UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549

FORM 10-Q

x		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.
For the quarterly period ended September 30, 2006
		OR
o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from               to               .

Commission file number                                     0-17262

S.Y. BANCORP, INC.
(Exact name of registrant as specified in its charter)

 

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 is a large accelerated filer, an accelerated filer, or a non-accelerated filer.  See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o                 Accelerated filer x                            Non-accelerated filer 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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Common Stock, no par value — 14,446,220
Shares issued and outstanding at November 1, 2006

 

 

PART 1 — FINANCIAL INFORMATION

Item 1.  Financial Statements

The following consolidated financial statements of S.Y. Bancorp, Inc. and Subsidiary, Stock Yards Bank & Trust Company, are submitted herewith:

–                Unaudited Condensed Consolidated Balance Sheets
September 30, 2006 and December 31, 2005

–                Unaudited Condensed Consolidated Statements of Income
for the three and nine months ended September 30, 2006 and 2005

–                Unaudited Condensed Consolidated Statements of Cash Flows
for the nine months ended September 30, 2006 and 2005

–                Unaudited Condensed Consolidated Statement of Changes in Stockholders’ Equity
for the nine months ended September 30, 2006

–                Unaudited Condensed Consolidated Statement of Comprehensive Income 
for the three and nine months ended September 30, 2006 and 2005

–                Notes to Unaudited Condensed Consolidated Financial Statements

 

 

S.Y. BANCORP, INC. AND SUBSIDIARY
Unaudited Condensed Consolidated Balance Sheets
September 30, 2006 and December 31, 2005
(In thousands, except share data)

		September 30,			December 31,
		2006			2005
Assets
Cash and due from banks		$	37,073		$	34,082
Federal funds sold		275			9,957
Mortgage loans held for sale		4,069			7,444
Securities available for sale (amortized cost of $129,052 in 2006 and $158,371 in 2005)		127,655			156,950
Securities held to maturity (approximate fair value of $3,416 in 2006 and $4,180 in 2005)		3,397			4,124
Federal Home Loan Bank stock		3,540			3,391
Loans		1,116,799			1,053,871
Less allowance for loan losses		12,442			12,035
Net loans		1,104,357			1,041,836
Premises and equipment, net		24,970			25,187
Accrued interest receivable and other assets		48,557			47,467
Total assets		$	1,353,893		$	1,330,438
Liabilities and Stockholders’ Equity
Deposits:
Non-interest bearing		$	168,190		$	180,628
Interest bearing		898,774			850,729
Total deposits		1,066,964			1,031,357
Securities sold under agreements to repurchase and federal funds purchased		91,804			79,886
Other short-term borrowings		1,210			2,139
Accrued interest payable and other liabilities		29,219			30,490
Federal Home Loan Bank advances		30,000			40,000
Subordinated debentures		120			20,769
Total liabilities		1,219,317			1,204,641
Stockholders’ equity:
Preferred stock, no par value. Authorized 1,000,000 shares; no shares issued or outstanding		—			—
Common stock, no par value. Authorized 20,000,000 shares; issued and outstanding 14,441,852 and 13,815,837 shares in 2006 and 2005, respectively		9,016			6,931
Additional paid-in capital		28,990			14,773
Retained earnings		97,756			105,290
Accumulated other comprehensive loss		(1,186		)	(1,197		)
Total stockholders’ equity		134,576			125,797
Total liabilities and stockholders’ equity		$	1,353,893		$	1,330,438

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

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S.Y.  BANCORP, INC. AND SUBSIDIARY
Unaudited Condensed Consolidated Statements of Income
For the three and nine months ended September 30, 2006 and 2005
(In thousands, except per share data)

		For three months ended September 30,						For nine month ended September 30,
		2006			2005			2006			2005
Interest income:
Loans		$	20,402		$	16,974		$	58,429		$	47,934
Federal funds sold		206			63			771			290
Mortgage loans held for sale		66			89			177			240
Securities — taxable		1,047			1,088			3,297			3,139
Securities — tax-exempt		308			347			926			1,038
Total interest income		22,029			18,561			63,600			52,641
Interest expense:
Deposits		7,188			4,817			19,753			13,677
Securities sold under agreements to repurchase and federal funds purchased		642			419			1,628			1,027
Other short-term borrowings		278			8			296			24
Federal Home Loan Bank advances		312			124			959			389
Subordinated debentures		2			465			934			1,396
Total interest expense		8,422			5,833			23,570			16,513
Net interest income		13,607			12,728			40,030			36,128
Provision for loan losses		450			—			1,400			225
Net interest income after provision for loan losses		13,157			12,728			38,630			35,903
Non-interest income:
Investment management and trust services		2,882			2,618			8,600			8,065
Service charges on deposit accounts		2,188			2,240			6,596			6,289
Bankcard transaction revenue		509			436			1,495			1,242
Gains on sales of mortgage loans held for sale		339			324			946			980
Brokerage commissions and fees		460			533			1,559			1,574
Other		564			667			1,800			2,034
Total non-interest income		6,942			6,818			20,996			20,184
Non-interest expenses:
Salaries and employee benefits		6,314			6,063			19,692			18,365
Net occupancy expense		899			894			2,608			2,560
Data processing expense		929			910			2,819			2,748
Furniture and equipment expense		285			291			888			896
Amortization of issuance costs of trust preferred securities		879			9			897			26
State bank taxes		327			626			971			1,202
Other		2,213			2,086			6,939			6,717
Total non-interest expenses		11,846			10,879			34,814			32,514
Income before income taxes		8,253			8,667			24,812			23,573
Income tax expense		2,832			2,816			8,203			7,453
Net income		$	5,421		$	5,851		$	16,609		$	16,120
Net income per share:
Basic		$	0.38		$	0.40		$	1.15		$	1.10
Diluted		0.37			0.40			1.13			1.09
Average common shares:
Basic		14,426			14,569			14,471			14,605
Diluted		14,718			14,807			14,736			14,843

 

See accompanying notes to unaudited condensed consolidated financial statements.

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S.Y. BANCORP, INC. AND SUBSIDIARY
Unaudited Condensed Consolidated Statements of Cash Flows
For the nine months ended September 30, 2006 and 2005
(In thousands)

		2006			2005
Operating activities:
Net income		$	16,609		$	16,120
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses		1,400			225
Depreciation, amortization and accretion, net		2,264			2,459
Amortization of debt issuance cost		897			26
Gains on sales of mortgage loans held for sale		(946		)	(980		)
Origination of mortgage loans held for sale		(66,568		)	(82,640		)
Proceeds from sale of mortgage loans held for sale		70,889			82,301
Loss on the sale of premises and equipment		13			—
Bank owned life insurance income		674			660
Gain (loss) on the sale of other real estate		(15		)	8
Share-based compensation		469			—
Excess tax benefits from share-based compensation arrangements		(297		)	241
Increase in accrued interest receivable and other assets		(3,227		)	(3,591		)
Increase (decrease) in accrued interest payable and other liabilities		(1,344		)	6,760
Net cash provided by operating activities		20,818			21,589
Investing activities:
Purchases of securities available for sale		(40,618		)	(59,075		)
Proceeds from maturities of securities available for sale		69,744			47,922
Proceeds from maturities of securities held to maturity		725			859
Net increase in loans		(63,921		)	(41,406		)
Purchases of premises and equipment		(2,151		)	(1,791		)
Proceeds from sales of premises and equipment		138			—
Proceeds from sales of other real estate		567			753
Net cash used in investing activities		(35,516		)	(52,738		)
Financing activities:
Net increase in deposits		35,607			44,338
Net (decrease) increase in securities sold under agreements to repurchase and federal funds purchased		11,918			13,558
Net (decrease) increase in other short-term borrowings		(929		)	(175		)
Repayments of Federal Home Loan Bank advances		(10,000		)	(10,000		)
Repayments of subordinated debentures		(20,649		)	(30		)
Issuance of common stock for options and employee benefit plans		1,534			755
Excess tax benefits from share-based compensation arrangements		297			—
Common stock repurchases		(3,993		)	(4,498		)
Cash dividends paid		(5,778		)	(4,597		)
Net cash provided by financing activities		8,007			39,351
Net increase in cash and cash equivalents		(6,691		)	8,202
Cash and cash equivalents at beginning of period		44,039			31,547
Cash and cash equivalents at end of period		$	37,348		$	39,749
Supplemental cash flow information:
Income tax payments		$	5,860		$	7,475
Cash paid for interest		$	23,600		$	16,443
Supplemental non-cash activitiy:
Transfers from loans to other real estate owned		$	824		$	870

 

See accompanying notes to unaudited condensed consolidated financial statements.

4

S.Y. BANCORP, INC. AND SUBSIDIARY
Unaudited Condensed Consolidated Statement of Changes in Stockholders’ Equity
For the nine months ended September 30, 2006
(In thousands, except per share data)

													Accumulated
		Common stock											other
		Number of					Additional			Retained			comprehensive
		shares		Amount			Paid in Capital			earnings			loss			Total
Balance December 31, 2005		13,816		$	6,931		$	14,773		$	105,290		$	(1,197	)	$	125,797
Net income		—		—			—			16,609			—			16,609
Change in accumulated other comprehensive loss, net of tax		—		—			—			—			11			11
Stock compensation expense		—		—			469			—			—			469
5% stock dividend		690		2,301			15,694			(17,995		)	—			—
Stock issued for stock options exercised and employee benefit plans		96		306			1,525			—			—			1,831
Cash dividends, $0.42 per share		—		—			—			(6,148		)	—			(6,148		)
Shares repurchased		(160	)	(522		)	(3,471		)	—			—			(3,993		)
Balance September 30, 2006		14,442		$	9,016		$	28,990		$	97,756		$	(1,186	)	$	134,576

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

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S.Y. BANCORP, INC. AND SUBSIDIARY
Unaudited Condensed Consolidated Statements of Comprehensive Income
For the three and nine months ended September 30, 2006 and 2005
(In thousands)

		Three months ended September 30						Nine months ended September 30
		2006			2005			2006			2005
Net income		$	5,421		$	5,851		$	16,609		$	16,120
Other comprehensive gain (loss), net of tax:
Unrealized holding gains (losses) on securities available for sale arising during the period		1,171			(903		)	11			(1,115		)
Other comprehensive income (loss)		1,171			(903		)	11			(1,115		)
Comprehensive income		$	6,592		$	4,948		$	16,620		$	15,005

 

See accompanying notes to unaudited condensed consolidated financial statements.

6

S.Y.  BANCORP, INC. AND SUBSIDIARY

Notes to Unaudited Condensed Consolidated Financial Statements

(1)                     Summary of Significant Accounting Policies

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q and do not include all information and footnotes required by U.S. generally accepted accounting principles for complete financial statements.  The consolidated financial statements of S.Y. Bancorp, Inc. (“Bancorp”) and its subsidiary reflect all adjustments (consisting only of adjustments of a normal recurring nature) which are, in the opinion of management, necessary for a fair presentation of financial condition and results of operations for the interim periods.

The financial statements include the accounts of S.Y. Bancorp, Inc. and its wholly-owned subsidiary, Stock Yards Bank & Trust Company (“Bank”).  All significant intercompany transactions have been eliminated in consolidation. Bancorp also owns S.Y. Bancorp Capital Trust I (“Trust”), a Delaware statutory business trust that is a 100% owned finance subsidiary.  The Trust is not consolidated in the financial statements of Bancorp.  See note 4 to the financial statements below for more information on the Trust.

A description of other significant accounting policies is presented in the notes to the Consolidated Financial Statements for the year ended December 31, 2005 included in S.Y. Bancorp, Inc.’s Annual Report on Form 10-K.  Certain reclassifications have been made in the prior year financial statements to conform to current year classifications.

Interim results for the three and nine month periods ended September 30, 2006 are not necessarily indicative of the results for the entire year.

(a)                      Critical Accounting Policies

Management has identified the accounting policy related to the allowance for loan losses as critical to the understanding of Bancorp’s results of operations and discussed this conclusion with the Audit Committee of the board of directors. Since the application of this policy requires significant management assumptions and estimates, it could result in materially different amounts to be reported if conditions or underlying circumstances were to change. Assumptions include many factors such as changes in borrowers’ financial condition which can change quickly or historical loss ratios related to certain loan portfolios which may or may not be indicative of future losses. To the extent that management’s assumptions prove incorrect, the results from operations could be materially affected by a higher provision for loan losses. The accounting policy related to the allowance for loan losses is applicable to the commercial banking segment of Bancorp.

Additionally, management has identified the accounting policy related to accounting for income taxes as critical to the understanding of Bancorp’s results of operations and discussed this conclusion with the Audit Committee of the board of directors. The objectives of accounting for income taxes are to recognize the amount of taxes payable or refundable for the current year and deferred tax liabilities and assets for the future tax consequences of events that have been recognized in an entity’s financial statements or tax returns. Judgment is required in assessing the future tax consequences of events that have been recognized in Bancorp’s financial statements or tax returns. Fluctuations in the actual outcome of these future tax consequences, including the effects of periodic IRS and state agency examinations, could materially impact Bancorp’s financial position and its results from operations.

 

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(b)                      Securities

Unrealized losses on Bancorp’s bond portfolio have not been recognized in income because the bonds are of high credit quality, management has the intent and the ability to hold for the foreseeable future, and the decline in fair values is largely due to an increase in prevailing interest rates since the purchase date.  The fair value is expected to recover as the securities reach their maturity date and/or interest rates decline.  These investments consist of 62 and 32 separate investment positions as of September 30, 2006 and 2005, respectively that are not considered other-than-temporarily impaired.

(c)                       Stock-Based Compensation

Prior to January 1, 2006, Bancorp used the intrinsic value method as described in Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB No. 25”) to measure stock-based compensation.  Under the intrinsic value method, compensation expense was measured as the difference between the market value of the underlying shares and the price the employee is required to pay on the grant date, if any.  Since Bancorp granted options at the current value of shares as of date of grant, no compensation expense was recorded.

On January 1, 2006, Bancorp adopted the modified version of prospective application of Statement of Financial Statement No. 123 (R) “Share-based Payment”, (“SFAS No. 123R”).  Under this method, the fair value of all new and modified awards granted subsequent to the date of adoption will be recognized as compensation expense, net of estimated forfeitures.  Further, the fair value of any unvested awards at the date of adoption was recognized as compensation expense, net of estimated forfeitures.

Bancorp currently has one stock-based compensation plan. Bancorp’s 1995 Stock Incentive Plan expired in 2005; however, options granted under this plan expire as late as 2015. The 2005 Stock Incentive Plan reserved 735,000 shares of common stock for issuance of stock based awards.  As of September 30, 2006, there were 543,896 shares available for future awards.  Options granted have been subject to a vesting schedule of 20% per year except for those granted to certain executive officers which vest six months after grant date. All outstanding options were granted at an exercise price equal to the market value of common stock at the time of grant and expire ten years after the grant date.

The fair value of Bancorp’s stock options is estimated at the date of grant using the Black-Scholes option pricing model, a leading formula for calculating the value of stock options.  This model requires the input of subjective assumptions, changes to which can materially affect the fair value estimate.  As a result of applying the provisions of SFAS No. 123R, Bancorp recognized, within salaries and employee benefits in the unaudited condensed consolidated income statements, stock-based compensation expense of $469,000 before income taxes and a deferred tax benefit of $164,000 resulting in a reduction of net income of $305,000, or $0.02 per basic and diluted shares for the nine months ended September 30, 2006.  For the third quarter of 2006, Bancorp recognized $85,000 of compensation expense before taxes, a deferred tax benefit of $30,000 and a reduction of net income of $55,000, or less than $0.01 per basic and diluted shares. Bancorp expects to record an additional $56,000 of compensation expense in the fourth quarter of 2006 for outstanding stock options.  As of September 30, 2006 Bancorp has $698,000 of unrecognized stock-based compensation expense that will be recorded as compensation expense over the next 4.25 years, the weighted-average remaining

 

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life of these options.  Bancorp received cash of $1,534,000 from the exercise of options during the first nine months of 2006.

In accordance with the Financial Accounting Standards Board Staff Position SFAS No. 123R—3, “Transition Election to Accounting for the Tax Effects of Share-Based Payment Awards”, Bancorp has elected the alternative transition method to calculate the beginning balance of the pool of excess tax benefits.  The beginning balance of excess tax benefits was calculated as the sum of all net increases in additional paid-in-capital related to tax benefits from stock-based employee compensation, less the incremental stock-based after-tax compensation costs that would have been recognized if the fair value recognition provisions of SFAS No. 123 had been used to account for stock-based compensation costs.

Prior to the adoption of SFAS No. 123R, Bancorp presented all tax benefits of deductions resulting from the exercise of share-based awards as operating cash inflows in the unaudited condensed consolidated statement of cash flows.  SFAS No. 123R requires the cash flows resulting from excess tax deductions related to the compensation costs recognized for the share-based awards be classified as financing cash inflows.  Cash flows provided by financing activities relating to excess tax benefits from share-based compensation arrangements increased by $297,000 and cash flows used in operating activities decreased by $297,000 for the nine months ended September 30, 2006. Cash flows relating to tax benefits from the exercise of stock options were previously reported as operating activities.

Had compensation cost for Bancorp’s stock-based compensation plan been determined using the fair value method as described in SFAS No. 123, Bancorp’s net income and earnings per share for the three and nine months periods ended September 30, 2005 would have approximated the pro forma amounts indicated below:

 

The weighted average fair value of each stock option included in the preceding pro forma amounts was estimated using a Black-Scholes option-pricing model and is amortized over the vesting period of the underlying options.

 

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Under SFAS No. 123, Bancorp recognized actual forfeitures as they occurred within the above pro forma income calculation.  Under SFAS No. 123R, Bancorp is required to reduce future stock-based compensation expense by estimated forfeitures at the grant date.  These forfeiture estimates are based on historical experience.

The following assumptions were used in option valuations:

 

The expected life of options is based on actual experience of past like-term options.  All outstanding options have a 10-year contractual term.  Bancorp evaluated historical exercise and post-vesting termination behavior when determining the expected life of 7.7 and 7.0 years for options granted during the first nine months of 2006 and 2005, respectively.

The dividend yield and expected volatility are based on historical information corresponding to the expected life of options granted.  The expected volatility is the volatility of the underlying shares for the expected term on a quarterly basis.

The risk free interest rate is the implied yield currently available on U. S. Treasury issues with a remaining term equal to the expected life of the options.

A summary of stock option activity and related information for the nine months ended September 30, 2006 follows.  The number of options and aggregate intrinsic value are stated in thousands of dollars.

 

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																Weighted
							Weighted						Weighted			Average
							Average			Aggregate			Average			Remaining
							Exercise			Intrinsic			Fair			Contractual
		Options		Exercise Price			Price			Value			Value			Life
At December 31, 2005
Vested and exercisable		834		$	6.90-$22.96		$	16.31		$	9,312		$	3.40
Unvested		8		16.00-20.90			19.80			66			4.52
Total outstanding		842		6.90-22.96			16.34			9,378			3.41
Vested		57		18.05-24.07			23.91			1,356			5.77
Granted		196		24.07			24.07			4,726			5.81
Exercised		66		6.90-22.96			13.19			1,127			2.62
Forfeited		7		24.07			24.07			164			5.81
At September 30, 2006
Vested and exercisable		824		6.90-24.07			17.08			14,069			3.63			5.89
Unvested		141		16.00-24.07			23.87			3,376			5.75			9.21
Total outstanding		965		6.90-24.07			18.08			$	17,445		3.94			6.38

 

On January 17, 2006, Bancorp granted 196,350 options to purchase common stock shares at the current market price of $24.07.  These options were awarded to employees and will primarily vest 20% per year over the next five years.  Of these options, 54,600 were granted to certain executive officers that vested in the third quarter, six months from the date of grant.  All options expire ten years from the date of grant.

On December 31, 2005, the Board of Directors of Bancorp accelerated the vesting of all employee stock options outstanding.  This resulted in the accelerated vesting of approximately 190,000 options to purchase shares of common stock of Bancorp.  The Board approved the accelerated vesting to reduce future compensation expense that Bancorp would otherwise be required to report in its consolidated financial statements upon adoption of SFAS No. 123R.  By vesting these stock options early, Bancorp avoided recognizing approximately $1,000,000 in expense over future vesting periods.  There are 8,000 options granted to non-employee directors that continue to vest on their original terms.  In the fourth quarter of 2006, 2,100 of these options will vest.

 

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(2)                     Allowance for Loan Losses

An analysis of the changes in the allowance for loan losses for the nine months ended September 30 follows (in thousands):

 

(3)                     Federal Home Loan Bank Advances

Under a blanket collateral agreement with the Federal Home Loan Bank of Cincinnati and secured by certain residential real estate loans, the Bank has outstanding borrowings of $30,000,000 via two separate fixed rate, non-callable advances of $10,000,000 and $20,000,000, which are due in February of 2007 and October of 2008, respectively, with a weighted average rate of 4.13%.  Interest payments are due monthly, with principal due at maturity.

(4)                     Subordinated Debentures

On June 1, 2001, S.Y. Bancorp Capital Trust I, a Delaware statutory business trust and 100%-owned finance subsidiary of Bancorp, issued $20.0 million of 9.00% Cumulative Trust Preferred Securities (“Securities”).  The principal asset of the Trust I was a $20.0 million subordinated debenture of Bancorp, and Bancorp owned all of the common securities of the Trust.  The securities and subordinated debenture bore interest at the rate of 9.00% and would have matured June 30, 2031, subject to prior redemption under certain circumstances.  The Securities, the assets of the Trust, and the common securities issued by the Trust were redeemable in whole or in part on or after June 30, 2006, or at any time in whole, but not in part, from the date of issuance upon the occurrence of certain events.  The Securities were included in Tier 1 capital for regulatory capital adequacy determination purposes, subject to certain limitations.  The obligations of Bancorp with respect to the issuance of the Securities constituted a full and unconditional guarantee by Bancorp of the Trust’s obligation with respect to the Securities.

On July 1, 2006, Bancorp redeemed these securities at par value.  Remaining unamortized issuance costs of $879,000 were recognized as non-interest expense in the third quarter of 2006.

The Bank also had subordinated debentures outstanding amounting to $120,000 at September 30, 2006 and $150,000 at December 31, 2005. Interest due on these debentures is at a variable rate equal to one percent less than the Bank’s prime rate adjusted annually on January 1.  The rate for the debentures was 6.25% and 4.25% for 2006 and 2005, respectively. The debentures are subordinated to the claims of creditors and depositors of the Bank and are subject to redemption by the Bank at the principal amount outstanding, upon the earlier of the death of the registered owners, or an event of default by the registered owners with respect to loans from the Bank.  While the debentures mature in 2049, the owners may redeem the debentures at any time.

 

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(5)                     Intangible Assets

Statement of Financial Accounting Standards No. 142, “Goodwill and Intangible Assets” (“SFAS No. 142”), requires that goodwill and intangible assets with indefinite useful lives no longer be amortized, but instead be tested for impairment at least annually.  Annual evaluations have resulted in no charges for impairment.  Bancorp currently has goodwill from the acquisition of a bank in southern Indiana in the amount of $682,000.  This goodwill is assigned to the commercial banking segment of Bancorp.

(6)                     Defined Benefit Retirement Plan

The Bank sponsors an unfunded, non-qualified, defined benefit retirement plan for certain key officers.  Benefits vest based on years of service.  The Bank does not make contributions to this plan.  Information about the components of the net periodic benefit cost of the defined benefit plan follows:

 

 

(7)                     Commitments to Extend Credit

As of September 30, 2006, Bancorp had various commitments outstanding that arose in the normal course of business, including standby letters of credit and commitments to extend credit, which are properly not reflected in the financial statements. In management’s opinion, commitments to extend credit of $387,587,000, and standby letters of credit of $16,491,000, represent normal banking transactions, and no significant losses are anticipated to result from these commitments as of September 30, 2006. Commitments to extend credit were $322,132,000, and letters of credit were $13,453,000, as of December 31, 2005. Bancorp’s exposure to credit loss in the event of nonperformance by the other party to these commitments is represented by the contractual amount of these instruments. Bancorp uses the same

 

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credit and collateral policies in making commitments and conditional guarantees as for on-balance sheet instruments.

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses. Commitments to extend credit are primarily made up of commercial lines of credit, construction and development loans and home equity credit lines. Since some of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Bancorp evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by Bancorp upon extension of credit, is based on management’s credit evaluation of the customer. Collateral held varies but may include accounts receivable, inventory, property, plant and equipment, income-producing commercial properties, residential properties and other real estate under development.

Standby letters of credit and financial guarantees written are conditional commitments issued by Bancorp to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support private borrowing arrangements.

(8)                     Preferred Stock

At Bancorp’s annual meeting of shareholders held in April 2003, the shareholders approved an amendment to the Articles of Incorporation to create a class of preferred stock and authorize 1,000,000 shares of this preferred stock with no par value.  The relative rights, preferences and other terms of this stock or any series within the class will be determined by the Board of Directors prior to any issuance.  Some of this preferred stock will be used in connection with a shareholders’ rights plan upon the occurrence of certain triggering events.  None of this stock had been issued as of September 30, 2006.

(9)                     Stock Dividend

On April 26, 2006 Bancorp declared a 5% stock dividend to shareholders of record on May 10, 2006 payable May 26, 2006.  Share and per share information has been adjusted as appropriate for this dividend.

 

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(10)              Net Income Per Share

The following table reflects, for the three and nine month periods ended September 30, 2006 and 2005, net income (the numerator) and average shares outstanding (the denominator) for the basic and diluted net income per share computations (in thousands except per share data):

 

 

(11)              Segments

The Bank’s, and thus Bancorp’s, principal activities include commercial banking and investment management and trust.  Commercial banking provides a full range of loan and deposit products to individual consumers and businesses.  Commercial banking also includes the Bank’s mortgage banking and brokerage activity.  Investment management and trust provides wealth management services including investment management, trust and estate administration, and retirement plan services.

The financial information for each business segment reflects that which is specifically identifiable or allocated based on an internal allocation method.  Income taxes are allocated based on the effective federal tax rate. The provision for loan losses has been allocated to the commercial banking segment.  The measurement of the performance of the business segments is based on the management structure of the Bank and is not necessarily comparable with similar information for any other financial institution.  The information presented is also not necessarily indicative of the segments’ operations, if they were independent entities.

Selected financial information by business segment for the quarter and nine months ended September 30, 2006 and 2005 follows:

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		Three months						Nine months
		ended September 30						ended September 30
		2006			2005			2006			2005
		(In thousands)						(In thousands)
Net interest income:
Commercial banking		$	13,638		$	12,700		$	40,082		$	35,981
Investment management and trust		(31		)	28			(52		)	147
Total		$	13,607		$	12,728		$	40,030		$	36,128
Non-interest income:
Commercial banking		$	4,060		$	4,200		$	12,396		$	12,119
Investment management and trust		2,882			2,618			8,600			8,065
Total		$	6,942		$	6,818		$	20,996		$	20,184
Non-interest expense:
Commercial banking		$	10,508		$	9,434		$	30,570		$	28,289
Investment management and trust		1,338			1,445			4,244			4,225
Total		$	11,846		$	10,879		$	34,814		$	32,514
Tax expense
Commercial banking		$	2,303		$	2,396		$	6,697		$	6,057
Investment management and trust		529			420			1,506			1,396
Total		$	2,832		$	2,816		$	8,203		$	7,453
Net income:
Commercial banking		$	4,437		$	5,070		$	13,811		$	13,529
Investment management and trust		984			781			2,798			2,591
Total		$	5,421		$	5,851		$	16,609		$	16,120

 

Principally, all of the net assets of S.Y. Bancorp, Inc. are involved in the commercial banking segment.

 

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S.Y.BANCORP, INC. AND SUBSIDIARY

Item 2.     Management’s Discussion and Analysis of Financial Condition and Results of Operations

This item discusses the results of operations for S.Y. Bancorp, Inc. (“Bancorp” or “Company”), and its subsidiary, Stock Yards Bank & Trust Company (“Bank”) for the three and nine month periods ended September 30, 2006 and compares those periods with the same periods of the previous year. Unless otherwise indicated, all references in this discussion to the Bank include Bancorp. In addition, the discussion describes the significant changes in the financial condition of Bancorp and the Bank that has occurred during the first nine months of 2006 compared to December 31, 2005. This discussion should be read in conjunction with the unaudited condensed consolidated financial statements and accompanying notes presented in Part 1, Item 1 of this report.

This report contains forward-looking statements under the Private Securities Litigation Reform Act that involve risks and uncertainties. Although Bancorp believes the assumptions underlying the forward-looking statements contained herein are reasonable, any of these assumptions could be inaccurate. Factors that could cause actual results to differ from results discussed in forward-looking statements include, but are not limited to the following: economic conditions both generally and more specifically in the markets in which Bancorp and 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, results of operations, or financial condition of Bancorp’s customers; other risks detailed in Bancorp’s filings with the Securities and Exchange Commission, all of which are difficult to predict and many of which are beyond the control of Bancorp.

Overview of 2006 through September 30

For the third quarter of 2006 Bancorp’s net income decreased from the same period in 2005 by $430,000, or 7%. For the nine month period ended September 30, 2006, net income increased 3% from the same period in 2005.

Highlights of the third quarter included a higher level of net interest income year over year, underscoring continued growth in the Company’s loan portfolio, together with a slight increase in net interest margin versus the year-earlier quarter.  Non-interest income also continued to increase year over year, primarily on the strength of fee income for investment management and trust services. During the third quarter, Bancorp redeemed its $20 million 9% cumulative trust preferred securities and expensed $879,000 of corresponding unamortized issuance costs compared to $9,000 of amortization expense in the prior year quarter.  Also, Bancorp recorded $450,000 provision for loan losses, compared with zero in the year-earlier quarter.  Finally, Bancorp recognized stock option expense in the third quarter totaling $85,000; no such expense was recorded in the prior-year quarter.

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 the rates paid on those deposits directly impacts profitability. Business volumes are influenced by overall economic factors including market interest rates, business spending, consumer confidence and competitive conditions within the marketplace.

Net interest income was up 7% for the third quarter and 11% year to date compared to the same periods of 2005, due to improved net interest margin and loan growth. Net interest margin for the third quarter of 2006 improved four basis points compared to the same quarter last year and declined two basis points compared to the second quarter of 2006. With approximately half of the loan portfolio comprised of variable rate loans, increases in rates earned on loans out paced increases in rates paid on deposits as the Federal Reserve Bank increased interest rates.  Also, the Bank was able to hold down deposit costs as market interest rates increased. As prevailing market rates have stopped rising, the net interest margin is likely to narrow as deposit rates increase.

 

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With fee income from investment management and trust services, Bancorp has a higher than industry average proportion of non-interest revenues which also has fueled net income growth. Compared to the same periods of last year, total non-interest income grew 2% for the third quarter and 4% in the first nine months. Growth in non-interest income was more than offset by growth in non-interest expenses, which were up 9% in the third quarter and 7% in the first nine months of 2006 compared to 2005.  Salaries and employee benefits are the largest component of non-interest expenses and these expenses increased due to annual compensations increases, new share-based compensation expense, and rising benefit costs.  The write off of unamortized debt issuance costs also impacted non interest expense totals in 2006. The Company’s efficiency ratio increased to 56.9% compared to 53.9% in the second quarter of 2006 and 55.1% in the third quarter last year.

Operating results in 2006 were affected by a higher provision for loan losses. Net charge-offs for the first nine months of 2006 were nine basis points of average loans. Non-performing loans at September 30, 2006 decreased to 0.61% of total loans compared to 0.67% at the end of the second quarter of 2006. At the end of the third quarter of 2005, non-performing loans to total loans was 0.38%.  Bancorp’s process of evaluating the credit risk inherent in the loan portfolio considers data including non-performing loans, past due loans, charge offs, internal watch lists, the nature of the Bank’s loan portfolio and relevant economic data. Taking into consideration all relevant data, management provided $450,000 in the third quarter and $1,400,000 in the first nine months of 2006. Management considers the allowance for loan losses adequate to cover losses inherent in the loan portfolio at September 30, 2006.

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

a)             Results Of Operations

Net income of $5,421,000 for the three months ended September 30, 2006 decreased $430,000, or 7%, from $5,851,000 for the comparable 2005 period.  Basic net income per share was $0.38 for the third quarter of 2006, a decrease of 5% from the $0.40 for the same period in 2005.  Net income per share on a diluted basis was $0.37 for the third quarter of 2006 compared to $0.40 for the third quarter of 2005; an 8% decrease.  Annualized return on average assets and annualized return on average stockholders’ equity were 1.60% and 16.29%, respectively, for the third quarter of 2006, compared to 1.83% and 18.77%, respectively, for the same period in 2005.

Net income of $16,609,000 for the nine months ended September 30, 2006 increased $489,000, or 3%, from $16,120,000 from the comparable 2005 period.  Basic net income per share was $1.15 for the first nine months of 2006, an increase of 5% from the $1.10 for the same period in 2005.  Net income per share on a diluted basis was $1.13 for the first nine months of 2006 compared to $1.09 for the first nine months of 2005.  This represents a 4% increase.  Annualized return on average assets and annualized return on average stockholders’ equity were 1.65% and 17.03%, respectively, for the first nine months of 2006, compared to 1.71% and 17.90%, respectively, for the same period in 2005.

Net Interest Income

The following tables present the average balance sheets for the three and nine month periods ended September 30, 2006 and 2005 along with the related calculation of tax-equivalent net interest income, net interest margin and net interest spread for the related periods.  See the notes following the tables for further explanation.

