Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 

FORM 10-Q

 

x                   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

 

For the quarterly period ended September 30, 2008

 

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 1-13661

 

S.Y. BANCORP, INC.

(Exact name of registrant as specified in its charter)

 

Kentucky

 

61-1137529

(State or other jurisdiction of

 

(I.R.S. Employer

incorporation or organization)

 

Identification No.)

 

1040 East Main Street, Louisville, Kentucky 40206

(Address of principal executive offices including zip code)

 

(502) 582-2571

(Registrant’s telephone number, including area code)

 

Not Applicable

(Former name, former address and former fiscal year,

if changed since last report)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes x   No 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 (Do not check if a smaller reporting company)

o

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

 

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 13,461,890

Shares issued and outstanding at October 30, 2008

 

 

 



Table of Contents

 

S.Y. BANCORP, INC. AND SUBSIDIARY

 

Index

 

PART I – 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, 2008 and December 31, 2007

 

 

 

 

Unaudited Condensed Consolidated Statements of Income

 

 

for the three months and nine months ended September 30, 2008 and 2007

 

 

 

 

Unaudited Condensed Consolidated Statements of Cash Flows

 

 

for the nine months ended September 30, 2008 and 2007

 

 

 

 

Unaudited Condensed Consolidated Statement of Changes in Stockholders’ Equity

 

 

for the nine months ended September 30, 2008

 

 

 

 

Unaudited Condensed Consolidated Statements of Comprehensive Income

 

 

for the three and nine months ended September 30, 2008 and 2007

 

 

 

 

Notes to Unaudited Condensed Consolidated Financial Statements

 

 

 

 

Item 2.

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

 

 

 

 

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

 

 

 

 

Item 4.

Controls and Procedures

 

 

 

 

PART II – OTHER INFORMATION

 

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

 

 

 

 

Item 6.

Exhibits

 

 

1



Table of Contents

 

S.Y. BANCORP, INC. AND SUBSIDIARY

Unaudited Condensed Consolidated Balance Sheets
September 30, 2008 and December 31, 2007

(In thousands, except share data)

 

 

 

September 30,

 

December 31,

 

 

 

2008

 

2007

 

 

 

(Unaudited)

 

 

 

Assets

 

 

 

 

 

Cash and due from banks

 

$

35,545

 

$

38,907

 

Federal funds sold

 

21,571

 

422

 

Mortgage loans held for sale

 

2,216

 

4,771

 

Securities available for sale (amortized cost of $203,630 in 2008 and $161,927 in 2007)

 

203,783

 

162,549

 

Securities held to maturity (fair value of $46 in 2008 and $1,128 in 2007)

 

44

 

1,129

 

Federal Home Loan Bank stock

 

4,324

 

3,931

 

Loans

 

1,316,661

 

1,201,938

 

Less allowance for loan losses

 

14,785

 

13,450

 

Net loans

 

1,301,876

 

1,188,488

 

Premises and equipment, net

 

28,239

 

27,195

 

Bank owned life insurance

 

23,895

 

23,122

 

Accrued interest receivable and other assets

 

31,963

 

31,705

 

Total assets

 

$

1,653,456

 

$

1,482,219

 

 

 

 

 

 

 

Liabilities and Stockholders’ Equity

 

 

 

 

 

Deposits:

 

 

 

 

 

Non-interest bearing

 

$

184,647

 

$

170,477

 

Interest bearing

 

1,081,319

 

936,230

 

Total deposits

 

1,265,966

 

1,106,707

 

Securities sold under agreements to repurchase and federal funds purchased

 

98,520

 

108,699

 

Other short-term borrowings

 

15,435

 

10,665

 

Accrued interest payable and other liabilities

 

34,565

 

33,034

 

Federal Home Loan Bank advances

 

90,000

 

90,000

 

Subordinated debentures

 

10,060

 

90

 

Total liabilities

 

1,514,546

 

1,349,195

 

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 13,457,080 and 13,599,563 shares in 2008 and 2007, respectively

 

5,747

 

6,214

 

Additional paid-in capital

 

7,158

 

9,821

 

Retained earnings

 

126,146

 

116,906

 

Accumulated other comprehensive income (loss)

 

(141

)

83

 

Total stockholders’ equity

 

138,910

 

133,024

 

Total liabilities and stockholders’ equity

 

$

1,653,456

 

$

1,482,219

 

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

2



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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, 2008 and 2007

(In thousands, except per share data)

 

 

 

For three months ended

 

For nine months ended

 

 

 

September 30,

 

September 30,

 

 

 

2008

 

2007

 

2008

 

2007

 

Interest income:

 

 

 

 

 

 

 

 

 

Loans

 

$

20,254

 

$

21,290

 

$

60,636

 

$

63,164

 

Federal funds sold

 

313

 

168

 

452

 

756

 

Mortgage loans held for sale

 

39

 

57

 

187

 

181

 

Securities – taxable

 

1,423

 

1,294

 

3,625

 

3,516

 

Securities – tax-exempt

 

259

 

263

 

743

 

822

 

Total interest income

 

22,288

 

23,072

 

65,643

 

68,439

 

Interest expense:

 

 

 

 

 

 

 

 

 

Deposits

 

6,342

 

7,855

 

19,003

 

23,540

 

Securities sold under agreements to repurchase and federal funds purchased

 

274

 

799

 

1,004

 

2,151

 

Other short-term borrowings

 

169

 

11

 

396

 

17

 

Federal Home Loan Bank advances

 

1,037

 

854

 

3,096

 

2,236

 

Subordinated debentures

 

1

 

2

 

3

 

5

 

Total interest expense

 

7,823

 

9,521

 

23,502

 

27,949

 

Net interest income

 

14,465

 

13,551

 

42,141

 

40,490

 

Provision for loan losses

 

900

 

850

 

3,100

 

2,090

 

Net interest income after provision for loan losses

 

13,565

 

12,701

 

39,041

 

38,400

 

Non-interest income:

 

 

 

 

 

 

 

 

 

Investment management and trust services

 

2,885

 

