**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

**FORM 10-K**

**ANNUAL REPORT PURSUANT TO SECTION 13OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

**Forthe fiscal year ended December 31, 2004**

**CommissionFile Number:  0-18832**

**FIRST FINANCIAL SERVICE CORPORATION**

(Exact name of registrantas specified in its charter)

| **Kentucky**                                                     | **61-1168311**                        |
|------------------------------------------------------------------|---------------------------------------|
| (State or other  jurisdiction of  incorporation or organization) | (I.R.S. Employer  Identification No.) |
| **2323  Ring Road, Elizabethtown, Kentucky**                     | **42701**                             |
| (Address of principal  executive offices)                        | Zip Code                              |

 

**Registrant’s telephone number,including area code:** (270)765-2131

**Securities registered pursuant to Section 12(g) ofthe Act:**

**Common Stock, par value$1.00 per share**

(Title of Class)

Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past ninety days. Yes   x    No   o

Indicate by check mark whether the registrant is anaccelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes  x    No   o

Indicate by check mark if disclosure of delinquentfilers pursuant to Item 405 of Regulation S-K is not contained herein, and willnot be contained, to the best of registrant’s knowledge, in definitive proxy orinformation statements incorporated by reference in Part III of this Form 10-Kor any amendment to this Form 10-K. o

The aggregate market value of the outstanding votingstock held by non-affiliates of the registrant based on a December 31,2004 closing price of $25.67 as quoted on the NASDAQ National Market****was $74,050,095. Solely for purposes ofthis calculation, the shares held by directors and executive officers of theregistrant and by any stockholder beneficially owning more than 5% of theregistrant’s outstanding common stock are deemed to be shares held byaffiliates.

As of February 28, 2005 there were issued andoutstanding****3,648,188****shares of the registrant’s common stock.

**DOCUMENTSINCORPORATED BY REFERENCE**

1.      Portionsof the Registrant’s Definitive Proxy Statement for the 2005 Annual Meeting ofShareholders to be held May 11, 2005 are incorporated by reference into Part IIIof this Form 10-K

 

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**FIRST FINANCIALSERVICE CORPORATION2004 ANNUAL REPORT AND FORM 10-KTABLE OF CONTENTS**
|                | ** ** | ** **                                                                                  | ** ** | **Page** | ** ** |
|----------------|------------|---------------------------------------------------------------------------------------------|------------|----------|------------|
|           |       | **Part I.**                                                                            |       |     |       |
| Item 1.        |       | Business                                                                                    |       | 2        |       |
| Item 2.        |       | Properties                                                                                  | ** ** | 17       | ** ** |
| Item 3.        |       | Legal  Proceedings                                                                          |       | 17       |       |
| Item 4.        |       | Submission  of Matters to a Vote of Security Holders                                        |       | 17       |       |
| ** **     |       | **Part II.**                                                                           |       |     |       |
| Item 5.        |       | Market  for Registrant’s Common Stock and Related Stockholder Matters                  |       | 18       |       |
| Item 6.        |       | Selected  Financial Data                                                                    |       | 19       |       |
| Item 7.        |       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations |       | 20       |       |
| Item 7A.  |       | Quantitative  and Qualitative Disclosures about Market Risk                                 |       | 40       |       |
| Item 8.        |       | Financial  Statements and Supplementary Data                                                |       | 43       |       |
| Item 9.        |       | Changes  in and Disagreements with Accountants on Accounting and Financial Disclosures      |       | 77       |       |
| Item 9A.  |       | Controls  and Procedures                                                                    |       | 77       |       |
| Item 9B.  |       | Other  Information                                                                          |       | 77       |       |
| ** **     |       | **Part III.**                                                                          |       |     |       |
| Item 10.  |       | Directors  and Executive Officers of the Registrant                                         |       | 77       |       |
| Item 11.  |       | Executive  Compensation                                                                     |       | 77       |       |
| Item 12.       |       | Security  Ownership of Certain Beneficial Owners and Management                             |       | 78       |       |
| Item 13.  |       | Certain  Relationships and Related Transactions                                             |       | 78       |       |
| ** **     |       | **Part IV.**                                                                           |       |     |       |
| Item 14.  |       | Principal  Accountant Fees and Services                                                     |       | 78       |       |
| Item 15.  |       | Exhibits  and Financial Statement Schedules                                                 |       | 78       |       |
| Signatures     |       | 80                                                                                          |       |

 

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**CautionaryStatement Regarding Forward-Looking Statements**

Certain statements contained in this Annual Report on Form 10-K,which are not statements of historical fact, constitute forward-lookingstatements within the meaning of the Private Securities Litigation Reform Act(the Act), including, without limitation, the statements specificallyidentified as forward-looking statements within this document. In addition,certain statements in our future filings with the Securities and ExchangeCommission, in press releases or in oral and written statements made by or withour approval, which are not statements of historical fact, constituteforward-looking statements within the meaning of the Act. Examples offorward-looking statements include, but are not limited to: (i) projectionsof revenue, income or loss, earnings or loss per share, the payment ornonpayment of dividends, capital structure and other financial items, (ii) statementsof plans and objectives of ours or our management or board of directors, includingthose relating to products or services, (iii) statements of futureeconomic performance and (iv) statements “anticipates”, “expects”, “intends”,“plans”, “targets”, and similar expressions are intended to identifyforward-looking statements but are not the exclusive means of identifying suchstatements.

Forward-looking statements involve risks anduncertainties, which may cause actual results to differ materially from thosein such statements. In addition to the matters described under “Item 1. Business-RiskFactors,” factors that could cause actual results to differ from thosediscussed in the forward-looking statements include, but are not limited to: (i) thestrength of the U.S. economy in general and the strength of the local economiesin which we operate; (ii) the effects of and changes in trade, monetaryand fiscal policies and laws, including interest rate policies of the FederalReserve Board; (iii) inflation, interest rates, market and monetaryfluctuations; (iv) the timely development of and acceptance of newproducts and services and perceived overall value of these products andservices by users; (v) changes in consumer spending, borrowing, andsavings habits; (vi) technological changes; (vii) acquisitions; (viii) ourability to increase our market share and control expenses; (ix) the effectof changes in laws and regulations (including laws and regulations concerningtaxes, banking, and securities) with which we must comply; (x) the effectof changes in accounting policies and practices, as may be adopted by theregulatory agencies as well as the Financial Accounting Standards Board,(xi) changes in our organization, compensation, and benefits plans;(xii) the costs and effects of litigation and of unexpected or adverseoutcomes in such litigation; and (xiii) our success at managing risksinvolved in the foregoing.

Such forward-lookingstatements speak only as of the date on which such statements are made, and weundertake no obligation to update any forward-looking statement to reflectevents or circumstances after the date on which such statement is made toreflect the occurrence of unanticipated events.

**PART I**

**Item 1**.        Business

First Financial Service Corporation was incorporatedin August 1989 under the laws of the Commonwealth of Kentucky and becamethe holding company for First Federal Savings Bank of Elizabethtown, effectiveon June 1, 1990. Since that date, we have engaged in no significantactivity other than holding the stock of the Bank and directing, planning andcoordinating the business activities of the Bank. Unless the text clearlysuggests otherwise, references to “us,” “we,” or  “our” include First Financial ServiceCorporation and its wholly-owned subsidiary. Accordingly, the information setforth in this report, including financial statements and related data, relatesprimarily to the Bank and its subsidiaries.   In 2004 we amended our articles ofincorporation to change our name from First Federal Financial Corporation ofKentucky to First Financial Service Corporation.

We are headquartered in Elizabethtown, Kentucky. Wewere originally founded in 1923 as a state-chartered institution and becamefederally chartered in 1940. In 1987,we converted to a federally charteredsavings bank and converted from mutual to stock form. We are a member of theFHLB of Cincinnati and, 

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since converting to astate charter, are subject to regulation, examination and supervision by theFederal Deposit Insurance Corporation (“FDIC”) and Kentucky Office of FinancialInstitutions (“KOFI”). Our deposits are insured by the Savings AssociationInsurance Fund (“SAIF”) and administered by the FDIC.

On January 8, 2003,we converted to a Kentucky chartered commercial bank from a federally charteredsavings bank. In connection with the conversion, we changed to a fiscal yearending on December 31. This report covers the year ended December 31,2004.

**General BusinessOverview**

We serve the needs and cater to the economic strengthsof the local communities in which we operate and strive to provide a high levelof personal and professional customer service. We offer a variety of financialservices to our retail and commercial banking customers. These services includepersonal and corporate banking services and personal investment financialcounseling services.

Our full complementof lending services includes:

·        abroad array of residential mortgage products, both fixed and adjustable rate;

·        consumerloans, including home equity lines of credit, auto loans, recreational vehicle,and other secured and unsecured loans;

·        specializedfinancing programs to support community development;

·        mortgagesfor multi-family real estate;

·        commercialreal estate loans;

·        commercialloans to businesses, including revolving lines of credit and term loans;

·        realestate development;

·        constructionlending; and

·        agriculturallending.

We also provide abroad selection of deposit instruments. These include:

·        multiplechecking and NOW accounts for both personal and business accounts;

·        varioussavings accounts, including those for minors;

·        moneymarket accounts;

·        taxqualified deposit accounts such as Individual Retirement Accounts; and

·        abroad array of certificate of deposit products.

We also support ourcustomers by providing services such as:

·        functioningas a federal tax depository;

·        providingaccess to merchant bankcard services;

·        supplyingvarious forms of electronic funds transfer;

·        providingdebit cards and credit cards; and

·        providingtelephone and Internet banking.

Through****ourpersonal investment financial counseling services, we offer a wide variety ofmutual funds, equity investments, and fixed and variable annuities.

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We invest in the wholesale capital markets through themanagement of our security portfolio and use various forms of wholesalefunding. The security portfolio contains a variety of instruments, includingcallable debentures, taxable and non-taxable debentures, fixed and adjustablerate mortgage backed securities, and collateralized mortgage obligations.

Our results of operationsdepend primarily on net interest income, which is the difference betweeninterest income from interest-earning assets and interest expense oninterest-bearing liabilities. Our operations are also affected by non-interestincome, such as service charges, insurance agency revenue, loan fees, gains andlosses from the sale of mortgage loans and gains from the sale of real estateheld for development. Our principal operating expenses, aside from interestexpense, consist of compensation and employee benefits, occupancy costs, dataprocessing expense and provisions for loan losses.

**Market Area Served**

We conduct operations in 14 full-service bankingcenters in six contiguous counties in Central Kentucky along the Interstate 65corridor. Our market presence ranges from the major metropolitan market ofLouisville in Jefferson County, Kentucky approximately 40 miles north of ourheadquarters in Elizabethtown, Kentucky to Hart County, Kentucky, approximately30 miles south of Elizabethtown. Our market is supported by a diversifiedindustry base and consists of a regional population of over 1 million. Louisvilleis the 16th largest city in the United States. Our core markets haveexperienced a compound annual growth rate of 6% in deposits for the past fouryears. Management anticipates a similar growth rate of its markets for the nextfew years and believes it is well positioned to benefit from this continuedgrowth.

The counties we operate in include Hardin, Nelson,Hart, Bullitt, Meade and Jefferson. In aggregate, excluding Jefferson County,we control over 21% of the deposit market share with the next largestcompetitor controlling just 8% of the market. Over the past four years, thesecounties have demonstrated an average growth rate in deposits of 6%. Accordingto the most recent census data, our core markets have experienced a populationincrease of 2%, a 19% increase in the median home price, and a growth in medianfamily income****of 22% over the pastthree census reporting years.

We expanded our presenceinto the Louisville market, primarily through our commercial lending operations.At December 31, 2004, over 20% of our total loan portfolio resides in thismarket. In an effort to better serve these customers and to enhance our retailbranch network in this market, in early 2004 we opened two new full-servicestate of the art retail facilities in Louisville. These facilities representour state of the art prototype branch with a retail-focused design. This designfeatures an internet café with access to online banking and bill paymentservices. Large plasma screens decorate the lobby providing customers withcurrent news and information about bank products and services as well asupcoming community events. The facilities are staffed to offer a full range offinancial services to the growing retail and commercial customer base. Ourcurrent deposit market share in this market remains under 1% of the current $14billion deposit base. Based on our operating strategy, we believe we canincrease our presence in Louisville, as the primary market share is held by sixlarge out-of-state holding companies.

**General andOperating Strategies**

Our operating strategy is to serve the needs and caterto the economic strengths of the local communities in which we operate andstrive to provide a high level of personal and professional customer service. Weoffer a variety of financial services to our retail and commercial bankingcustomers.

Our growth strategy is focused on a combination ofacquisitions and expansion in our existing markets through internal growth aswell as establishing new branches.

*Acquisitions.  *Managementbelieves that the consolidation in the banking industries, along with theeasing of restrictions on bank branching, as well as increased regulatoryburdens, concerns about 

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technology and marketing,are likely to lead owners of community banks and agencies within the Bank’smarket areas to explore the possibility of sale or combination with abroader-based financial service companies such as ourselves.

In addition, branching opportunities have arisen fromtime to time as a result of divestiture of branches by large national andregional bank holding companies of certain overlapping branches resulting fromconsolidations. As a result, branch locations have become available for purchase.

Management’s strategy in assimilating acquisitions isto emphasize revenue growth as well as to continuously review the operations ofthe acquired entities and streamline operations where feasible. Management doesnot believe that implementing wholesale administrative cost reductions inacquired institutions, particularly reducing customer focused personnel, isbeneficial to our long-term growth, because significant administrative changesin community banks can have an adverse impact on customer satisfaction in theacquired institution’s community. However, management has determined thatcertain human resource, processing, and accounting functions can beconsolidated immediately upon acquisition to achieve higher productivity levelswithout compromising customer service. Increases in revenue growth areemphasized by offering customers a broader product line consistent with fullservice banking.

Management is very selective when evaluating apotential acquisition based upon factors such as the operating strategy,market, financial condition, and the culture of the acquisition candidate. Thelast acquisition we made was in July 1998 with the acquisition of threebank branches.

*Branch Expansion.  *Managementcontinues to consider markets for branch expansion. Because of the economicgrowth in our markets over the past several years, we may consider furtherbranch expansion in our current or surrounding market areas. However, we do notrule out branch expansion in other areas experiencing economic growth.

We opened two new full service banking centers inLouisville in early 2004. While no new banking centers are expected to open inLouisville during 2005, negotiating for future branch sites is on going. Negotiationscontinue on several locations, contingent upon successful rezoning efforts. Ourexpectation is to accomplish the rezoning and begin construction on at leastone facility by the end of the year.

During 2005, a major expansion of our Mt. Washingtonlocation in Bullitt County will be completed. We intend to start constructionon a new full service-banking center in Elizabethtown during 2005 with plans ofopening in early 2006. We are also considering other possible locations withinour core market area to protect and grow our 21% market share.

**Internal Growth.  **Managementbelieves that its largest source of internal growth is through our ongoingsolicitation program conducted by branch managers and lending officers,followed by referrals from customers. The primary reason for referrals ispositive customer feedback regarding our customer service and response time.

Our goal in continuing our expansion is to maintain aprofitable, customer-focused financial institution. We believe that ourexisting structure, management, data and operational systems are sufficient toachieve further internal growth in asset size, revenues and capital withoutproportionate increases in operating costs. This growth should also allow us toincrease the lending limits, thereby enabling us to increase our ability toserve the needs of existing and new customers. Our operating strategy hasalways been to provide high quality community banking services to our customersand increase market share through active solicitation of new business, repeatbusiness and referrals from customers, and continuation of selected promotionalstrategies.

For the most part,our banking customers seek a banking relationship with a service-orientedcommunity banking organization. Our operational systems have been designed tofacilitate personalized service. Management believes its banking locations havean atmosphere which facilitates personalized 

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servicesand decision-making, yet are of sufficient financial size with broad productlines to meet customers’ needs. We also believe that economic expansion in ourmarket areas will continue to contribute to internal growth. Through ourprimary emphasis on customer service and our management’s banking experience,we intend to continue internal growth by attracting customers and primarilyfocusing on the following:

·       *Products Offered*—We offer personal andcorporate banking services, mortgage origination, mortgage servicing, personalinvestment, and financial counseling services as well as internet and telephonebanking. We offer a full range of commercial banking services, checkingaccounts, ATM’s, checking accounts with interest, savings accounts, moneymarket accounts, certificates of deposit, NOW accounts, Individual RetirementAccounts, brokerage and residential mortgage services, branch banking, anddebit and credit cards. We also offer installment loans, including auto,recreational vehicle, and other secured and unsecured loans sourced directly byour branches. See “Lending Activities” below for a discussion of products weprovide to commercial accounts.

·       *Operational Efficiencies*—We seek tomaximize operational and support efficiencies consistent with maintaining highquality customer service. Where feasible, we share a common information systemdesigned to enhance customer service and improve efficiencies by providingsystem-wide voice and data communication connections. We have consolidated loanprocessing, bank balancing, financial reporting, investment management,information systems, payroll and benefit management, loan review, and audits.

·       *Marketing Activities*—We focus on a proactive solicitationprogram for new business, as well as identifying and developing products andservices that satisfy customer needs. We actively sponsor community eventswithin our branch areas. We believe that active community involvementcontributes to our long-term success.

**Lending Activities**

**Commercial Real Estate &Construction Lending**.   The largest portion of ourlending activity is the origination of commercial loans that are primarilysecured by real estate, including construction loans. These loans are generatedat banking centers primarily in our market area. In recent years, we have putgreater emphasis on small business lending, originating loans for small andmedium-sized businesses from our various locations.   We make commercial loans to a variety ofindustries. Substantially all of the commercial real estate loans originated byus have adjustable interest rates with maturities of 25 years or less or areloans with fixed interest rates and maturities of five years or less. At December 31,2004, we had $302.6 million outstanding in commercial real estate loans. Thesecurity for commercial real estate loans includes retail businesses,warehouses, churches, apartment buildings and motels. In addition, the paymentexperience of loans secured by income producing properties typically depends onthe success of the related real estate project and thus may be more vulnerableto adverse conditions in the real estate market or in the economy generally.

Loans secured by multi-family residential property,consisting of properties with more than four separate dwelling units amountedto $15.0 million of the loan portfolio at December 31, 2004. These loansare included in the $302.6 million outstanding in commercial real estate loansdiscussed above. We generally do not lend above 75% of the appraised values ofmulti-family residences on first mortgage loans. The mortgage loans wecurrently offer on multi-family dwellings are generally one or five year ARMswith maturities of 25 years or less.

Construction loans involve additional risks becauseloan funds are advanced upon the security of the project under construction,which is of uncertain value before the completion of construction. Theuncertainties inherent in estimating construction costs, delays arising fromlabor problems, material shortages, and other unpredictable contingencies, makeit relatively difficult to evaluate accurately the 

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total loan funds requiredto complete a project, and related loan-to-value ratios. The analysis of prospectiveconstruction loan projects requires significantly different expertise from thatrequired for permanent residential mortgage lending. At December 31, 2004we had $10.9 million outstanding in construction loans.

Our underwriting criteria are designed to evaluate andminimize the risks of each construction loan. Among other things, we considerevidence of the availability of permanent financing or a takeout commitment tothe borrower; the reputation of the borrower and his or her financialcondition; the amount of the borrower’s equity in the project; independentappraisals and cost estimates; pre-construction sale and leasing information;and cash flow projections of the borrower.

**Commercial Business Lending**.   Thecommercial business loan portfolio has grown in recent years as a result of ourfocus on small business lending. We make secured and unsecured loans forcommercial, corporate, business, and agricultural purposes, including issuingletters of credit and engaging in inventory financing and commercial leasingactivities.  Commercial loans generallyare made to small-to-medium size businesses located within our defined marketarea. Commercial loans generally carry a higher yield and are made for ashorter term than real estate loans. Commercial loans, however, involve ahigher degree of risk than residential real estate loans due to potentiallygreater volatility in the value of the assigned collateral, the need for moretechnical analysis of the borrower’s financial position, the potentiallygreater impact that changing economic conditions may have on the borrower’sability to retire debt, and the additional expertise required for commerciallending personnel.   Commercial businessloans outstanding at December 31, 2004 totaled $32.2 million.

**Residential Real Estate.  **Residentialmortgage loans are secured primarily by single-family homes. The majority ofour mortgage loan portfolio is secured by real estate in Hardin, Nelson, Hart,Meade, and Bullitt counties. Fixed rate residential real estate loans originatedhave terms ranging from ten to thirty years. Interest rates are competitivelypriced within the primary geographic lending market, and vary according to theterm for which they are fixed. At December 31, 2004 we had $159.0 millionin residential mortgage loans outstanding.

We generally emphasize the origination ofadjustable-rate mortgage loans (“ARMs”) when possible. We offer six ARMproducts with an annual adjustment, which is tied to a national index with amaximum adjustment of 2% annually, and a lifetime maximum adjustment cap of 6%.As of December 31, 2004, approximately 38.8% of our residential realestate loans were adjustable rate loans with adjustment periods ranging fromone to five years and balloon loans of seven years or less. The origination ofthese ARMs can be more difficult in a low interest rate environment where thereis a significant demand for fixed rate mortgages. We limit the maximumloan-to-value ratio on one-to-four-family residential first mortgages to 90% ofthe appraised value and generally limit the loan-to-value ratio on secondmortgages on one-to-four-family dwellings to 90%.

**Consumer Lending.  **Consumerloans include loans on automobiles, boats, recreational vehicles and otherconsumer goods, as well as loans secured by savings accounts, home improvementloans, and unsecured lines of credit. As of December 31, 2004, consumerloans outstanding were $100.9 million. These loans involve a higher risk ofdefault than loans secured by one-to-four-family residential loans. We believe,however, that the shorter term and the normally higher interest rates availableon various types of consumer loans help maintain a profitable spread betweenthe average loan yield and cost of funds. Home equity lines of credit as of December 31,2004, totaled $46.3 million.

Our underwriting standards reflect the greater risk inconsumer lending than in residential real estate lending. Among other things,the capacity of individual borrowers to repay can change rapidly, particularlyduring an economic downturn, collection costs can be relatively higher forsmaller loans, and the value of collateral may be more likely to depreciate. TheConsumer Lending Policy establishes the appropriate consumer lending authorityfor all loan officers based on experience, training, and past performance for 

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approving high qualityloans. Loans beyond individual authorities must be approved by additionalofficers, the Executive Loan Committee or the Board of Directors, based on thesize of the loan. We require detailed financial information and credit bureaureports for each consumer loan applicant to establish the applicant’s credithistory, the adequacy of income for debt retirement, and job stability based onthe applicant’s employment records. Co-signers are required for applicants whoare determined marginal or who fail to qualify individually under thesestandards. Adequate collateral is required on the majority of consumer loans.The Executive Loan Committee monitors and evaluates unsecured lending activityby each loan officer.

The indirect consumer loan portfolio is comprised ofnew and used automobile, motorcycle and all terrain vehicle loans originated onour behalf by a select group of auto dealers within the service area. Indirectconsumer loans are considered to have greater risk of loan losses than directconsumer loans due to, among other things: borrowers may have no existing relationship with us; borrowers may notbe residents of the lending area; less detailed financial statement informationmay be collected at application; collateral values can be more difficult todetermine; and the condition of vehicles securing the loan can deterioraterapidly. To address the additional risks associated with indirect consumerlending, the Executive Loan Committee continually evaluates data regarding thedealers enrolled in the program, including monitoring turn down and delinquencyrates. All applications are approved by specific lending officers, selectedbased on experience in this field, who obtain credit bureau reports on eachapplication to assist in the decision. Aggressive collection proceduresencourage more timely recovery of late payments. At December 31, 2004,total loans under the indirect consumer loan program totaled $30.8 million.

**SubsidiaryActivities**

In 1978, we formed First Service Corporation ofElizabethtown (“First Service”). First Service acts as a broker for the purposeof selling investment services to our customers in the area of tax-deferredannuities, government securities, mutual funds, and stocks and bonds. FirstService employs four full-time employees to perform these services. Thisinvestment function operates under licenses held by First Service. The netincome of First Service was $57,000 for the year ended December 31, 2004.

In July 1999, we formed First Heartland MortgageCompany of Elizabethtown (“First Heartland”) through which the secondary marketlending department originates qualified VA, KHC, RHC and conventional secondarymarket loans on the behalf of the investors, thereby providing necessaryliquidity to us and needed loan products to our customers. The loans are soldwith servicing released. During 2004, First Heartland originated $45.2 millionin loans on the behalf of investors. The net income of First Heartland Mortgagewas $153,000 for the year ended December 31, 2004.

In March 2003, we formed First Federal OfficePark, LLC, a direct result of the charter conversion. The subsidiary holdscommercial lots adjacent to our home office on Ring Road in Elizabethtown,which are available for sale. During the year ended December 31, 2004 lotsales resulted in a $391,000 gain. We have four lots held for sale remaining inthis subsidiary, of the initial nine lots held for sale.

In March 2003, weformed First Heartland Title, LLC, and in July 2004, we formed FirstFederal Title Services, LLC, through which we provide title insurance coveragefor mortgage borrowers. First Heartland Title is a joint venture with a localtitle insurance company and First Federal Title Services is a joint venturewith a title insurance company in Louisville. We hold a 48% interest in bothsubsidiaries. The subsidiaries generated $100,000 in net income for the yearended December 31, 2004 of which our portion was $48,000.

**Competition**

We face substantial competition both in attracting andretaining deposits and in lending. Direct competition for deposits comes fromcommercial banks, savings institutions, and credit unions located in 

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north-central Kentucky,and less directly from money market mutual funds and from sellers of corporateand government debt securities.

The primary competitive factors in lending areinterest rates and loan origination fees and the range of services offered bythe various financial institutions. Competition for origination of real estateloans normally comes from commercial banks, savings institutions, mortgagebankers, mortgage brokers, and insurance companies. Retail establishmentseffectively compete for loans by offering credit cards and retail installmentcontracts for the purchase of goods and merchandise. We believe that we havebeen able to compete effectively in our primary market area.

We have offices in nine cities in six Central Kentuckycounties. In addition to the financial institutions, with offices in thesecounties, we compete with several commercial banks and savings institutions insurrounding counties, many of which have assets substantially greater than wehave. These competitors attempt to gain market share through their financialproduct mix, pricing strategies, internet banking and banking center locations.In addition, Kentucky’s interstate banking statute, which permits banks in allstates to enter the Kentucky market if they have reciprocal interstate bankingstatutes, has further increased competition for us. We believe that competitionfrom both bank and non-bank entities will continue to remain strong in the nearfuture.

Thefollowing table sets forth our market share and rank in terms of deposits ineach Kentucky county where we have offices. We have two offices in JeffersonCounty, which is Louisville, Kentucky. The Louisville metropolitan area has apopulation of more than one million.
| **County** | ** ** | ** ** | ** ** | **Number of Offices** | ** ** | **FFKY Market Share %** | ** ** | **FFKY Rank** | ** ** |
|------------|------------|------------|------------|---------------------------------|------------|----------------------------------------|------------|--------------------|------------|
| Hardin     |       |       | 4          |                            |       |                                   | 21.0       |               |       |   | 1 |   |   |
| Nelson     |       |       | 2          |                            |       |                                   | 8.0        |               |       |   | 4 |   |   |
| Hart       |       |       | 1          |                            |       |                                   | 18.0       |               |       |   | 3 |   |   |
| Bullitt    |       |       | 2          |                            |       |                                   | 21.0       |               |       |   | 3 |   |   |
| Meade      |       |       | 3          |                            |       |                                   | 58.0       |               |       |   | 1 |   |   |
| Jefferson  |       |       | 2          |                            |       |                                   | <1.0    |               |       |   | N/M |   |   |

 

**Employees**

As of December 31,2004, we had 252 employees, of which 240 were full-time and 12 part-time. Noneof our employees are subject to a collective bargaining agreement, and webelieve that we enjoy good relations with our personnel.

**Regulation**

**General Regulatory Matters.  **OnJanuary 8, 2003, we converted from a federally chartered savings bank to aKentucky chartered commercial bank. Before the conversion, we were subject tothe regulation of the Office of Thrift Supervision. As a Kentucky charteredcommercial bank, we are now subject to supervision and regulation, whichinvolves regular bank examinations, by both the FDIC and the KOFI. Our depositsare insured by the FDIC. Kentucky’s banking statutes contain a “super-parity”provision that permits a well-rated Kentucky banking corporation to engage inany banking activity in which a national bank operating in any state; a statebank, thrift or savings bank operating in any other state; or a federalchartered thrift or federal savings association meeting the qualified thriftlender test and operating in any state could engage, provided it first obtainsa legal opinion specifying the statutory or regulatory provisions that permitthe activity.

In connection with the conversion, we registered tobecome a bank holding company under the Bank Holding Company Act of 1956, andare subject to supervision and regulation by the Board of Governors of theFederal Reserve System (the “Federal Reserve Board”). As a bank holdingcompany, we are required 

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to file with the FederalReserve Board annual and quarterly reports and other information regarding itsbusiness operations and the business operations of its subsidiaries. We arealso subject to examination by the Federal Reserve Board and to operationalguidelines established by the Federal Reserve Board. We are subject to the BankHolding Company Act and other federal laws on the types of activities in whichwe may engage, and to other supervisory requirements, including regulatoryenforcement actions for violations of laws and regulations.

**Acquisitions and Change in Control.  **Asa bank holding company, we must obtain Federal Reserve Board approval beforeacquiring, directly or indirectly, ownership or control of more than 5% of thevoting stock of a bank, and before engaging, or acquiring a company that is nota bank but is engaged in certain non-banking activities. In approving theseacquisitions, the Federal Reserve Board considers a number of factors, andweighs the expected benefits to the public such as greater convenience,increased competition and gains in efficiency, against the risks of possibleadverse effects such as undue concentration of resources, decreased or unfaircompetition, conflicts of interest or unsound banking practices. The FederalReserve Board also considers the financial and managerial resources of the bankholding company, its subsidiaries and any company to be acquired, and theeffect of the proposed transaction on these resources. It also evaluatescompliance by the holding company’s financial institution subsidiaries and thetarget institution with the Community Reinvestment Act. The CommunityReinvestment Act generally requires each financial institution to takeaffirmative action to ascertain and meet the credit needs of its entirecommunity, including low and moderate income neighborhoods.

Federal law also prohibits a person or group ofpersons from acquiring “control” of a bank holding company without notifyingthe Federal Reserve Board in advance, and then only if the Federal ReserveBoard does not object to the proposed transaction. The Federal Reserve Boardhas established a rebuttable presumptive standard that the acquisition of 10%or more of the voting stock of a bank holding company with a class ofsecurities registered under the Securities Exchange Act of 1934 wouldconstitute an acquisition of control of the bank holding company. In addition,any company is required to obtain the approval of the Federal Reserve Boardbefore acquiring 25% (5% in the case of an acquirer that is a bank holdingcompany) or more of any class of a bank holding company’s voting securities, orotherwise obtaining control or a “controlling influence” over a bank holdingcompany.

**The Gramm-Leach-Bliley Act.****  **TheGramm-Leach-Bliley Act of 1999 (the “GLB Act”), signed into law on November 12,1999, amended a number of Federal banking laws that affect the Corporation andFirst Federal. The provisions of the GLB Act believed to be of mostsignificance to us are discussed below. In particular, the GLB Act permits abank holding company to elect to become a financial holding company, whichpermits the holding company to conduct activities that are “financial innature.”  To become and maintain itsstatus as a financial holding company, the bank holding company and all of itsaffiliated depository institutions must be well-capitalized, well managed, andhave at least a satisfactory Community Reinvestment Act rating. We have notfiled an election to become a financial holding company.

**Other Holding Company Regulations.  **Federallaw substantially restricts transactions between financial institutions andtheir affiliates. As a result, a bank is limited in extending credit to itsholding company (or any non-bank subsidiary), in investing in the stock orother securities of the bank holding company or its non-bank subsidiaries,and/or in taking such stock or securities as collateral for loans to anyborrower. Moreover, transactions between a bank and a bank holding company (orany non-bank subsidiary) must generally be on terms and under circumstances atleast as favorable to the bank as those prevailing in comparable transactionswith independent third parties or, in the absence of comparable transactions,on terms and under circumstances that in good faith would be available tononaffiliated companies.

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Under Federal Reserve policy, a bank holding companyis expected to act as a source of financial strength to, and to commitresources to support, its bank subsidiaries. This support may be required attimes when, absent such a policy, the bank holding company may not be inclinedto provide it. In addition, any capital loans by the bank holding company toits bank subsidiaries are subordinate in right of payment to deposits and tocertain other indebtedness of the bank subsidiary. In the event of a bankholding company’s bankruptcy, any commitment by the bank holding company to afederal bank regulatory agency to maintain the capital of subsidiary banks willbe assumed by the bankruptcy trustee and entitled to a priority of payment.

**Capital Requirements.  **TheFederal Reserve Board and the FDIC have issued substantially similar risk-basedand leverage capital guidelines applicable to the banking organizations theysupervise. Under the risk-based capital requirements, we are generally requiredto maintain a minimum ratio of total capital to risk-weighted assets (includingcertain off-balance sheet activities, such as standby letters of credit) of 8%.At least half of the total capital must be composed of common equity, retainedearnings and qualifying perpetual preferred stock and certain hybrid capitalinstruments, less certain intangibles (“Tier 1 capital”). The remainder mayconsist of certain subordinated debt, certain hybrid capital instruments,qualifying preferred stock and a limited amount of the loan loss allowance (“Tier2 capital” which, together with Tier 1 capital, composes “total capital”). Tobe considered well-capitalized under the risk-based capital guidelines, aninstitution must maintain a total risk-weighted capital ratio of at least 10%and a Tier 1 risk-weighted ratio of 6% or greater. For further information, seeItem 7—Management Discussion and Analysis of Financial Condition and Results ofOperations-Capital.

The Federal Deposit Insurance Corporation Act of 1991(“FDICIA”), among other things, identifies five capital categories for insureddepository institutions: well-capitalized, adequately capitalized,undercapitalized, significantly undercapitalized and criticallyundercapitalized. The Corporation and First Federal are classified as “well-capitalized.”  FDICIA also requires the bank regulatoryagencies to implement systems for “prompt corrective action” for institutionsthat fail to meet minimum capital requirements within these five categories,with progressively more severe restrictions on operations, management andcapital distributions according to the category in which an institution isplaced. Failure to meet capital requirements can also cause an institution tobe directed to raise additional capital. FDICIA also mandates that the agenciesadopt safety and soundness standards relating generally to operations andmanagement, asset quality and executive compensation, and authorizesadministrative action against an institution that fails to meet such standards.

In addition, the Federal Reserve Board and the FDIChave each adopted risk-based capital standards that explicitly identifyconcentrations of credit risk and the risk arising from non-traditionalactivities, as well as an institution’s ability to manage these risks, asimportant factors to be taken into account by each agency in assessing aninstitution’s overall capital adequacy. The capital guidelines also providethat an institution’s exposure to a decline in the economic value of itscapital due to changes in interest rates be considered by the agency as afactor in evaluating a banking organization’s capital adequacy. The agenciesalso jointly adopted a regulation, effective January 1, 2002, amendingtheir regulatory capital standards to change the treatment of certain recourseobligations, direct credit subsidies, residual interest and other positions insecuritized transactions that expose banking organizations to credit risk. Theregulation amends the agencies’ regulatory capital standards to align moreclosely the risk-based capital treatment of recourse obligations and directcredit subsidies, to vary the capital requirements for positions in securitizedtransactions (and certain other credit exposures) according to their relativerisk, and to require capital commensurate with the risks associated withresidual interests.

In addition to the “prompt corrective action”directives, failure to meet capital guidelines can subject a bankingorganization to a variety of other enforcement remedies, including additionalsubstantial restrictions on its operations and activities, termination ofdeposit insurance by the FDIC, and under some conditions the appointment of aconservator or receiver.

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**Deposit Insurance.  **Ourdeposits are insured by the FDIC up to the statutory maximum limit of $100,000per depositor through the Savings Association Insurance Fund.  For this protection, we must pay semiannualassessments to the FDIC. The assessment rate for an insured depositoryinstitution depends on the assessment risk classification assigned to theinstitution by the FDIC, which will be determined by the institution’s capitallevel and supervisory evaluations.

**Dividends.  **TheCorporation is a legal entity separate and distinct from the Bank. The majorityof our revenue is from dividends paid to it by the Bank. The Bank is subject tolaws and regulations that limit the amount of dividends they can pay. If, inthe opinion of a federal regulatory agency, an institution under itsjurisdiction is engaged in or is about to engage in an unsafe or unsoundpractice, the agency may require, after notice and hearing, that theinstitution cease and desist from such practice. The federal banking agencieshave indicated that paying dividends that deplete an institution’s capital baseto an inadequate level would be an unsafe and unsound banking practice. UnderFDICIA, an insured institution may not pay any dividend if payment would cause itto become undercapitalized or if it already is undercapitalized. Moreover, theFederal Reserve and the FDIC have issued policy statements providing that bankholding companies and banks should generally pay dividends only out of currentoperating earnings.

