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COMMUNITY TRUST BANCORP INC /KY/ - Quarter Report: 2014 September (Form 10-Q)

ctbi10q0914.htm

 
 


 

 
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, 2014
   
 
Or
   
[   ]
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from _____________ to _____________
   

Commission file number 0-11129

COMMUNITY TRUST BANCORP, INC.
(Exact name of registrant as specified in its charter)

Kentucky
61-0979818
(State or other jurisdiction of incorporation or organization)
IRS Employer Identification No.
   
346 North Mayo Trail
Pikeville, Kentucky
(Address of principal executive offices)
41501
(Zip code)

(606) 432-1414
(Registrants 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.

Yes  ü
No
 
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.)

Yes  ü
No
 
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.

Large accelerated filer
Accelerated filer  ü
Non-accelerated filer
Smaller reporting company
   
(Do not check if a smaller reporting company)
 

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

Yes
   No ü

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

Common stock – 17,437,297 shares outstanding at October 31, 2014
 
 
 
 



 
 

 


CAUTIONARY STATEMENT
REGARDING FORWARD LOOKING STATEMENTS
 
Certain of the statements contained herein that are not historical facts are forward-looking statements within the meaning of the Private Securities Litigation Reform Act. CTBI’s actual results may differ materially from those included in the forward-looking statements. Forward-looking statements are typically identified by words or phrases such as “believe,” “expect,” “anticipate,” “intend,” “estimate,” “may increase,” “may fluctuate,” and similar expressions or future or conditional verbs such as “will,” “should,” “would,” and “could.” These forward-looking statements involve risks and uncertainties including, but not limited to, economic conditions, portfolio growth, the credit performance of the portfolios, including bankruptcies, and seasonal factors; changes in general economic conditions including the performance of financial markets, prevailing inflation and interest rates, realized gains from sales of investments, gains from asset sales, and losses on commercial lending activities; results of various investment activities; the effects of competitors’ pricing policies, changes in laws and regulations, competition, and demographic changes on target market populations’ savings and financial planning needs; industry changes in information technology systems on which we are highly dependent; failure of acquisitions to produce revenue enhancements or cost savings at levels or within the time frames originally anticipated or unforeseen integration difficulties; the adoption by CTBI of a Federal Financial Institutions Examination Council (FFIEC) policy that provides guidance on the reporting of delinquent consumer loans and the timing of associated credit charge-offs for financial institution subsidiaries; and the resolution of legal  proceedings and related matters.  In addition, the banking industry in general is subject to various monetary and fiscal policies and regulations, which include those determined by the Federal Reserve Board, the Federal Deposit Insurance Corporation, and state regulators, whose policies and regulations could affect CTBI’s results.  These statements are representative only on the date hereof, and CTBI undertakes no obligation to update any forward-looking statements made.


PART I - FINANCIAL INFORMATION

Item 1. Condensed Consolidated Financial Statements
 
The accompanying information has not been audited by our 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, 2013 for further information in this regard.




 
 

 

Community Trust Bancorp, Inc.
Condensed Consolidated Balance Sheets

(dollars in thousands)
 
(unaudited)
September 30
2014
   
December 31
2013
 
Assets:
           
Cash and due from banks
  $ 62,510     $ 64,828  
Interest bearing deposits
    48,455       33,200  
Federal funds sold
    7,493       8,613  
Cash and cash equivalents
    118,458       106,641  
                 
Certificates of deposit in other banks
    9,179       9,568  
Securities available-for-sale at fair value (amortized cost of $635,133 and $621,753, respectively)
    633,572       609,405  
Securities held-to-maturity at amortized cost (fair value of $1,631 and $1,601, respectively)
    1,662       1,662  
Loans held for sale
    367       828  
                 
Loans
    2,683,905       2,615,354  
Allowance for loan and lease losses
    (34,090 )     (34,008 )
Net loans
    2,649,815       2,581,346  
                 
Premises and equipment, net
    50,604       52,000  
Federal Home Loan Bank stock
    17,927       25,673  
Federal Reserve Bank stock
    4,887       4,886  
Goodwill
    65,490       65,490  
Core deposit intangible (net of accumulated amortization of $8,085 and $7,925, respectively)
    530       690  
Bank owned life insurance
    54,800       53,687  
Mortgage servicing rights
    3,112       3,424  
Other real estate owned
    32,747       39,188  
Other assets
    26,936       27,228  
Total assets
  $ 3,670,086     $ 3,581,716  
                 
Liabilities and shareholders’ equity:
               
Deposits:
               
Noninterest bearing
  $ 660,100     $ 621,321  
Interest bearing
    2,242,081       2,233,753  
Total deposits
    2,902,181       2,855,074  
                 
Repurchase agreements
    220,095       208,067  
Federal funds purchased and other short-term borrowings
    11,114       12,465  
Advances from Federal Home Loan Bank
    1,199       1,286  
Long-term debt
    61,341       61,341  
Other liabilities
    35,918       30,991  
Total liabilities
    3,231,848       3,169,224  
                 
Shareholders’ equity:
               
Preferred stock, 300,000 shares authorized and unissued
    -       -  
Common stock, $5 par value, shares authorized 25,000,000; shares outstanding 2014 – 17,431,146; 2013 – 17,403,441
    87,155       79,107  
Capital surplus
    212,184       167,122  
Retained earnings
    139,914       174,289  
Accumulated other comprehensive loss, net of tax
    (1,015 )     (8,026 )
Total shareholders’ equity
    438,238       412,492  
                 
Total liabilities and shareholders’ equity
  $ 3,670,086     $ 3,581,716  
 

See notes to condensed consolidated financial statements.

 
 
 

 

Community Trust Bancorp, Inc.
Condensed Consolidated Statements of Income and Comprehensive Income
(unaudited)

   
Three Months Ended
   
Nine Months Ended
 
   
September 30
   
September 30
 
(in thousands except per share data)
 
2014
   
2013
   
2014
   
2013
 
Interest income:
                       
Interest and fees on loans, including loans held for sale
  $ 32,191     $ 33,290     $ 95,741     $ 98,810  
Interest and dividends on securities
                               
Taxable
    2,763       3,196       8,616       9,220  
Tax exempt
    664       561       1,912       1,676  
Interest and dividends on Federal Reserve Bank and Federal Home Loan Bank stock
    252       345       882       1,035  
Other, including interest on federal funds sold
    87       63       310       273  
Total interest income
    35,957       37,455       107,461       111,014  
                                 
Interest expense:
                               
Interest on deposits
    2,475       2,778       7,409       8,699  
Interest on repurchase agreements and other short-term borrowings
    205       232       614       729  
Interest on advances from Federal Home Loan Bank
    6       7       17       20  
Interest on long-term debt
    283       288       850       877  
Total interest expense
    2,969       3,305       8,890       10,325  
                                 
Net interest income
    32,988       34,150       98,571       100,689  
Provision for loan losses
    3,300       2,129       5,380       7,349  
Net interest income after provision for loan losses
    29,688       32,021       93,191       93,340  
                                 
Noninterest income:
                               
Service charges on deposit accounts
    6,321       6,349       17,739       18,298  
Gains on sales of loans, net
    303       653       781       2,805  
Trust and wealth management income
    2,395       2,005       6,703       6,028  
Loan related fees
    1,128       1,088       2,573       3,532  
Bank owned life insurance
    523       517       1,473       2,265  
Brokerage revenue
    505       576       1,709       1,644  
Securities losses
    (34 )     (23 )     (145 )     (31 )
Other noninterest income
    865       906       2,210       2,724  
Total noninterest income
    12,006       12,071       33,043       37,265  
                                 
Noninterest expense:
                               
Officer salaries and employee benefits
    2,584       2,705       8,206       7,891  
Other salaries and employee benefits
    10,881       10,543       31,950       31,553  
Occupancy, net
    2,007       1,945       6,108       5,844  
Equipment
    831       920       2,669       2,886  
Data processing
    2,017       1,850       5,875       5,438  
Bank franchise tax
    1,208       1,124       3,625       3,370  
Legal fees
    558       585       1,912       1,747  
Professional fees
    491       491       1,331       1,305  
FDIC insurance
    575       624       1,782       1,863  
Other real estate owned provision and expense
    707       905       2,948       3,914  
Repossession expense
    322       284       863       1,182  
Other noninterest expense
    3,682       3,615       10,711       10,884  
Total noninterest expense
    25,863       25,591       77,980       77,877  
                                 
Income before income taxes
    15,831       18,501       48,254       52,728  
Income taxes
    4,907       5,848       14,995       16,313  
Net income
    10,924       12,653       33,259       36,415  
                                 
                                 
Other comprehensive income (loss):
                               
Unrealized holding gains (losses) on securities available-for-sale:
                               
Unrealized holding gains (losses) arising during the period
    (2,009 )     (981 )     10,642       (24,904 )
Less: Reclassification adjustments for realized losses included in net income
    (34 )     (23 )     (145 )     (31 )
Tax (benefit) expense
    (691 )     (336 )     3,776       (8,706 )
Other comprehensive income (loss), net of tax
    (1,284 )     (622 )     7,011       (16,167 )
Comprehensive income
  $ 9,640     $ 12,031     $ 40,270     $ 20,248  
                                 
Basic earnings per share
  $ 0.63     $ 0.74     $ 1.92     $ 2.13  
Diluted earnings per share
  $ 0.63     $ 0.73     $ 1.91     $ 2.12  
                                 
Weighted average shares outstanding-basic
    17,326       17,154       17,317       17,123  
Weighted average shares outstanding-diluted
    17,402       17,257       17,395       17,212  
                                 
Dividends declared per share
  $ 0.300     $ 0.291     $ 0.881     $ 0.863  


See notes to condensed consolidated financial statements.

 
 
 

 


Community Trust Bancorp, Inc.
Condensed Consolidated Statements of Cash Flows
(unaudited)

   
Nine Months Ended
 
   
September 30
 
(in thousands)
 
2014
   
2013
 
Cash flows from operating activities:
           
Net income
  $ 33,259     $ 36,415  
Adjustments to reconcile net income to net cash provided by operating activities:
               
Depreciation and amortization
    3,307       3,440  
Deferred taxes
    1,421       570  
Stock-based compensation
    548       498  
Excess tax benefits of stock-based compensation
    22       100  
Provision for loan losses
    5,380       7,349  
Write-downs of other real estate owned and other repossessed assets
    1,402       1,958  
Gains on sale of mortgage loans held for sale
    (781 )     (2,805 )
Losses on sales of securities
    145       31  
Gains (losses) on sale of assets, net
    (3 )     160  
Proceeds from sale of mortgage loans held for sale
    33,240       122,764  
Funding of mortgage loans held for sale
    (31,998 )     (98,240 )
Amortization of securities premiums and discounts, net
    2,011       3,221  
Change in cash surrender value of bank owned life insurance
    (1,113 )     (1,119 )
Mortgage servicing rights:
               
Fair value adjustments
    546       (173 )
New servicing assets created
    (234 )     (768 )
Changes in:
               
Other assets
    297       3,674  
Other liabilities
    (943 )     1,316  
Net cash provided by operating activities
    46,506       78,391  
                 
Cash flows from investing activities:
               
Certificates of deposit in other banks:
               
Maturity of certificates of deposit
    389       (4,472 )
Purchase of certificates of deposit
    0       240  
Securities available-for-sale (AFS):
               
Purchase of AFS securities
    (177,579 )     (197,263 )
Proceeds from the sales of AFS securities
    112,949       14,354  
Proceeds from prepayments and maturities of AFS securities
    49,094       94,211  
Change in loans, net
    (73,376 )     (76,276 )
Purchase of premises and equipment
    (1,750 )     (933 )
Proceeds from sale of premises and equipment
    22       93  
Redemption of stock by Federal Home Loan Bank
    7,746       0  
Additional investment in Federal Reserve Bank stock
    (1 )     (1 )
Proceeds from sale of other real estate and other repossessed assets
    4,551       6,408  
Additional investment in other real estate and other repossessed assets
    0       (173 )
Additional investment in bank owned life insurance
    0       (7,950 )
Proceeds from bank owned life insurance
    0       644  
Net cash used in investing activities
    (77,955 )     (171,118 )
                 
Cash flows from financing activities:
               
Change in deposits, net
    47,107       (29,564 )
Change in repurchase agreements, federal funds purchased, and other short-term borrowings, net
    10,677       6,254  
Proceeds from Federal Home Loan Bank advances
    0       30,000  
Payments on advances from Federal Home Loan Bank
    (87 )     (113 )
Issuance of common stock
    930       2,376  
Excess tax benefits of stock-based compensation
    (22 )     (100 )
Dividends paid
    (15,339 )     (14,690 )
Net cash provided by (used in) financing activities
    43,266       (5,837 )
Net increase (decrease) in cash and cash equivalents
    11,817       (98,564 )
Cash and cash equivalents at beginning of period
    106,641       207,560  
Cash and cash equivalents at end of period
  $ 118,458     $ 108,996  
                 
Supplemental disclosures:
               
Income taxes paid
  $ 10,170     $ 14,250  
Interest paid
    8,058       9,426  
Non-cash activities:
               
Loans to facilitate the sale of other real estate and other repossessed assets
    5,745       2,231  
Common stock dividends accrued, paid in subsequent quarter
    207       4,992  
Real estate acquired in settlement of loans
    5,267       6,135  
 

See notes to condensed consolidated financial statements.

 
 
 

 

Community Trust Bancorp, Inc.
Notes to Condensed Consolidated Financial Statements (unaudited)


Note 1 - Summary of Significant Accounting Policies
 
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, 2014, the results of operations for the three and nine months ended September 30, 2014 and 2013, and the cash flows for the nine months ended September 30, 2014 and 2013.  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, 2014 and 2013, and the cash flows for the nine months ended September 30, 2014 and 2013, are not necessarily indicative of the results to be expected for the full year.  The condensed consolidated balance sheet as of December 31, 2013 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, 2013, included in our 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.

All share data has been adjusted for the 10% stock dividend issued on June 2, 2014.

New Accounting Standards

Ø Accounting for Investments in Qualified Affordable Housing Projects – In January 2014, the FASB issued ASU No. 2014-01, Investments—Equity Method and Joint Ventures (Topic 323):  Accounting for Investments in Qualified Affordable Housing Projects, which enables companies that invest in affordable housing projects that qualify for the low-income housing tax credit (LIHTC) to elect to use the proportional amortization method if certain conditions are met.  Under the proportional amortization method, the initial investment cost of the project is amortized in proportion to the amount of tax credits and benefits received, with the results of the investment presented on a net basis as a component of income tax expense (benefit).  ASU 2014-01 is effective for interim and annual periods beginning after December 15, 2014, with early adoption permitted.  We are currently evaluating the impact of adopting ASU 2014-01, but we do not expect the adoption to have a material effect on CTBI’s financial condition or results of operations.

Ø Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure – In January 2014, the FASB also issued ASU No. 2014-04, Receivables—Troubled Debt Restructurings by Creditors (Subtopic 310-40):  Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure, which clarifies when an in-substance foreclosure or repossession of residential real estate property occurs, requiring a creditor to reclassify the loan to other real estate.  According to ASU 2014-04, a consumer mortgage loan should be reclassified to other real estate either upon the creditor obtaining legal title to the real estate collateral or when the borrower voluntarily conveys all interest in the real estate property to the creditor through a deed in lieu of foreclosure or similar legal agreement.  ASU 2014-04 also clarifies that a creditor should not delay reclassification when a borrower has a legal right of redemption.  Our current practice is consistent with the new guidance.  We expect to adopt ASU 2014-04 in the first quarter 2015 and do not expect the adoption to have a material effect on CTBI’s financial condition or results of operations.

Critical Accounting Policies and Estimates
 
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 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.

We have identified the following critical accounting policies:
 
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 Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) 320, Investment 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 other than temporary, the carrying value of the securities is written down to fair value as a realized loss with a charge to income for the portion attributable to credit losses and a charge to other comprehensive income for the portion that is not credit related.
 