3,227

 

9,400

 

9,760

 

Service charges on deposit accounts

 

2,196

 

2,260

 

6,305

 

6,482

 

Bankcard transaction revenue

 

662

 

596

 

1,974

 

1,728

 

Gains on sales of mortgage loans held for sale

 

366

 

227

 

999

 

874

 

Loss on sales of securities available for sale

 

(607

)

 

(607

)

 

Brokerage commissions and fees

 

413

 

498

 

1,298

 

1,443

 

Bank owned life insurance income

 

263

 

250

 

773

 

733

 

Other

 

396

 

498

 

1,347

 

1,470

 

Total non-interest income

 

6,574

 

7,556

 

21,489

 

22,490

 

Non-interest expenses:

 

 

 

 

 

 

 

 

 

Salaries and employee benefits

 

6,824

 

6,865

 

21,318

 

20,104

 

Net occupancy expense

 

1,121

 

917

 

3,166

 

2,737

 

Data processing expense

 

840

 

979

 

2,488

 

3,045

 

Furniture and equipment expense

 

290

 

291

 

842

 

873

 

State bank taxes

 

340

 

326

 

994

 

815

 

Other

 

2,505

 

2,149

 

7,295

 

6,811

 

Total non-interest expenses

 

11,920

 

11,527

 

36,103

 

34,385

 

Income before income taxes

 

8,219

 

8,730

 

24,427

 

26,505

 

Income tax expense

 

2,776

 

2,843

 

7,817

 

8,617

 

Net income

 

$

5,443

 

$

5,887

 

$

16,610

 

$

17,888

 

Net income per share:

 

 

 

 

 

 

 

 

 

Basic

 

$

0.41

 

$

0.42

 

$

1.24

 

$

1.25

 

Diluted

 

0.40

 

0.41

 

1.22

 

1.23

 

Average common shares:

 

 

 

 

 

 

 

 

 

Basic

 

13,435

 

14,185

 

13,432

 

14,299

 

Diluted

 

13,652

 

14,400

 

13,615

 

14,525

 

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

3



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S.Y. BANCORP, INC. AND SUBSIDIARY

Unaudited Condensed Consolidated Statements of Cash Flows
For the nine months ended September 30, 2008 and 2007

(In thousands)

 

 

 

2008

 

2007

 

Operating activities:

 

 

 

 

 

Net income

 

$

16,610

 

$

17,888

 

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

 

 

 

 

 

Provision for loan losses

 

3,100

 

2,090

 

Depreciation, amortization and accretion, net

 

1,884

 

1,930

 

Deferred income tax benefit

 

(630

)

(505

)

Loss on sale of securities available for sale

 

607

 

 

Gains on sales of mortgage loans held for sale

 

(999

)

(874

)

Origination of mortgage loans held for sale

 

(76,633

)

(59,917

)

Proceeds from sale of mortgage loans held for sale

 

80,187

 

61,730

 

Bank owned life insurance income

 

(773

)

(733

)

Gain (loss) on the sale of other real estate

 

(3

)

28

 

Stock compensation expense

 

534

 

386

 

Excess tax benefits from share-based compensation arrangements

 

(108

)

(33

)

Increase in accrued interest receivable and other assets

 

(72

)

(9,498

)

Increase (decrease) in accrued interest payable and other liabilities

 

1,471

 

(3

)

Net cash provided by operating activities

 

25,175

 

12,489

 

Investing activities:

 

 

 

 

 

Purchases of securities available for sale

 

(243,762

)

(62,029

)

Proceeds from sale of securities available for sale

 

3,344

 

 

Proceeds from maturities of securities available for sale

 

197,674

 

62,985

 

Proceeds from maturities of securities held to maturity

 

1,084

 

1,054

 

Net increase in loans

 

(117,649

)

(6,946

)

Purchases of premises and equipment

 

(2,940

)

(2,169

)

Proceeds from sale of other real estate

 

1,907

 

3,122

 

Net cash used in investing activities

 

(160,342

)

(3,983

)

Financing activities:

 

 

 

 

 

Net increase (decrease) in deposits

 

159,259

 

(35,813

)

Net increase (decrease) in securities sold under agreements to repurchase and federal funds purchased

 

(10,179

)

8,967

 

Net increase in other short-term borrowings

 

4,770

 

267

 

Proceeds from Federal Home Loan Bank advances

 

 

20,000

 

Repayments of Federal Home Loan Bank advances

 

 

(10,000

)

Issuance of subordinated debentures

 

10,000

 

 

Repayments of subordinated debentures

 

(30

)

(30

)

Issuance of common stock for options and dividend reinvestment plan

 

1,085

 

1,089

 

Excess tax benefits from share-based compensation arrangements

 

108

 

33

 

Common stock repurchases

 

(5,382

)

(12,211

)

Cash dividends paid

 

(6,677

)

(6,608

)

Net cash provided by (used in) financing activities

 

152,954

 

(34,306

)

Net increase (decrease) in cash and cash equivalents

 

17,787

 

(25,800

)

Cash and cash equivalents at beginning of period

 

39,329

 

59,678

 

Cash and cash equivalents at end of period

 

$

57,116

 

$

33,878

 

Supplemental cash flow information:

 

 

 

 

 

Income tax payments

 

$

6,010

 

$

7,570

 

Cash paid for interest

 

23,661

 

27,371

 

Supplemental non-cash activity:

 

 

 

 

 

Transfers from loans to other real estate owned

 

$

1,161

 

$

2,742

 

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

4



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S.Y. BANCORP, INC. AND SUBSIDIARY

Unaudited Condensed Consolidated Statement of Changes in Stockholders’ Equity
For the nine months ended September 30, 2008

(In thousands, except per share data)

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

Common stock

 

 

 

 

 

other

 

 

 

 

 

Number of

 

 

 

Additional

 

Retained

 

comprehensive

 

 

 

 

 

shares

 

Amount

 

Paid-in capital

 

earnings

 

income (loss)

 

Total

 

Balance December 31, 2007

 

13,600

 