Under Kentucky law, dividends by Kentucky banks may bepaid only from current or retained net profits. Before any dividend may bedeclared for any period (other than with respect to preferred stock), a bankmust increase its capital surplus by at least 10% of the net profits of thebank for the period until the bank’s capital surplus equals the amount of itsstated capital attributable to its common stock. Moreover, the KDFICommissioner must approve the declaration of dividends if the total dividends tobe declared by a bank for any calendar year would exceed the bank’s total netprofits for such year combined with its retained net profits for the precedingtwo years, less any required transfers to surplus or a fund for the retirementof preferred stock or debt. We are also subject to the Kentucky BusinessCorporation Act, which generally prohibits dividends to the extent they resultin the insolvency of the corporation from a balance sheet perspective or ifbecoming unable to pay debts as they come due.

**Consumer Protection Laws.**   Weare subject to a number of federal and state laws designed to protect borrowersand promote lending to various sectors of the economy and population. Theselaws include the Equal Credit Opportunity Act, the Fair Credit Reporting Act,the Truth in Lending Act, the Home Mortgage Disclosure Act, and the Real EstateSettlement Procedures Act, and state law counterparts.

Federal law currently contains extensive customerprivacy protections provisions. Under these provisions, a financial institutionmust provide to its customers, at the inception of the customer relationshipand annually thereafter, the institution’s policies and procedures regardingthe handling of customers’ nonpublic personal financial information. Theseprovisions also provide that, except for certain limited exceptions, aninstitution may not provide such personal information to unaffiliated thirdparties unless the institution discloses to the customer that such informationmay be so provided and the customer is given the opportunity to opt out of suchdisclosure. Federal law makes it a criminal offense, except in limitedcircumstances, to obtain or attempt to obtain customer information of afinancial nature by fraudulent or deceptive means.

The Community Reinvestment Act (“CRA”) requires theFDIC to assess our record in meeting the credit needs of the communities weserve, including low- and moderate-income neighborhoods and persons. The FDIC’sassessment of our record is made available to the public. The assessment alsois part of the Federal Reserve Board’s consideration of applications toacquire, merge or consolidate with another banking institution or its holdingcompany, to establish a new branch office or to relocate an office. The FederalReserve Board will also assess the CRA record of the subsidiary banks of a bankholding company 

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in connection with anapplication to acquire a bank or other bank holding company, and such recordsmay be the basis for denying the application.

**Bank Secrecy Act.  **The BankSecrecy Act of 1970 (“BSA”) was enacted to deter money laundering, establishregulatory reporting standards for currency transactions and improve detectionand investigation of criminal, tax and other regulatory violations. BSA andsubsequent laws and regulations require us to take steps to prevent the use ofthe Bank in the flow of illegal or illicit money, including, withoutlimitation, ensuring effective management oversight, establishing soundpolicies and procedures, developing effective monitoring and reportingcapabilities, ensuring adequate training and establishing a comprehensiveinternal audit of BSA compliance activities.

In recent years, federal regulators have increased theattention paid to compliance with the provisions of BSA and related laws, withparticular attention paid to “Know Your Customer” practices. Banks have beenencouraged by regulators to enhance their identification procedures prior toaccepting new customers in order to deter criminal elements from using thebanking system to move and hide illegal and illicit activities.

**USA Patriot Act.  **TheUSA PATRIOT Act of 2001 (the “Patriot Act”) contains anti-money launderingmeasures affecting insured depository institutions, broker-dealers and certainother financial institutions. The Patriot Act requires financial institutionsto implement policies and procedures to combat money laundering and thefinancing of terrorism, including standardsfor verifying customer identification at account opening, and rules topromote cooperation among financial institutions, regulators and lawenforcement entities in identifying parties that may be involved in terrorismor money laundering, and grants the Secretary of the Treasury broad authorityto establish regulations and to impose requirements and restrictions onfinancial institutions’ operations. In addition, the Patriot Act requires thefederal bank regulatory agencies to consider the effectiveness of a financialinstitution’s anti-money laundering activities when reviewing bank mergers andbank holding company acquisitions.

***Business Risk***

We, like other financial companies, are subject to anumber of risks, many of which are outside of management’s control, though westrive to manage those risks while optimizing returns. Among the risks assumedare: (a) credit risk, which is the risk that loan and lease customers orother counter parties will be unable to perform their contractual obligations, (b) marketrisk, which is the risk that changes in market rates and prices will adverselyaffect our financial condition or results of operation, (c) liquidityrisk, which is the risk that we will have insufficient cash or access to cashto meet our operating needs, and (d) operational risk, which is the riskof loss resulting from inadequate or failed internal processes, people, andsystems, or from external events.

In addition to the otherinformation included or incorporated by reference into this report, readersshould consider that the following important factors, among others, couldmaterially impact our business, future results of operations, and future cashflows.

**(a)   CreditRisk**

We extend credit to a variety of customers based oninternally set standards and the judgment of management. We manage the creditrisk it takes through a program of underwriting standards that we follow, thereview of certain credit decisions, and an on-going process of assessment ofthe quality of the credit we have already extended. There can be no assurancethat our credit standards and our on-going process of credit assessment willprotect us from significant credit losses.

Our loans and deposits arefocused in central Kentucky and adverse economic conditions in that state, inparticular, could negatively impact results from operations, cash flows, andfinancial condition. Adverse 

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economicconditions and other factors, such as political or business development ornatural hazards that may affect Kentucky, may reduce demand for credit orfee-based products and could negatively affect real estate and other collateralvalues, interest rate levels, and the availability of credit to refinance loansat or prior to maturity.

**(b)   MarketRisk**

Changes in interest rates could negatively impact ourfinancial condition or results of operations.

Our results of operations depend substantially on netinterest income, the difference between interest earned on interest-earningassets (such as investments and loans) and interest paid on interest-bearingliabilities (such as deposits and borrowings). Interest rates are highlysensitive to many factors, including governmental monetary policies anddomestic and international economic and political conditions. Conditions suchas inflation, recession, unemployment, money supply, and other factors beyondour control may also affect interest rates. If our interest-earning assetsmature or reprice more quickly than interest-bearing liabilities in a givenperiod, a decrease in market rates could adversely affect net interest income. Likewise,if interest-bearing liabilities mature or reprice more quickly thaninterest-earning assets in a given period, an increase in market rates couldadversely affect net interest income.

At December 31, 2004, our total loans were $605.9million. Of this total, 64% had adjustable interest rates or were within oneyear of maturity and 36% had fixed interest rates. Fixed-rate loans increaseour exposure to interest rate risk in a rising rate environment becauseinterest-bearing liabilities would be subject to repricing before assets becomesubject to repricing. Adjustable-rate loans decrease the risk associated withchanges in interest rates but involve other risks, such as the inability ofborrowers to make higher payments in an increasing interest rate environment. Atthe same time, for secured loans, the marketability of the underlyingcollateral may be adversely affected by higher interests rates. In a declininginterest rate environment, there may be an increase in prepayments on loans asthe borrowers refinance their loans at lower interest rates. Under thesecircumstances, our results of operations could be negatively impacted.

When evaluating short-term interest rate riskexposure, the primary measurement represents scenarios that model a 200 basispoint increasing (decreasing) parallel shift in rates over the nexttwelve-month period versus rates implied by the current yield curve. At the endof 2004, that scenario modeled net interest income to be approximately 6.2%lower than the internal forecast of net interest income using the baselinescenario if rates were to decrease 200 basis points in a parallel shift and4.5% higher than the internal forecast of net interest income using thebaseline scenario if rates were to increase 200 basis points in a parallelshift. This position is well within the board of directors’ 10.0% policy limitfor change in net interest income given a +/- 200 basis point change in rates.

Although fluctuations inmarket interest rates are neither completely predictable nor controllable, ourAsset Liability Committee meets periodically to monitor our interest ratesensitivity position and oversee its financial risk management by establishingpolicies and operating limits. For further discussion, see the “Asset/LiabilityManagement and Market Risk” section of Management’s Discussion and Analysis ofFinancial Condition and Results of Operations.

**(c)   LiquidityRisk**

If we are unable to borrow funds through access to thecapital markets, we may not be able to meet the cash flow requirements of ourdepositors and borrowers, or meet the operating cash needs of the Corporationto fund corporate expansion or other activities.

Liquidity policies and limits are established by theboard of directors, with operating limits set by the Asset Liability Committee(“ALCO”), based upon analyses of the ratio of loans to deposits, the percentage

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of assets funded with non-coreor wholesale funding. ALCO regularly monitors the overall liquidity position ofthe Bank and holding company to ensure that various alternative strategiesexist to cover unanticipated events that could affect liquidity. Liquidity isthe ability to meet cash flow needs on a timely basis at a reasonable cost. Theliquidity of the Bank is used to make loans and to repay deposit liabilities asthey become due or are demanded by customers. The ALCO establishes boardapproved policies and monitors guidelines to diversify our wholesale fundingsources to avoid concentrations in any one-market source. Wholesale funding sourcesinclude Federal funds purchased, securities sold under repurchase agreements,non-core brokered deposits, and medium and long-term debt, which includesFederal Home Loan Bank (FHLB) advances that are collateralized withmortgage-related assets.

We maintain a portfolio of securities that can be usedas a secondary source of liquidity. There are other sources of liquidity shouldthey be needed. These include the sale or securitization of loans, the abilityto acquire additional non-core brokered deposits, additional collateralizedborrowings such as FHLB advances, the issuance of debt securities, and theissuance of preferred or common securities in public or private transactions.

If we were unable toaccess any of these funding sources when needed, we might be unable to meet theneeds of our customers, which could adversely impact our financial condition,our results of operations, cash flows, and our level of regulatory-qualifyingcapital. For further discussion, see the “Liquidity” section of Management’sDiscussion and Analysis of Financial Condition and Results of Operations.

**(d)   OperationalRisk**

We have significant competition in both attracting andretaining deposits and in originating loans.

Competition is intense in most of the markets we serve.We compete on price and service with other banks and financial companies suchas savings and loans, credit unions, finance companies, mortgage bankingcompanies, and brokerage firms. Competition could intensify in the future as aresult of industry consolidation, the increasing availability of products andservices from non-banks, greater technological developments in the industry,and banking reform.

Management maintains internal operational controls andwe have invested in technology to help us process large volumes of transactions.However, there can be no assurance that we will be able to continue processingat the same or higher levels of transactions. If our systems of internalcontrols should fail to work as expected, if our systems were to be used in anunauthorized manner, or if employees were to subvert the system of internalcontrols, significant losses could occur.

We process large volumes of transactions on a dailybasis and are exposed to numerous types of operation risk. Operational riskresulting from inadequate or failed internal processes, people, and systemsincludes the risk of fraud by employees or persons outside of our company, theexecution of unauthorized transactions by employees, errors relating totransaction processing and systems, and breaches of the internal control systemand compliance requirements. This risk of loss also includes potential legalactions that could arise as a result of the operational deficiency or as aresult of noncompliance with applicable regulatory standards.

We establish and maintain systems of internaloperational controls that provide management with timely and accurateinformation about our level of operational risk. While not foolproof, thesesystems have been designed to manage operational risk at appropriate, costeffective levels. We have also established procedures that are designed toensure that policies relating to conduct, ethics, and business practices arefollowed. From time to time, we experience loss from operational risk,including the effects of operational errors.

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While management continually monitors and improves oursystem of internal controls, data processing systems, and corporate wideprocesses and procedures, there can be no assurance that we will not suffersuch losses in the future.

New, or changes in existing tax, accounting, areregulatory laws, regulations, rules, standards, policies, and interpretationscould significantly impact strategic initiatives, results of operations, cashflows, and financial condition.

The financial servicesindustry is extensively regulated. Federal and state banking regulations aredesigned primarily to protect deposit insurance funds and consumers, not tobenefit a financial company’s shareholders. These regulations may sometimesimpose significant limitations on operations. The significant federal and statebanking regulations that affect us are described in this report under theheading “Regulation”. These regulations, along with currently existing tax,accounting, and monetary laws, regulations, rules, standards, policies andinterpretations control the methods by which financial institutions conductbusiness, implement strategic initiatives and tax compliance, and governfinancial reporting and disclosures. These laws, regulations, rules, standards,policies, and interpretations are constantly evolving and may changesignificantly over time. Events that may not have a direct impact on us, suchas the bankruptcy of U.S. companies, have resulted in legislators, regulators,and authoritative bodies, such as the Financial Accounting Standards Board, theSecurities and Exchange Commission, the Public Company Accounting OversightBoard, and other various taxing authorities responding by adopting and orproposing substantive revisions to laws, regulations, rules, standards,policies, and interpretations. The nature, extent, and timing of the adoptionof significant new laws and regulations, or changes in or repeal of existinglaws and regulations may have a material impact on our business and results ofoperations. However, it is impossible to predict at this time, the extent towhich any such adoption, change, or repeal would impact us.

**AvailableInformation**

We file annual reports on Form 10-K,quarterly reports on Form 10-Q, current reports on Form 8-K,and amendments to those reports with the Securities and Exchange Commission. Thesereports are available at the SEC’s website at *http://www.sec.gov*.The reports are also available on our website at *http://www.ffsbky.com*.You may obtain electronic or paper copies of our reports free of charge bycontacting Rebecca Bowling, Corporate Secretary-Treasurer, First Federal Savings Bank, 2323 Ring Road,Elizabethtown, Kentucky 42701 (telephone) 270-765-2131.

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**Item 2**.                        Properties

Ourexecutive offices, principal support and operational functions are located at2323 Ring Road in Elizabethtown, Kentucky. All of our banking centers arelocated in Kentucky. The location of the 14 banking centers, whether owned orleased, and their respective approximate square footage is described in thefollowing table.
| Banking Centers            | ** ** | ** ** | ** ** | **Owned or  Leased** | ** ** | **Approximate  Square  Footage** | ** ** |
|---------------------------------|------------|------------|------------|---------------------------|------------|----------------------------------|------------|
| **ELIZABETHTOWN**               |       |       |       |                      |       |                             |       |
| 2323 Ring Road                  |       | Owned      |       |                      | 55,000     |                             |       |
| 325 West Dixie Avenue           |       | Owned      |       |                      | 5,880      |                             |       |
| 101 Wal-Mart Drive              |       | Leased     |       |                      | 984        |                             |       |
| **RADCLIFF**                    |       |       |       |                      |       |                             |       |
| 475 West Lincoln Trail          |       | Owned      |       |                      | 2,728      |                             |       |
| **BARDSTOWN**                   |       |       |       |                      |       |                             |       |
| 401 East John Rowan Blvd.       |       | Leased     |       |                      | 4,500      |                             |       |
| 315 North Third Street          |       | Owned      |       |                      | 1,271      |                             |       |
| **MUNFORDVILLE**                |       |       |       |                      |       |                             |       |
| 925 Main Street                 |       | Owned      |       |                      | 2,928      |                             |       |
| **SHEPHERDSVILLE**              |       |       |       |                      |       |                             |       |
| 395 N. Buckman Street           |       | Owned      |       |                      | 7,600      |                             |       |
| **MT. WASHINGTON**              |       |       |       |                      |       |                             |       |
| 279 Bardstown Road              |       | Owned      |       |                      | 2,500      |                             |       |
| **BRANDENBURG**                 |       |       |       |                      |       |                             |       |
| 416 East Broadway               |       | Leased     |       |                      | 4,395      |                             |       |
| 50 Old Mill Road                |       | Leased     |       |                      | 575        |                             |       |
| **FLAHERTY**                    |       |       |       |                      |       |                             |       |
| 4055 Flaherty Road              |       | Leased     |       |                      | 1,216      |                             |       |
| **LOUISVILLE**                  |       |       |       |                      |       |                             |       |
| 11810 Interchange Drive         |       | Owned      |       |                      | 4,170      |                             |       |
| 3650 South Hurstbourne  Parkway |       | Owned      |       |                      | 4,170      |                             |       |

 

**Item 3**.                        LegalProceedings

Although, from time totime, we are involved in various legal proceedings in the normal course ofbusiness, there are no material pending legal proceedings to which we are aparty, or to which any of our property is subject.

**Item 4**.                        Submissionof Matters to a Vote of Security Holders

No matters were submittedfor shareholder approval during the fourth quarter of 2004.

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**PART II**

**Item 5**.                        Marketfor the Registrant’s Common Equity and Related Stockholder Matters

(a)    MarketInformation

Our Common Stock is tradedon the NASDAQ National Market System (NASDAQ) under the symbol “FFKY”. Thefollowing table shows the high and low closing prices of our Common Stock andthe dividends paid.
| ** **     | ** ** | **Quarter Ended** | ** ** |
|----------------|------------|------------------------|------------|
| **2004:**      | ** ** | ** **             | ** ** | **3/31** | ** ** | **6/30** | ** ** | **9/30** | ** ** | **12/31** | ** ** |
| High           |       | $                      | 27.25      |   | $ | 26.50 |   | $ | 26.40 |   | $ | 25.90 |   |
| Low            |       | 24.85                  |       | 22.24 |   | 24.03 |   | 24.51 |   |
| Cash dividends |       | 0.18                   |       | 0.18 |   | 0.19 |   | 0.19 |   |
|                |            |                        |            |  |  |  |  |  |  |  |  |  |  |  |  |

 
| **2003:**         | ** ** | ** ** | ** ** | **3/31** | ** ** | **6/30** | ** ** | **9/30** | ** ** | **12/31** | ** ** |
|-------------------|------------|------------|------------|----------|------------|----------|------------|----------|------------|-----------|------------|
| High              |       | $          | 28.91      |     | $          | 35.95    |       | $        | 32.97      |      | $          | 31.74 |   |
| Low               |       | 22.25      |       | 27.37    |       | 29.60    |       | 24.62    |       |
| Cash dividends(1) |       | 0.16       |       | 0.18     |       | 0.18     |       | 0.18     |       |
|                   |            |            |            |          |            |          |            |          |            |           |            |  |  |  |  |

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(1)   Adjustedto reflect a 10% stock dividend declared April 16, 2003.

(b)   Holders

At February 28, 2005 the number of shareholderswas approximately 1,100.

(c)    Dividends

It is currently thepolicy of our Board of Directors to continue to pay quarterly dividends, butany future dividends are subject to the Board’s discretion based on itsconsideration of the our operating results, financial condition, capital,income tax considerations, regulatory restrictions and other factors.

(d)   Securities Authorized for Issuance Under EquityCompensation Plans
| **Plan category**                                      | ** ** | ** ** | ** **   | **Number of securities  to be issued  upon exercise of  outstanding options,  warrants and rights** | ** ** | **Weighted-average  exercise price of  outstanding options,  warrants and rights** | ** **   | **Number of securities  remaining available for  future issuance under  equity compensation plans  (excluding securities  reflected in column(1))** | ** ** |
|-------------------------------------------------------------|------------|------------|--------------|--------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------|--------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| Equity  compensation plans approved by security holders     |       |       | 123,470      |                                                                                                                                             |       |                                                                                                        | $            | 22.18                                                                                                                                                                                                      |       |   |   | 32,400 |   |   |
| Equity compensation plans not approved by security  holders |       |       | –– |                                                                                                                                             |       |                                                                                                        | –– |                                                                                                                                                                                                       |       |   | –– |   |   |
| Total                                                       |       |       | 123,470      |                                                                                                                                             |       |                                                                                                        | $            | 22.18                                                                                                                                                                                                      |       |   |   | 32,400 |   |   |

 

Of the options outstanding at December 31, 2004,1,100 were granted under a previous plan. See Note 11 of the Notes toConsolidated Financial Statements for additional information required by thisitem.

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**Item 6**.                        SelectedConsolidated Financial and Other Data
| ** **                              | ** ** | **At December 31,** | ** ** | **At June 30,** | ** ** |
|-----------------------------------------|------------|-------------------------------|------------|---------------------------|------------|
| **Financial Condition Data:** | ** ** | ** **                    | ** ** | **2004**                  | ** ** | **2003** | ** ** | **2002** | ** ** | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** |
| Total assets                            |       | $                             | 737,646    |                      | $          | 676,335 |   | $ | 670,728 |   | $ | 679,395 |   | $ | 606,726 |   | $ | 560,785 |   |
| Net loans  outstanding(1)               |       | 599,428                       |       | 550,153                   |       | 528,535 |   | 520,261 |   | 517,145 |   | 471,231 |   |
| Interest bearing  deposits              |       | ––                  |       | ––              |       | –– |   | 64,000 |   | –– |   | –– |   |
| Investments                             |       | 56,843                        |       | 34,938                    |       | 18,575 |   | 23,693 |   | 22,934 |   | 45,182 |   |
| Deposits                                |       | 586,386                       |       | 529,162                   |       | 521,121 |   | 529,882 |   | 468,825 |   | 423,759 |   |
| Borrowings                              |       | 88,904                        |       | 88,283                    |       | 87,683 |   | 87,778 |   | 77,298 |   | 80,339 |   |
| Stockholders’  equity              |       | 59,801                        |       | 56,321                    |       | 59,647 |   | 58,615 |   | 54,592 |   | 51,681 |   |
| Number of:                              |       |                          |       |                      |       |   |   |   |   |   |   |   |   |
| Real estate loans  outstanding          |       | 9,358                         |       | 8,028                     |       | 7,156 |   | 7,577 |   | 7,618 |   | 7,154 |   |
| Deposit accounts                        |       | 48,637                        |       | 48,443                    |       | 49,210 |   | 49,726 |   | 49,615 |   | 47,238 |   |
| Offices                                 |       | 14                            |       | 13                        |       | 13 |   | 13 |   | 13 |   | 13 |   |
| Full time  equivalent employees         |       | 246                           |       | 237                       |       | 219 |   | 209 |   | 192 |   | 170 |   |
|                                         |            |                               |            |                           |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 
| ** **                         | ** ** | **Year Ended  December 31,** | ** ** | **Six Months Ended  December 31,** | ** ** | **Year Ended June 30,** | ** ** |
|------------------------------------|------------|----------------------------------------|------------|---------------------------------------------------|------------|----------------------------------------|------------|
| ** **                         | ** ** | **2004**                               | ** ** | **2003**                                          | ** ** | **2002**                               | ** ** | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** |
| **Operations Data:**               | ** ** | ** **                             | ** ** | ** **                                        | ** ** |                                   | ** ** | ** ** |   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Interest income                    |       | $                                      | 39,143     |                                              | $          | 39,339                                 |       |   | $ | 21,556 | ** ** |   | $ | 44,100 |   | $ | 45,392 |   | $ | 38,542 |   |
| Interest expense                   |       | 14,792                                 |       | 16,365                                            |       |                                   | 9,394      | ** ** |   | 21,426 |   | 27,429 |   | 20,873 |   |
| Net interest  income               |       | 24,351                                 |       | 22,974                                            |       |                                   | 12,162     | ** ** |   | 22,674 |   | 17,963 |   | 17,669 |   |
| Provision for  loan losses         |       | 1,656                                  |       | 1,656                                             |       |                                   | 1,161      | ** ** |   | 1,604 |   | 1,086 |   | 400 |   |
| Non-interest  income               |       | 8,104                                  |       | 7,981                                             |       |                                   | 3,177      | ** ** |   | 5,398 |   | 5,145 |   | 3,877 |   |
| Non-interest  expense              |       | 19,274                                 |       | 17,292                                            |       |                                   | 7,597      | ** ** |   | 15,281 |   | 13,570 |   | 12,691 |   |
| Income tax  expense                |       | 3,735                                  |       | 4,004                                             |       |                                   | 2,199      | ** ** |   | 3,729 |   | 2,803 |   | 2,792 |   |
| Net income                         |       | 7,790                                  |       | 8,003                                             |       |                                   | 4,382      | ** ** |   | 7,458 |   | 5,649 |   | 5,663 |   |
| Earnings per share:(2)             |       |                                   |       |                                              |       |                                   |       | ** ** |   |   |   |   |   |   |   |
| Basic                              |       | $                                      | 2.13       |                                              | $          | 2.12                                   |       |   | $ | 1.09 | ** ** |   | $ | 1.81 |   | $ | 1.37 |   | $ | 1.32 |   |
| Diluted                            |       | 2.12                                   |       | 2.10                                              |       |                                   | 1.08       | ** ** |   | 1.80 |   | 1.36 |   | 1.31 |   |
| Book value per share(2)            |       | 16.40                                  |       | 15.20                                             |       |                                   | 14.88      | ** ** |   | 14.29 |   | 13.21 |   | 12.51 |   |
| Dividends paid  per share(2)       |       | 0.74                                   |       | 0.70                                              |       |                                   | 0.33       | ** ** |   | 0.65 |   | 0.65 |   | 0.65 |   |
| Dividend payout  ratio             |       | 35                                     | %          | 33                                                | %          |                                   | 30         | % |   | 36 | % | 48 | % | 49 | % |
| Return on average  assets          |       | 1.12                                   | %          | 1.18                                              | %          |                                   | 1.31       | % |   | 1.19 | % | 0.95 | % | 1.08 | % |
| Average equity to  average  assets |       | 8.28                                   | %          | 8.26                                              | %          |                                   | 8.77       | % |   | 9.10 | % | 8.97 | % | 10.28 | % |
| Return on average  equity          |       | 13.47                                  | %          | 14.32                                             | %          |                                   | 14.89      | % |   | 13.08 | % | 10.62 | % | 10.52 | % |
| Efficiency ratio                   |       | 59                                     | %          | 56                                                | %          |                                   | 50         | % |   | 54 | % | 59 | % | 59 | % |

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(1)   Includesloans held for sale.

(2)   Amountsadjusted to reflect a 10% stock dividend declared April 16, 2003.

19

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**Item 7**.                        ManagementDiscussion and Analysis of Financial Condition and Results of Operations

Management’s Discussionand Analysis of Financial Condition and Results of Operations analyzes themajor elements of our balance sheets and statements of income. This sectionshould be read in conjunction with the Company’s Consolidated FinancialStatements and accompanying Notes and other detailed information.

**OVERVIEW**

We conduct operations in 14 full-service bankingcenters in six contiguous counties in Kentucky along the Interstate 65 corridor.Our market presence ranges from the major metropolitan market of Louisville inJefferson County, Kentucky approximately 40 miles north of our headquarters inElizabethtown, Kentucky to Hart County, Kentucky, approximately 30 miles southof Elizabethtown. Our core markets have experienced a compound annual growthrate of 6% in deposits for the past four years. We anticipate a similar growthrate of our markets for the next few years and believe we are well positionedto benefit from this continued growth.

During the year, we opened two new full-servicefacilities in the growing Louisville market and redesigned one of our existingHardin County facilities. We anticipate the redesign of our Mt. Washingtonfacility in Bullitt County to be completed in the first quarter of 2005. Weintend to start construction on a new full service-banking center inElizabethtown during 2005 with plans of opening in early 2006. These facilitiesrepresent our state of the art prototype branch with a retail-focused design. Thisdesign features an internet café with access to online banking and bill paymentservices. Large plasma screens decorate the lobby providing customers withcurrent news and information about bank products and services as well as upcomingcommunity events. The facilities are staffed to offer a full range of financialservices to the growing retail and commercial customer base. We believe thesefacilities will allow us to more effectively support our lending relationshipsin Louisville and to develop a larger presence within that market in the future.While we fully anticipate these facilities to significantly enhance the valueof our franchise in the near future, the additional expense in operating thesenew facilities will continue to place pressure on earnings for a period of time.We are optimistic that our expansion strategy for Louisville will minimize thisperiod and the long-term benefits will outweigh the initial investment.

We are focused onexpanding our leadership role in our markets emphasizing both the retail andcommercial lines of business. In addition to expanding our leadership position,we are also focused on maintaining a high level of profitability. We identifiedseveral key factors to support these initiatives including:

·       Emphasizecommercial lending

·       Expandour retail base in our current branches as well as in growing markets withinour region

·       Sustainour excellent credit quality

·       Grownon-interest income

·       Maintainan operationally efficient organization.

We have increased ourreturn on equity from 10.5% in 2000, to 13.5% in 2004. The increase in returnon equity was accompanied by a compound annual growth rate of 10% in dilutedearning per share over the same period of time. While management believesopportunities for improvement exist, it attributes much of the improvement inreturn on equity to our ability to implement the elements of our strategicinitiative.

20

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*Emphasizecommercial lending:*

Our emphasis on commerciallending continued to produce positive results generating a $72 million, or 27%increase in commercial loans to $346 million at December 31, 2004,compared to $272 million at December 31, 2003. This favorable trend hasresulted in a 36% annual compound growth rate over the past four years. The percentageof commercial loans in our portfolio has increased from 49% at December 31,2003, to 57% at December 31, 2004 while residential loans declined from35% at December 31, 2003, to 26% at December 31, 2004. The portfoliomix also changed significantly during 2003 as commercial loans grew from 35% to49% of the total loan portfolio. We intend to continue this commercial lendingemphasis and anticipate continued increases in the commercial and commercialreal estate portfolios.

*Expand our retailbase in our current branches as well as in growing markets within our region:*

In January 2003, weimplemented an effort to develop a bank-wide service and sales cultureemphasizing expanded account relationships. To achieve this goal, we increasedthe number of associates in banking centers, relationship bankers, businessdevelopment officers, stockbrokers, and loan officers with experience incommercial lending. The results of this effort as well as our transition from afederally chartered thrift to a state-chartered commercial bank in January 2003,have contributed to our growth. The resulting increase in staff along with theexpansion into the Metro Louisville market have contributed to a $849,000, or9% increase in employee compensation expense for the year ended December 31,2004, compared to the year ended December 31, 2003. We expect a continuedincrease in employee compensation expense in the 2005 calendar year as wecontinue our expansion into our current markets.

*Maintain anoperationally efficient organization:*

Despite the increase in employee compensation expensefor 2004, we still maintained an efficiency ratio of 59% for the year ended December 31,2004, an increase from 56% in 2003, but comparable to 60% in 2000.

The following discussionand analysis covers the primary factors affecting our performance and financialcondition. It should be read in conjunction with the accompanying auditedconsolidated financial statements included in this report.

**APPLICATION OFCRITICAL ACCOUNTING POLICIES**

Our accounting andreporting policies comply with accounting principles generally accepted in theUnited States of America and conform to general practices within the bankingindustry. The accounting policy relating to the allowance for loan losses iscritical to the understanding of our results of operations since theapplication of this policy requires significant management assumptions andestimates that could result in materially different amounts to be reported ifconditions or underlying circumstances were to change.

**Allowancefor Loan Losses**—We maintain an allowance sufficient to absorbprobable incurred credit losses existing in the loan portfolio and theExecutive Loan Committee evaluates the adequacy of the allowance for loanlosses on a quarterly basis. We estimate the allowance required using past loanloss experience, known and inherent risks in the portfolio, adverse situationsthat may affect the borrower’s ability to repay, estimated value of theunderlying collateral, and current economic conditions. While we estimate theallowance for loan losses, in part, based on historical losses within each loancategory, estimates for losses within the commercial real estate portfolio aremore dependent upon credit analysis and recent payment performance. Allocation ofthe allowance may be made for specific loans or loan categories, but the entireallowance is available for any loan that, in management’s judgment, should becharged off.

21

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The allowance consists ofspecific and general components. The specific component relates to loans that areindividually classified as impaired or loans otherwise classified assubstandard or doubtful. The general component covers non-classified loans andis based on historical loss experience adjusted for current factors. Themethodology for allocating the allowance for loan and lease losses takes intoaccount our strategic plan to increase our emphasis on commercial and consumerlending. We increase the amount of the allowance allocated to commercial loansand consumer loans in response to the growth of the commercial and consumerloan portfolios and management’s recognition of the higher risks and loanlosses in these lending areas. Allowance estimates are developed inconsultation with regulatory authorities and actual loss experience adjustedfor current economic conditions. Allowance estimates are considered a prudentmeasurement of the risk in the loan portfolio and are applied to individualloans based on loan type.

Based on ourcalculation, an allowance of $6.5 million or 1.0% of total loans was theestimate of losses within the loan portfolio as of December 31, 2004. Thisestimate resulted in a provision for loan losses on the income statement of$1.7 million during 2004. If the mix and amount of future charge off percentagesdiffer significantly from those assumptions used by management in making itsdetermination, the allowance for loan losses and provision for loan losses onthe income statement could be materially affected.

**RESULTS OFOPERATIONS**

Net income for the period ended December 31, 2004was $7.8 million or $2.12 per share diluted compared to $8.0 million or $2.10per share diluted for the same period in 2003. The increase in diluted earningsper share was due to a stock repurchase of 60,000 shares of our own commonstock, which decreased to capital by $1.6 million. The decrease in earnings wasprimarily the result of an increase in non-interest expense of $2.0 million forthe 2004 period compared to 2003, the direct result of our expansion efforts. Ourbook value per common share increased from $15.20 at December 31, 2003 to$16.40 at December 31, 2004. Net income for 2004 generated a return onaverage assets of 1.12% and a return on average equity of 13.47%. These comparewith a return on average assets of 1.18% and a return on average equity of14.32% for the 2003 period.

We reported net income of $8.0 million during the yearended December 31, 2003 compared with $8.1 million for the 2002 period. Dilutedearnings per share increased 6% from $1.98 during 2002 to $2.10 for 2003. Earningsremained relatively constant for the comparative periods. Favorable increasesin non-interest income generated from the gain on sale of mortgage loans,service charges on deposit accounts, and two lots held for sale were offset bya decline in net interest income as well as an increase in non-interest expense.Our book value per common share increased from $14.88 at December 31, 2002to $15.20 at December 31, 2003. Net income for 2003 generated return onaverage assets of 1.18% and return on average equity of 14.32%. These comparewith return on average assets of 1.24% and return on average equity of 13.87%for the 2002 period.

We reported net income of $4.4 million during the sixmonths ended December 31, 2002 compared with $3.7 million for the sameperiod ended 2001, an increase of 17%. Diluted earnings per share increased 20%from $.90 during 2001 to $1.08 for 2002. The increase in earnings for 2002 wasprimarily attributable to increased net interest income, and an absence of goodwillamortization, service charges on deposit accounts and gain on sale of mortgageloans. Our book value per common share increased from $13.77 at December 31,2001 to $14.88 at December 31, 2002. Net income for the six months ended December 31,2002 generated a return on average assets of 1.31% and a return on averageequity of 14.89%. These compare with a return on average assets of 1.23% and areturn on average equity of 13.35% for the 2001 period.

22

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***Net Interest Income***—Theprincipal source of our revenue is net interest income. Net interest income isthe difference between interest income on interest-earning assets, such asloans and securities and the interest expense on liabilities used to fund thoseassets, such as interest-bearing deposits and borrowings. Net interest incomeis impacted by both changes in the amount and composition of interest-earningassets and interest-bearing liabilities as well as market interest rates.

Net interest margin as a percent of average earningassets increased by 15 basis points to 3.76% for the year ended December 31,2004 compared to 3.61% for the 2003 period. Net interest margin continued tobenefit from a decrease in interest expense on deposits as well as the increasein the yield on our variable rate commercial loans.****Our cost of funds averaged 2.45% during 2004, a decrease of36 basis points from the 2003 average cost of funds of 2.81%. The improvementwas the result of the continued re-pricing of certificate of depositmaturities rolling off at higher rates into current lower interest rates, aswell as the continued decrease in certificate of deposit balances as apercentage of total deposits. Going forward, our cost of funds is expected toincrease as the general market deposit rates have become increasingly competitivewith the recent upward trend in interest rates.

The yield on earning assets was 6.04% for the 2004period, a decrease from 6.18% for the 2003 period. The decrease in the yield onearning assets was primarily the result of a decrease in mortgage loans ascustomers refinanced their mortgage loans elsewhere, or the loans were sold tothe secondary market. We were successful in increasing the balance ofcommercial loans over that same time frame. In addition to changing the mix ofassets in the loan portfolio, the shift also increased the percentage ofvariable rate loans in the portfolio, which will increase the yield in anincreasing interest rate environment. We increased our prime lending rate 125basis points since the Federal Open Market Committee began increasingshort-term interest rates in June 2004. Management expects its yield onloans to improve with additional increases in the prime-lending rate.

The net result of the above factors has resulted in anincrease in net interest income of $1.4 million for the year ended December 31,2004 compared to the year ended in 2003. *(Foradditional analysis on the effect of increasing and decreasing interest rateson the Corporation’s net interest margin, see the interest rate sensitivitymodel under “ Asset/Liability Management and Market Risk.”)*

Net interest income for the year ended December 31,2003 declined to $23.0 million compared to $23.8 million for the 2002 perioddue to a narrowing net interest margin. Our net interest margin declined from3.84% for 2002 to 3.61% for 2003. The net interest rate spread decreased from3.53% during 2002 to 3.37% in 2003. The net interest margin declined due to areduction in short-term market interest rates by the Federal Reserve, whichoccurred in January 2003. Customer deposit interest rates did not adjustdownward as quickly to offset declining interest yields on loans andinvestments. Additionally, lower interest rates encouraged a large volume ofresidential refinancing in favor of the secondary market loans, reducing ourresidential mortgage loan portfolio**.**Duringthe 2003 period, residential mortgage loans held in our portfolio decreased by$75.7 million as a majority of the new and refinanced residential mortgage loanoriginations were sold during 2003. The substitution of commercial andcommercial real estate loans for residential mortgage loans has resulted in adeclining yield on our loan portfolio.

For the six months ended December 31,2002, net interest income was $12.2 million, up $1.2 million from the $11.0million attained during the comparable period of 2001. We were able to increasenet interest income through growth in our interest-earning assets and declinesin the cost of interest-bearing liabilities. Net interest margin remainedsteady at 3.82% for the six months ended December 31, 2002 as compared to3.83% for the 2001 six month period. The net interest rate spread increasedfrom 3.45% during 2001 or 3.52% in 2002. The net interest spread and marginbenefited from a significant decline in our cost of funds due to a reduction onshort-term market interest rates by the Federal Reserve, which occurredprincipally during calendar 2001. Our cost of funds averaged 3.25% during 2002,a decrease of 115 basis points from the 2001 average cost of funds of 4.40% comparedto a decrease of 108 basis points 

23

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oninterest earning assets from 7.85% to 6.77%. The 2002 period includessubordinated debt, which was issued in March 2002. Although substantiallyall categories of interest income and interest expense declined during 2002,interest rates payable on deposit products generally declined more than rateson interest-bearing assets. During the 2002 period, average interest-earningassets were $637.3 million, an increase of $62.8 million over the same periodin 2001. Total average interest bearing liabilities increased from $523.8million during 2001 or $578.7 million for the same period in 2002.

**AVERAGE BALANCESHEETS**

Thefollowing table sets forth information relating to the Bank’s average balancesheet and reflects the average yield on assets and average cost of liabilitiesfor the periods indicated. Dividing income or expense by the average monthlybalance of assets or liabilities, respectively, derives such yields and costsfor the periods presented.
| ** **                                                                        | ** ** | **Year Ended December 31,** | ** ** |
|-----------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                        | ** ** | **2004**                                   | ** ** | **2003** | ** ** |
| ** **                                                                        | ** ** | **Average**                                | ** ** | ** ** | ** ** | **Average** | ** ** | **Average** | ** ** | ** ** | ** ** | **Average** | ** ** |
| ** **                                                                        | ** ** | **Balance**                                | ** ** | **Interest** | ** ** | **Yield/Cost** | ** ** | **Balance** | ** ** | **Interest** | ** ** | **Yield/Cost** | ** ** |
| ** **                                                                        | ** ** | **(Dollars in thousands)**       | ** ** |
| **ASSETS**                                                                        |       |                                       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest earning assets:                                                          |       |                                       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Equity securities                                                                 |       | $                                          | 3,215      |   | $ | 124 |   |   | 3.86 | % |   | $ | 2,073 |   | $ | 79 |   |   | 3.81 | % |   |
| State and political  subdivision securities(1)                                    |       | 1,058                                      |       | 67 |   |   | 6.33 | % |   | 1,083 |   | 67 |   |   | 6.19 | % |   |
| U.S. Treasury and agencies                                                        |       | 26,761                                     |       | 728 |   |   | 2.72 | % |   | 12,766 |   | 367 |   |   | 2.87 | % |   |
| Corporate bond                                                                    |       | 2,000                                      |       | 66 |   |   | 3.30 | % |   | 2,000 |   | 64 |   |   | 3.20 | % |   |
| Mortgage-backed securities                                                        |       | 9,343                                      |       | 352 |   |   | 3.77 | % |   | 6,976 |   | 269 |   |   | 3.86 | % |   |
| Loans receivable(2)(3)(4)                                                         |       | 583,020                                    |       | 37,364 |   |   | 6.41 | % |   | 531,750 |   | 37,413 |   |   | 7.04 | % |   |
| FHLB stock                                                                        |       | 6,671                                      |       | 275 |   |   | 4.12 | % |   | 6,421 |   | 257 |   |   | 4.00 | % |   |
| Interest bearing deposits                                                         |       | 16,635                                     |       | 189 |   |   | 1.14 | % |   | 73,555 |   | 845 |   |   | 1.15 | % |   |
| **Total interest earning  assets**                                                |       | 648,703                                    |       | 39,165 |   |   | 6.04 | % |   | 636,624 |   | 39,361 |   |   | 6.18 | % |   |
| Less: Allowance for loan losses                                                   |       | (5,890                                     | )          |   |   |   |   |   |   | (5,006 | ) |   |   |   |   |   |   |
| Non-interest earning assets                                                       |       | 55,760                                     |       |   |   |   |   |   |   | 45,075 |   |   |   |   |   |   |   |
| **Total assets**                                                                  |       | $                                          | 698,573    |   |   |   |   |   |   |   | $ | 676,693 |   |   |   |   |   |   |   |
| **LIABILITIES AND STOCKHOLDERS’  EQUITY**                                    |       |                                       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest bearing liabilities:                                                     |       |                                       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Savings accounts                                                                  |       | $                                          | 84,089     |   | $ | 783 |   |   | 0.93 | % |   | $ | 77,905 |   | $ | 799 |   |   | 1.03 | % |   |
| NOW and money market  accounts                                                    |       | 135,265                                    |       | 1,156 |   |   | 0.85 | % |   | 115,785 |   | 959 |   |   | 0.83 | % |   |
| Certificates of deposit and  other time deposits                                  |       | 291,486                                    |       | 8,539 |   |   | 2.93 | % |   | 301,730 |   | 10,366 |   |   | 3.44 | % |   |
| Federal funds purchased                                                           |       | 3,424                                      |       | 47 |   |   | 1.37 | % |   | –– |   | –– |   |   | –– |   |   |
| FHLB Advances                                                                     |       | 78,543                                     |       | 3,738 |   |   | 4.76 | % |   | 77,726 |   | 3,738 |   |   | 4.81 | % |   |
| Subordinated debentures                                                           |       | 10,000                                     |       | 529 |   |   | 5.29 | % |   | 10,000 |   | 503 |   |   | 5.03 | % |   |
| **Total interest bearing  liabilities**                                           |       | 602,807                                    |       | 14,792 |   |   | 2.45 | % |   | 583,146 |   | 16,365 |   |   | 2.81 | % |   |
| Non-interest bearing  liabilities:                                                |       |                                       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Non-interest bearing  deposits                                                    |       | 34,925                                     |       |   |   |   |   |   |   | 34,075 |   |   |   |   |   |   |   |
| Other liabilities                                                                 |       | 3,014                                      |       |   |   |   |   |   |   | 3,594 |   |   |   |   |   |   |   |
| **Total liabilities**                                                             |       | 640,746                                    |       |   |   |   |   |   |   | 620,815 |   |   |   |   |   |   |   |
| Stockholders’ equity                                                         |       | 57,827                                     |       |   |   |   |   |   |   | 55,878 |   |   |   |   |   |   |   |
| **Total liabilities and  stockholders’ equity**                              |       | $                                          | 698,573    |   |   |   |   |   |   |   | $ | 676,693 |   |   |   |   |   |   |   |
| **Net interest income**                                                           |       |                                       |       | $ | 24,373 |   |   |   |   |   |   |   | $ | 22,996 |   |   |   |   |   |
| **Net interest spread**                                                           |       |                                       |       |   |   |   | 3.58 | % |   |   |   |   |   |   | 3.37 | % |   |
| **Net interest margin**                                                           |       |                                       |       |   |   |   | 3.76 | % |   |   |   |   |   |   | 3.61 | % |   |
| Ratio  of average interest earning assets to average interest bearing liabilities |       |                                       |       |   |   |   | 107.61 | % |   |   |   |   |   |   | 109.17 | % |   |

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(1)**  **Taxableequivalent yields are calculated assuming a 34% federal income tax rate.

24

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(2)          Includes loan fees,immaterial in amount, in both interest income and the calculation of yield onloans.

(3)          Calculationsinclude non-accruing loans in the average loan amounts outstanding.

(4)          Includesloans held for sale.
| ** **                                                                        | ** ** | **Six Months Ended  December 31, 2002** | ** ** | **Year Ended  June 30, 2002** | ** ** |
|-----------------------------------------------------------------------------------|------------|-------------------------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                                                        | ** ** | **Average**                                                 | ** ** | ** **                                   | ** ** | **Average** | ** ** | **Average** | ** ** | ** ** | ** ** | **Average** | ** ** |
| ** **                                                                        | ** ** | **Balance**                                                 | ** ** | **Interest**                                 | ** ** | **Yield/Cost** | ** ** | **Balance** | ** ** | **Interest** | ** ** | **Yield/Cost** | ** ** |
| ** **                                                                        | ** ** | **(Dollars in thousands)**                        | ** ** |
| **ASSETS**                                                                        |       |                                                        |       |                                         |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest earning assets:                                                          |       |                                                        |       |                                         |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Equity securities                                                                 |       | $                                                           | 908        |                                         | $          | 16 |   |   | 3.52 | % |   | $ | 952 |   | $ | 34 |   |   | 3.57 | % |   |
| State and political subdivision securities(1)                                     |       | 1,071                                                       |       | 33                                           |       |   | 6.16 | % |   | 1,022 |   | 71 |   |   | 6.95 | % |   |
| U.S. Treasury and agencies                                                        |       | 16,266                                                      |       | 293                                          |       |   | 3.60 | % |   | 10,741 |   | 589 |   |   | 5.48 | % |   |
| Corporate bond                                                                    |       | 2,000                                                       |       | 39                                           |       |   | 3.90 | % |   | –– |   | –– |   |   | –– |   |   |
| Mortgage-backed securities                                                        |       | 649                                                         |       | 16                                           |       |   | 4.93 | % |   | 854 |   | 54 |   |   | 6.32 | % |   |
| Loans receivable(2)(3)(4)                                                         |       | 525,574                                                     |       | 20,346                                       |       |   | 7.74 | % |   | 523,559 |   | 42,045 |   |   | 8.03 | % |   |
| FHLB stock                                                                        |       | 6,222                                                       |       | 145                                          |       |   | 4.66 | % |   | 5,995 |   | 325 |   |   | 5.42 | % |   |
| Interest bearing deposits                                                         |       | 84,568                                                      |       | 679                                          |       |   | 1.61 | % |   | 50,260 |   | 1,006 |   |   | 2.00 | % |   |
| **Total interest earning assets**                                                 |       | 637,258                                                     |       | 21,567                                       |       |   | 6.77 | % |   | 593,383 |   | 44,124 |   |   | 7.44 | % |   |
| Less: Allowance for loan losses                                                   |       | (4,192                                                      | )          |                                         |       |   |   |   |   | (3,273 | ) |   |   |   |   |   |   |
| Non-interest earning assets                                                       |       | 38,370                                                      |       |                                         |       |   |   |   |   | 36,371 |   |   |   |   |   |   |   |
| **Total assets**                                                                  |       | $                                                           | 671,436    |                                         |       |   |   |   |   |   | $ | 626,481 |   |   |   |   |   |   |   |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                    |       |                                                        |       |                                         |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest bearing  liabilities:                                                    |       |                                                        |       |                                         |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Savings accounts                                                                  |       | $                                                           | 76,026     |                                         | $          | 551 |   |   | 1.45 | % |   | $ | 54,165 |   | $ | 1,190 |   |   | 2.20 | % |   |
| NOW and money market accounts                                                     |       | 111,789                                                     |       | 815                                          |       |   | 1.46 | % |   | 97,339 |   | 1,764 |   |   | 1.81 | % |   |
| Certificates of deposit and other time deposits                                   |       | 303,412                                                     |       | 5,878                                        |       |   | 3.87 | % |   | 308,747 |   | 14,559 |   |   | 4.72 | % |   |
| FHLB Advances                                                                     |       | 77,736                                                      |       | 1,888                                        |       |   | 4.86 | % |   | 77,709 |   | 3,741 |   |   | 4.81 | % |   |
| Subordinated debentures                                                           |       | 10,000                                                      |       | 262                                          |       |   | 5.24 | % |   | 2,987 |   | 172 |   |   | 5.76 | % |   |
| **Total interest bearing liabilities**                                            |       | 578,963                                                     |       | 9,394                                        |       |   | 3.25 | % |   | 540,947 |   | 21,426 |   |   | 3.96 | % |   |
| Non-interest  bearing liabilities:                                                |       |                                                        |       |                                         |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Non-interest bearing deposits                                                     |       | 29,669                                                      |       |                                         |       |   |   |   |   | 22,996 |   |   |   |   |   |   |   |
| Other liabilities                                                                 |       | 3,962                                                       |       |                                         |       |   |   |   |   | 5,531 |   |   |   |   |   |   |   |
| **Total liabilities**                                                             |       | 612,594                                                     |       |                                         |       |   |   |   |   | 569,474 |   |   |   |   |   |   |   |
| Stockholders’ equity                                                         |       | 58,842                                                      |       |                                         |       |   |   |   |   | 57,007 |   |   |   |   |   |   |   |
| **Total liabilities stockholders’ equity**                                   |       | $                                                           | 671,436    |                                         |       |   |   |   |   |   | $ | 626,481 |   |   |   |   |   |   |   |
| **Net interest income**                                                           |       |                                                        |       | $                                            | 12,173     |   |   |   |   |   |   |   | $ | 22,698 |   |   |   |   |   |
| **Net interest spread**                                                           |       |                                                        |       |                                         |       |   | 3.52 | % |   |   |   |   |   |   | 3.48 | % |   |
| **Net interest margin**                                                           |       |                                                        |       |                                         |       |   | 3.82 | % |   |   |   |   |   |   | 3.83 | % |   |
| Ratio of average  interest earning assets to average interest bearing liabilities |       |                                                        |       |                                         |       |   | 110.07 | % |   |   |   |   |   |   | 109.69 | % |   |

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(1)**         **Taxable equivalentyields are calculated assuming a 34% federal income tax rate.

(2)**         **Includes loan fees, immaterial in amount,in both interest income and the calculation of yield on loans.

(3)**         **Calculations include non-accruing loansin the average loan amounts outstanding.

(4)**         **Includes loans held for sale.

25

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**RATE/VOLUMEANALYSIS**

The table below sets forthcertain information regarding changes in interest income and interest expenseof the Bank for the periods indicated. For each category of interest-earningassets and interest-bearing liabilities, information is provided on changesattributable to (1) changes in rate (changes in rate multiplied by oldvolume); (2) changes in volume (change in volume multiplied by old rate);and (3) changes in rate-volume (change in rate multiplied by change involume). Changes in rate-volume are proportionately allocated between rate andvolume variance.
| ** **                                           | ** ** | **Year Ended**                  | ** ** | **Year Ended**                 | ** ** |
|------------------------------------------------------|------------|--------------------------------------|------------|-------------------------------------|------------|
| ** **                                           | ** ** | **December 31,**                | ** ** | **December 31,**               | ** ** |
| ** **                                           | ** ** | **2004 vs. 2003**          | ** ** | **2003 vs. 2002**         | ** ** |
| ** **                                           | ** ** | **Increase (decrease)**         | ** ** | **Increase (decrease)**        | ** ** |
| ** **                                           | ** ** | **Due to change in**  | ** ** | **Due to change in** | ** ** |
| ** **                                           | ** ** | ** **                           | ** ** | ** **                          | ** ** | **Net** | ** ** | ** ** | ** ** | ** ** | ** ** | **Net** | ** ** |
| ** **                                           | ** ** | **Rate**                             | ** ** | **Volume**                          | ** ** | **Change** | ** ** | **Rate** | ** ** | **Volume** | ** ** | **Change** | ** ** |
| ** **                                           | ** ** | **(Dollars in thousands)** | ** ** |
| **Interest income:**                                 |       |                                 |       |                                |       |   |   |   |   |   |   |   |   |   |   |
| Equity securities                                    |       | $                                    | 1          |                                | $          | 44 |   | $ | 45 |   | $ | 2 |   |   | $ | 44 |   |   | $ | 46 |   |
| State and political subdivision securities           |       | 2                                    |       | (2                                  | )          | –– |   | (4 | ) |   | 2 |   |   | (2 | ) |
| U.S. Treasury and agencies                           |       | (22                                  | )          | 383                                 |       | 361 |   | (175 | ) |   | (21 | ) |   | (196 | ) |
| Corporate bond                                       |       | 2                                    |       | ––                        |       | 2 |   | 30 |   |   | — |   |   | 30 |   |
| Mortgage-backed securities                           |       | (6                                   | )          | 89                                  |       | 83 |   | (13 | ) |   | 244 |   |   | 231 |   |
| Loans                                                |       | (3,489                               | )          | 3,440                               |       | (49 | ) | (4,065 | ) |   | 642 |   |   | (3,423 | ) |
| FHLB stock                                           |       | 8                                    |       | 10                                  |       | 18 |   | (39 | ) |   | 12 |   |   | (27 | ) |
| Interest bearing deposits                            |       | (9                                   | )          | (647                                | )          | (656 | ) | (412 | ) |   | (32 | ) |   | (444 | ) |
| **Total interest earning assets**                    |       | (3,513                               | )          | 3,317                               |       | (196 | ) | (4,676 | ) |   | 891 |   |   | (3,785 | ) |
| **Interest  expense:**                               |       |                                 |       |                                |       |   |   |   |   |   |   |   |   |   |   |
| Savings accounts                                     |       | (77                                  | )          | 61                                  |       | (16 | ) | (609 | ) |   | 108 |   |   | (501 | ) |
| NOW and money market accounts                   |       | 31                                   |       | 166                                 |       | 197 |   | (732 | ) |   | 110 |   |   | (622 | ) |
| Certificates of deposit and other time deposits |       | (1,485                               | )          | (342                                | )          | (1,827 | ) | (1,870 | ) |   | 10 |   |   | (1,860 | ) |
| Federal funds purchased                              |       | ––                         |       | 47                                  |       | 47 |   | –– |   |   | –– |   |   | –– |   |
| FHLB advances                                        |       | (39                                  | )          | 39                                  |       | –– |   | (10 | ) |   | 2 |   |   | (8 | ) |
| Trust Preferred Securities                           |       | 26                                   |       | ––                        |       | 26 |   | (51 | ) |   | 120 |   |   | 69 |   |
| **Total interest bearing liabilities**               |       | (1,544                               | )          | (29                                 | )          | (1,573 | ) | (3,272 | ) |   | 350 |   |   | (2,922 | ) |
| **Net  change in net interest income**               |       | $                                    | (1,969     | )                                   | $          | 3,346 |   | $ | 1,377 |   | $ | (1,404 | ) |   | $ | 541 |   |   | $ | (863 | ) |

*** ***

***Non-Interest Income***—Non-interestincome was $8.1 million for the year ended December 31, 2004, as comparedto $8.0 million for the 2003 period. The increased level of non-interest incomeduring 2004 was primarily due to an increase in customer service fees ondeposit accounts, gain on sale of investments, gain on sale of real estate heldfor development and other income due to our investment in bank owned lifeinsurance. Offsetting these increases was a decrease in the gain on sale ofmortgage loans for 2004, resulting from a decline in refinancing activity. For2005, we anticipate the gain from the sales of investments and the gain on saleof real estate held for development to decrease from the 2004 period. Duringthe fourth quarter of 2004 we made the decision to outsource our trustoperations. Included in other income for the 2004 and 2003 periods is incomefrom trust operations of $128,000 and $125,000 respectively. This source ofnon-interest income will largely be eliminated with our decision to outsource 

26

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our trust operations. Inconjunction, we estimate trust expenses of approximately $200,000 will beeliminated from salary and benefit expense.

Customer service fees on deposit accounts increased$357,000 due to growth in customer deposits, and an increase in overdraft feeincome on retail checking accounts. We continue to increase our customer basethrough cross-selling opportunities and marketing initiatives and promotions. Gainon sale of real estate held for development increased $89,000, primarily fromproperties held for development through our subsidiary First Federal OfficePark. We also reportedgains from investment sales of $202,000 for the 2004 period. Othernon-interest income increased primarily due to income received from ourinvestment in bank owned life insurance. Bank owned life insurance incomeincreased $186,000. Offsetting these increases was a decrease in gain on saleof mortgage loans of $702,000 resulting from a decline in refinancing activityof 1-4 family loans, which we sell into the secondary market through oursubsidiary, First Heartland Mortgage Company.

Non-interest income was $8.0 million for the yearended December 31, 2003, as compared to $5.9 million for the 2002 period,an increase of $2.1 million or 35%. The increased level of non-interest incomeduring 2003 was primarily due to increased gains on sale of mortgage loans,growth in fees and services charges resulting from a higher volume of retailand commercial transactions and the sale of two lots held for investment duringthe December 31, 2003 quarter. Offsetting these increases were decreasesin brokerage and insurance commissions.

Customer service fees on deposit accounts increased by$562,000 or 14% during 2003 due to growth in customer deposits, overdraft feeincome on retail checking accounts and the sale of fee based products. Gain onsale of mortgage loans increased by $749,000 to $1.6 million for 2003 comparedto 2002. The increase in gain on sale of mortgage loans was the result of anincrease in consumer refinance activity of 1-4 family fixed-rateresidential loans, which we sell into the secondary market through oursubsidiary, First Heartland Mortgage Company. Income from brokerage commissionsand insurance sales decreased $153,000 as a result of a decline in demand forthese products. All other non-interest income increased by $891,000 during 2003compared to 2002, attributable to a wide variety of customer service feesresulting from the growth in loans and deposits, the sale of two lotspreviously held for sale and the creation of First Heartland Title, LLC, asubsidiary of the Bank that provides title insurance coverage for mortgageborrowers. The subsidiary is a joint venture with a local title insurancecompany in which the Bank holds a 48% interest. The new LLC generated $120,000in income for the year ended December 31, 2003.

Non-interest income was $3.2 million for the sixmonths ended December 31, 2002, compared to $2.6 million for the 2001period. The increased level of non-interest income during 2002 was primarilydue to increased service fees on deposit accounts and to a lesser extent, gainon sale of mortgage loans. Offsetting these increases were slight decreases inbrokerage and insurance commissions and other income.

Customer service fees on deposit accounts increased by$711,000 or 50% during 2002 due to growth in overdraft fee income on retailchecking accounts. Gain on sale of mortgage loans increased by $164,000 or 46%for 2002 compared to 2001 as declining market interest rates continued anincrease in consumer refinance activity of 1-4 family fixed-rateresidential loans, which we sell into the secondary market. Income frombrokerage commissions and insurance sales decreased $46,000 as a result of adecline in demand for these products. Other income decreased during the 2002period by $294,000 due to increases in customer fees waived and increasedlosses on repossessed assets attributed to the indirect dealer loan program.

***Non-InterestExpense***—Non-interest expense increased $2.0million or 11% to $19.3 million for the year ended December 31, 2004compared to 2003. The primary factors impacting non-interest expense includeadditional operating and employee compensation expenses relating to the recentretail expansion efforts. Employee compensation and benefits, the largestcomponent of non-interest expense, increased $849,000****or 9% for 2004. Twenty retail staff positions have been addedsince the third quarter a year ago 

27

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for the expansion inLouisville coupled with an expanded facility in Hardin County, Kentucky. Additionalincreases in staff have taken place throughout the year as we strengthen ourretail sales culture and provide expanded products and services to our retailand commercial customers. The increase in compensation was also attributable toan increase in our self-funded health insurance program due to an increase inthe amount of health insurance claims.

Our efficiency ratio was 59% at December 31, 2004compared to 56% for 2003. The two full service branch openings havesignificantly contributed to higher operating costs including a $299,000increase in office occupancy and equipment expense, additional postage forpromotions and direct mailings for marketing, along with increasedcommunications, and supplies expense. Bank franchise tax expense increased$199,000 year to date due to a higher tax expense accrual resulting from theconversion from a federally chartered thrift to a Kentucky state-charteredcommercial bank. The state tax expense for a bank charter is calculated basedupon different rules resulting in an increase for 2004.

We anticipate the increased level of non-interestexpense to continue into 2005 with continued retail expansion and market shareprotection efforts. We anticipate a major expansion of our Mt. Washington, KYlocation will be completed during 2005. We intend to start construction on anew full service-banking center in Elizabethtown, KY during 2005 with plans ofopening in early 2006. We are also considering other possible locations withinthe core market area to protect and grow our 21% market share.

Non-interest expense increased by $1.7 million or 11%to $17.3 million for the year ended December 31, 2003 compared to 2002. Themost significant factors impacting non-interest expense for the period includean increase in staffing levels and employee benefits expense, and a change inaccounting rules that discontinued amortization of goodwill fromacquisitions. Our efficiency ratios were 56% and 52% for the years ended December 31,2003 and 2002. Employee compensation and benefits increased $1.6 million or 21%for 2003. The increase in employee compensation reflects higher incentivebonuses due to certain corporate performance objectives being met, coupled withgrowth in the overall staffing level from 219 full-time equivalent employees atDecember 31, 2002 to 237 full-time equivalent employees at December 30,2003. As a result of adopting new accounting standards on July 1, 2002, weceased annual amortization of $832,000 on remaining goodwill assets of $8.4million. Accordingly, no amortization expense was recognized for the year endedDecember 31, 2003 or the six months ended December 31, 2002. The newstandards require annual impairment testing for goodwill with impairment beingrecorded if the carrying amount of goodwill exceeds its implied fair value. Thesetests have not resulted in any impairments. All other non-interest expensesincreased $468,000 to $7.8 million during the 2003 period compared to 2002.

Non-interest expenseincreased by $316,000 or 4% during the six-month period ended December 31,2002 compared to the same period in 2001. Factors impacting non-interestexpense included an increase in staffing levels and a change in accounting rules inwhich goodwill amortization expense from acquisitions is no longer recorded. Ourefficiency ratio improved to 50% in 2002 compared to 53% in 2001. Employeecompensation and benefits increased $542,000 or 16% for 2002. The increasereflects growth in the overall staffing level from 201 full-time equivalentemployees at December 31, 2001 to 219 at December 31, 2002. Ourcontinued emphasis on building our commercial and retail staff to reflect ourcommercial philosophy was the largest contributing factor. Goodwillamortization expense reported for the six months ended December 21, 2001was $416,000 compared to zero for the six months ended December 31, 2002.

**ANALYSIS OFFINANCIAL CONDITION**

Total assets at December 31, 2004 increased to$737.6 million compared to $676.3 million at December 31, 2003, anincrease of $61.3 million. The increase was primarily related to an increase ininvestment securities of $21.9 million and an increase in net loans receivableof $49.3 million. The growth 

28

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in investment securitiesand loans was principally funded with cash and cash equivalents, whichdecreased by $12.1 million, and deposits, which increased by $57.2 million.

Total assets at December 31,2003 increased to $676.3 million compared to $670.7 million at December 31,2002. The available-for-sale and held-to-maturity investment portfoliosincreased during the 2003 period due to investments in equity securities andtwo mortgage-backed securities with fixed rate terms of five and seven years. Also,during the 2003 period, we invested $7.0 million in bank owned life insurance. Netloans receivable increased $21.6 million from December 31, 2002 to $550.2million at December 31, 2003.

**Loans Receivable**

Net loans receivable increased $49.3 million or 9% to$599.4 million at December 31, 2004 compared to $550.2 million at December 31,2003. Our commercial, commercial real estate, and real estate constructionportfolios increased $73.4 million, a 27% increase in these loans to****$345.6 million at December 31, 2004. Forthe 2004 period, these loans comprised 57% of the total loan portfolio comparedto****49% of the loan portfolio at December 31,2003, and 34% of the loan portfolio at December 31, 2002. Also,contributing to the increase was a $7.9 million increase in consumer loans.Offsetting this growth was a $31.4 million, or 16% decrease in the residentialmortgage loan portfolio to $159.0 million at December 31, 2004, comparedto $190.9 million****at December 31,2003. The decrease was due to an increase in customer refinancing activity intofixed-rate, secondary market loan products. For 2005, the decline in mortgageloans is expected to slow from the decreases experienced in 2003 and early 2004.The growth in commercial loans is expected to continue in line with recenttrends.

Residential mortgage loans decreased by $72.9 millionduring the 2003 period as declining market interest rates caused an increase in1-4 family refinancing activity into fixed-rate, secondary market loanproducts. Our emphasis on commercial lending continued to produce positiveresults generating a****$91 million,or 50% increase in commercial loans to $272.2 million at December 31,2003, compared to $182 million at December 31, 2002. Our dealer loanprogram increased $7.7 million to $28.3 million at December 31, 2003.

**LoanPortfolio Composition.  **The following table presents asummary of the loan portfolio, net of deferred loan fees, by type. There are noforeign loans in our portfolio and other than the categories noted; there is noconcentration of loans in any industry exceeding 10% of total loans.
| ** **                | ** ** | **December 31,**                | ** ** | **June 30,** | ** ** |
|---------------------------|------------|--------------------------------------|------------|-------------------|------------|
| ** **                | ** ** | **2004**                             | ** ** | **2003**          | ** ** | **2002** | ** ** | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** |
| ** **                | ** ** | **Amount**                           | ** ** | **%**             | ** ** | **Amount** | ** ** | **%** | ** ** | **Amount** | ** ** | **%** | ** ** | **Amount** | ** ** | **%** | ** ** | **Amount** | ** ** | **%** | ** ** | **Amount** | ** ** | **%** | ** ** |
| ** **                | ** ** | **(Dollars in thousands)** | ** ** |
| Type of Loan:             |       |                                 |       |              |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Real Estate:              |       |                                 |       |              |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Residential               |       | $158,966                             |       | 26.23             | %          | $190,088 |   | 34.21 | % | $262,990 |   | 49.34 | % | $291,668 |   | 55.66 | % | $320,860 |   | 61.70 | % | $308,507 |   | 65.16 | % |
| Construction              |       | 10,850                               |       | 1.79              |       | 9,952 |   | 1.79 |   | 12,857 |   | 2.41 |   | 10,805 |   | 2.06 |   | 9,205 |   | 1.77 |   | 8,975 |   | 1.89 |   |
| Commercial                |       | 302,567                              |       | 49.94             |       | 230,964 |   | 41.56 |   | 133,328 |   | 25.01 |   | 111,502 |   | 21.28 |   | 84,378 |   | 16.22 |   | 64,088 |   | 13.53 |   |
| Consumer and home  equity |       | 70,141                               |       | 11.58             |       | 64,759 |   | 11.65 |   | 67,398 |   | 12.64 |   | 67,882 |   | 12.95 |   | 66,492 |   | 12.79 |   | 59,692 |   | 12.61 |   |
| Indirect consumer         |       | 30,798                               |       | 5.08              |       | 28,279 |   | 5.09 |   | 20,594 |   | 3.86 |   | 19,640 |   | 3.75 |   | 21,822 |   | 4.20 |   | 15,186 |   | 3.21 |   |
| Commercial, other         |       | 31,376                               |       | 5.18              |       | 30,658 |   | 5.52 |   | 32,268 |   | 6.05 |   | 20,988 |   | 4.01 |   | 16,662 |   | 3.20 |   | 16,295 |   | 3.44 |   |
| Loans held for sale       |       | 1,219                                |       | 0.20              |       | 1,021 |   | 0.18 |   | 3,676 |   | 0.69 |   | 1,511 |   | 0.29 |   | 632 |   | 0.12 |   | 740 |   | 0.16 |   |
| Total loans               |       | $605,917                             |       | 100.00            | %          | $555,721 |   | 100.00 | % | $533,111 |   | 100.00 | % | $523,996 |   | 100.00 | % | $520,051 |   | 100.00 | % | $473,483 |   | 100.00 | % |

 

29

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**LoanMaturity Schedule.  **The following table sets forthinformation at December 31, 2004, regarding the dollar amount of loans,net of deferred loan fees, maturing in the loan portfolio based on theircontractual terms to maturity.
| ** **                                   | ** ** | ** **                           | ** **                           | **Due after**          | ** ** | ** **                | ** **     | ** ** | ** ** |
|----------------------------------------------|------------|--------------------------------------|--------------------------------------|-----------------------------|------------|---------------------------|----------------|------------|------------|
| ** **                                   | ** ** | **Due during**                  | ** **                           | **1 through**          | ** ** | **Due after 5** | ** **     | ** ** | ** ** |
| ** **                                   | ** ** | **the year ended**         | ** **                           | **5 years after** | ** ** | **years after**      | ** **     | ** ** | ** ** |
| ** **                                   | ** ** | **December 31,**                | ** **                           | **December 31,**       | ** ** | **December 31,**     | ** **     | **Total**  | ** ** |
| ** **                                   | ** ** | **2005**                             | ** **                           | **2004**                    | ** ** | **2004**                  | ** **     | **Loans**  | ** ** |
| ** **                                   | ** ** | **(Dollars in thousands)** | ** **                           |
| Residential  mortgage                        |       |                                 | $   4,189   |                        |       |                      | $ 26,162  |       |       |   | $ 128,615 |   |   | $ 158,966 |   |
| Real estate  construction                    |       |                                 | 9,298                                |                        |       |                      | 1,258          |       |       |   | 294 |   |   | 10,850 |   |
| Real estate  commercial                      |       |                                 | 80,455                               |                        |       |                      | 181,441        |       |       |   | 40,671 |   |   | 302,567 |   |
| Consumer, home  equity and indirect consumer |       |                                 | 6,816                                |                        |       |                      | 58,292         |       |       |   | 35,831 |   |   | 100,939 |   |
| Commercial, other                            |       |                                 | 10,079                               |                        |       |                      | 19,376         |       |       |   | 1,921 |   |   | 31,376 |   |
| Loans held for sale                          |       |                                 | 1,219                           |                        |       |                      | —         |       |       |   | — |   |   | 1,219 |   |
| Total                                        |       |                                 | $ 112,056                       |                        |       |                      | $ 286,529 |       |       |   | $ 207,332 |   |   | $ 605,917 |   |

 

Thefollowing table breaks down loans maturing after one year, by fixed andadjustable rates.
| ** **                                   | ** ** | ** **                                   | ** **     | **Floating or**      | ** ** | ** ** | ** **     |
|----------------------------------------------|------------|----------------------------------------------|----------------|---------------------------|------------|------------|----------------|
| ** **                                   | ** ** | **  Fixed Rates  ** | ** **     | **Adjustable Rates** | ** ** | **Total**  | ** **     |
| ** **                                   | ** ** | **(Dollars in thousands)**         | ** **     |
| Residential  mortgage                        |       |                                         | $ 94,747  |                      |       |       | $ 60,030  |   |   | $ 154,777 |   |
| Real estate  construction                    |       |                                         | 1,552          |                      |       |       | —         |   |   | 1,552 |   |
| Real estate  commercial                      |       |                                         | 65,936         |                      |       |       | 156,176        |   |   | 222,112 |   |
| Consumer, home  equity and indirect consumer |       |                                         | 45,786         |                      |       |       | 48,337         |   |   | 94,123 |   |
| Commercial, other                            |       |                                         | 12,051         |                      |       |       | 9,246          |   |   | 21,297 |   |
| Total                                        |       |                                         | $ 220,072 |                      |       |       | $ 273,789 |   |   | $ 493,861 |   |

 

**Allowance andProvision for Loan Losses**

Our financial performance depends on the quality ofthe loans we originate and management’s ability to assess the degree of risk inexisting loans when it determines the allowance for loan losses. An increase inloan charge-offs or non-performing loans or an inadequate allowance for loanlosses could reduce net interest income, net income and capital and limit therange of products and services we can offer.

The Executive Loan Committee evaluates the allowancefor loan losses quarterly to maintain a level sufficient to absorb probableincurred credit losses existing in the loan portfolio. Periodic provisions tothe allowance are made as needed. The allowance is determined based on theapplication of loss estimates to graded loans by categories. The amount of theprovision for loan losses necessary to maintain an adequate allowance is alsobased upon an analysis of such factors as changes in lending policies andprocedures; underwriting standards; collection; charge-off and recoveryhistory; changes in national and local economic business conditions anddevelopments; changes in the characteristics of the portfolio; ability anddepth of lending management and staff; changes in the trend of the volume andseverity of past due, non-accrual and classified loans; troubled debtrestructuring and other loan modifications; and results of regulatoryexaminations.

The methodology for allocating the allowance for loanand lease losses takes into account our strategic plan to increase our emphasison commercial and consumer lending. We increase the amount of the allowanceallocated to commercial loans and consumer loans in response to the growth ofthe commercial and consumer loan portfolios and management’s recognition of thehigher risks and loan losses in these lending areas. The indirect consumer loanprogram is comprised of new and used automobile, motorcycle and all terrainvehicle loans originated on our behalf by a select group of auto 

30

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dealers within the ourservice area. The indirect loan program involves a greater degree of risk andis evaluated quarterly and monitored by the Board of Directors. In light of thegreater charge-offs from indirect consumer loans compared to direct consumerloans, proportionally more of the allowance for consumer loans is allocated forindirect loans than direct loans. As the indirect loan program has evolved,dealer analysis and underwriting standards have been refined to improve theloan loss experience of the program. Estimating the allowance is a continuousprocess. In this regard, the Executive Loan Committee continues to monitor theperformance of indirect consumer loans as well as our other loan products andupdates estimates as the evidence warrants.

Thefollowing table sets forth an analysis of loan loss experience for the periodsindicated.
| ** **                                                                | ** ** | ** **                                                           | ** **   | **Six Months Ended**                                       | ** ** | ** **                             | ** **   |
|---------------------------------------------------------------------------|------------|----------------------------------------------------------------------|--------------|----------------------------------------------------------------------|------------|----------------------------------------|--------------|
| ** **                                                                | ** ** | **Year Ended December 31,**                           | ** **   | **December 31,**                                                | ** ** | **Year Ended June 30,** | ** **   |
| ** **                                                                | ** ** | **     2004     ** | ** **   | **     2003     ** | ** ** | **2002**                               | ** **   | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** |
| ** **                                                                | ** ** | **(Dollars in thousands)**                                 | ** **   |
| Balance at  beginning of period                                           |       |                                                                 | $ 5,568 |                                                                 |       |                                   | $ 4,576 |   |   |   | $ 3,735 |   |   |   | $ 2,906 |   |   | $ 2,252 |   | $ 2,108 |   |
| Loans charged-off:                                                        |       |                                                                 |         |                                                                 |       |                                   |         |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Real estate mortgage                                                      |       |                                                                 | 41           |                                                                 |       |                                   | 60           |   |   |   | 5 |   |   |   | 25 |   |   | 2 |   | 36 |   |
| Consumer                                                                  |       |                                                                 | 702          |                                                                 |       |                                   | 721          |   |   |   | 419 |   |   |   | 635 |   |   | 482 |   | 147 |   |
| Commercial                                                                |       |                                                                 | 206          |                                                                 |       |                                   | 76           |   |   |   | — |   |   |   | 256 |   |   | 15 |   | 82 |   |
| Total charge-offs                                                         |       |                                                                 | 949          |                                                                 |       |                                   | 857          |   |   |   | 424 |   |   |   | 916 |   |   | 499 |   | 265 |   |
| Recoveries:                                                               |       |                                                                 |         |                                                                 |       |                                   |         |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Real estate mortgage                                                      |       |                                                                 | —       |                                                                 |       |                                   | —       |   |   |   | — |   |   |   | 6 |   |   | 4 |   | 1 |   |
| Consumer                                                                  |       |                                                                 | 214          |                                                                 |       |                                   | 190          |   |   |   | 74 |   |   |   | 97 |   |   | 63 |   | 8 |   |
| Commercial                                                                |       |                                                                 | —       |                                                                 |       |                                   | 3            |   |   |   | 30 |   |   |   | 38 |   |   | — |   | — |   |
| Total recoveries                                                          |       |                                                                 | 214          |                                                                 |       |                                   | 193          |   |   |   | 104 |   |   |   | 141 |   |   | 67 |   | 9 |   |
| Net loans charged-off                                                     |       |                                                                 | 735          |                                                                 |       |                                   | 664          |   |   |   | 320 |   |   |   | 775 |   |   | 432 |   | 256 |   |
| Provision for loan losses                                                 |       |                                                                 | 1,656        |                                                                 |       |                                   | 1,656        |   |   |   | 1,161 |   |   |   | 1,604 |   |   | 1,086 |   | 400 |   |
| Balance at end of  period                                                 |       |                                                                 | $ 6,489 |                                                                 |       |                                   | $ 5,568 |   |   |   | $ 4,576 |   |   |   | $ 3,735 |   |   | $ 2,906 |   | $ 2,252 |   |
| Allowance for loan  losses to total loans (excluding loans held for sale) |       |                                                                 | 1.07         | %                                                                    |       |                                   | 1.00         | % |   |   | 0.86 | % |   |   | 0.71 | % |   | 0.56 | % | 0.48 | % |
| Net charge-offs  to average loans outstanding                             |       |                                                                 | 0.13         | %                                                                    |       |                                   | 0.12         | % |   |   | 0.12 | % |   |   | 0.15 | % |   | 0.09 | % | 0.06 | % |
| Allowance for loan  losses to total non-performing loans                  |       |                                                                 | 124          | %                                                                    |       |                                   | 105          | % |   |   | 100 | % |   |   | 100 | % |   | 88 | % | 130 | % |

 

The provision for loan losses remained constant at$1.7 million for the year ended December 31, 2004, compared to the 2003period. The total allowance for loan losses increased $921,000 to $6.5 millionor 1.07% of total loans for December 31, 2004 compared to 1.00% of totalloans for December 31, 2003. The increased allowance is primarily due toincreases in commercial loans during the 2004 period and to an increase in ourspecial mention loans. Net loan charge-offs increased $71,000 to $735,000during 2004 compared to $664,000 during 2003, due to an increase in commercialloan net charge-offs.

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The provision for loan losses decreased 17% to $1.7million for the fiscal year ended December 30, 2003 compared to $2.0million for the 2002 period. The higher provision expense for 2002 was due to achange in loan types. The total allowance for loan losses increased $992,000 to$5.6 million from December 31, 2002 to December 31, 2003. Weincreased the allowance for loan losses due to the continued strong growth incommercial real estate lending and changes in the product mix within the loanportfolios. Net loan charge-offs decreased $49,000 to $664,000 during 2003compared to $713,000 during 2002. The decrease in charge-offs is primarilyrelated to a decrease in charge-offs of indirect consumer loans during the 2003period.

The provision for loan losses was $1.2 million for thesix months ended December 31, 2002 compared to $760,000 for the 2001 sixmonth period. The total allowance for loan losses increased $841,000 to $4.6million from June 30, 2002 to December 31, 2002. We increased theprovision and allowance for loan losses due to a change in the loanclassification and charge-off estimates, the increase in non-performing loans,which reflected the generally recognized slowing in the economy, and continuedstrong growth in commercial real estate lending. Net loan charge-offs decreased$62,000 to $320,000 during the 2002 six-month period compared to $382,000during 2001. The decrease in charge-offs is primarily related to an increase inrecoveries of consumer and commercial loan charge-offs during the 2002 period.

Thefollowing table depicts management’s allocation of the allowance for loanlosses by loan type. Allowance funding and allocation is based on management’scurrent evaluation of risk in each category, economic conditions, past lossexperience, loan volume, past due history and other factors. Since thesefactors and management’s assumptions are subject to change, the allocation isnot necessarily predictive of future portfolio performance.
| ** ** | ** ** | **December 31,**                | ** ** | **June 30,**    | ** ** |
|------------|------------|--------------------------------------|------------|----------------------|------------|
| ** ** | ** ** | **2004**                             | ** ** | **2003**             | ** ** | **2002** | ** ** | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** |
| ** ** | ** ** | **Amount of**                   | ** ** | **Percent of**  | ** ** | **Amount of** | ** ** | **Percent of** | ** ** | **Amount of** | ** ** | **Percent of** | ** ** | **Amount of** | ** ** | **Percent of** | ** ** | **Amount of** | ** ** | **Percent of** | ** ** | **Amount of** | ** ** | **Percent of** | ** ** |
| ** ** | ** ** | **Allowance**                        | ** ** | **Total loans** | ** ** | **Allowance** | ** ** | **Total loans** | ** ** | **Allowance** | ** ** | **Total loans** | ** ** | **Allowance** | ** ** | **Total loans** | ** ** | **Allowance** | ** ** | **Total loans** | ** ** | **Allowance** | ** ** | **Total loans** | ** ** |
| ** ** | ** ** | **(Dollars in thousands)** | ** ** |
| Residential  mortgage |   |   | $  413 |   |   |   | 26  | %      |   |   | $  456 |   |   |   | 34  | %      |   |   | $  608 |   |   |   | 49  | %      |   |   | $  645 |   |   |   | 56  | %      |   |   | $  884 |   |   |   | 62  | %      |   |   | $ 1,116 |   |   |   | 65  | %      |   |
|-----------------------|--------|--------|------------------|--------|--------|--------|-----|--------|--------|--------|------------------|--------|--------|--------|-----|--------|--------|--------|------------------|--------|--------|--------|-----|--------|--------|--------|------------------|--------|--------|--------|-----|--------|--------|--------|------------------|--------|--------|--------|-----|--------|--------|--------|--------------|--------|--------|--------|-----|--------|--------|
| Consumer              |   |   | 1,345            |   |   |   | 17  |   |   |   | 1,235            |   |   |   | 17  |   |   |   | 1,096            |   |   |   | 17  |   |   |   | 1,023            |   |   |   | 17  |   |   |   | 953              |   |   |   | 17  |   |   |   | 603          |   |   |   | 16  |   |   |
| Commercial            |   |   | 4,731            |   |   |   | 57  |   |   |   | 3,877            |   |   |   | 49  |   |   |   | 2,872            |   |   |   | 34  |   |   |   | 2,067            |   |   |   | 27  |   |   |   | 1,069            |   |   |   | 21  |   |   |   | 533          |   |   |   | 19  |   |   |
| Total                 |   |   | $ 6,489     |   |   |   | 100 | %      |   |   | $ 5,568     |   |   |   | 100 | %      |   |   | $ 4,576     |   |   |   | 100 | %      |   |   | $ 3,735     |   |   |   | 100 | %      |   |   | $ 2,906     |   |   |   | 100 | %      |   |   | $ 2,252 |   |   |   | 100 | %      |   |

 

Federal regulations require insured institutions toclassify their own assets on a regular basis. The regulations provide for threecategories of classified loans—substandard, doubtful and loss. The regulationsalso contain a special mention and a specific allowance category. Specialmention is defined as loans that do not currently expose an insured institutionto a sufficient degree of risk to warrant classification but do possess creditdeficiencies or potential weaknesses deserving management’s close attention.Assets classified as substandard or doubtful require the institution toestablish general allowances for loan losses. If an asset or portion thereof isclassified as loss, the insured institution must either establish specifiedallowances for loan losses in the amount of 100% of the portion of the assetclassified loss, or charge off such amount. At December 31, 2004, on thebasis of management’s review of the loan portfolio, we had $6.9 million of assets classifiedsubstandard, $979,000 classified as doubtful, $12.6 million classified asspecial mention and $35,000 of assets classified as loss.

Loans are classifiedaccording to estimated loss as follows: Substandard-2.5% to 35%; Doubtful-5% to50%; Loss-100%; and Special Mention-2% to 10%. We additionally provide areserve estimate for probable incurred losses in non-classified loans rangingfrom .20% to 3.50%. Although we may allocate a portion of the allowance tospecific loans or loan categories, the entire allowance is available for activecharge-offs. Allowance estimates are developed in consultation with regulatoryauthorities and actual loss experience adjusted for current economic conditions.Allowance estimates are considered a prudent measurement of the risk in theloan portfolio and are applied to individual loans based on loan type.

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**Non-PerformingAssets**

Non-performing assets consist of certain restructuredloans for which interest rate or other terms have been renegotiated, loans onwhich interest is no longer accrued, real estate acquired through foreclosureand repossessed assets. We do not have any loans greater than 90 days past duestill on accrual. Loans, including impaired loans under SFAS 114, are placed onnon-accrual status when they become past due 90 days or more as to principal orinterest, unless they are adequately secured and in the process of collection. Loansare considered impaired if full principal or interest payments are notanticipated in accordance with the contractual loan terms. Impaired loans arecarried at the present value of expected future cash flows discounted at theloan’s effective interest rate or at the fair value of the collateral if theloan is collateral dependent.

Loans are reviewed on a regular basis and normalcollection procedures are implemented when a borrower fails to make a requiredpayment on a loan. If the delinquency on a mortgage loan exceeds 90 days and isnot cured through normal collection procedures or an acceptable arrangement isnot worked out with the borrower, we institute measures to remedy the default,including commencing a foreclosure action. Consumer loans generally are chargedoff when a loan is deemed uncollectible by management and any availablecollateral has been disposed of. Commercial business and real estate loandelinquencies are handled on an individual basis by management with the adviceof legal counsel. We anticipate that the volume of non-performing real estateloans will continue to increase, reflecting anticipated growth of our loanportfolio.

Interest income on loans is recognized on the accrualbasis except for those loans in a non-accrual of income status. The accrual ofinterest on impaired loans is discontinued when management believes, afterconsideration of economic and business conditions and collection efforts thatthe borrowers’ financial condition is such that collection of interest isdoubtful, typically after the loan becomes 90 days delinquent. When interestaccrual is discontinued, existing accrued interest is reversed and interestincome is subsequently recognized only to the extent cash payments arereceived.

Real estate acquired as a result of foreclosure or bydeed in lieu of foreclosure is classified as real estate owned until such timeas it is sold. New and used automobile, motorcycle and all terrain vehiclesacquired as a result of foreclosure are classified as repossessed assets untilthey are sold. When such property is acquired it is recorded at the lower ofthe unpaid principal balance of the related loan or its fair market value. Anywrite-down of the property at the time of acquisition is charged to theallowance for loan losses. Subsequent gains and losses are included innon-interest income and non-interest expense.

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Thefollowing table sets forth information with respect to non-performing assets asof the periods indicated.
| ** **                                                           | ** **                                                            | **December 31,**               | ** ** | **June 30,** | ** ** |
|----------------------------------------------------------------------|-----------------------------------------------------------------------|-------------------------------------|------------|-------------------|------------|
| ** **                                                           | ** **                                                            | **2004**                            | ** ** | **2003**          | ** ** | **2002** | ** ** | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** |
| ** **                                                           | ** **                                                            | **(Dollar in thousands)** | ** ** |
| Restructured                                                         |                                                                  | $ 3,218                        |       | $ 3,037      |       | $ 3,325 |   | $ 3,350 |   | $     — |   | $     — |   |
| Past due 90 days  still on accrual                                   |                                                                  | —                              |       | —            |       | — |   | — |   | — |   | — |   |
| Loans on  non-accrual status                                         |                                                                  | 2,022                               |       | 2,281             |       | 1,259 |   | 386 |   | 3,309 |   | 1,728 |   |
| Total non-performing loans                                           |                                                                  | 5,240                               |       | 5,318             |       | 4,584 |   | 3,736 |   | 3,309 |   | 1,728 |   |
| Real estate  acquired through foreclosure                            |                                                                  | 681                                 |       | 387               |       | 510 |   | 660 |   | 296 |   | — |   |
| Other repossessed  assets                                            |                                                                  | 40                                  |       | 62                |       | 119 |   | 119 |   | 70 |   | — |   |
| Total non-performing assets                                          |                                                                  | $ 5,961                        |       | $ 5,767      |       | $ 5,213 |   | $ 4,515 |   | $ 3,675 |   | $ 1,728 |   |
| Interest income  that would have been earned on non-performing loans |                                                                  | $  336                    |       | $  374  |       | $  177 |   | $  300 |   | $  276 |   | $  139 |   |
| Interest income  recognized on non-performing loans                  |                                                                  | 197                                 |       | 227               |       | 126 |   | 201 |   | — |   | — |   |
| Ratios:                                                              | Non-performing  loans to total loans (excluding loans held for sale)  |                                | 0.87       | %                 | 0.96       | % | 0.87 | % | 0.72 | % | 0.64 | % | 0.37 | % |
|                                                                 | Non-performing  assets to total loans (excluding loans held for sale) |                                | 0.99       | %                 | 1.04       | % | 0.98 | % | 0.86 | % | 0.71 | % | 0.37 | % |

 

Included in non-performingassets for the 2004 period is $3.2 million in restructured commercial andresidential mortgage loans. The restructured loans primarily consist of threecredit relationships aggregating $3.0 million, including a $2.3 millioncommercial relationship, a $217,000 commercial relationship and a $461,000residential mortgage relationship. The terms of these loans have beenrenegotiated to reduce the rate of interest and extend the term thus reducingthe amount of cash flow required from the borrower to service the loans. Theterms of the restructured loans are currently being met.

**InvestmentSecurities**

Interest on securities provides us our largest sourceof interest income after interest on loans, constituting 4.5% of the totalinterest income for the year ended December 31, 2004. The securities portfolio serves as a source ofliquidity and earnings and contributes to the management of interest rate risk.We have the authority to invest in various types of liquid assets,including short-term United States Treasury obligations and securities ofvarious federal agencies, obligations of states and political subdivisions,corporate bonds, certificates of deposit at insured savings and loans andbanks, bankers’ acceptances, and federal funds. We may also invest a portion ofour assets in certain commercial paper and corporate debt securities. We arealso authorized to invest in mutual funds and stocks whose assets conform tothe investments that we are authorized to make directly. The available-for-saleand held-to-maturity investment portfolios increased by $21.9 million or 63%during the 2004 period due to investments in U.S. Treasury and agencies and amortgage-backed security. See Note 2 of the Notes to Consolidated FinancialStatements for further information concerning the investment portfolio.

34

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Thefollowing table sets forth the carrying value of our securities portfolio atthe dates indicated.
| ** **                          | ** ** | **December 31,**                | ** ** | **June 30,**                                 | ** ** |
|-------------------------------------|------------|--------------------------------------|------------|---------------------------------------------------|------------|
| ** **                          | ** ** | **2004**                             | ** ** | **2003**                                          | ** ** | **2002** | ** ** | **2002** | ** ** |
| ** **                          | ** ** | **(Dollars in thousands)** | ** ** |
| **Securities  available-for-sale:** |       |                                 |       |                                              |       |   |   |   |   |
| U.S. Treasury and agencies          |       | $ 15,929                        |       | $       — |       | $       — |   | $       — |   |
| Mortgage-backed                     |       | 1,879                                |       | —                                            |       | — |   | — |   |
| Equity                              |       | 3,079                                |       | 2,939                                             |       | 914 |   | 930 |   |
| State and municipal                 |       | 1,041                                |       | 1,070                                             |       | 1,085 |   | 1,048 |   |
| Total                               |       | $ 4,120                         |       | $ 4,009                                      |       | $ 1,999 |   | $ 1,978 |   |
| **Securities  held-to-maturity:**   |       |                                 |       |                                              |       |   |   |   |   |
| U.S. Treasury and agencies          |       | $ 26,095                        |       | $ 19,999                                     |       | $ 13,986 |   | $ 20,964 |   |
| Mortgage-backed                     |       | 6,820                                |       | 8,930                                             |       | 590 |   | 751 |   |
| Corporate                           |       | 2,000                                |       | 2,000                                             |       | 2,000 |   | — |   |
| Total                               |       | $ 32,915                        |       | $ 28,929                                     |       | $ 14,576 |   | $ 21,715 |   |

 

Thefollowing table sets forth the scheduled maturities, amortized cost, fair valueand weighted average yields for our securities at December 31, 2004.
| ** **                             | ** ** | ** **                            | ** **    | ** ** | ** ** | **Weighted**  | ** ** |
|----------------------------------------|------------|---------------------------------------|---------------|------------|------------|---------------|------------|
| ** **                             | ** ** | **  Amortized  ** | ** **    | **Fair**   | ** ** | **Average**   | ** ** |
| ** **                             | ** ** | **Cost**                              | ** **    | **Value**  | ** ** | **Yield***    | ** ** |
| ** **                             | ** ** | **(Dollars in thousands)**  | ** **    |
| **Securities available-for-sale:**     |       |                                  |          |       |       |          |       |   |   |   |   |
| Due in one year or less                |       |                                  | $ 12,059 |       |       | $ 12,026 |       |   | 2.37 | % |   |
| Due after one year through five years  |       |                                  | 4,810         |       |       | 4,822         |       |   | 2.94 |   |   |
| Due after five years through ten years |       |                                  | 114           |       |       | 122           |       |   | 4.55 |   |   |
| Mortgage-backed                        |       |                                  | 1,901         |       |       | 1,879         |       |   | 3.57 |   |   |
| Equity                                 |       |                                  | 1,898         |       |       | 3,079         |       |   | 3.86 |   |   |
| Total                                  |       |                                  | $ 20,782 |       |       | $ 21,928 |       |   | 2.82 |   |   |

 
| ** **                            | ** ** | ** **                            | ** **    | ** ** | ** ** | **Weighted**  | ** ** |
|---------------------------------------|------------|---------------------------------------|---------------|------------|------------|---------------|------------|
| ** **                            | ** ** | **  Amortized  ** | ** **    | **Fair**   | ** ** | **Average**   | ** ** |
| ** **                            | ** ** | **Cost**                              | ** **    | **Value**  | ** ** | **Yield***    | ** ** |
| ** **                            | ** ** | **(Dollars in thousands)**  | ** **    |
| **Securities held-to-maturity:**      |       |                                  |          |       |       |          |       |   |   |   |   |
| Due after one year through five years |       |                                  | $ 26,095 |       |       | $ 25,854 |       |   | 2.84 | % |   |
| Due after ten years                   |       |                                  | 2,000         |       |       | 2,000         |       |   | 3.30 |   |   |
| Mortgage-backed                       |       |                                  | 6,820         |       |       | 6,703         |       |   | 3.99 |   |   |
| Total                                 |       |                                  | $ 34,915 |       |       | $ 34,557 |       |   | 3.09 |   |   |

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*                    Theweighted average yields are calculated on amortized cost on a nontax-equivalent basis.

**Deposits**

We attract both short-term and long-term deposits fromthe general public by offering a wide range of deposit accounts and interestrates. In recent years we have been required by market conditions to relyincreasingly on short-term certificate accounts and other deposit alternativesthat are more responsive to market interest rates. We use forecasts based oninterest rate risk simulations to assist management in monitoring our use ofcertificates of deposit and other deposit products as funding sources and theimpact of their use on interest income and net interest margin in various rateenvironments.

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In conjunction with ourinitiatives to expand and enhance our retail branch network we have undertakena renewed emphasis on growing our customer checking account base to betterenhance profitability and franchise value, as well as lower our dependence oncertificate of deposit funding. During 2004, we introduced 10 new checkingaccount products and significant enhancements to existing products. Aheightened level of advertising and promotions coupled with associate incentiveplans designed to encourage the sale of checking accounts should enable us tomake progress with this effort.

We rely primarily oncustomer service and long-standing relationships with customers to attract andretain deposits. Market interest rates and rates on deposit products offered bycompeting financial institutions can significantly affect our ability toattract and retain deposits.****Duringthe year ended December 31, 2004, total deposits increased by $57.2million compared to the 2003 period. The increase in retail deposits wasprimarily in money market accounts due to growth in public entity deposits forthe period and an increase in certificate of deposit balances as we have becomeincreasingly competitive with rates in recent months.

To evaluate our fundingneeds in light of deposit trends resulting from these changing conditions,management and Board committees evaluate simulated performance reports thatforecast changes in margins. We continue to offer attractive certificate ratesfor various terms to allow us to retain deposit customers and reduce interestrate risk during the current low-rate environment, while protecting the marginwhen interest rates increase as the economy recovers.

We offer statement andpassbook savings accounts, NOW accounts, money market accounts and fixed andvariable rate certificates with varying maturities. We also offer tax-deferredindividual retirement accounts. The flow of deposits is influencedsignificantly by general economic conditions, changes in interest rates andcompetition. As of December 31, 2004, approximately 47% of our depositsconsisted of various savings and demand deposit accounts from which customerscan withdraw funds at any time without penalty. Interest rates paid, maturityterms, service fees and withdrawal penalties are established by management on aperiodic basis.

We also offer certificatesof deposit with a variety of terms and interest rates. These certificates haveminimum deposit requirements as well. The variety of deposit accounts allows usto compete more effectively in obtaining funds and to respond with moreflexibility to the flow of funds away from depository institutions into directinvestment vehicles such as government and corporate securities. However, ourability to attract and maintain deposits and its cost of funds have been, andwill continue to be, significantly affected by market conditions.

As of December 31,2004, the holders of our certificates of deposits in amounts of $100,000 ormore were $104.4 million in****non-brokereddeposits, most of who reside within our service areas. Certificates of depositsin amounts of $100,000 or more obtained from deposit brokers were $500,000 forthe 2004 period. Brokered deposits consist of certificates of deposit placed bydeposit brokers for a fee and are utilized to support our asset growth.

Thefollowing table breaks down our deposits.
| ** **               | ** ** | **December 31,**                | ** ** | **June 30,** | ** ** |
|--------------------------|------------|--------------------------------------|------------|-------------------|------------|
| ** **               | ** ** | **2004**                             | ** ** | **2003**          | ** ** | **2002** | ** ** | **2002** | ** ** |
| ** **               | ** ** | **(Dollars in thousands)** | ** ** |
| Non-interest  bearing    |       | $ 38,441                        |       | $ 28,632     |       | $ 32,391 |   | $ 28,341 |   |
| NOW demand               |       | 73,801                               |       | 67,504            |       | 65,012 |   | 64,479 |   |
| Savings                  |       | 78,499                               |       | 86,419            |       | 72,301 |   | 78,143 |   |
| Money market             |       | 85,418                               |       | 51,773            |       | 45,978 |   | 47,936 |   |
| Certificates of  deposit |       | 270,076                              |       | 254,258           |       | 267,194 |   | 274,305 |   |
| Individual  Retirement   |       | 40,151                               |       | 40,576            |       | 38,245 |   | 36,678 |   |
| Total                    |       | $ 586,386                       |       | $ 529,162    |       | $ 521,121 |   | $ 529,882 |   |

 

36

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Thefollowing table shows at December 31, 2004 the amount of our certificatesof deposit of $100,000 or more by time remaining until maturity.
| ** **                 | ** ** | **Certificates**        | ** **     |
|----------------------------|------------|-------------------------|----------------|
| **Maturity Period**   | ** ** | ** **              | ** **     | **of Deposit** | ** ** |
| ** **                 | ** ** | **(In Thousands)** | ** **     |
| Three months or less       |       |                    | $ 12,042  |   |   |
| Three through six  months  |       |                    | 16,501         |   |   |
| Six through  twelve months |       |                    | 28,259         |   |   |
| Over twelve  months        |       |                    | 48,117         |   |   |
| Total                      |       |                    | $ 104,919 |   |   |
|                            |            |                         |                |  |  |  |  |

 

**Borrowings**

Deposits are the primary source of funds for ourlending and investment activities and for our general business purposes. We canalso use advances (borrowings) from the FHLB of Cincinnati to supplement oursupply of lendable funds, meet deposit withdrawal requirements and extend theterm of its liabilities. Advances from the FHLB are secured by our stock in theFHLB, certain commercial real estate loans and substantially all of our firstmortgage loans. At December 31, 2004 we had $78.9 million in advancesoutstanding from the FHLB and the capacity to increase our borrowings anadditional $24.9 million.

The FHLB of Cincinnati functions as a central reservebank providing credit for savings banks and other member financial institutions.As a member, we are required to own capital stock in the FHLB and areauthorized to apply for advances on the security of such stock and certain ofour home mortgages and other assets (principally, securities which areobligations of, or guaranteed by, the United States) provided that we meetcertain standards related to creditworthiness. For further information, seeNote 6 of the Notes to Consolidated Financial Statements in this Annual Report.

Thefollowing table sets forth information about our FHLB advances as of and forthe periods ended.
| ** **                                                     | ** ** | **December 31,**                     | ** ** |
|----------------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                                     | ** ** | **2004**                             | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                                     | ** ** | **(Dollars in thousands)** | ** ** |
| Average balance  outstanding                                   |       | $ 78,543                        |       | $ 77,726 |   | $ 77,736 |   |
| Maximum amount  outstanding at any month-end during the period |       | 78,974                               |       | 78,283 |   | 77,767 |   |
| Year end balance                                               |       | 78,904                               |       | 78,283 |   | 77,683 |   |
| Weighted average  interest rate:                               |       |                                 |       |   |   |   |   |
| At end of year                                                 |       | 4.87                                 | %          | 4.88 | % | 4.93 | % |
| During the year                                                |       | 4.76                                 | %          | 4.81 | % | 4.81 | % |

 

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**LIQUIDITY**

Liquidity risk arises from the possibility we may notbe able to satisfy current or future financial commitments, or may becomeunduly reliant on alternative funding sources. The objective of liquidity riskmanagement is to ensure that the cash flow requirements of depositors andborrowers, as well as our operating cash needs, are met, taking into accountall on- and off-balance sheet funding demands. Liquidity risk management alsoincludes ensuring cash flow needs are met at a reasonable cost. We maintain aninvestment and funds management policy, which identifies the primary sources ofliquidity, establishes procedures for monitoring and measuring liquidity, andestablishes minimum liquidity requirements in compliance with regulatoryguidance. The liquidity position is continually monitored and reviewed by theAsset Liability Committee.

Funds are available from a number of sources,including the sale of securities in the available-for-sale portion of theinvestment portfolio, principal paydowns on loans and mortgage-backedsecurities, proceeds realized from loans held for sale, brokered deposits andother wholesale funding. During 2004, we obtained our first brokered deposit inthe amount of $500,000. We also secured federal funds borrowing lines from twoof our correspondent banks totaling $10 million and $15 million respectively. Ourbanking centers also provide access to retail deposit markets. If largecertificate depositors shift to our competitors or the stock market in responseto interest rate changes, we have the ability to replenish those depositsthrough alternative funding sources. Traditionally, we have also utilizedborrowings from the FHLB to supplement our funding requirements. At December 31,2004, we had an unused approved line of credit in the amount of $89.1 millionand****sufficient collateralavailable to borrow, approximately, an additional $24.9 million in advancesfrom the FHLB. We believe our sources of liquidity are adequate to meetexpected cash needs for the foreseeable future.

At the holding company level, the Corporation usescash to pay dividends to stockholders, repurchase common stock, make selectedinvestments and acquisitions, and service debt. The main sources of funding forthe holding company include dividends and returns of investment from the Bank,a revolving credit agreement with an unaffiliated bank, and access to thecapital markets.

The primary source offunding for the Corporation has been dividends and returns of investment fromthe Bank. As discussed in Note 9 to the consolidated financial statements,banking regulations limit the amount of dividends that may be paid. Accordingly,consolidated cash flows as presented in the consolidated statements of cashflows may not represent cash immediately available to the Corporation. During2004, the Bank declared and paid dividends to the Corporation of $4.5 million.

**CAPITAL**

Stockholders’ equity increased $3.5 million for theyear ended December 31, 2004 compared to the 2003 period. During the yearended December 31, 2004, we purchased 60,000 shares of our own commonstock. As a result, the transaction decreased total capital by $1.6 million,which in turn reduced consolidated regulatory capital. We continue to qualifyas well capitalized under regulatory guidelines after the transaction. Ourstock repurchase programs have generally authorized the repurchase of up to 10%of the outstanding stock from time to time in the open market or privatetransactions during an 18-month period. Management considers repurchasingshares when the financial and other terms of the purchase and its impact onearnings per share and other financial measures offer an attractive return tostockholders. We adopted our most recent plan on March 19, 2003 andextended it until March 19, 2005. In addition, our average stockholders’equity to average assets ratio increased to 8.28% for the year ended December 31,2004 compared to 8.26% for 2003.

In March 2002, a trust formed by First Financialcompleted the private placement of 10,000 shares of cumulative trust preferredsecurities with a liquidation preference of $1,000 per security. The proceedsof the offering were loaned to us in exchange for floating rate juniorsubordinated deferrable interest 

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debentures. Distributionson the securities are payable quarterly at a rate per annum equal to the 3-monthLIBOR plus 3.60%. We undertook the issuance of these securities to enhance ourregulatory capital position as the securities are considered as Tier I capitalunder current regulatory guidelines.

Kentucky banking laws limit the amount of dividendsthat may be paid to First Financial Service Corporation by First FederalSavings Bank without prior approval of the KOFI. Under these laws, the amountof dividends that may be paid in any calendar year is limited to current year’snet income, as defined in the laws, combined with the retained net income ofthe preceding two years, less any dividends declared during those periods. At December 31,2004, without prior regulatory approval, we had approximately $5.6 million ofretained earnings that could be utilized for payment of dividends if authorizedby our board of directors.

Each of the federal bankregulatory agencies has established minimum leverage capital requirements forbanking organizations. Banking organizations must maintain a minimum ratio ofTier 1 capital to adjusted average quarterly assets equal to 3% to 5% subjectto federal bank regulatory evaluation of an organization’s overall safety andsoundness. We intend to maintain a capital position that meets or exceeds the “wellcapitalized” requirements as defined by the FDIC. The following table shows theratios of Tier 1 capital and total capital to risk-adjusted assets and theleverage ratios for the Corporation and the Bank as of December 31, 2004.

**CapitalAdequacy Ratios as of**December 31, 2004
| ** **                              | ** ** | **Regulatory** | ** ** | **Well-Capitalized** | ** ** | ** **   | ** ** | ** **               | ** ** |
|-----------------------------------------|------------|----------------|------------|----------------------|------------|--------------|------------|--------------------------|------------|
| **Risk-Based Capital Ratios** | ** ** | ** **     | ** ** | **Minimums**         | ** ** | **Minimums** | ** ** | **The Corporation** | ** ** | **The Bank** | ** ** |
| Tier 1 capital(1)                       |       |           | 4.0        | %                    |       |         | 6.0        | %                        |       |   | 10.4 | % |   |   | 10.0 | % |   |
| Total risk-based  capital(2)            |       |           | 8.0        | %                    |       |         | 10.0       | %                        |       |   | 11.6 | % |   |   | 11.2 | % |   |
| Tier 1 leverage ratio(3)                |       |           | 4.0        | %                    |       |         | 5.0        | %                        |       |   | 8.5 | % |   |   | 8.1 | % |   |
|                                         |            |                |            |                      |            |              |            |                          |            |  |  |  |  |  |  |  |  |  |  |

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(1)          Shareholders’ equityplus corporation-obligated mandatory redeemable capital securities, lessunrealized gains (losses) on debt securities available for sale, net ofdeferred income taxes, less nonqualifying intangible assets; computed as aratio of risk-weighted assets, as defined in the risk-based capital guidelines.

(2)          Tier 1 capital plusqualifying loan loss allowance and subordinated debt; computed as a ratio ofrisk-weighted assets, as defined in the risk-based capital guidelines.

(3)          Tier1 capital computed as a percentage of fourth quarter average assets lessnonqualifying intangibles.

**OFF BALANCE SHEETARRANGEMENTS**

Wehave no off balance sheet arrangements other than stand-by letters ofcredit as disclosed in Note 16 to the consolidated financial statements.

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**AGGREGATE CONTRACTUAL OBLIGATIONS**
| ** **                              | ** ** | ** **                           | ** ** | **Less than** | ** ** | **Greater than  one year to** | ** ** | **Greater than  3 years to** | ** ** | **More than** | ** ** |
|-----------------------------------------|------------|--------------------------------------|------------|--------------------|------------|----------------------------------------------|------------|---------------------------------------------|------------|--------------------|------------|
| **December 31, 2004**         | ** ** | ** **                           | ** ** | **Total**          | ** ** | **one year**                            | ** ** | **3 years**                            | ** ** | **5 years**   | ** ** | **5 years** | ** ** |
| ** **                              | ** ** | **(Dollars in thousands)** | ** ** |
| **Aggregate  Contractual Obligations:** |       |                                 |       |               |       |                                         |       |                                        |       |               |       |   |   |   |   |
| Time deposits                           |       | $                                    | 310,227    |               | $          | 167,491                                      |       |                                        | $          | 113,860            |       |   |   | $ | 15,705 |   |   | $ | 13,171 |   |
| FHLB borrowings                         |       | 78,904                               |       | 957                |       |                                         | 273        |                                        |       |               | 241        |   |   | 77,433 |   |
| Subordinated debentures                 |       | 10,000                               |       | —             |       |                                         | —     |                                        |       |               | —     |   |   | 10,000 |   |
| Lease commitments                       |       | 1,674                                |       | 274                |       |                                         | 440        |                                        |       |               | 364        |   |   | 596 |   |
|                                         |            |                                      |            |                    |            |                                              |            |                                             |            |                    |            |  |  |  |  |  |  |  |  |  |  |  |

 

FHLB borrowings represent the amounts that are due tothe FHLB of Cincinnati. These amounts have fixed maturity dates. Some of theseborrowings, although fixed, are subject to conversion provisions at the optionof the FHLB. The FHLB has the right to convert these advances to variable ratesor we can prepay the advance at no penalty. There is a substantial penalty ifwe prepay the advance before the FHLB exercises its right. We do not believethese advances will be converted in the near term.

The subordinated debentures, which mature March 26,2032, are redeemable prior to the maturity date at our option on or after March 26,2007 at their principal amount plus accrued interest. The subordinateddebentures are also redeemable in whole or in part from time to time, upon theoccurrence of specific events defined within the trust indenture. We have theoption to defer distributions on the subordinated debentures from time to timefor a period not to exceed 20 consecutive quarters.

Lease commitmentsrepresent the total future minimum lease payments under non-cancelableoperating leases.

**IMPACT OF INFLATION &CHANGING PRICES**

The financial statements and related data presentedherein have been prepared in accordance with generally accepted accountingprinciples, which require the measurement of financial position and operatingresults in historical dollars without considering changes in the relativepurchasing power of money over time due to inflation.

We have an asset andliability structure that is essentially monetary in nature. As a result,interest rates have a more significant impact on our performance than theeffects of general levels of inflation. Periods of high inflation are oftenaccompanied by relatively higher interest rates, and periods of low inflationare accompanied by relatively lower interest rates. As market interest ratesrise or fall in relation to the rates earned on our loans and investments, thevalue of these assets decreases or increases respectively.

**Item 7A**.                Quantitativeand Qualitative Disclosures About Market Risk

**ASSET/LIABILITYMANAGEMENT AND MARKET RISK**

To minimize the volatility of net interest income andexposure to economic loss that may result from fluctuating interest rates, wemanage our exposure to adverse changes in interest rates through asset andliability management activities within guidelines established by our AssetLiability Committee (“ALCO”). The ALCO, which includes senior managementrepresentatives, has the responsibility for approving and ensuring compliancewith asset/liability management polices. Interest rate risk is the exposure toadverse changes in the net interest income as a result of market fluctuationsin interest rates. The ALCO, on an ongoing basis, monitors interest rate andliquidity risk in order to implement appropriate funding and balance sheetstrategies. Management considers interest rate risk to be our most significantmarket risk.

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We utilize an earnings simulation model to analyze netinterest income sensitivity. Potential changes in market interest rates andtheir subsequent effects on net interest income are then evaluated. The modelprojects the effect of instantaneous movements in interest rates of both 100and 200 basis points. Assumptions based on the historical behavior of ourdeposit rates and balances in relation to changes in interest rates are alsoincorporated into the model. These assumptions are inherently uncertain and, asa result, the model cannot precisely measure future net interest income orprecisely predict the impact of fluctuations in market interest rates on netinterest income. Actual results will differ from the model’s simulated resultsdue to timing, magnitude and frequency of interest rate changes as well aschanges in market conditions and the application and timing of variousmanagement strategies.

Our interest sensitivity profile was asset sensitiveat both December 31, 2004 and December 31, 2003. Given a sustained100 basis point decrease in rates, our base net interest income would decreaseby an estimated 2.38% at December 31, 2004 compared to a decrease of 4.34%at December 31, 2003. Given a 100 basis point increase in interest ratesour base net interest income would increase by an estimated 2.19% at December 31,2004 compared to an increase of 1.63% at December 31, 2003.

Our interest sensitivity at any point in time will beaffected by a number of factors. These factors include the mix of interestsensitive assets and liabilities as well as their relative pricing schedules. Itis also influenced by market interest rates, deposit growth, loan growth, decayrates and prepayment speed assumptions.

As demonstrated by the December 31, 2004 and December 31,2003 sensitivity tables presented below, we are continuing to transition awayfrom a liability sensitive to an asset sensitive position as compared to priorperiods in anticipation of rising interest rates for the next several months.The change in our asset sensitivity is a result of changes in the loanportfolio to a greater extent than changes in the investment portfolio. Whilelending practices have shifted to shorter term, variable rate commercial andconsumer loans, that impact will be evidenced in smaller degrees over time.

Oursensitivity to interest rate changes is presented based on data as of December 31,2004 and December 31, 2003.
| ** **                     | ** ** | **December 31, 2004**           | ** ** |
|--------------------------------|------------|--------------------------------------|------------|
| ** **                     | ** ** | **Decrease in Rates**      | ** ** | ** ** | ** ** | **Increase in Rates** | ** ** |
| ** **                     | ** ** | **200  Basis Points**           | ** ** | **100  Basis Points** | ** ** | **Base** | ** ** | **100  Basis Points** | ** ** | **200  Basis Points** | ** ** |
| ** **                     | ** ** | **(Dollars in thousands)** | ** ** |
| **Projected  interest income** |       |                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Loans                          |       |                                 | $          | 38,503 |   |   |   | $ | 39,834 |   |   | $ | 40,943 |   |   | $ | 41,960 |   |   |   | $ | 42,995 |   |   |
| Investments                    |       |                                 | 1,963      |   |   |   | 2,332 |   |   | 2,517 |   |   | 2,667 |   |   |   | 2,820 |   |   |
| **Total  interest income**     |       |                                 | 40,466     |   |   |   | 42,166 |   |   | 43,460 |   |   | 44,627 |   |   |   | 45,815 |   |   |
| **Projected interest expense** |       |                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Deposits                       |       |                                 | 10,215     |   |   |   | 10,805 |   |   | 11,395 |   |   | 11,914 |   |   |   | 12,433 |   |   |
| Borrowed funds                 |       |                                 | 4,262      |   |   |   | 4,307 |   |   | 4,352 |   |   | 4,393 |   |   |   | 4,434 |   |   |
| Total interest  expense        |       |                                 | 14,477     |   |   |   | 15,112 |   |   | 15,747 |   |   | 16,307 |   |   |   | 16,867 |   |   |
| **Net interest income**        |       |                                 | $          | 25,989 |   |   |   | $ | 27,054 |   |   | $ | 27,713 |   |   | $ | 28,320 |   |   |   | $ | 28,948 |   |   |
| Change from base               |       |                                 | $          | (1,724 | ) |   |   | $ | (659 | ) |   |   |   |   | $ | 607 |   |   |   | $ | 1,235 |   |   |
| % Change from base             |       |                                 | (6.22      | )% |   |   | (2.38 | )% |   |   |   |   | 2.19 | % |   |   | 4.46 | % |   |

 

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| ** **                     | ** ** | **December 31, 2003**      | ** ** |
|--------------------------------|------------|--------------------------------------|------------|
| ** **                     | ** ** | **Decrease in Rates**      | ** ** | ** ** | ** ** | **Increase in Rates** | ** ** |
| ** **                     | ** ** | **200  Basis Points**           | ** ** | **100  Basis Points** | ** ** | **Base** | ** ** | **100  Basis Points** | ** ** | **200  Basis Points** | ** ** |
| ** **                     | ** ** | **(Dollars in thousands)** | ** ** |
| **Projected  interest income** |       |                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Loans                          |       |                                 | $          | 32,629 |   |   |   | $ | 34,706 |   |   | $ | 36,625 |   |   | $ | 38,380 |   |   |   | $ | 40,033 |   |   |
| Investments                    |       |                                 | 1,179      |   |   |   | 1,286 |   |   | 2,250 |   |   | 2,764 |   |   |   | 3,283 |   |   |
| **Total  interest income**     |       |                                 | 33,808     |   |   |   | 35,992 |   |   | 38,875 |   |   | 41,144 |   |   |   | 43,316 |   |   |
| **Projected interest expense** |       |                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Deposits                       |       |                                 | 6,925      |   |   |   | 8,283 |   |   | 10,018 |   |   | 11,806 |   |   |   | 13,594 |   |   |
| Borrowed funds                 |       |                                 | 4,051      |   |   |   | 4,130 |   |   | 4,208 |   |   | 4,287 |   |   |   | 4,366 |   |   |
| Total interest  expense        |       |                                 | 10,976     |   |   |   | 12,413 |   |   | 14,226 |   |   | 16,093 |   |   |   | 17,960 |   |   |
| **Net interest income**        |       |                                 | $          | 22,832 |   |   |   | $ | 23,579 |   |   | $ | 24,649 |   |   | $ | 25,051 |   |   |   | $ | 25,356 |   |   |
| Change from base               |       |                                 | $          | (1,817 | ) |   |   | $ | (1,070 | ) |   |   |   |   | $ | 402 |   |   |   | $ | 707 |   |   |
| % Change from base             |       |                                 | (7.37      | )% |   |   | (4.34 | )% |   |   |   |   | 1.63 | % |   |   | 2.87 | % |   |

 

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**Item 8.**                        FinancialStatements and Supplementary Data

**FIRST FINANCIALSERVICE CORPORATIONTable of Contents**

AuditedConsolidated Financial Statements:
| ·  Report  on Management’s Assessment of Internal Control Over Financial  Reporting                 | ** ** | 44    |
|--------------------------------------------------------------------------------------------------------------------|------------|-------|
| ·  Report of Independent Registered Public  Accounting Firm on Internal Control Over Financial Reporting | ** ** | 45    |
| ·  Report of Independent Registered Public  Accounting Firm on Financial Statements                      |       | 47    |
| ·  Consolidated Statements of Financial  Condition                                                       | ** ** | 48    |
| ·  Consolidated Statements of Income                                                                     | ** ** | 49    |
| ·  Consolidated Statements of Comprehensive  Income                                                      | ** ** | 50    |
| ·  Consolidated Statements of Changes in  Stockholders’ Equity                                      | ** ** | 51    |
| ·  Consolidated Statements of Cash Flows                                                                 | ** ** | 52    |
| ·  Notes to Consolidated Financial Statements                                                            |       | 53-76 |

 

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**Reporton Management’s Assessment of Internal Control Over Financial Reporting**

First Financial Service Corporation is responsible forthe preparation, integrity, and fair presentation of the consolidated financialstatements included in this annual report. The consolidated financialstatements and notes included in this annual report have been prepared inconformity with accounting principles generally accepted in the United States of America andnecessarily include some amounts that are based on management’s best estimatesand judgments.

We, as management of First Financial ServiceCorporation, are responsible for establishing and maintaining effectiveinternal control over financial reporting that is designed to produce reliablefinancial statements in conformity with accounting principles generallyaccepted in the United States of America. The system of internal control overfinancial reporting as it relates to the financial statements is evaluated foreffectiveness by management and tested for reliability through a program ofinternal audits. Actions are taken to correct potential deficiencies as theyare identified. Any system of internal control, no matter how well designed,has inherent limitations, including the possibility that a control can be circumventedor overridden and misstatements due to error or fraud may occur and not bedetected. Also, because of changes in conditions, internal controleffectiveness may vary over time. Accordingly, even an effective system ofinternal control will provide only reasonable assurance with respect tofinancial statement preparation.

The Audit Committee, consisting entirely ofindependent directors, meets regularly with management, internal auditors andthe independent registered public accounting firm, and reviews audit plans andresults, as well as management’s actions taken in discharging responsibilitiesfor accounting, financial reporting, and internal control. Crowe Chizek andCompany LLC, independent registered public accounting firm, and the internalauditors have direct and confidential access to the Audit Committee at alltimes to discuss the results of their examinations.

Managementassessed the system of internal control over financial reporting as of December 31,2004, in relation to criteria for effective internal control over financialreporting as described in “Internal Control-Integrated Framework,” issued bythe Committee of Sponsoring Organizations of the Treadway Commission. Based onthis assessment, management concludes that, as of December 31, 2004, itssystem of internal control over financial reporting is effective and meets thecriteria of the “Internal Control—Integrated Framework”. Crowe Chizek andCompany LLC, independent registered public accounting firm, has issued anattestation report on management’s assessment of the Corporation’s internalcontrol over financial reporting.
| Date: March 15, 2005 | By:      | /s/ B. KEITH JOHNSON                    |
|--------------------------------|----------|-----------------------------------------|
|                           |     | B. Keith Johnson                        |
|                           | * * | *President and Chief Executive Officer* |
| Date: March 15,  2005     | By:      | /s/ GREGORY SCHREACKE                   |
|                           |     | Gregory Schreacke                       |
|                           | * * | *Chief Financial Officer*               |
|                           | * * | *Principal Accounting Officer*          |

 

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** **

**Reportof Independent Registered Public Accounting Firm On Internal Control OverFinancial Reporting**

We have audited management’s assessment, included inthe accompanying Report on Management’s Assessment of Internal Control OverFinancial Reporting, that First Financial Service Corporation maintainedeffective internal control over financial reporting as of December 31,2004, based on criteria established in Internal Control—Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission(COSO). First Financial Service Corporation’s management is responsible formaintaining effective internal control over financial reporting and for itsassessment of the effectiveness of internal control over financial reporting. Ourresponsibility is to express an opinion on management’s assessment and anopinion on the effectiveness of the company’s internal control over financialreporting based on our audit.

We conducted our audit in accordance with thestandards of the Public Company Accounting Oversight Board (United States). Thosestandards require that we plan and perform the audit to obtain reasonableassurance about whether effective internal control over financial reporting wasmaintained in all material respects. Our audit included obtaining anunderstanding of internal control over financial reporting, evaluatingmanagement’s assessment, testing and evaluating the design and operatingeffectiveness of internal control, and performing such other procedures as weconsidered necessary in the circumstances. We believe that our audit provides areasonable basis for our opinion.

A company’s internal control over financial reportingis a process designed to provide reasonable assurance regarding the reliabilityof financial reporting and the preparation of financial statements for externalpurposes in accordance with United States of America generally acceptedaccounting principles. A company’s internal control over financial reportingincludes those policies and procedures that (1) pertain to the maintenanceof records that, in reasonable detail, accurately and fairly reflect thetransactions and dispositions of the assets of the company; (2) providereasonable assurance that transactions are recorded as necessary to permitpreparation of financial statements in accordance with generally acceptedaccounting principles, and that receipts and expenditures of the company arebeing made only in accordance with authorizations of management and directorsof the company; and (3) provide reasonable assurance regarding preventionor timely detection of unauthorized acquisition, use, or disposition of thecompany’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal controlover financial reporting may not prevent or detect misstatements. Also,projections of any evaluation of effectiveness to future periods are subject tothe risk that controls may become inadequate because of changes in conditions,or that the degree of compliance with the policies or procedures maydeteriorate.

In our opinion, management’s assessment that FirstFinancial Service Corporation maintained effective internal control overfinancial reporting as of December 31, 2004 is fairly stated, in allmaterial respects, based on criteria established in Internal Control—IntegratedFramework issued by the Committee of Sponsoring Organizations of the TreadwayCommission (COSO). Also, in our opinion, First Financial Service Corporationmaintained, in all material respects, effective internal control over financialreporting as of December 31, 2004 based on criteria established inInternal Control—Integrated Framework issued by the Committee of SponsoringOrganizations of the Treadway Commission (COSO).

We have also audited, inaccordance with the standards of the Public Company Accounting Oversight Board(United States of America), the accompanying consolidated statements of financialcondition of First Financial Service Corporation as of December 31, 2004and 2003 and the related statements of income and comprehensive income,stockholders’ equity, and cash flows for the years ended December 31, 

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2004 and2003, the six month period ended December 31, 2002, and the year ended June 30,2002 and our report dated March 15, 2005 expressed an unqualified opinion.
|                      | Crowe Chizek and Company LLC |
|----------------------|------------------------------|
| Louisville, Kentucky |                         |
| March 15, 2005  |                         |

 

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** **

**Reportof Independent Registered Public Accounting Firm On Financial Statements**

Board of Directors and StockholdersFirst Financial Service CorporationElizabethtown,Kentucky

We have audited the accompanying consolidatedstatements of financial condition of First Financial Service Corporation as of December 31,2004 and 2003, and the related consolidated statements of income, comprehensiveincome, changes in stockholders’ equity and cash flows for the years ended December 31,2004 and 2003, the six month period ended December 31, 2002 and the yearended June 30, 2002. These financial statements are the responsibility ofthe Corporation’s management. Our responsibility is to express an opinion onthese financial statements based on our audits.

We conducted our audits in accordance with auditingstandards of the Public Company Accounting Oversight Board  (United States). Those standards require thatwe plan and perform the audit to obtain reasonable assurance about whether thefinancial statements are free of material misstatement. An audit includesexamining, on a test basis, evidence supporting the amounts and disclosures inthe financial statements. An audit also includes assessing the accountingprinciples used and significant estimates made by management, as well asevaluating the overall financial statement presentation. We believe that ouraudits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statementsreferred to above present fairly, in all material respects, the financialposition of First Financial Service Corporation as of December 31, 2004and 2003, and the results of its operations and its cash flows for the yearsended December 31, 2004 and 2003, the six month period ended December 31,2002 and the year ended June 30, 2002 in conformity with accountingprinciples generally accepted in the United States of America.

We also have audited, inaccordance with the standards of the Public Company Accounting Oversight Board(United States), the effectiveness of First Financial Service Corporation’s internal control over financialreporting as of December 31, 2004, based on criteria established inInternal Control-Integrated Framework issued by the Committee of SponsoringOrganizations of the Treadway Commission and our report dated March 15,2005 expressed an unqualified opinion thereon.
|                      | Crowe Chizek and Company LLC |
|----------------------|------------------------------|
| Louisville, Kentucky |                         |
| March 15, 2005  |                         |

 

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**FIRST FINANCIAL SERVICE CORPORATIONConsolidated Statements of Financial Condition**
| ** **                                                                                                                                         | ** ** | **December 31,**                                                                        | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------|------------|
| ** **                                                                                                                                         | ** ** | **       2004       ** | ** ** | **       2003       ** | ** ** |
| ** **                                                                                                                                         | ** ** | **(Dollars In Thousands,  Except Share Data)**                           | ** ** |
| **ASSETS**                                                                                                                                         |       |                                                                                         |       |   |   |   |   |   |   |
| Cash and due from banks                                                                                                                            |       |                                                                                         | $          | 27,910 |   |   |   | $ | 28,030 |   |   |
| Federal funds sold                                                                                                                                 |       |                                                                                         | 8,000      |   |   |   | 20,000 |   |   |
| Cash and cash equivalents                                                                                                                          |       |                                                                                         | 35,910     |   |   |   | 48,030 |   |   |
| Securities available-for-sale                                                                                                                      |       |                                                                                         | 21,928     |   |   |   | 4,009 |   |   |
| Securities held-to-maturity, fair value of  $34,557(2004) and $30,919 (2003)                                                                       |       |                                                                                         | 34,915     |   |   |   | 30,929 |   |   |
| Total securities                                                                                                                                   |       |                                                                                         | 56,843     |   |   |   | 34,938 |   |   |
| Loans held for sale                                                                                                                                |       |                                                                                         | 1,219      |   |   |   | 1,021 |   |   |
| Loans receivable, net of unearned fees                                                                                                             |       |                                                                                         | 604,698    |   |   |   | 554,700 |   |   |
| Allowance for loan losses                                                                                                                          |       |                                                                                         | (6,489     | ) |   |   | (5,568 | ) |   |
| Net loans receivable                                                                                                                               |       |                                                                                         | 599,428    |   |   |   | 550,153 |   |   |
| Federal Home Loan Bank stock                                                                                                                       |       |                                                                                         | 6,845      |   |   |   | 6,570 |   |   |
| Cash surrender value of life insurance                                                                                                             |       |                                                                                         | 7,353      |   |   |   | 7,067 |   |   |
| Premises and equipment, net                                                                                                                        |       |                                                                                         | 17,469     |   |   |   | 15,466 |   |   |
| Real estate owned:                                                                                                                                 |       |                                                                                         |       |   |   |   |   |   |   |
| Acquired through foreclosure                                                                                                                       |       |                                                                                         | 681        |   |   |   | 387 |   |   |
| Held for development                                                                                                                               |       |                                                                                         | 389        |   |   |   | 446 |   |   |
| Other repossessed assets                                                                                                                           |       |                                                                                         | 40         |   |   |   | 62 |   |   |
| Goodwill                                                                                                                                           |       |                                                                                         | 8,384      |   |   |   | 8,384 |   |   |
| Accrued interest receivable                                                                                                                        |       |                                                                                         | 2,487      |   |   |   | 1,931 |   |   |
| Other assets                                                                                                                                       |       |                                                                                         | 1,817      |   |   |   | 2,901 |   |   |
| **TOTAL ASSETS**                                                                                                                                   |       |                                                                                         | $          | 737,646 |   |   |   | $ | 676,335 |   |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                      |       |                                                                                         |       |   |   |   |   |   |   |
| **LIABILITIES:**                                                                                                                                   |       |                                                                                         |       |   |   |   |   |   |   |
| Deposits:                                                                                                                                          |       |                                                                                         |       |   |   |   |   |   |   |
| Non-interest bearing                                                                                                                               |       |                                                                                         | $          | 38,441 |   |   |   | $ | 28,632 |   |   |
| Interest bearing                                                                                                                                   |       |                                                                                         | 547,945    |   |   |   | 500,530 |   |   |
| Total deposits                                                                                                                                     |       |                                                                                         | 586,386    |   |   |   | 529,162 |   |   |
| Advances from Federal Home Loan Bank                                                                                                               |       |                                                                                         | 78,904     |   |   |   | 78,283 |   |   |
| Subordinated debentures                                                                                                                            |       |                                                                                         | 10,000     |   |   |   | 10,000 |   |   |
| Accrued interest payable                                                                                                                           |       |                                                                                         | 413        |   |   |   | 416 |   |   |
| Accounts payable and other liabilities                                                                                                             |       |                                                                                         | 637        |   |   |   | 1,027 |   |   |
| Deferred income taxes                                                                                                                              |       |                                                                                         | 1,505      |   |   |   | 1,126 |   |   |
| **TOTAL LIABILITIES**                                                                                                                              |       |                                                                                         | 677,845    |   |   |   | 620,014 |   |   |
| **STOCKHOLDERS’  EQUITY:**                                                                                                                    |       |                                                                                         |       |   |   |   |   |   |   |
| Serial preferred stock, 5,000,000 shares authorized  and unissued                                                                                  |       |                                                                                         | —     |   |   |   | — |   |   |
| Common stock, $1 par value per share; authorized  10,000,000 shares; issued and outstanding, 3,645,438 shares (2004), and  3,705,438 shares (2003) |       |                                                                                         | 3,645      |   |   |   | 3,705 |   |   |
| Additional paid-in capital                                                                                                                         |       |                                                                                         | 8,226      |   |   |   | 9,726 |   |   |
| Retained earnings                                                                                                                                  |       |                                                                                         | 47,174     |   |   |   | 42,092 |   |   |
| Accumulated other comprehensive income, net of tax                                                                                                 |       |                                                                                         | 756        |   |   |   | 798 |   |   |
| **TOTAL STOCKHOLDERS’ EQUITY**                                                                                                                |       |                                                                                         | 59,801     |   |   |   | 56,321 |   |   |
| **TOTAL  LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                               |       |                                                                                         | $          | 737,646 |   |   |   | $ | 676,335 |   |   |

 

See notes to consolidated financial statements.

48

----

**FIRST FINANCIALSERVICE CORPORATIONConsolidated Statements of Income**
| ** **                                                | ** ** | ** **                                                                       | ** ** | ** **                                                                       | ** ** | **Six Months Ended**                                                   | ** ** | **Year Ended**                                                              | ** ** |
|-----------------------------------------------------------|------------|----------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------|------------|
| ** **                                                | ** ** | **Year Ended December 31,**                                       | ** ** | **December 31, **                                                      | ** ** | **June 30,**                                                                | ** ** |
| ** **                                                | ** ** | **      2004      ** | ** ** | **      2003      ** | ** ** | **      2002      ** | ** ** | **      2002      ** | ** ** |
| ** **                                                | ** ** | **(Dollars in thousands, except per share data)**  | ** ** |
| **Interest Income:**                                      |       |                                                                             |       | ** **                                                                       |       |                                                                             |       | ** **                                                                       |       |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Interest and fees on loans                                |       |                                                                             | $          | 37,364                                                                           | ** ** |                                                                             |       | $                                                                                | 37,413     | ** ** |   |   | $ | 20,346 | ** ** |   |   | $ | 42,045 | ** ** |   |
| Interest and dividends on investments and deposits        |       |                                                                             | 1,779      | ** **                                                                       |       |                                                                             | 1,926      | ** **                                                                       |       |   | 1,210 | ** ** |   |   | 2,055 | ** ** |   |
| Total interest income                                     |       |                                                                             | 39,143     | ** **                                                                       |       |                                                                             | 39,339     | ** **                                                                       |       |   | 21,556 | ** ** |   |   | 44,100 | ** ** |   |
| **Interest  Expense:**                                    |       |                                                                             |       | ** **                                                                       |       |                                                                             |       | ** **                                                                       |       |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Deposits                                                  |       |                                                                             | 10,478     | ** **                                                                       |       |                                                                             | 12,124     | ** **                                                                       |       |   | 7,244 | ** ** |   |   | 17,513 | ** ** |   |
| Federal funds purchased                                   |       |                                                                             | 47         | ** **                                                                       |       |                                                                             | —     | ** **                                                                       |       |   | — | ** ** |   |   | — | ** ** |   |
| Federal Home Loan Bank advances                           |       |                                                                             | 3,738      | ** **                                                                       |       |                                                                             | 3,738      | ** **                                                                       |       |   | 1,888 | ** ** |   |   | 3,741 | ** ** |   |
| Subordinated debentures                                   |       |                                                                             | 529        | ** **                                                                       |       |                                                                             | 503        | ** **                                                                       |       |   | 262 | ** ** |   |   | 172 | ** ** |   |
| Total interest expense                                    |       |                                                                             | 14,792     | ** **                                                                       |       |                                                                             | 16,365     | ** **                                                                       |       |   | 9,394 | ** ** |   |   | 21,426 | ** ** |   |
| Net interest income                                       |       |                                                                             | 24,351     | ** **                                                                       |       |                                                                             | 22,974     | ** **                                                                       |       |   | 12,162 | ** ** |   |   | 22,674 | ** ** |   |
| Provision for loan  losses                                |       |                                                                             | 1,656      | ** **                                                                       |       |                                                                             | 1,656      | ** **                                                                       |       |   | 1,161 | ** ** |   |   | 1,604 | ** ** |   |
| Net interest income after provision for loan  losses |       |                                                                             | 22,695     | ** **                                                                       |       |                                                                             | 21,318     | ** **                                                                       |       |   | 11,001 | ** ** |   |   | 21,070 | ** ** |   |
| **Non-interest  Income:**                                 |       |                                                                             |       | ** **                                                                       |       |                                                                             |       | ** **                                                                       |       |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Customer service fees on deposit accounts                 |       |                                                                             | 4,913      | ** **                                                                       |       |                                                                             | 4,556      | ** **                                                                       |       |   | 2,139 | ** ** |   |   | 3,283 | ** ** |   |
| Gain on sale of mortgage loans                            |       |                                                                             | 862        | ** **                                                                       |       |                                                                             | 1,564      | ** **                                                                       |       |   | 518 | ** ** |   |   | 651 | ** ** |   |
| Gain on sale of investments                               |       |                                                                             | 202        | ** **                                                                       |       |                                                                             | —     | ** **                                                                       |       |   | — | ** ** |   |   | — | ** ** |   |
| Gain on sale of real estate held for development          |       |                                                                             | 526        | ** **                                                                       |       |                                                                             | 437        | ** **                                                                       |       |   | — | ** ** |   |   | — | ** ** |   |
| Brokerage and insurance commissions                       |       |                                                                             | 404        | ** **                                                                       |       |                                                                             | 353        | ** **                                                                       |       |   | 230 | ** ** |   |   | 543 | ** ** |   |
| Other income                                              |       |                                                                             | 1,197      | ** **                                                                       |       |                                                                             | 1,071      | ** **                                                                       |       |   | 290 | ** ** |   |   | 921 | ** ** |   |
| Total non-interest income                                 |       |                                                                             | 8,104      | ** **                                                                       |       |                                                                             | 7,981      | ** **                                                                       |       |   | 3,177 | ** ** |   |   | 5,398 | ** ** |   |
| **Non-interest  Expense:**                                |       |                                                                             |       | ** **                                                                       |       |                                                                             |       | ** **                                                                       |       |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Employee compensation and benefits                        |       |                                                                             | 10,295     | ** **                                                                       |       |                                                                             | 9,446      | ** **                                                                       |       |   | 4,005 | ** ** |   |   | 7,262 | ** ** |   |
| Office occupancy expense and equipment                    |       |                                                                             | 1,833      | ** **                                                                       |       |                                                                             | 1,534      | ** **                                                                       |       |   | 786 | ** ** |   |   | 1,488 | ** ** |   |
| Marketing and advertising                                 |       |                                                                             | 726        | ** **                                                                       |       |                                                                             | 568        | ** **                                                                       |       |   | 287 | ** ** |   |   | 612 | ** ** |   |
| Outside services and data processing                      |       |                                                                             | 2,134      | ** **                                                                       |       |                                                                             | 1,826      | ** **                                                                       |       |   | 855 | ** ** |   |   | 1,545 | ** ** |   |
| State franchise tax                                       |       |                                                                             | 822        | ** **                                                                       |       |                                                                             | 623        | ** **                                                                       |       |   | 268 | ** ** |   |   | 472 | ** ** |   |
| Goodwill amortization                                     |       |                                                                             | —     | ** **                                                                       |       |                                                                             | —     | ** **                                                                       |       |   | — | ** ** |   |   | 832 | ** ** |   |
| Other expense                                             |       |                                                                             | 3,464      | ** **                                                                       |       |                                                                             | 3,295      | ** **                                                                       |       |   | 1,396 | ** ** |   |   | 3,070 | ** ** |   |
| Total non-interest expense                                |       |                                                                             | 19,274     | ** **                                                                       |       |                                                                             | 17,292     | ** **                                                                       |       |   | 7,597 | ** ** |   |   | 15,281 | ** ** |   |
| Income before income taxes                                |       |                                                                             | 11,525     | ** **                                                                       |       |                                                                             | 12,007     | ** **                                                                       |       |   | 6,581 | ** ** |   |   | 11,187 | ** ** |   |
| Income taxes                                              |       |                                                                             | 3,735      | ** **                                                                       |       |                                                                             | 4,004      | ** **                                                                       |       |   | 2,199 | ** ** |   |   | 3,729 | ** ** |   |
| **Net Income**                                            |       |                                                                             | $          | 7,790                                                                            | ** ** |                                                                             |       | $                                                                                | 8,003      | ** ** |   |   | $ | 4,382 | ** ** |   |   | $ | 7,458 | ** ** |   |
| Shares applicable to basic income per share               |       |                                                                             | 3,659      | ** **                                                                       |       |                                                                             | 3,780      | ** **                                                                       |       |   | 4,035 | ** ** |   |   | 4,128 | ** ** |   |
| **Basic  income per share**                               |       |                                                                             | $          | 2.13                                                                             | ** ** |                                                                             |       | $                                                                                | 2.12       | ** ** |   |   | $ | 1.09 | ** ** |   |   | $ | 1.81 | ** ** |   |
| Shares applicable to diluted income per share             |       |                                                                             | 3,675      | ** **                                                                       |       |                                                                             | 3,815      | ** **                                                                       |       |   | 4,052 | ** ** |   |   | 4,146 | ** ** |   |
| **Diluted  income per share**                             |       |                                                                             | $          | 2.12                                                                             | ** ** |                                                                             |       | $                                                                                | 2.10       | ** ** |   |   | $ | 1.08 | ** ** |   |   | $ | 1.80 | ** ** |   |

 

See notes to consolidated financial statements.

49

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**FIRST FINANCIALSERVICE CORPORATIONConsolidated Statements of Comprehensive Income**
| ** **                                                     | ** ** | **Year Ended December 31,**                                       | ** ** | **Six Months Ended  December 31,**                                | ** ** | **Year Ended  June 30,** | ** ** |
|----------------------------------------------------------------|------------|----------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------|------------|------------------------------------|------------|
| ** **                                                     | ** ** | **      2004      ** | ** ** | **      2003      ** | ** ** | **2002**                           | ** ** | **2002** | ** ** |
| ** **                                                     | ** ** | **(Dollars in thousands)**                                             | ** ** |
| **Net  Income**                                                |       |                                                                             | $          | 7,790                                                                            |       |                               |       | $ | 8,003 |   |   |   | $ | 4,382 |   |   |   | $ | 7,458 |   |   |
| Other comprehensive  income (loss):                            |       |                                                                             |       |                                                                             |       |                               |       |   |   |   |   |   |   |   |   |   |   |
| Change in unrealized gain (loss) on securities                 |       |                                                                             | 138        |                                                                             |       |                               | 606        |   |   |   | 20 |   |   |   | (35 | ) |   |
| Reclassification of realized amount                            |       |                                                                             | (202       | )                                                                                |       |                               | —     |   |   |   | — |   |   |   | — |   |   |
| Net unrealized gain (loss) recognized in comprehensive  income |       |                                                                             | (64        | )                                                                                |       |                               | 606        |   |   |   | 20 |   |   |   | (35 | ) |   |
| Tax effect                                                     |       |                                                                             | 22         |                                                                             |       |                               | (206       | ) |   |   | (7 | ) |   |   | 12 |   |   |
| Total other comphrehensive income (loss)                       |       |                                                                             | (42        | )                                                                                |       |                               | 400        |   |   |   | 13 |   |   |   | (23 | ) |   |
| **Comphrehensive  Income**                                     |       |                                                                             | $          | 7,748                                                                            |       |                               |       | $ | 8,403 |   |   |   | $ | 4,395 |   |   |   | $ | 7,435 |   |   |

 

See notes to consolidated financial statements.

50

----

**FIRST FINANCIAL SERVICE CORPORATIONConsolidated Statements of Changes in Stockholders’ EquityYear Ended June 2002Six Months Ended December 31, 2002Years Ending December 31, 2003 and 2004**
| ** **                                                                            | ** ** | ** **                                                         | ** ** | ** ** | ** ** | ** **     | ** ** | ** **   | ** ** | **Accumulated**              | ** ** | ** ** | ** ** |
|---------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|------------|------------|----------------|------------|--------------|------------|------------------------------|------------|------------|------------|
| ** **                                                                            | ** ** | ** **                                                         | ** ** | ** ** | ** ** | ** **     | ** ** | ** **   | ** ** | **Other**                    | ** ** | ** ** | ** ** |
| ** **                                                                            | ** ** | ** **                                                         | ** ** | ** ** | ** ** | **Additional** | ** ** | ** **   | ** ** | **Comprehensive**            | ** ** | ** ** | ** ** |
| ** **                                                                            | ** ** | **Common**                                                         | ** ** | **Stock**  | ** ** | **Paid-in**    | ** ** | **Retained** | ** ** | **Income, Net of** | ** ** | ** ** | ** ** |
| ** **                                                                            | ** ** | **Shares**                                                         | ** ** | **Amount** | ** ** | **Capital**    | ** ** | **Earnings** | ** ** | **Tax**                      | ** ** | **Total**  | ** ** |
| ** **                                                                            | ** ** | **(In thousands, except per share data)** | ** ** |
| **Balance,  June 30, 2001**                                                           |       |                                                               | 3,758      |       |       | $              | 3,758      |         | $          | 21                           |       | $          | 50,405     |   |   | $ | 408 |   |   | $ | 54,592 |   |
| Net income                                                                            |       |                                                               |       |       |       |           |       |         |       | 7,458                        |       |       |       |   |   | 7,458 |   |
| Exercise of stock  options, net of redemptions                                   |       |                                                               | 3          |       |       | 3              |       | (3           | )          |                         |       |       |       |   |   | — |   |
| Net change in  unrealized gain (losses) on securities available-for-sale, net of tax  |       |                                                               |       |       |       |           |       |         |       |                         |       |       | (23        | ) |   | (23 | ) |
| Cash dividends  declared ($.65 per share)                                             |       |                                                               |       |       |       |           |       |         |       | (2,700                       | )          |       |       |   |   | (2,700 | ) |
| Stock repurchased                                                                     |       |                                                               | (32        | )          |       | (32            | )          | —       |       | (680                         | )          |       | —     |   |   | (712 | ) |
| **Balance, June 30, 2002**                                                            |       |                                                               | 3,729      |       |       | 3,729          |       | 18           |       | 54,483                       |       |       | 385        |   |   | 58,615 |   |
| Net income                                                                            |       |                                                               |       |       |       |           |       |         |       | 4,382                        |       |       |       |   |   | 4,382 |   |
| Exercise of stock  options, net of redemptions                                   |       |                                                               | 2          |       |       | 2              |       | (2           | )          |                         |       |       |       |   |   | — |   |
| Net change in  unrealized gains (losses) on securities available-for-sale, net of tax |       |                                                               |       |       |       |           |       |         |       |                         |       |       | 13         |   |   | 13 |   |
| Cash dividends  declared ($.33 per share)                                             |       |                                                               |       |       |       |           |       |         |       | (1,316                       | )          |       |       |   |   | (1,316 | ) |
| Stock repurchased                                                                     |       |                                                               | (87        | )          |       | (87            | )          | (16          | )          | (1,944                       | )          |       | —     |   |   | (2,047 | ) |
| **Balance, December 31, 2002**                                                        |       |                                                               | 3,644      |       |       | 3,644          |       | —       |       | 55,605                       |       |       | 398        |   |   | 59,647 |   |
| Net income                                                                            |       |                                                               |       |       |       |           |       |         |       | 8,003                        |       |       |       |   |   | 8,003 |   |
| Stock dividend—10%                                                               |       |                                                               | 337        |       |       | 337            |       | 10,213       |       | (10,550                      | )          |       |       |   |   | — |   |
| Exercise of stock  options, net of redemptions                                   |       |                                                               | 34         |       |       | 34             |       | 525          |       |                         |       |       |       |   |   | 559 |   |
| Net change in  unrealized gains (losses) on securities available-for-sale, net of tax |       |                                                               |       |       |       |           |       |         |       |                         |       |       | 400        |   |   | 400 |   |
| Cash dividends  declared ($.70 per share)                                             |       |                                                               |       |       |       |           |       |         |       | (2,660                       | )          |       |       |   |   | (2,660 | ) |
| Stock repurchased                                                                     |       |                                                               | (310       | )          |       | (310           | )          | (1,012       | )          | (8,306                       | )          |       | —     |   |   | (9,628 | ) |
| **Balance,  December 31, 2003**                                                       |       |                                                               | 3,705      |       |       | 3,705          |       | 9,726        |       | 42,092                       |       |       | 798        |   |   | 56,321 |   |
| Net income                                                                            |       |                                                               |       |       |       |           |       |         |       | 7,790                        |       |       |       |   |   | 7,790 |   |
| Net change in  unrealized gains (losses) on securities available-for-sale, net of tax |       |                                                               |       |       |       |           |       |         |       |                         |       |       | (42        | ) |   | (42 | ) |
| Cash dividends  declared ($.74 per share)                                             |       |                                                               |       |       |       |           |       |         |       | (2,708                       | )          |       |       |   |   | (2,708 | ) |
| Stock repurchased                                                                     |       |                                                               | (60        | )          |       | (60            | )          | (1,500       | )          | —                       |       |       | —     |   |   | (1,560 | ) |
| **Balance, December 31, 2004**                                                        |       |                                                               | 3,645      |       |       | $              | 3,645      |         | $          | 8,226                        |       | $          | 47,174     |   |   | $ | 756 |   |   | $ | 59,801 |   |

 

See notes to consolidated financial statements.

51

----

**FIRST FINANCIALSERVICE CORPORATIONConsolidated Statements of Cash Flows**
| ** **                                                                         | ** ** | ** **                                                                       | ** ** | ** **                                                                       | ** ** | **Six Months Ended** | ** ** | **Year Ended** | ** ** |
|------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------|------------|--------------------------------|------------|---------------------|------------|
| ** **                                                                         | ** ** | **Year Ended December 31,**                                       | ** ** | **December 31,**                                                            | ** ** | **June 30,**              | ** ** |
| ** **                                                                         | ** ** | **      2004      ** | ** ** | **      2003      ** | ** ** | **2002**                       | ** ** | **2002**            | ** ** |
| ** **                                                                         | ** ** | **(Dollars in thousands)**                                             | ** ** |
| **Operating Activities:**                                                          |       |                                                                             |       |                                                                             |       |                           |       |                |       |   |   |   |   |   |   |   |   |
| Net income                                                                         |       |                                                                             | $          | 7,790                                                                            |       |                           |       | $                   | 8,003      |   |   |   | $ | 4,382 |   |   |   | $ | 7,458 |   |   |
| Adjustments  to reconcile net income to net cash provided by operating activities: |       |                                                                             |       |                                                                             |       |                           |       |                |       |   |   |   |   |   |   |   |   |
| Provision for loan losses                                                          |       |                                                                             | 1,656      |                                                                             |       |                           | 1,656      |                |       |   | 1,161 |   |   |   | 1,604 |   |   |
| Depreciation on premises and equipment                                             |       |                                                                             | 1,119      |                                                                             |       |                           | 981        |                |       |   | 505 |   |   |   | 1,052 |   |   |
| Federal Home Loan Bank stock dividends                                             |       |                                                                             | (275       | )                                                                                |       |                           | (256       | )                   |       |   | (144 | ) |   |   | (325 | ) |   |
| Goodwill amortization                                                              | ** ** | ** **                                                                       | —     |                                                                             |       |                           | —     |                |       |   | — |   |   |   | 832 |   |   |
| Net amortization (accretion)                                                       |       |                                                                             | 87         |                                                                             |       |                           | (204       | )                   |       |   | 13 |   |   |   | (58 | ) |   |
| Gain on sale of investments available-for-sale                                     |       |                                                                             | (202       | )                                                                                |       |                           | —     |                |       |   | — |   |   |   | — |   |   |
| Gain on sale of real estate held for development                                   |       |                                                                             | (526       | )                                                                                |       |                           | (437       | )                   |       |   | — |   |   |   | — |   |   |
| Gain on sale of mortgage loans                                                     |       |                                                                             | (862       | )                                                                                |       |                           | (1,564     | )                   |       |   | (518 | ) |   |   | (651 | ) |   |
| Origination of loans held for sale                                                 |       |                                                                             | (52,368    | )                                                                                |       |                           | (87,233    | )                   |       |   | (33,536 | ) |   |   | (41,461 | ) |   |
| Proceeds on sale of loans held for sale                                            |       |                                                                             | 53,032     |                                                                             |       |                           | 91,452     |                |       |   | 31,889 |   |   |   | 41,233 |   |   |
| Deferred taxes                                                                     |       |                                                                             | 401        |                                                                             |       |                           | 95         |                |       |   | (212 | ) |   |   | (523 | ) |   |
| Changes  in:                                                                       |       |                                                                             |       |                                                                             |       |                           |       |                |       |   |   |   |   |   |   |   |   |
| Cash surrender value of life insurance                                             |       |                                                                             | (286       | )                                                                                |       |                           | (67        | )                   |       |   | — |   |   |   | — |   |   |
| Interest receivable                                                                |       |                                                                             | (556       | )                                                                                |       |                           | (189       | )                   |       |   | 183 |   |   |   | 99 |   |   |
| Other assets                                                                       |       |                                                                             | 1,084      |                                                                             |       |                           | (520       | )                   |       |   | (421 | ) |   |   | (101 | ) |   |
| Interest payable                                                                   |       |                                                                             | (3         | )                                                                                |       |                           | (88        | )                   |       |   | (12 | ) |   |   | (1,453 | ) |   |
| Accounts payable and other liabilities                                             |       |                                                                             | (150       | )                                                                                |       |                           | 79         |                |       |   | (627 | ) |   |   | (901 | ) |   |
| Net cash from operating activities                                                 |       |                                                                             | 9,941      |                                                                             |       |                           | 11,708     |                |       |   | 2,663 |   |   |   | 6,805 |   |   |
| **Investing Activities:**                                                          |       |                                                                             |       |                                                                             |       |                           |       |                |       |   |   |   |   |   |   |   |   |
| Change in interest bearing deposits                                                | ** ** | ** **                                                                       | —     |                                                                             |       |                           | —     |                |       |   | 64,000 |   |   |   | (64,000 | ) |   |
| Sales of securities available-for-sale                                             |       |                                                                             | 745        |                                                                             |       |                           | —     |                |       |   | — |   |   |   | — |   |   |
| Purchases of securities available-for-sale                                         |       |                                                                             | (18,640    | )                                                                                |       |                           | (1,415     | )                   |       |   | — |   |   |   | — |   |   |
| Purchases of securities held-to-maturity                                           |       |                                                                             | (24,100    | )                                                                                |       |                           | (46,078    | )                   |       |   | (29,000 | ) |   |   | (24,000 | ) |   |
| Maturities of securities held-to-maturity                                          |       |                                                                             | 20,141     |                                                                             |       |                           | 31,940     |                |       |   | 34,126 |   |   |   | 23,263 |   |   |
| Investment in cash surrender value of life insurance                               | ** ** | ** **                                                                       | —     |                                                                             |       |                           | (7,000     | )                   |       |   | — |   |   |   | — |   |   |
| Net increase in loans                                                              |       |                                                                             | (51,005    | )                                                                                |       |                           | (25,750    | )                   |       |   | (7,120 | ) |   |   | (4,254 | ) |   |
| Net purchases of premises and equipment                                            |       |                                                                             | (3,288     | )                                                                                |       |                           | (4,603     | )                   |       |   | (690 | ) |   |   | (1,085 | ) |   |
| Sales of real estate held for development                                          |       |                                                                             | 509        |                                                                             |       |                           | 540        |                |       |   | — |   |   |   | — |   |   |
| Net cash from investing activities                                                 |       |                                                                             | (75,638    | )                                                                                |       |                           | (52,366    | )                   |       |   | 61,316 |   |   |   | (70,076 | ) |   |
| **Financing Activities**                                                           |       |                                                                             |       |                                                                             |       |                           |       |                |       |   |   |   |   |   |   |   |   |
| Net change in deposits                                                             |       |                                                                             | 57,224     |                                                                             |       |                           | 8,041      |                |       |   | (8,761 | ) |   |   | 61,057 |   |   |
| Advances from Federal Home Loan Bank                                               |       |                                                                             | 821        |                                                                             |       |                           | 844        |                |       |   | — |   |   |   | 723 |   |   |
| Repayments to Federal Home Loan Bank                                               |       |                                                                             | (200       | )                                                                                |       |                           | (244       | )                   |       |   | (95 | ) |   |   | (243 | ) |   |
| Proceeds from stock options exercised                                              | ** ** | ** **                                                                       | —     |                                                                             |       |                           | 559        |                |       |   | — |   |   |   | — |   |   |
| Net proceeds from issuance of subordinated debentures                              | ** ** | ** **                                                                       | —     |                                                                             |       |                           | —     |                |       |   | — |   |   |   | 9,698 |   |   |
| Dividends paid                                                                     |       |                                                                             | (2,708     | )                                                                                |       |                           | (2,660     | )                   |       |   | (1,316 | ) |   |   | (2,700 | ) |   |
| Common stock repurchased                                                           |       |                                                                             | (1,560     | )                                                                                |       |                           | (9,628     | )                   |       |   | (2,047 | ) |   |   | (712 | ) |   |
| Net cash from financing activities                                                 |       |                                                                             | 53,577     |                                                                             |       |                           | (3,088     | )                   |       |   | (12,219 | ) |   |   | 67,823 |   |   |
| **Increase (decrease) in cash and cash equivalents**                               |       |                                                                             | (12,120    | )                                                                                |       |                           | (43,746    | )                   |       |   | 51,760 |   |   |   | 4,552 |   |   |
| **Cash and cash equivalents, beginning of year**                                   |       |                                                                             | 48,030     |                                                                             |       |                           | 91,776     |                |       |   | 40,016 |   |   |   | 35,464 |   |   |
| **Cash and cash equivalents, end of year**                                         |       |                                                                             | $          | 35,910                                                                           |       |                           |       | $                   | 48,030     |   |   |   | $ | 91,776 |   |   |   | $ | 40,016 |   |   |

 

See notes to consolidated financial statements.

52

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**1.**   SUMMARYOF SIGNIFICANT ACCOUNTING POLICIES

The following is a description of the significantaccounting policies First Financial Service Corporation follows in preparingand presenting its consolidated financial statements:

**Principlesof Consolidation and Business**—The consolidatedfinancial statements include the accounts of First Financial ServiceCorporation and its wholly owned subsidiary, First Federal Savings Bank. First Federal Savings Bank has three whollyowned subsidiaries, First Service Corporation of Elizabethtown, First HeartlandMortgage Company and First Federal Office Park, LLC. Unless the textclearly suggests otherwise, references to “us,” “we,” or “our” include FirstFinancial Service Corporation and its wholly-owned subsidiary. All significant intercompany transactions andbalances have been eliminated.

On January 8, 2003, the First Federal SavingsBank converted from a federal savings bank, regulated by the Office of ThriftSupervision (OTS), to a commercial bank chartered under Kentucky banking lawsregulated by the Federal Deposit Insurance Corporation (FDIC) and the KentuckyDepartment of Financial Institutions (KDFI). At the same time, the FirstFinancial Service Corporation became a bank holding company regulated by theFederal Reserve and changed its fiscal year from June 30 to December 31.

Our business consists primarily of attracting depositsfrom the general public and origination of mortgage loans on commercialproperty, single-family residences and multi-family housing. We also make homeimprovement loans, consumer loans and commercial business loans. Our primarylending area is a region within North Central Kentucky. The economy within thisregion is diversified with a variety of medical service, manufacturing, andagricultural industries, and Fort Knox, a military installation.

The principal sources of funds for our lending andinvestment activities are deposits, repayment of loans and Federal Home LoanBank advances. Our principal source of income is interest on loans. In addition,other income is derived from loan origination fees, service charges, returns oninvestment securities, gain on sale of mortgage loans, and brokerage andinsurance commissions.

First Service Corporation acts as a broker for thepurpose of selling investment services to our customers in the area oftax-deferred annuities, government securities and stocks and bonds. FirstHeartland Mortgage Company, through the secondary mortgage lending department,originates qualified government and conventional secondary market loans on thebehalf of the investors. First Federal Office Park, LLC holds commercial lotsadjacent to our home office on Ring Road in Elizabethtown, which are availablefor sale.

**Estimatesand Assumptions**—The preparation of consolidatedfinancial statements in conformity with accounting principles generallyaccepted in the United States of America requires us to make estimates andassumptions that affect the reported amounts of assets and liabilities anddisclosure of the amount of revenues and expenses during the reporting period. Actualresults could differ from those estimates. The allowance for loan losses andthe fair value of financial instruments are particularly subject to change.

**CashFlows**—For purposes of the statement of cash flows, weconsider all highly liquid debt instruments purchased with an original maturityof three months or less to be cash equivalents. Cash and cash equivalentsinclude cash on hand, amounts due from banks, federal funds sold and certaininterest bearing deposits. Net cash flows are reported for interest-bearingdeposits, loans, premises and equipment and deposits.

53

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**1.**   SUMMARY OFSIGNIFICANT ACCOUNTING POLICIES—(Continued)

**Securities**—Weclassify investments into held-to-maturity and available-for-sale. Debtsecurities in which management has a positive intent and ability to hold areclassified as held-to-maturity and are carried at cost adjusted for theamortization of premiums and discounts using the interest method over the termsof the securities. Debt and equity securities, which do not fall into thiscategory, nor held for the purpose of selling in the near term, are classifiedas available-for-sale. Unrealized holding gains and losses, net of tax, onavailable-for-sale securities are reported as a component of othercomprehensive income.

Interest income includes amortization of purchasepremium or discount. Premiums and discounts on securities are amortized on thelevel-yield method. Gains and losses on sales are recorded on the trade dateand determined using the specific identification method.

Declines in the fair value of securities below theircost that are other than temporary are reflected as realized losses. Inestimating other-than-temporary losses, management considers: (1) thelength of time and extent that fair value has been less than cost, (2) thefinancial condition and near term prospects of the issuer, and (3) our abilityand intent to hold the security for a period sufficient to allow for anyanticipated recovery in fair value.

**LoansReceivable**—Loans receivable are stated at unpaidprincipal balances, less undistributed construction loans, and net deferredloan origination fees. We defer loan origination fees and discounts net ofcertain direct origination costs. These net deferred fees are amortized usingthe level yield method on a loan-by-loan basis over the lives of the underlyingloans.

Interest income on loans is recognized on the accrualbasis except for those loans in nonaccrual status. The accrual of interest isdiscontinued when a loan becomes 90 or more days delinquent. When interestaccrual is discontinued, interest income is subsequently recognized only to theextent cash payments are received. Interest accruals resume when the loanbecomes less than 90 days delinquent.

**Allowancefor Loan Losses**—The allowance for loan losses is avaluation allowance for probable incurred credit losses. Loan losses arecharged against the allowance when we believe the uncollectibility of a loanbalance is confirmed. Subsequent recoveries, if any, are credited to theallowance. Our periodic evaluation of the adequacy of the allowance is based onour past loan loss experience, known and inherent risks in the portfolio,adverse situations that may affect the borrower’s ability to repay, estimatedvalue of any underlying collateral, and current economic conditions. Allocationsof the allowance may be made for specific loans, but the entire allowance isavailable for any loan that, in management’s judgment, should be charged-off.

The allowance consists of specific and generalcomponents. The specific component relates to loans that are individuallyclassified as impaired or loans otherwise classified as substandard or doubtful.The general component covers non-classified loans and is based on historicalloss experience adjusted for current factors.

Loans are considered impaired when, based on currentinformation and events, it is probable that full principal or interest paymentsare not anticipated in accordance with the contractual loan terms. Factorsconsidered by management in determining impairment include payment status,collateral value, and the probability of collecting scheduled principal andinterest payments when due. Loans that experience insignificant payment delaysand payment shortfalls generally are not classified as impaired. Impaired loansare carried at the present value of expected future cash flows discounted atthe loan’s effective interest rate or at the fair value of the collateral ifthe loan is collateral dependent. Commercial and commercial real estate loansare individually evaluated for impairment. Large groups of smaller balance 

54

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**1.**   SUMMARY OFSIGNIFICANT ACCOUNTING POLICIES—(Continued)

homogeneous loans, such asconsumer and residential real estate loans, are collectively evaluated forimpairment and are separately identified for impairment disclosures. A portionof the allowance for loan losses is allocated to impaired loans if the value ofsuch loans is less than the unpaid balance. If these allocations cause theallowance for loan losses to require an increase, such increase is reported inthe provision for loan losses.

**MortgageBanking Activities**—Mortgage loans originated andintended for sale in the secondary market are carried at the lower of aggregatecost or market value. To deliver closed loans to the secondary market and tocontrol its interest rate risk prior to sale, we enter into “best efforts”agreements to sell loans. The aggregate market value of mortgage loans held forsale considers the price of the sales contracts. The loans are sold withservicing released.

On July 1, 2002, we became subject to newaccounting guidance for certain commitments to originate loans. The newguidance requires loan commitments related to the origination of mortgage loansheld for sale to be accounted for as derivative instruments. Our commitmentsare for fixed rate mortgage loans, generally lasting 60 to 90 days and are atmarket rates when initiated. Considered derivatives, we had commitments tooriginate $3.3 million****and $2.2million in loans at December 31, 2004 and 2003, which we intend to sellafter the loans are closed.

The impact of adopting this guidance was not materialand substantially all of the gain on sale generated from mortgage bankingactivities continues to be recorded when closed loans are delivered into thesales contracts.

**FederalHome Loan Bank Stock**—Investment in stock of FederalHome Loan Bank is carried at cost.

**CashSurrender Value of Life Insurance**—We have purchasedlife insurance policies on certain key executives. The life insurance isrecorded at its cash surrender value, or the amount that can be realized.

**Premisesand Equipment**—Land is carried cost. Premises andequipment are stated at cost less accumulated depreciation. Buildings andrelated components are depreciated using the straight-line method with usefullives ranging from 5 to 40 years. Furniture, fixtures and equipment aredepreciated using the straight-line method with useful lives ranging from 3 to15 years.

**RealEstate Owned**—Real estate properties acquired throughforeclosure and in settlement of loans are stated at lower of cost or fairvalue less estimated selling costs at the date of foreclosure. The excess ofcost over fair value less the estimated costs to sell at the time offoreclosure is charged to the allowance for loan losses. Costs relating todevelopment and improvement of property are capitalized, whereas costs relatingto holding property are not capitalized and are charged against operations inthe current period.

**Real Estate Held For Development**—Realestate properties held for development and sale are carried at the lower ofcost, including cost of development and improvement subsequent to acquisition,or fair value less estimated selling costs. The portion of interest costsrelating to the development of real estate is capitalized.

**OtherRepossessed Assets**—Consumer assets acquired throughrepossession and in settlement of loans, typically automobiles, are carried atlower of cost or fair value at the date of repossession. The excess cost overfair value at time of repossession is charged to the allowance for loan losses.

**StockDividend**—The Corporation declared a 10% stock dividendon April 16, 2003 to its shareholders of record as of April 28, 2003,payable on May 14, 2003. The payment of this dividend is in 

55

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**1.**   SUMMARY OFSIGNIFICANT ACCOUNTING POLICIES—(Continued)

addition to the regularquarterly cash dividends. Per share amounts have been restated for the impactof the stock dividend.

**Brokerageand Insurance Commissions**—Brokerage commissions arerecognized as income on settlement date. Insurance commissions on loan products(credit life, mortgage life, accidental death, and guaranteed auto protection)are recognized as income over the life of the loan.

**Stock Option Plans**—Employeecompensation expense under stock option plans is reported using the intrinsicvalue method. No stock-based compensation cost is reflected in net income, asall options granted had an exercise price equal to the market price of theunderlying common stock at date of grant. The following table illustrates theeffect on net income and earnings per share if expense was measured using thefair value recognition provisions of FASB Statement No. 123, Accountingfor Stock-Based Compensation.
| ** **                                                                         | ** **  | ** **                                                                     | ** ** | ** **            | ** ** | **Six Months Ended** | ** ** | **Year Ended** | ** ** |
|------------------------------------------------------------------------------------|-------------|--------------------------------------------------------------------------------|------------|-----------------------|------------|--------------------------------|------------|---------------------|------------|
| ** **                                                                         | ** **  | **Year Ended December 31,**                                          | ** ** | **December 31,** | ** ** | **June 30,**              | ** ** |
| ** **                                                                         | ** **  | **2004**                                                                       | ** ** | **2003**              | ** ** | **2002**                       | ** ** | **2002**            | ** ** |
| ** **                                                                         | ** **  | **(Dollars in thousands except per share data)** | ** ** |
| Net income:                                                                        |        |                                                                           |       |                  |       |                           |       |                |       |   |   |   |   |   |   |   |   |
| As reported                                                                        |        |                                                                           | $          | 7,790                 |       |                           |       | $                   | 8,003      |   |   |   | $ | 4,382 |   |   |   | $ | 7,458 |   |   |
| Deduct: Stock-based compensation expense determined  under fair value based method |        |                                                                           | (190)      |                  |       |                           | (108)      |                |       |   | (54) |   |   |   | (118) |   |   |
| Pro-forma                                                                          |        |                                                                           | $          | 7,600                 |       |                           |       | $                   | 7,895      |   |   |   | $ | 4,328 |   |   |   | $ | 7,340 |   |   |
| Earnings per  share:                                                               |        |                                                                           |       |                  |       |                           |       |                |       |   |   |   |   |   |   |   |   |
| Basic                                                                              | As Reported |                                                                           |       | $                     | 2.13       |                           |       |                | $          | 2.12 |   |   |   | $ | 1.09 |   |   |   | $ | 1.81 |   |   |
|                                                                               | Pro-forma   |                                                                           |       | 2.08                  |       |                           |       | 2.09                |       |   |   | 1.07 |   |   |   | 1.78 |   |   |
| Diluted                                                                            | As Reported |                                                                           |       | $                     | 2.12       |                           |       |                | $          | 2.10 |   |   |   | $ | 1.08 |   |   |   | $ | 1.80 |   |   |
|                                                                               | Pro-forma   |                                                                           |       | 2.07                  |       |                           |       | 2.07                |       |   |   | 1.07 |   |   |   | 1.77 |   |   |

 

Theweighted-average assumptions for options granted during the year and theresulting estimated weighted average fair values per share used in computingpro forma disclosures is presented below. There were no options granted for theyear ended December 31, 2003 and the six-month period ended December 31,2002.
| ** **                                    | ** ** | **December 31,  2004** | ** ** | **June 30,  2002** | ** ** |
|-----------------------------------------------|------------|-----------------------------|------------|-------------------------|------------|
| Assumptions:                                  |       |                        |       |                    |       |   |   |   |   |
| Risk-free interest rate                       |       |                        | 4.13       | %                       |       |   | 4.94 | % |   |
| Expected dividend yield                       |       |                        | 2.84       | %                       |       |   | 4.44 | % |   |
| Expected life (years)                         |       |                        | 10         |                    |       |   | 10 |   |   |
| Expected common stock market price volatility |       |                        | 26         | %                       |       |   | 28 | % |   |
| Estimated fair  value per share               |       |                        | $          | 7.03                    |       |   |   | $ | 3.79 |   |   |
|                                               |            |                             |            |                         |            |  |  |  |  |  |  |

 

**IncomeTaxes**—Deferred income tax assets and liabilities aredetermined using the liability method. Under this method, the net deferred taxasset or liability is determined based on the tax effects of the differencesbetween the book and tax basis of the various balance sheet assets andliabilities.

56

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**1.**   SUMMARY OFSIGNIFICANT ACCOUNTING POLICIES—(Continued)

**EmployeeStock Ownership Plan**—Compensation expense is based onthe market price of shares as they are committed to be released to participantaccounts. Dividends on allocated ESOP shares reduce retained earnings. Sincethe ESOP has not acquired shares in advance of allocation to participantaccounts, the plan has no unallocated shares.

**EarningsPer Common Share**—Basic earnings per common share isnet income divided by the weighted average number of common shares outstandingduring the period. Diluted earnings per common share include the dilutiveeffect of additional potential common shares issuable under stock options.

**ComprehensiveIncome**—Comprehensive income consists of net income andother comprehensive income. Other comprehensive income includes unrealizedgains and losses on securities available-for-sale, which are also recognized asa separate component of equity, net of tax.

**Derivatives**—TheCorporation only uses derivative instruments as described in “Mortgage BankingActivities.”

**NewAccounting Pronouncements**—On October 1, 2002, newguidance was issued on the accounting for financial institution acquisitions. Underthis new guidance, if certain criteria are met, the amount of theunidentifiable intangible asset resulting from prior financial institutionsacquisitions is to be reclassified to goodwill commensurate with the previouslyadopted business combination standards. Accordingly, we reclassified $6.6million of previously recognized unidentifiable intangible assets to goodwilleffective July 1, 2002. Thus, the acquisition intangibles consist solelyof goodwill, which is no longer amortized. Instead, goodwill is assessed atleast annually for impairment and any such impairment is recognized in theperiod identified. The effect on pre-tax income of ceasing goodwillamortization for the years ended December 31, 2004 and 2003 and the sixmonths ended December 31, 2002 was $832,000, $832,000 and $416,000.

Theeffect of not amortizing goodwill, net of tax effects, is summarized asfollows:
| ** **                       | ** ** | **Year Ended**   | ** ** | **Six Months Ended** | ** ** | **Year Ended** | ** ** |
|----------------------------------|------------|-----------------------|------------|--------------------------------|------------|---------------------|------------|
| ** **                       | ** ** | **December 31,** | ** ** | **December 31,**          | ** ** | **June 30,**   | ** ** |
| ** **                       | ** ** | **2004**              | ** ** | **2003**                       | ** ** | **2002**            | ** ** | **2002** | ** ** |
| Reported net  income             |       | $                     | 7,790      |                           | $          | 8,003               |       |   | $ | 4,382 |   |   |   | $ | 7,458 |   |   |
| Add back:  goodwill amortization |       | —                |       | —                         |       |                | —     |   |   |   | 631 |   |   |
| Adjusted net  income             |       | $                     | 7,790      |                           | $          | 8,003               |       |   | $ | 4,382 |   |   |   | $ | 8,089 |   |   |
| Basic earnings  per share:       |       |                  |       |                           |       |                |       |   |   |   |   |   |   |
| Reported net income              |       | $                     | 2.13       |                           | $          | 2.12                |       |   | $ | 1.09 |   |   |   | $ | 1.81 |   |   |
| Goodwill amortization            |       | —                |       | —                         |       |                | —     |   |   |   | 0.15 |   |   |
| Adjusted net income              |       | $                     | 2.13       |                           | $          | 2.12                |       |   | $ | 1.09 |   |   |   | $ | 1.96 |   |   |
| Diluted earnings  per share:     |       |                  |       |                           |       |                |       |   |   |   |   |   |   |
| Reported net income              |       | $                     | 2.12       |                           | $          | 2.10                |       |   | $ | 1.08 |   |   |   | $ | 1.80 |   |   |
| Goodwill amortization            |       | —                |       | —                         |       |                | —     |   |   |   | 0.15 |   |   |
| Adjusted net  income             |       | $                     | 2.12       |                           | $          | 2.10                |       |   | $ | 1.08 |   |   |   | $ | 1.95 |   |   |

 

On January 1, 2003, we adopted Interpretation 45,Guarantor’s Accounting and Disclosure Requirements for Guarantees. On July 1,2003, we adopted Statement 149, amendment of Statement 133 on DerivativeInstruments and Hedging Activities, and Statement 150, Accounting for CertainFinancial 

57

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**1.**   SUMMARY OFSIGNIFICANT ACCOUNTING POLICIES—(Continued)

Instruments withCharacteristics of both Liabilities and Equities. On October 1, 2003, weadopted Interpretation 46, Consolidation of Variable Interest Entities. Adoptionof the new standards did not materially affect our operating results orfinancial condition.

**Effectof Newly Issued But Not Yet Effective Accounting Standards**—InDecember 2004, the Financial Accounting Standards Board (“FASB”) issuedStatement of Financial Accounting Standard (“SFAS”) No. 123 (Revised 2004)(“SFAS No. 123R”), “Share-Based Payment.” SFAS No. 123R is a revisionof FASB Statement 123, “Accounting for Stock-Based Compensation” and supersedesAPB Opinion No. 25, “Accounting for Stock Issued to Employees,” and itsrelated implementation guidance. SFAS No. 123R requires all publiccompanies to record compensation cost for stock options provided to employeesin return for employee service. The cost is measured at the fair value of theoptions when granted, and this cost is expensed over the employee serviceperiod, which is normally the vesting period of the options. This will apply toawards granted or modified after the first quarter or year beginning after June 15,2005. Compensation cost will also be recorded for prior option grants that vestafter the date of adoption. The effect on results of operations will depend onthe level of future option grants and the calculation of the fair value of theoptions granted at such future date, as well as the vesting periods provided, andso they cannot currently be predicted. Existing options that will vest afteradoption date are expected to result in additional compensation expense ofapproximately $44,000 during the balance of 2005, $66,000 in 2006, $60,000 in 2007,$60,000 in 2008 and $45,000 in 2009 and thereafter. There will be nosignificant effect on financial position as total equity will not change.

Statement of Position 03-3 requires that a valuationallowance for loans acquired in a transfer, including in a businesscombination, reflect only losses incurred after acquisition and should not berecorded at acquisition. It applies to any loan acquired in a transfer thatshowed evidence of credit quality deterioration since it was made.

**OperatingSegments**—Segments are parts of a company evaluated bymanagement with separate financial information. Our internal financialinformation is primarily reported and evaluated in three lines of business,banking, mortgage banking, and brokerage. These segments are dominated bybanking at a magnitude for which separate individual segment disclosures arenot required.

**Reclassifications**—Someitems in the prior year financial statements were re-classified to conform tothe current presentation.

58

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**2.**   SECURITIES

Theamortized cost basis and fair values of securities are as follows:
| ** **                          | ** ** | ** **                            | ** ** | **Gross**                              | ** ** | **Gross**      | ** ** | ** **                                  | ** ** |
|-------------------------------------|------------|---------------------------------------|------------|----------------------------------------|------------|----------------|------------|---------------------------------------------|------------|
| ** **                          | ** ** | **  Amortized  ** | ** ** | **  Unrealized  ** | ** ** | **Unrealized** | ** ** | ** **                                  | ** ** |
| ** **                          | ** ** | **Cost**                              | ** ** | **Gains**                              | ** ** | **Losses**     | ** ** | **  Fair Value  ** | ** ** |
| ** **                          | ** ** | **(Dollars in thousands)**  | ** ** |
| **Securities  available-for-sale:** |       |                                  |       |                                   |       |           |       |                                        |       |   |   |   |   |   |   |   |   |
| **December 31, 2004:**         |       |                                  |       |                                   |       |           |       |                                        |       |   |   |   |   |   |   |   |   |
| U.S. Treasury and agencies          |       |                                  | $          | 15,985                                 |       |           |       | $                                           | —     |   |   |   | $ | (56 | ) |   |   | $ | 15,929 |   |   |
| Mortgage-backed                     |       |                                  | 1,901      |                                   |       |           | —     |                                        |       |   | (22 | ) |   |   | 1,879 |   |   |
| Equity                              |       |                                  | 1,898      |                                   |       |           | 1,181      |                                        |       |   | — |   |   |   | 3,079 |   |   |
| State and municipal                 |       |                                  | 999        |                                   |       |           | 42         |                                        |       |   | — |   |   |   | 1,041 |   |   |
| Total                               |       |                                  | $          | 20,783                                 |       |           |       | $                                           | 1,223      |   |   |   | $ | (78 | ) |   |   | $ | 21,928 |   |   |
| **December 31, 2003:**         |       |                                  |       |                                   |       |           |       |                                        |       |   |   |   |   |   |   |   |   |
| Equity                              |       |                                  | $          | 1,801                                  |       |           |       | $                                           | 1,138      |   |   |   | $ | — |   |   |   | $ | 2,939 |   |   |
| State and municipal                 |       |                                  | 999        |                                   |       |           | 71         |                                        |       |   | — |   |   |   | 1,070 |   |   |
| Total                               |       |                                  | $          | 2,800                                  |       |           |       | $                                           | 1,209      |   |   |   | $ | — |   |   |   | $ | 4,009 |   |   |

 
| ** **                        | ** ** | ** **                            | ** ** | **Gross**                                | ** ** | **Gross**        | ** ** | ** **                                  | ** ** |
|-----------------------------------|------------|---------------------------------------|------------|------------------------------------------|------------|------------------|------------|---------------------------------------------|------------|
| ** **                        | ** ** | **  Amortized  ** | ** ** | **  Unrecognized  ** | ** ** | **Unrecognized** | ** ** | ** **                                  | ** ** |
| ** **                        | ** ** | **Cost**                              | ** ** | **Gains**                                | ** ** | **Losses**       | ** ** | **  Fair Value  ** | ** ** |
| **Securities  held-to-maturity:** |       |                                  |       |                                     |       |             |       |                                        |       |   |   |   |   |   |   |   |   |
| **December 31, 2004:**       |       |                                  |       |                                     |       |             |       |                                        |       |   |   |   |   |   |   |   |   |
| U.S. Treasury and agencies        |       |                                  | $          | 26,095                                   |       |             |       | $                                           | 3          |   |   |   | $ | (244 | ) |   |   | $ | 25,854 |   |   |
| Mortgage-backed                   |       |                                  | 6,820      |                                     |       |             | 7          |                                        |       |   | (124 | ) |   |   | 6,703 |   |   |
| Corporate                         |       |                                  | 2,000      |                                     |       |             | —     |                                        |       |   | — |   |   |   | 2,000 |   |   |
| Total                             |       |                                  | $          | 34,915                                   |       |             |       | $                                           | 10         |   |   |   | $ | (368 | ) |   |   | $ | 34,557 |   |   |
| **December 31, 2003:**       |       |                                  |       |                                     |       |             |       |                                        |       |   |   |   |   |   |   |   |   |
| U.S. Treasury and agencies        |       |                                  | $          | 19,999                                   |       |             |       | $                                           | 77         |   |   |   | $ | — |   |   |   | $ | 20,076 |   |   |
| Mortgage-backed                   |       |                                  | 8,930      |                                     |       |             | 9          |                                        |       |   | (96 | ) |   |   | 8,843 |   |   |
| Corporate                         |       |                                  | 2,000      |                                     |       |             | —     |                                        |       |   | — |   |   |   | 2,000 |   |   |
| Total                             |       |                                  | $          | 30,929                                   |       |             |       | $                                           | 86         |   |   |   | $ | (96 | ) |   |   | $ | 30,919 |   |   |

 

59

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**2.**   SECURITIES—(Continued)

The amortized cost andfair value of securities at December 31, 2004, by contractual maturity,are shown below.
| ** **                              | ** ** | **Available for Sale**      | ** ** | **Held-to-Maturity** | ** ** |
|-----------------------------------------|------------|---------------------------------------|------------|----------------------|------------|
| ** **                              | ** ** | **  Amortized  ** | ** ** | **Fair**             | ** ** | **  Amortized  ** | ** ** | **Fair** | ** ** |
| ** **                              | ** ** | **Cost**                              | ** ** | **Value**            | ** ** | **Cost** | ** ** | **Value** | ** ** |
| ** **                              | ** ** | **(Dollars in thousands)**  | ** ** |
| Due in one year  or less                |       |                                  | $          | 12,060               |       |   | $ | 12,026 |   |   | $ | — |   |   | $ | — |   |
| Due after one  year through five years  |       |                                  | 4,810      |                 |       | 4,822 |   |   | 26,095 |   |   | 25,854 |   |
| Due after five  years through ten years |       |                                  | 114        |                 |       | 122 |   |   | — |   |   | — |   |
| Due after ten  years                    |       |                                  | —     |                 |       | — |   |   | 2,000 |   |   | 2,000 |   |
| Mortgage-backed                         |       |                                  | 1,901      |                 |       | 1,879 |   |   | 6,820 |   |   | 6,703 |   |
| Equity                                  |       |                                  | 1,898      |                 |       | 3,079 |   |   | — |   |   | — |   |
|                                    |       |                                  | $          | 20,783               |       |   | $ | 21,928 |   |   | $ | 34,915 |   |   | $ | 34,557 |   |

 

The following schedulesets forth the proceeds from sales of available-for-sale securities and thegross realized gains on those sales:
| ** **           | ** ** | ** **                            | ** ** | **Six Months Ended** | ** ** | **Year Ended** | ** ** |
|----------------------|------------|---------------------------------------|------------|--------------------------------|------------|---------------------|------------|
| ** **           | ** ** | **Year Ended December 31,** | ** ** | **December 31,**          | ** ** | **June 30,**   | ** ** |
| ** **           | ** ** | **2004**                              | ** ** | **2003**                       | ** ** | **2002**            | ** ** | **2002** | ** ** |
| ** **           | ** ** | **(Dollars in thousands)**  | ** ** |
| Proceeds from  sales |       |                                  | $          | 745                            |       |                |       | — |   |   |   | — |   |   |   | — |   |   |
| Gross realized gains |       |                                  | 202        |                           |       |                | —     |   |   |   | — |   |   |   | — |   |   |

 

The tax expense related to the realized gain was$69,000 for the year ended December 31, 2004.

Investment securities having an amortized cost of$34.5 million and fair value of $36.1 million at December 31, 2004 werepledged to secure public deposits.

Securitieswith unrealized losses at year-end 2004 and 2003 not recognized in income areas follows:

**December 31, 2004**
| ** **                              | ** ** | **Less than 12 Months** | ** ** | **12 Months or More** | ** ** | **Total** | ** ** |
|-----------------------------------------|------------|----------------------------------------|------------|--------------------------------------|------------|-----------|------------|
| ** **                              | ** ** | **Fair**                               | ** ** | **Unrealized**                       | ** ** | **Fair**  | ** ** | **Unrealized** | ** ** | **Fair** | ** ** | **Unrealized** | ** ** |
| **Description of Securities** | ** ** | ** **                             | ** ** | **Value**                            | ** ** | **Loss**  | ** ** | **Value** | ** ** | **Loss** | ** ** | **Value** | ** ** | **Loss** | ** ** |
| U. S. Treasury  and  agencies           |       | $                                      | 41,783     |                                 |       | $         | (300       | ) |   | $ | — |   |   | $ | — |   |   | $ | 41,483 |   |   | $ | (300 | ) |   |
| Mortgage-backed                         |       | 1,879                                  |       |                                 | (22        | )         |       | 6,703 |   |   | (124 | ) |   | 8,582 |   |   | (146 | ) |   |
| Total temporarily  impaired             |       | $                                      | 43,662     |                                 |       | $         | (322       | ) |   | $ | 6,703 |   |   | $ | (124 | ) |   | $ | 50,065 |   |   | $ | (446 | ) |   |
|                                         |            |                                        |            |                                      |            |           |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

60

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**2.**   SECURITIES—(Continued)

**December 31, 2003**
| ** **                              | ** ** | **Less than 12 Months** | ** ** | **12 Months or More** | ** ** | **Total** | ** ** |
|-----------------------------------------|------------|----------------------------------------|------------|--------------------------------------|------------|-----------|------------|
| ** **                              | ** ** | **Fair**                               | ** ** | **Unrealized**                       | ** ** | **Fair**  | ** ** | **Unrealized** | ** ** | **Fair** | ** ** | **Unrealized** | ** ** |
| **Description of Securities** | ** ** | ** **                             | ** ** | **Value**                            | ** ** | **Loss**  | ** ** | **Value** | ** ** | **Loss** | ** ** | **Value** | ** ** | **Loss** | ** ** |
| Mortgage-backed                         |       | $                                      | 8,843      |                                 |       | $         | (96        | ) |   |   | $ | — |   |   |   | $ | — |   |   | $ | 8,843 |   |   | $ | (96 | ) |   |
| Total temporarily  impaired             |       | $                                      | 8,843      |                                 |       | $         | (96        | ) |   |   | $ | — |   |   |   | $ | — |   |   | $ | 8,843 |   |   | $ | (96 | ) |   |
|                                         |            |                                        |            |                                      |            |           |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

At December 31, 2004and 2003 we had no securities that were impaired. All unrealized losses arereviewed at least on a quarterly basis to determine whether the losses areother than temporary and more frequently when economic or market concernswarrant such evaluation. Consideration is given to the length of time and theextent to which the fair value has been less than cost, the financial conditionand near-term prospects of the issuer, and our intent and ability to retain theinvestment in the issuer for a period of time sufficient to allow for anyanticipated recovery in fair value. In analyzing an issuer’s financialcondition, we may consider whether the securities are issued by the federalgovernment or its agencies, whether downgrades by bond rating agencies haveoccurred, and the results of reviews of the issuer’s financial condition. Whileits likely that we will hold the securities to maturity, even though some areclassified as available for sale, we believe the unrealized losses are marketdriven and full principal will be recovered.

**3.**   LOANS RECEIVABLE

Loansreceivable are summarized as follows:
| ** **                         | ** ** | **December 31,**                | ** ** |
|------------------------------------|------------|--------------------------------------|------------|
| ** **                         | ** ** | **2004**                             | ** ** | **2003** | ** ** |
| ** **                         | ** ** | **(Dollars in thousands)** | ** ** |
| Commercial                         |       | $                                    | 32,228     |   | $ | 31,281 |   |
| Real estate  commercial            |       | 302,567                              |       | 230,964 |   |
| Real estate  construction          |       | 10,850                               |       | 9,952 |   |
| Residential  mortgage              |       | 159,550                              |       | 190,911 |   |
| Consumer and home  equity          |       | 70,143                               |       | 64,759 |   |
| Indirect consumer                  |       | 30,798                               |       | 28,279 |   |
| Loans held for  sale               |       | 1,219                                |       | 1,021 |   |
|                               |       | 607,355                              |       | 557,167 |   |
| Less:                              |       |                                 |       |   |   |
| Net deferred loan origination fees |       | (1,438                               | )          | (1,446 | ) |
| Allowance for loan losses          |       | (6,489                               | )          | (5,568 | ) |
|                               |       | (7,927                               | )          | (7,014 | ) |
| Loans Receivable                   |       | $                                    | 599,428    |   | $ | 550,153 |   |

 

We utilize eligible real estate loans to collateralizeadvances and letters of credit from the Federal Home Loan Bank.****We had $342 and $211 million inresidential mortgage loans and commercial real estate loans pledged under thisarrangement at December 31, 2004 and 2003.

61

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**3.**   LOANS RECEIVABLE—(Continued)

The allowance for loanloss is summarized as follows:
| ** **                  | ** ** | ** **                                | ** ** | ** **                     | ** ** | **As of and For the** | ** ** | **As of and For** | ** ** |
|-----------------------------|------------|-------------------------------------------|------------|--------------------------------|------------|-------------------------------------------|------------|----------------------------------|------------|
| ** **                  | ** ** | **As of and For the** | ** ** | **Six Months Ended** | ** ** | **the Year Ended**              | ** ** |
| ** **                  | ** ** | **Years Ended December 31,**    | ** ** | **December 31,**          | ** ** | **June 30,**                         | ** ** |
| ** **                  | ** ** | **2004**                                  | ** ** | **2003**                       | ** ** | **2002**                                  | ** ** | **2002**                         | ** ** |
| ** **                  | ** ** | **(Dollars in thousands)**      | ** ** |
| Balance,  beginning of year |       |                                      | $          | 5,568                          |       |                                      |       | $                                | 4,576      |   |   |   | $ | 3,735 |   |   |   | $ | 2,906 |   |   |
| Provision for  loan losses  |       |                                      | 1,656      |                           |       |                                      | 1,656      |                             |       |   | 1,161 |   |   |   | 1,604 |   |   |
| Charge-offs                 |       |                                      | (949       | )                              |       |                                      | (857       | )                                |       |   | (424 | ) |   |   | (916 | ) |   |
| Recoveries                  |       |                                      | 214        |                           |       |                                      | 193        |                             |       |   | 104 |   |   |   | 141 |   |   |
| Balance, end of year        |       |                                      | $          | 6,489                          |       |                                      |       | $                                | 5,568      |   |   |   | $ | 4,576 |   |   |   | $ | 3,735 |   |   |

 

Impairedloans are summarized below. There were no impaired loans for the periodspresented without an allowance allocation.
| ** **                                   | ** ** | ** **                                | ** ** | ** **                     | ** ** | **As of and For the** | ** ** | **As of and For the** | ** ** |
|----------------------------------------------|------------|-------------------------------------------|------------|--------------------------------|------------|-------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                   | ** ** | **As of and For the** | ** ** | **Six Months Ended** | ** ** | **Year Ended**                       | ** ** |
| ** **                                   | ** ** | **Years Ended December 31,**    | ** ** | **December 31,**          | ** ** | **June 30,**                         | ** ** |
| ** **                                   | ** ** | **2004**                                  | ** ** | **2003**                       | ** ** | **2002**                                  | ** ** | **2002**                                  | ** ** |
| ** **                                   | ** ** | **(Dollars in thousands)**      | ** ** |
| Year-end impaired  loans                     |       |                                      | $          | 5,240                          |       |                                      |       | $                                         | 5,318      |   |   |   | $ | 4,584 |   |   |   | $ | 3,736 |   |   |
| Amount of  allowance for loan loss allocated |       |                                      | 928        |                           |       |                                      | 911        |                                      |       |   | 751 |   |   |   | 511 |   |   |
| Average impaired  loans outstanding          |       |                                      | 4,783      |                           |       |                                      | 4,804      |                                      |       |   | 4,066 |   |   |   | 3,507 |   |   |
| Interest income  recognized                  |       |                                      | 197        |                           |       |                                      | 227        |                                      |       |   | 126 |   |   |   | 201 |   |   |
| Interest income received                     |       |                                      | 197        |                           |       |                                      | 227        |                                      |       |   | 126 |   |   |   | 201 |   |   |

 

Non-performingloans were as follows:
| ** **                                    | ** ** | **December 31,**                                                            | ** ** |
|-----------------------------------------------|------------|----------------------------------------------------------------------------------|------------|
| ** **                                    | ** ** | **      2004      ** | ** ** | **      2003      ** | ** ** |
| ** **                                    | ** ** | **(Dollars in thousands)**                                             | ** ** |
| Restructured                                  |       |                                                                             | $          | 3,218 |   |   |   | $ | 3,037 |   |   |
| Loans past due  over 90 days still on accrual |       |                                                                             | —     |   |   |   | — |   |   |
| Non accrual loans                             |       |                                                                             | 2,022      |   |   |   | 2,281 |   |   |
| Total                                         |       |                                                                             | $          | 5,240 |   |   |   | $ | 5,318 |   |   |

 

62

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**4.   PREMISES ANDEQUIPMENT**

Premisesand equipment consist of the following:
| ** **                         | ** ** | **December 31,**                | ** ** |
|------------------------------------|------------|--------------------------------------|------------|
| ** **                         | ** ** | **2004**                             | ** ** | **2003** | ** ** |
| ** **                         | ** ** | **(Dollars in thousands)** | ** ** |
| Land                               |       | $                                    | 2,902      |   | $ | 3,067 |   |
| Buildings                          |       | 13,468                               |       | 12,491 |   |
| Furniture,  fixtures and equipment |       | 9,280                                |       | 7,209 |   |
|                               |       | 25,650                               |       | 22,767 |   |
| Less accumulated  depreciation     |       | (8,181                               | )          | (7,301 | ) |
|                               |       | $                                    | 17,469     |   | $ | 15,466 |   |

 

Certainpremises are leased under various operating leases. Rental expense was$259,000, $278,000, $134,000 and $263,000 for the years ended December 31,2004 and 2003, six months ended December 31, 2002 and the year ended June 30,2002, respectively. Future minimum commitments under these leases are:
| ** ** | ** ** | **Year Ended**                  | ** ** |
|------------|------------|--------------------------------------|------------|
| ** ** | ** ** | **December 31,**                | ** ** |
| ** ** | ** ** | **(Dollars in thousands)** | ** ** |
| 2005       |       |                                 | $          | 274 |   |   |
| 2006       |       |                                 | 244        |   |   |
| 2007       |       |                                 | 196        |   |   |
| 2008       |       |                                 | 181        |   |   |
| 2009       |       |                                 | 183        |   |   |
| Thereafter |       |                                 | 596        |   |   |
|       |       |                                 | $          | 1,674 |   |   |

 

**5.   DEPOSITS**

TimeDeposits of $100,000 or more were $104.9 million and $88.9 million at December 31,2004 and 2003, respectively. At December 31, 2004, scheduled maturities oftime deposits are as follows:
| ** ** | ** ** | **Amount**                           | ** ** |
|------------|------------|--------------------------------------|------------|
| ** ** | ** ** | **(Dollars in thousands)** | ** ** |
| 2005       |       |                                 | $          | 167,491 |   |   |
| 2006       |       |                                 | 89,671     |   |   |
| 2007       |       |                                 | 24,189     |   |   |
| 2008       |       |                                 | 15,705     |   |   |
| 2009       |       |                                 | 12,984     |   |   |
| Thereafter |       |                                 | 187        |   |   |
|       |       |                                 | $          | 310,227 |   |   |

 

**6.   ADVANCES FROMFEDERAL HOME LOAN BANK**

Under the collateral requirements of the Federal HomeLoan Bank (FHLB) of Cincinnati we have available collateral to borrow anadditional $24.9 million from the FHLB at December 31, 2004. During January 2001,we entered into $75 million in convertible fixed rate advances with a maturityof ten years. 

63

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**6.**   ADVANCES FROMFEDERAL HOME LOAN BANK—(Continued)

These advances are fixedfor periods of two to three years. At the end of the fixed term and quarterlythereafter, the FHLB has the right to convert these advances to variable rateadvances tied to the three-month LIBOR index or the Corporation can prepay theadvance at no penalty. There is a substantial penalty if we prepay the advancebefore the FHLB exercises its right.

Advancesfrom the FHLB at year-end are as follows:
| ** **                                                                                    | ** ** | **December 31,**                | ** ** |
|-----------------------------------------------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                                                                    | ** ** | **2004**                             | ** ** | **2003** | ** ** |
| ** **                                                                                    | ** ** | **Weighted-**                        | ** ** | ** ** | ** ** | **Weighted-** | ** ** | ** ** | ** ** |
| ** **                                                                                    | ** ** | **Average**                          | ** ** | ** ** | ** ** | **Average** | ** ** | ** ** | ** ** |
| ** **                                                                                    | ** ** | **Rate**                             | ** ** | **Amount** | ** ** | **Rate** | ** ** | **Amount** | ** ** |
| ** **                                                                                    | ** ** | **(Dollars in Thousands)** | ** ** |
| Fixed rate advances:                                                                          |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Mortgage matched advances with interest  rates from 5.30% to 7.80% due through 2009 |       |                                 | 6.45       | % |   | $ | 80 |   |   | 6.48 | % |   | $ | 170 |   |
| Convertible fixed rate advances due  through 2011                                        |       |                                 | 4.92       | % |   | 75,000 |   |   | 4.92 | % |   | 75,000 |   |
| Other fixed rate advances due  through 2019                                              |       |                                 | 4.86       | % |   | 3,824 |   |   | 5.04 | % |   | 3,113 |   |
| Total borrowings  exercises its                                                               |       |                                 |       |   |   | $ | 78,904 |   |   |   |   |   | $ | 78,283 |   |

 

Theaggregate minimum annual repayments of borrowings as of December 31, 2004is as follows:
| ** ** | ** ** | **(Dollars in thousands)** | ** ** |
|------------|------------|--------------------------------------|------------|
| 2005       |       |                                 | $          | 957 |   |   |
| 2006       |       |                                 | 137        |   |   |
| 2007       |       |                                 | 136        |   |   |
| 2008       |       |                                 | 124        |   |   |
| 2009       |       |                                 | 117        |   |   |
| Thereafter |       |                                 | 77,433     |   |   |
|       |       |                                 | $          | 78,904 |   |   |

 

**7.   SUBORDINATEDDEBENTURES**

On March 26, 2002, a trust formed by the FirstFinancial Service Corporation, First Federal Statutory Trust I (Trust), issued$10.0 million of Floating Rate Capital Securities (Trust Preferred Securities).The proceeds of the offering were loaned by the Trust to us in exchange forsubordinated debentures with terms that are identical to the Trust PreferredSecurities. Issuance costs of $302,000 paid from the proceeds are beingamortized to maturity. The subordinated debentures and deferred issue costs arethe sole assets of the Trust. We have guaranteed that the Trust will makedistributions to the holders of the Trust Preferred Securities if the Trust hasavailable funds to make such distribution. Distributions on the Trust PreferredSecurities are payable quarterly in arrears at the annual rate (adjustedquarterly) of three-month LIBOR plus 3.60% (5.55% as of the last adjustment),and are included in interest expense. The annual rate cannot exceed 11% priorto March 26, 2007.

The subordinated debentures, which mature March 26,2032, are redeemable prior to the maturity date at our option on or after March 26,2007 at their principal amount plus accrued interest. The subordinateddebentures are also redeemable in whole or in part from time to time, upon theoccurrence of specific events defined within the trust debenture. We have theoption to defer distributions on the 

64

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**7.**   SUBORDINATEDDEBENTURES—(Continued)

subordinated debenturesfrom time to time for a period not to exceed 20 consecutive quarters. The TrustPreferred Securities are subject to mandatory redemption, in whole or in part,upon repayment of the subordinated debentures.

The SubordinatedDebentures are considered as Tier I capital for the Corporation under currentregulatory guidelines.

**8.   INCOME TAXES**

Wefile a consolidated federal income tax return and income tax is apportionedamong all companies based on their taxable income or loss. Provision for incometaxes is as follows:
| ** **                | ** ** | ** **                                                                       | ** ** | ** **                                                                       | ** ** | **Six Months Ended** | ** ** | **Year Ended** | ** ** |
|---------------------------|------------|----------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------|------------|--------------------------------|------------|---------------------|------------|
| ** **                | ** ** | **Year Ended December 31,**                                       | ** ** | **December 31,**                                                            | ** ** | **June 30,**              | ** ** |
| ** **                | ** ** | **      2004      ** | ** ** | **      2003      ** | ** ** | **2002**                       | ** ** | **2002**            | ** ** |
| ** **                | ** ** | **(Dollars in thousands)**                                             | ** ** |
| Current                   |       |                                                                             | $          | 3,334                                                                            |       |                           |       | $                   | 3,909      |   |   |   | $ | 2,411 |   |   |   | $ | 4,252 |   |   |
| Deferred                  |       |                                                                             | 401        |                                                                             |       |                           | 95         |                |       |   | (212 | ) |   |   | (523 | ) |   |
| Total income tax  expense |       |                                                                             | $          | 3,735                                                                            |       |                           |       | $                   | 4,004      |   |   |   | $ | 2,199 |   |   |   | $ | 3,729 |   |   |

 

The provision for incometaxes differs from the amount computed at the statutory rates as follows:
| ** **                                               | ** ** | ** **                                                                       | ** ** | ** **                                                                       | ** ** | **Six Months Ended** | ** ** | **Year Ended** | ** ** |
|----------------------------------------------------------|------------|----------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------|------------|--------------------------------|------------|---------------------|------------|
| ** **                                               | ** ** | **Year Ended December 31,**                                       | ** ** | **December 31,**                                                            | ** ** | **June 30,**              | ** ** |
| ** **                                               | ** ** | **      2004      ** | ** ** | **      2003      ** | ** ** | **2002**                       | ** ** | **2002**            | ** ** |
| ** **                                               | ** ** | **(Dollars in thousands)**                                             | ** ** |
| Federal statutory  rate                                  |       |                                                                             | 34.0       | %                                                                                |       |                           | 34.0       | %                   |       |   | 34.0 | % |   |   | 34.0 | % |   |
| Tax-exempt interest income                               |       |                                                                             | (0.1       | )                                                                                |       |                           | (0.2       | )                   |       |   | (0.2 | ) |   |   | (0.2 | ) |   |
| Increase in cash surrender value  of life insurance |       |                                                                             | (0.9       | )                                                                                |       |                           | (0.2       | )                   |       |   | — |   |   |   | — |   |   |
| Acquisition intangibles                                  |       |                                                                             | —     |                                                                             |       |                           | —     |                |       |   | — |   |   |   | 0.7 |   |   |
| Dividends to ESOP                                        |       |                                                                             | (0.4       | )                                                                                |       |                           | (0.4       | )                   |       |   | (0.3 | ) |   |   | (0.4 | ) |   |
| Other                                                    |       |                                                                             | (0.2       | )                                                                                |       |                           | 0.1        |                |       |   | (0.1 | ) |   |   | (0.8 | ) |   |
| Effective rate                                           |       |                                                                             | 32.4       | %                                                                                |       |                           | 33.3       | %                   |       |   | 33.4 | % |   |   | 33.3 | % |   |

 

Temporary differencesbetween the financial statements carrying amounts and tax bases of assets andliabilities that give rise to significant portions of deferred income taxesrelate to the following:

65

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**8.**   INCOME TAXES—(Continued)
| ** **                                                | ** ** | **December 31,**                                                            | ** ** |
|-----------------------------------------------------------|------------|----------------------------------------------------------------------------------|------------|
| ** **                                                | ** ** | **      2004      ** | ** ** | **      2003      ** | ** ** |
| ** **                                                | ** ** | **(Dollars in thousands)**                                             | ** ** |
| **Deferred tax assets:**                                  |       |                                                                             |       |   |   |   |   |   |   |
| Allowance for loan losses                                 |       |                                                                             | $          | 2,206 |   |   |   | $ | 1,893 |   |   |
| Accrued liabilities and other                             |       |                                                                             | 127        |   |   |   | 285 |   |   |
|                                                      |       |                                                                             | 2,333      |   |   |   | 2,178 |   |   |
| **Deferred  tax liabilities:**                            |       |                                                                             |       |   |   |   |   |   |   |
| Depreciation                                              |       |                                                                             | $          | 1,360 |   |   |   | $ | 995 |   |   |
| Net unrealized gain on securities available-for-sale |       |                                                                             | 389        |   |   |   | 411 |   |   |
| Federal Home Loan Bank stock                              |       |                                                                             | 1,185      |   |   |   | 1,091 |   |   |
| Intangibles                                               |       |                                                                             | 503        |   |   |   | 302 |   |   |
| Deferred gain on like-kind exchange                       |       |                                                                             | 34         |   |   |   | 196 |   |   |
| Other                                                     |       |                                                                             | 367        |   |   |   | 309 |   |   |
|                                                      |       |                                                                             | 3,838      |   |   |   | 3,304 |   |   |
| **Net deferred tax liability**                            |       |                                                                             | $          | 1,505 |   |   |   | $ | 1,126 |   |   |

 

Federal income tax lawsprovided savings banks with additional bad debt deductions through 1987,totaling $9.3 million for us. Accounting standards do not require a deferredtax liability to be recorded on this amount, which would otherwise total $3.2million at December 31, 2004 and 2003. If we were liquidated or otherwiseceased to be a bank or if tax laws were to change, the $3.2 million would berecorded as a liability with an offset to expense.

**9.   STOCKHOLDERS’EQUITY**

(a)          **Charter Conversion**—On October 22,2002, our Board of Directors adopted a plan to convert from a federal savingsbank to a commercial bank chartered under Kentucky banking laws. The plan also providedthat First Financial Service Corporation would become a bank holding company. EffectiveJanuary 8, 2003, we became a Kentucky State Chartered Commercial Bank andFirst Financial Service Corporation became a bank holding company regulated bythe Federal Reserve Board. Expenses of $16,300 and $20,000 were recognizedduring 2003 and 2002 associated with the conversion.

(b)         **Regulatory Capital Requirements**—TheCorporation and the Bank are subject to regulatory capital requirementsadministered by federal banking agencies. Capital adequacy guidelines and,additionally for banks, prompt corrective action regulations involvequantitative measures of assets, liabilities, and certain off-balance-sheetitems calculated under regulatory accounting practices. Capital amounts andclassifications are also subject to qualitative judgments by regulators. Failureto meet capital requirements can initiate regulatory action.

Quantitativemeasures established by regulation to ensure capital adequacy require theCorporation and the Bank to maintain minimum amounts and ratios (set forth inthe following table) of Total and Tier I capital (as defined in theregulations) to risk weighted assets (as defined) and of Tier I capital (asdefined) to average assets (as defined). As of December 31, 2004, theCorporation and the Bank met all capital adequacy requirements to which theyare subject to.

66

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**9.**   STOCKHOLDERS’EQUITY—(Continued)

The mostrecent notification from the FDIC categorized the Corporation and the Bank aswell capitalized under the regulatory framework for prompt corrective action. Tobe categorized as well capitalized, we must maintain minimum Total Risk Based,Tier I Risk Based and Tier I Leverage rations as set forth in the table. Thereare no conditions or events since that notification that management believeshave changed our capital ratings.

The actual and requiredcapital amounts and ratios are presented below.
| ** **                                               | ** ** | **Actual**                           | ** ** | **For Capital  Adequacy Purposes** | ** ** | **To Be Considered  Well Capitalized  Under Prompt  Correction  Action Provisions** | ** ** |
|----------------------------------------------------------|------------|--------------------------------------|------------|----------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------|------------|
| ** **                                               | ** ** | **Amount**                           | ** ** | **  Ratio  **            | ** ** | **Amount**                                                                                                   | ** ** | **Ratio** | ** ** | **Amount** | ** ** | **Ratio** | ** ** |
| ** **                                               | ** ** | **(Dollars in thousands)** | ** ** |
| **As of December 31, 2004:**                             |       |                                 |       |                                         |       |                                                                                                         |       |   |   |   |   |   |   |   |   |   |   |
| Total risk-based  capital (to risk—weighted assets) |       |                                 |       |                                         |       |                                                                                                         |       |   |   |   |   |   |   |   |   |   |   |
| Consolidated                                             |       | $                                    | 67,798     |                                         |       | 11.6                                                                                                         | %          |   | $ | 46,793 |   |   | 8.0 | % |   | $ | 58,492 |   | 10.0 | % |
| Bank                                                     |       | 65,087                               |       |                                         | 11.2       |                                                                                                         |       | 46,600 |   |   | 8.0 |   |   | 58,250 |   | 10.0 |   |
| Tier I capital  (to risk—weighted assets)      |       |                                 |       |                                         |       |                                                                                                         |       |   |   |   |   |   |   |   |   |   |   |
| Consolidated                                             |       | 61,029                               |       |                                         | 10.4       |                                                                                                         |       | 23,397 |   |   | 4.0 |   |   | 35,095 |   | 6.0 |   |
| Bank                                                     |       | 58,318                               |       |                                         | 10.0       |                                                                                                         |       | 23,300 |   |   | 4.0 |   |   | 34,950 |   | 6.0 |   |
| Tier I capital  (to average assets)                      |       |                                 |       |                                         |       |                                                                                                         |       |   |   |   |   |   |   |   |   |   |   |
| Consolidated                                             |       | 61,029                               |       |                                         | 8.5        |                                                                                                         |       | 28,860 |   |   | 4.0 |   |   | 36,075 |   | 5.0 |   |
| Bank                                                     |       | 58,318                               |       |                                         | 8.1        |                                                                                                         |       | 28,762 |   |   | 4.0 |   |   | 35,953 |   | 5.0 |   |
|                                                          |            |                                      |            |                                              |            |                                                                                                              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 
| ** **                                               | ** ** | **Actual**                           | ** ** | **For Capital  Adequacy Purposes** | ** ** | **To Be Considered  Well Capitalized  Under Prompt  Correction  Action Provisions** | ** ** |
|----------------------------------------------------------|------------|--------------------------------------|------------|----------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------|------------|
| ** **                                               | ** ** | **Amount**                           | ** ** | **  Ratio  **            | ** ** | **Amount**                                                                                                   | ** ** | **Ratio** | ** ** | **Amount** | ** ** | **Ratio** | ** ** |
| ** **                                               | ** ** | **(Dollars in thousands)** | ** ** |
| **As of December 31, 2003**                              |       |                                 |       |                                         |       |                                                                                                         |       |   |   |   |   |   |   |   |   |   |   |
| Total risk-based  capital (to risk—weighted assets) |       |                                 |       |                                         |       |                                                                                                         |       |   |   |   |   |   |   |   |   |   |   |
| Consolidated                                             |       | $                                    | 63,094     |                                         |       | 12.0                                                                                                         | %          |   | $ | 42,073 |   |   | 8.0 | % |   | $ | 52,591 |   | 10.0 | % |
| Bank                                                     |       | 60,602                               |       |                                         | 11.6       |                                                                                                         |       | 41,853 |   |   | 8.0 |   |   | 52,316 |   | 10.0 |   |
| Tier I capital  (to risk—weighted assets)      |       |                                 |       |                                         |       |                                                                                                         |       |   |   |   |   |   |   |   |   |   |   |
| Consolidated                                             |       | 57,305                               |       |                                         | 10.9       |                                                                                                         |       | 21,037 |   |   | 4.0 |   |   | 31,555 |   | 6.0 |   |
| Bank                                                     |       | 54,813                               |       |                                         | 10.5       |                                                                                                         |       | 20,926 |   |   | 4.0 |   |   | 31,389 |   | 6.0 |   |
| Tier I capital  (to average assets)                      |       |                                 |       |                                         |       |                                                                                                         |       |   |   |   |   |   |   |   |   |   |   |
| Consolidated                                             |       | 57,305                               |       |                                         | 8.6        |                                                                                                         |       | 26,718 |   |   | 4.0 |   |   | 33,398 |   | 5.0 |   |
| Bank                                                     |       | 54,813                               |       |                                         | 8.2        |                                                                                                         |       | 26,718 |   |   | 4.0 |   |   | 33,398 |   | 5.0 |   |
|                                                          |            |                                      |            |                                              |            |                                                                                                              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

(c)          **Dividend Restrictions**—Our principal sourceof funds for dividend payments is dividends received from the Bank. Bankingregulations limit the amount of dividends that may be paid without priorapproval of regulatory agencies. Under these regulations, the amount ofdividends that may be paid in any calendar year is limited to the current year’snet profits, combined with 

67

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**9.**   STOCKHOLDERS’EQUITY—(Continued)

the retained net profitsof the preceding two years, subject to the capital requirements described above.During 2005, the Bank could, without prior approval, declare dividends ofapproximately $5.6 million plus any 2005 net profits retained to the date ofthe dividend declaration.

(d)         **Liquidation Account**—In connection with ourconversion from mutual to stock form of ownership during 1987, we established a“liquidation account”, currently in the amount of $693,537 for the purpose ofgranting to eligible deposit account holders a priority in the event of futureliquidation. Only in such an event, an eligible account holder who continues tomaintain a deposit account will be entitled to receive a distribution from theliquidation account. The total amount of the liquidation account decreases inan amount proportionately corresponding to decreases in the deposit accountbalances of the eligible account holders.

**10.**   EARNINGS PER SHARE 

Thereconciliation of the numerators and denominators of the basic and diluted EPSis as follows:
| ** **                                         | ** ** | **Year Ended**                                                | ** ** | **Six Months Ended**                      | ** ** | **Year Ended**                                   | ** ** |
|----------------------------------------------------|------------|--------------------------------------------------------------------|------------|-----------------------------------------------------|------------|-------------------------------------------------------|------------|
| ** **                                         | ** ** | **December 31,**                                              | ** ** | **   December 31,  ** | ** ** | **   June 30,   ** | ** ** |
| ** **                                         | ** ** | **2004**                                                           | ** ** | **2003**                                            | ** ** | **2002**                                              | ** ** | **2002** | ** ** |
| ** **                                         | ** ** | **(In thousands, except per share data)** | ** ** |
| Net income  available to common shareholders  |       | $                                                                  | 7,790      |                                                | $          | 8,003                                                 |       |   | $ | 4,382 |   |   |   | $ | 7,458 |   |   |
| Basic EPS:                                         |       |                                                               |       |                                                |       |                                                  |       |   |   |   |   |   |   |
| Weighted average common shares                     |       | 3,659                                                              |       | 3,780                                               |       |                                                  | 4,035      |   |   |   | 4,128 |   |   |
| Diluted EPS:                                       |       |                                                               |       |                                                |       |                                                  |       |   |   |   |   |   |   |
| Weighted average common shares                     |       | 3,659                                                              |       | 3,780                                               |       |                                                  | 4,035      |   |   |   | 4,128 |   |   |
| Dilutive effect of stock options                   |       | 16                                                                 |       | 35                                                  |       |                                                  | 16         |   |   |   | 16 |   |   |
| Weighted average common and incremental shares     |       | 3,675                                                              |       | 3,815                                               |       |                                                  | 4,051      |   |   |   | 4,144 |   |   |
| Earnings Per  Share:                               |       |                                                               |       |                                                |       |                                                  |       |   |   |   |   |   |   |
| Basic                                              |       | $                                                                  | 2.13       |                                                | $          | 2.12                                                  |       |   | $ | 1.09 |   |   |   | $ | 1.81 |   |   |
| Diluted                                            |       | $                                                                  | 2.12       |                                                | $          | 2.10                                                  |       |   | $ | 1.08 |   |   |   | $ | 1.80 |   |   |

 

Stock options for 10,000,8,250, and 66,000 shares of common stock were not included in the December 31,2004, December 31, 2002, and June 30, 2002 computation of dilutedearnings per share respectively, because their impact was anti-dilutive.  All of the outstanding stock options for theyear ended December 31, 2003 were included in the computation of dilutedearnings per share.

68

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**11.**   EMPLOYEE BENEFIT PLANS

**(a)****         Pension Plans**—We are a participant in theFinancial Institutions Retirement Fund, a multiple-employer definedbenefit pension plan, covering employees hired before June 1, 2002. Becausethe plan was curtailed, employees hired on or after that date are not eligiblefor membership in the fund. Eligible employees are 100% vested at thecompletion of five years of participation in the plan. Our policy is tocontribute annually the minimum funding amounts. Employer contributions andadministrative expenses charged to operations for the years ended December 31,2004 and 2003, six months ended December 31, 2002, and the year ended June 30,2002 totaled $253,000, $250,000, $60,000, and $120,000, respectively. Therewere no accrued liabilities associated with the plan as of December 31,2004. Accrued liabilities associated with the plan as of December 31, 2003was $147,000.

**(b)****        **We have a contributory thrift plan as wellas a 401 (k) plan, which covers substantially all of the employees. Underthe terms of the thrift plan, voluntary employee after tax contributions arematched by up to 6% of the employee base pay and employees are 100% vested atthe completion of three years of participation in the plan. Under the terms ofthe 401 (k) plan, voluntary employee pre tax contributions are matched byup to 6% of the employee base pay and employees are 100% vested at thecompletion of three years of participation in the plan. Though the employee mayparticipate in one or both plans, the employer will match voluntarycontributions on only one of the two plans. Employer contributions andadministrative expenses charged to operations****for these plans****for theyears ended December 31, 2004 and 2003, six months ended December 31,2002, and the year ended June 30, 2002 were $302,000, $270,000, $121,000,and $223,000, respectively.

**(c)****          Employee Stock Ownership Plan**—We have anon-contributory employee stock ownership plan (ESOP) in which employees areeligible to participate upon completion of one year of service. Employees arevested in accordance with a schedule, which provides for 100% vesting uponcompletion of seven years of service.

