 3.74% in 2013.

 

Total non-interest income in 2014 increased $153,000 compared to 2013, and remained consistent at 32% of total revenues, reflecting a 12% increase in investment management and trust services which was mostly offset by decreases in most other areas of non-interest income. Non-interest income in 2013 included a $449,000 gain on the Oldham acquisition.

 

Higher non-interest expenses for 2014 resulted from increases in salaries and benefits and occupancy expense and other non-interest expenses related to amortization of tax credit investments, partially offset by decreases in FDIC insurance premiums and furniture and equipment expense.  In 2014, Bancorp recorded net gains on sales of other real estate owned compared to net losses recorded in 2013.  Bancorp’s efficiency ratio for 2014 of 59.1% decreased from 60.8% in 2013.   Included in 2013 results were one-time acquisition costs related to the Oldham transaction and a write-off of debt issuance costs related to redemption of trust preferred securities.

 

Also favorably impacting 2014 results, Bancorp released reserves for loan losses totaling $400 thousand in 2014, compared to a provision for loan losses of $6.6 million in 2013, in response to Bancorp’s improvements in the overall quality of the loan portfolio during 2014.  The provision for loan losses represents a charge to earnings necessary to establish an allowance for loan losses that, in management’s evaluation, is adequate to provide coverage for the inherent losses on outstanding loans.  Bancorp’s allowance for loan losses was 1.33% of total loans at December 31, 2014, compared with 1.66% of total loans at December 31, 2013.

 

Bancorp’s effective tax rate increased to 30.5% in 2014 from 29.2% in 2013.  The increase in income tax expense from 2013 to 2014 is the result of proportionally lower nontaxable income from the increase in cash value of life insurance and municipal securities. This was partially offset by the effect of reclassifying amortization of tax credit investments to other non-interest expense.

 

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Table of Contents

 

Tangible common equity (TCE), a non-GAAP measure, is a measure of a company’s capital which is useful in evaluating the quality and adequacy of capital.  It is calculated by subtracting the value of intangible assets and any preferred equity from the book value of Bancorp’s stockholders’ equity.  The ratio of tangible common equity to total tangible assets was 10.05% as of December 31, 2014, compared to 9.50% at December 31, 2013. See the Non-GAAP Financial Measures section for details on reconcilement to US GAAP measures.

 

Challenges for 2015 will include maintaining a stable net interest margin, achieving continued loan growth, managing credit quality and increasing regulatory requirements.

 

·                  Bancorp expects net interest margin to decline slightly in 2015, as rates are expected to be largely unchanged through the first half of 2015.  Loan prepayments are expected to diminish below 2014 levels while prevailing rates for new loans will likely result in a somewhat lower net interest margin for 2015.  However, increased deposit and loan rate competition could negatively impact this expectation, as could a decrease in longer term interest rates.

·                  The Federal Reserve Board lowered its key short term rate in 2008 to unprecedentedly low levels, and rates have remained low through 2014.  Indications are that the Federal Reserve will likely keep short term rates low through at least mid-2015.  Approximately 38% of Bancorp’s loans are indexed to the prime interest rate and reprice immediately with Federal Reserve rate changes. However, approximately 50% of variable rate loans have reached their contractual floor of 4% or higher, meaning they will not reprice immediately when the prime rate increases.  Deposit rates generally do not reprice as quickly as loans.  Once rates begin to rise, Bancorp’s net interest margin likely will be negatively affected until the increase in the prime rate exceeds 75 basis points from today’s levels.

·                 Bancorp’s goals for 2015 include net loan growth at a pace comparable to that experienced in 2014. This will be impacted by competition, prevailing economic conditions, and the impact of prepayments in the loan portfolio.  Bancorp believes there is opportunity for growth, and Bancorp’s ability to deliver attractive growth over the long-term is linked to Bancorp’s success.

·                  Bancorp expects to encounter slower growth of our investment management and trust services in 2015 as some revenue that boosted 2014 results is not expected to recur at the same level in 2015.

·                  Bancorp expects an increase in non-interest income for 2015 from gains on sales of mortgage loans held for sale, as purchase transactions are expected to increase.  However, if rates rise later in 2015, Bancorp expects refinance activity will slow.

·                  Bancorp expects year-over-year increases in non-interest expense including personnel, data processing and occupancy expenses.  Bancorp also anticipates higher non-interest expenses to meet the ongoing and increasing burden of additional regulatory requirements.

 

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

 

2013 Acquisition

 

On April 30, 2013, Bancorp completed the acquisition of 100% of the outstanding shares of THE BANCorp, Inc. (“Oldham”), parent company of THE BANK — Oldham County, Inc.  As a result of the transaction, THE BANK — Oldham County merged into Stock Yards Bank & Trust Company.  Since the acquisition date, results of operations acquired in the Oldham transaction have been included in Bancorp’s financial results.  The Oldham transaction has been accounted for using the acquisition method of accounting and, accordingly, assets acquired, liabilities assumed and consideration transferred were recorded at estimated fair value on the acquisition date.  The fair value adjustments resulted in net assets acquired in excess of the consideration paid.  Accordingly, a non-taxable gain of $449,000 was recognized.  In connection with the Oldham acquisition, Bancorp incurred expenses totaling $1,548,000 related to executing the transaction and integrating and conforming acquired operations with and into Bancorp.

 

Results of Operations

 

Net income was $34.8 million or $2.36 per share on a diluted basis for 2014 compared to $27.2 million or $1.89 per share for 2013 and $25.8 million or $1.85 per share for 2012.