$

6,214

 

$

9,821

 

$

116,906

 

$

83

 

$

133,024

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 

 

 

16,610

 

 

16,610

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Change in accumulated other comprehensive loss, net of tax

 

 

 

 

 

(224

)

(224

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Stock compensation expense

 

 

 

534

 

 

 

534

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Stock issued for stock options exercised and dividend reinvestment plan

 

69

 

236

 

957

 

 

 

1,193

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Stock issued for non-vested restricted stock

 

23

 

76

 

463

 

(539

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash dividends, $0.51 per share

 

 

 

 

(6,845

)

 

(6,845

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Shares repurchased or cancelled

 

(235

)

(779

)

(4,617

)

14

 

 

(5,382

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance September 30, 2008

 

13,457

 

$

5,747

 

$

7,158

 

$

126,146

 

$

(141

)

$

138,910

 

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

5



Table of Contents

 

S.Y. BANCORP, INC. AND SUBSIDIARY

Unaudited Condensed Consolidated Statements of Comprehensive Income
For the three and nine months ended September 30, 2008 and 2007

(In thousands)

 

 

 

Three months ended

 

Nine months ended

 

 

 

September 30,

 

September 30,

 

 

 

2008

 

2007

 

2008

 

2007

 

Net income

 

$

5,443

 

$

5,887

 

$

16,610

 

$

17,888

 

Other comprehensive income (loss), net of tax:

 

 

 

 

 

 

 

 

 

Unrealized gains (losses) on securities available for sale:

 

 

 

 

 

 

 

 

 

Unrealized gains (losses) arising during the period
(net of tax of ($173), $454, ($333), and $380, respectively)

 

(323

)

844

 

(619

)

705

 

Reclassification adjustment for securities losses realized in income (net of tax of $212, $0, $212, and $0, respectively)

 

395

 

 

395

 

 

Other comprehensive income (loss)

 

72

 

844

 

(224

)

705

 

Comprehensive income

 

$

5,515

 

$

6,731

 

$

16,386

 

$

18,593

 

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

6



Table of Contents

 

S.Y. BANCORP, INC. AND SUBSIDIARY

 

(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 consolidated financial statements include the accounts of S.Y. Bancorp, Inc. and its wholly-owned subsidiary, Stock Yards Bank & Trust Company (“Bank”).  Significant intercompany transactions and accounts have been eliminated in consolidation.

 

A description of other significant accounting policies is presented in the notes to the Consolidated Financial Statements for the year ended December 31, 2007 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, 2008 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 or lower provision for loan losses. The accounting policy related to the allowance for loan losses is applicable to the commercial banking segment of Bancorp.

 

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.

 

(b)                     Securities

 

Investment securities consisted of the following at September 30, 2008.

 

7



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S.Y. BANCORP, INC. AND SUBSIDIARY

 

 

 

 

 

 

 

Unrealized

 

 

 

Cost

 

Fair Value

 

Gain/(Loss)

 

Securities available for sale

 

 

 

 

 

 

 

U.S. Treasury securities

 

$

6,795

 

$

6,958

 

$

163

 

Government agency securities

 

137,558

 

137,963

 

405

 

Total government securities

 

144,353

 

144,921

 

568

 

 

 

 

 

 

 

 

 

Mortgage backed securities - GNMA

 

22,423

 

22,683

 

260

 

Mortgage backed securities - government agencies

 

7,043

 

7,028

 

(15

)

Total mortgage backed securities

 

29,466

 

29,711

 

245

 

 

 

 

 

 

 

 

 

Tax-exempt securities

 

26,578

 

26,834

 

256

 

 

 

 

 

 

 

 

 

Trust preferred securities of other financial institutions

 

3,233

 

2,317

 

(916

)

 

 

 

 

 

 

 

 

Total securities available for sale

 

$

203,630

 

$

203,783

 

$

153

 

 

 

 

 

 

 

 

 

Securities held to maturity

 

 

 

 

 

 

 

Mortgage backed securities - government agencies

 

$

44

 

$

46

 

$

2

 

 

 

 

 

 

 

 

 

Total securities held to maturity

 

$

44

 

$

46

 

$

2

 

 

 

 

 

 

 

 

 

Federal Home Loan Bank stock

 

 

 

 

 

 

 

Federal Home Loan Bank stock

 

$

4,324

 

$

4,324

 

$

 

 

 

 

 

 

 

 

 

Total Federal Home Loan Bank stock

 

$

4,324

 

$

4,324

 

$

 

 

Unrealized losses on Bancorp’s investment securities portfolio have not been recognized in income because the securities 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 changes in the prevailing interest rate and credit environment since the purchase date.  The fair value is expected to recover as the securities reach their maturity date and/or the interest rate and credit environment returns to conditions similar to when the securities were purchased.

 

Debt securities with gross unrealized losses consist of 49 and 41 separate investment positions as of September 30, 2008 and December 31, 2007, respectively.

 

As of September 30, 2008, Bancorp has 5 securities which were temporarily impaired for 12 months or longer, all of which are debt securities.  These securities, which have a total fair value of $1,473,000, have an unrealized loss of $23,000.

 

In the third quarter of 2008, the Bancorp sold $4,125,000 par of preferred securities of financial companies, generating a loss of $607,000 and eliminating the Company’s position in these types of securities.  Management has the intent and ability to hold all remaining investment securities available for sale for the foreseeable future.

 

The Company’s investment in a domestic private investment fund is comprised of bank and other financial industry stocks and is carried at cost in accordance with Statement of Position 78-9.  This investment was previously included in securities available for sale, and was reclassified to other assets in the third quarter of 2008.

 

8



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S.Y. BANCORP, INC. AND SUBSIDIARY

 

Management evaluates the impairment of securities on a quarterly basis, considering various factors including issuer financial condition, agency rating, payment prospects, impairment duration and general industry condition.  Based on the evaluation as of September 30, 2008, management is of the opinion that none of the investment securities are other than temporarily impaired.