 

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		Three months ended September 30
		2006								2005
		Average						Average		Average						Average
(Dollars in thousands)		Balances			Interest			Rate		Balances			Interest			Rate
Earning assets:
Federal funds sold		$	16,090		$	206		5.08	%	$	7,733		$	63		3.23	%
Mortgage loans held for sale		3,878			66			6.75	%	6,305			89			5.60	%
Securities:
Taxable		98,662			995			3.90	%	104,413			1,048			3.98	%
Tax-exempt		32,073			441			5.47	%	36,037			496			5.46	%
FHLB stock		3,509			52			5.88	%	3,316			40			4.79	%
Loans, net of unearned income		1,097,176			20,527			7.42	%	1,019,737			17,018			6.62	%
Total earning assets		1,251,388			22,287			7.05	%	1,177,541			18,754			6.32	%
Less allowance for loan losses		12,515								12,556
		1,238,873								1,164,985
Non-earning assets:
Cash and due from banks		34,524								34,877
Premises and equipment		24,982								25,913
Accrued interest receivable and other assets		49,275								44,115
Total assets		$	1,347,654							$	1,269,890

 

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		Three months ended September 30
		2006								2005
		Average						Average		Average						Average
(Dollars in thousands)		Balances			Interest			Rate		Balances			Interest			Rate
Interest bearing liabilities:
Deposits:
Interest bearing demand deposits		$	216,577		$	793		1.45	%	$	236,818		$	686		1.15	%
Savings deposits		46,403			74			0.63	%	47,400			55			0.46	%
Money market deposits		178,804			1,648			3.66	%	163,464			993			2.41	%
Time deposits		443,510			4,673			4.18	%	374,490			3,083			3.27	%
Securities sold under agreements to repurchase and federal funds purchased		79,932			642			3.19	%	84,593			419			1.97	%
Other short-term borrowings		18,166			278			6.07	%	1,074			8			2.96	%
FHLB advances		30,000			312			4.13	%	20,178			124			2.44	%
Long-term debt		344			2			2.33	%	20,591			465			8.96	%
Total interest bearing liabilities		1,013,736			8,422			3.30	%	948,608			5,833			2.44	%
Non-interest bearing liabilities:
Non-interest bearing demand deposits		174,815								174,356
Accrued interest payable and other liabilities		27,037								23,234
Total liabilities		1,215,588								1,146,198
Stockholders’ equity		132,066								123,692
Total liabilities and stockholders’ equity		$	1,347,654							$	1,269,890
Net interest income					$	13,865							$	12,921
Net interest spread								3.75	%							3.88	%
Net interest margin								4.39	%							4.35	%

 

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		Nine months ended September 30
		2006								2005
		Average						Average		Average						Average
(Dollars in thousands)		Balances			Interest			Rate		Balances			Interest			Rate
Earning assets:
Federal funds sold		$	22,209		$	771		4.64	%	$	13,782		$	290		2.81	%
Mortgage loans held for sale		3,589			177			6.59	%	5,884			240			5.45	%
Securities:
Taxable		105,152			3,148			3.91	%	100,856			3,023			4.01	%
Tax-exempt		32,771			1,325			5.43	%	36,336			1,487			5.47	%
FHLB stock		3,459			149			5.76	%	3,277			116			4.73	%
Loans, net of unearned income		1,082,517			58,777			7.26	%	1,006,744			48,146			6.39	%
Total earning assets		1,249,697			64,347			6.87	%	1,166,879			53,302			6.11	%
Less allowance for loan losses		12,337								12,737
		1,237,360								1,154,142
Non-earning assets:
Cash and due from banks		34,069								33,920
Premises and equipment		25,079								26,087
Accrued interest receivable and other assets		47,667								42,752
Total assets		$	1,344,175							$	1,256,901

 

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		Nine months ended September 30
		2006								2005
		Average						Average		Average						Average
(Dollars in thousands)		Balances			Interest			Rate		Balances			Interest			Rate
Interest bearing liabilities:
Deposits:
Interest bearing demand deposits		$	224,709		$	2,383		1.42	%	$	247,361		$	2,089		1.13	%
Savings deposits		47,409			223			0.63	%	46,718			143			0.41	%
Money market deposits		179,538			4,428			3.30	%	164,011			2,663			2.17	%
Time deposits		428,260			12,719			3.97	%	367,483			8,782			3.20	%
Securities sold under agreements to repurchase and federal funds purchased		78,730			1,628			2.76	%	77,772			1,027			1.77	%
Other short-term borrowings		6,595			296			6.00	%	983			24			3.26	%
FHLB advances		32,125			959			3.99	%	21,978			389			2.37	%
Long-term debt		13,941			934			8.83	%	20,771			1,396			8.99	%
Total interest bearing liabilities		1,011,307			23,570			3.11	%	947,077			16,513			2.33	%
Non-interest bearing liabilities:
Non-interest bearing demand deposits		173,619								167,058
Accrued interest payable and other liabilities		28,892								22,360
Total liabilities		1,213,818								1,136,495
Stockholders’ equity		130,357								120,406
Total liabilities and stockholders’ equity		$	1,344,175							$	1,256,901
Net interest income					$	40,777							$	36,789
Net interest spread								3.76	%							3.78	%
Net interest margin								4.35	%							4.22	%

 

 

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