 

Net income for 2014 was positively impacted by:

 

·                  a release of net reserves for loan losses of $0.4 million in 2014 compared to a provision of $6.6 million in 2013,

 

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·                  a $6.5 million or 8% increase in net interest income, including the effect of the redemption of $30 million of trust preferred securities on December 31, 2013, and

·                  a $1.9 million or 12% increase in investment management and trust revenue.

 

Net income for 2014 was negatively impacted by:

 

·                  a $1.8 million or 8% decrease in non-interest income not including investment management and trust revenue,

·                  a $1.9 million or 3% increase in non-interest expenses, and

·                  a $4.1 million or 36% increase in income tax expense.

 

The following paragraphs provide a more detailed analysis of significant factors affecting operating results.

 

Net Interest Income

 

Net interest income, the most significant component of Bancorp’s earnings, represents total interest income less total interest expense.  Net interest spread is the difference between the taxable equivalent rate earned on average interest earning assets and the rate expensed on average interest bearing liabilities.  Net interest margin represents net interest income on a taxable equivalent basis as a percentage of average earning assets.  Net interest margin is affected by both the interest rate spread and the level of non-interest bearing sources of funds.  The level of net interest income is determined by the mix and volume of interest earning assets, interest bearing deposits and interest bearing liabilities and by changes in interest rates. The discussion that follows is based on tax-equivalent interest data.

 

Comparative information regarding net interest income follows:

 

 

 

 

 

 

 

 

 

2014/2013

 

2013/2012

 

(Dollars in thousands)

 

2014

 

2013

 

2012

 

Change

 

Change

 

 

 

 

 

 

 

 

 

 

 

 

 

Net interest income, tax-equivalent basis

 

$

84,730

 

$

78,306

 

$

75,653

 

8.2

%

3.5

%

Net interest spread

 

3.67

%

3.59

%

3.74

%

8

bp

(15

)bp

Net interest margin

 

3.75

%

3.74

%

3.94

%

1

bp

(20

)bp

Average earning assets

 

$

2,259,843

 

$

2,096,088

 

$

1,922,134

 

7.8

%

9.1

%

Five year Treasury bond rate at year end

 

1.65

%

1.75

%

0.73

%

(10

)bp

102

bp

Average five year Treasury bond rate

 

1.63

%

1.17

%

0.75

%

46

bp

42

bp

Prime rate at year end

 

3.25

%

3.25

%

3.25

%

0

bp

0

bp

Average prime rate

 

3.25

%

3.25

%

3.25

%

0

bp

0

bp

 

bp = basis point = 1/100th of a percent

 

All references above to net interest margin and net interest spread exclude the sold portion of certain participation loans from calculations.  Such loans remain on Bancorp’s balance sheet as required by US GAAP principles because Bancorp retains some form of effective control; however, Bancorp receives no interest income on the sold portion of these loans.  These participation loans sold are excluded in the calculation of margins, which Bancorp believes provides a more accurate determination of the performance of its loan portfolio.

 

Prime rate and the five year Treasury bond rate are included above to provide a general indication of the interest rate environment in which Bancorp operated.  Approximately $701 million, or 38%, of Bancorp’s loans are variable rate; most of these loans are indexed to the prime rate and may reprice as that rate changes.  However, approximately $353 million of variable rate loans, have reached their contractual floor of 4% or higher.  Approximately $142 million of variable rate loans have contractual floors below 4%.  The remaining $206 million of variable rate loans have no contractual floor. Bancorp intends to establish floors whenever possible upon acquisition of new customers.  Bancorp’s

 

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variable rate loans are primarily comprised of commercial lines of credit and real estate loans.  At inception, most of Bancorp’s fixed rate loans are priced in relation to the five year Treasury bond.

 

Average loan balances increased $117 million or 7.1% in 2014; however, the declining interest rate environment drove average loan yields lower by 26 basis points.  Bancorp grew average interest bearing deposits $109 million or 7.6%.  Average interest costs on interest bearing deposits decreased 30 basis points, again reflecting the declining interest rate market and a more favorable mix of deposits. In the fourth quarter of 2013, Bancorp redeemed $30 million of trust preferred securities which carried a rate of 10.00%; this accounted for approximately 13 basis points of improvement in net interest margin. Average Federal Home Loan Bank (“FHLB”) advances increased by $3.2 million or 9.8%, with average rates decreasing by 38 basis points.

 

Management anticipates a stable prime rate through the first half 2015, with moderate increases through the remainder of the year.  Time deposit maturities of approximately $211 million, or 68% of total time deposits, in 2015 are not likely to spark improvement in interest expense as prevailing market rates are similar to existing rates on those deposits.  Overall, management expects the net interest margin to decline slightly through 2015.  The margin could be affected negatively if competition causes increases in deposit rates or a greater than expected decline in loan pricing in Bancorp’s markets.

 

Net interest margin in 2014 and 2013 reflected prepayment fees associated with loan refinancing activity.  Adjusting for these sources of additional income, Bancorp’s more normalized or core net interest margin remained generally stable in 2014, increasing to 3.70% for 2014 from 3.66% for 2013.  (See “Non-GAAP Financial Measures” section for reconcilement of non-GAAP measures to US GAAP measures.)  Management believes these core margins better reveal the pressure of a low interest rate environment and a highly competitive loan market.