 

(c)                      Stock-Based Compensation

 

On January 1, 2006, Bancorp adopted the modified version of prospective application of Statement of Financial Standard 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.  The 2005 Stock Incentive Plan reserved 735,000 shares of common stock for issuance of stock based awards.  As of September 30, 2008, there were 272,225 shares available for future awards.  Bancorp’s 1995 Stock Incentive Plan expired in 2005; however, options granted under this plan expire as late as 2015.  Options and stock appreciation rights (SARs) 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. Restricted shares vest over two to five years.  All awards under both plans 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.

 

As a result of applying the provisions of SFAS No. 123R, Bancorp recognized, within salaries and employee benefits in the consolidated statements of income, stock-based compensation expense of $534,000 and $386,000 before income taxes and a deferred tax benefit of $187,000 and $135,000 resulting in a reduction of net income of $347,000 and $251,000 for the nine months ended September 30, 2008 and 2007, respectively. For the third quarter of 2008 and 2007, Bancorp recognized $171,000 and $144,000 of compensation expense before taxes, a deferred tax benefit of $60,000 and $50,000, and a reduction of net income of $111,000 and $94,000, respectively.  Bancorp expects to record an additional $127,000 of compensation expense in 2008. As of September 30, 2008 Bancorp has $1,558,000 of unrecognized stock-based compensation expense that will be recorded as compensation expense over the next five years as awards vest.  Bancorp received cash of $1,035,000 and $1,037,000 from the exercise of options during the first nine months of 2008 and 2007, respectively.

 

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 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.

 

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.

 

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The fair value of Bancorp’s stock options and SARs 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.  The fair value of restricted shares is determined by Bancorp’s closing stock price on the date of grant.  The following assumptions were used in SAR/option valuations:

 

 

 

2008

 

2007

 

 

 

 

 

 

 

Dividend yield

 

1.95

%

1.81

%

Expected volatility

 

14.99

 

14.49

 

Risk free interest rate

 

3.84

 

4.69

 

Forfeitures

 

5.65

 

5.55

 

Expected life of options and SARs (in years)

 

7.5

 

7.7

 

 

The expected life of options is based on actual experience of past like-term awards.  All outstanding options have a 10-year contractual term.  Bancorp evaluated historical exercise and post-vesting termination behavior when determining the expected life of options and SARs.

 

The dividend yield and expected volatility are based on historical information corresponding to the expected life of awards 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 awards.

 

A summary of stock option and SARs activity and related information for the nine months ended September 30, 2008 follows.  The number of options and SARs and aggregate intrinsic value are stated in thousands.

 

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Weighted

 

 

 

 

 

 

 

Weighted

 

 

 

Weighted

 

Average

 

 

 

 

 

 

 

Average

 

Aggregate

 

Average

 

Remaining

 

 

 

Options

 

 

 

Exercise

 

Intrinsic

 

Fair

 

Contractual

 

 

 

and SARs

 

Exercise Price

 

Price

 

Value

 

Value

 

Life

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

At December 31, 2007

 

 

 

 

 

 

 

 

 

 

 

 

 

Vested and exercisable

 

800

 

$

9.76-26.83

 

$

18.10

 

$

4,794

 

$

3.90

 

 

 

Unvested

 

216

 

18.05-26.83

 

25.42

 

13

 

5.96

 

 

 

Total outstanding

 

1,016

 

9.76-26.83

 

19.65

 

4,807

 

4.34

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Granted

 

114

 

23.37

 

23.37

 

827

 

4.57

 

 

 

Exercised

 

(69

)

9.76-26.83

 

15.16

 

706

 

3.08

 

 

 

Forfeited

 

(13

)

22.81-26.83

 

24.48

 

84

 

5.43

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

At September 30, 2008

 

 

 

 

 

 

 

 

 

 

 

 

 

Vested and exercisable

 

801

 

9.82-26.83

 

18.91

 

9,379

 

4.10

 

4.86

 

Unvested

 

247

 

20.25-26.83

 

24.75

 

1,449

 

5.48

 

8.41

 

Total outstanding

 

1,048

 

9.82-26.83

 

20.29

 

$

10,828

 

4.43

 

5.70

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Vested during quarter

 

23

 

18.05-23.37

 

23.27

 

$

170

 

4.56

 

 

 

 

The weighted average fair values of options and SARs granted in 2008 and 2007 were $4.57 and $6.14, respectively.

 

In February 2008, Bancorp adopted a stock appreciation rights program under the terms of the Company’s 2005 Stock Incentive Plan and granted 114,195 SARs at the current market price of $23.37 and a fair value of $4.57.   Of these SARs, 22,700 were granted to certain executive officers and vested in the third quarter of 2008.    Other awards will primarily vest 20% per year over the next five years.  All SARs expire ten years from the date of grant.

 

Also, in February 2008, Bancorp granted 23,043 shares of common stock at the weighted average current market price of $23.44.  These grants vest over two to five years.  As of September 30, 2008, 590 restricted shares had been forfeited. In the first nine months of 2008, 4,752 restricted shares granted in 2007 vested.

 

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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, 2008 and 2007 follows (in thousands):

 

 

 

2008

 

2007

 

Beginning balance January 1,

 

$

13,450

 

$

12,203

 

Provision for loan losses

 

3,100

 

2,090

 

Loans charged off

 

(2,310

)

(2,447

)

Recoveries

 

545

 

704

 

Ending balance September 30,

 

$

14,785

 

$

12,550

 

 

(3)                     Federal Home Loan Bank Advances

 

The Bank had outstanding borrowings of $90 million, at September 30, 2008, via four separate advances. The first two are fixed rate, non-callable advances of $20 million and $30 million.  The third advance of $20 million is a fixed rate advance eligible to be called by the FHLB in December of 2008, and then quarterly going forward until its maximum maturity in December of 2010.  The fourth advance of $20 million is a fixed rate advance eligible to be called by the FHLB in November of 2008 and then quarterly going forward until its maximum maturity in May of 2012.  The weighted average rate of these advances was 4.58% at September 30, 2008. Interest payments are due monthly, with principal due at maturity. Advances from the FHLB are collateralized by certain commercial and residential real estate mortgage loans under a blanket mortgage collateral agreement and FHLB stock.