Sharesof our common stock are acquired in non-leveraged transactions. At the time ofpurchase, the shares are released and allocated to eligible employeesdetermined by a formula specified in the plan agreement. Accordingly, the planhas no unallocated shares. The number of shares to be purchased and allocatedis at the Board of Directors discretion. Shares in the plan and the fair valueof shares released during the year charged to compensation expense were asfollows:
| ** **            | ** ** | **Year Ended**   | ** ** | **Six Months Ended** | ** ** | **Year Ended** | ** ** |
|-----------------------|------------|-----------------------|------------|--------------------------------|------------|---------------------|------------|
| ** **            | ** ** | **December 31,** | ** ** | **December 31,**          | ** ** | **June 30,**   | ** ** |
| ** **            | ** ** | **2004**              | ** ** | **2003**                       | ** ** | **2002**            | ** ** | **2002** | ** ** |
| ESOP shares  (ending) |       | 182,709               |       | 185,291                        |       |                | 200,413    |   |   | 199,464 |   |
| Shares released       |       | 2,148                 |       | 2,048                          |       |                | 1,014      |   |   | 2,513 |   |
| Compensation expense  |       | $                     | 54,000     |                           | $          | 54,000              |       |   | $ | 27,000 |   |   | $ | 54,000 |   |
|                       |            |                       |            |                                |            |                     |            |  |  |  |  |  |  |  |  |

 

**(b)**         **Stock Option Plan**—Under the 1998 StockOption and Incentive Plan, we may grant either incentive or non-qualified stockoptions to key employees for an aggregate of 166,000 shares of our common stockat not less than fair market value at the date such options are granted. Theoption to purchase shares vest over periods of one to five years and expire tenyears after the date of grant. At December 31, 2004 options available forfuture grant under the 1998 Stock Option 

69

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**11.**   EMPLOYEE BENEFITPLANS—(Continued)

Plan totaled 32,400. Of the options outstanding at December 31,2004, 1,100 were granted under a previous plan. A summary of optiontransactions is as follows:
| ** **                          | ** ** | **Year Ended December 31,** | ** ** |
|-------------------------------------|------------|--------------------------------------------|------------|
| ** **                          | ** ** | **2004**                                   | ** ** | **2003** | ** ** |
| ** **                          | ** ** | **Number  of  Options**                    | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Number  of  Options** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
| Outstanding,  beginning of period   |       | 68,970                                     |       |   | $ | 19.36 |   |   | 108,900 |   |   | $ | 17.74 |   |   |
| Granted during  period              |       | 54,500                                     |       |   | $ | 25.75 |   |   | — |   |   | — |   |   |
| Exercised during  the period        |       | —                                     |       |   | — |   |   | (39,930 | ) |   | 14.66 |   |   |
| Outstanding, end  of period         |       | 123,470                                    |       |   | $ | 22.18 |   |   | 68,970 |   |   | $ | 19.36 |   |   |
| Eligible for exercise at period end |       | 64,680                                     |       |   | $ | 19.65 |   |   | 49,390 |   |   | $ | 19.93 |   |   |

 
| ** **                           | ** ** | **Six Months Ended  December 31, 2002** | ** ** | **Year Ended  June 30, 2002**          | ** ** |
|--------------------------------------|------------|-----------------------------------------|------------|----------------------------------------|------------|
| ** **                           | ** ** | **Number  of  Options**                 | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Number  of  Options** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
| Outstanding,  beginning of period    |       | 115,500                                 |       |                                   | $          | 17.58 |   |   | 114,950 |   |   | $ | 17.44 |   |   |
| Granted during  period               |       | —                                  |       |                                   | —     |   |   | 11,000 |   |   | 14.75 |   |   |
| Exercised during  the period         |       | (6,600                                  | )          |                                   | 15.15      |   |   | (10,450 | ) |   | 13.02 |   |   |
| Outstanding, end  of period          |       | 108,900                                 |       |                                   | $          | 17.74 |   |   | 115,500 |   |   | $ | 17.58 |   |   |
| Eligible for  exercise at period end |       | 68,530                                  |       |                                   | $          | 17.25 |   |   | 63,030 |   |   | $ | 16.73 |   |   |

 

The following tablesummarizes information about stock options outstanding at December 31,2004:
| ** **                              | ** ** | **Options Outstanding** | ** ** | **Options Exercisable** | ** ** |
|-----------------------------------------|------------|------------------------------|------------|------------------------------|------------|
| **Range of  Exercise Prices** | ** ** | ** **                   | ** ** | **Number  Outstanding**      | ** ** | **Weighted Average  Remaining  Contractual Life** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Number  Exercisable** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
| $14.55 to $15.46                        |       |                         | 14,520     |                         |       |   | 6.1 years |   |   |   | $ | 14.99 |   |   |   | 10,230 |   |   |   | $ | 14.98 |   |   |
| $20.34 to $20.57                        |       |                         | 52,800     |                         |       |   | 4.6 |   |   |   | 20.47 |   |   |   | 52,800 |   |   |   | 20.47 |   |   |
| $22.27                                  |       |                         | 1,650      |                         |       |   | 4.2 |   |   |   | 22.27 |   |   |   | 1,650 |   |   |   | 22.27 |   |   |
| $25.64 to $26.23                        |       |                         | 54,500     |                         |       |   | 9.8 |   |   |   | 25.75 |   |   |   | — |   |   |   | — |   |   |
|                                    |       |                         | 123,470    |                         |       |   | 7.1 |   |   |   | $ | 22.18 |   |   |   | 64,680 |   |   |   | $ | 19.65 |   |   |
|                                         |            |                              |            |                              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

70

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**12.**   CASH FLOW ACTIVITIES

The following information is presented as supplementaldisclosures to the statement of cash flows.

**(a)****         CashPaid for:**
| ** **       | ** ** | **Year Ended**                  | ** ** | **Six Months Ended** | ** ** | **Year Ended** | ** ** |
|------------------|------------|--------------------------------------|------------|--------------------------------|------------|---------------------|------------|
| ** **       | ** ** | **December 31,**                | ** ** | **December 31,**          | ** ** | **June 30,**   | ** ** |
| ** **       | ** ** | **2004**                             | ** ** | **2003**                       | ** ** | **2002**            | ** ** | **2002** | ** ** |
| ** **       | ** ** | **(Dollars in thousands)** | ** ** |
| Interest expense |       | $                                    | 14,795     |                           | $          | 16,453              |       |   | $ | 9,406 |   |   |   | $ | 22,879 |   |   |
| Income taxes     |       | $                                    | 3,532      |                           | $          | 4,203               |       |   | $ | 2,615 |   |   |   | $ | 4,257 |   |   |

 

**(b)****         Supplementaldisclosure of non-cash activities:**
| ** **                                                                               | ** ** | **Year Ended**                  | ** ** | **Six Months Ended** | ** ** | **Year Ended** | ** ** |
|------------------------------------------------------------------------------------------|------------|--------------------------------------|------------|--------------------------------|------------|---------------------|------------|
| ** **                                                                               | ** ** | **December 31,**                | ** ** | **December 31,**          | ** ** | **June 30,**   | ** ** |
| ** **                                                                               | ** ** | **2004**                             | ** ** | **2003**                       | ** ** | **2002**            | ** ** | **2002** | ** ** |
| ** **                                                                               | ** ** | **(Dollars in thousands)** | ** ** |
| Loans to  facilitate sales of real estate owned and repossessed assets                   |       | $                                    | 1,124      |                           | $          | 1,123               |       |   | $ | 1,025 |   |   |   | $ | 1,006 |   |   |
| Transfers from loans to  real estate acquired through foreclosure and repossessed assets |       | $                                    | 1,396      |                           | $          | 944                 |       |   | $ | 875 |   |   |   | $ | 1,419 |   |   |

 

**13.**   CONDENSED FINANCIAL INFORMATION (PARENTCOMPANY ONLY) 

The following condensedstatements summarize the financial position, operating results and cash flowsof First Financial Service Corporation (Parent Company only).

**Condensed Statements of Financial Condition**
| ** **                                    | ** ** | **December 31,**                | ** ** |
|-----------------------------------------------|------------|--------------------------------------|------------|
| ** **                                    | ** ** | **2004**                             | ** ** | **2003** | ** ** |
| ** **                                    | ** ** | **(Dollars in thousands)** | ** ** |   |
| **Assets**                                    |       |                                 |       |   |   |   |
| Cash and interest  bearing deposits           |       | $                                    | 157        |   | $ | 169 |   |   |
| Investment in  Bank                           |       | 67,089                               |       | 63,568 |   |   |
| Securities  available-for sale                |       | 2,447                                |       | 2,438 |   |   |
| Receivable from  Bank                         |       | —                               |       | 165 |   |   |
| Other assets                                  |       | 270                                  |       | 280 |   |   |
|                                          |       | $                                    | 69,963     |   | $ | 66,620 |   |   |
| **Liabilities and Stockholders’ Equity** |       |                                 |       |   |   |   |
| Subordinated  debentures                      |       | $                                    | 10,000     |   | $ | 10,000 |   |   |
| Other liabilities                             |       | 162                                  |       | 299 |   |   |
| Stockholders’  equity                    |       | 59,801                               |       | 56,321 |   |   |
|                                          |       | $                                    | 69,963     |   | $ | 66,620 |   |   |
|                                               |            |                                      |            |  |  |  |  |  |  |

** **

71

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**13.**   CONDENSEDFINANCIAL INFORMATION (PARENT COMPANY ONLY)—(Continued)

**CondensedStatements of Income**
| ** **                                                | ** ** | **Year Ended**                  | ** ** | **Six Months Ended** | ** ** | **Year Ended** | ** ** |
|-----------------------------------------------------------|------------|--------------------------------------|------------|--------------------------------|------------|---------------------|------------|
| ** **                                                | ** ** | **December 31,**                | ** ** | **December 31,**          | ** ** | **June 30,**   | ** ** |
| ** **                                                | ** ** | **2004**                             | ** ** | **2003**                       | ** ** | **2002**            | ** ** | **2002** | ** ** |
| ** **                                                | ** ** | **(Dollars in thousands)** | ** ** |
| Dividend from Bank                                        |       | $                                    | 4,500      |                           | $          | 6,318               |       |   | $ | 1,680 |   |   |   | $ | 2,940 |   |   |
| Interest income                                           |       | 114                                  |       | 88                             |       |                | 70         |   |   |   | 69 |   |   |
| Interest expense                                          |       | (514                                 | )          | (487                           | )          |                | (273       | ) |   |   | (146 | ) |   |
| Gain on sale of  investments                              |       | 202                                  |       | —                         |       |                | —     |   |   |   | — |   |   |
| Other expenses                                            |       | (238                                 | )          | (269                           | )          |                | (116       | ) |   |   | (197 | ) |   |
| Income before  income tax benefit                         |       | 4,064                                |       | 5,650                          |       |                | 1,361      |   |   |   | 2,666 |   |   |
| Income tax  benefit                                       |       | 220                                  |       | 286                            |       |                | 136        |   |   |   | 147 |   |   |
| Income before  equity in undistributed net income of Bank |       | 4,284                                |       | 5,936                          |       |                | 1,497      |   |   |   | 2,813 |   |   |
| Equity in  undistributed net income of Bank               |       | 3,506                                |       | 2,067                          |       |                | 2,885      |   |   |   | 4,645 |   |   |
| Net income                                                |       | $                                    | 7,790      |                           | $          | 8,003               |       |   | $ | 4,382 |   |   |   | $ | 7,458 |   |   |

 

72

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**13.**   CONDENSEDFINANCIAL INFORMATION (PARENT COMPANY ONLY)—(Continued)

**CondensedStatements of Cash Flows**
| ** **                                                                          | ** ** | **Year Ended**                  | ** ** | **Six Months Ended** | ** ** | **Year Ended** | ** ** |
|-------------------------------------------------------------------------------------|------------|--------------------------------------|------------|--------------------------------|------------|---------------------|------------|
| ** **                                                                          | ** ** | **December 31,**                | ** ** | **December 31,**          | ** ** | **June 30,**   | ** ** |
| ** **                                                                          | ** ** | **2004**                             | ** ** | **2003**                       | ** ** | **2002**            | ** ** | **2002** | ** ** |
| ** **                                                                          | ** ** | **(Dollars in thousands)** | ** ** |
| Operating Activities:                                                               |       |                                 |       |                           |       |                |       |   |   |   |   |   |   |
| Net income                                                                          |       | $                                    | 7,790      |                           | $          | 8,003               |       |   | $ | 4,382 |   |   |   | $ | 7,458 |   |   |
| Adjustments to reconcile net income to cash  provided by operating activities: |       |                                 |       |                           |       |                |       |   |   |   |   |   |   |
| Equity in undistributed net income of  Bank                                    |       | (3,506                               | )          | (2,067                         | )          |                | (2,885     | ) |   |   | (4,645 | ) |   |
| Gain on sale of investments available-for-sale                                      |       | (202                                 | )          | —                         |       |                | —     |   |   |   | — |   |   |
| Decrease (increase) in other assets                                                 |       | 10                                   |       | 18                             |       |                | 25         |   |   |   | (317 | ) |   |
| (Decrease) increase in other liabilities                                            |       | (106                                 | )          | (265                           | )          |                | 1          |   |   |   | (27 | ) |   |
| Net cash from  operating activities                                                 |       | 3,986                                |       | 5,689                          |       |                | 1,523      |   |   |   | 2,469 |   |   |
| Investing  Activities:                                                              |       |                                 |       |                           |       |                |       |   |   |   |   |   |   |
| Purchases of securities available-for-sale                                          |       | (640                                 | )          | (1,415                         | )          |                | —     |   |   |   | — |   |   |
| Sales of securities available-for-sale                                              |       | 745                                  |       | —                         |       |                | —     |   |   |   | — |   |   |
| Net change in receivable from Bank                                                  |       | 165                                  |       | 433                            |       |                | (332       | ) |   |   | (6 | ) |   |
| Net cash from  investing activities                                                 |       | 270                                  |       | (982                           | )          |                | (332       | ) |   |   | (6 | ) |   |
| Financing  Activities:                                                              |       |                                 |       |                           |       |                |       |   |   |   |   |   |   |
| Proceeds from stock options exercised                                               |       | —                               |       | 559                            |       |                | —     |   |   |   | — |   |   |
| Proceeds from issuance of subordinated debentures                              |       | —                               |       | —                         |       |                | —     |   |   |   | 10,000 |   |   |
| Dividends paid                                                                      |       | (2,708                               | )          | (2,660                         | )          |                | (1,316     | ) |   |   | (2,700 | ) |   |
| Common stock repurchases                                                            |       | (1,560                               | )          | (9,628                         | )          |                | (2,047     | ) |   |   | (712 | ) |   |
| Net cash from  financing activities                                                 |       | (4,268                               | )          | (11,729                        | )          |                | (3,363     | ) |   |   | 6,588 |   |   |
| Net increase (decrease) in cash                                                     |       | (12                                  | )          | (7,022                         | )          |                | (2,172     | ) |   |   | 9,051 |   |   |
| Cash and interest bearing deposits, beginning of  year                              |       | 169                                  |       | 7,191                          |       |                | 9,363      |   |   |   | 312 |   |   |
| Cash and interest  bearing deposits, end of year                                    |       | $                                    | 157        |                           | $          | 169                 |       |   | $ | 7,191 |   |   |   | $ | 9,363 |   |   |

 

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**14.**   FAIR VALUE OFFINANCIAL INSTRUMENTS

The estimated fair valueof financial instruments is as follows:
| ** **                           | ** ** | **December 31, 2004**      | ** ** | **December 31, 2003** | ** ** |
|--------------------------------------|------------|--------------------------------------|------------|---------------------------------|------------|
| ** **                           | ** ** | **Carrying  Value**                  | ** ** | **Fair  Value**                 | ** ** | **Carrying   Value ** | ** ** | **Fair  Value** | ** ** |
| ** **                           | ** ** | **(Dollars in thousands)** | ** ** |
| **Financial assets:**                |       |                                 |       |                            |       |   |   |   |   |
| Cash and cash  equivalents           |       | $                                    | 35,910     |                            | $          | 35,910 |   | $ | 48,030 |   | $ | 48,030 |   |
| Securities  available-for-sale       |       | 21,928                               |       | 21,928                          |       | 4,009 |   | 4,009 |   |
| Securities held-to-maturity          |       | 34,915                               |       | 34,557                          |       | 30,929 |   | 30,919 |   |
| Loans held for sale                  |       | 1,219                                |       | 1,239                           |       | 1,021 |   | 1,039 |   |
| Loans, net                           |       | 598,209                              |       | 603,134                         |       | 549,132 |   | 558,608 |   |
| Federal Home Loan Bank stock         |       | 6,845                                |       | 6,845                           |       | 6,570 |   | 6,570 |   |
| Accrued interest receivable          |       | 2,487                                |       | 2,487                           |       | 1,931 |   | 1,931 |   |
| **Financial  liabilities:**          |       |                                 |       |                            |       |   |   |   |   |
| Deposits                             |       | 586,386                              |       | 581,477                         |       | 529,162 |   | 529,822 |   |
| Advances from Federal Home Loan Bank |       | 78,904                               |       | 82,409                          |       | 78,283 |   | 84,275 |   |
| Subordinated debentures              |       | 10,000                               |       | 10,000                          |       | 10,000 |   | 10,000 |   |
| Accrued interest  payable            |       | 413                                  |       | 413                             |       | 416 |   | 416 |   |
|                                      |            |                                      |            |                                 |            |  |  |  |  |  |  |  |  |

 

The methods and assumptions used in estimating fairvalue disclosures for financial instruments are presented below:

Carrying amount is theestimated fair value for cash and cash equivalents, interest bearing deposits,Federal Home Loan Bank stock, accrued interest receivable and payable, demanddeposits and variable rate loans or deposits that reprice frequently and fully.Security fair values are based on market prices or dealer quotes and if no suchinformation is available, on the rate and term of the security and informationabout the issuer. The value of loans held for sale is based on the underlyingsale commitments. For fixed rate loans or deposits and for variable rate loansor deposits with infrequent reprising or reprising limits, fair value is basedon discounted cash flows using current market rates applied to the estimatedlife and credit risk. Fair values for impaired loans are estimated usingdiscounted cash flow analysis or underlying collateral values. Fair values ofadvances from Federal Home Loan Bank are based on current rates for similarfinancing. The principal amount of the subordinated debentures is the estimatedfair value. The fair value of off-balance-sheet items is based on the currentfees or cost that would be charged to enter into or terminate such arrangementsand is not material.

**15.   CONTINGENCIES**

In the normal course ofbusiness, there are various outstanding legal proceedings and claims. In theopinion of management, after consultation with legal counsel, the dispositionof such legal proceedings and claims will not materially affect ourconsolidated financial position, results of operations or liquidity.

**16.**   FINANCIAL INSTRUMENTS WITHOFF-BALANCE-SHEET RISK

We are a party to financial instruments withoff-balance-sheet risk in the normal course of business to meet the financingneeds of our customers. These financial instruments primarily includecommitments to extend credit and involve, to varying degrees, elements ofcredit and interest-rate risk in excess of the 

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**16.**   FINANCIALINSTRUMENTS WITH OFF-BALANCE-SHEET RISK—(Continued)

amount recognized in thebalance sheet. The contract or notional amounts of these instruments reflectthe extent of our involvement in particular classes of financial instruments.

Our exposure to credit loss in the event ofnonperformance by the other party to the financial instrument for commitmentsto extend credit is represented by the contractual notional amount of thoseinstruments. Creditworthiness for all instruments is evaluated on acase-by-case basis in accordance with our credit policies. We use the samecredit policies in making commitments and conditional obligations as we do foron-balance-sheet instruments. Collateral from the customer may be requiredbased on management’s credit evaluation of the customer and may includebusiness assets of commercial customers as well as personal property and realestate of individual customers or guarantors.

Commitments to extend credit are agreements to lend toa customer as long as there is no violation of any condition established in thecontract. Commitments generally have fixed expiration dates or othertermination clauses and may require payment of a fee. Since many of thecommitments are expected to expire without being drawn upon, the totalcommitment amounts do not necessarily represent future cash requirements.

Commitmentsto make loans for the portfolio, excluding mortgage-banking activitiesdiscussed in Note 1 and undisbursed portions of loans in process, were asfollows:
| ** **                 | ** ** | **December 31, 2004**      | ** ** | **December 31, 2003** | ** ** |
|----------------------------|------------|--------------------------------------|------------|---------------------------------|------------|
| ** **                 | ** ** | ** Fixed **                | ** ** | **Variable**                    | ** ** | ** Fixed ** | ** ** | **Variable** | ** ** |
| ** **                 | ** ** | **Rate**                             | ** ** | **Rate**                        | ** ** | **Rate** | ** ** | **Rate** | ** ** |
| ** **                 | ** ** | **(Dollars in thousands)** | ** ** |
| Commitments to  make loans |       |                                 | $          | —                          |       |   | $ | 470 |   |   | $ | — |   |   | $ | — |   |
| Unused lines of  credit    |       |                                 | —     |                            |       | 89,109 |   |   | — |   |   | 74,085 |   |
| Standby letters  of credit |       |                                 | —     |                            |       | 11,180 |   |   | — |   |   | 9,209 |   |
|                       |       |                                 | $          | —                          |       |   | $ | 100,759 |   |   | $ | — |   |   | $ | 83,294 |   |

 

Unused lines of credit at December 31, 2004 wereat current rates ranging from 3.00% to 18.00% and primarily at the nationalprime rate of interest plus .5% to 2% for standby letters of credit.

At December 31, 2004and 2003, we had $85.4 million, and $53.5 million in letters of credit from theFederal Home Loan Bank issued to collateralize public deposits. These lettersof credit are secured by a blanket pledge of eligible one-to-four familyresidential mortgage loans. (For additional information see Note 3 on LoansReceivable and Note 6 on Advances from the Federal Home Loan Bank.)

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**17.**   RELATED PARTYTRANSACTIONS

Certaindirectors, executive officers and principal shareholders of the Company,including associates of such persons, are our loan and deposit customers. Relatedparty deposits at December 31, 2004 and 2003 were $2.8 million and $3.4million. A summary of the related party loan activity, for loans aggregating$60,000 or more to any one related party, is as follows:
| ** **        | ** ** | **Year Ended  December 31,**                   | ** ** |
|-------------------|------------|----------------------------------------------------------|------------|
| ** **        | ** ** | **    2004    ** | ** ** | **    2003    ** | ** ** |
| ** **        | ** ** | **(Dollars in thousands)**                     | ** ** |
| Beginning of year |       |                                                     | $          | 305 |   |   | $ | 1,264 |   |
| New loans         |       |                                                     | 34         |   |   | 148 |   |
| Repayments        |       |                                                     | (24        | ) |   | (77 | ) |
| Other changes     |       |                                                     | —     |   |   | (1,030 | ) |
| End of year       |       |                                                     | $          | 315 |   |   | $ | 305 |   |

 

Other changes includeadjustments for loans applicable to one reporting period that are excludablefrom the other reporting period.

**18.**   SUMMARY OF QUARTERLYFINANCIAL DATA—(Unaudited)
| **Year Ended December 31, 2004:** | ** ** | ** **                                                                     | ** ** | ** March 31, ** | ** ** | **June 30,** | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------|------------|--------------------------------------------------------------------------------|------------|--------------------------------|------------|-------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                            | ** ** | **(Dollars in thousands except per share data)** | ** ** |
| Total interest  income                                |       |                                                                           | $          | 9,550                          |       |              | $          | 9,440                  |       |                  | $          | 9,784 |   |   |   | $ | 10,369 |   |   |
| Total interest  expense                               |       |                                                                           | 3,777      |                           |       | 3,575             |       |                   | 3,590      |                  |       |   | 3,850 |   |   |
| Net interest  income                                  |       |                                                                           | 5,773      |                           |       | 5,865             |       |                   | 6,194      |                  |       |   | 6,519 |   |   |
| Provision for  loan losses                            |       |                                                                           | 389        |                           |       | 259               |       |                   | 824        |                  |       |   | 184 |   |   |
| Non-interest  income                                  |       |                                                                           | 1,771      |                           |       | 2,261             |       |                   | 2,122      |                  |       |   | 1,950 |   |   |
| Non-interest  expense                                 |       |                                                                           | 4,439      |                           |       | 5,016             |       |                   | 4,970      |                  |       |   | 4,849 |   |   |
| Net income                                            |       |                                                                           | 1,838      |                           |       | 1,926             |       |                   | 1,714      |                  |       |   | 2,312 |   |   |
| Earnings per share:                                   |       |                                                                           |       |                           |       |              |       |                   |       |                  |       |   |   |   |   |
| Basic                                                 |       |                                                                           | 0.50       |                           |       | 0.53              |       |                   | 0.47       |                  |       |   | 0.63 |   |   |
| Diluted                                               |       |                                                                           | 0.50       |                           |       | 0.53              |       |                   | 0.47       |                  |       |   | 0.62 |   |   |
|                                                       |            |                                                                                |            |                                |            |                   |            |                        |            |                       |            |  |  |  |  |  |  |  |  |  |  |

 
| **Year Ended  December 31, 2003:** | ** ** | ** ** | ** ** | **March 31,** | ** ** | **June 30,** | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|------------------------------------|------------|------------|------------|---------------|------------|--------------|------------|-------------------|------------|------------------|------------|
| Total interest  income             |       |       | $          | 10,124        |       |         | $          | 9,971             |       |             | $          | 9,745 |   |   |   | $ | 9,499 |   |   |
| Total interest  expense            |       |       | 4,296      |          |       | 4,174        |       |              | 3,988      |             |       |   | 3,907 |   |   |
| Net interest  income               |       |       | 5,828      |          |       | 5,797        |       |              | 5,757      |             |       |   | 5,592 |   |   |
| Provision for  loan losses         |       |       | 329        |          |       | 420          |       |              | 438        |             |       |   | 469 |   |   |
| Non-interest  income               |       |       | 1,718      |          |       | 1,882        |       |              | 1,974      |             |       |   | 2,407 |   |   |
| Non-interest  expense              |       |       | 4,044      |          |       | 4,333        |       |              | 4,405      |             |       |   | 4,510 |   |   |
| Net income                         |       |       | 2,122      |          |       | 1,950        |       |              | 1,921      |             |       |   | 2,010 |   |   |
| Earnings per share:                |       |       |       |          |       |         |       |              |       |             |       |   |   |   |   |
| Basic                              |       |       | 0.54       |          |       | 0.52         |       |              | 0.52       |             |       |   | 0.54 |   |   |
| Diluted                            |       |       | 0.53       |          |       | 0.52         |       |              | 0.51       |             |       |   | 0.54 |   |   |
|                                    |            |            |            |               |            |              |            |                   |            |                  |            |  |  |  |  |  |  |  |  |  |  |

 

 

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**Item 9.   Changesin and Disagreements with Accountants on Accounting and Financial Disclosure**

None

**Item 9A.**                Controls andProcedures

Management is responsible for establishing andmaintaining effective disclosure controls and procedures, as defined under Rules 13a-15(e) and15d-15(e) of the Securities Exchange Act of 1934. As of December 31,2004, an evaluation was performed under the supervision and with theparticipation of management, including the Chief Executive Officer and ChiefFinancial Officer, of the effectiveness of the design and operation of ourdisclosure controls and procedures. Based on that evaluation, managementconcluded that disclosure controls and procedures as of December 31, 2004were effective in ensuring material information required to be disclosed inthis Annual Report on Form 10-K was recorded, processed, summarized,and reported on a timely basis. Additionally, there were no changes in ourinternal control over financial reporting that occurred during the quarterended December 31, 2004 that have materially affected, or are reasonablylikely to materially affect, our internal control over financial reporting.

Management’s responsibilities related to establishingand maintaining effective disclosure controls and procedures include maintainingeffective internal controls over financial reporting that are designed toproduce reliable financial statements in accordance with accounting principlesgenerally accepted in the United States. As disclosed in the Report onManagement’s Assessment of Internal Control Over Financial Reporting of thisAnnual Report, we assessed our system of internal control over financialreporting as of December 31, 2004, in relation to criteria for effectiveinternal control over financial reporting as described in “Internal Control—IntegratedFramework,” issued by the Committee of Sponsoring Organizations of the TreadwayCommission. Based on this assessment, we believe that, as of December 31,2004, our system of internal control over financial reporting met thosecriteria and is effective.

There have been nosignificant changes in our internal controls or in other factors that couldsignificantly affect internal controls subsequent to December 31, 2004.

**Item 9B.**               Other Information

None

**PART III**

**Item 10.**                 Directors andExecutive Officers of the Registrant

The informationcontained under the sections captioned “Proposal I—Election of Directors” and “Section 16(a) BeneficialOwnership Reporting Compliance” in the Company’s definitive proxy statement forthe 2005 Annual Meeting of Shareholders (the “Proxy Statement”) is incorporatedherein by reference.

(a)          Code of Ethics

You may obtain copies ofFirst Financial Service Corporation’s code of ethics free of charge bycontacting Rebecca Bowling, Corporate Secretary—Treasurer, First Federal Savings Bank, 2323 Ring Road,Elizabethtown, Kentucky 42701 (telephone) 270-765-2131.

**Item 11.**                 ExecutiveCompensation

The information containedunder the sections captioned “Summary Compensation Table,” “Option Exercisesand Year-end Value Table,” “Directors Compensation,” and “Retirement Plan” inthe Proxy Statement is incorporated herein by reference.

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**Item 12.**                 SecurityOwnership of Certain Beneficial Owners and Management

(a)          Security Ownership ofCertain Beneficial Owners

Information required by this item is incorporatedherein by reference to the section captioned “Voting Securities and PrincipalHolders Thereof” in the Proxy Statement

(b)         Security Ownership ofManagement

Informationrequired by this item is incorporated herein by reference to the sectionscaptioned “Proposal I—Election of Directors” and “Voting Securities andPrincipal Holders Thereof” in the Proxy Statement.

(c)          Changes in Control

Management of the Companyknows of no arrangements, including any pledge by any person of securities ofthe Company, the operation of which may at a subsequent date result in a changeof control of the Company.

**Item 13.**                 CertainRelationships and Related Transactions

The information requiredby this item is incorporated herein by reference to the section captioned “Transactionswith the Corporation and the Bank” in the Proxy Statement.

**Item 14.**                 PrincipalAccountant Fees and Services

The information requiredby this item is incorporated by reference to the section captioned “IndependentPublic Accountants” in the Proxy Statement.

**PART IV**

**Item 15.**                 Exhibits,Financial Statement Schedules and Reports on Form 8-K

**1.****                FinancialStatements Filed**
| (a) (1) |   | Report of Independent Registered Public Accounting  Firm on Financial Statements—Crowe Chizek and Company LLC                                                                                              |
|--------------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (b)          |   | Consolidated Statements of Financial Condition at  December 31, 2004 and 2003.                                                                                                                             |
| (c)          |   | Consolidated Statements of Income for the years  ended December 31, 2004 and 2003, the six-month period ended  December 31, 2002 and the year ended June 30, 2002.                               |
| (d)          |   | Consolidated Statements of Comprehensive Income for  the years ended December 31, 2004 and 2003, the six-month period ended  December 31, 2002 and the year ended June 30, 2002.                 |
| (e)          |   | Consolidated Statements of Changes in Stockholders’  Equity for the years ended December 31, 2004 and 2003, the six-month  period ended December 31, 2002 and the year ended June 30, 2002. |
| (f)          |   | Consolidated Statements of Cash Flows for the years  ended December 31, 2004 and 2003, the six-month period ended  December 31, 2002 and the year ended June 30, 2002.                           |
| (g)          |   | Notes to Consolidated Financial Statements                                                                                                                                                                      |

 

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**2.****                FinancialStatements Schedules**

All financialstatement schedules have been omitted, as the required information is eitherinapplicable or included in the financial statements or related notes.

**3.****                Exhibits**
| 3 (a), 4 (a) |   | Articles of Incorporation*                                                                                                                                                                 |
|--------------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3 (b), 4 (b) |   | Amended and Restated Bylaws                                                                                                                                                                |
| 4 (c)        |   | Rights Agreement between First Financial Service  Corporation and Illinois Stock Tranfser Company dated April 15, 2003**                                                              |
| 10 (a)       |   | 1998 Stock Option and Incentive Compensation Plan                                                                                                                                          |
| 10 (b)       |   | Form of Stock Option Agreement                                                                                                                                                        |
| 10 (c)       |   | Executive Compensation                                                                                                                                                                     |
| 21           |   | Subsidiaries of the Registrant                                                                                                                                                             |
| 23 (a)       |   | Consent of Crowe Chizek and Company LLC, Independent  Registered Public Accounting Firm                                                                                                    |
| 31.1         |   | Certification of Chief Executive Officer Pursuant to  Section 302 of Sarbanes-Oxley Act                                                                                               |
| 31.2         |   | Certification of Chief Financial Officer Pursuant to  Section 302 of Sarbanes-Oxley Act                                                                                               |
| 32           |   | Certification of Chief Executive Officer and Chief  Financial Officer Pursuant to 18 U.S.C. Section 1350 (As Adopted  Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002) |

----

*                    Incorporatedby reference to Exhibit 3 of the Company’s Form 10-Q filedAugust 9, 2004.

**             Incorporated byreference to Form 8-K dated April 15, 2003.

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**SIGNATURES**

Pursuantto the requirements of Section 13 or 15(d) of the Securities ExchangeAct of 1934, the registrant has duly caused this report to be signed on itsbehalf by the undersigned, thereunto duly authorized.
|               | FIRST FINANCIAL SERVICE CORPORATION |
|---------------|-------------------------------------|
| Date: 3/15/05 | By:                                 | /s/ B. KEITH JOHNSON |   |
|          |                                | B. Keith Johnson |
|          |                                | *President and Chief Executive Officer* |
|          |                                | *Duly Authorized Representative* |

 

Pursuantto the requirements of the Securities Exchange Act of 1934, this report hasbeen signed below by the following persons on behalf of the registrant and inthe capacities and on the dates indicated.
| By:    | /s/ B. KEITH  JOHNSON                         |   | By:                            | /s/ BOB  BROWN                |   |
|--------|-----------------------------------------------|--------|--------------------------------|-------------------------------|--------|
|   | B. Keith Johnson                              |   | Bob Brown                      |
|   | *Principal Executive Officer  & Director* |   | *Director*                     |
| Date:  | 3/15/05                                       | Date:  | 3/15/05                        |
| By:    | /s/ WRENO M. HALL                             |   | By:                            | /s/ DIANE E. LOGSDON          |   |
|   | Wreno M. Hall                                 |   | Diane E. Logsdon               |
|   | *Director*                                    |   | *Director*                     |
| Date:  | 3/15/05                                       | Date:  | 3/15/05                        |
| By:    | /s/ J. ALTON RIDER                            |   | By:                            | /s/ JOHN L. NEWCOMB, JR. |   |
|   | J. Alton Rider                                |   | John L. Newcomb, Jr.      |
|   | *Director*                                    |   | *Director*                     |
| Date:  | 3/15/05                                       | Date:  | 3/15/05                        |
| By:    | /s/ WALTER D. HUDDLESTON                      |   | By:                            | /s/ MICHAEL THOMAS, DVM       |   |
|   | Walter D. Huddleston                          |   | Michael Thomas, DVM            |
|   | *Director*                                    |   | *Director*                     |
| Date:  | 3/15/05                                       | Date:  | 3/15/05                        |
| By:    | /s/ STEPHEN MOUSER                            |   | By:                            | /s/ DONALD SCHEER             |   |
|   | Stephen Mouser                                |   | Donald Scheer                  |
|   | *Director*                                    |   | *Director*                     |
| Date:  | 3/15/05                                       | Date:  | 3/15/05                        |
| By:    | /s/ GAIL SCHOMP                               |   | By:                            | /s/ GREGORY SCHREACKE         |   |
|   | Gail Schomp                                   |   | Gregory Schreacke              |
|   | *Director*                                    |   | *Chief Financial Officer*      |
|   |                                          |   | *Principal Accounting Officer* |
| Date:  | 3/15/05                                       | Date:  | 3/15/05                        |

 

80

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**INDEXTO EXHIBITS**
| Exhibit No.              | ** ** | ** **                                                                                                                                                                                 | ** ** | **Description** |
|-------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------|
|   3 (a), 4 (a) |       | Articles of Incorporation*                                                                                                                                                                 |
|   3 (b), 4 (b)      |       | Amended and Restated  Bylaws                                                                                                                                                               |
|   4 (c)        |       | Rights Agreement between  First Financial Service Corporation and Illinois Stock Tranfser Company dated  April 15, 2003**                                                             |
| 10 (a)                        |       | 1998 Stock Option and  Incentive Compensation Plan                                                                                                                                         |
| 10 (b)                        |       | Form of Stock  Option Agreement                                                                                                                                                       |
| 10 (c)                        |       | Executive Compensation                                                                                                                                                                     |
| 21                            |       | Subsidiaries of the  Registrant                                                                                                                                                            |
| 23 (a)                        |       | Consent of Crowe Chizek  and Company LLC, Independent Registered Public Accounting Firm                                                                                                    |
| 31.1                          |       | Certification of Chief  Executive Officer Pursuant to Section 302 of Sarbanes-Oxley Act                                                                                               |
| 31.2                          |       | Certification of Chief  Financial Officer Pursuant to Section 302 of Sarbanes-Oxley Act                                                                                               |
| 32                            |       | Certification of Chief  Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350  (As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002) |

----

*                    Incorporatedby reference to Exhibit 3 of the Company’s Form 10-Q filed August 9,2004.

********            **Incorporated by reference to Form 8-Kdated April 15, 2003.

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