 

Asset/Liability Management and Interest Rate Risk

 

Managing interest rate risk is fundamental for the financial services industry. The primary objective of interest rate risk management is to neutralize effects of interest rate changes on net income. By considering both on and off-balance sheet financial instruments, management evaluates interest rate sensitivity while attempting to optimize net interest income within the constraints of prudent capital adequacy, liquidity needs, market opportunities and customer requirements.

 

Interest Rate Simulation Sensitivity Analysis

 

Bancorp uses an earnings simulation model to estimate and evaluate the impact of an immediate change in interest rates on earnings in a one year forecast. The simulation model is designed to reflect the dynamics of interest earning assets, interest bearing liabilities and off-balance sheet financial instruments. By estimating the effects of interest rate increases and decreases, the model can reveal approximate interest rate risk exposure. The simulation model is used by management to gauge approximate results given a specific change in interest rates at a given point in time.  The model is therefore a tool to indicate earnings trends in given interest rate scenarios and does not indicate actual expected results.

 

The December 31, 2014 simulation analysis, which shows very little interest rate sensitivity, indicates that an increase in interest rates of 100 to 200 basis points would have a negative effect on net interest income, and a decrease of 100 basis points in interest rates would also have a slightly negative effect on net interest income.  These estimates are summarized below.

 

 

 

Net interest
income %
change

 

 

 

 

 

Increase 200 bp

 

(4.28

)

Increase 100 bp

 

(3.24

)

Decrease 100 bp

 

(1.31

)

Decrease 200 bp

 

N/A

 

 

Loans indexed to the prime rate, with floors of 4% or higher, comprise approximately 19% of total loans.  Since the prime rate is currently 3.25%, rates would have to increase more than 75 bp before the rates on such loans will rise.  This effect, captured in the simulation analysis above, negatively impacts the effect of rising rates.

 

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The scenario of rates decreasing 200 bp is not reasonably possible given current low rates for short-term instruments and most deposits.

 

Undesignated derivative instruments described in Note 21 to Bancorp’s consolidated financial statements are recognized on the consolidated balance sheet at fair value, with changes in fair value, due to changes in prevailing interest rates, recorded in other non-interest income. Because of matching terms of offsetting contracts, in addition to collateral provisions which mitigate the impact of non-performance risk, changes in fair value subsequent to initial recognition have a minimal effect on earnings, and are therefore not included in the simulation analysis results above.

 

Derivatives designated as cash flow hedges described in Note 21 to Bancorp’s consolidated financial statements are recognized on the consolidated balance sheet at fair value, with changes in fair value, due to changes in prevailing interest rates, recorded net of tax in other comprehensive income.

 

The following table presents the increases in net interest income due to changes in rate and volume computed on a tax-equivalent basis and indicates how net interest income in 2014 and 2013 was impacted by volume increases and the lower average interest rate environment. The tax-equivalent adjustments are based on a 35% federal tax rate. The change in interest due to both rate and volume has been allocated to the change due to rate and the change due to volume in proportion to the relationship of the absolute dollar amounts of the change in each.

 

Taxable Equivalent Rate/Volume Analysis

 

 

 

2014/2013

 

2013/2012

 

 

 

Increase (decrease)

 

Increase (decrease)

 

 

 

due to

 

due to

 

(In thousands)

 

Net change

 

Rate

 

Volume

 

Net change

 

Rate

 

Volume

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest income

 

 

 

 

 

 

 

 

 

 

 

 

 

Loans

 

$

1,136

 

$

(4,335

)

$

5,471

 

$

(1,376

)

$

(6,932

)

$

5,556

 

Federal funds sold

 

(3

)

20

 

(23

)

(25

)

3

 

(28

)

Mortgage loans held for sale

 

(45

)

27

 

(72

)

(125

)

(2

)

(123

)

Securities

 

 

 

 

 

 

 

 

 

 

 

 

 

Taxable

 

1,466

 

316

 

1,150

 

442

 

(1,199

)

1,641

 

Tax-exempt

 

34

 

(59

)

93

 

(48

)

(205

)

157

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total interest income

 

2,588

 

(4,031

)

6,619

 

(1,132

)

(8,335

)

7,203

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest expense

 

 

 

 

 

 

 

 

 

 

 

 

 

Deposits

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest bearing demand deposits

 

108

 

21

 

87

 

(126

)

(231

)

105

 

Savings deposits

 

1

 

(4

)

5

 

(22

)

(34

)

12

 

Money market deposits

 

62

 

(35

)

97

 

(569

)

(712

)

143

 

Time deposits

 

(861

)

(565

)

(296

)

(1,438

)

(1,214

)

(224

)

Securities sold under agreements to repurchase

 

(6

)

(8

)

2

 

(34

)

(37

)

3

 

Federal funds purchased and other short-term borrowings

 

(3

)

(1

)

(2

)

1

 

1

 

 

Federal Home Loan Bank advances

 

(47

)

(129

)

82

 

(1,574

)

(663

)

(911

)

Long-term debt

 

(3,090

)

 

(3,090

)

(23

)

77

 

(100

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total interest expense

 

(3,836

)

(721

)

(3,115

)

(3,785

)

(2,813

)

(972

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net interest income

 

$

6,424

 

$

(3,310

)

$

9,734

 

$

2,653

 

$

(5,522

)

$

8,175

 

 