 

The Bank’s agreement with the Federal Home Loan Bank of Cincinnati (FHLB) enables the Bank to borrow up to an additional $21.2 million as of September 30, 2008 under terms to be established at the time of the advance. The Bank also has a standby letter of credit from the FHLB for $30 million outstanding at September 30, 2008.  Under Kentucky law, customer cash balances in Investment Management and Trust accounts, may be retained as deposits in the Bank.  As a part of this transaction, Kentucky law requires these deposits above the per account protection provided by the FDIC, to be backed by some form of collateral.  The standby letter of credit from the FHLB collateralizes these accounts.

 

(4)                     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.

 

(5)                     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 (in thousands):

 

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Three months ended September 30

 

Nine months ended September 30

 

 

 

2008

 

2007

 

2008

 

2007

 

Components of net periodic benefit cost:

 

 

 

 

 

 

 

 

 

Service cost

 

$

 

$

 

$

 

$

 

Interest cost

 

27

 

28

 

82

 

85

 

Expected return on plan assets

 

 

 

 

 

Amortization of prior service cost

 

 

 

 

 

Amortization of the net loss

 

6

 

7

 

18

 

20

 

 

 

 

 

 

 

 

 

 

 

Net periodic benefit cost

 

$

33

 

$

35

 

$

100

 

$

105

 

 

(6)                     Commitments to Extend Credit

 

As of September 30, 2008, 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 $334,832,000 including standby letters of credit of $21,262,000 represent normal banking transactions, and no significant losses are anticipated to result from these commitments as of September 30, 2008. Commitments to extend credit were $360,604,000, including letters of credit of $19,414,000, as of December 31, 2007. 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 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 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.

 

(7)                     Preferred Stock

 

At Bancorp’s 2003 annual meeting of shareholders, 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, 2008.

 

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(8)                     Net Income Per Share

 

The following table reflects, for the three and nine months ended September 30, 2008 and 2007, 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):

 

 

 

Three months ended

 

Nine months ended

 

 

 

September 30

 

September 30

 

 

 

2008

 

2007

 

2008

 

2007

 

Net income, basic and diluted

 

$

5,443

 

$

5,887

 

$

16,610

 

$

17,888

 

Average shares outstanding

 

13,435

 

14,185

 

13,432

 

14,299

 

Effect of dilutive securities

 

217

 

215

 

183

 

226

 

 

 

 

 

 

 

 

 

 

 

Average shares outstanding including dilutive securities

 

13,652

 

14,400

 

13,615

 

14,525

 

 

 

 

 

 

 

 

 

 

 

Net income per share, basic

 

$

0.41

 

$

0.42

 

$

1.24

 

$

1.25

 

Net income per share, diluted

 

$

0.40

 

$

0.41

 

$

1.22

 

$

1.23

 

 

(9)                     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.  Principally, all of the net assets of Bancorp are involved in the commercial banking segment.  Income taxes are allocated to the investment management and trust segment based on the marginal federal tax rate.  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 three and nine month periods ended  September 30, 2008 and 2007 follows:

 

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Three months

 

Nine months

 

 

 

ended September 30

 

ended September 30

 

 

 

2008

 

2007

 

2008

 

2007

 

 

 

(In thousands)

 

(In thousands)

 

Net interest income (expense):

 

 

 

 

 

 

 

 

 

Commercial banking

 

$

14,384

 

$

13,503

 

$

41,893

 

$

40,344

 

Investment management and trust

 

81

 

48

 

248

 

144

 

Total

 

$

14,465

 

$

13,551

 

$

42,141

 

$

40,488

 

 

 

 

 

 

 

 

 

 

 

Provision for loan losses:

 

 

 

 

 

 

 

 

 

Commercial banking

 

$

900

 

$

850

 

$

3,100

 

$

2,090

 

Investment management and trust

 

 

 

 

 

Total

 

$

900

 

$

850

 

$

3,100

 

$

2,090

 

 

 

 

 

 

 

 

 

 

 

Non-interest income:

 

 

 

 

 

 

 

 

 

Commercial banking

 

$

3,689

 

$

4,329

 

$

12,089

 

$

12,732

 

Investment management and trust

 

2,885

 

3,227

 

9,400

 

9,760

 

Total

 

$

6,574

 

$

7,556

 

$

21,489

 

$

22,492

 

 

 

 

 

 

 

 

 

 

 

Non-interest expense:

 

 

 

 

 

 

 

 

 

Commercial banking

 

$

10,456

 

$

9,888

 

$

31,550

 

$

29,604

 

Investment management and trust

 

1,464

 

1,639

 

4,553

 

4,781

 

Total

 

$

11,920

 

$

11,527

 

$

36,103

 

$

34,385

 

 

 

 

 

 

 

 

 

 

 

Tax expense

 

 

 

 

 

 

 

 

 

Commercial banking

 

$

2,253

 

$

2,270

 

$

6,037

 

$

6,824

 

Investment management and trust

 

523

 

573

 

1,780

 

1,793

 

Total

 

$

2,776

 

$

2,843

 

$

7,817

 

$

8,617

 

 

 

 

 

 

 

 

 

 

 

Net income:

 

 

 

 

 

 

 

 

 

Commercial banking

 

$

4,464

 

$

4,824

 

$

13,295

 

$

14,558

 

Investment management and trust

 

979

 

1,063

 

3,315

 

3,330

 

Total

 

$

5,443

 

$

5,887

 

$

16,610

 

$

17,888

 

 

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(10)              Subsequent Events

 

Company management is carefully evaluating participation in the U.S. Treasury’s recently announced voluntary capital purchase program.  Under the program the Treasury will purchase senior preferred shares on terms standardized for all participants.  Subscription amounts range from 1 to 3 percent of risk-weighted assets.  For Bancorp, the Treasury investment would range from approximately $14.4 million to $43.3 million.  Interested institutions must apply by mid-November 2008.

