Stock Yards Bancorp - 10-Q quarterly report FY

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

FORM 10-Q

Commission file number       0-17262

S.Y. BANCORP, INC.

(Exact name of registrant as specified in its charter)

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

Yes  ý      No  o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act.).

Yes  ý      No  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  ý

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 – 13,829,137

Shares issued and outstanding at November 3, 2005

S.Y. BANCORP, INC. AND SUBSIDIARY

Notes to Unaudited Condensed Consolidated Financial Statements

(1)                     Summary of Significant Accounting Policies

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

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

A description of other significant accounting policies is presented in the notes to the Consolidated Financial Statements for the year ended December 31, 2004 included in S.Y. Bancorp, Inc.’s Annual Report on Form 10-K.

Interim results for the three and nine month periods ended September 30, 2005 are not necessarily indicative of the results for the entire year.

(a)                      Critical Accounting Policies

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

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(b)                      Stock-Based Compensation

As permitted by Statement of Financial Accounting Standards (SFAS) No 148, Accounting for Stock-Based Compensation – Transition and Disclosure, an amendment of FASB Statement No. 123, Bancorp has continued to apply the provisions of Accounting Principles Board Opinion No. 25, Accounting for Stock-Based Compensation, for all stock option grants and has elected to disclose pro forma net income and earnings per share amounts as if the fair-value based method had been applied in measuring compensation costs.

No stock-based compensation is reflected in net income because all options granted under the current stock incentive plan have an exercise price equal to the market price of Bancorp’s stock at the grant date. Bancorp discloses pro forma net income and earnings per share in the notes to its financial statements as if compensation were measured at the date of grant based on the fair value of the award and recognized over the service period.

Bancorp’s as reported and pro forma earnings per share information for the three months ended September 30 are as follows (in thousands, except per share data):

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(2)                     Allowance for Loan Losses

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

(3)                     Federal Home Loan Bank Advances

Under a blanket collateral agreement with the Federal Home Loan Bank of Cincinnati and secured by certain residential real estate loans, the Bank has borrowed $20,000,000 via two separate fixed rate, noncallable advances of $10,000,000. The advances are due in February of 2006 and 2007, respectively, with a weighted average rate of 2.45%. Interest payments are due monthly, with principal due at maturity.

(4)                     Subordinated Debentures

On June 1, 2001, S.Y. Bancorp Capital Trust I (the Trust), a Delaware statutory business trust and 100%-owned finance subsidiary of Bancorp, issued $20.0 million of 9.00% Cumulative Trust Preferred Securities (Securities) which will mature on June 30, 2031, but prior redemption is permitted under certain circumstances, such as changes in tax or regulatory capital rules. The principal asset of the Trust is a $20.0 million subordinated debenture of Bancorp. The subordinated debenture bears interest at the rate of 9.00% and matures June 30, 2031, subject to prior redemption under certain circumstances. Bancorp owns all of the common securities of the Trust.

The Securities, the assets of the Trust, and the common securities issued by the Trust are redeemable in whole or in part on or after June 30, 2006, or at any time in whole, but not in part, from the date of issuance upon the occurrence of certain events. The Securities are included in Tier I capital for regulatory capital adequacy determination purposes, subject to certain limitations.

The obligations of Bancorp with respect to the issuance of the Securities constitute a full and unconditional guarantee by Bancorp of the Trust’s obligation with respect to the Securities.

Subject to certain exceptions and limitations, Bancorp may, from time to time, defer subordinated debenture interest payments, which would result in a deferral of distribution payments on the related Securities and, with certain exceptions, prevent Bancorp from declaring or paying cash distributions on Bancorp’s common stock or debt securities that rank pari passu or junior to the subordinated debenture.

Prior to 2003, the Trust was consolidated in Bancorp’s financial statements, with the trust preferred securities issued by the Trust reported in liabilities as “Long Term Debt – Trust Preferred Securities” and the subordinated debentures eliminated in consolidation. Under FASB Interpretation No. 46, as revised in December 2003, the Trust is no longer consolidated with Bancorp. Accordingly, Bancorp does not report the securities issued by the Trust as liabilities, and instead reports as liabilities the subordinated debentures

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(5)                     Intangible Assets

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

(6)                     Defined Benefit Retirement Plan

The Bank sponsors an unfunded, nonqualified, 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 (dollars in thousands):

(7)                     Commitments to Extend Credit

As of September 30, 2005, Bancorp had various commitments outstanding that arose in the normal course of business, such as 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 $324,331,000, including standby letters of credit of $13,807,000, represent normal banking transactions,

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and no significant losses are anticipated to result from these commitments as of September 30, 2005. Commitments to extend credit were $274,039,000, including letters of credit of $13,774,000, as of December 31, 2004. 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. At September 30, 2005, no amounts have been accrued in the financial statements related to these instruments.

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

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

(8)                     Preferred Stock

At Bancorp’s annual meeting of shareholders held in April 2003, the shareholders approved an amendment to the Articles of Incorporation to create a class of preferred stock and authorize 1,000,000 shares of this preferred stock with no par value. The relative rights, preferences and other terms of this stock or any series within the class will be determined by the board of directors prior to any issuance. Some of this preferred stock will be used in connection with a shareholders’ rights plan upon the occurrence of certain triggering events. None of this stock had been issued as of September 30, 2005.

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(9)                     Net Income Per Share

The following table reflects, for the three and nine month periods ended September 30, 2005 and 2004, 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):

(10)              Segments

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

The financial information for each business segment reflects that which is specifically identifiable or allocated based on an internal allocation method. 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.