Bancorp’s tax equivalent net interest income increased $6.4 million for the year ended December 31, 2014 compared to the same period of 2013, while 2013 increased $2.7 million compared to 2012.  Net interest income for 2014 compared to 2013 was positively impacted by an increase in loan volume, securities volume and rates, a decrease in deposit rates, a more favorable mix of deposits, a decrease in rates of FHLB advances, and the redemption of long-term debt.  Net interest income was negatively impacted by a decline in the average rate earned on loans and higher volume of FHLB

 

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advances.  Volume increases of loans and securities boosted net interest income by $6.6 million. The redemption of long-term debt contributed $3.0 million to net interest income for 2014. Higher rates on securities resulted in $0.26 million while declining rates on deposits, particularly time deposits, contributed $0.6 million to the increase of net interest income.  Partially offsetting the increases, declining rates on loans negatively impacted net interest income by $4.3 million.  FHLB advance interest decreased $47 thousand attributable to lower rates, net of the effect of higher volume.

 

For the year 2013 compared to 2012, net interest income was positively impacted by an increase in loan and securities volume and a decrease in deposit rates, a more favorable mix of deposits, and decreases in the volume and rates of FHLB advances.  Net interest income was negatively impacted by a decline in the average rate earned on assets.  Loan and securities volume increases boosted net interest income by $7.2 million and declining rates on deposits, particularly time deposits, contributed $2.2 million to the increase of net interest income.  Partially offsetting the increases, declining rates on loans and securities negatively impacted net interest income by $8.3 million, while FHLB advance interest decreased $1.6 million attributable to both volume and rate decreases.

 

Provision for Loan Losses

 

In determining the provision for loan losses, management considers many factors. Among these are the quality and underlying collateral of the loan portfolio, previous loss experience, the size and composition of the loan portfolio and an assessment of the impact of current economic conditions on borrowers’ ability to pay. The provision for loan losses and resulting ratios is summarized below:

 

(Dollars in thousands)

 

2014

 

2013

 

2012

 

 

 

 

 

 

 

 

 

(Credit) provision for loan losses

 

$

(400

)

$

6,550

 

$

11,500

 

Allowance to loans at year end

 

1.33

%

1.66

%

2.01

%

Allowance to average loans for year

 

1.41

%

1.72

%

2.04

%

 

The provision for loan losses represents a charge to earnings necessary to establish an allowance for loan losses that, in management’s evaluation, is adequate to provide coverage for the inherent losses on outstanding loans.  The release of reserves for loan losses in 2014 reflected continued improvement in overall credit quality metrics and management’s specific assessment of the overall quality of the loan portfolio. Over the past year, non-performing loans have declined 48%, while non-performing assets have declined 37%.  More information on this process can be found in the “Allowance for loan losses” section.

 

Non-performing loans decreased to $11.9 million at December 31, 2014 from $22.9 million at year-end 2013, primarily due to a decrease in non-accrual loans and loans classified as troubled debt restructurings (TDR).  The decrease in non-accrual loans primarily reflected the migration of a few credits to other real estate owned and a limited number of partial charge-offs of collateral-dependent loans.  TDRs, which are currently accruing interest, decreased from $7.2 million at December 31, 2013 to $6.4 million at December 31, 2014, largely due to principal paydowns by customers whose conditions are improving.  The ratio of non-performing loans to total loans was 0.64% at December 31, 2014, down from 1.33% at December 31, 2013.  Net charge-offs totaled 0.18% of average loans for 2014, a decrease compared to 0.60% for 2013.  See “Financial Condition-Non-performing Loans and Assets” for further discussion of non-performing loans.  See “Financial Condition-Summary of Loan Loss Experience” for further discussion of loans charged off during the year.

 

Bancorp’s loan portfolio is diversified with no significant concentrations of credit. Geographically, most loans are extended to borrowers in the metropolitan areas of Louisville, Indianapolis and Cincinnati.  The adequacy of the allowance is monitored on an ongoing basis and it is the opinion of management that the balance of the allowance for loan losses at December 31, 2014 is adequate to absorb probable losses inherent in the loan portfolio as of the financial statement date. See “Financial Condition-Allowance for Loan Losses” for more information on the allowance for loan losses.

 

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Table of Contents

 

Non-Interest Income and Non-Interest Expenses

 

The following table provides a comparison of the components of non-interest income for 2014, 2013 and 2012. Below the table is a discussion of significant changes and trends.

 

 

 

 

 

 

 

 

 

2014/2013

 

2013/2012

 

(Dollars in thousands)

 

2014

 

2013

 

2012

 

Change

 

%

 

Change

 

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Investment management and trust services

 

$

18,212

 

$

16,287

 

$

14,278

 

$

1,925

 

11.8

%

$

2,009

 

14.1

%

Service charges on deposit acccounts

 

8,883

 

8,986

 

8,516

 

(103

)

(1.1

)

470

 

5.5

 

Bankcard transaction revenue

 

4,673

 

4,378

 

3,985

 

295

 

6.7

 

393

 

9.9

 

Mortgage banking revenue

 

2,653

 

3,978

 

5,771

 

(1,325

)

(33.3

)

(1,793

)

(31.1

)

Loss on sales of securities available for sale

 

(9

)

(5

)

 

(4

)

80.0

 

(5

)

(100.0

)

Brokerage commissions and fees

 

2,060

 

2,159

 

2,593

 

(99

)

(4.6

)

(434

)

(16.7

)

Bank owned life insurance income

 

927

 

1,031

 

1,006

 

(104

)

(10.1

)

