Community Trust Bancorp - 10-Q quarterly report FY

 

 

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C.  20549

FORM 10-Q

COMMUNITY TRUST BANCORP, INC.

(Exact name of registrant as specified in its charter)

(Registrant’s telephone number)

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.

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files.)

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 definition of “accelerated filer, large accelerated filer, and smaller reporting company” in Rule 12b-2 of the Exchange Act.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

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

Common stock – 15,156,225 shares outstanding at October 31, 2009

 

 

 

The accompanying information has not been audited by independent registered public accountants; however, in the opinion of management such information reflects all adjustments necessary for a fair presentation of the results for the interim period.  All such adjustments are of a normal and recurring nature.

The accompanying condensed consolidated financial statements are presented in accordance with the requirements of Form 10-Q and consequently do not include all of the disclosures normally required by accounting principles generally accepted in the United States of America or those normally made in the Registrant’s annual report on Form 10-K.  Accordingly, the reader of the Form 10-Q should refer to the Registrant’s Form 10-K for the year ended December 31, 2008 for further information in this regard.

(unaudited)

(unaudited)

 
 

 

In the opinion of management, the unaudited condensed consolidated financial statements include all adjustments (which consist of normal recurring accruals) necessary, to present fairly the condensed consolidated financial position as of September 30, 2009, the results of operations for the three and nine months ended September 30, 2009 and 2008, and the cash flows for the nine months ended September 30, 2009 and 2008.  In accordance with accounting principles generally accepted in the United States of America for interim financial information, these statements do not include certain information and footnote disclosures required by accounting principles generally accepted in the United States of America for complete annual financial statements.  The results of operations for the three and nine months ended September 30, 2009 and 2008, and the cash flows for the nine months ended September 30, 2009 and 2008, are not necessarily indicative of the results to be expected for the full year.  The condensed consolidated balance sheet as of December 31, 2008 has been derived from the audited consolidated financial statements of Community Trust Bancorp, Inc. (“CTBI”) for that period.  For further information, refer to the consolidated financial statements and footnotes thereto for the year ended December 31, 2008, included in CTBI’s Annual Report on Form 10-K.

 

Principles of Consolidation –The unaudited condensed consolidated financial statements include the accounts of CTBI and its separate and distinct, wholly owned subsidiaries Community Trust Bank, Inc. (the “Bank”) and Community Trust and Investment Company.  All significant intercompany transactions have been eliminated in consolidation.

 

Reclassifications – Certain reclassifications considered to be immaterial have been made in the prior year condensed consolidated financial statements to conform to current year classifications.  These reclassifications had no effect on net income.

These financial statements consider events that occurred through November 6, 2009, the date the financial statements were issued.

New Accounting Standards–

 

CTBI’s compensation expense related to stock option grants was $353 thousand and $505 thousand, respectively, for the nine months ended September 30, 2009 and 2008, respectively.  Restricted stock expense for the first nine months of 2009 and 2008 was $67 thousand and $40 thousand, respectively.  As of September 30, 2009, there was a total of $0.6 million of unrecognized compensation expense related to unvested stock option awards that will be recognized as expense as the awards vest over a weighted average period of 1.3 years.

 

There were options to purchase 9,000 shares of CTBI common stock and 5,710 shares of restricted stock granted during the nine months ended September 30, 2009.  The options were granted pursuant to the terms of the 2006 Stock Ownership Incentive Plan, with an exercise price per share of $29.82 (equal to fair market value on date of grant), a term of 10 years, and vesting in five years.   The restrictions on the restricted stock will lapse at the end of five years.  However, in the event of a change in control of CTBI or the death of the participant, the restrictions will lapse.  In the event of the disability of the participant, the restrictions will lapse on a pro rata basis (with respect to 20% of the participant’s restricted stock for each year since the date of award). The Compensation Committee of the Board of Directors will have discretion to review and revise restrictions applicable to a participant’s restricted stock in the event of the participant’s retirement.  There were options to purchase 63,700 shares of CTBI common stock and 11,076 shares of restricted stock granted during the nine months ended September 30, 2008.