Prior to June 30, 2005, results from the Bank’s brokerage department were included in investment management and trust. In the current and future periods, brokerage results will be included in the commercial and retail banking segment. Brokerage services are primarily directed toward the Bank’s retail customers and the management structure of the brokerage department reports through the commercial and retail banking segment. Prior periods presented have been amended to be consistent with this change.

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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), and its subsidiary, Stock Yards Bank & Trust Company (Bank) for the three and nine month periods ended September 30, 2005 and compares those periods with the same periods of the previous year. Unless otherwise indicated, all references in this discussion to the Bank include Bancorp. In addition, the discussion describes the significant changes in the financial condition of Bancorp and the Bank that have occurred during the first nine months of 2005 compared to December 31, 2004. This discussion should be read in conjunction with the unaudited condensed consolidated financial statements and accompanying notes presented in Part 1, Item 1 of this report.

This report contains forward-looking statements under the Private Securities Litigation Reform Act that involve risks and uncertainties. Although Bancorp believes the assumptions underlying the forward-looking statements contained herein are reasonable, any of these assumptions could be inaccurate. Factors that could cause actual results to differ from results discussed in forward-looking statements include, but are not limited to the following: economic conditions both generally and more specifically in the markets in which Bancorp and its subsidiaries operate; competition for Bancorp’s customers from other providers of financial services; government legislation and regulation which change from time to time and over which Bancorp has no control; changes in interest rates; material unforeseen changes in liquidity, results of operations, or financial condition of Bancorp’s customers; other risks detailed in Bancorp’s filings with the Securities and Exchange Commission, all of which are difficult to predict and many of which are beyond the control of Bancorp.

Overview of 2005 through September 30

The first nine months of 2005 were highlighted by higher earnings as a result of improved net interest margin, moderate loan growth combined with improved credit quality, and strong growth in non-interest income from several areas of the Bank.  As a result of the improvement in credit quality, Bancorp made no provision for loan losses during the third quarter and $225,000 for the nine month period ended September 30, 2005. Bancorp completed the first three quarters of the year with net income exceeding the comparable period of 2004 by 15%. This represents a continuation of the Company’s eighteenth consecutive year of higher earnings.

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

Net interest income was up 10% for the first nine months of the year, primarily due to loan growth and improving net interest margin. While net interest margin was up only 1 basis point for the first nine months of the year compared to the prior year, in comparing the third quarter of 2005 to third quarter of 2004, net interest margin increased 24 basis points. Additionally, the net interest margin for the third quarter of 2005 exceeded the second quarter of 2005 by eleven basis points.  The rise in net interest margin during the quarter was due to the Bank’s ability to hold down deposit costs as market interest rates increased.  With approximately half of the loan portfolio comprised of variable rate loans, increases in rates earned on loans outpaced increases in rates on deposits.

Bancorp has a higher than average proportion of non-interest revenues which also has proven to fuel net income growth. Total non-interest income grew 9% in the first nine months of 2005 as compared to the same period of 2004. Increasing revenues from investment management and trust services, gains on the sale of mortgage loans

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held for sale and brokerage revenues helped offset a decline in service charges on deposit accounts. Growth in non-interest income helped offset growth in non-interest expenses which were up 11% in the first nine months of 2005 compared to 2004.  These expenses rose primarily due to increases in salaries and employee benefits due to additions to staff to support the Bank’s growth, annual compensation increases and rising benefit costs.  Salaries and employee benefits costs in 2004 were lower due to better than expected claims experience in the Company’s self-funded health plan.

Operating results in 2005 were also positively affected by a lower provision for loan losses as credit quality metrics used by management improved. Net charge-offs were down 33% for the first nine months of 2005 compared to 2004. Nonperforming loans were down 23% compared to both the level one year ago and second quarter of 2005. Bancorp’s process of evaluating the credit risk inherent in the loan portfolio considers data including nonperforming loans, past due loans, charge offs, internal watch lists, the nature of the Bank’s loan portfolio and relevant economic data. Taking into consideration all relevant data, management considers the allowance for loan losses adequate to cover losses inherent in the loan portfolio at September 30, 2005.

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

(a)                     Results Of Operations

Net income of $5,851,000 for the three months ended September 30, 2005 increased $880,000 or 18% from $4,971,000 for the comparable 2004 period. Basic net income per share was $0.42 for the third quarter of 2005, an increase of 17% from the $0.36 for the same period in 2004. Net income per share on a diluted basis was $0.41 for the third quarter of 2005 compared to $0.35 for the third quarter of 2004 representing a 17% increase. Annualized return on average assets and annualized return on average stockholders’ equity were 1.83% and 18.77%, respectively, for the third quarter of 2005, compared to 1.71% and 17.90%, respectively, for the same period in 2004.

Net income of $16,120,000 for the nine months ended September 30, 2005 increased $2,122,000 or 15% from $13,998,000 from the comparable 2004 period. Basic net income per share was $1.16 for the first nine months of 2005, an increase of 14% from the $1.02 for the same period in 2004. Net income per share on a diluted basis was $1.14 for the first nine months of 2005 compared to $0.99 for the first nine months of 2004. This represents a 15% increase. Annualized return on average assets and annualized return on average stockholders’ equity were 1.71% and 17.90%, respectively, for the first nine months of 2005, compared to 1.65% and 17.44%, respectively, for the same period in 2004.

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