25

 

2.5

 

Gain on acquisition

 

 

449

 

 

(449

)

(100.0

)

449

 

100.0

 

Other

 

1,756

 

1,739

 

2,308

 

17

 

1.0

 

(569

)

(24.7

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

$

39,155

 

$

39,002

 

$

38,457

 

$

153

 

0.4

%

$

545

 

1.4

%

 

The largest component of non-interest income is investment management and trust revenue. The magnitude of investment management and trust revenue distinguishes Bancorp from other community banks of similar asset size. Trust assets under management totaled $2.27 billion at December 31, 2014, compared to $2.23 billion at December 31, 2013 and $1.96 billion at December 31, 2012.  Investment management and trust services revenue, which constitutes an average of 42% of non-interest income, increased $1.9 million, or 11.8%, for 2014 compared to 2013, primarily due to an increased market value of assets under management and, to a lesser extent, an increase in one-time executor fees.  Recurring fees, which generally make up over 95% of the investment management and trust revenue, increased 10% for 2014, compared to 2013.  Most recurring fees earned for managing accounts are based on a percentage of market value on a monthly basis. While fees are based on market values, they typically do not fluctuate directly with the overall stock market, as accounts usually contain fixed income and equity asset classes, which generally react inversely to each other.  Some revenues of the investment management and trust department, most notably executor, insurance, and some employee benefit plan-related fees, are non-recurring in nature and the timing of these revenues corresponds with the related administrative activities.  Non-recurring fees increased $309 thousand for 2014 compared to 2013.  For 2014, 2013 and 2012 executor fees totaled approximately $739 thousand, $437 thousand and $106 thousand, respectively. Management expects to encounter slower growth of our investment management and trust revenue in 2015 as some revenue that boosted 2014 results is not expected to recur at the same level in 2015.  Still, management expects the investment management and trust department will continue to factor significantly in financial results and provide strategic diversity to revenue streams.

 

Service charges on deposit accounts decreased $103 thousand or 1.1%, for the year ended December 31, 2014 compared to the same period a year ago.  Service charge income is driven by transaction volume, which can fluctuate throughout the year.  A significant component of service charges is related to fees earned on overdrawn checking accounts.  Management expects this source of revenue to decline slightly in 2015 due to anticipated changes in customer behavior and increased regulatory restrictions.

 

Bankcard transaction revenue increased $295 thousand, or 6.7%, for the year ended December 31, 2014 compared to the same period in 2013, and primarily represents income Bancorp derives from customers’ use of debit cards.  This category reflects a change in the manner in which bankcard revenue and expense are received and recorded by Bancorp, related to the selection of a new bankcard processor.  In 2013, Bancorp moved processing of its bankcard transactions to

 

22



Table of Contents

 

a new vendor which provides more detailed information regarding related income and expense.  As a result, beginning in mid-2013, information previously recorded as net revenue has been grossed up to more accurately reflect income and expense.  This more detailed information is not available for prior periods and thus impacts the comparability of the information on an absolute basis for revenue and expense.  It is, however, comparable on a net basis.

 

Bankcard income, net of bankcard expenses which are recorded in data processing expenses, was $3.0 million, $2.8 million and $2.9 million for 2014, 2013 and 2012, respectively.  The increase in 2014 primarily reflects an increase in volume of transactions, partially offset by a decrease in the interchange rates received.  Most of this revenue is interchange income based on rates set by service providers in a competitive market. Beginning in October 2011, this rate was set by the Federal Reserve for banks with over $10 billion in assets.  While this threshold indicates Bancorp will not be directly affected, this change has affected Bancorp and other similarly sized institutions as merchants gravitate to lower cost interchanges. Volume, which is dependent on consumer behavior, is expected to continue to increase slowly.  However, management expects interchange rates to decrease, resulting in income from this source to remain consistent with levels experienced in 2014.

 

Mortgage banking revenue primarily includes gains on sales of mortgage loans. Bancorp’s mortgage banking department originates residential mortgage loans to be sold in the secondary market. Interest rates on the loans sold are locked with the borrower and investor prior to closing the loans, thus Bancorp bears no interest rate risk related to these loans.  The department offers conventional, VA and FHA financing, for purchases and refinances, as well as programs for first time home buyers. Interest rates on mortgage loans directly impact the volume of business transacted by the mortgage banking division.  Mortgage banking revenue decreased $1.3 million, or 33.3%, in 2014 compared to 2013.  Market rates for mortgage loans increased slightly since the first quarter of 2013, resulting in lower volume of refinance activity in 2014 compared to 2013.  Declines in refinance activity reflect national trends, as fewer borrowers remain in the marketplace with incentive to refinance.

 

In 2014, Bancorp sold securities with total fair market value of $7.7 million, generating a net loss of $9 thousand.  These securities consisted of mortgage-backed securities with small remaining balances, obligations of state and political subdivisions, and agency securities.  In 2013, Bancorp sold obligations of state and political subdivisions with total fair market value of $696 thousand, generating a loss of $5 thousand. These sales were made in the ordinary course of portfolio management.

 

Brokerage commissions and fees decreased $99 thousand, or 4.6%, in 2014 compared to 2013, corresponding to overall brokerage volume. Brokerage commissions and fees earned consist primarily of stock, bond and mutual fund sales as well as wrap fees on accounts.  Wrap fees are charges for investment programs that bundle together a suite of services, such as brokerage, advisory, research, and management, and are based on a percentage of assets. Bancorp deploys its brokers primarily through its branch network through an arrangement with a third party broker-dealer, while larger managed accounts are serviced in the investment management and trust department.