 

In October 2008, the FDIC announced the Temporary Liquidity Guarantee Program.  The new program will (1) guarantee newly issued senior unsecured debt such as fed funds, and (2) provide full deposit insurance coverage for non-interest bearing deposit accounts regardless of the dollar amount.  The program is automatic without cost until mid-November 2008.  After that time, fees will be assessed by the FDIC to cover the cost of each part of the program.  Institutions may opt out of either program by December 5, 2008.  Company management is carefully evaluating participation in the first program, and intends to continue participation in the second program.

 

In October 2008 PNC agreed to acquire National City Bank.  According to published FDIC deposit data, as of June 30, 2008, National City Bank ranked as having the largest market share, and PNC ranked as having the third largest market share in the Louisville MSA.  The transaction is expected to occur by the end of 2008 and the effect of the transaction on the banking environment in Louisville, Bancorp’s primary market, remains to be seen.

 

(11)              Income Taxes

 

Bancorp adopted Financial Accounting Standards Board Interpretation No. 48 “Accounting for Uncertainty in Income Taxes, an Interpretation of FASB Statement No. 109” (“FIN 48”) in 2007.  FIN 48 provides guidance on financial statement recognition and measurement of tax positions taken, or expected to be taken, in tax returns.  The initial adoption of FIN 48 had no impact on the Company’s financial statements.  As of December 31, 2007 and September 30, 2008, the gross amount of unrecognized tax benefits was $230,000.  If recognized, all of the tax benefits would increase net income, resulting in a decrease of the effective tax rate.  The amount of unrecognized tax benefits may increase or decrease in the future for various reasons including adding amounts for current tax year positions, expiration of open income tax returns due to statutes of limitation, changes in management’s judgment about the level of uncertainty, status of examination, litigation and legislative activity and the addition or elimination of uncertain tax positions.  Federal and state income tax returns are subject to examination from the 2003 tax return year and forward.  Management does not anticipate significant adjustments to the total amount of unrecognized tax benefits within the next twelve months.

 

Bancorp’s policy is to report interest and penalties, if any, related to unrecognized tax benefits in income tax expense.  As of January 1 and September 30, 2008, the amount accrued for the potential payment of interest and penalties was $20,000.

 

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(12)              Fair Value Measurements

 

Effective January 1, 2008 the Company adopted FASB Statement No. 157, “Fair Value Measurements”.  This statement is definitional and disclosure oriented and addresses how companies should approach measuring fair value when required by Generally Accepted Accounting Principals (“GAAP”); it does not create or modify any current GAAP requirements to apply fair value accounting. FASB Statement No. 157 prescribes various disclosures about financial statement categories and amounts which are measured at fair value, if such disclosures are not already specified elsewhere in GAAP.  The adoption of FASB Statement No. 157 did not have an impact on Bancorp’s consolidated financial statements. In February 2008 the FASB issued a statement delaying the effective date of Statement No. 157 for nonfinancial assets and nonfinancial liabilities except those that are recognized or disclosed at fair value on a recurring basis. Accordingly, the Company has deferred applying Statement No. 157 to other real estate owned and goodwill until 2009.

 

Statement No. 157 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between participants at the measurement date. Statement No. 157  also establishes a hierarchy to group assets and liabilities carried at fair value in three levels based upon the markets in which the assets and liabilities trade and the reliability of assumptions used to determine fair value. These levels are:

 

·                  Level 1               Valuation is based upon quoted prices for identical instruments traded in active markets.

 

·                  Level 2               Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market.

 

·                  Level 3               Valuation is generated from model-based techniques that use significant assumptions not observable in the market. These unobservable assumptions would reflect our own estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques could include pricing models, discounted cash flows and other similar techniques.

 

Our policy is to maximize the use of observable inputs and minimize the use of unobservable inputs in fair value measurements. Where there exists limited or no observable market data, we use our own estimates generally considering characteristics of the asset/liability, the current economic and competitive environment and other factors. For this reason, results cannot be determined with precision and may not be realized on an actual sale or immediate settlement of the asset or liability.

 

The Company’s investment securities available for sale are recorded at fair value on a recurring basis. Other accounts including mortgage loans held for sale, mortgage servicing rights, impaired loans, and other real estate owned may be recorded at fair value on a non-recurring basis, generally in the application of lower of cost or market adjustments or write-downs of specific assets.

 

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The portfolio of investment securities available for sale is comprised of debt securities of the U.S. Treasury and other U.S. government-sponsored corporations, mortgage-backed securities, obligations of state and political subdivisions, and trust preferred securities of other banks. The trust preferred securities are priced using quoted prices of identical securities in an active market.  These measurements are classified as Level 1 in the hierarchy above.  All other securities are priced using standard industry models or matrices with various assumptions such as yield curves, volatility, prepayment speeds, default rates, time value, credit rating and market prices for the instruments. These assumptions are generally observable in the market place and can be derived from or supported by observable data. These measurements are classified as Level 2 in the hierarchy above.

 

Below are the carrying values of assets measured at fair value on a recurring basis (in thousands).

 

 

 

Fair value at September 30, 2008

 

 

 

Total

 

Level 1

 

Level 2

 

Level 3

 

Investment securities available for sale

 

$

203,783

 

$

960

 

$

202,823

 

$

 

 

Mortgage loans held for sale are carried at the lower of cost or market value. The portfolio is comprised of residential real estate loans and fair value is based on specific prices of underlying contracts for sales to investors.  These measurements are classified as Level 2.

 

Mortgage servicing rights (MSRs) are recorded at fair value upon capitalization, are amortized to correspond with estimated servicing income, and are periodically assessed for impairment based on fair value at the reporting date.  Fair value is based on a valuation model that calculates the present value of estimated net servicing income. The model incorporates assumptions that market participants would use in estimating future net servicing income. These measurements are classified as Level 3.

 

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

 

 

 

Fair value at September 30, 2008

 

 

 

Total

 

Level 1

 

Level 2

 

Level 3

 

Mortgage loans held for sale

 

$

2,216

 

$

 

$

2,216

 

$

 

Mortgage servicing rights

 

518

 

 

 

 

 

518

 

Total

 

$

2,734

 

$

 

$

2,216

 

$

518

 

 

The following represent impairment charges recognized during the period.

 

Mortgage servicing rights, which are carried at the lower of cost or fair value, were written down to fair value of $518,000, resulting in a valuation allowance of $25,000.  A corresponding charge of $25,000 was included in earnings for the period.

 

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Loans are measured for impairment and, if indicated, are written down based on the value of underlying collateral.  In cases of real estate collateral, fair value is generally determined from external appraisals and assessment of values as estimated by management. In cases of non-real estate collateral, fair value is estimated using judgments and estimates of external professionals and of management. Many of these inputs are not observable and, accordingly, these measurements are classified as Level 3.  At September 30, 2008, the carrying value of impaired loans with a valuation allowance was $3,342,000 and the corresponding valuation allowance was $1,214,000. The valuation allowance for impaired loans decreased $74,000 from $1,288,000 at June 30, 2008.  Charge-offs of impaired loans totaled $411,000 for the third quarter of 2008.

 

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 months ended September 30, 2008 and compares this period with the same period of the previous year. Unless otherwise indicated, all references in this discussion to the Bank include Bancorp. In addition, the discussion describes the significant changes in the financial condition of Bancorp and the Bank that have occurred during the first nine months of 2008 compared to the year ended December 31, 2007. 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 the Bank operate; competition for Bancorp’s customers from other providers of financial services; government legislation and regulation which change from time to time and over which Bancorp has no control; changes in interest rates; material unforeseen changes in liquidity, results of operations, or financial condition of Bancorp’s customers; and other risks detailed in Bancorp’s filings with the Securities and Exchange Commission, all of which are difficult to predict and many of which are beyond the control of Bancorp.

 

Overview of 2008 through September 30

 

Driven primarily by loan growth, the third quarter and first nine months of 2008 were marked by higher net interest income.  However, net income was lower as compared to the year-earlier periods, due to continued pressure on net interest margin, a higher provision for loan losses, increasing non-interest expenses arising primarily from the Company’s expansion, and decreasing non-interest income.  Lower non-interest income was due to a decline in investment management and trust fees, combined with a loss on the sale of securities, partially offset by an increase in mortgage and bankcard transaction revenue.  With these factors combined, the Company completed the third quarter and first nine months of 2008 with net income less than the comparable periods of 2007 by 7.5% and 7.1%, respectively.  The impact of the Company’s stock repurchase program over the past year helped mitigate the effect of lower net income on earnings per share. Diluted earnings per share for the third quarter and first nine months of 2008 was down 2.4% and 0.8%, respectively, compared to the year-earlier periods.

 

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

 

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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 overall economic factors including market interest rates, business spending, consumer confidence and competitive conditions within the marketplace.  Bancorp’s loan totals at September 30, 2008 increased 9.5% compared to December 31, 2007.  To support the growth, the Company aggressively sought deposits.

 

Net interest income increased 6.7% for the third quarter and 4.1% year to date compared with the year-earlier periods.  The increase for 2008 was primarily due to strong loan growth in the first half of the year but was offset by the compression on net interest margin in the wake of rate cuts by the Federal Reserve as well as the effect of competitive factors, particularly on deposit rates.  Net interest margin for the third quarter, at 3.78% decreased 29 basis points from the second quarter of 2008 and was 41 basis points lower than the 4.19% reported in the year-earlier period.  For the first nine months ended September 30, 2008, net interest margin was 3.94% compared to 4.22% for the year-earlier period.  This ongoing margin pressure, which began in the third quarter of 2006, reflects the drop in prevailing short-term interest rates coupled with the impact on interest rates associated with local competition for loans and deposits.  In the second and third quarters of 2008, the Company increased its liquidity, primarily by increasing deposit rates.  Deploying the liquidity in short term assets rather than loans had a negative impact on the net interest margin. The Company expects continued competitive pressures particularly on deposit rates will negatively impact net interest margins.

 

The Bank increased its provision for loan losses to $900,000 in the third quarter from $850,000 in the third quarter of 2007.  For the first nine months of 2008, the provision totaled $3,100,000, compared to $2,090,000 for the same period in 2007.  While the Company’s asset quality remains strong despite turmoil in the economy, management continues to be concerned about, and regularly monitors the loan portfolio for, the effects of well-publicized macroeconomic challenges. The Company’s allowance for loan losses was 1.12% of total loans at September 30, 2008, compared with 1.12% of total loans at December 31, 2007, and 1.08% at September 30, 2007.

 

Non-performing loans at September 30, 2008 were $3,940,000 or 0.30% relative to total loans, an increase from $3,370,000 or 0.28% at the end of the fourth quarter of 2007, and a decrease from $5,481,000 or 0.42% in the second quarter of 2008.  Net charge-offs totaled $571,000 or 0.04% of average loans in the third quarter of 2008 compared with $365,000 or 0.03% in the same period last year, and $616,000 or .05% in the second quarter of 2008.  Management continues to believe it has appropriately recognized the loan-loss exposure in its portfolio.

 

Non-interest income decreased 13.0% in the third quarter compared with the same quarter last year, primarily due to lower investment management and trust service income, service charges on deposit accounts and other non-interest income.  Some of this decrease was offset by increased gains on sales of mortgage loans, which rose 61.2% compared to the same period in 2007, and higher bankcard transaction revenue, which rose 11.1% compared to the same period in 2007, along with bank owned life insurance (BOLI) and other non-interest income.  In the third quarter of 2008, the Bancorp sold $4,125,000 par of preferred securities of financial companies, generating a loss of $607,000 and eliminating the Company’s position in these types of securities.  Management has the intent and ability to hold all remaining investment securities available for sale for the foreseeable future.  Non-interest income decreased 4.4% in the first nine months of 2008 compared with the year-earlier period, again driven primarily by lower investment management and trust service income, combined with the loss on the securities sold.