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.
 
When the fair value of a security is below its amortized cost, and depending on the length of time the condition exists and the extent the fair market value is below amortized cost, additional analysis is performed to determine whether an other than temporary impairment condition exists.  Available-for-sale and held-to-maturity securities are analyzed quarterly for possible other than temporary impairment.  The analysis considers (i) whether we have the intent to sell our securities prior to recovery and/or maturity and (ii) whether it is more likely than not that we will not have to sell our securities prior to recovery and/or maturity.  Often, the information available to conduct these assessments is limited and rapidly changing, making estimates of fair value subject to judgment.  If actual information or conditions are different than estimated, the extent of the impairment of the security may be different than previously estimated, which could have a material effect on the CTBI’s results of operations and financial condition.
 
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, an allowance for loan and lease losses, and unamortized deferred fees or costs.  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 remain current for a period of time, generally six months, and future payments appear reasonably certain.  Included in certain loan categories of impaired loans are troubled debt restructurings that were classified as impaired.  A restructuring of a debt constitutes a troubled debt restructuring if the creditor for economic or legal reasons related to the debtor’s financial difficulties grants a concession to the debtor that it would not otherwise consider.

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 defined by ASC 310-35, Impairment of a Loan.  We evaluate the collectability of both principal and interest when assessing the need for loss provision.  Historical loss rates are analyzed and 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.
 
A loan is considered impaired when, based on current information and events, it is probable that CTBI will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement.  Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due.  Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired.  Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed.  Impairment is measured on a loan-by-loan basis for commercial and construction loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent.

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, Contingencies.
 
When any secured commercial loan is considered uncollectable, whether past due or not, a current assessment of the value of the underlying collateral is made.  If the balance of the loan exceeds the fair value of the collateral, the loan is placed on non-accrual and the loan is charged down to the value of the collateral less estimated cost to sell or a specific reserve equal to the difference between book value of the loan and the fair value assigned to the collateral is created until such time as the loan is foreclosed.  When the foreclosed collateral has been legally assigned to CTBI, a charge off is taken, if necessary, in order that the remaining balance reflects the fair value estimated less costs to sell of the collateral then transferred to other real estate owned or other repossessed assets.  When any unsecured commercial loan is considered uncollectable the loan is charged off no later than at 90 days past due.
 
All closed-end consumer loans (excluding conventional 1-4 family residential loans and installment and revolving loans secured by real estate) are charged off no later than 120 days (5 monthly payments) delinquent.  If a loan is considered uncollectable, it is charged off earlier than 120 days delinquent.  For conventional 1-4 family residential loans and installment and revolving loans secured by real estate, when a loan is 90 days past due, a current assessment of the value of the real estate is made.  If the balance of the loan exceeds the fair value of the property, the loan is placed on nonaccrual.  Foreclosure proceedings are normally initiated after 120 days.  When the foreclosed property has been legally assigned to CTBI, the fair value less estimated costs to sell is transferred to other real estate owned and the remaining balance is taken as a charge-off.
 
Historical loss rates for loans are adjusted for significant factors that, in management’s judgment, reflect the impact of any current conditions on loss recognition.  We continue to use twelve rolling quarters for our historical loss rate analysis.  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, trends in loan losses, industry concentrations and their relative strengths, amount of unsecured loans, and underwriting exceptions.  Based upon management’s judgment, “best case,” “worst case,” and “most likely” scenarios are 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 to approximate the most likely scenario.  Management continually reevaluates the other subjective factors included in its ALLL analysis.
 
Other Real Estate Owned – When foreclosed properties are acquired, appraisals are obtained and the properties are booked at the current market value less expected sales costs.  Additionally, periodic updated appraisals are obtained on unsold foreclosed properties.  When an updated appraisal reflects a market value below the current book value, a charge is booked to current earnings to reduce the property to its new market value less expected sales costs.  Our policy for determining the frequency of periodic reviews is based upon consideration of the specific properties and the known or perceived market fluctuations in a particular market and is typically between 12 and 18 months but generally not more than 24 months.  All revenues and expenses related to the carrying of other real estate owned are recognized by a charge to income.

Note 2 – Stock-Based Compensation
 
CTBI’s compensation expense related to stock option grants was $3 thousand and $2 thousand, respectively for the three months ended September 30, 2014 and 2013 and $8 thousand and $7 thousand, respectively, for the nine months ended September 30, 2014 and 2013.  Restricted stock expense for the three months ended September 30, 2014 and 2013 was $202 thousand and $161 thousand, respectively, including $30 thousand and $31 thousand in dividends paid for each period.  Restricted stock expense for the nine months ended September 30, 2014 and 2013 was $540 thousand and $491 thousand, respectively, including $90 thousand and $93 thousand in dividends.  As of September 30, 2014, there was a total of $77 thousand 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 4.5 years and a total of $1.0 million of unrecognized compensation expense related to restricted stock grants that will be recognized as expense as the awards vest over a weighted average period of 1.5 years.
 
There were no shares of restricted stock granted during the three months ended September 30, 2014 or 2013.  There were 4,572 and 11,904 shares of restricted stock granted during the nine months ended September 30, 2014 and 2013, respectively.  The restrictions on the restricted stock lapse ratably over four years or in the event of a change in control of CTBI or the death of the participant.  In the event of the disability of the participant, the restrictions will lapse on a pro rata basis.  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 10,000 options granted to purchase shares of CTBI common stock during the three and nine months ended September 30, 2014.  There were no options granted during the three months ended September 30, 2013, but 1,650 options were granted during the nine months ended September 30, 2013.

The fair value of options granted during the nine months ended September 30, 2014 and 2013 were established at the date of grant using a Black-Scholes option pricing model with the weighted average assumptions as follows:

   
Nine Months Ended
 
   
September 30
 
   
2014
   
2013
 
Expected dividend yield
    3.40 %     3.74 %
Risk-free interest rate
    2.01 %     1.33 %
Expected volatility
    30.77 %     39.11 %
Expected term (in years)
    7.0       7.5  
Weighted average fair value of options
  $ 7.76     $ 8.23  

Note 3 – Securities
 
Securities are classified into held-to-maturity and available-for-sale categories.  Held-to-maturity (HTM) securities are those that CTBI has the positive intent and ability to hold to maturity and are reported at amortized cost.  Available-for-sale (AFS) 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, 2014 are summarized as follows:

Available-for-Sale

(in thousands)
 
Amortized Cost
   
Gross Unrealized Gains
   
Gross Unrealized Losses
   
Fair Value
 
U.S. Treasury and government agencies
  $ 140,853     $ 261     $ (2,706 )   $ 138,408  
State and political subdivisions
    133,640       3,768       (718 )     136,690  
U.S. government sponsored agency mortgage-backed securities
    335,640       2,934       (4,781 )     333,793  
Total debt securities
    610,133       6,963       (8,205 )     608,891  
Marketable equity securities
    25,000       0       (319 )     24,681  
Total available-for-sale securities
  $ 635,133     $ 6,963     $ (8,524 )   $ 633,572  

Held-to-Maturity

(in thousands)
 
Amortized Cost
   
Gross Unrealized Gains
   
Gross Unrealized Losses
   
Fair Value
 
U.S. Treasury and government agencies
  $ 480     $ 0     $ (32 )   $ 448  
State and political subdivisions
    1,182       1       0       1,183  
Total held-to-maturity securities
  $ 1,662     $ 1     $ (32 )   $ 1,631  

The amortized cost and fair value of securities as of December 31, 2013 are summarized as follows:

Available-for-Sale

(in thousands)
 
Amortized Cost
   
Gross Unrealized Gains
   
Gross Unrealized Losses
   
Fair Value
 
U.S. Treasury and government agencies
  $ 65,524     $ 225     $ (5,139 )   $ 60,610  
State and political subdivisions
    118,055       1,907       (3,259 )     116,703  
U.S. government sponsored agency mortgage-backed securities
    383,174       4,325       (8,189 )     379,310  
Total debt securities
    566,753       6,457       (16,587 )     556,623  
Marketable equity securities
    55,000       0       (2,218 )     52,782  
Total available-for-sale securities
  $ 621,753     $ 6,457     $ (18,805 )   $ 609,405  

Held-to-Maturity

(in thousands)
 
Amortized Cost
   
Gross Unrealized Gains
   
Gross Unrealized Losses
   
Fair Value
 
U.S. Treasury and government agencies
  $ 480     $ 0     $ (62 )   $ 418  
State and political subdivisions
    1,182       1       0       1,183  
Total held-to-maturity securities
  $ 1,662     $ 1     $ (62 )   $ 1,601  
 
The amortized cost and fair value of securities at September 30, 2014 by contractual maturity are shown below.  Expected maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.

   
Available-for-Sale
   
Held-to-Maturity
 
(in thousands)
 
Amortized Cost
   
Fair Value
   
Amortized Cost
   
Fair Value
 
Due in one year or less
  $ 3,371     $ 3,400     $ 0     $ 0  
Due after one through five years
    108,097       108,713       0       0  
Due after five through ten years
    129,882       129,250       1,182       1,183  
Due after ten years
    33,143       33,735       480       448  
U.S. government sponsored agency mortgage-backed securities
    335,640       333,793       0       0  
Total debt securities
    610,133       608,891       1,662       1,631  
Marketable equity securities
    25,000       24,681       0       0  
Total securities
  $ 635,133     $ 633,572     $ 1,662     $ 1,631  
 
During the nine months ended September 30, 2014, there was a combined loss of $145 thousand.  A pre-tax gain of $1.8 million and a pre-tax loss of $2.0 million were realized during the year.  During the nine months ended September 30, 2013, there was a combined loss of $31 thousand.

The amortized cost of securities pledged as collateral, to secure public deposits and for other purposes, was $237.7 million at September 30, 2014 and $257.5 million at December 31, 2013.

The amortized cost of securities sold under agreements to repurchase amounted to $264.5 million at September 30, 2014 and $255.4 million at December 31, 2013.
 
Certain investments in debt and marketable equity securities are reported in the financial statements at amounts less than their historical costs.  CTBI evaluates its investment portfolio on a quarterly basis for impairment.  The analysis performed as of September 30, 2014 indicates that all impairment is considered temporary, market and interest rate driven, and not credit-related.  The percentage of total investments with unrealized losses as of September 30, 2014 was 57.8% compared to 67.8% as of December 31, 2013.  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, 2014 that are not deemed to be other-than-temporarily impaired.

Available-for-Sale

(in thousands)
 
Amortized Cost
   
Gross Unrealized Losses
   
Fair Value
 
Less Than 12 Months
                 
U.S. Treasury and government agencies
  $ 56,052     $ (103 )   $ 55,949  
State and political subdivisions
    6,305       (30 )     6,275  
U.S. government sponsored agency mortgage-backed securities
    97,714       (809 )     96,905  
Total debt securities
    160,071       (942 )     159,129  
Marketable equity securities
    0       0       0  
Total <12 months temporarily impaired AFS securities
    160,071       (942 )     159,129  
                         
12 Months or More
                       
U.S. Treasury and government agencies
    55,519       (2,603 )     52,916  
State and political subdivisions
    25,528       (688 )     24,840  
U.S. government sponsored agency mortgage-backed securities
    109,373       (3,972 )     105,401  
Total debt securities
    190,420       (7,263 )     183,157  
Marketable equity securities
    25,000       (319 )     24,681  
Total ≥12 months temporarily impaired AFS securities
    215,420       (7,582 )     207,838  
                         
Total
                       
U.S. Treasury and government agencies
    111,571       (2,706 )     108,865  
State and political subdivisions
    31,833       (718 )     31,115  
U.S. government sponsored agency mortgage-backed securities
    207,087       (4,781 )     202,306  
Total debt securities
    350,491       (8,205 )     342,286  
Marketable equity securities
    25,000       (319 )     24,681  
Total temporarily impaired AFS securities
  $ 375,491     $ (8,524 )   $ 366,967  

Held-to-Maturity

(in thousands)
 
Amortized Cost
   
Gross Unrealized Losses
   
Fair Value
 
12 Months or More
                 
U.S. Treasury and government agencies
  $ 480     $ (32 )   $ 448  
Total temporarily impaired HTM securities
  $ 480     $ (32 )   $ 448  

U.S. Treasury and Government Agencies
 
The unrealized losses in U.S. Treasury and government agencies were caused by interest rate increases.  The contractual terms of those investments do not permit the issuer to settle the securities at a price less than amortized cost.  CTBI does not consider those investments to be other-than-temporarily impaired at September 30, 2014, because CTBI does not intend to sell the investments and it is not more likely than not that we will be required to sell the investments before recovery of their amortized cost, which may be at maturity.

State and Political Subdivisions
 
The unrealized losses in securities of state and political subdivisions were caused by interest rate increases.  The contractual terms of those investments do not permit the issuer to settle the securities at a price less than amortized cost.  CTBI does not consider those investments to be other-than-temporarily impaired at September 30, 2014, because CTBI does not intend to sell the investments before recovery of their amortized cost, which may be at maturity.

U.S. Government Sponsored Agency Mortgage-Backed Securities

The unrealized losses in U.S. government sponsored agency mortgage-backed securities were caused by interest rate increases.  CTBI expects to recover the amortized cost basis over the term of the securities.  CTBI does not consider those investments to be other-than-temporarily impaired at September 30, 2014, because (i) the decline in market value is attributable to changes in interest rates and not credit quality, (ii) CTBI does not intend to sell the investments, and (iii) it is not more likely than not we will be required to sell the investments before recovery of their amortized cost, which may be at maturity.

Marketable Equity Securities
 
CTBI’s investments in marketable equity securities consist of investments in fixed income mutual funds ($24.7 million of the total fair value and $319 thousand of the total unrealized losses in common stock investments).  The severity of the impairment (fair value is approximately 1.3% less than cost) and the duration of the impairment correlates with the rise in interest rates during the latter half of 2013.  CTBI evaluated the near-term prospects of these funds in relation to the severity and duration of the impairment.  Based on that evaluation, CTBI does not consider those investments to be other-than-temporarily impaired at September 30, 2014.
 
The analysis performed as of December 31, 2013 indicated that all impairment was considered temporary, market and interest rate 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 December 31, 2013 that are not deemed to be other-than-temporarily impaired.

Available-for-Sale

(in thousands)
 
Amortized Cost
   
Gross Unrealized Losses
   
Fair Value
 
Less Than 12 Months
                 
U.S. Treasury and government agencies
  $ 21,750     $ (1,617 )   $ 20,133  
State and political subdivisions
    57,165       (2,789 )     54,376  
U.S. government sponsored agency mortgage-backed securities
    248,705       (8,182 )     240,523  
Total debt securities
    327,620       (12,588 )     315,032  
Marketable equity securities
    55,000       (2,218 )     52,782  
Total <12 months temporarily impaired AFS securities
    382,620       (14,806 )     367,814  
                         
12 Months or More
                       
U.S. Treasury and government agencies
    35,750       (3,522 )     32,228  
State and political subdivisions
    7,639       (470 )     7,169  
U.S. government sponsored agency mortgage-backed securities
    6,579       (7 )     6,572  
Total debt securities
    49,968       (3,999 )     45,969  
Marketable equity securities
    0       0       0  
Total ≥12 months temporarily impaired AFS securities
    49,968       (3,999 )     45,969  
                         
Total
                       
U.S. Treasury and government agencies
    57,500       (5,139 )     52,361  
State and political subdivisions
    64,804       (3,259 )     61,545  
U.S. government sponsored agency mortgage-backed securities
    255,284       (8,189 )     247,095  
Total debt securities
    377,588       (16,587 )     361,001  
Marketable equity securities
    55,000       (2,218 )     52,782  
Total temporarily impaired AFS securities
  $ 432,588     $ (18,805 )   $ 413,783  

Held-to-Maturity

(in thousands)
 
Amortized Cost
   
Gross Unrealized Losses
   
Fair Value
 
12 Months or More
                 
U.S. Treasury and government agencies
  $ 480     $ (62 )   $ 418  
Total temporarily impaired HTM securities
  $ 480     $ (62 )   $ 418  

Note 4 – Loans

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

 
(in thousands)
 
September 30
2014
   
December 31
2013
 
Commercial construction
  $ 120,248     $ 110,779  
Commercial secured by real estate
    931,455       872,542  
Equipment lease financing
    10,055       8,840  
Commercial other
    347,035       374,881  
Real estate construction
    62,105       56,075  
Real estate mortgage
    703,323       697,601  
Home equity
    88,291       84,880  
Consumer direct
    121,367       122,215  
Consumer indirect
    300,026       287,541  
Total loans
  $ 2,683,905     $ 2,615,354  
 
CTBI has segregated and evaluates its loan portfolio through nine portfolio segments. CTBI serves customers in small and mid-sized communities in eastern, northeastern, central, and south central Kentucky, southern West Virginia, and northeastern Tennessee.  Therefore, CTBI’s exposure to credit risk is significantly affected by changes in these communities.
 