 

Income related to bank-owned life insurance (“BOLI”) was $927 thousand in 2014 compared to $1.0 million for 2013, due to a lower interest crediting rate in 2014.  BOLI represents the cash surrender value for life insurance policies on certain key employees who have provided consent for Bancorp to be the beneficiary of a portion of such policies.  Any proceeds received under the policies and the related change in cash surrender value are recorded as non-interest income.  This income helps offset the cost of various employee benefits.

 

The Oldham transaction has been accounted for using the acquisition method of accounting and, accordingly, assets acquired, liabilities assumed and consideration transferred were recorded at estimated fair value on the acquisition date.  See Note 3 to Bancorp’s consolidated financial statements for information relating to the acquisition.  The fair value adjustments resulted in net assets acquired in excess of the consideration paid.  Accordingly, a non-taxable gain of $449 thousand was recognized in 2013.

 

Other non-interest income increased $17 thousand, or 1.0%, during 2014 compared to 2013 due to a variety of factors, none of which were individually significant.

 

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Table of Contents

 

The following table provides a comparison of the components of non-interest expenses for 2014, 2013 and 2012. Below the table is a discussion of significant changes and trends.

 

 

 

 

 

 

 

 

 

2014/2013

 

2013/2012

 

(Dollars in thousands)

 

2014

 

2013

 

2012

 

Change

 

%

 

Change

 

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Salaries and employee benefits

 

$

44,687

 

$

41,145

 

$

37,960

 

$

3,542

 

8.6

%

$

3,185

 

8.4

%

Net occupancy expense

 

5,963

 

5,615

 

5,651

 

348

 

6.2

 

(36

)

(0.6

)

Data processing expense

 

6,393

 

6,319

 

5,278

 

74

 

1.2

 

1,041

 

19.7

 

Furniture and equipment expense

 

1,016

 

1,126

 

1,306

 

(110

)

(9.8

)

(180

)

(13.8

)

FDIC insurance

 

1,314

 

1,431

 

1,494

 

(117

)

(8.2

)

(63

)

(4.2

)

(Gain) loss on other real estate owned

 

(271

)

652

 

1,410

 

(923

)

(141.6

)

(758

)

(53.8

)

Acquisition costs

 

 

1,548

 

 

(1,548

)

(100.0

)

1,548

 

100.0

 

Other

 

14,107

 

13,516

 

12,373

 

591

 

4.4

 

1,143

 

9.2

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

$

73,209

 

$

71,352

 

$

65,472

 

$

1,857

 

2.6

%

$

5,880

 

9.0

%

 

Salaries and benefits are the largest component of non-interest expenses and increased $3.5 million or 8.6% for 2014 compared to 2013, largely due to increased staffing levels, normal increases in salaries, and higher incentive accruals, health insurance costs and stock-based compensation expense.  Increased staffing levels included senior staff with higher per capita salaries in investment management and trust, lending and operational functions.  Higher incentive accruals correspond to the increased overall level of 2014 profitability.  At December 31, 2014, Bancorp had 524 full-time equivalent employees compared to 519 at the same date in 2013 and 495 for 2012.

 

Net occupancy expense increased $348 thousand or 6.2% from 2013 to 2014, largely due to a $150 thousand non-recurring rent refund on a leased facility which lowered rent expense in 2013 and a variety of other factors, none of which is individually significant.  At December 31, 2014 Bancorp had 34 banking center locations including the main office.  In the first quarter of 2015, Bancorp opened an additional leased branch location in the Indianapolis MSA.

 

Data processing expense increased $74 thousand or 1.2% from 2013 to 2014 due to a variety of factors, none of which is individually significant.  This category includes ongoing computer equipment maintenance costs related to investments in new technology needed to maintain and improve the quality of delivery channels and internal resources.

 

Furniture and equipment expense decreased $110 thousand or 9.8% in 2014, as compared to 2013, due to a variety of factors, none of which is individually significant.  Costs of capital asset additions flow through the statement of income over the lives of the assets in the form of depreciation expense.

 

FDIC insurance expense decreased $117 thousand, or 8.2% for the year ended December 31, 2014, as compared to the same period in 2013.  The assessment is calculated quarterly by the FDIC.  The decline in expense is due primarily to a reduction in the assessment rate, driven by improved credit metrics in 2014.

 

Loss on other real estate owned (OREO) decreased $923 thousand for the year ended December 31, 2014, as compared to the same period of 2013.  Net gains on OREO totaled $271 thousand for 2014 compared to losses totaling $652 thousand for 2013.  Bancorp liquidated several properties at prices greater than their carrying values in the first quarter of 2014 resulting in gains on foreclosed assets.