 

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Non-interest expense increased 3.4% in the third quarter of 2008 versus the same period last year.  Higher non-interest expense for 2008 was primarily due to increasing occupancy expenses in part from the development of a second office in the Indianapolis market and the Company’s recent entry into the Cincinnati market.  Non-interest expense increased 5.0% in the first nine months of 2008 compared with the year-earlier period.  The Company’s third quarter efficiency ratio was 55.97% compared with 55.13% in the second quarter of 2008 and 53.95% in the third quarter last year.

 

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

 

a)             Results Of Operations

 

Net income of $5,443,000 for the three months ended September 30, 2008 decreased $444,000, or 7.5%, from $5,887,000 for the comparable 2007 period.  Basic net income per share was $0.41 for the third quarter of 2008, a decrease of 2.4% from the $0.42 for the same period in 2007.  Net income per share on a diluted basis was $0.40 for the third quarter of 2008 compared to $0.41 for the third quarter of 2007; a 2.4% decrease.  As noted above, the impact of the Company’s repurchase of 639,024 common shares in the past twelve months helped mitigate the effect of lower net income on earnings per share.  Annualized return on average assets and annualized return on average stockholders’ equity were 1.31% and 15.84%, respectively, for the third quarter of 2008, compared to 1.66% and 16.50%, respectively, for the same period in 2007.

 

Net income of $16,610,000 for the nine months ended September 30, 2008 decreased $1,278,000, or 7.1%, from $17,888,000 from the comparable 2007 period.  Basic net income per share was $1.24 for the first nine months of 2008, a decrease of 0.8% from the $1.25 for the same period in 2007.  Net income per share on a diluted basis was $1.22 for the first nine months of 2008, a decrease of 0.8% from the $1.23 for the first nine months of 2007.  Annualized return on average assets and annualized return on average stockholders’ equity were 1.43% and 16.50%, respectively, for the first nine months of 2008, compared to 1.70% and 17.00%, respectively, for the same period in 2007.

 

Net Interest Income

 

The following tables present the average balance sheets for the three and nine month periods ended September 30, 2008 and 2007 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

 

 

 

2008

 

2007

 

 

 

Average

 

 

 

Average

 

Average

 

 

 

Average

 

(Dollars in thousands)

 

Balances

 

Interest

 

Rate

 

Balances

 

Interest

 

Rate

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Earning assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

Federal funds sold

 

$

66,224

 

$

313

 

1.88

%

$

12,404

 

$

168

 

5.37

%

Mortgage loans held for sale

 

2,657

 

39

 

5.84

%

3,369

 

57

 

6.71

%

Securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

Taxable

 

137,462

 

1,365

 

3.95

%

107,195

 

1,234

 

4.57

%

Tax-exempt

 

25,190

 

370

 

5.84

%

27,159

 

377

 

5.51

%

FHLB stock

 

4,286

 

58

 

5.38

%

3,792

 

60

 

6.28

%

Loans, net of unearned income

 

1,315,401

 

20,400

 

6.17

%

1,155,211

 

21,437

 

7.36

%

Total earning assets

 

1,551,220

 

22,545

 

5.78

%

1,309,130

 

23,333

 

7.07

%

Less allowance for loan losses

 

14,816

 

 

 

 

 

12,504

 

 

 

 

 

 

 

1,536,404

 

 

 

 

 

1,296,626

 

 

 

 

 

Non-earning assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and due from banks

 

28,256

 

 

 

 

 

35,284

 

 

 

 

 

Premises and equipment

 

28,504

 

 

 

 

 

24,720

 

 

 

 

 

Accrued interest receivable and other assets

 

54,197

 

 

 

 

 

53,023

 

 

 

 

 

Total assets

 

$

1,647,361

 

 

 

 

 

$

1,409,653

 

 

 

 

 

 

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Three months ended September 30

 

 

 

2008

 

2007

 

 

 

Average

 

 

 

Average

 

Average

 

 

 

Average

 

(Dollars in thousands)

 

Balances

 

Interest

 

Rate

 

Balances

 

Interest

 

Rate

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest bearing liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

Deposits:

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest bearing demand deposits

 

$

204,898

 

$

201

 

0.39

%

$

204,458

 

$

764

 

1.48

%

Savings deposits

 

43,426

 

12

 

0.11

%

41,595

 

49

 

0.47

%

Money market deposits

 

326,431

 

1,456

 

1.77

%

213,417

 

2,048

 

3.81

%

Time deposits

 

536,070

 

4,673

 

3.47

%

433,811

 

4,994

 

4.57

%

Securities sold under agreements to repurchase and federal funds purchased

 

78,466

 

274

 

1.39

%

92,552

 

799

 

3.43

%

Other short-term borrowings

 

14,756

 

169

 

4.56

%

1,215

 

11

 

3.59

%

FHLB advances

 

90,000

 

1,037

 

4.58

%

70,000

 

854

 

4.84

%

Long-term debt

 

169

 

1

 

2.35

%

90

 

2

 

8.82

%

Total interest bearing liabilities

 

1,294,216

 

7,823

 

2.40

%

1,057,138

 

9,521

 

3.57

%

Non-interest bearing liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

Non-interest bearing demand deposits

 

181,668

 

 

 

 

 

170,437

 

 

 

 

 

Accrued interest payable and other liabilities

 

34,813

 

 

 

 

 

40,495

 

 

 

 

 

Total liabilities

 

1,510,697

 

 

 

 

 

1,268,070

 

 

 

 

 

Stockholders’ equity

 

136,664

 

 

 

 

 

141,583

 

 

 

 

 

Total liabilities and stockholders’ equity

 

$

1,647,361

 

 

 

 

 

$

1,409,653

 

 

 

 

 

Net interest income

 

 

 

$

14,722

 

 

 

 

 

$

13,812

 

 

 

Net interest spread

 

 

 

 

 

3.38

%

 

 

 

 

3.50

%

Net interest margin

 

 

 

 

 

3.78

%

 

 

 

 

4.19

%

 

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Nine months ended September 30

 

 

 

2008

 

2007