Commercial construction loans are for the purpose of erecting or rehabilitating buildings or other structures for commercial purposes, including any infrastructure necessary for development.   Included in this category are improved property, land development, and tract development loans.  The terms of these loans are generally short-term with permanent financing upon completion.
 
Commercial real estate loans include loans secured by nonfarm, nonresidential properties, 1-4 family/multi-family properties, farmland, and other commercial real estate.  These loans are originated based on the borrower’s ability to service the debt and secondarily based on the fair value of the underlying collateral.

Equipment lease financing loans are fixed, variable, and tax exempt leases for commercial purposes.
 
Commercial other loans consist of commercial check loans, agricultural loans, receivable financing, floorplans, loans to financial institutions, loans for purchasing or carrying securities, and other commercial purpose loans.  Commercial loans are underwritten based on the borrower’s ability to service debt from the business’s underlying cash flows.  As a general practice, we obtain collateral such as real estate, equipment, or other assets, although such loans may be uncollateralized but guaranteed.

Real estate construction loans are typically for owner-occupied properties.  The terms of these loans are generally short-term with permanent financing upon completion.
 
Residential real estate loans are a mixture of fixed rate and adjustable rate first and second lien residential mortgage loans.  As a policy, CTBI holds adjustable rate loans and sells the majority of its fixed rate first lien mortgage loans into the secondary market.  Changes in interest rates or market conditions may impact a borrower’s ability to meet contractual principal and interest payments.  Residential real estate loans are secured by real property.

Home equity lines are revolving adjustable rate credit lines secured by real property.

Consumer direct loans are fixed rate products comprised of unsecured loans, consumer revolving credit lines, deposit secured loans, and all other consumer purpose loans.
 
Consumer indirect loans are fixed rate loans secured by automobiles, trucks, vans, and recreational vehicles originated at the selling dealership underwritten and purchased by CTBI’s indirect lending department.  Both new and used products are financed.  Only dealers who have executed dealer agreements with CTBI participate in the indirect lending program.

Not included in the loan balances above were loans held for sale in the amount of $0.4 million at September 30, 2014 and $0.8 million at December 31, 2013, respectively.

Refer to note 1 to the condensed consolidated financial statements for further information regarding our nonaccrual policy.  Nonaccrual loans segregated by class of loans were as follows:

 (in thousands)
 
September 30
2014
   
December 31
2013
 
Commercial:
           
Commercial construction
  $ 4,700     $ 4,519  
Commercial secured by real estate
    14,202       6,576  
Commercial other
    3,134       2,801  
                 
Residential:
               
Real estate construction
    413       481  
Real estate mortgage
    6,019       5,152  
Home equity
    483       429  
Total nonaccrual loans
  $ 28,951     $ 19,958  

The following tables present CTBI’s loan portfolio aging analysis, segregated by class, as of September 30, 2014 and December 31, 2013:

   
September 30, 2014
 
(in thousands)
 
30-59 Days Past Due
   
60-89 Days Past Due
   
90+ Days Past Due
   
Total Past Due
   
Current
   
Total Loans
   
90+ and Accruing*
 
Commercial:
                                         
Commercial construction
  $ 142     $ 0     $ 5,951     $ 6,093     $ 114,155     $ 120,248     $ 1,251  
Commercial secured by real estate
    4,428       1,646       19,233       25,307       906,148       931,455       5,680  
Equipment lease financing
    0       0       0       0       10,055       10,055       0  
Commercial other
    2,351       2,410       5,466       10,227       336,808       347,035       2,882  
Residential:
                                                       
Real estate construction
    122       188       1,004       1,314       60,791       62,105       607  
Real estate mortgage
    1,402       4,350       12,914       18,666       684,657       703,323       8,361  
Home equity
    760       305       723       1,788       86,503       88,291       425  
Consumer:
                                                       
Consumer direct
    1,349       363       43       1,755       119,612       121,367       43  
Consumer indirect
    2,009       371       358       2,738       297,288       300,026       358  
Total
  $ 12,563     $ 9,633     $ 45,692     $ 67,888     $ 2,616,017     $ 2,683,905     $ 19,607  

   
December 31, 2013
 
(in thousands)
 
30-59 Days Past Due
   
60-89 Days Past Due
   
90+ Days Past Due
   
Total Past Due
   
Current
   
Total Loans
   
90+ and Accruing*
 
Commercial:
                                         
Commercial construction
  $ 250     $ 166     $ 6,012     $ 6,428     $ 104,351     $ 110,779     $ 1,673  
Commercial secured by real estate
    3,703       1,982       16,660       22,345       850,197       872,542       12,403  
Equipment lease financing
    0       0       0       0       8,840       8,840       0  
Commercial other
    344       422       6,156       6,922       367,959       374,881       3,723  
Residential:
                                                       
Real estate construction
    81       383       694       1,158       54,917       56,075       213  
Real estate mortgage
    1,274       4,419       9,346       15,039       682,562       697,601       4,847  
Home equity
    786       330       737       1,853       83,027       84,880       324  
Consumer:
                                                       
Consumer direct
    1,063       291       119       1,473       120,742       122,215       119  
Consumer indirect
    2,750       668       297       3,715       283,826       287,541       297  
Total
  $ 10,251     $ 8,661     $ 40,021     $ 58,933     $ 2,556,421     $ 2,615,354     $ 23,599  

*90+ and Accruing are also included in 90+ Days Past Due column.

The risk characteristics of CTBI’s material portfolio segments are as follows:

Commercial construction loans generally are made to customers for the purpose of building income-producing properties.  Personal guarantees of the principals are generally required.  Such loans are made on a projected cash flow basis and are secured by the project being constructed.  Construction loan draw procedures are included in each specific loan agreement, including required documentation items and inspection requirements.  Construction loans may convert to term loans at the end of the construction period, or may be repaid by the take-out commitment from another financing source.  If the loan is to convert to a term loan, the repayment ability is based on the borrower’s projected cash flow.  Risk is mitigated during the construction phase by requiring proper documentation and inspections whenever a draw is requested.  Loans in amounts greater than $500,000 generally require a performance bond to be posted by the general contractor to assure completion of the project.
 
Commercial real estate loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate.  Commercial real estate lending typically involves higher loan principal amounts and the repayment of these loans is generally dependent on the successful operation of the property securing the loan or the business conducted on the property securing the loan.  Commercial real estate loans may be more adversely affected by conditions in the real estate markets or in the general economy.  Management monitors and evaluates commercial real estate loans based on collateral and risk grade criteria.

Equipment lease financing is underwritten by our commercial lenders using the same underwriting standards as would be applied to a secured commercial loan requesting 100% financing.  The pricing for equipment lease financing is comparable to that of borrowers with similar quality commercial credits with similar collateral.  Maximum terms of equipment leasing are determined by the type and expected life of the equipment to be leased.  Residual values are determined by appraisals or opinion letters from industry experts.  Leases must be in conformity with our consolidated annual tax plan.  As we underwrite our equipment lease financing in a manner similar to our commercial loan portfolio described below, the risk characteristics for this portfolio mirror that of the commercial loan portfolio.
 
Commercial loans are primarily based on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower.  The cash flows of borrowers, however, may not be as expected and the collateral securing these loans may fluctuate in value.  Most commercial loans are secured by the assets being financed or other business assets such as accounts receivable or inventory and may incorporate a personal guarantee; however, some short-term loans may be made on an unsecured basis.  In the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers.
 
With respect to residential loans that are secured by 1-4 family residences and are generally owner occupied, CTBI generally establishes a maximum loan-to-value ratio and requires private mortgage insurance if that ratio is exceeded.  Home equity loans are typically secured by a subordinate interest in 1-4 family residences. Residential construction loans are handled through the home mortgage area of the bank.  The repayment ability of the borrower and the maximum loan-to-value ratio are calculated using the normal mortgage lending criteria.  Draws are processed based on percentage of completion stages including normal inspection procedures.  Such loans generally convert to term loans after the completion of construction.

Consumer loans are secured by consumer assets such as automobiles or recreational vehicles.  Some consumer loans are unsecured such as small installment loans and certain lines of credit.  Our determination of a borrower’s ability to repay these loans is primarily dependent on the personal income and credit rating of the borrowers, which can be impacted by economic conditions in their market areas such as unemployment levels.  Repayment can also be impacted by changes in property values on residential properties.  Risk is mitigated by the fact that the loans are of smaller individual amounts and spread over a large number of borrowers.
 
The indirect lending area of the bank generally deals with purchasing/funding consumer contracts with new and used automobile dealers.  The dealers generate consumer loan applications which are forwarded to the indirect loan processing area for approval or denial.  Loan approvals or denials are based on the creditworthiness and repayment ability of the borrower, and on the collateral value.  The dealers may have recourse agreements with the Bank.

Credit Quality Indicators:
 
CTBI categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors.  CTBI also considers the fair value of the underlying collateral and the strength and willingness of the guarantor(s).  CTBI analyzes commercial loans individually by classifying the loans as to credit risk.  Loans classified as loss, doubtful, substandard, or special mention are reviewed quarterly by CTBI for further deterioration or improvement to determine if appropriately classified and valued if deemed impaired.  All other commercial loan reviews are completed every 12 to 18 months.  In addition, during the renewal process of any loan, as well as if a loan becomes past due or if other information becomes available, CTBI will evaluate the loan grade.  CTBI uses the following definitions for risk ratings:

Ø
Pass grades include investment grade, low risk, moderate risk, and acceptable risk loans.  The loans range from loans that have no chance of resulting in a loss to loans that have a limited chance of resulting in a loss.  Customers in this grade have excellent to fair credit ratings.  The cash flows are adequate to meet required debt repayments.

Ø
Watch graded loans are loans that warrant extra management attention but are not currently criticized.  Loans on the watch list may be potential troubled credits or may warrant “watch” status for a reason not directly related to the asset quality of the credit.  The watch grade is a management tool to identify credits which may be candidates for future classification or may temporarily warrant extra management monitoring.

Ø
Other assets especially mentioned (OAEM) reflects loans that are currently protected but are potentially weak.  These loans constitute an undue and unwarranted credit risk but not to the point of justifying a classification of substandard.  The credit risk may be relatively minor yet constitute an unwarranted risk in light of circumstances surrounding a specific asset. Loans in this grade display potential weaknesses which may, if unchecked or uncorrected, inadequately protect CTBI’s credit position at some future date.  The loans may be adversely affected by economic or market conditions.

Ø
Substandard grading indicates that the loan is inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged.  These loans have a well-defined weakness or weaknesses that jeopardize the orderly liquidation of the debt with the distinct possibility that CTBI will sustain some loss if the deficiencies are not corrected.

Ø
Doubtful graded loans have the weaknesses inherent in the substandard grading with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.  The probability of loss is extremely high, but because of certain important and reasonably specific pending factors which may work to CTBI’s advantage or strengthen the asset(s), its classification as an estimated loss is deferred until its more exact status may be determined.  Pending factors include proposed merger, acquisition, or liquidation procedures, capital injection, perfecting liens on additional collateral, and refinancing plans.

The following table presents the credit risk profile of CTBI’s commercial loan portfolio based on rating category and payment activity, segregated by class of loans, as of September 30, 2014 and December 31, 2013:

 (in thousands)
 
Commercial Construction
   
Commercial Secured by Real Estate
   
Equipment Leases
   
Commercial Other
   
Total
 
September 30, 2014
                             
Pass
  $ 100,227     $ 814,562     $ 10,055     $ 300,255     $ 1,225,099  
Watch
    8,876       66,827       0       35,301       111,004  
OAEM
    1,495       13,436       0       868       15,799  
Substandard
    5,099       23,564       0       7,727       36,390  
Doubtful
    4,551       13,066       0       2,884       20,501  
Total
  $ 120,248     $ 931,455     $ 10,055     $ 347,035     $ 1,408,793  
                                         
December 31, 2013
                                       
Pass
  $ 85,699     $ 746,202     $ 8,840     $ 321,819     $ 1,162,559  
Watch
    13,519       77,561       0       32,800       123,880  
OAEM
    0       6,639       0       6,200       12,839  
Substandard
    7,208       37,334       0       11,772       56,314  
Doubtful
    4,353       4,806       0       2,291       11,450  
Total
  $ 110,779     $ 872,542     $ 8,840     $ 374,881     $ 1,367,042  
 
The following table presents the credit risk profile of the CTBI’s residential real estate and consumer loan portfolios based on performing or nonperforming status, segregated by class, as of September 30, 2014 and December 31, 2013:

(in thousands)
 
Real Estate Construction
   
Real Estate Mortgage
   
Home Equity
   
Consumer Direct
   
Consumer
Indirect
   
Total
 
September 30, 2014
                                   
Performing
  $ 61,085     $ 688,943     $ 87,383     $ 121,324     $ 299,668     $ 1,258,403  
Nonperforming (1)
    1,020       14,380       908       43       358       16,709  
Total
  $ 62,105     $ 703,323     $ 88,291     $ 121,367     $ 300,026     $ 1,275,112  
                                                 
December 31, 2013
                                               
Performing
  $ 55,381     $ 687,602     $ 84,127     $ 122,096     $ 287,244     $ 1,236,450  
Nonperforming (1)
    694       9,999       753       119       297       11,862  
Total
  $ 56,075     $ 697,601     $ 84,880     $ 122,215     $ 287,541     $ 1,248,312  

(1)  A loan is considered nonperforming if it is 90 days or more past due and/or on nonaccrual.
 
A loan is considered impaired, in accordance with the impairment accounting guidance (ASC 310-10-35-16), when based on current information and events, it is probable CTBI will be unable to collect all amounts due from the borrower in accordance with the contractual terms of the loan.  Impaired loans include nonperforming commercial loans but also include loans modified in troubled debt restructurings where concessions have been granted to borrowers experiencing financial difficulties.  These concessions could include a reduction in the interest rate on the loan, payment extensions, forgiveness of principal, forbearance, or other actions intended to maximize collection.

The following tables present impaired loans, the average investment in impaired loans, and interest income recognized on impaired loans for the periods ended September 30, 2014, December 31, 2013, and September 30, 2013:

   
September 30, 2014
 
(in thousands)
 
Recorded Balance
   
Unpaid Contractual Principal Balance
   
Specific Allowance
 
Loans without a specific valuation allowance:
                 
Commercial construction
  $ 5,250     $ 5,251     $ 0  
Commercial secured by real estate
    33,010       34,086       0  
Commercial other
    15,972       18,247       0  
Real estate mortgage
    1,874       1,875       0  
                         
Loans with a specific valuation allowance:
                       
Commercial construction
    4,149       4,149       734  
Commercial secured by real estate
    6,070       6,219       1,273  
Commercial other
    586       710       211  
                         
Totals:
                       
Commercial construction
    9,399       9,400       734  
Commercial secured by real estate
    39,080       40,305       1,273  
Commercial other
    16,558       18,957       211  
Real estate mortgage
    1,874       1,875       0  
Total
  $ 66,911     $ 70,537     $ 2,218  

   
Three Months Ended
   
Nine Months Ended
 
   
September 30, 2014
   
September 30, 2014
 
(in thousands)
 
Average Investment in Impaired Loans
   
*Interest Income Recognized
   
Average Investment in Impaired Loans
   
*Interest Income Recognized
 
Loans without a specific valuation allowance:
                       
Commercial construction
  $ 5,259     $ 44     $ 5,330     $ 172  
Commercial secured by real estate
    33,290       261       34,464       858  
Commercial other
    17,577       248       16,421       619  
Real estate mortgage
    1,860       12       1,583       44  
                                 
Loans with a specific valuation allowance:
                               
Commercial construction
    4,213       0       4,270       0  
Commercial secured by real estate
    6,076       5       4,912       9  
Commercial other
    587       0       460       0  
                                 
Totals:
                               
Commercial construction
    9,472       44       9,600       172  
Commercial secured by real estate
    39,366       266       39,376       867  
Commercial other
    18,164       248       16,881       619  
Real estate mortgage
    1,860       12       1,583       44  
Total
  $ 68,862     $ 570     $ 67,440     $ 1,702  
 
   
December 31, 2013
 
(in thousands)
 
Recorded Balance
   
Unpaid Contractual Principal Balance
   
Specific Allowance
   
Average Investment in Impaired Loans
   
*Interest Income Recognized
 
Loans without a specific valuation allowance:
                             
Commercial construction
  $ 5,457     $ 5,458     $ 0     $ 5,595     $ 240  
Commercial secured by real estate
    35,258       36,173       0       32,472       1,231  
Commercial other
    14,839       16,435       0       15,396       568  
Real estate mortgage
    1,024       1,024       0       934       43  
                                         
Loans with a specific valuation allowance:
                                       
Commercial construction
    4,353       4,359       1,189       4,935       0  
Commercial secured by real estate
    4,039       4,326       1,005       5,033       1  
Commercial other
    330       453       102       525       0  
                                         
Totals:
                                       
Commercial construction
    9,810       9,817       1,189       10,530       240  
Commercial secured by real estate
    39,297       40,499       1,005       37,505       1,232  
Commercial other
    15,169       16,888       102       15,921       568  
Real estate mortgage
    1,024       1,024       0       934       43  
Total
  $ 65,300     $ 68,228     $ 2,296     $ 64,890     $ 2,083  

   
September 30, 2013
 
(in thousands)
 
Recorded Balance
   
Unpaid Contractual Principal Balance
   
Specific Allowance
 
Loans without a specific valuation allowance:
                 
Commercial construction
  $ 5,586     $ 6,163     $ 0  
Commercial secured by real estate
    31,054       31,929       0  
Commercial other
    15,179       18,212       0  
Real estate mortgage
    1,028       1,028       0  
                         
Loans with a specific valuation allowance:
                       
Commercial construction
    4,557       4,563       1,827  
Commercial secured by real estate
    5,423       5,733       1,295  
Commercial other
    465       590       158  
                         
Totals:
                       
Commercial construction
    10,143       10,726       1,827  
Commercial secured by real estate
    36,477       37,662       1,295  
Commercial other
    15,644       18,802       158  
Real estate mortgage
    1,028       1,028       0  
Total
  $ 63,292     $ 68,218     $ 3,280  

   
Three Months Ended
   
Nine Months Ended
 
   
September 30, 2013
   
September 30, 2013
 
(in thousands)
 
Average Investment in Impaired Loans
   
*Interest Income Recognized
   
Average Investment in Impaired Loans
   
*Interest Income Recognized
 
Loans without a specific valuation allowance:
                       
Commercial construction
  $ 5,597     $ 77     $ 5,622     $ 204  
Commercial secured by real estate
    31,142       405       31,491       938  
Commercial other
    15,264       134       15,508       439  
Real estate mortgage
    1,027       8       903       32  
                                 
Loans with a specific valuation allowance:
                               
Commercial construction
    4,572       0       5,101       0  
Commercial secured by real estate
    5,622       0       5,362       0  
Commercial other
    515       0       587       0  
                                 
Totals:
                               
Commercial construction
    10,169       77       10,723       204  
Commercial secured by real estate
    36,764       405       36,853       938  
Commercial other
    15,779       134       16,095       439  
Real estate mortgage
    1,027       8       903       32  
Total
  $ 63,739     $ 624     $ 64,574     $ 1,613  

*Cash basis interest is substantially the same as interest income recognized.
 
Included in certain loan categories of impaired loans are certain loans and leases that have been modified in a troubled debt restructuring, where economic concessions have been granted to borrowers who have experienced financial difficulties. These concessions typically result from our loss mitigation activities and could include reductions in the interest rate, payment extensions, forgiveness of principal, forbearance or other actions.  Modifications of terms for our loans and their inclusion as troubled debt restructurings are based on individual facts and circumstances.  Loan modifications that are included as troubled debt restructurings may involve either an increase or reduction of the interest rate, extension of the term of the loan, or deferral of principal and/or interest payments, regardless of the period of the modification.  All of the loans identified as troubled debt restructuring were modified due to financial stress of the borrower.  In order to determine if a borrower is experiencing financial difficulty, an evaluation is performed to determine the probability that the borrower will be in payment default on any of its debt in the foreseeable future without the modification.  This evaluation is performed under CTBI’s internal underwriting policy.
 
When we modify loans and leases in a troubled debt restructuring, we evaluate any possible impairment similar to other impaired loans based on the present value of expected future cash flows, discounted at the contractual interest rate of the original loan or lease agreement, or use the current fair value of the collateral, less selling costs for collateral dependent loans. If we determined that the value of the modified loan is less than the recorded investment in the loan (net of previous charge-offs, deferred loan fees or costs and unamortized premium or discount), impairment is recognized through an allowance estimate or a charge-off to the allowance. In periods subsequent to modification, we evaluate all troubled debt restructuring, including those that have payment defaults, for possible impairment and recognize impairment through the allowance.

During 2014, certain loans were modified in troubled debt restructurings, where economic concessions were granted to borrowers consisting of reductions in the interest rates, payment extensions, forgiveness of principal, and forbearances.  Presented below, segregated by class of loans, are troubled debt restructurings that occurred during the three and nine months ended September 30, 2014 and 2013 and the year ended December 31, 2013:

   
Three Months Ended
September 30, 2014
 
(in thousands)
 
Number of Loans
   
Term Modification
   
Rate Modification
   
Combination
   
Post-Modification Outstanding Balance
 
Commercial:
                             
Commercial construction
    1     $ 7     $ 0     $ 0     $ 7  
Commercial secured by real estate
    4       2,416       0       67       2,483  
Commercial other
    4       451       0       0       451  
Total troubled debt restructurings
    9     $ 2,874     $ 0     $ 67     $ 2,941  

   
Nine Months Ended
September 30, 2014
 
(in thousands)
 
Number of Loans
   
Term Modification
   
Rate Modification
   
Combination
   
Post-Modification Outstanding Balance
 
Commercial:
                             
Commercial construction
    1     $ 7     $ 0     $ 0     $ 7  
Commercial secured by real estate
    7       2,647       0       67       2,714  
Commercial other
    7       512       0       0       512  
Residential:
                                       
Real estate mortgage
    2       0       0       849       849  
Total troubled debt restructurings
    17     $ 3,166     $ 0     $ 916     $ 4,082  

   
Three Months Ended
September 30, 2013
 
(in thousands)
 
Number of Loans
   
Term Modification
   
Rate Modification
   
Combination
   
Post-Modification Outstanding Balance
 
Commercial:
                             
Commercial secured by real estate
    3     $ 905     $ 0     $ 0     $ 905  
Commercial other
    7       103       0       60       163  
Total troubled debt restructurings
    10     $ 1,008     $ 0     $ 60     $ 1,068  
 
   
Nine Months Ended
September 30, 2013
 
(in thousands)
 
Number of Loans
   
Term Modification
   
Rate Modification
   
Combination
   
Post-Modification Outstanding Balance
 
Commercial:
                             
Commercial construction
    6     $ 2,603     $ 0     $ 0     $ 2,603  
Commercial secured by real estate
    23       2,172       0       0       2,172  
Commercial other
    29       6,468       0       152       6,620  
Residential:
                                       
Real estate mortgage
    1       373       0       0       373  
Total troubled debt restructurings
    59     $ 11,616     $ 0     $ 152     $ 11,768  

   
Year Ended
December 31, 2013
 
(in thousands)
 
Number of Loans
   
Term Modification
   
Rate Modification
   
Combination
   
Post-Modification Outstanding Balance
 
Commercial:
                             
Commercial construction
    6     $ 2,603     $ 0     $ 0     $ 2,603  
Commercial secured by real estate
    27       2,568       0       2,920       5,488  
Commercial other
    30       6,471       0       152       6,623  
Residential:
                                       
Real estate mortgage
    1       373       0       0       373  
Total troubled debt restructurings
    64     $ 12,015     $ 0     $ 3,072     $ 15,087  

No charge-offs have resulted from modifications for any of the presented periods.
 
Loans retain their accrual status at the time of their modification. As a result, if a loan is on nonaccrual at the time it is modified, it stays as nonaccrual, and if a loan is on accrual at the time of the modification, it generally stays on accrual.  Commercial and consumer loans modified in a troubled debt restructuring are closely monitored for delinquency as an early indicator of possible future default.  If loans modified in a troubled debt restructuring subsequently default, CTBI evaluates the loan for possible further impairment.  The allowance for loan losses may be increased, adjustments may be made in the allocation of the allowance, or partial charge-offs may be taken to further write-down the carrying value of the loan.  Presented below, segregated by class of loans, are loans that were modified as troubled debt restructurings within the past twelve months which have subsequently defaulted.  CTBI generally considers a loan in default when it is 90 days or more past due or transferred to nonaccrual.

 (in thousands)
 
Three Months Ended
September 30, 2014
   
Nine Months Ended
September 30, 2014
 
   
Number of Loans
   
Recorded Balance
   
Number of Loans
   
Recorded Balance
 
Commercial:
                       
Commercial secured by real estate
    1     $ 2,892       1     $ 2,892  
Residential:
                               
Real estate mortgage
    1       594       2       1,175  
Total defaulted restructured loans
    2     $ 3,486       3     $ 4,067  

 (in thousands)
 
Three Months Ended
September 30, 2013
   
Nine Months Ended
September 30, 2013
 
   
Number of Loans
   
Recorded Balance
   
Number of Loans
   
Recorded Balance
 
Commercial:
                       
Commercial secured by real estate
    1       69       1       69  
Commercial other
    2       173       7       2,203  
Total defaulted restructured loans
    3     $ 242       8     $ 2,272  

Note 5 – Allowance for Loan and Lease Losses
 
The following tables present the balance in the allowance for loan losses and the recorded investment in loans based on portfolio segment and impairment method for the three and nine months ended September 30, 2014 and 2013 and the twelve months ended December 31, 2013:

   
Three Months Ended
September 30, 2014
 
(in thousands)
 
Commercial Construction
   
Commercial Secured by Real Estate
   
Equipment Lease Financing
   
Commercial Other
   
Real Estate Construction
   
Real Estate Mortgage
   
Home
Equity
   
Consumer Direct
   
Consumer Indirect
   
Total
 
Allowance for loan losses
                                                           
Beginning balance
  $ 2,916     $ 14,402     $ 102     $ 4,677     $ 450     $ 5,142     $ 643     $ 1,597     $ 3,688     $ 33,617  
Provision charged to expense
    84       1,255       25       959       (6 )     8       42       216       717       3,300  
Losses charged off
    0       834       0       1,169       7       216       65       298       881       3,470  
Recoveries
    15       12       0       154       0       10       1       96       355       643  
Ending balance
  $ 3,015     $ 14,835     $ 127     $ 4,621     $ 437     $ 4,944     $ 621     $ 1,611     $ 3,879     $ 34,090  
                                                                                 
Ending balance:
                                                                               
Individually evaluated for impairment
  $ 734     $ 1,273     $ 0     $ 211     $ 0     $ 0     $ 0     $ 0     $ 0     $ 2,218  
Collectively evaluated for impairment
  $ 2,281     $ 13,562     $ 127     $ 4,410     $ 437     $ 4,944     $ 621     $ 1,611     $ 3,879     $ 31,872  
                                                                                 
Loans
                                                                               
Ending balance:
                                                                               
Individually evaluated for impairment
  $ 9,399     $ 39,080     $ 0     $ 16,558     $ 0     $ 1,874     $ 0     $ 0     $ 0     $ 66,911  
Collectively evaluated for impairment
  $ 110,849     $ 892,375     $ 10,055     $ 330,477     $ 62,105     $ 701,449     $ 88,291     $ 121,367     $ 300,026     $ 2,616,994  

   
Nine Months Ended
September 30, 2014
 
(in thousands)
 
Commercial Construction
   
Commercial Secured by Real Estate
   
Equipment Lease Financing
   
Commercial Other
   
Real Estate Construction
   
Real Estate Mortgage
   
Home
Equity
   
Consumer Direct
   
Consumer Indirect
   
Total
 
Allowance for loan losses
                                                           
Beginning balance
  $ 3,396     $ 14,535     $ 121     $ 5,238     $ 397     $ 4,939     $ 601     $ 1,127     $ 3,654     $ 34,008  
Provision charged to expense
    (406 )     1,489       6       1,059       161       412       110       1,031       1,518       5,380  
Losses charged off
    0       1,452       0       2,074       123       437       93       980       2,485       7,644  
Recoveries
    25       263       0       398       2       30       3       433       1,192       2,346  
Ending balance
  $ 3,015     $ 14,835     $ 127     $ 4,621     $ 437     $ 4,944     $ 621     $ 1,611     $ 3,879     $ 34,090  
                                                                                 
Ending balance:
                                                                               
Individually evaluated for impairment
  $ 734     $ 1,273     $ 0     $ 211     $ 0     $ 0     $ 0     $ 0     $ 0     $ 2,218  
Collectively evaluated for impairment
  $ 2,281     $ 13,562     $ 127     $ 4,410     $ 437     $ 4,944     $ 621     $ 1,611     $ 3,879     $ 31,872  
                                                                                 
Loans
                                                                               
Ending balance:
                                                                               
Individually evaluated for impairment
  $ 9,399     $ 39,080     $ 0     $ 16,558     $ 0     $ 1,874     $ 0     $ 0     $ 0     $ 66,911  
Collectively evaluated for impairment
  $ 110,849     $ 892,375     $ 10,055     $ 330,477     $ 62,105     $ 701,449     $ 88,291     $ 121,367     $ 300,026     $ 2,616,994  

   
Twelve Months Ended
December 31, 2013
 
(in thousands)
 
Commercial Construction
   
Commercial Secured by Real Estate
   
Equipment Lease Financing
   
Commercial Other
   
Real Estate Construction
   
Real Estate Mortgage
   
Home
Equity
   
Consumer Direct
   
Consumer Indirect
   
Total
 
Allowance for loan losses
                                                           
Beginning balance
  $ 4,033     $ 13,541     $ 126     $ 5,469     $ 376     $ 4,767     $ 563     $ 1,102     $ 3,268     $ 33,245  
Provision charged to expense
    189       2,438       (5 )     1,477       106       860       268       696       2,539       8,568  
Losses charged off
    1,135       1,607       0       2,265       89       744       241       1,166       3,802       11,049  
Recoveries
    309       163       0       557       4       56       11       495       1,649       3,244  
Ending balance
  $ 3,396     $ 14,535     $ 121     $ 5,238     $ 397     $ 4,939     $ 601     $ 1,127     $ 3,654     $ 34,008  
                                                                                 
Ending balance:
                                                                               
Individually evaluated for impairment
  $ 1,189     $ 1,005     $ 0     $ 102     $ 0     $ 0     $ 0     $ 0     $ 0     $ 2,296  
Collectively evaluated for impairment
  $ 2,207     $ 13,530     $ 121     $ 5,136     $ 397     $ 4,939     $ 601     $ 1,127     $ 3,654     $ 31,712  
                                                                                 
Loans
                                                                               
Ending balance:
                                                                               
Individually evaluated for impairment
  $ 9,810     $ 39,297     $ 0     $ 15,169     $ 0     $ 1,024     $ 0     $ 0     $ 0     $ 65,300  
Collectively evaluated for impairment
  $ 100,969     $ 833,245     $ 8,840     $ 359,712     $ 56,075     $ 696,577     $ 84,880     $ 122,215     $ 287,541     $ 2,550,054  
 
   
Three Months Ended
September 30, 2013
 
(in thousands)
 
Commercial Construction
   
Commercial Secured by Real Estate
   
Equipment Lease Financing
   
Commercial Other
   
Real Estate Construction
   
Real Estate Mortgage
   
Home
Equity
   
Consumer Direct
   
Consumer Indirect
   
Total
 
Allowance for loan losses
                                                           
Beginning balance
  $ 3,835     $ 14,162     $ 117     $ 4,793     $ 368     $ 4,950     $ 576     $ 1,134     $ 3,666     $ 33,601  
Provision charged to expense
    (101 )     448       3       551       59       202       73       272       622       2,129  
Losses charged off
    0       477       0       464       49       216       62       336       915       2,519  
Recoveries
    151       13       0       102       4       11       1       105       415       802  
Ending balance
  $ 3,885     $ 14,146     $ 120     $ 4,982     $ 382     $ 4,947     $ 588     $ 1,175     $ 3,788     $ 34,013  
                                                                                 
Ending balance:
                                                                               
Individually evaluated for impairment
  $ 1,827     $ 1,295     $ 0     $ 158     $ 0     $ 0     $ 0     $ 0     $ 0     $ 3,280  
Collectively evaluated for impairment
  $ 2,058     $ 12,851     $ 120     $ 4,824     $ 382     $ 4,947     $ 588     $ 1,175     $ 3,788     $ 30,733  
                                                                                 
Loans
                                                                               
Ending balance:
                                                                               
Individually evaluated for impairment
  $ 10,143     $ 36,477     $ 0     $ 15,644     $ 0     $ 1,028     $ 0     $ 0     $ 0     $ 63,292  
Collectively evaluated for impairment
  $ 97,797     $ 841,458     $ 9,380     $ 360,842     $ 53,545     $ 692,781     $ 82,498     $ 123,960     $ 290,812     $ 2,553,073  
 
   
Nine Months Ended
September 30, 2013
 
(in thousands)
 
Commercial Construction
   
Commercial Secured by Real Estate
   
Equipment Lease Financing
   
Commercial Other
   
Real Estate Construction
   
Real Estate Mortgage
   
Home
Equity
   
Consumer Direct
   
Consumer Indirect
   
Total
 
Allowance for loan losses
                                                           
Beginning balance
  $ 4,033     $ 13,541     $ 126     $ 5,469     $ 376     $ 4,767     $ 563     $ 1,102     $ 3,268     $ 33,245  
Provision charged to expense
    806       2,064       (6 )     937       89       648       250       611       1,950       7,349  
Losses charged off
    1,112       1,495       0       1,768       87       498       235       927       2,700       8,822  
Recoveries
    158       36       0       344       4       30       10       389       1,270       2,241  
Ending balance
  $ 3,885     $ 14,146     $ 120     $ 4,982     $ 382     $ 4,947     $ 588     $ 1,175     $ 3,788     $ 34,013  
                                                                                 
Ending balance:
                                                                               
Individually evaluated for impairment
  $ 1,827     $ 1,295     $ 0     $ 158     $ 0     $ 0     $ 0     $ 0     $ 0     $ 3,280  
Collectively evaluated for impairment
  $ 2,058     $ 12,851     $ 120     $ 4,824     $ 382     $ 4,947     $ 588     $ 1,175     $ 3,788     $ 30,733  
                                                                                 
Loans
                                                                               
Ending balance:
                                                                               
Individually evaluated for impairment
  $ 10,143     $ 36,477     $ 0     $ 15,644     $ 0     $ 1,028     $ 0     $ 0     $ 0     $ 63,292  
Collectively evaluated for impairment
  $ 97,797     $ 841,458     $ 9,380     $ 360,842     $ 53,545     $ 692,781     $ 82,498     $ 123,960     $ 290,812     $ 2,553,073  

Note 6 – Other Real Estate Owned

Activity for other real estate owned was as follows:

   
Three Months Ended
   
Nine Months Ended
 
   
September 30
   
September 30
 
(in thousands)
 
2014
   
2013
   
2014
   
2013
 
Beginning balance of other real estate owned
  $ 33,062     $ 43,632     $ 39,188     $ 47,537  
New assets acquired
    1,803       1,525       5,267       6,180  
Capitalized costs
    0       0       0       6  
Fair value adjustments
    (241 )     (182 )     (1,402 )     (1,958 )
Sale of assets
    (1,877 )     (1,897 )     (10,306 )     (8,687 )
Ending balance of other real estate owned
  $ 32,747     $ 43,078     $ 32,747     $ 43,078  
 
Carrying costs and fair value adjustments associated with foreclosed properties for the three months ended September 30, 2014 and 2013 were $0.7 million and $0.9 million, respectively.  Carrying costs and fair value adjustments associated with foreclosed properties for the nine months ended September 30, 2014 and 2013 were $2.9 million and $3.9 million.

Note 7 – Earnings Per Share

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

   
Three Months Ended
   
Nine Months Ended
 
   
September 30
   
September 30
 
(in thousands except per share data)
 
2014
   
2013
   
2014
   
2013
 
Numerator:
                       
Net income
  $ 10,924     $ 12,653     $ 33,259     $ 36,415  
                                 
Denominator:
                               
Basic earnings per share:
                               
Weighted average shares
    17,326       17,154       17,317       17,123  
Diluted earnings per share:
                               
Effect of dilutive stock options and restricted stock grants
    76       103       78       89  
Adjusted weighted average shares
    17,402       17,257       17,395       17,212  
                                 
Earnings per share:
                               
Basic earnings per share
  $ 0.63     $ 0.74     $ 1.92     $ 2.13  
Diluted earnings per share
    0.63       0.73       1.91       2.12  
 
Options to purchase 63,270 common shares at a weighted average price of $35.41 were excluded from the diluted calculations above for the three months ended September 30, 2014, because the exercise prices on the options were greater than the average market price for the period.  There were no options to purchase common shares that were excluded from the diluted calculations above for the nine months ended September 30, 2014.  In addition to in-the-money stock options, unvested restricted stock grants were also used in the calculation of diluted earnings per share based on the treasury method.  There were no options to purchase common shares that were excluded from the diluted calculations above for the three months ended September 30, 2013, but options to purchase 91,071 common shares at a weighted average price of $35.41 were excluded for the nine months ended September 30, 2013.

Note 8 – Fair Market Value of Financial Assets and Liabilities

Fair Value Measurements
 
ASC 820, Fair Value Measurements, 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.  Fair value measurements must maximize the use of observable inputs and minimize the use of unobservable inputs.  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 – Quoted prices in active markets for identical assets or liabilities.

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.

Recurring Measurements
 
The following tables present the fair value measurements of assets recognized in the accompanying balance sheets measured at fair value on a recurring basis as of September 30, 2014 and December 31, 2013 and indicate the level within the fair value hierarchy of the valuation techniques.

 
       
Fair Value Measurements at
September 30, 2014 Using
 
 
(in thousands)
 
Fair Value
   
Quoted Prices in Active Markets for Identical Assets
(Level 1)
   
Significant Other Observable Inputs
(Level 2)
   
Significant Unobservable Inputs
(Level 3)
 
Assets measured – recurring basis
                       
Available-for-sale securities:
                       
U.S. Treasury and government agencies
  $ 138,408     $ 0     $ 138,408     $ 0  
State and political subdivisions
    136,690       0       136,690       0  
U.S. government sponsored agency mortgage-backed securities
    333,793       0       333,793       0  
Marketable equity securities
    24,681       24,681       0       0  
Mortgage servicing rights
    3,112       0       0       3,112  

 
       
Fair Value Measurements at
December 31, 2013 Using
 
 
(in thousands)
 
Fair Value
   
Quoted Prices in Active Markets for Identical Assets
(Level 1)
   
Significant Other Observable Inputs
(Level 2)
   
Significant Unobservable Inputs
(Level 3)
 
Assets measured – recurring basis
                       
Available-for-sale securities:
                       
U.S. Treasury and government agencies
  $ 60,610     $ 0     $ 60,610     $ 0  
State and political subdivisions
    116,703       0       116,703       0  
U.S. government sponsored agency mortgage-backed securities
    379,310       0       379,310       0  
Marketable equity securities
    52,782       52,782       0       0  
Mortgage servicing rights
    3,424       0       0       3,424  
 
Following is a description of the valuation methodologies and inputs used for assets measured at fair value on a recurring basis and recognized in the accompanying balance sheets, as well as the general classification of such assets pursuant to the valuation hierarchy.  These valuation methodologies were applied to all of CTBI’s financial assets carried at fair value.  CTBI had no liabilities measured at fair value as of September 30, 2014 and December 31, 2013.  There have been no significant changes in the valuation techniques during the quarter ended September 30, 2014.  For assets classified within Level 3 of the fair value hierarchy, the process used to develop the reported fair value is described below.

Available-for-Sale Securities
 
Securities classified as available-for-sale are reported at fair value on a recurring basis.  CTBI’s CRA investment funds (included in marketable equity securities) are classified as Level 1 of the valuation hierarchy where quoted market prices are available in the active market on which the individual securities are traded.
 
If quoted market prices are not available, CTBI obtains fair value measurements from an independent pricing service, such as Interactive Data, which utilizes pricing models to determine fair value measurement.  CTBI reviews the pricing quarterly to verify the reasonableness of the pricing.  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 factors.  U.S. Treasury and government agencies, state and political subdivisions, and U.S. government sponsored agency mortgage-backed securities are classified as Level 2 inputs.
 
In certain cases where Level 1 or Level 2 inputs are not available, securities are classified within Level 3 of the hierarchy.  Fair value determinations for Level 3 measurements are estimated on a quarterly basis where assumptions used are reviewed to ensure the estimated fair value complies with accounting standards generally accepted in the United States.  As of September 30, 2014, CTBI does not own any securities classified as Level 3 inputs.

Mortgage Servicing Rights
 
Mortgage servicing rights do not trade in an active, open market with readily observable prices.  CTBI reports mortgage servicing rights 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.  Accordingly, fair value is determined by the independent third party by utilizing assumptions about factors such as mortgage interest rates, discount rates, mortgage loan prepayment speeds, market trends and industry demand.  Due to the nature of the valuation inputs, mortgage servicing rights are classified within Level 3 of the hierarchy.  Fair value determinations for Level 3 measurements of mortgage servicing rights are tested for impairment on a quarterly basis where assumptions used are reviewed to ensure the estimated fair value complies with accounting standards generally accepted in the United States.  See the table below for inputs and valuation techniques used for Level 3 mortgage servicing rights.

Transfers between Levels

There were no transfers between Levels 1, 2, and 3 as of September 30, 2014.

Level 3 Reconciliation
 
Following is a reconciliation of the beginning and ending balances of recurring fair value measurements recognized in the accompanying balance sheet using significant unobservable (Level 3) inputs for the three and nine months ended September 30, 2014 and 2013:

 (in thousands)
 
Three Months Ended
September 30, 2014
   
Nine Months Ended
September 30, 2014
 
   
Mortgage Servicing Rights
   
Mortgage Servicing Rights
 
Beginning balance
  $ 3,062     $ 3,424  
Total recognized gains (losses)
               
Included in net income
    80       (212 )
Issues
    89       234  
Settlements
    (119 )     (334 )
Ending balance
  $ 3,112     $ 3,112  
                 
Total gains (losses) for the period included in net income attributable to the change in unrealized gains or losses related to assets still held at the reporting date
  $ 80     $ (212 )

 (in thousands)
 
Three Months Ended
September 30, 2013
   
Nine Months Ended
September 30, 2013
 
   
Mortgage Servicing Rights
   
Mortgage Servicing Rights
 
Beginning balance
  $ 3,222     $ 2,364  
Total recognized gains (losses)
               
Included in net income
    10       656  
Issues
    206       768  
Settlements
    (133 )     (483 )
Ending balance
  $ 3,305     $ 3,305  
                 
Total gains (losses) for the period included in net income attributable to the change in unrealized gains or losses related to assets still held at the reporting date
  $ 10     $ 656  

Realized and unrealized gains and losses for items reflected in the tables above are included in net income in the consolidated statements of income as follows:

 (in thousands)
 
Three Months Ended
September 30, 2014
   
Nine Months Ended
September 30, 2014
 
   
Noninterest Income
   
Noninterest Expense
   
Noninterest Income
   
Noninterest Expense
 
Total gains (losses)
  $ (39 )   $ 0     $ (546 )   $ 0  

 (in thousands)
 
Three Months Ended
September 30, 2013
   
Nine Months Ended
September 30, 2013
 
   
Noninterest Income
   
Noninterest Expense
   
Noninterest Income
   
Noninterest Expense
 
Total gains (losses)
  $ (123 )   $ 0     $ 173     $ 0  

Nonrecurring Measurements
 
The following tables present the fair value measurements of assets recognized in the accompanying balance sheets measured at fair value on a nonrecurring basis as of September 30, 2014 and December 31, 2013 and indicate the level within the fair value hierarchy of the valuation techniques.

 
       
Fair Value Measurements at
September 30, 2014 Using
 
 
(in thousands)
 
Fair Value
   
Quoted Prices in Active Markets for Identical Assets
(Level 1)
   
Significant Other Observable Inputs
(Level 2)
   
Significant Unobservable Inputs
(Level 3)
 
Assets measured – nonrecurring basis
                       
Impaired loans (collateral dependent)
  $ 7,375     $ 0     $ 0     $ 7,375  
Other real estate/assets owned
    6,316       0       0       6,316  

 
       
Fair Value Measurements at
December 31, 2013 Using
 
 
(in thousands)
 
Fair Value
   
Quoted Prices in Active Markets for Identical Assets
(Level 1)
   
Significant Other Observable Inputs
(Level 2)
   
Significant Unobservable Inputs
(Level 3)
 
Assets measured – nonrecurring basis
                       
Impaired loans (collateral dependent)
  $ 6,830     $ 0     $ 0     $ 6,830  
Other real estate/assets owned
    11,111       0       0       11,111  
 
Following is a description of the valuation methodologies and inputs used for assets measured at fair value on a nonrecurring basis and recognized in the accompanying balance sheet, as well as the general classification of such assets pursuant to the valuation hierarchy.  For assets classified within Level 3 of the fair value hierarchy, the process used to develop the reported fair value is described below.

Impaired Loans (Collateral Dependent)
 
The estimated fair value of collateral-dependent impaired loans is based on the appraised fair value of the collateral, less estimated cost to sell.  Collateral-dependent impaired loans are classified within Level 3 of the fair value hierarchy.
 
CTBI considers the appraisal or evaluation as the starting point for determining fair value and then considers other factors and events in the environment that may affect the fair value.  Appraisals of the collateral underlying collateral-dependent loans are obtained when the loan is determined to be collateral-dependent and subsequently as deemed necessary by the Chief Credit Officer.  Appraisals are reviewed for accuracy and consistency by the Chief Credit Officer.  Appraisers are selected from the list of approved appraisers maintained by management.  The appraised values are reduced by discounts to consider lack of marketability and estimated cost to sell if repayment or satisfaction of the loan is dependent on the sale of the collateral.  These discounts and estimates are developed by the Chief Credit Officer by comparison to historical results.
 
Loans considered impaired under ASC 310-35, Impairment of a Loan, 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 subsequent (i) partial write-downs that are based on the observable market price or current appraised value of the collateral or (ii) the full charge-off of the loan carrying value.  Quarter-to-date fair value adjustments on impaired loans were an increase of $1.3 million, and decreases of $0.9 million and $0.5 million for the quarters ended September 30, 2014, December 31, 2013 and September 30, 2013, respectively.  Year-to-date adjustments were $1.5 million for the nine months ended September 30, 2014, $0.6 million for the year ended December 31, 2013, and $1.6 million for the nine months ended September 30, 2013.

Other Real Estate Owned
 
In accordance with the provisions of ASC 360, Property, Plant, and Equipment, other real estate owned (OREO) is carried at the lower of fair value at acquisition date or current estimated fair value, less estimated cost to sell when the real estate is acquired.  Estimated fair value of OREO is based on appraisals or evaluations.  OREO is classified within Level 3 of the fair value hierarchy.  Long-lived assets are subject to nonrecurring fair value adjustments to reflect subsequent partial write-downs that are based on the observable market price or current appraised value of the collateral.  Quarter-to-date fair value adjustments on other real estate/assets owned were $0.2 million, $0.5 million, and $0.2 million for the quarters ended September 30, 2014, December 31, 2013, and September 30, 2013, respectively.  Year-to-date adjustments were $1.4 million for the nine months ended September 30, 2014, $2.5 million for the year ended December 31, 2013, and $2.0 million for the nine months ended September 30, 2013.
 
Our policy for determining the frequency of periodic reviews is based upon consideration of the specific properties and the known or perceived market fluctuations in a particular market and is typically between 12 and 18 months but generally not more than 24 months.  Appraisers are selected from the list of approved appraisers maintained by management.

Unobservable (Level 3) Inputs

The following tables present quantitative information about unobservable inputs used in recurring and nonrecurring Level 3 fair value measurements at September 30, 2014 and December 31, 2013.

(in thousands)
 
Quantitative Information about Level 3 Fair Value Measurements
 
   
Fair Value at September 30, 2014
 
Valuation Technique(s)
Unobservable Input
 
Range (Weighted Average)
 
Mortgage servicing rights
  $ 3,112  
Discount cash flows, computer pricing model
Constant prepayment rate
    4.6% - 24.4%  
                  (10.5%)   
           
Probability of default
    0.00% - 100.00%  
                  (3.54%)   
           
Discount rate
    9.94% - 11.50%  
                  (10.13%)   
                     
Impaired loans (collateral-dependent)
  $ 7,375  
Market comparable properties
Marketability discount
    5.0% - 10.0%  
                  (7.0%)   
                     
Other real estate/assets owned
  $ 6,316  
Market comparable properties
Comparability adjustments (%)
    3.0% - 67.0%  
                  (17.1%)   

(in thousands)
 
Quantitative Information about Level 3 Fair Value Measurements
 
   
Fair Value at December 31, 2013
 
Valuation Technique(s)
Unobservable Input
 
Range (Weighted Average)
 
Mortgage servicing rights
  $ 3,424  
Discount cash flows, computer pricing model
Constant prepayment rate
    4.3% - 23.6%  
                  (9.7%)   
           
Probability of default
    0.00% - 33.33%  
                  (3.36%)   
           
Discount rate
 
Not applicable
 
                (10.0%)   
                     
Impaired loans (collateral-dependent)
  $ 6,830  
Market comparable properties
Marketability discount
    5.0% - 10.0%  
                  (7.0%)   
                     
Other real estate/assets owned
  $ 11,111  
Market comparable properties
Comparability adjustments (%)
    5.0% - 38.0%  
                  (9.0%)   

Sensitivity of Significant Unobservable Inputs
 
The following is a discussion of the sensitivity of significant unobservable inputs, the interrelationships between those inputs and other unobservable inputs used in recurring fair value measurement and of how those inputs might magnify or mitigate the effect of changes in the unobservable inputs on the fair value measurement.

Mortgage Servicing Rights
 
Market value for mortgage servicing rights is derived based on unobservable inputs, such as prepayment speeds of the underlying loans generated using the Andrew Davidson Prepayment Model, FHLMC/FNMA guidelines, the weighted-average life of the loan, the discount rate, the weighted average coupon, and the weighted average default rate.  Significant increases (decreases) in either of those inputs in isolation would result in a significantly lower (higher) fair value measurement.  Generally, a change in the assumption used for prepayment speeds is accompanied by a directionally opposite change in the assumption for interest rates.

Fair Value of Financial Instruments

The following table presents estimated fair value of CTBI’s financial instruments as of September 30, 2014 and indicates the level within the fair value hierarchy of the valuation techniques.

 
 
       
Fair Value Measurements
at September 30, 2014 Using
 
 
(in thousands)
 
Carrying Amount
   
Quoted Prices in Active Markets for Identical Assets
 (Level 1)
   
Significant Other Observable Inputs (Level 2)
   
Significant Unobservable Inputs
 (Level 3)
 
Financial assets:
                       
Cash and cash equivalents
  $ 118,458     $ 118,458     $ 0     $ 0  
Certificates of deposit in other banks
    9,179       0       9,202       0  
Securities available-for-sale
    633,572       24,681       608,891       0  
Securities held-to-maturity
    1,662       0       1,631       0  
Loans held for sale
    367       376       0       0  
Loans, net
    2,649,815       0       0       2,661,358  
Federal Home Loan Bank stock
    17,927       0       17,927       0  
Federal Reserve Bank stock
    4,887       0       4,887       0  
Accrued interest receivable
    13,333       0       13,333       0  
Mortgage servicing rights
    3,112       0       0       3,112  
                                 
Financial liabilities:
                               
Deposits
  $ 2,902,181     $ 660,100     $ 2,236,889     $ 0  
Repurchase agreements
    220,095       0       0       220,077  
Federal funds purchased
    11,114       0       11,114       0  
Advances from Federal Home Loan Bank
    1,199       0       1,420       0  
Long-term debt
    61,341       0       0       35,557  
Accrued interest payable
    1,863       0       1,863       0  
                                 
Unrecognized financial instruments:
                               
Letters of credit
  $ 0     $ 0     $ 0     $ 0  
Commitments to extend credit
    0       0       0       0  
Forward sale commitments
    0       0       0       0  

The following table presents estimated fair value of CTBI’s financial instruments as of December 31, 2013 and indicates the level within the fair value hierarchy of the valuation techniques.

 
 
       
Fair Value Measurements
at December 31, 2013 Using
 
 
(in thousands)
 
Carrying Amount
   
Quoted Prices in Active Markets for Identical Assets
(Level 1)
   
Significant Other Observable Inputs (Level 2)
   
Significant Unobservable Inputs
 (Level 3)
 
Financial assets:
                       
Cash and cash equivalents
  $ 106,641     $ 106,641     $ 0     $ 0  
Certificates of deposit in other banks
    9,568       0       9,582       0  
Securities available-for-sale
    609,405       52,782       556,623       0  
Securities held-to-maturity
    1,662       0       1,601       0  
Loans held for sale
    828       845       0       0  
Loans, net
    2,581,346       0       0       2,589,811  
Federal Home Loan Bank stock
    25,673       0       25,673       0  
Federal Reserve Bank stock
    4,886       0       4,886       0  
Accrued interest receivable
    12,886       0       12,886       0  
Mortgage servicing rights
    3,424       0       0       3,424  
                                 
Financial liabilities:
                               
Deposits
  $ 2,855,074     $ 621,321     $ 2,230,608     $ 0  
Repurchase agreements
    208,067       0       0       207,992  
Federal funds purchased
    12,465       0       12,465       0  
Advances from Federal Home Loan Bank
    1,286       0       1,531       0  
Long-term debt
    61,341       0       0       31,362  
Accrued interest payable
    1,032       0       1,032       0  
                                 
Unrecognized financial instruments:
                               
Letters of credit
  $ 0     $ 0     $ 0     $ 0  
Commitments to extend credit
    0       0       0       0  
Forward sale commitments
    0       0       0       0  

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.

Certificates of deposit in other banks – Fair values are based on quoted market prices or dealer quotes for similar instruments.
 
Securities held-to-maturity – Fair values are based on quoted market prices, if available.  If a quoted price is not available, fair value is estimated using quoted prices for similar securities.  The fair value estimate is provided to management from a third party using modeling assumptions specific to each type of security that are reviewed and approved by management.  Quarterly sampling of fair values provided by additional third parties supplement the fair value review process.

Loans held for sale – The fair value is predetermined at origination based on sale price.
 
Loans (net of the allowance for loan and lease losses) – 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.

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.

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.

Accrued interest receivable – The carrying amount approximates fair value.
 
Deposits – The fair value of fixed maturity time deposits is estimated by discounting the future cash flows using the rates currently offered for deposits of similar remaining maturities.  For deposits including demand deposits, savings accounts, NOW accounts, and certain money market accounts, the carrying value approximates fair value.

Repurchase agreements – The fair value is estimated by discounting future cash flows using current rates.

Federal funds purchased – The carrying amount approximates fair value.

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.
 
Commitments to originate loans, forward sale commitments, letters of credit, and lines of credit – The fair value of commitments to originate loans is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties.  For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates.  The fair value of forward sale commitments is estimated based on current market prices for loans of similar terms and credit quality.  The fair values of letters of credit and lines of credit are based on fees currently charged for similar agreements or on the estimated cost to terminate or otherwise settle the obligations with the counterparties at the reporting date.  The fair values of these commitments are not material.

Note 9 – Accumulated Other Comprehensive Income

Unrealized gains (losses) on AFS securities

Amounts reclassified from accumulated other comprehensive income (AOCI) and the affected line items in the statements of income during the three and nine months ended September 30, 2014 and 2013 were:

   
Amounts Reclassified from AOCI
 
 (in thousands)
 
Three Months Ended
September 30
   
Nine Months Ended
September 30
 
 
2014
   
2013
   
2014
   
2013
 
Affected line item in the statements of income
                       
Securities losses
  $ (34 )   $ (23 )   $ (145 )   $ (31 )
Tax benefit
    (12 )     (8 )     (51 )     (11 )
Total reclassifications out of AOCI
  $ (22 )   $ (15 )   $ (94 )   $ (20 )


 
 

 

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

Overview
 
The following Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is intended to help the reader understand Community Trust Bancorp, Inc., our operations, and our present business environment.  The MD&A is provided as a supplement to – and should be read in conjunction with – our condensed consolidated financial statements and the accompanying notes contained in this quarterly report.  The MD&A includes the following sections:

v
Our Business

v
Results of Operations and Financial Condition

v
Dividends

v
Liquidity and Market Risk

v
Interest Rate Risk

v
Capital Resources

v
Impact of Inflation, Changing Prices, and Economic Conditions

v
Stock Repurchase Program

v
Critical Accounting Policies and Estimates

Our Business
 
Community Trust Bancorp, Inc. (“CTBI”) is a bank holding company headquartered in Pikeville, Kentucky.  Currently, we own one commercial bank and one trust company.  Through our subsidiaries, we have eighty-one banking locations in eastern, northeastern, central, and south central Kentucky, southern West Virginia, and northeastern Tennessee, four trust offices across Kentucky, and one trust office in northeastern Tennessee.  At September 30, 2014, we had total consolidated assets of $3.7 billion and total consolidated deposits, including repurchase agreements, of $3.1 billion, making us the largest bank holding company headquartered in the Commonwealth of Kentucky.  Total shareholders’ equity at September 30, 2014 was $438.2 million.
 
Through our subsidiaries, we engage in a wide range of commercial and personal banking and trust and wealth management activities, which include accepting time and demand deposits; making secured and unsecured loans to corporations, individuals and others; providing cash management services to corporate and individual customers; issuing letters of credit; renting safe deposit boxes; and providing funds transfer services.  The lending activities of our Bank include making commercial, construction, mortgage, and personal loans.  Lease-financing, lines of credit, revolving lines of credit, term loans, and other specialized loans, including asset-based financing, are also available.  Our corporate subsidiaries act as trustees of personal trusts, as executors of estates, as trustees for employee benefit trusts, as registrars, transfer agents, and paying agents for bond and stock issues, as depositories for securities, and as providers of full service brokerage services.  For further information, see Item 1 of our annual report on Form 10-K for the year ended December 31, 2013.

Results of Operations and Financial Condition
 
For the quarter ended September 30, 2014, we reported earnings of $10.9 million, or $0.63 per basic share, compared to $12.7 million, or $0.74 per basic share, earned during the third quarter 2013 and $12.2 million, or $0.70 per basic share, earned during the second quarter 2014.  Net income for the quarter was adversely impacted by an increase in our loan loss provision.  Year-to-date earnings for the nine months ended September 30, 2014 were $33.3 million, or $1.92 per basic share, compared to $36.4 million, or $2.13 per basic share earned during the first nine months of 2013.  The variance from prior year is due to decreased net interest income and noninterest income, partially offset by a decrease in our provision for loan losses.

Income Statement Review

(dollars in thousands)
             
Change 2014 vs. 2013
 
Nine Months Ended September 30
 
2014
   
2013
   
Amount
   
Percent
 
Net interest income
  $ 98,571     $ 100,689     $ (2,118 )     (2.1 )%
Provision for loan losses
    5,380       7,349       (1,969 )     (26.8 )
Noninterest income
    33,043       37,265       (4,222 )     (11.3 )
Noninterest expense
    77,980       77,877       103       0.1  
Income taxes
    14,995       16,313       (1,318 )     (8.1 )
Net income
  $ 33,259     $ 36,415     $ (3,156 )     (8.7 )%
                                 
Average earning assets
  $ 3,409,905     $ 3,386,571     $ 23,334       0.7 %
                                 
Yield on average earnings assets
    4.27 %     4.44 %     (0.17 )%     (3.8 )%
Cost of interest bearing funds
    0.47 %     0.53 %     (0.06 )%     (12.4 )%
                                 
Net interest margin
    3.92 %     4.03 %     (0.11 )%     (2.7 )%

Net Interest Income
 
Net interest income for the quarter decreased $1.2 million, or 3.4%, from prior year third quarter but increased $0.2 million, or 0.5% from prior quarter as our net interest margin decreased 19 basis points and 4 basis points, respectively, for those time periods.  The current low rate environment continues to have a negative impact on our net interest margin.  Average earning assets increased 1.6% from third quarter 2013 and 0.4% from prior quarter while our yield on average earning assets decreased 24 basis points and 4 basis points, respectively.  Loans represented 77.5% of our average earning assets for the quarter ended September 30, 2014 compared to 77.0% for the quarter ended September 30, 2013 and 76.3% for the quarter ended June 30, 2014.  At September 30, 2014, loans represented 78.7% of our earning assets, reflecting the change in earning asset mix resulting from the $51 million in loan growth during the quarter.  While interest income increased slightly during the quarter, the new loan growth was at a lower yield than our previous average book yield.  Consequently, the yield on the loan portfolio decreased as did the net interest margin. The cost of interest bearing funds decreased 5 basis points from prior year third quarter and 1 basis point from prior quarter.  Net interest income for the nine months ended September 30, 2014 decreased $2.1 million, or 2.1%, from prior year.  Assuming our cost of funds continues to plateau, pressure will be placed on our margin as our loan portfolio continues to reprice at lower rates.

Provision for Loan Losses
 
The provision for loan losses that was added to the allowance for the third quarter 2014 was $3.3 million compared to $2.1 million in the third quarter 2013 and $0.7 million for the quarter ended June 30, 2014.  Year-to-date allocations to the reserve were $5.4 million at September 30, 2014 compared to $7.3 million at September 30, 2013.  This provision represented a charge against current earnings in order to maintain the allowance at an appropriate level determined using the accounting estimates described in the Critical Accounting Policies and Estimates section.  The quarterly increase in our provision was due to increases in net charge-offs and to fund new loan growth.  Our year-to-date loan loss provision remains lower than prior year, primarily due to the year-to-date decline in net losses to average loans.  Our reserve coverage (allowance for loan and lease loss reserve to nonperforming loans) at September 30, 2014 was 70.2% compared to 80.5% at September 30, 2013 and 75.5% at June 30, 2014.  The decline in our reserve coverage is the result of an increase in loans categorized as nonperforming that management has individually reviewed under ASC 310-10-35, Impairment of a Loan, and determined that no specific reserve is needed.  Generally accepted accounting principles do not allow the ASC 310-10-35 pool of loans without specific reserves to be used in determining the allocation of allowance using ASC 450, Contingencies.  As a result, the allowance amount as a percentage of nonperforming loans is lower.  Our loan loss reserve as a percentage of total loans outstanding decreased to 1.27% from the 1.30% at September 30, 2013 and 1.28% at June 30, 2014.

Noninterest Income
 
Noninterest income decreased $0.1 million, or 0.5%, for the quarter ended September 30, 2014 compared to the same period in 2013 but increased $1.0 million, or 9.4%, from prior quarter.  The increase from prior quarter was primarily due to increased deposit service charges, trust revenue, and loan related fees.  Noninterest income for the first nine months of 2014 decreased 11.3% from prior year.  The decrease from prior year was primarily attributable to decreases in gains on sales of loans, deposit service charges, loan related fees, and other noninterest income.  The decrease in gains on sales of loans from prior year was reflective of the decline in secondary market residential real estate mortgage activity, and the decrease in deposit service charges from prior year was a result of the change in our processing of overdrafts.  However, gains on sales of loans and deposit service charges have increased for the past two quarters.  Deposit service charges increased $0.3 million from prior quarter with increases in overdraft revenue and Visa debit fee income.  Loan related fees were impacted by the fluctuation in the fair value of our mortgage servicing rights.  The decrease in other noninterest income was due to the prior year death benefits received in bank owned life insurance of $0.9 million.

Noninterest Expense
 
Noninterest expense for the quarter ended September 30, 2014 increased 1.1% from prior year third quarter and 2.4% from prior quarter.  Noninterest expense for the first nine months of 2014 increased 0.1% from prior year.  Increases in personnel expense and data processing expense were partially offset by decreases in net other real estate owned expense and repossession expense, as well as adjustments totaling $0.8 million to reduce the accrual for the Federal Reserve item which was previously disclosed in our annual report on Form 10-K for the year ended December 31, 2013.  The increase in personnel expense in the third quarter 2014 was the result of an increased loss experience in our health insurance plan partially offset by a decrease in the accrual for our annual performance based bonus.

Balance Sheet Review
 
CTBI’s total assets at $3.7 billion increased $88.4 million, or an annualized 9.8%, from December 31, 2013 and $17.5 million, or an annualized 1.9%, during the quarter.  Loans outstanding at September 30, 2014 were $2.7 billion, increasing $68.6 million, or an annualized 10.4%, from December 31, 2013 and $51.3 million, or an annualized 7.7%, during the quarter.  We experienced growth during the quarter in all loan portfolios.  The commercial loan portfolio increased $26.5 million, the indirect loan portfolio increased $16.2 million, the residential loan portfolio increased $6.9 million, and the consumer direct loan portfolio increased $1.8 million.  CTBI’s investment portfolio increased $24.2 million, or an annualized 15.7%, from December 31, 2013 but decreased $14.0 million, or an annualized 8.5%, during the quarter.  Deposits, including repurchase agreements, at $3.1 billion increased $59.1 million, or an annualized 7.7%, from December 31, 2013 and $17.1 million, or an annualized 2.2%, from prior quarter.

Shareholders’ equity at September 30, 2014 was $438.2 million compared to $412.5 million at December 31, 2013 and $433.9 million at June 30, 2014.  Our tangible common equity/tangible assets ratio increased to 10.33%.  CTBI’s annualized dividend yield to shareholders as of September 30, 2014 was 3.57%.

Loans

(in thousands)
 
September 30, 2014
 
Loan Category
 
Balance
   
Variance from Prior Year-End
   
Net Charge-Offs
   
Nonperforming
   
ALLL
 
Commercial:
                             
Construction
  $ 120,248       8.5 %   $ (25 )   $ 5,951     $ 3,015  
Secured by real estate
    931,455       6.8       1,189       19,882       14,835  
Equipment lease financing
    10,055       13.7       0       0       127  
Commercial other
    347,035       (7.4 )     1,676       6,016       4,621  
Total commercial
    1,408,793       3.1       2,840       31,849       22,598  
                                         
Residential:
                                       
Real estate construction
    62,105       10.8       121       1,020       437  
Real estate mortgage
    703,323       0.8       407       14,380       4,944  
Home equity
    88,291       4.0       90       908       621  
Total residential
    853,719       1.8       618       16,308       6,002  
                                         
Consumer:
                                       
Consumer direct
    121,367       (0.7 )     547       43       1,611  
Consumer indirect
    300,026       4.3       1,293       358       3,879  
Total consumer
    421,393       2.8       1,840       401       5,490  
                                         
Total loans
  $ 2,683,905       2.6 %   $ 5,298     $ 48,558     $ 34,090  

Asset Quality
 
CTBI’s total nonperforming loans were $48.6 million at September 30, 2014, an 11.5% increase from the $43.6 million at December 31, 2013 and a 9.0% increase from the $44.5 million at June 30, 2014.  Nonaccrual loans increased $3.2 million for the quarter and loans 90+ days past due increased $0.8 million.  The increase in nonaccrual loans for the quarter included one hotel credit totaling $2.9 million which was previously identified as impaired.  The year over year increase of $11.8 million also includes a $7.4 million income producing commercial real estate loan relationship that was put on nonaccrual in the first quarter 2014.  The increase in loans 90+ days past due consists of an increase of $1.9 million in mortgage loans, partially offset by a decrease of $1.1 million in commercial loans.  These credits, in addition to all loans in the 90+ days past due category, are reviewed by management and are considered to be well secured and in the process of collection; therefore, these loans require no specific reserves to the allowance for loan and lease losses.  Loans 30-89 days past due at $20.9 million was an increase of $4.9 million from December 31, 2013 but a decrease of $0.6 million from June 30, 2014.  Our loan portfolio management processes focus on the immediate identification, management, and resolution of problem loans to maximize recovery and minimize loss.   Our loan risk management processes include weekly delinquent loan review meetings at the market levels and monthly delinquent loan review meetings involving senior corporate management to review all nonaccrual loans and loans 30 days or more past due.  Any activity regarding a criticized/classified loan (i.e. problem loan) must be approved by CTB’s Watch List Asset Committee (i.e. Problem Loan Committee).  CTB’s Watch List Asset Committee also meets on a quarterly basis and reviews every criticized/classified loan of $100,000 or greater.  We also have a Loan Review Department that reviews every market within CTB annually and performs extensive testing of the loan portfolio to assure the accuracy of loan grades and classifications for delinquency, troubled debt restructuring, impaired status, impairment, nonaccrual status, and adequate loan loss reserves.
 
Impaired loans, loans not expected to meet contractual principal and interest payments other than insignificant delays, at September 30, 2014 totaled $66.9 million, compared to $65.3 million at December 31, 2013 and $66.2 million at June 30, 2014.  Included in certain loan categories of impaired loans are troubled debt restructurings that were classified as impaired.  At September 30, 2014, CTBI had $23.6 million in commercial loans secured by real estate, $7.5 million in commercial real estate construction loans, $9.4 million in commercial other loans, and $1.9 million in real estate mortgage loans that were modified in troubled debt restructurings and impaired.  Management evaluates all impaired loans for impairment and records a direct charge-off or provides specific reserves when necessary.

For further information regarding nonperforming and impaired loans, see note 4 to the condensed consolidated financial statements.
 
CTBI generally does not offer high risk loans such as option ARM products, high loan to value ratio mortgages, interest-only loans, loans with initial teaser rates, or loans with negative amortizations, and therefore, CTBI would have no significant exposure to these products.
 
Net loan charge-offs for the quarter ended September 30, 2014 were $2.8 million, or 0.42% of average loans annualized, compared to $1.7 million, or 0.26%, experienced for the third quarter 2013 and $0.7 million, or 0.11%, for the second quarter 2014.  Significant increases in charge-offs quarter over quarter were recognized in both the commercial loan portfolio (41 basis points) and the consumer loan portfolio (44 basis points) while there was a modest increase in the residential loan portfolio (5 basis points).  The commercial portfolio charge-offs were impacted by a $0.5 million charge-off of a commercial real estate loan and a $0.7 million charge-off of a commercial loan to a heavy duty equipment retailer.  Management believes the increase in charge-offs in the consumer portfolio is more a reflection of the unusually low level of charge-offs in the second quarter of 2014 and not an indication of a significant change in asset quality in the consumer portfolio.  Of the total net charge-offs for the quarter, $1.6 million were in commercial loans, $0.5 million were in indirect auto loans, and $0.3 million were in residential real estate mortgage loans.  Year-to-date net charge-offs declined from 0.34% of average loans to 0.27%.
 
We continued to experience improvement in other real estate owned.  Our level of foreclosed properties at $32.7 million at September 30, 2014 was a decrease from $39.2 million at December 31, 2013 and $33.1 million at June 30, 2014.  Sales of foreclosed properties for the quarter ended September 30, 2014 totaled $1.9 million while new foreclosed properties totaled $1.8 million.  Sales for the nine months ended September 30, 2014 totaled $10.3 million while new foreclosed properties totaled $5.3 million.  At September 30, 2014, the book value of properties under contracts to sell was $3.2 million; however, the closings had not occurred at quarter-end.
 
When foreclosed properties are acquired, appraisals are obtained and the properties are booked at the current market value less expected sales costs.  Additionally, periodic updated appraisals are obtained on unsold foreclosed properties.  When an updated appraisal reflects a market value below the current book value, a charge is booked to current earnings to reduce the property to its new market value less expected sales costs.   Charges to earnings in the third quarter 2014 to reflect the decrease in current market values of foreclosed properties totaled $0.2 million.  There were 18 properties reappraised during the third quarter 2014.  Of these, eight were written down by a total of $0.2 million.  Charges during the quarters ended September 30, 2013 and June 30, 2014 were $0.2 million and $0.3 million, respectively.  Our policy for determining the frequency of periodic reviews is based upon consideration of the specific properties and the known or perceived market fluctuations in a particular market and is typically between 12 and 18 months but generally not more than 24 months.  Approximately eighty-five percent of our OREO properties have been reappraised within the past 12 months.  Management anticipates that our foreclosed properties will remain elevated as we work through current market conditions.

The major classifications of foreclosed properties are shown in the following table:

(in thousands)
 
September 30,
 2014
   
December 31,
2013
 
1-4 family
  $ 6,728     $ 8,640  
Agricultural/farmland
    244       792  
Construction/land development/other
    18,768       20,278  
Multifamily
    1,000       1,456  
Non-farm/non-residential
    6,007       8,022  
Total foreclosed properties
  $ 32,747     $ 39,188  

The appraisal aging analysis of foreclosed properties, as well as the holding period, at September 30, 2014 is shown below:

(in thousands)
     
Appraisal Aging Analysis
 
Holding Period Analysis
 
Days Since Last Appraisal
 
Current Book Value
 
Holding Period
 
Current Book Value
 
Up to 3 months
  $ 4,280  
Less than one year
  $ 5,733  
3 to 6 months
    13,312  
1 to 2 years
    2,705  
6 to 9 months
    7,819  
2 to 3 years
    3,016  
9 to 12 months
    2,357  
3 to 4 years
    11,758  
12 to 24 months
    4,886  
4 to 5 years
    3,083  
Over 24 months
    93  
Over 5 years
    6,452  
Total
  $ 32,747  
Total
  $ 32,747  

Dividends

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

Pay Date
Record Date
Amount Per Share
October 1, 2014
September 15, 2014
$0.300
July 1, 2014
June 15, 2014
$0.290
April 1, 2014
March 15, 2014
$0.291
January 1, 2014
December 15, 2013
$0.291
October 1, 2013
September 15, 2013
$0.291
July 1, 2013
June 15, 2013
$0.286

The Board of Directors of CTBI declared the payment of a quarterly cash dividend of $0.30 per share to be paid on January 1, 2015 to shareholders of record on December 15, 2014.

Liquidity and Market Risk
 
The objective of CTBI’s Asset/Liability management function is to maintain consistent growth in net interest income within our policy limits. This objective is accomplished through management of our consolidated balance sheet composition, liquidity, and interest rate risk exposures arising from changing economic conditions, interest rates, and customer preferences. The goal of liquidity management is to provide adequate funds to meet changes in loan and lease demand or deposit withdrawals. This is accomplished by maintaining liquid assets in the form of cash and cash equivalents and investment securities, sufficient unused borrowing capacity, and growth in core deposits. As of September 30, 2014, we had approximately $118.5 million in cash and cash equivalents and approximately $633.6 million in securities valued at estimated fair value designated as available-for-sale and available to meet liquidity needs on a continuing basis compared to $106.6 million and $609.4 million at December 31, 2013.  Additional asset-driven liquidity is provided by the remainder of the securities portfolio and the repayment of loans.  In addition to core deposit funding, we also have a variety of other short-term and long-term funding sources available.  We also rely on Federal Home Loan Bank advances for both liquidity and management of our asset/liability position.  Federal Home Loan Bank advances were $1.2 million at September 30, 2014 compared to $1.3 million at December 31, 2013.  As of September 30, 2014, we had a $382 million available borrowing position with the Federal Home Loan Bank compared to $343 million at December 31, 2013.  We generally rely upon net inflows of cash from financing activities, supplemented by net inflows of cash from operating activities, to provide cash for our investing activities.  As is typical of many financial institutions, significant financing activities include deposit gathering, use of short-term borrowing facilities such as repurchase agreements and federal funds purchased, and issuance of long-term debt.  At September 30, 2014 and December 31, 2013, we had $44 million in lines of credit with various correspondent banks available to meet any future cash needs.  Our primary investing activities include purchases of securities and loan originations.  We do not rely on any one source of liquidity and manage availability in response to changing consolidated balance sheet needs.  At September 30, 2014, federal funds sold were $7.5 million compared to $8.6 million at December 31, 2013, and deposits with the Federal Reserve were $46.2 million compared to $28.5 million at December 31, 2013.  Additionally, we project cash flows from our investment portfolio to generate additional liquidity over the next 90 days.
 
The investment portfolio consists of investment grade short-term issues suitable for bank investments.  The majority of the investment portfolio is in U.S. government and government sponsored agency issuances.  The average life of the portfolio is 4.15 years. At the end of September 30, 2014, available-for-sale (“AFS”) securities comprised approximately 99.7% of the total investment portfolio, and the AFS portfolio was approximately 145% of equity capital.  Eighty-four percent of the pledge eligible portfolio was pledged.

Interest Rate Risk
 
We consider interest rate risk one of our most significant market risks. Interest rate risk is the exposure to adverse changes in net interest income due to changes in interest rates.  Consistency of our net interest revenue is largely dependent upon the effective management of interest rate risk.  We employ a variety of measurement techniques to identify and manage our interest rate risk including the use of an earnings simulation model to analyze net interest income sensitivity to changing interest rates.  The model is based on actual cash flows and repricing characteristics for on and off-balance sheet instruments and incorporates market-based assumptions regarding the effect of changing interest rates on the prepayment rates of certain assets and liabilities.  Assumptions based on the historical behavior of deposit rates and balances in relation to changes in interest rates are also incorporated into the model.  These assumptions are inherently uncertain, and as a result, the model cannot precisely measure net interest income or precisely predict the impact of fluctuations in interest rates on net interest income.  Actual results will differ from simulated results due to timing, magnitude, and frequency of interest rate changes as well as changes in market conditions and management strategies.
 
CTBI’s Asset/Liability Management Committee (ALCO), which includes executive and senior management representatives and reports to the Board of Directors, monitors and manages interest rate risk within Board-approved policy limits.  Our current exposure to interest rate risks is determined by measuring the anticipated change in net interest income spread evenly over the twelve-month period.

Capital Resources
 
Shareholders’ equity was $438.2 million at September 30, 2014 and $412.5 million at December 31, 2013.  CTBI’s annualized dividend yield to shareholders as of September 30, 2014 was 3.57%.  Our primary source of capital growth is the retention of earnings.  Cash dividends were $0.881 per share for the nine months ended September 30, 2014 and $0.863 per share for the nine months ended September 30, 2013.  We retained 54.1% of our earnings for the first nine months of 2014 compared to 59.5% for the first nine months of 2013.
 
Regulatory guidelines require bank holding companies, commercial banks, and savings banks to maintain certain minimum capital ratios and define companies as “well-capitalized” that sufficiently exceed the minimum ratios.  The banking regulators may alter minimum capital requirements as a result of revising their internal policies and their ratings of individual institutions.  To be “well-capitalized” banks and bank holding companies must maintain a Tier 1 leverage ratio of no less than 5.0%, a Tier 1 risk based ratio of no less than 6.0%, and a total risk based ratio of no less than 10.0%.  Our ratios as of September 30, 2014 were 11.97%, 16.57%, and 17.82%, respectively, all exceeding the threshold for meeting the definition of “well-capitalized.”
 
As of September 30, 2014, we are not aware of any other current recommendations by banking regulatory authorities which, if they were to be implemented, would have, or are reasonably likely to have, a material adverse impact on our liquidity, capital resources, or operations, except as provided for in the Dodd-Frank Act, which is discussed in the Supervision and Regulation section of Item 1. Business in our annual report on Form 10-K for the year ended December 31, 2013, and Basel III which is discussed below.

  Basel III
 
On July 2, 2013, the Federal Reserve approved final rules that substantially amend the regulatory risk-based capital rules applicable to CTBI and CTB.  The FDIC has subsequently approved these rules.  The final rules were adopted following the issuance of proposed rules by the Federal Reserve in June 2012, and implement the “Basel III” regulatory capital reforms and changes required by the Dodd-Frank Act.  “Basel III” refers to two consultative documents released by the Basel Committee on Banking Supervision in December 2009, the rules text released in December 2010, and loss absorbency rules issued in January 2011, which include significant changes to bank capital, leverage and liquidity requirements.
 
The rules include new risk-based capital and leverage ratios, which would be phased in from 2015 to 2019, and would refine the definition of what constitutes “capital” for purposes of calculating those ratios. The new minimum capital level requirements applicable to CTBI and CTB under the final rules would be: (i) a new common equity Tier 1 capital ratio of 4.5%; (ii) a Tier 1 capital ratio of 6% (increased from 4%); (iii) a total capital ratio of 8% (unchanged from current rules); and (iv) a Tier 1 leverage ratio of 4% for all institutions.  The final rules also establish a “capital conservation buffer” above the new regulatory minimum capital requirements, which must consist entirely of common equity Tier 1 capital. The capital conservation buffer will be phased-in over four years beginning on January 1, 2016, as follows: the maximum buffer will be 0.625% of risk-weighted assets for 2016, 1.25% for 2017, 1.875% for 2018, and 2.5% for 2019 and thereafter. This will result in the following minimum ratios beginning in 2019: (i) a common equity Tier 1 capital ratio of 7.0%, (ii) a Tier 1 capital ratio of 8.5%, and (iii) a total capital ratio of 10.5%. Under the final rules, institutions are subject to limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses if its capital level falls below the buffer amount. These limitations establish a maximum percentage of eligible retained income that could be utilized for such actions.
 
Basel III provided discretion for regulators to impose an additional buffer, the “countercyclical buffer,” of up to 2.5% of common equity Tier 1 capital to take into account the macro-financial environment and periods of excessive credit growth.  However, the final rules permit the countercyclical buffer to be applied only to “advanced approach banks” (i.e., banks with $250 billion or more in total assets or $10 billion or more in total foreign exposures), which currently excludes CTBI and CTB.  The final rules also implement revisions and clarifications consistent with Basel III regarding the various components of Tier 1 capital, including common equity, unrealized gains and losses, as well as certain instruments that will no longer qualify as Tier 1 capital, some of which will be phased out over time.  However, the final rules provide that small depository institution holding companies with less than $15 billion in total assets as of December 31, 2009 (which includes CTBI) will be able to permanently include non-qualifying instruments that were issued and included in Tier 1 or Tier 2 capital prior to May 19, 2010 in additional Tier 1 or Tier 2 capital until they redeem such instruments or until the instruments mature.
 
The final rules also contain revisions to the prompt corrective action framework, which is designed to place restrictions on insured depository institutions, including the Bank, if their capital levels begin to show signs of weakness.  These revisions take effect January 1, 2015.  Under the prompt corrective action requirements, which are designed to complement the capital conservation buffer, insured depository institutions will be required to meet the following increased capital level requirements in order to qualify as “well capitalized:” (i) a new common equity Tier 1 capital ratio of 6.5%; (ii) a Tier 1 capital ratio of 8% (increased from 6%); (iii) a total capital ratio of 10% (unchanged from current rules); and (iv) a Tier 1 leverage ratio of 5% (increased from 4%).
 
The final rules set forth certain changes for the calculation of risk-weighted assets, which we will be required to utilize beginning January 1, 2015.  The standardized approach final rule utilizes an increased number of credit risk exposure categories and risk weights, and also addresses: (i) an alternative standard of creditworthiness consistent with Section 939A of the Dodd-Frank Act; (ii) revisions to recognition of credit risk mitigation; (iii) rules for risk weighting of equity exposures and past due loans; (iv) revised capital treatment for derivatives and repo-style transactions; and (v) disclosure requirements for top-tier banking organizations with $50 billion or more in total assets that are not subject to the “advance approach rules” that apply to banks with greater than $250 billion in consolidated assets.  Based on our current capital composition and levels, we anticipate that our capital ratios, on a Basel III basis, will continue to exceed the well-capitalized minimum capital requirements upon the effectiveness of the final rule.

Impact of Inflation, Changing Prices, and Economic Conditions
 
The majority of our assets and liabilities are monetary in nature. Therefore, CTBI differs greatly from most commercial and industrial companies that have significant investment in nonmonetary assets, such as fixed assets and inventories.  However, inflation does have an important impact on the growth of assets in the banking industry and on the resulting need to increase equity capital at higher than normal rates in order to maintain an appropriate equity to assets ratio.  Inflation also affects other expenses, which tend to rise during periods of general inflation.
 
We believe one of the most significant impacts on financial and operating results is our ability to react to changes in interest rates.  We seek to maintain an essentially balanced position between interest rate sensitive assets and liabilities in order to protect against the effects of wide interest rate fluctuations.
 
Since 2008, the U.S. economy has faced a severe economic crisis including a major recession from which it is slowly recovering.  Commerce and business growth across a wide range of industries and regions in the U.S. remains reduced and local governments and many businesses continue to experience financial difficulty.  While reflecting some improvement in many parts of the country and in parts of our own service area, unemployment levels in our service area remain elevated.  There can be no assurance that these conditions will continue to improve and these conditions could worsen.  Regionally, recent economic conditions in the coal industry are resulting in increased unemployment in the markets we serve where coal is a major contributor to the economy.  In addition, ongoing federal budget negotiations, the implementation of the Patient Protection and Affordable Care Act, the Federal Open Market Committee’s plan for economic easing, and the level of U.S. debt may have a destabilizing effect on financial markets.
 
Our financial performance generally, and in particular the ability of borrowers to pay interest on and repay principal of outstanding loans and the value of collateral securing those loans, as well as demand for loans and other products and services we offer, is highly dependent upon the business environment in the markets where we operate, in the states of Kentucky, West Virginia, and Tennessee and in the United States as a whole.  A favorable business environment is generally characterized by, among other factors, economic growth, efficient capital markets, low inflation, low unemployment, high business and investor confidence, and strong business earnings.  Unfavorable or uncertain economic and market conditions can be caused by declines in economic growth, business activity, or investor or business confidence; limitations on the availability or increases in the cost of credit and capital; increases in inflation or interest rates; high unemployment; natural disasters; or a combination of these or other factors.
 
Overall, during recent years, the business environment has been adverse for many households and businesses in the United States and worldwide.  While economic conditions in the United States and worldwide have improved since the recession, there can be no assurance that this improvement will continue.  Economic pressure on consumers and uncertainty regarding continuing economic improvement may result in changes in consumer and business spending, borrowing, and savings habits.  Such conditions could adversely affect the credit quality of our loans and our business, financial condition, and results of operations.

Stock Repurchase Program
 
CTBI’s stock repurchase program currently has 288,519 shares remaining under CTBI’s current repurchase authorization.  We have not repurchased any shares of our common stock since February 2008.  As of September 30, 2014, a total of 2,211,481 shares have been repurchased through this program.

Critical Accounting Policies and Estimates
 
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 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.

We have identified the following critical accounting policies:
 
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 Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) 320, Investment 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 other than temporary, the carrying value of the securities is written down to fair value as a realized loss with a charge to income for the portion attributable to credit losses and a charge to other comprehensive income for the portion that is not credit related.
 
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.
 
When the fair value of a security is below its amortized cost, and depending on the length of time the condition exists and the extent the fair market value is below amortized cost, additional analysis is performed to determine whether an other than temporary impairment condition exists.  Available-for-sale and held-to-maturity securities are analyzed quarterly for possible other than temporary impairment.  The analysis considers (i) whether we have the intent to sell our securities prior to recovery and/or maturity and (ii) whether it is more likely than not that we will not have to sell our securities prior to recovery and/or maturity.  Often, the information available to conduct these assessments is limited and rapidly changing, making estimates of fair value subject to judgment.  If actual information or conditions are different than estimated, the extent of the impairment of the security may be different than previously estimated, which could have a material effect on the CTBI’s results of operations and financial condition.
 
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, an allowance for loan and lease losses, and unamortized deferred fees or costs.  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 remain current for a period of time, generally six months, and future payments appear reasonably certain.  Included in certain loan categories of impaired loans are troubled debt restructurings that were classified as impaired.  A restructuring of a debt constitutes a troubled debt restructuring if the creditor for economic or legal reasons related to the debtor’s financial difficulties grants a concession to the debtor that it would not otherwise consider.

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 defined by ASC 310-35, Impairment of a Loan.  We evaluate the collectability of both principal and interest when assessing the need for loss provision.  Historical loss rates are analyzed and 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.
 
A loan is considered impaired when, based on current information and events, it is probable that CTBI will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement.  Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due.  Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired.  Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed.  Impairment is measured on a loan-by-loan basis for commercial and construction loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent.

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, Contingencies.
 
When any secured commercial loan is considered uncollectable, whether past due or not, a current assessment of the value of the underlying collateral is made.  If the balance of the loan exceeds the fair value of the collateral, the loan is placed on non-accrual and the loan is charged down to the value of the collateral less estimated cost to sell or a specific reserve equal to the difference between book value of the loan and the fair value assigned to the collateral is created until such time as the loan is foreclosed.  When the foreclosed collateral has been legally assigned to CTBI, a charge off is taken, if necessary, in order that the remaining balance reflects the fair value estimated less costs to sell of the collateral then transferred to other real estate owned or other repossessed assets.  When any unsecured commercial loan is considered uncollectable the loan is charged off no later than at 90 days past due.
 
All closed-end consumer loans (excluding conventional 1-4 family residential loans and installment and revolving loans secured by real estate) are charged off no later than 120 days (5 monthly payments) delinquent.  If a loan is considered uncollectable, it is charged off earlier than 120 days delinquent.  For conventional 1-4 family residential loans and installment and revolving loans secured by real estate, when a loan is 90 days past due, a current assessment of the value of the real estate is made.  If the balance of the loan exceeds the fair value of the property, the loan is placed on nonaccrual.  Foreclosure proceedings are normally initiated after 120 days.  When the foreclosed property has been legally assigned to CTBI, the fair value less estimated costs to sell is transferred to other real estate owned and the remaining balance is taken as a charge-off.
 
Historical loss rates for loans are adjusted for significant factors that, in management’s judgment, reflect the impact of any current conditions on loss recognition.  We continue to use twelve rolling quarters for our historical loss rate analysis.  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, trends in loan losses, industry concentrations and their relative strengths, amount of unsecured loans, and underwriting exceptions.  Based upon management’s judgment, “best case,” “worst case,” and “most likely” scenarios are 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 to approximate the most likely scenario.  Management continually reevaluates the other subjective factors included in its ALLL analysis.
 
Other Real Estate Owned – When foreclosed properties are acquired, appraisals are obtained and the properties are booked at the current market value less expected sales costs.  Additionally, periodic updated appraisals are obtained on unsold foreclosed properties.  When an updated appraisal reflects a market value below the current book value, a charge is booked to current earnings to reduce the property to its new market value less expected sales costs.  Our policy for determining the frequency of periodic reviews is based upon consideration of the specific properties and the known or perceived market fluctuations in a particular market and is typically between 12 and 18 months but generally not more than 24 months.  All revenues and expenses related to the carrying of other real estate owned are recognized by a charge to income.
 

 
 

 


Item 3.  Quantitative and Qualitative Disclosures About Market Risk
 
Interest rate risk management focuses on maintaining consistent growth in net interest income within Board-approved policy limits.  CTBI uses an earnings simulation model to analyze net interest income sensitivity to movements in interest rates.  Given a 200 basis point increase to the yield curve used in the simulation model, it is estimated net interest income for CTBI would increase by 1.10 percent over one year and decrease by 1.61 percent over two years.  A 25 basis point decrease in the yield curve would decrease net interest income by an estimated 0.12 percent over one year and increase by 0.28 percent over two years.  For further discussion of CTBI’s market risk, see the Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Market Risk included in the annual report on Form 10-K for the year ended December 31, 2013.


Item 4.  Controls and Procedures

EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
 
CTBI’s management is responsible for establishing and maintaining effective disclosure controls and procedures, as defined under Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934.  As of the end of the period covered by this report, an evaluation was carried out by CTBI’s management, with the participation of our Chief Executive Officer and the Executive Vice President, Chief Financial Officer, and Treasurer, of the effectiveness of the design and operation of our disclosure controls and procedures.  Based on this evaluation, management concluded that disclosure controls and procedures as of September 30, 2014 were effective in ensuring material information required to be disclosed in this quarterly report on Form 10-Q was recorded, processed, summarized, and reported on a timely basis.

CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING
 
There were no changes in CTBI’s internal control over financial reporting that occurred during the quarter ended September 30, 2014 that have materially affected, or are reasonably likely to materially affect, CTBI’s internal control over financial reporting.



 
 

 


PART II - OTHER INFORMATION

Item 1.
Legal Proceedings
None
     
Item 1A.
Risk Factors
None
     
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
None
     
Item 3.
Defaults Upon Senior Securities
None
     
Item 4.
Mine Safety Disclosure
Not applicable
     
Item 5.
Other Information:
 
 
CTBI’s Principal Executive Officer and Principal Financial Officer have furnished to the SEC the certifications with respect to this Form 10-Q that are required by Sections 302 and 906 of the Sarbanes-Oxley Act of 2002
 
     
Item 6.
a. Exhibits:
 
 
(1)   Certifications Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
Exhibit 31.1
Exhibit 31.2
 
(2)   Certifications Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
Exhibit 32.1
Exhibit 32.2
 
(3)  XBRL Instance Document
Exhibit 101.INS
 
(4)  XBRL Taxonomy Extension Schema
Exhibit 101.SCH
 
(5)  XBRL Taxonomy Extension Calculation Linkbase
Exhibit 101.CAL
 
(6)  XBRL Taxonomy Extension Definition Linkbase
Exhibit 101.DEF
 
(7)  XBRL Taxonomy Extension Label Linkbase
Exhibit 101.LAB
 
(8)  XBRL Taxonomy Extension Presentation Linkbase
Exhibit 101.PRE


 

 
 

 


SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, CTBI has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
  COMMUNITY TRUST BANCORP, INC.  
       
Date:  November 7, 2014
By:
/s/ Jean R. Hale  
    Jean R. Hale  
    Chairman, President, and Chief Executive Officer  
       
 
 
 
/s/ Kevin J. Stumbo  
    Kevin J. Stumbo  
   
Executive Vice President, Chief Financial Officer, and Treasurer