 

The fair values of options granted during the nine months ended September 30, 2009 and 2008, were established at the date of grant using a Black-Scholes option pricing model with the weighted average assumptions as follows:

 

Securities are classified into held-to-maturity and available-for-sale categories.  Held-to-maturity securities are those that CTBI has the positive intent and ability to hold to maturity and are reported at amortized cost.  Available-for-sale securities are those that CTBI may decide to sell if needed for liquidity, asset-liability management or other reasons.  Available-for-sale securities are reported at fair value, with unrealized gains or losses included as a separate component of equity, net of tax.

The amortized cost and fair value of securities at September 30, 2009 are summarized as follows:

The amortized cost and fair value of securities as of December 31, 2008 are summarized as follows:

 

The amortized cost and fair value of securities at September 30, 2009 by contractual maturity are shown below.  Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

 

There were gains on sales of securities in the amount of $0.5 million realized during the first nine months of 2009 and a $4 thousand loss on the sale of a municipal bond.  There was a combined loss of $14.5 million realized in 2008 due to other than temporary impairment charges on auction rate securities and a $50 thousand loss on the sale of auction rate securities.

 

Securities in the amount of $275 million and $276 million at September 30, 2009 and December 31, 2008, respectively, were pledged to secure public deposits, trust funds, and repurchase agreements.

 

CTBI evaluates its investment portfolio on a quarterly basis for impairment.  The analysis performed as of September 30, 2009 indicates that all impairment is considered temporary, market driven, and not credit-related.  The following tables provide the amortized cost, gross unrealized losses, and fair market value, aggregated by investment category and length of time the individual securities have been in a continuous unrealized loss position as of September 30, 2009.

As of September 30, 2009, there were no held-to-maturity securities with unrealized losses.

 

The analysis performed as of December 31, 2008 indicated that all impairment was considered temporary, due to fluctuations in interest rates, and not credit-related.  The following tables provide the amortized cost, gross unrealized losses, and fair value, aggregated by investment category and length of time the individual securities have been in a continuous unrealized loss position as of December 31, 2008.

Major classifications of loans, net of unearned income and deferred loan origination costs, are summarized as follows:

Activity in the allowance for loan and lease losses was as follows:

The following table presents the components of mortgage banking income:

 

Mortgage loans serviced for others are not included in the accompanying balance sheets.  Loans serviced for the benefit of others (primarily FHLMC) were $416.5 million at September 30, 2009 and $349 million at December 31, 2008.  Servicing loans for others generally consists of collecting mortgage payments, maintaining escrow accounts, disbursing payments to investors, and processing foreclosures.  Custodial escrow balances maintained in connection with the foregoing loan servicing, and included in demand deposits, were approximately $1.5 million at September 30, 2009 compared to $0.4 million at December 31, 2008.

Activity for capitalized mortgage servicing rights using the fair value method was as follows:

 

The fair value of capitalized mortgage servicing rights was $3.1 million at September 30, 2009 compared to $2.2 million at December 31, 2008 and $3.2 million at September 30, 2008.  Fair values were determined by third-party valuations using a discount rate of 10.0% for the quarters ended September 30, 2009 and December 31, 2008, and 9.5% for the quarter ended September 30, 2008 and weighted average default rates of 1.8%, 1.7% and 1.4% respectively.  Prepayment speeds generated using the Andrew Davidson Prepayment Model averaged 16.3% at September 30, 2009 compared to 20.7% at December 31, 2008 and 11.6% at September 30, 2008.  MSR values are very sensitive to movement in interest rates as expected future net servicing income depends on the projected balance of the underlying loans, which can be greatly impacted by the level of prepayments.  CTBI does not currently hedge against changes in the fair value of its MSR portfolio.