 

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Table of Contents

 

In connection with the Oldham acquisition in 2013, Bancorp incurred $1.5 million in expenses related to executing the transaction and integrating and conforming acquired operations with and into Bancorp. Those expenses consisted largely of systems conversions and/or integration of operations.  A summary of acquisition costs, all recorded in the second quarter of 2013, included in the consolidated statement of income follows:

 

(in thousands)

 

Amount

 

 

 

 

 

Data conversion expenses

 

$

906

 

Consulting

 

262

 

Salaries and employee benefits

 

103

 

Legal

 

96

 

All other

 

181

 

Total acquisition costs

 

$

1,548

 

 

Other non-interest expenses increased $591 thousand, or 4.4% for the year ended December 31, 2014 compared to the same period of 2013.  In 2014, the amortization for certain investments in tax credit partnerships was reclassified in the income statement.  Accordingly, Bancorp recorded $1.1 million in amortization expense as other non-interest expense and reduced income tax expense by $788 thousand.  Other increases included $240 thousand increase in capital-based state taxes and a $137 thousand increase in legal and professional fees.   In the fourth quarter of 2013, Bancorp recorded $1.3 million of amortization of remaining debt issuance costs related to the redemption of its trust preferred securities.  Also included in 2013 was a one-time decrease of $505 thousand in marketing expense related to a debit card rewards program conversion, This category also includes core deposit intangible amortization, mortgage servicing rights (“MSR) amortization, marketing, OREO maintenance, printing, mail and telecommunications, none of which had individually significant variances.

 

Income Taxes

 

A three year comparison of income tax expense and effective tax rate follows:

 

(Dollars in thousands)

 

2014

 

2013

 

2012

 

 

 

 

 

 

 

 

 

Income tax expense

 

$

15,281

 

$

11,228

 

$

9,634

 

Effective tax rate

 

30.5

%

29.2

%

27.2

%

 

The increase in the effective tax rate from 2013 to 2014 arose from proportionally lower nontaxable income from the increase in cash value of life insurance and municipal securities. The reclassification of tax credit investment amortization expense explained above reduced 2014 income tax expense by $788 thousand. The increase in the effective tax rate from 2012 to 2013 is primarily the result of higher tax-exempt interest in 2012 due to a $740 thousand prepayment penalty received on a tax-exempt loan.  For more information regarding income taxes and the effective tax rate see Note 8 to Bancorp’s consolidated financial statements.

 

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Table of Contents

 

Financial Condition

 

Earning Assets and Interest Bearing Liabilities

 

Summary information with regard to Bancorp’s financial condition follows:

 

 

 

 

 

 

 

 

 

2014/2013

 

2013/2012

 

(Dollars in thousands)

 

2014

 

2013

 

2012

 

Change

 

%

 

Change

 

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Average earning assets

 

$

2,259,843

 

$

2,096,088

 

$

1,922,134

 

$

163,755

 

7.8

%

$

173,954

 

9.1

%

Average interest bearing liabilities

 

1,664,406

 

1,582,591

 

1,488,939

 

81,815

 

5.2

 

93,652

 

6.3

 

Average total assets

 

2,398,430

 

2,232,868

 

2,070,967

 

165,562

 

7.4

 

161,901

 

7.8

 

Total year end assets

 

2,563,868

 

2,389,262

 

2,148,262

 

174,606

 

7.3

%

241,000

 

11.2

%

 

Bancorp has experienced growth in earning assets over the last several years primarily in the area of loans.  From 2013 to 2014, average loans increased 7.1%, or $117.3 million, compared to 7.2% or $110.2 million from 2012 to 2013.  Record loan production of approximately $537 million during 2014 due to increased calling efforts was largely offset by loan payoffs, including the effects of amortization and scheduled maturities.  Average securities available-for-sale increased $55.8 million, or 16.6% from 2013 to 2014, compared to $75.7 million, or 29.0% from 2012 to 2013 as Bancorp deployed funds from deposit growth into longer-term earning assets.

 

The increase in average interest bearing liabilities from 2013 to 2014 occurred primarily in money market and demand deposits as clients have excess cash and few short-term investment alternatives in the current environment.  Average total interest bearing deposit accounts increased 7.6% and non-interest bearing deposit accounts increased 14.4% in 2014.  Time deposits decreased 9.4% or $34.2 million in 2014, as Bancorp intentionally did not renew higher cost deposits.  Customers migrated from time deposits to demand deposits as low rates did not compensate them for giving up liquidity.  Bancorp continued to utilize fixed rate advances from the FHLB during 2014 as they compared favorably to similar term time deposits.  Bancorp had an average of $35.7 million in outstanding FHLB advances in 2014 compared to $32.5 million and $60.1 million in 2013 and 2012, respectively.  At December 31, 2014 and 2013, federal funds purchased from correspondent banks totaled $47.4 million and $55.3 million, respectively.

 

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Table of Contents

 

Average Balances and Interest Rates — Taxable Equivalent Basis

 

 

 

Year 2014

 

Year 2013

 

Year 2012

 

(Dollars in thousands)

 

Average
balances

 

Interest

 

Average
rate

 

Average
balances

 

Interest

 

Average
rate

 

Average
balances

 

Interest

 

Average
rate

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Earning assets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Federal funds sold

 

$

91,970

 

$

292

 

0.32

%

$

99,381

 

$

295

 

0.30

%

$

108,828

 

$

320

 

0.29

%

Mortgage loans held for sale

 

4,120

 

174

 

4.22

%

5,885

 

219

 

3.72

%

9,191

 

344

 

3.74

%

Securities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Taxable

 

334,293

 

7,308

 

2.19

%

281,734

 

5,836

 

2.07

%

210,948

 

5,419

 

2.57

%

Tax-exempt

 

58,605

 

1,677

 

2.86

%

55,385

 

1,643

 

2.97

%

50,430

 

1,691

 

3.35

%

FHLB stock and other securities

 

6,755

 

257

 

3.80

%

6,916

 

263

 

3.80

%

6,117

 

238

 