Short-term debt consists of the following:

 

On October 28, 2009, Community Trust Bancorp, Inc. entered into a revolving credit promissory note for a line of credit in the amount of $12 million at a floating interest rate of 2.25% in excess of the one-month LIBOR Rate.  An unused commitment fee of 0.15% has been established.  Currently, all $12 million remain available for general corporate purposes.  The agreement, which is effective October 29, 2009, replaces the agreement dated July 29, 2008, and will mature on October 28, 2010.

 

All federal funds purchased and the majority of repurchase agreements mature and reprice daily.  The average rates paid for federal funds purchased and repurchase agreements on September 30, 2009 were 0.15% and 1.49%, respectively.

Federal Home Loan Bank advances consisted of the following monthly amortizing and term borrowings:

The advances from the Federal Home Loan Bank that require monthly principal payments were due for repayment as follows:

The term advances that require the total payment to be made at maturity follow:

 

Advances totaling $20.7 million at September 30, 2009 were collateralized by FHLB stock of $24.7 million and a blanket lien on qualifying first mortgage loans.  As of September 30, 2009, CTBI had a $409.8 million FHLB borrowing capacity, leaving $301.4 million available for additional advances.  The advances had fixed interest rates ranging from 0.43% to 4.00% with a weighted average rate of 0.54%.  The advances are subject to restrictions or penalties in the event of prepayment.

Long-term debt consists of the following:

 

CTBI has outstanding $61.3 million in junior subordinated debentures with an unconsolidated Delaware statutory trust subsidiary which in turn issued $59.5 million of capital securities in a private placement to institutional investors.  The debentures, which mature 30 years from the date of issuance, are redeemable at par at CTBI's option after five years, were issued at a rate of 6.52% until June 1, 2012, and thereafter at a floating rate based on the three-month LIBOR plus 1.59%.  The underlying capital securities were issued at the equivalent rates and terms.  The proceeds of the debentures were used to fund the redemption on April 2, 2007 of all CTBI's outstanding 9.0% and 8.25% junior subordinated debentures in the total amount of $61.3 million.

The following table sets forth the computation of basic and diluted earnings (loss) per share:

 

Options to purchase 425,974 and 388,024 common shares, respectively, were excluded from the diluted calculations above for the three and nine months ended September 30, 2009 because the exercise prices on the options were greater than the average market price for the period.  Options to purchase 210,163 and 293,251 common shares, respectively, were excluded from the diluted calculations above for the three and nine months ended September 30, 2008.

 

Effective January 1, 2008, CTBI adopted ASC 820 (formerly FAS 157, Fair Value Measurements).  This standard defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements.  ASC 820 applies whenever other standards require (or permit) assets or liabilities to be measured at fair value but does not expand the use of fair value in any new circumstances.  In this standard, the FASB clarifies the principle that fair value should be based on the assumptions market participants would use when pricing the asset or liability.  In support of this principle, ASC 820 establishes a fair value hierarchy that prioritizes the information used to develop those assumptions.  The fair value hierarchy is as follows:

Level 1 Inputs – Unadjusted quoted process in active markets for identical assets or liabilities that the entity has the ability to access at the measurement date.

Level 2 Inputs - Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. These might include quoted prices for similar assets and liabilities in active markets, and inputs other than quoted prices that are observable for the asset or liability, such as interest rates and yield curves that are observable at commonly quoted intervals.

Level 3 Inputs - Unobservable inputs for determining the fair values of assets or liabilities that reflect an entity’s own assumptions about the assumptions that market participants would use in pricing the assets or liabilities.

The application of ASC 820 in situations where the market for a financial asset is not active was clarified in October 2008 by the issuance of ASC 820-10-35 (formerly FSP FAS 157-3, Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active).  This clarification was effective for financial statements issued as of September 30, 2008 and thereafter and did not have a material impact on the methods by which CTBI determines the fair values of its financial assets.  ASC 820 was also clarified in April 2009 effective for the second quarter 2009 by ASC-10-65 (formerly FSP No. FAS 157-4, Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly).  This section clarifies factors that determine whether transactions are orderly or not in evaluating the reliability of market transactions for fair value estimates.  ASC 820-10-15 (formerly FSP FAS 157-2) deferred the application of ASC 820 for nonfinancial assets and nonfinancial liabilities that are measured at fair value on a nonrecurring basis to fiscal years beginning after November 15, 2008.  CTBI adopted the provisions of this standard with respect to nonfinancial assets and nonfinancial liabilities beginning on January 1, 2009.

The following tables present information about CTBI’s assets measured at fair value on a recurring basis as of September 30, 2009 and December 31, 2008, and indicates the fair value hierarchy of the valuation techniques utilized by CTBI to determine such fair value.

U.S. Treasury and government agencies, State and political subdivision, U.S. government sponsored agencies and mortgage-backed pass through certificates, Collateralized mortgage obligations, Marketable equity securities – Level 2 Inputs.  For these securities, CTBI obtains fair value measurements from an independent pricing service. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond’s terms and conditions, among other things.

Marketable equity securities – Level 3 Inputs.  The securities owned by CTBI that were measured using Level 3 criteria are auction rate securities issued by FNMA.  These securities were valued using an independent third party.  For these securities, the valuation methods used were (1) a discounted cash flow model valuation, where the expected cash flows of the securities are discounted to the present using a yield that incorporates compensation for illiquidity and (2) a market comparables method, where the securities are valued based on indications, from the secondary market, of what discounts buyers demand when purchasing similar securities.  Using these methods, the auction rate securities are classified as Level 3.

Mortgage Servicing Rights – Level 3 Inputs.  CTBI records MSRs at fair value on a recurring basis with subsequent remeasurement of MSRs based on change in fair value.  In determining fair value, CTBI utilizes the expertise of an independent third party.  An estimate of the fair value of CTBI’s MSRs is determined by the independent third party utilizing assumptions about factors such as mortgage interest rates, discount rates, mortgage loan prepayment speeds, market trends and industry demand.  All of CTBI’s MSRs are classified as Level 3.

Following is a reconciliation of the beginning and ending balances of recurring fair value measurements using significant unobservable (Level 3) inputs:

 

Assets measured at fair value on a non-recurring basis as of September 30, 2009 and December 31, 2008 are summarized below:

 

Impaired Loans – Level 3 Inputs.  Loans considered impaired under ASC 310 (formerly FAS 114, Accounting by Creditors for Impairment of a Loan, as amended by FAS 118, Accounting by Creditors for Impairment of a Loan — Income Recognition and Disclosure), are loans for which, based on current information and events, it is probable that the creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement.  Impaired loans are subject to nonrecurring fair value adjustments to reflect (1) partial write-downs that are based on the observable market price or current appraised value of the collateral or (2) the full charge-off of the loan carrying value. Quarter-to-date losses on impaired loans were $1.5 million and year-to-date losses on impaired loans totaled $4.5 million at September 30, 2009.

Other real estate/assets owned – Level 3 Inputs.  In accordance with the provisions of ASC 360 (formerly FAS 144), long-lived assets held for sale with a carrying amount of $31.3 million were written down to their fair value less costs to sale during the quarter.  Long-lived assets are nonfinancial assets subject to nonrecurring fair value adjustments to reflect partial write-downs that are based on the observable market price or current appraised value of the collateral.  Losses on other real estate/assets owned were $0.1 million and $0.7 million, respectively, for the three and nine months ended September 30, 2009.

The following table presents the carrying amounts and estimated fair values of financial instruments at September 30, 2009 and December 31, 2008:

The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value:

Cash and Cash Equivalents – The carrying amount approximates fair value.

Other Short-term Investments – Fair values are based on quoted market prices or dealer quotes.

Held-to-Maturity Securities – Fair values are based on quoted market prices or dealer quotes.

 

Loans (net of the allowance for loan and lease losses and including impaired loans) – The fair value of fixed rate loans and variable rate mortgage loans is estimated by discounting the future cash flows using current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities.  For other variable rate loans, the carrying amount approximates fair value.

Loans Held for Sale – The fair value is predetermined based on sale price.

Federal Reserve Bank Stock – The carrying value of Federal Reserve Bank stock approximates fair value based on the redemption provisions of the Federal Reserve Bank.

 

Federal Home Loan Bank Stock – The carrying value of Federal Home Loan Bank stock approximates fair value based on the redemption provisions of the Federal Home Loan Bank.

Accrued Interest Receivable – The carrying amount approximates fair value.

Deposits – The fair value of deposits is estimated by discounting the future cash flows using the rates currently offered for deposits of similar remaining maturities.

Short-term Borrowings – The fair value is estimated by discounting future cash flows using current rates.

 

Advances from Federal Home Loan Bank – The fair value of these fixed-maturity advances is estimated by discounting future cash flows using rates currently offered for advances of similar remaining maturities.

Long-term Debt – The fair value is estimated by discounting future cash flows using current rates.

Accrued Interest Payable – The carrying amount approximates fair value.

 

Other Financial Instruments – The estimated fair value for other financial instruments and off-balance sheet loan commitments approximates cost at September 30, 2009 and December 31, 2008.  Off-balance sheet loan commitments at September 30, 2009 and December 31, 2008 were $456.4 million and $481.8 million, respectively.

 

Commitments to Extend Credit – The fair value of commitments to extend credit is based upon the difference between the interest rate at which we are committed to make the loans and the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities, adjusted for the estimated volume of loan commitments actually expected to close.  The fair value of such commitments is not material.

 

 

 

Community Trust Bancorp, Inc. (“CTBI”) is a bank holding company headquartered in Pikeville, Kentucky.  At September 30, 2009, CTBI owned one commercial bank and one trust company.  Through its subsidiaries, CTBI has seventy-six banking locations in eastern, northeastern, central, and south central Kentucky and southern West Virginia, and five trust offices across Kentucky.  At September 30, 2009, CTBI had total consolidated assets of $3.0 billion and total consolidated deposits, including repurchase agreements, of $2.6 billion, making it the largest depository of Kentucky based deposits of any bank holding company headquartered in the Commonwealth of Kentucky.  Total shareholders’ equity at September 30, 2009 was $318.6 million.

 

The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires the appropriate application of certain accounting policies, many of which require us to make estimates and assumptions about future events and their impact on amounts reported in our consolidated financial statements and related notes.  Since future events and their impact cannot be determined with certainty, the actual results will inevitably differ from our estimates.  Such differences could be material to the consolidated financial statements.

 

We believe the application of our accounting policies and the estimates required therein are reasonable.  These accounting policies and estimates are constantly reevaluated, and adjustments are made when facts and circumstances dictate a change.  Historically, we have found our application of accounting policies to be appropriate, and actual results have not differed materially from those determined using necessary estimates.

 

See note 1 to the condensed consolidated financial statements for further information regarding our accounting policies.  We have identified the following critical accounting policies:

 

Cash and Cash Equivalents – Cash and cash equivalents include cash on hand, amounts due from banks, interest bearing deposits in other financial institutions, and federal funds sold.  Generally, federal funds are sold for one-day periods.

 

Investments – Management determines the classification of securities at purchase.  We classify securities into held-to-maturity, trading, or available-for-sale categories.  Held-to-maturity securities are those which we have the positive intent and ability to hold to maturity and are reported at amortized cost.  In accordance with ASC 320 (formerly FAS 115, Accounting for Certain Investments in Debt and Equity Securities), investments in debt securities that are not classified as held-to-maturity and equity securities that have readily determinable fair values shall be classified in one of the following categories and measured at fair value in the statement of financial position:

 

a. Trading securities.Securities that are bought and held principally for the purpose of selling them in the near term (thus held for only a short period of time) shall be classified as trading securities.Trading generally reflects active and frequent buying and selling, and trading securities are generally used with the objective of generating profits on short-term differences in price.

 

b. Available-for-sale securities. Investments not classified as trading securities (nor as held-to-maturity securities) shall be classified as available-for-sale securities.

 

We do not have any securities that are classified as trading securities.  Available-for-sale securities are reported at fair value, with unrealized gains and losses included as a separate component of shareholders’ equity, net of tax.  If declines in fair value are not temporary, the carrying value of the securities is written down to fair value as a realized loss.

 

Gains or losses on disposition of securities are computed by specific identification for all securities except for shares in mutual funds, which are computed by average cost.  Interest and dividend income, adjusted by amortization of purchase premium or discount, is included in earnings.

Available-for-Sale Securities –Available-for-sale securities are valued using the following valuation techniques:

 

Securities Available-for-Sale – Level 2 Inputs.  For these securities, CTBI obtains fair value measurements from an independent pricing service. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond’s terms and conditions, among other things.

 

Securities Available-for-Sale – Level 3 Inputs.  The securities owned by CTBI that were measured using Level 3 criteria are auction rate securities issued by FNMA.  These securities were valued using an independent third party.  For these securities, the valuation methods used were (1) a discounted cash flow model valuation, where the expected cash flows of the securities are discounted to the present using a yield that incorporates compensation for illiquidity and (2) a market comparables method, where the securities are valued based on indications, from the secondary market, of what discounts buyers demand when purchasing similar securities.  Using these methods, the auction rate securities are classified as Level 3.

 

Loans – Loans with the ability and the intent to be held until maturity and/or payoff are reported at the carrying value of unpaid principal reduced by unearned interest and an allowance for loan and lease losses.  Income is recorded on the level yield basis.  Interest accrual is discontinued when management believes, after considering economic and business conditions, collateral value, and collection efforts, that the borrower’s financial condition is such that collection of interest is doubtful.  Any loan greater than 90 days past due must be well secured and in the process of collection to continue accruing interest.  Cash payments received on nonaccrual loans generally are applied against principal, and interest income is only recorded once principal recovery is reasonably assured.  Loans are not reclassified as accruing until principal and interest payments are brought current and future payments appear reasonably certain.

 

Loan origination and commitment fees and certain direct loan origination costs are deferred and the net amount amortized over the estimated life of the related loans, leases, or commitments as a yield adjustment.

 

Allowance for Loan and Lease Losses– We maintain an allowance for loan and lease losses (“ALLL”) at a level that is appropriate to cover estimated credit losses on individually evaluated loans determined to be impaired, as well as estimated credit losses inherent in the remainder of the loan and lease portfolio.  Since arriving at an appropriate ALLL involves a high degree of management judgment, we use an ongoing quarterly analysis to develop a range of estimated losses.  In accordance with accounting principles generally accepted in the United States, we use our best estimate within the range of potential credit loss to determine the appropriate ALLL.  Credit losses are charged and recoveries are credited to the ALLL.

 

We utilize an internal risk grading system for commercial credits.  Those larger commercial credits that exhibit probable or observed credit weaknesses are subject to individual review.  The borrower’s cash flow, adequacy of collateral coverage, and other options available to CTBI, including legal remedies, are evaluated.  The review of individual loans includes those loans that are impaired as ASC 310 (formerly FAS 114, Accounting by Creditors for Impairment of a Loan).  We evaluate the collectibility of both principal and interest when assessing the need for loss provision.  Historical loss rates are applied to other commercial loans not subject to specific allocations.  The ALLL allocation for this pool of commercial loans is established based on the historical average, maximum, minimum, and median loss ratios.

 

Homogenous loans, such as consumer installment, residential mortgages, and home equity lines are not individually risk graded.  The associated ALLL for these loans is measured under ASC 450 (formerly FAS 5, Accounting for Contingencies).  The ALLL allocation for these pools of loans is established based on the average, maximum, minimum, and median loss ratios over the previous eight quarters.

 

Historical loss rates for commercial and retail loans are adjusted for significant factors that, in management’s judgment, reflect the impact of any current conditions on loss recognition.  Factors that we consider include delinquency trends, current economic conditions and trends, strength of supervision and administration of the loan portfolio, levels of underperforming loans, level of recoveries to prior year’s charge offs, trend in loan losses, industry concentrations and their relative strengths, amount of unsecured loans and underwriting exceptions.  These factors are reviewed quarterly and a weighted range developed with a “most likely” scenario determined.  The total of each of these weighted factors is then applied against the applicable portion of the portfolio and the ALLL is adjusted accordingly.

 

Loans Held for Sale – Mortgage loans originated and intended for sale in the secondary market are carried at the lower of cost or estimated market value in the aggregate.  Net unrealized losses, if any, are recognized in a valuation allowance by charges to income.

 

Premises and Equipment – Premises and equipment are stated at cost less accumulated depreciation and amortization.  Capital leases are included in premises and equipment at the capitalized amount less accumulated amortization.  Premises and equipment are evaluated for impairment on a quarterly basis.

 

Depreciation and amortization are computed primarily using the straight-line method.  Estimated useful lives range up to 40 years for buildings, 2 to 10 years for furniture, fixtures, and equipment, and up to the lease term for leasehold improvements.  Capitalized leased assets are amortized on a straight-line basis over the lives of the respective leases.

 

Other Real Estate – Real estate acquired by foreclosure is carried at the lower of the investment in the property or its fair value.  Other real estate owned by CTBI included in other assets at September 30, 2009 and December 31, 2008 was $36.6 million and $10.4 million, respectively.

 

Goodwill and Core Deposit Intangible– We evaluate total goodwill and core deposit intangible for impairment, based upon ASC 350 (formerly FAS 142, Goodwill and Other Intangible Assets and FAS 147, Acquisitions of Certain Financial Institutions), using fair value techniques including multiples of price/equity.  Goodwill and core deposit intangible are evaluated for impairment on an annual basis or as other events may warrant.

 

Amortization of core deposit intangible is estimated at approximately $0.6 million annually for year one, approximately $0.4 million in year two, and approximately $0.1 million in years three and four.

 

Income Taxes – Income tax expense is based on the taxes due on the consolidated tax return plus deferred taxes based on the expected future tax consequences of temporary differences between carrying amounts and tax bases of assets and liabilities, using enacted tax rates.

 

Earnings Per Share (“EPS”) – Basic EPS is calculated by dividing net income available to common shareholders by the weighted average number of common shares outstanding, excluding restricted shares.

 

Diluted EPS adjusts the number of weighted average shares of common stock outstanding by the dilutive effect of stock options, including restricted shares, as prescribed in ASC 718 (formerly FAS 123R).

 

Segments – Management analyzes the operation of CTBI assuming one operating segment, community banking services.  CTBI, through its operating subsidiaries, offers a wide range of consumer and commercial community banking services.  These services include: (i) residential and commercial real estate loans; (ii) checking accounts; (iii) regular and term savings accounts and savings certificates; (iv) full service securities brokerage services; (v) consumer loans; (vi) debit cards; (vii) annuity and life insurance products; (viii) Individual Retirement Accounts and Keogh plans; (ix) commercial loans; (x) trust services; and (xi) commercial demand deposit accounts.

 

Bank Owned Life Insurance –CTBI’s bank owned life insurance policies are carried at their cash surrender value.  We recognize tax-free income from the periodic increases in cash surrender value of these policies and from death benefits.

 

Mortgage Servicing Rights – Mortgage servicing rights (“MSRs”) are carried at fair market value with the implementation of ASC 860 (formerly FAS 156) in January 2007.  MSRs are valued using Level 3 inputs as defined in ASC 820 (formerly FAS 157).  The fair value is determined quarterly based on an independent third-party valuation using a discounted cash flow analysis and calculated using a computer pricing model.  The computer valuation is based on key economic assumptions including the prepayment speeds of the underlying loans, the weighted-average life of the loan, the discount rate, the weighted-average coupon, and the weighted-average default rate, as applicable.  Along with the gains received from the sale of loans, fees are received for servicing loans.  These fees include late fees, which are recorded in interest income, and ancillary fees and monthly servicing fees, which are recorded in noninterest income.  Costs of servicing loans are charged to expense as incurred.  Changes in fair market value of the MSRs are reported in mortgage banking income.

 

Stock Options – At September 30, 2009 and December 31, 2008, CTBI had a share-based employee compensation plan, which is described more fully in note 13 to the consolidated financial statements for the year ended December 31, 2008, included in CTBI’s Annual Report on Form 10-K.  CTBI accounts for this plan under the recognition and measurement principles of ASC 718 (formerly FAS 123R, Share-Based Payment).

 

Reclassifications – Certain reclassifications considered to be immaterial have been made in the prior year condensed consolidated financial statements to conform to current year classifications.  These reclassifications had no effect on net income.

The following schedule shows the quarterly cash dividends paid for the past six quarters:

 

CTBI reported earnings for the quarter ended September 30, 2009 of $5.6 million or $0.37 per basic share compared to $5.9 million or $0.39 per basic share earned during the quarter ended June 30, 2009 and a loss of ($0.6 million) or ($0.04) per basic share incurred during the third quarter of 2008.  The loss recorded in the third quarter 2008 was a result of the $13.5 million other than temporary impairment (OTTI) charge to earnings incurred due to the U.S. Treasury placing Freddie Mac and Fannie Mae into conservatorship.  Year-to-date September 30, 2009 earnings per basic share were $1.20 compared to $1.11 for the same period in 2008.

 

CTBI had basic weighted average shares outstanding of 15.1 million for both the three and nine months ended September 30, 2009 compared to 15.0 million for both the three and nine months ended September 30, 2008.  The following table sets forth on an annualized basis the return on average assets and return on average shareholders’ equity for the three months and nine months ended September 30, 2009 and 2008:

Net Interest Income

 

CTBI saw improvement in its net interest margin of 18 basis points from prior quarter, although it remains below prior year with a decrease of 16 basis points compared to the quarter ended September 30, 2008.  Net interest income for the quarter increased 6.4% from prior quarter and 2.1% from prior year third quarter with average earning assets increasing 0.2% and 6.1%, respectively, for the same periods.  CTBI’s balance sheet is asset sensitive in the short time period but liability sensitive at the one year time period.  Deposit repricing is occurring more slowly than loan repricing placing pressure on the margin; however, current margin improvement from repricing is evidenced as the yield on average earnings assets increased 5 basis points from prior quarter in comparison to the 18 basis point decrease in the cost of interest bearing funds during the same period.  Net interest income increased $1.6 million from prior quarter.  YTD 2009 net interest income was $76.9 million compared to $78.5 million for the same period in 2008.  Average earnings assets for the quarter ending September 30, 2009 increased $6.0 million from prior quarter and 2009 YTD average earning assets increased $140.0 million from the nine months ended September 30, 2008.

The following table summarizes the annualized net interest spread and net interest margin for the three and nine months ended September 30, 2009 and 2008.

The analysis of the changes in the allowance for loan losses and selected ratios is set forth below:

 

Net loan charge-offs for the quarter of $5.2 million, or 0.87% of average loans annualized, was an increase from prior quarter's 0.63% and prior year third quarter’s 0.36%.  Of the total net charge offs of $5.2 million, $3.5 million was charged off in commercial loans with specific reserve allocations for these loans of $3.0 million or 81% of total commercial loan charge offs.  Residential real estate and other consumer loans are not generally provided a specific allocation during the credit review process.   Allocations to loan loss reserves were $5.8 million for the quarter ended September 30, 2009 compared to $4.5 million for the quarter ended June 30, 2009 and $2.9 million for the quarter ended September 30, 2008.  Our loan loss reserves as a percentage of total loans outstanding at September 30, 2009 increased to 1.33% from the 1.32% at June 30, 2009 and the 1.29% at September 30, 2008.  The adequacy of our loan loss reserves is analyzed quarterly and adjusted as necessary with a focus on maintaining appropriate reserves for potential losses.