3.89

%

Loans, net of unearned income

 

1,764,100

 

80,352

 

4.55

%

1,646,787

 

79,216

 

4.81

%

1,536,620

 

80,592

 

5.24

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total earning assets

 

2,259,843

 

90,060

 

3.99

%

2,096,088

 

87,472

 

4.17

%

1,922,134

 

88,604

 

4.61

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Less allowance for loan losses

 

28,954

 

 

 

 

 

32,282

 

 

 

 

 

31,890

 

 

 

 

 

 

 

2,230,889

 

 

 

 

 

2,063,806

 

 

 

 

 

1,890,244

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Non-earning assets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and due from banks

 

37,504

 

 

 

 

 

33,888

 

 

 

 

 

31,695

 

 

 

 

 

Premises and equipment

 

39,223

 

 

 

 

 

38,691

 

 

 

 

 

37,634

 

 

 

 

 

Accrued interest receivable and other assets

 

90,814

 

 

 

 

 

96,483

 

 

 

 

 

111,394

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total assets

 

$

2,398,430

 

 

 

 

 

$

2,232,868

 

 

 

 

 

$

2,070,967

 

 

 

 

 

 

 

 

Year 2014

 

Year 2013

 

Year 2012

 

(Dollars in thousands)

 

Average
balances

 

Interest

 

Average
rate

 

Average
balances

 

Interest

 

Average
rate

 

Average
balances

 

Interest

 

Average
rate

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest bearing liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Deposits

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest bearing demand deposits

 

$

477,434

 

$

496

 

0.10

%

$

392,939

 

$

388

 

0.10

%

$

317,017

 

$

514

 

0.16

%

Savings deposits

 

108,386

 

40

 

0.04

%

96,515

 

39

 

0.04

%

78,640

 

61

 

0.08

%

Money market deposits

 

632,810

 

1,290

 

0.20

%

585,512

 

1,228

 

0.21

%

539,395

 

1,797

 

0.33

%

Time deposits

 

330,108

 

2,495

 

0.76

%

364,347

 

3,356

 

0.92

%

383,008

 

4,794

 

1.25

%

Securities sold under agreements to repurchase

 

61,748

 

140

 

0.23

%

60,737

 

146

 

0.24

%

59,861

 

180

 

0.30

%

Federal funds purchased and other short-term borrowings

 

18,211

 

29

 

0.16

%

19,546

 

32

 

0.16

%

19,431

 

31

 

0.16

%

FHLB advances

 

35,709

 

840

 

2.35

%

32,518

 

887

 

2.73

%

60,113

 

2,461

 

4.09

%

Long-term debt

 

 

 

 

30,477

 

3,090

 

10.14

%

31,474

 

3,113

 

9.89

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total interest bearing liabilities

 

1,664,406

 

5,330

 

0.32

%

1,582,591

 

9,166

 

0.58

%

1,488,939

 

12,951

 

0.87

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Non-interest bearing liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Non-interest bearing demand deposits

 

462,085

 

 

 

 

 

404,113

 

 

 

 

 

341,534

 

 

 

 

 

Accrued interest payable and other liabilities

 

26,514

 

 

 

 

 

26,057

 

 

 

 

 

42,943

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total liabilities

 

2,153,005

 

 

 

 

 

2,012,761

 

 

 

 

 

1,873,416

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Stockholders’ equity

 

245,425

 

 

 

 

 

220,107

 

 

 

 

 

197,551

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total liabilities and stockholders’ equity

 

$

2,398,430

 

 

 

 

 

$

2,232,868

 

 

 

 

 

$

2,070,967

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net interest income

 

 

 

$

84,730

 

 

 

 

 

$

78,306

 

 

 

 

 

$

75,653

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net interest spread

 

 

 

 

 

3.67

%

 

 

 

 

3.59

%

 

 

 

 

3.74

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net interest margin

 

 

 

 

 

3.75

%

 

 

 

 

3.74

%

 

 

 

 

3.94

%

 

Notes:

 

·                  Yields on municipal securities have been computed on a fully tax-equivalent basis using the federal income tax rate of 35%.

·                  The approximate tax-equivalent adjustments to interest income were $973,000, $1,008,000 and $1,703,000 for the years ended December 31, 2014, 2013 and 2012, respectively.

·                  Average balances for loans include the principal balance of non-accrual loans and exclude participation loans accounted for as secured borrowings.  These participation loans totaled $8,910,000, $9,990,000 and $27,298,000 for the years ended December 31, 2014, 2013 and 2012.

·                  Loan interest income includes loan fees and is computed on a fully tax-equivalent basis using the federal income tax rate of 35%.  Loan fees, net of deferred costs, included in interest income amounted to $790,000, $1,390,000 and $1,916,000 in 2014, 2013 and 2012, respectively. For 2012, $1,060,000 of the loans fees represented the prepayment penalty on a tax-equivalent basis of one loan payoff.

 

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Table of Contents

 

Securities

 

The primary purpose of the securities portfolio is to provide another source of interest income, as well as liquidity management. In managing the composition of the balance sheet, Bancorp seeks a balance between earnings sources and credit and liquidity considerations.

 

Securities available-for-sale include securities that may be sold in response to changes in interest rates, resultant prepayment risk and other factors related to interest rate and prepayment risk changes. Securities available-for-sale are carried at fair value with unrealized gains or losses, net of tax effect, included in stockholders’ equity.

 

The carrying value of securities available-for-sale is summarized as follows: