UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C.  20549





FORM
10-Q


(Mark
One)





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





For
the quarterly period ended June 30, 2009





OR





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





Commission
File Number 0-18832





First
Financial Service Corporation


(Exact
Name of Registrant as specified in its charter)





Kentucky
            
            61-1168311(State
      or other jurisdiction
            
            (IRS
      Employer Identification No.)of
      incorporation or organization)








2323
      Ring Road
            
            (270)
      765-2131Elizabethown,
      Kentucky 42701
            
            (Registrant's
      telephone number,(Address
      of principal executive offices)
            
            including
      area code)(Zip
      Code)





(270)
765-2131


(Registrant's
telephone number, including area code)





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





Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such files). Yes  ̈ No
 ̈





Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting
company.  See definition of “accelerated filer”, “large accelerated
filer” and “smaller reporting company” in Rule 12b-2 of the Exchange
Act.





Large Accelerated Filer ̈Accelerated FilerxNon-Accelerated Filer ̈Smaller Reporting Company ̈


(Do not check if a smaller


reporting
company)





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





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





Class
                
                Outstanding as of July 31,
    2009Common
      Stock
                
                4,696,762shares





FIRST
FINANCIAL SERVICE CORPORATION


FORM
10-Q


TABLE
OF CONTENTS





PART I – FINANCIAL
      INFORMATIONPreliminary
      Note Regarding Forward-Looking Statements
              3Item
      1.
              Consolidated
      Financial Statements and Notes to Consolidated Financial
      Statements
              4Item
      2.
              Management's
      Discussion and Analysis of Financial Condition and Results of
      Operations
              26Item
      3.
              Quantitative
      and Qualitative Disclosures about Market Risk
              42Item
      4.
              Controls
      and Procedures
              44PART II – OTHER
      INFORMATIONItem
      1.
              Legal
      Proceedings
              44Item
      1A.
              Risk
      Factors
              44Item
      2.
              Unregistered
      Sales of Equity Securities and Use of Proceeds
              44Item
      3.
              Defaults
      upon Senior Securities
              44Item
      4.
              Submission
      of Matters to a Vote of Security Holders
              44Item
      5.
              Other
      Information
              45Item
      6.
              Exhibits
              45SIGNATURES
              46


2


PRELIMINARY
NOTE REGARDING


FORWARD-LOOKING
STATEMENTS





Statements
in this report that are not statements of historical fact are forward-looking
statements. First Financial Service Corporation (the “Corporation”) may make
forward-looking statements in future filings with the Securities and Exchange
Commission (“SEC”), in press releases, and in oral and written statements made
by or with the approval of the Corporation.  Forward-looking
statements include, but are not limited to: (1) projections of revenues, income
or loss, earnings or loss per share, capital structure and other financial
items; (2) plans and objectives of the Corporation or its management or Board of
Directors; (3) statements regarding future events, actions or economic
performance; and (4) statements of assumptions underlying such
statements.  Words such as “estimate,” “strategy,” “believes,”
“anticipates,” “expects,” “intends,” “plans,” “targeted,” and similar
expressions are intended to identify forward-looking statements, but are not the
exclusive means of identifying such statements.





Various
risks and uncertainties may cause actual results to differ materially from those
indicated by our forward-looking statements.  In addition to those
risks described under “Item 1A Risk Factors,” of this report and our Annual
Report on Form 10-K, the following factors could cause such differences: changes
in general economic conditions and economic conditions in Kentucky and the
markets we serve, any of which may affect, among other things, our level of
non-performing assets, charge-offs, and provision for loan loss expense; changes
in interest rates that may reduce interest margins and impact funding sources;
changes in market rates and prices which may adversely impact the value of
financial products including securities, loans and deposits; changes in tax
laws, rules and regulations; various monetary and fiscal policies and
regulations, including those determined by the Federal Reserve Board, the
Federal Deposit Insurance Corporation (“FDIC”) and the Kentucky Office of
Financial Institutions (“KOFI”); competition with other local and regional
commercial banks, savings banks, credit unions and other non-bank financial
institutions; our ability to grow core businesses; our ability to develop and
introduce new banking-related products, services and enhancements and gain
market acceptance of such products; and management’s ability to manage these and
other risks.





Our
forward-looking statements speak only as of the date on which they are made, and
we undertake no obligation to update any forward-looking statement to reflect
events or circumstances after the date of the statement to reflect the
occurrence of unanticipated events.


3





Item
      1.FIRST
      FINANCIAL SERVICE CORPORATION
                      Consolidated
      Balance Sheets(Unaudited)




June 30,
                          
                          
                          December 31,(Dollars in thousands, except share data)
                          
                          2009
                          
                          
                          2008ASSETS:Cash
      and due from banks
                          
                          $
                          17,523
                          
                          
                          $
                          17,310Interest
      bearing deposits
                          
                          
                          2,513
                          
                          
                          
                          3,595Total
      cash and cash equivalents
                          
                          
                          20,036
                          
                          
                          
                          20,905Securities
      available-for-sale
                          
                          
                          33,976
                          
                          
                          
                          15,775Securities
      held-to-maturity, fair value of $1,803 Jun (2009)and
      $6,846 Dec (2008)
                          
                          
                          1,804
                          
                          
                          
                          7,022Total
      securities
                          
                          
                          35,780
                          
                          
                          
                          22,797Loans
      held for sale
                          
                          
                          6,140
                          
                          
                          
                          9,567Loans,
      net of unearned fees
                          
                          
                          975,712
                          
                          
                          
                          903,434Allowance
      for loan losses
                          
                          
                          (14,236
                          )
                          
                          
                          (13,565
                          )Net
      loans
                          
                          
                          967,616
                          
                          
                          
                          899,436Federal
      Home Loan Bank stock
                          
                          
                          8,515
                          
                          
                          
                          8,515Cash
      surrender value of life insurance
                          
                          
                          8,834
                          
                          
                          
                          8,654Premises
      and equipment, net
                          
                          
                          31,965
                          
                          
                          
                          30,068Real
      estate owned:Acquired
      through foreclosure
                          
                          
                          8,319
                          
                          
                          
                          5,925Held
      for development
                          
                          
                          45
                          
                          
                          
                          45Other
      repossessed assets
                          
                          
                          93
                          
                          
                          
                          91Goodwill
                          
                          
                          11,931
                          
                          
                          
                          11,931Core
      deposit intangible
                          
                          
                          1,501
                          
                          
                          
                          1,703Accrued
      interest receivable
                          
                          
                          4,443
                          
                          
                          
                          4,379Deferred
      income taxes
                          
                          
                          884
                          
                          
                          
                          1,147Other
      assets
                          
                          
                          2,414
                          
                          
                          
                          1,451TOTAL
      ASSETS
                          
                          $
                          1,102,376
                          
                          
                          $
                          1,017,047LIABILITIES
      AND STOCKHOLDERS' EQUITYLIABILITIES:Deposits:Non-interest
      bearing
                          
                          $
                          58,555
                          
                          
                          $
                          55,668Interest
      bearing
                          
                          
                          762,422
                          
                          
                          
                          719,731Total
      deposits
                          
                          
                          820,977
                          
                          
                          
                          775,399Short-term
      borrowings
                          
                          
                          114,600
                          
                          
                          
                          94,869Advances
      from Federal Home Loan Bank
                          
                          
                          52,809
                          
                          
                          
                          52,947Subordinated
      debentures
                          
                          
                          18,000
                          
                          
                          
                          18,000Accrued
      interest payable
                          
                          
                          263
                          
                          
                          
                          288Accounts
      payable and other liabilities
                          
                          
                          2,707
                          
                          
                          
                          2,592TOTAL
      LIABILITIES
                          
                          
                          1,009,356
                          
                          
                          
                          944,095Commitments
      and contingent liabilities
                          
                          
                          -
                          
                          
                          
                          -STOCKHOLDERS'
      EQUITY:Serial
      preferred stock, $1 par value per share; authorized 5,000,000 shares;
      issued and outstanding, 20,000 shares with a liquidation preference of
      $1,000/share June (2009)
                          
                          
                          19,754
                          
                          
                          
                          -Common
      stock, $1 par value per share; authorized 10,000,000 shares; issued and
      outstanding, 4,696,762 shares Jun (2009), and 4,668,030 shares Dec
      (2008)
                          
                          
                          4,697
                          
                          
                          
                          4,668Additional
      paid-in capital
                          
                          
                          34,730
                          
                          
                          
                          34,145Retained
      earnings
                          
                          
                          35,666
                          
                          
                          
                          36,476Accumulated
      other comprehensive loss
                          
                          
                          (1,827
                          )
                          
                          
                          (2,337
                          )TOTAL
      STOCKHOLDERS' EQUITY
                          
                          
                          93,020
                          
                          
                          
                          72,952TOTAL
      LIABILITIES AND STOCKHOLDERS' EQUITY
                          
                          $
                          1,102,376
                          
                          
                          $
                          1,017,047





See
notes to the unaudited consolidated financial statements.


4




FIRST
FINANCIAL SERVICE CORPORATION


Consolidated
Statements of Income


(Unaudited)





Three Months Ended
                
                
                Six Months Ended(Dollars in thousands, except per share data)
                
                June 30,
                
                
                June 30,2009
                
                
                2008
                
                
                2009
                
                
                2008Interest
      and Dividend Income:Loans,
      including fees
                
                $
                14,155
                
                
                $
                13,348
                
                
                $
                28,099
                
                
                $
                27,380Taxable
      securities
                
                
                305
                
                
                
                309
                
                
                
                613
                
                
                
                693Tax
      exempt securities
                
                
                118
                
                
                
                105
                
                
                
                224
                
                
                
                205Total
      interest income
                
                
                14,578
                
                
                
                13,762
                
                
                
                28,936
                
                
                
                28,278Interest
      Expense:Deposits
                
                
                4,346
                
                
                
                4,808
                
                
                
                8,846
                
                
                
                10,494Short-term
      borrowings
                
                
                47
                
                
                
                183
                
                
                
                90
                
                
                
                505Federal
      Home Loan Bank advances
                
                
                600
                
                
                
                601
                
                
                
                1,197
                
                
                
                1,197Subordinated
      debentures
                
                
                329
                
                
                
                167
                
                
                
                658
                
                
                
                334Total
      interest expense
                
                
                5,322
                
                
                
                5,759
                
                
                
                10,791
                
                
                
                12,530Net
      interest income
                
                
                9,256
                
                
                
                8,003
                
                
                
                18,145
                
                
                
                15,748Provision
      for loan losses
                
                
                1,913
                
                
                
                514
                
                
                
                3,958
                
                
                
                1,098Net
      interest income after provision for loan losses
                
                
                7,343
                
                
                
                7,489
                
                
                
                14,187
                
                
                
                14,650Non-interest
      Income:Customer
      service fees on deposit accounts
                
                
                1,645
                
                
                
                1,632
                
                
                
                3,122
                
                
                
                3,048Gain
      on sale of mortgage loans
                
                
                355
                
                
                
                239
                
                
                
                532
                
                
                
                387Total
      other-than-temporary impairment losses
                
                
                209
                
                
                
                (216
                )
                
                
                280
                
                
                
                (216
                )Portion
      of loss recognized in other comprehensive income (before
      taxes)
                
                
                (454
                )
                
                
                -
                
                
                
                (680
                )
                
                
                -Net
      impairment losses recognized in earnings
                
                
                (245
                )
                
                
                (216
                )
                
                
                (400
                )
                
                
                (216
                )Write
      down on real estate acquired through foreclosure
                
                
                (233
                )
                
                
                -
                
                
                
                (250
                )
                
                
                -Brokerage
      commissions
                
                
                99
                
                
                
                125
                
                
                
                192
                
                
                
                243Other
      income
                
                
                469
                
                
                
                360
                
                
                
                897
                
                
                
                632Total
      non-interest income
                
                
                2,090
                
                
                
                2,140
                
                
                
                4,093
                
                
                
                4,094Non-interest
      Expense:Employee
      compensation and benefits
                
                
                4,149
                
                
                
                3,480
                
                
                
                8,151
                
                
                
                6,898Office
      occupancy expense and equipment
                
                
                808
                
                
                
                679
                
                
                
                1,656
                
                
                
                1,332Marketing
      and advertising
                
                
                245
                
                
                
                209
                
                
                
                510
                
                
                
                423Outside
      services and data processing
                
                
                795
                
                
                
                766
                
                
                
                1,588
                
                
                
                1,483Bank
      franchise tax
                
                
                257
                
                
                
                253
                
                
                
                521
                
                
                
                503FDIC
      insurance premiums
                
                
                788
                
                
                
                94
                
                
                
                967
                
                
                
                184Amortization
      of core deposit intangible
                
                
                101
                
                
                
                -
                
                
                
                202
                
                
                
                -Other
      expense
                
                
                1,301
                
                
                
                1,036
                
                
                
                2,632
                
                
                
                2,029Total
      non-interest expense
                
                
                8,444
                
                
                
                6,517
                
                
                
                16,227
                
                
                
                12,852Income
      before income taxes
                
                
                989
                
                
                
                3,112
                
                
                
                2,053
                
                
                
                5,892Income
      taxes
                
                
                274
                
                
                
                1,013
                
                
                
                577
                
                
                
                1,910Net
      Income
                
                
                715
                
                
                
                2,099
                
                
                
                1,476
                
                
                
                3,982Less:Dividends
      on preferred stock
                
                
                (213
                )
                
                
                -
                
                
                
                (480
                )
                
                
                -Accretion
      on preferred stock
                
                
                (14
                )
                
                
                -
                
                
                
                (25
                )
                
                
                -Net
      income available to common shareholders
                
                $
                488
                
                
                $
                2,099
                
                
                $
                971
                
                
                $
                3,982Shares
      applicable to basic income per common share
                
                
                4,687,983
                
                
                
                4,664,235
                
                
                
                4,682,683
                
                
                
                4,663,784Basic
      income per common share
                
                $
                0.10
                
                
                $
                0.45
                
                
                $
                0.21
                
                
                $
                0.85Shares
      applicable to diluted income per common share
                
                
                4,726,226
                
                
                
                4,692,565
                
                
                
                4,685,686
                
                
                
                4,695,358Diluted
      income per common share
                
                $
                0.10
                
                
                $
                0.45
                
                
                $
                0.21
                
                
                $
                0.85Cash
      dividends declared per common share
                
                $
                0.190
                
                
                $
                0.190
                
                
                $
                0.380
                
                
                $
                0.380




See
notes to the unaudited consolidated financial statements.


5




FIRST
FINANCIAL SERVICE CORPORATION


Consolidated
Statements of Comprehensive Income


(Unaudited)





Three Months Ended
                  
                  
                  Six Months EndedJune 30,
                  
                  
                  June 30,(Dollars in thousands)
                  
                  2009
                  
                  
                  2008
                  
                  
                  2009
                  
                  
                  2008Net
      Income
                  
                  $
                  715
                  
                  
                  $
                  2,099
                  
                  
                  $
                  1,476
                  
                  
                  $
                  3,982Other
      comprehensive income (loss):Change
      in unrealized gain (loss) on securities available-for-sale
                  
                  
                  371
                  
                  
                  
                  (569
                  )
                  
                  
                  610
                  
                  
                  
                  (387
                  )Reclassification
      of realized amount on securities available-for-sale
                  
                  
                  236
                  
                  
                  
                  216
                  
                  
                  
                  376
                  
                  
                  
                  216Non-credit
      component of other-than- temporary impairment on held-to-maturity
      securities
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (215
                  )
                  
                  
                  -Accretion
      of non-credit component of other- than-temporary impairment on
      held-to-maturity securities
                  
                  
                  2
                  
                  
                  
                  -
                  
                  
                  
                  2
                  
                  
                  
                  -Net
      unrealized gain (loss) recognized incomprehensive
      income
                  
                  
                  609
                  
                  
                  
                  (353
                  )
                  
                  
                  773
                  
                  
                  
                  (171
                  )Tax
      effect
                  
                  
                  (207
                  )
                  
                  
                  120
                  
                  
                  
                  (263
                  )
                  
                  
                  58Total
      other comphrehensive income (loss)
                  
                  
                  402
                  
                  
                  
                  (233
                  )
                  
                  
                  510
                  
                  
                  
                  (113
                  )Comprehensive
      Income
                  
                  $
                  1,117
                  
                  
                  $
                  1,866
                  
                  
                  $
                  1,986
                  
                  
                  $
                  3,869





See
notes to the unaudited consolidated financial statements.


6





FIRST
FINANCIAL SERVICE CORPORATION


Consolidated
Statement of Changes in Stockholders' Equity


Six
Months Ended June 30, 2009


(Dollars
In Thousands, Except Per Share Amounts)


(Unaudited)





AccumulatedOtherAdditional
                                                
                                                
                                                
                                                
                                                
                                                ComprehensiveShares
                                                
                                                
                                                Amount
                                                
                                                
                                                Paid-in
                                                
                                                
                                                Retained
                                                
                                                
                                                (Loss), Net ofPreferred
                                                
                                                
                                                Common
                                                
                                                
                                                Preferred
                                                
                                                
                                                Common
                                                
                                                
                                                Capital
                                                
                                                
                                                Earnings
                                                
                                                
                                                Tax
                                                
                                                
                                                TotalBalance,
      January 1, 2009
                                                
                                                
                                                -
                                                
                                                
                                                
                                                4,668
                                                
                                                
                                                $
                                                -
                                                
                                                
                                                $
                                                4,668
                                                
                                                
                                                $
                                                34,145
                                                
                                                
                                                $
                                                36,476
                                                
                                                
                                                $
                                                (2,337
                                                )
                                                
                                                $
                                                72,952Net
      income
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                1,476
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                1,476Issuance
      of preferred stock and acommon
      stock warrant
                                                
                                                
                                                20,000
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                19,729
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                271
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                20,000Shares
      issued under dividendreinvestment
      program
                                                
                                                
                                                
                                                
                                                
                                                
                                                1
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                1
                                                
                                                
                                                
                                                1
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                2Stock
      issued for stock options exercised
                                                
                                                
                                                
                                                
                                                
                                                
                                                8
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                8
                                                
                                                
                                                
                                                42
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                50Stock
      issued for employee benefitplans
                                                
                                                
                                                
                                                
                                                
                                                
                                                20
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                20
                                                
                                                
                                                
                                                219
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                239Stock-based
      compensation expense
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                52
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                52Net
      change in unrealized gains (losses)on
      securities available-for-sale,net
      of tax
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                510
                                                
                                                
                                                
                                                510Dividends
      on preferred stock
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                (480
                                                )
                                                
                                                
                                                
                                                
                                                
                                                
                                                (480
                                                )Accretion
      of preferred stock discount
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                25
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                (25
                                                )
                                                
                                                
                                                
                                                
                                                
                                                
                                                -Cash
      dividends declared($.38
      per share)
                                                
                                                
                                                -
                                                
                                                
                                                
                                                -
                                                
                                                
                                                
                                                -
                                                
                                                
                                                
                                                -
                                                
                                                
                                                
                                                -
                                                
                                                
                                                
                                                (1,781
                                                )
                                                
                                                
                                                -
                                                
                                                
                                                
                                                (1,781
                                                )Balance,
      June 30, 2009
                                                
                                                
                                                20,000
                                                
                                                
                                                
                                                4,697
                                                
                                                
                                                $
                                                19,754
                                                
                                                
                                                $
                                                4,697
                                                
                                                
                                                $
                                                34,730
                                                
                                                
                                                $
                                                35,666
                                                
                                                
                                                $
                                                (1,827
                                                )
                                                
                                                $
                                                93,020





See
notes to the unaudited consolidated financial statements.


7




FIRST
FINANCIAL SERVICE CORPORATION


Consolidated
Statements of Cash Flows


(Dollars
In Thousands)


(Unaudited)





Six Months EndedJune 30,2009
                
                
                2008Operating
      Activities:Net
      income
                
                $
                1,476
                
                
                $
                3,982Adjustments
      to reconcile net income to net cash provided by operating
      activities:Provision
      for loan losses
                
                
                3,958
                
                
                
                1,098Depreciation
      on premises and equipment
                
                
                828
                
                
                
                758Federal
      Home Loan Bank stock dividends
                
                
                -
                
                
                
                (204
                )Core
      deposit intangible amortization
                
                
                202
                
                
                
                -Net
      amortization (accretion) available-for-sale
                
                
                128
                
                
                
                (2
                )Net
      amortization (accretion) held-to-maturity
                
                
                7
                
                
                
                5Impairment
      loss on securities available-for-sale
                
                
                376
                
                
                
                216Impairment
      loss on securities held-to-maturity
                
                
                24
                
                
                
                -Gain
      on sale of mortgage loans
                
                
                (532
                )
                
                
                (387
                )Origination
      of loans held for sale
                
                
                (80,084
                )
                
                
                (32,378
                )Proceeds
      on sale of loans held for sale
                
                
                84,043
                
                
                
                30,359Stock-based
      compensation expense
                
                
                52
                
                
                
                67Changes
      in:Cash
      surrender value of life insurance
                
                
                (180
                )
                
                
                (180
                )Interest
      receivable
                
                
                (64
                )
                
                
                75Other
      assets
                
                
                (963
                )
                
                
                (388
                )Interest
      payable
                
                
                (25
                )
                
                
                (734
                )Accounts
      payable and other liabilities
                
                
                115
                
                
                
                (59
                )Net
      cash from operating activities
                
                
                9,361
                
                
                
                2,228Investing
      Activities:Cash
      paid for acquisition of Farmers State Bank, net of cash
      acquired
                
                
                -
                
                
                
                (1,466
                )Purchases
      of securities available-for-sale
                
                
                (18,590
                )
                
                
                -Maturities
      of securities available-for-sale
                
                
                871
                
                
                
                1,639Maturities
      of securities held-to-maturity
                
                
                4,974
                
                
                
                11,906Net
      change in loans
                
                
                (77,961
                )
                
                
                (27,084
                )Net
      purchases of premises and equipment
                
                
                (2,725
                )
                
                
                (2,997
                )Net
      cash from investing activities
                
                
                (93,431
                )
                
                
                (18,002
                )Financing
      ActivitiesNet
      change in deposits
                
                
                45,578
                
                
                
                40,092Change
      in short-term borrowings
                
                
                19,731
                
                
                
                (9,800
                )Repayments
      to Federal Home Loan Bank
                
                
                (138
                )
                
                
                (68
                )Proceeds
      from issuance of subordinated debentures
                
                
                -
                
                
                
                8,000Payoff
      of subordinated debentures
                
                
                -
                
                
                
                -Issuance
      of preferred stock, net
                
                
                20,000
                
                
                
                -Issuance
      of common stock
                
                
                2
                
                
                
                -Issuance
      of common stock for stock options exercised
                
                
                50
                
                
                
                -Issuance
      of common stock for employee benefit plans
                
                
                239
                
                
                
                68Dividends
      paid on common stock
                
                
                (1,781
                )
                
                
                (1,772
                )Dividends
      paid on preferred stock
                
                
                (480
                )
                
                
                -Net
      cash from financing activities
                
                
                83,201
                
                
                
                36,520(Decrease)
      Increase in cash and cash equivalents
                
                
                (869
                )
                
                
                20,746Cash
      and cash equivalents, beginning of period
                
                
                20,905
                
                
                
                14,948Cash
      and cash equivalents, end of period
                
                $
                20,036
                
                
                $
                35,694





See
notes to the unaudited consolidated financial statements.


8





NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS





1.
            BASIS
      OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING
    POLICIES





Basis of
Presentation – The accompanying unaudited consolidated financial
statements include the accounts of First Financial Service Corporation and its
wholly owned subsidiary, First Federal Savings Bank.  First Federal
Savings Bank has three wholly owned subsidiaries, First Service Corporation of
Elizabethtown, Heritage Properties, LLC and First Federal Office Park,
LLC.  Unless the text clearly suggests otherwise, references to "us,"
"we," or "our" include First Financial Service Corporation and its wholly-owned
subsidiary.  All significant intercompany transactions and balances
have been eliminated in consolidation.





The
accompanying unaudited consolidated financial statements have been prepared in
accordance with U.S. generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Rule 10-01 of
Regulation S-X.  Accordingly, they do not include all of the
information and footnotes required by U.S. generally accepted accounting
principles for complete financial statements.  In the opinion of
management, all adjustments (consisting of normal recurring accruals) considered
necessary for a fair presentation have been included.  Operating
results for the six-month period ending June 30, 2009 are not necessarily
indicative of the results that may occur for the year ending December 31,
2009.  For further information, refer to the consolidated financial
statements and footnotes thereto included in the Corporation’s annual report on
Form 10-K for the period ended December 31, 2008.





Adoption of New
Accounting Standards– In May 2009, the FASB issued Statement
No. 165 –Subsequent
Events. SFAS No. 165 establishes the period after the balance sheet
date during whichmanagement shall evaluate events or transactions that may occur
for potential recognition or disclosure in the financial statements and the
circumstances under which an entity shall recognize events or transactions that
occur after the balance sheet date. SFAS No. 165 also requires disclosure
of the date through which subsequent events have been evaluated. The new
standard becomes effective for interim and annual periods ending after
June 15, 2009. We adopted this standard for the interim reporting period
ending June 30, 2009. The adoption of this statement did not have a
material impact on our consolidated financial position or results of operations.
We evaluated subsequent events through August 10, 2009, the date the financial
statements were issued, and believe that no events have occurred requiring
further disclosure or adjustment to the consolidated financial
statements.





In early
April 2009, the FASB issued the following FASB Staff Positions (“FSPs”) that
areintended to provide additional guidance on interim fair value disclosures,
fair value measurementsand other-than-temporary impairment (OTTI):





§
            FSP
      FAS 107-1 and APB 28-1, Interim Disclosures about Fair
      Value of Financial Instruments. This FSP amends SFAS No. 107,
      Disclosures about Fair
      Value of Financial Instruments, to require disclosures in the body
      or in the accompanying notes of its summarized financial information for
      interim reporting periods and in its financial statements for annual
      reporting periods the fair value of all financial instruments for which it
      is practicable to estimate that value, whether recognized or not
      recognized in the balance sheet. This FSP also amends APB opinion
      No. 28, Interim
      Financial Reporting, to require entities to disclose the methods
      and significant assumptions used to estimate the fair value of financial
      instruments and describe changes in methods and significant assumptions,
      in both interim and annual financial statements. This FSP is effective for
      interim reporting periods ending after June 15, 2009, with early
      adoption permitted for periods ending after March 15, 2009. An entity
      may early adopt this FSP only if it also elects to early adopt FSP FAS
      157-4, Determining Fair
      Value When the Volume and Level of Activity for the Asset or Liability
      Have Significantly Decreased and Identifying Transactions That Are Not
      Orderly,and FSP FAS 115-2 and FAS 124-2, Recognition and Presentation
      of Other-Than-Temporary Impairments. Adoption of this FSP did not
      have a material impact.


9


NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS





1.
              BASIS
      OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING
    POLICIES





§
            FSP
      FAS 157-4. This FSP provides additional guidance for estimating fair value
      in accordance with SFAS No. 157, when the volume and level of
      activity for the asset or liability have significantly decreased. This FSP
      also includes guidance on identifying circumstances that indicate a
      transaction is not orderly. This FSP emphasizes that even if there has
      been a significant decrease in the volume and level of activity for the
      asset or liability and regardless of the valuation technique(s) used, the
      objective of a fair value measurement remains the same. Fair value is the
      price that would be received to sell an asset or paid to transfer a
      liability in an orderly transaction (that is, not a forced liquidation or
      distressed sale) between market participants at the measurement date under
      current market conditions. This FSP amends SFAS No. 157 to require that a
      reporting entity: (1) disclose in interim and annual periods the
      inputs and valuation technique(s) used to measure fair value and a
      discussion of changes in valuation techniques and related inputs, if any,
      during the period, and (2) define major categoryfor
      equity securities and debt securities to be major security typesas
      described in paragraph 19 of SFAS No. 115, Accounting for CertainInvestments in
      Debt and Equity Securities(as amended by FSP FAS 115-2 and FAS
      124-2). This FSP is effective for interim reporting periods ending after
      June 15, 2009, with early adoption permitted for periods ending after
      March 15, 2009. If a reporting entity elects to adopt early either
      FSP FAS 115-2 and FAS 124-2 or FSP FAS 107-1 and APB 28-1, the reporting
      entity also is required to adopt early this
FSP.





Additionally,
if the reporting entity elects to adopt early this FSP, FSP FAS 115-2 and FAS
124-2 also must be accounted for as a change in accounting estimate according to
paragraph 19 of SFAS No. 154, Accounting Changes and Error
Corrections.  We early adopted this FSP for our first quarter
ended March 31, 2009, but its adoption did not have a material
impact.





§
            FSP
      FAS 115-2 and FAS 124-2. The objective of an other-than-temporary
      impairment analysis under existing U.S. generally accepted accounting
      principles (GAAP) is to determine whether the holder of an investment
      in a debt or equity security for which changes in fair value are not
      regularly recognized in earnings (such as securities classified as
      held-to-maturity or available-for-sale) should recognize a loss in
      earnings when the investment is impaired. An investment is impaired if the
      fair value of the investment is less than its amortized cost basis. This
      FSP amends the other-than-temporary impairment guidance in U.S. GAAP for
      debt securities to make the guidance more operational and to improve the
      presentation and disclosure of other-than-temporary impairments on debt
      and equity securities in the financial statements. Specifically, the
      recognition guidance in this FSP applies to debt securities classified as
      available-for-sale and held-to-maturity that are subject to
      other-than-temporary impairment guidance within SFAS No. 115, FSP FAS
      115-1 and FAS 124-1, FSP EITF 99-20-1, Amendments to the Impairment
      Guidance of EITF Issue No. 99-20,and AICPA Statement of
      Position 03-3, Accounting for Certain Loans
      or Debt Securities Acquired in a Transfer.This FSP does not amend
      existing recognition and measurement guidance related to
      other-than-temporary impairments on equity securities. Among other
      provisions, this FSP requires entities to split other-than-temporary
      impairment charges between credit losses (i.e., the loss based on the
      entity’s estimate of the decrease in cash flows, including those that
      result from expected voluntary prepayments), which are charged to
      earnings, and the remainder of the impairment charge (non-credit
      component) to other comprehensive income, net of applicable income taxes.
      An entity must disclose information for interim and annual periods that
      enables users of its financial statements to understand the types of
      available-for-sale and held-to-maturity debt and equity securities held,
      including information about investments in an unrealized loss position for
      which an other-than-temporary impairment has or has not been recognized.
      In addition, for interim and annual periods, an entity must disclose
      information that enables users of financial statements to understand the
      reasons that a portion of an other-than-temporary impairment of a debt
      security was not recognized in earnings and the methodology and
      significant inputs used to calculate the portion of the total
      other-than-temporary impairment that was recognized in earnings. This FSP
      is effective for interim reporting periods ending after June 15,
      2009, with early adoption permitted for periods ending after
      March 15, 2009. If an entity elects to adopt early either FSP FAS
      157-4 or FSP FAS 107-1 and APB 28-1, the entity also is required to adopt
      early this FSP. Additionally, if an entity elects to adopt early this FSP,
      it is required to adopt FSP FAS 157-4. For debt securities held at the
      beginning of the interim period of adoption for which an
      other-than-temporary impairment was previously recognized, if an entity
      does not intend to sell and it is not more likely than not that the entity
      will be required to sell the security before recovery of its amortized
      cost basis (after considering the guidance in paragraphs 19–26 of this
      FSP), the entity must recognize the cumulative effect of initially
      applying this FSP as an adjustment to the opening balance of retained
      earnings with a corresponding adjustment to accumulated other
      comprehensive income. In the period of adoption, an entity must provide
      the disclosures required by SFAS No. 154, for changes in accounting
      principles. We early adopted this FSP for our first quarter ended March
      31, 2009.  Previous other-than-temporary impairment charges were
      recorded on equity securities so there is no cumulative effect adjustment
      upon adoption.


10


NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS





1.
            BASIS
      OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING
    POLICIES





In April
2009, the FASB issued FSP FAS 141(R)-1, Accounting for Assets Acquired and
Liabilities Assumed in a Business Combination That Arise from
Contingencies. This FSP addresses concerns raised by constituents about
the application of Statement No. 141(R) to assets and liabilities arising from
contingencies in a business combination.  The FSP provides a model
more consistent with that provided in the original Statement No. 141 to account
for pre-acquisition contingencies.  The FSP requires an acquirer to
recognize at fair value “an asset acquired or liability assumed in a business
combination that arises from a contingency if the acquisition-date fair value of
that asset or liability can be determined during the measurement period.” The
FSP is effective for business combinations whose acquisition date is on or after
the beginning of the first annual reporting period beginning on or after
December 15, 2008.  FSP FAS 141(R)-1 is expected to have an impact on
our accounting for any business combinations closing on or after January 1,
2009.





In March
2008, the FASB issued Statement No. 161 – Disclosures about Derivative
Instruments and Hedging Activities–an amendment of FASB Statement No.
133. SFAS No. 161 requires enhanced disclosures about how and why an
entityuses
derivative instruments, how derivative instruments and related items are
accounted for under Statement 133 and how derivativeinstruments and related
hedged items affect an entity’s financial position, financial performance and
cash flows. The new standard iseffective for us on
January 1, 2009. Adoption of this standard did not have a material
impact.





In April
2008, the FASB issued FSP FAS 142-3, Determination of the Useful Life of
Intangible Assets.This FSP amends the factors that should be considered
in developing renewal or extension assumptionsused to determine the useful life
of a recognized intangible asset.  The FSP provides that in addition
to considering the entity specific factors in paragraph 11 of Statement No. 142,
an entity must consider its own historical experience in renewing or extending
similar arrangements.  Alternatively, if an entity lacks historical
experience, it must consider the assumptions a market participant would use
consistent with the highest and best use of the asset, adjusted for the entity
specific factors in paragraph 11 of Statement No. 142. The FSP is effective for
financial statements issued for fiscal years beginning after December 15, 2008,
and interim periods within those fiscal years.  Early adoption is
prohibited. Adoption of this standard did not have a material
impact.





In
June 2008, the FASB issued FSP No. EITF 03-6-1, Determining Whether Instruments
Granted inShare-Based
Payment Transactions are Participating Securities. This FASB staff
position concludedthat all outstanding unvested share-based payment awards that
contain rights to nonforfeitable dividends participate in undistributed earnings
with common shareholders and therefore are considered participating securities
for purposes of computing earnings per share. Entities that have participating
securities that are not convertible into common stock are required to use the
“two-class” method of computing earnings per share. The two-class method is an
earnings allocation formula that dividends declared (or accumulated) and
participation rights in undistributed earnings. This FASB staff position is
effective for fiscal years beginning after December 15, 2008 and interim
periods within those fiscal years. This FASB staff position became effective for
us on January 1, 2009. Adoption of this standard did not have a material
impact.





In
December 2007, the FASB issued SFAS 141 (revised 2007), Business Combinations(SFAS 141R). SFAS 141R
establishes principles and requirements for how the acquirer of a business
recognizes and measures in its financial statements the identifiable assets
acquired, the liabilities assumed, and any non-controlling interest in the
acquiree. SFAS 141R also provides guidance for recognizing and measuring the
goodwill acquired in the business combination and determines what information to
disclose to enable users of the financial statements to evaluate the nature and
financial effects of the business combination. SFAS 141R is effective for
business combinations where the acquisition date is on or after fiscal years
beginning after December 15, 2008. SFAS141R
is expected to have an impact on our accounting for any business combinations
closing on or after January 1, 2009.





In
December 2007, the FASB issued SFAS 160, Non-controlling Interests in
Consolidated Financial Statements– an amendment of ARB No. 51 (SFAS 160).
SFAS 160 establishes accounting and reporting standards for the non-controlling
interest in a subsidiary and for the deconsolidation of a subsidiary. SFAS 160
clarifies that a non-controlling interest in a subsidiary is an ownership
interest in the consolidated entity that should be reported as equity in the
consolidated financial statements and requires retroactive adoption of the
presentation and disclosure requirements for existing minority interests. All
other requirements of SFAS 160 shall be applied prospectively. SFAS 160 is
effective for fiscal years beginning after December 15,
2008.  Adoption of this standard did not have a material
impact.


11


NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS





1.
            BASIS
      OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING
    POLICIES





Effect of Newly Issued But Not Yet
Effective Accounting Standards – In December 2008, the FASBissued FASB
Staff Position No. 132(R)-1, Employers’ Disclosures about
Postretirement Benefit PlanAssets. This FASB staff
position amends FASB Statement No. 132 to provide guidance on an employer’sdisclosures about plan
assets of a defined benefit pension or other postretirement plan. FSP FAS
132(R)-1 requires disclosure of the fairvalue of each major
category of plan assets for pension plans and other postretirement benefit
plans. This FASB staff positionbecomes effective for
us on January 1, 2010.  Adoption of this standard is not expected to
have a material impact.





In
June 2009, the FASB issued Statement No. 166 – Accounting for Transfers of
Financial Assets–anamendment of FASB
Statement No. 140. SFAS No. 166 amends SFAS No. 140 and
removes the conceptof a qualifying special-purpose entity and limits the
circumstances in which a financial asset, or portion of a financial asset,
should be derecognized when the transferor has not transferred the entire
financial asset to an entity that is not consolidated with the transferor in the
financial statements being presented and/or when the transferor has continuing
involvement with the transferred financial asset. The new standard will become
effective for us on January 1, 2010. We are currently evaluating the impact
of adopting this standard but do not expect the impact of adoption to be
material to our results of operation or financial position.





In
June 2009, the FASB issued Statement No. 167 – Amendments to FASB Interpretation
No. 46(R).SFAS No. 167 amends tests under Interpretation
No. 46(R) for variable interest entities to determinewhether a variable
interest entity must be consolidated. SFAS No. 167 requires an entity to perform
an analysis to determine whether an entity’s variable interest or interests give
it a controlling financial interest in a variable interest entity. This
statement requires ongoing reassessments of whether an entity is the primary
beneficiary of a variable interest entity and enhanced disclosures that provide
more transparent information about an entity’s involvement with a variable
interest entity. The new standard will become effective for us on
January 1, 2010. We are currently evaluating the impact of adopting the
standard but do not expect the impact of adoption to be material to our results
of operation or financial position.


12





NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS





2.
            SECURITIES





The
amortized cost basis and fair values of securities are as follows:





Gross
                        
                        
                        Gross(Dollars in thousands)
                        
                        Amortized
                        
                        
                        Unrealized
                        
                        
                        UnrealizedCost
                        
                        
                        Gains
                        
                        
                        Losses
                        
                        
                        Fair ValueSecurities
      available-for-sale:June
      30, 2009:U.S.
      Treasury and agencies
                        
                        $
                        15,000
                        
                        
                        $
                        23
                        
                        
                        $
                        -
                        
                        
                        $
                        15,023Government-sponsored
      mortgage-backed securities
                        
                        
                        5,283
                        
                        
                        
                        133
                        
                        
                        
                        -
                        
                        
                        
                        5,416Equity
                        
                        
                        933
                        
                        
                        
                        51
                        
                        
                        
                        (3
                        )
                        
                        
                        981State
      and municipal
                        
                        
                        12,907
                        
                        
                        
                        2
                        
                        
                        
                        (601
                        )
                        
                        
                        12,308Trust
      preferred securities
                        
                        
                        2,394
                        
                        
                        
                        -
                        
                        
                        
                        (2,146
                        )
                        
                        
                        248Total
                        
                        $
                        36,517
                        
                        
                        $
                        209
                        
                        
                        $
                        (2,750
                        )
                        
                        $
                        33,976December
      31, 2008:Government-sponsored
      mortgage-backed securities
                        
                        $
                        6,079
                        
                        
                        $
                        70
                        
                        
                        $
                        (10
                        )
                        
                        $
                        6,139Equity
                        
                        
                        933
                        
                        
                        
                        17
                        
                        
                        
                        (2
                        )
                        
                        
                        948State
      and municipal
                        
                        
                        9,558
                        
                        
                        
                        3
                        
                        
                        
                        (946
                        )
                        
                        
                        8,615Trust
      preferred securities
                        
                        
                        2,732
                        
                        
                        
                        -
                        
                        
                        
                        (2,659
                        )
                        
                        
                        73Total
                        
                        $
                        19,302
                        
                        
                        $
                        90
                        
                        
                        $
                        (3,617
                        )
                        
                        $
                        15,775





Gross
                    
                    
                    GrossAmortized
                    
                    
                    Unrecognized
                    
                    
                    UnrecognizedCost
                    
                    
                    Gains
                    
                    
                    Losses
                    
                    
                    Fair ValueSecurities
      held-to-maturity:June
      30, 2009:Government-sponsored
      mortgage-backed securities
                    
                    $
                    1,302
                    
                    
                    $
                    14
                    
                    
                    $
                    -
                    
                    
                    $
                    1,316State
      and municipal
                    
                    
                    481
                    
                    
                    
                    3
                    
                    
                    
                    (18
                    )
                    
                    
                    466Trust
      preferred securities
                    
                    
                    21
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    21Total
                    
                    $
                    1,804
                    
                    
                    $
                    17
                    
                    
                    $
                    (18
                    )
                    
                    $
                    1,803December
      31, 2008:U.S.
      Treasury and agencies
                    
                    $
                    4,503
                    
                    
                    $
                    54
                    
                    
                    $
                    -
                    
                    
                    $
                    4,557Government-sponsored
      mortgage-backed securities
                    
                    
                    1,780
                    
                    
                    
                    -
                    
                    
                    
                    (7
                    )
                    
                    
                    1,773State
      and municipal
                    
                    
                    481
                    
                    
                    
                    2
                    
                    
                    
                    -
                    
                    
                    
                    483Trust
      preferred securities
                    
                    
                    258
                    
                    
                    
                    -
                    
                    
                    
                    (225
                    )
                    
                    
                    33Total
                    
                    $
                    7,022
                    
                    
                    $
                    56
                    
                    
                    $
                    (232
                    )
                    
                    $
                    6,846




13





NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS





2.
            SECURITIES
      – (Continued)





The
amortized cost and fair value of securities at June 30, 2009, by contractual
maturity, are shown below.  Securities not due at a single maturity
date, primarily equity securities, are shown separately.





Amortized
                          
                          
                          Fair(Dollars
      in thousands)
                          
                          Cost
                          
                          
                          ValueSecurities
      available-for-sale:Due
      in one year or less
                          
                          $
                          110
                          
                          
                          $
                          110Due
      after one year through five years
                          
                          
                          15,115
                          
                          
                          
                          15,139Due
      after five years through ten years
                          
                          
                          3,463
                          
                          
                          
                          3,463Due
      after ten years
                          
                          
                          11,613
                          
                          
                          
                          8,867Government-sponsored
      mortgage-backed securities
                          
                          
                          5,283
                          
                          
                          
                          5,416Equity
                          
                          
                          933
                          
                          
                          
                          981Total
                          
                          $
                          36,517
                          
                          
                          $
                          33,976Amortized
                          
                          
                          Fair(Dollars
      in thousands)
                          
                          Cost
                          
                          
                          ValueSecurities
      held-to-maturity:Due
      in one year or less
                          
                          $
                          235
                          
                          
                          $
                          217Due
      after one year through five years
                          
                          
                          246
                          
                          
                          
                          249Due
      after ten years
                          
                          
                          21
                          
                          
                          
                          21Government-sponsored
      mortgage-backed securities
                          
                          
                          1,302
                          
                          
                          
                          1,316Total
                          
                          $
                          1,804
                          
                          
                          $
                          1,803





There
were not any sales of available-for-sale securities for the June 30, 2009 and
2008 periods.





Investment
securities pledged to secure public deposits and FHLB advances had an amortized
cost of $14.0 million and fair value of $13.6 million at June 30, 2009 and a
$19.6 million amortized cost and fair value of $18.8 million at December 31,
2008.


14





NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS





2.
            SECURITIES
      – (Continued)





The
following table summarizes the investment securities with unrealized losses at
June 30, 2009 and December 31, 2008 by aggregated major security type and length
of time in a continuous unrealized loss position:





June 30, 2009
                                
                                Less than 12 Months
                                
                                
                                12 Months or More
                                
                                
                                TotalFair
                                
                                
                                Unrealized
                                
                                Fair
                                
                                
                                Unrealized
                                
                                
                                Fair
                                
                                
                                UnrealizedDescription of Securities
                                
                                Value
                                
                                
                                Loss
                                
                                
                                Value
                                
                                
                                Loss
                                
                                
                                Value
                                
                                
                                LossEquity
                                
                                $
                                83
                                
                                
                                $
                                (3
                                )
                                
                                $
                                -
                                
                                
                                $
                                -
                                
                                
                                $
                                83
                                
                                
                                $
                                (3
                                )State
      and municipal
                                
                                
                                327
                                
                                
                                
                                (18
                                )
                                
                                
                                8,618
                                
                                
                                
                                (601
                                )
                                
                                
                                8,945
                                
                                
                                
                                (619
                                )Trust
      preferred securities
                                
                                
                                248
                                
                                
                                
                                (2,146
                                )
                                
                                
                                21
                                
                                
                                
                                -
                                
                                
                                
                                269
                                
                                
                                
                                (2,146
                                )Total
      temporarily impaired
                                
                                $
                                658
                                
                                
                                $
                                (2,167
                                )
                                
                                $
                                8,639
                                
                                
                                $
                                (601
                                )
                                
                                $
                                9,297
                                
                                
                                $
                                (2,768
                                )December
      31, 2008
                                
                                Less
      than 12 Months
                                
                                
                                12
      Months or More
                                
                                
                                TotalFair
                                
                                
                                Unrealized
                                
                                Fair
                                
                                
                                Unrealized
                                
                                
                                Fair
                                
                                
                                UnrealizedDescription of Securities
                                
                                Value
                                
                                
                                Loss
                                
                                
                                Value
                                
                                
                                Loss
                                
                                
                                Value
                                
                                
                                LossGovernment-sponsored
      mortgage-backed securities
                                
                                $
                                3,944
                                
                                
                                $
                                (15
                                )
                                
                                $
                                526
                                
                                
                                $
                                (2
                                )
                                
                                $
                                4,470
                                
                                
                                $
                                (17
                                )Equity
                                
                                
                                6
                                
                                
                                
                                (2
                                )
                                
                                
                                -
                                
                                
                                
                                -
                                
                                
                                
                                6
                                
                                
                                
                                (2
                                )State
      and municipal
                                
                                
                                938
                                
                                
                                
                                (99
                                )
                                
                                
                                7,450
                                
                                
                                
                                (847
                                )
                                
                                
                                8,388
                                
                                
                                
                                (946
                                )Trust
      preferred securities
                                
                                
                                106
                                
                                
                                
                                (2,884
                                )
                                
                                
                                -
                                
                                
                                
                                -
                                
                                
                                
                                106
                                
                                
                                
                                (2,884
                                )Total
      temporarily impaired
                                
                                $
                                4,994
                                
                                
                                $
                                (3,000
                                )
                                
                                $
                                7,976
                                
                                
                                $
                                (849
                                )
                                
                                $
                                12,970
                                
                                
                                $
                                (3,849
                                )





Each
quarter we review all investments with an unrealized loss position for other
than temporary impairment (“OTTI”) under SFAS No. 115, “Accounting for Certain
Investments in Debt and Equity Securities”(“SFAS No. 115”) and
EITF 99-20-1, “Amendments to the Impairment Guidance of EITF 99-20. EITF 99-20-1
revises the impairment guidance for beneficial interests in EITF 99-20 to better
align with the requirements of SFAS No. 115 for determining whether an
impairment of debt securities has occurred.





As
discussed in Note 1, in early April 2009, the FASB issued FSP FAS 115-2,
and FAS 124-2,  Recognition and Presentation of
Other-Than-Temporary Impairments.  Among other provisions,
the  FSP requires entities to split other than temporary impairment
charges between credit losses (i.e., the  loss based on the entity’s
estimate of the decrease in cash flows,  including those that result
from  expected voluntary prepayments), which are charged to earnings,
and the remainder of the  impairment charge (non-credit component) to
accumulated other comprehensive income. This  requirement pertains to
both securities held to maturity and securities available for sale.





The
unrealized losses on the state and municipal securities were caused primarily by
interest rate decreases.  The contractual terms of those investments
do not permit the issuer to settle the securities at a price less than the
amortized cost of the investment.  Because we do not have the intent
to sell these securities and it is likely that we will not be required to sell
the securities before their anticipated recovery, we do not consider these
investments to be other-than-temporarily impaired at June 30,
2009.  We also considered the financial condition and near term
prospects of the issuer and identified no matters that would indicate less than
full recovery.





As
discussed in Note 6 - Fair Value, the fair value of our portfolio of trust
preferred securities, which are included in the corporate category, has
decreased significantly as a result of the current credit crisis and lack of
liquidity in the financial markets.  There are limited trades in trust
preferred securities and the majority of holders of such instruments have
elected not to participate in the market unless they are required to sell as a
result of liquidation, bankruptcy, or other forced or distressed
conditions.




15





NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS





2.
            SECURITIES
      – (Continued)





To
determine if the five trust preferred securities were other than temporarily
impaired as of June 30, 2009, we used a discounted cash flow
analysis.  The cash flow models used were used to determine if the
current present value of the cash flows expected on each security were still
equivalent to the original cash flows projected on the security when
purchased.   The cash flow analysis takes into consideration
assumptions for prepayments, defaults and deferrals for the underlying pool of
banks, insurance companies and REITs.




Management
works with independent third parties to identify its best estimate of the cash
flow estimated to be collected. If this estimate results in a present value of
expected cash flows that is less than the amortized cost basis of a security
(that is, credit loss exists), an OTTI is considered to have occurred. If there
is no credit loss, any impairment is considered temporary. The cash flow
analysis we performed included the following general assumptions:
 
 ·
              We
      assume default rates on individual entities behind the pools based on
      Fitch ratings for financial institutions and A.M. Best ratings for
      insurance companies.  These ratings are used to predict the
      default rates for the next seven
quarters.
 ·
              We
      assume that annual defaults for the remaining life of each security will
      be 37.5 basis points. According to FTN Financial: "The FDIC lists the
      number of bank failures each year from 1934-2008. Comparing bank failures
      to the number of FDIC institutions produces an annual average default rate
      of 36 basis points."
 ·
              We
      assume a recovery rate of 15% on deferrals after two
  years.
 ·
              We
      assume 2% prepayments through the five year par call and then 2% per annum
      for the remaining life of the security. According to FTN Financial:
      "Prepayments were common in 2006 and 2007 when issuers were able to
      refinance into lower cost borrowings. That was a much different
      environment than today and most parties expect prepayments to be very low
      absent a change in credit
conditions."
 ·
              Our
      securities have been modeled using the above assumptions by FTN Financial
      using the forward LIBOR curve plus original spread to discount projected
      cash flows to present values.





Additionally,
in making our determination, we considered all available market information that
could be obtained without undue cost and effort, and considered the unique
characteristics of each trust preferred security individually by assessing the
available market information and the various risks associated with that security
including:





·
              Valuation
      estimates provided by our investment
broker;


·
              The
      amount of fair value decline;


·
              How
      long the decline in fair value has
existed;


·
              Significant
      rating agency changes on the
issuer;


·
              Level
      of interest rates and any movement in pricing for credit and other
      risks;


·
              Information
      about the performance of the underlying institutions that issued the debt
      instruments, such as net income, return on equity, capital adequacy,
      non-performing assets, Texas ratios,
etc;


·
              Our
      intent to sell the security or whether it is more likely than not that we
      will be required to sell the security before its anticipated recovery;
      and


·
              Other
      relevant observable inputs.






(Dollars
      in thousands)
                                Security
                              Tracnhe
                              
                              Moody's
                                      Credit
                                    Ratings
                                  When
                                Purchased
                              
                              Current
                                    Moody's
                                  Credit
                                Ratings
                              
                              Par
                                Value
                              
                              
                              Book
                                Value
                              
                              
                              Estimated
                                  Fair
                                Value
                              
                              
                              Current
                                    Deferrals
                                  and
                                Defaults
                              
                              
                              %
      of Current
                                      Deferrals
      and
                                    Defaults
                                  to
      Current
                                CollateralPreferred
      Term Securities IV
                              Mezzanine
                              
                              
                              A3
                              
                              Ca
                              
                              $
                              244
                              
                              
                              $
                              199
                              
                              
                              $
                              19
                              
                              
                              $
                              18,000
                              
                              
                              
                              27
                              %Preferred
      Term Securities VI
                              Mezzanine
                              
                              
                              A1
                              
                              Caa1
                              
                              
                              259
                              
                              
                              
                              21
                              
                              
                              
                              21
                              
                              
                              
                              25,000
                              
                              
                              
                              61
                              %Preferred
      Term Securities XV B1
                              Mezzanine
                              
                              
                              A2
                              
                              Ca
                              
                              
                              1,004
                              
                              
                              
                              830
                              
                              
                              
                              113
                              
                              
                              
                              103,700
                              
                              
                              
                              17
                              %Preferred
      Term Securities XXI C2
                              Mezzanine
                              
                              
                              A3
                              
                              Ca
                              
                              
                              1,018
                              
                              
                              
                              862
                              
                              
                              
                              73
                              
                              
                              
                              138,500
                              
                              
                              
                              18
                              %Preferred
      Term Securities XXII C1
                              Mezzanine
                              
                              
                              A3
                              
                              Ca
                              
                              
                              503
                              
                              
                              
                              503
                              
                              
                              
                              43
                              
                              
                              
                              231,500
                              
                              
                              
                              17
                              %Total
                              
                              
                              
                              
                              
                              
                              
                              $
                              3,028
                              
                              
                              $
                              2,415
                              
                              
                              $
                              269





The
following table details the four debt securities with other-than-temporary
impairment at June 30, 2009 and the related credit losses recognized in
earnings:





(Dollars in thousands)
                          
                          PreTSL XXI
                          
                          
                          PreTSL VI
                          
                          
                          PreTSL IV
                          
                          
                          PreTSL XV
                          
                          
                          TotalAmount
      of other-than-temporary impairment related to credit loss at January 1,
      2009
                          
                          $
                          -
                          
                          
                          $
                          -
                          
                          
                          $
                          -
                          
                          
                          $
                          -
                          
                          
                          $
                          -Addition
                          
                          
                          156
                          
                          
                          
                          25
                          
                          
                          
                          44
                          
                          
                          
                          175
                          
                          
                          
                          400Amount
      of other-than-temporary impairment related to credit loss at June 30,
      2009
                          
                          $
                          156
                          
                          
                          $
                          25
                          
                          
                          $
                          44
                          
                          
                          $
                          175
                          
                          
                          $
                          400


16


NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS





3.
            LOANS





Loans are
summarized as follows:





June
      30,
                    
                    
                    December
      31,(Dollars
      in thousands)
                    
                    2009
                    
                    
                    2008Commercial
                    
                    $
                    56,661
                    
                    
                    $
                    56,863Real
      estate commercial
                    
                    
                    617,528
                    
                    
                    
                    563,314Real
      estate construction
                    
                    
                    16,983
                    
                    
                    
                    17,387Residential
      mortgage
                    
                    
                    176,170
                    
                    
                    
                    165,337Consumer
      and home equity
                    
                    
                    72,649
                    
                    
                    
                    69,649Indirect
      consumer
                    
                    
                    36,601
                    
                    
                    
                    31,754Loans
      held for sale
                    
                    
                    6,140
                    
                    
                    
                    9,567982,732
                    
                    
                    
                    913,871Less:Net
      deferred loan origination fees
                    
                    
                    (880
                    )
                    
                    
                    (870
                    )Allowance
      for loan losses
                    
                    
                    (14,236
                    )
                    
                    
                    (13,565
                    )(15,116
                    )
                    
                    
                    (14,435
                    )Loans
      Receivable
                    
                    $
                    967,616
                    
                    
                    $
                    899,436








The
allowance for loan loss is summarized as follows:





As of and For the
                  
                  
                  As of and For theThree Months Ended
                  
                  
                  Six Months EndedJune 30,
                  
                  
                  June 30,(Dollars in thousands)
                  
                  2009
                  
                  
                  2008
                  
                  
                  2009
                  
                  
                  2008Balance,
      beginning of period
                  
                  $
                  15,072
                  
                  
                  $
                  8,395
                  
                  
                  $
                  13,565
                  
                  
                  $
                  7,922Allowance
      related to acquisition
                  
                  
                  -
                  
                  
                  
                  327
                  
                  
                  
                  -
                  
                  
                  
                  327Provision
      for loan losses
                  
                  
                  1,913
                  
                  
                  
                  514
                  
                  
                  
                  3,958
                  
                  
                  
                  1,098Charge-offs
                  
                  
                  (2,813
                  )
                  
                  
                  (425
                  )
                  
                  
                  (3,406
                  )
                  
                  
                  (574
                  )Recoveries
                  
                  
                  64
                  
                  
                  
                  106
                  
                  
                  
                  119
                  
                  
                  
                  144Balance,
      end of period
                  
                  $
                  14,236
                  
                  
                  $
                  8,917
                  
                  
                  $
                  14,236
                  
                  
                  $
                  8,917





Impaired
loans are summarized below.  There were no impaired loans for the
periods presented without an allowance allocation.





As
      of and For the
                    
                    
                    As
      of and For theSix
      Months Ended
                    
                    
                    Year
      EndedJune
      30,
                    
                    
                    December
      31,(Dollars
      in thousands)
                    
                    2009
                    
                    
                    2008End
      of period impaired loans
                    
                    $
                    26,235
                    
                    
                    $
                    16,769Amount
      of allowance for loanloss
      allocated
                    
                    
                    3,440
                    
                    
                    
                    3,090




17


NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS





3.
            LOANS
      –
      (Continued)





We report
non-performing loans as impaired.  Our non-performing loans were as
follows:





June 30,
                  
                  
                  December 31,(Dollars in thousands)
                  
                  2009
                  
                  
                  2008Restructured
                  
                  $
                  2,116
                  
                  
                  $
                  1,182Loans
      past due over 90 days still on accrual
                  
                  
                  -
                  
                  
                  
                  -Non
      accrual loans
                  
                  
                  24,119
                  
                  
                  
                  15,587Total
                  
                  $
                  26,235
                  
                  
                  $
                  16,769





4.
            EARNINGS
      PER SHARE





The
reconciliation of the numerators and denominators of the basic and diluted EPS
is as follows:





Three
      Months Ended
                    
                    
                    Six
      Months Ended(Dollars
      in thousands,
                    
                    June
      30,
                    
                    
                    June
      30,except
      per share data)
                    
                    2009
                    
                    
                    2008
                    
                    
                    2009
                    
                    
                    2008Basic:Net
      income
                    
                    $
                    715
                    
                    
                    $
                    2,099
                    
                    
                    $
                    1,476
                    
                    
                    $
                    3,982Less:Preferred
      stock dividends
                    
                    
                    (213
                    )
                    
                    
                    -
                    
                    
                    
                    (480
                    )
                    
                    
                    -Accretion
      on preferred stock discount
                    
                    
                    (14
                    )
                    
                    
                    -
                    
                    
                    
                    (25
                    )
                    
                    
                    -Net
      income available to common shareholders
                    
                    $
                    488
                    
                    
                    $
                    2,099
                    
                    
                    $
                    971
                    
                    
                    $
                    3,982Weighted
      average common shares
                    
                    
                    4,688
                    
                    
                    
                    4,664
                    
                    
                    
                    4,683
                    
                    
                    
                    4,664Diluted:Weighted
      average common shares
                    
                    
                    4,688
                    
                    
                    
                    4,664
                    
                    
                    
                    4,683
                    
                    
                    
                    4,664Dilutive
      effect of stock options and warrants
                    
                    
                    38
                    
                    
                    
                    28
                    
                    
                    
                    3
                    
                    
                    
                    31Weighted
      average common and incremental shares
                    
                    
                    4,726
                    
                    
                    
                    4,692
                    
                    
                    
                    4,686
                    
                    
                    
                    4,695Earnings
      Per Common Share:Basic
                    
                    $
                    0.10
                    
                    
                    $
                    0.45
                    
                    
                    $
                    0.21
                    
                    
                    $
                    0.85Diluted
                    
                    $
                    0.10
                    
                    
                    $
                    0.45
                    
                    
                    $
                    0.21
                    
                    
                    $
                    0.85





Stock
options for 127,590 and 157,805 shares of common stock were not included in the
June 30, 2009 computation of diluted earnings per share for the quarter and year
to date because their impact was anti-dilutive.  Stock options for
55,050 shares of common stock were not included in the 2008 computation of
diluted earnings per share for the quarter and year to date because their impact
was anti-dilutive.  Warrants to purchase 215,983 shares at June 30,
2009 were not included in the year to date computation because their impact was
anti-dilutive.





5.
            STOCK
      OPTION PLAN





Our 2006
Stock Incentive Plan, which is shareholder approved, succeeded our 1998 Stock
Option and Incentive Plan. Under the 2006 Plan, we may grant either incentive or
non-qualified stock options tokey employees and directorsfor a total of 647,350 shares
of our common stock at not less than fair value at the date such options are
granted.Options
available for future grant under the 1998 Plan totaled 38,500 shares and were
rolled into the 2006 Plan.We believe that the ability to award stock options and other forms of
stock-based incentive compensation can assist us in attracting and retaining key
employees. Stock-based incentive compensation is also a means to align the
interests of key employees with those of our shareholders by providing awards
intended to reward recipients for our long-term growth.The option to purchase shares
vest over periods of one to five years and expire ten years after the date of
grant.We issue new
shares of common stock upon the exercise of stock options. At June 30, 2009
options available for future grant under the 2006 Plan totaled 590,750.Compensation cost related to
options granted under the 1998 and 2006 Plans that was charged against earnings
for the six month periods ended June 30, 2009and 2008 was $52,000 and
$60,000.




18




NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS





5.
            STOCK
      OPTION PLAN - (Continued)





The fair
value of each option award is estimated on the date of grant using the
Black-Scholes option valuation model that uses various weighted-average
assumptions.  The risk-free interest rate is based on the U.S.
Treasury yield curve in effect at the time of grant.  The expected
volatility is based on the fluctuation in the price of a share of stock over the
period for which the option is being valued and the expected life of the options
granted represents the period of time the options are expected to be
outstanding.  There were no stock option grants for the June 30, 2009
period.





A summary
of option activity under the 1998 and 2006 Plans as of June 30, 2009 is
presented below:





WeightedWeighted
                    
                    
                    AverageNumber
                    
                    
                    Average
                    
                    
                    Remaining
                    
                    
                    Aggregateof
                    
                    
                    Exercise
                    
                    
                    Contractual
                    
                    
                    IntrinsicOptions
                    
                    
                    Price
                    
                    
                    Term
                    
                    
                    Value(Dollars In Thousands)Outstanding,
      beginning of period
                    
                    
                    208,517
                    
                    
                    $
                    19.19Granted
      during period
                    
                    
                    -
                    
                    
                    
                    -Forfeited
      during period
                    
                    
                    (1,464
                    )
                    
                    
                    16.74Exercised
      during period
                    
                    
                    (32,582
                    )
                    
                    
                    15.43Outstanding,
      end of period
                    
                    
                    174,471
                    
                    
                    $
                    19.91
                    
                    
                    
                    5.2
                    
                    
                    $
                    -Eligible
      for exercise at period end
                    
                    
                    125,291
                    
                    
                    $
                    18.58
                    
                    
                    
                    4.2
                    
                    
                    $
                    -





The total
intrinsic value of options exercised during the period ended June 30, 2009 was
$116,000.  There were no options exercised, modified or settled in
cash for the period ended June 30, 2008.  There was no tax benefit
recognized from the option exercises as they are considered incentive stock
options.  Management expects all outstanding unvested options will
vest.





As of
June 30, 2009 there was $204,000 of total unrecognized compensation cost related
to non-vested share-based compensation arrangements granted under the 1998 and
2006 Plans.  That cost is expected to be recognized over a
weighted-average period of 3.1 years.  Cash received from option
exercises under all share-based payment arrangements for the periods ended June
30, 2009 and 2008 was $50,000 and $0.





6.
            FAIR
      VALUE





SFAS No.
157 defines fair value as the price that would be received to sell an asset or
paid to transfer a liability in an orderly transaction between market
participants at the measurement date.  SFAS No. 157 establishes a fair
value hierarchy that prioritizes the use of inputs used in valuation
methodologies into the following three levels:





Level 1: Quoted prices
(unadjusted) for identical assets or liabilities in active markets.  A
quoted price in an active market provides the most reliable evidence of fair
value and shall be used to measure fair value whenever available.





19





NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS





6.
              FAIR
      VALUE - (Continued)





Level 2:Significant other
observable inputs other than Level 1 prices such as quoted prices for similar
assets or liabilities; quoted prices in markets that are not active; or other
inputs that are observable or can be corroborated by observable market
data.





Level 3: Significant
unobservable inputs that reflect a reporting entity’s own assumptions about the
assumptions that market participants would use in pricing an asset or
liability.





We used
the following methods and significant assumptions to estimate the fair value of
available-for-sale-securities.





Available-for-sale
securities: The fair values of equity securities are determined by
obtaining quoted prices on nationally recognized securities exchanges (Level 1
inputs).  The fair values of debt securities are determined by a
matrix pricing, which is a mathematical technique widely used in the industry to
value debt securities without relying exclusively on quoted prices for the
specific securities but rather by relying on the securities’ relationship to
other benchmark quoted securities (Level 2 inputs).  In certain cases
where there is limited activity or less transparency around inputs to the
valuation, securities are classified within (Level 3) of the valuation
hierarchy.  Discounted cash flows are calculated using spread to swap
and LIBOR curves that are updated to incorporate loss severities, volatility,
credit spread and optionality.  Rating agency and industry research
reports as well as defaults and deferrals on individual securities are reviewed
and incorporated into the calculations.





Assets and Liabilities
Measured at Fair Value on a Recurring Basis





Assets
measured at fair value on a recurring basis are summarized below:





Quoted Prices inActive Markets for
                    
                    
                    Significant Other
                    
                    
                    SignificantJune 30,
                    
                    
                    Identical Assets
                    
                    
                    Observable Inputs
                    
                    
                    Unobservable Inputs(Dollars in thousands)
                    
                    2009
                    
                    
                    (Level 1)
                    
                    
                    (Level 2)
                    
                    
                    (Level 3)Assets:U.S.
      Treasury and agencies
                    
                    $
                    15,023
                    
                    
                    $
                    -
                    
                    
                    $
                    15,023
                    
                    
                    $
                    -Government-sponsored
      mortgage-backed securities
                    
                    
                    5,416
                    
                    
                    
                    -
                    
                    
                    
                    5,416
                    
                    
                    
                    -Equity
                    
                    
                    981
                    
                    
                    
                    690
                    
                    
                    
                    -
                    
                    
                    
                    291State
      and municipal
                    
                    
                    12,308
                    
                    
                    
                    -
                    
                    
                    
                    12,308
                    
                    
                    
                    -Trust
      preferred securities
                    
                    
                    248
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    248Total
                    
                    $
                    33,976
                    
                    
                    $
                    690
                    
                    
                    $
                    32,747
                    
                    
                    $
                    539





Quoted Prices inActive Markets for
                    
                    
                    Significant Other
                    
                    
                    SignificantDecember 31,
                    
                    
                    Identical Assets
                    
                    
                    Observable Inputs
                    
                    
                    Unobservable Inputs(Dollars in thousands)
                    
                    2008
                    
                    
                    (Level 1)
                    
                    
                    (Level 2)
                    
                    
                    (Level 3)Assets:Government-sponsored
      mortgage-backed securities
                    
                    $
                    6,139
                    
                    
                    $
                    -
                    
                    
                    $
                    6,139
                    
                    
                    $
                    -Equity
                    
                    
                    948
                    
                    
                    
                    657
                    
                    
                    
                    -
                    
                    
                    
                    291State
      and municipal
                    
                    
                    8,615
                    
                    
                    
                    -
                    
                    
                    
                    8,615
                    
                    
                    
                    -Trust
      preferred securities
                    
                    
                    73
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    73Total
                    
                    $
                    15,775
                    
                    
                    $
                    657
                    
                    
                    $
                    14,754
                    
                    
                    $
                    364




20


NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS





6.
            FAIR
      VALUE - (Continued)





Between
June 2002 and July 2006, we invested in four AFS and one HTM investment grade
tranches of trust preferred collateralized debt obligation (“CDO”)
securities.  The securities were issued and are referred to as
Preferred Term Securities Limited (“PreTSL”).  The underlying
collateral for the PreTSL is unguaranteed pooled trust preferred securities
issued by banks, insurance companies and REITs geographically dispersed across
the United States.  We hold five PreTSL securities, none of which are
currently investment grade.  Prior to September 30, 2008, we
determined the fair value of the trust preferred securities using a valuation
technique based on Level 2 inputs.  The Level 2 inputs included
estimates of the market value for each security provided through our investment
broker.





Since
late 2007, the markets for collateralized debt obligations and trust preferred
securities have become increasingly inactive.  The inactivity was
first evidenced in late 2007 when new issues of similar securities were
discounted in order to complete the offering.  Beginning in the second
quarter of 2008, the purchase and sale activity of these securities
substantially decreased as investors elected to hold the securities instead of
selling them at substantially depressed prices.  Our brokers have
indicated that little if any activity is occurring in this sector and that the
PreTSL securities trades that are taking place are primarily distressed sales
where the seller must liquidate as a result of insolvency, redemptions or
closure of a fund holding the security, or other distressed
conditions.  As a result, the bid-ask spreads have widened
significantly and the volume of trades decreased significantly compared to
historical volumes.





As of
June 30, 2009, we determined that the market for the trust preferred securities
that we hold and for similar CDO securities (such as higher-rated tranches
within the same CDO security) are also not active.  That determination
was made considering that there are few observable transactions for the trust
preferred securities or similar CDO securities and the observable prices for
those transactions have varied substantially over time.  Consequently,
we have considered those observable inputs and determined that our trust
preferred securities are classified within Level 3 of the fair value
hierarchy.





We have
determined that an income approach valuation technique (using cash flows and
present value techniques) that maximizes the use of relevant observable inputs
and minimizes the use of unobservable inputs is equally or more representative
of fair value than relying on the estimation of market value technique used at
prior measurement dates, which now has few observable inputs and relies on an
inactive market with distressed sales conditions that would require significant
adjustments.





We
received valuation estimates on our trust preferred securities for June 30,
2009.  Those valuation estimates were based on proprietary pricing
models utilizing significant unobservable inputs in an inactive market with
distressed sales, Level 3 inputs, rather than actual transactions in an active
market.





In
accordance with the requirements of SFAS 157, we determined that a risk-adjusted
discount rate appropriately reflects the reporting entity’s estimate of the
assumptions that market participants would use in an active market to estimate
the selling price of the asset at the measurement date.





We
conduct a thorough review of fair value hierarchy classifications on a quarterly
basis.  Reclassification of certain financial instruments may occur
when input observability changes.




21


NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS





6.
            FAIR
      VALUE - (Continued)





The table
below presents a reconciliation and income statement classification of gains and
losses for all assets measured at fair value on a recurring basis using
significant unobservable inputs (Level 3) for the three month and six month
periods ended June 30, 2009:





Fair ValueMeasurementsUsing SignificantUnobservable Inputs(Level 3)Three months endedJune 30, 2009(Dollars in thousands)
                  
                  Asset/LiabilityBeginning
      balance, April 1, 2009
                  
                  $
                  330Total
      gains or losses realized:Included
      in earningsImpairment
      charges on securities
                  
                  
                  (236
                  )Increase
      in fair value of securities
                  
                  
                  445Transfers
      in and/or out of Level 3
                  
                  
                  -Ending
      balance, June 30, 2009
                  
                  $
                  539





Fair ValueMeasurementsUsing SignificantUnobservable Inputs(Level 3)Six months endedJune 30, 2009(Dollars in thousands)
                  
                  Asset/LiabilityBeginning
      balance, January 1, 2009
                  
                  $
                  364Total
      gains or losses realized:Included
      in earningsImpairment
      charges on securities
                  
                  
                  (376
                  )Increase
      in fair value of securities
                  
                  
                  551Transfers
      in and/or out of Level 3
                  
                  
                  -Ending
      balance, June 30, 2009
                  
                  $
                  539




22


NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS





6.
            FAIR
      VALUE - (Continued)





Assets and Liabilities
Measured at Fair Value on a Nonrecurring Basis





Assets
measured at fair value on a nonrecurring basis are summarized
below:





Quoted Prices inActive Markets for
                    
                    
                    Significant Other
                    
                    
                    SignificantJune 30,
                    
                    
                    Identical Assets
                    
                    
                    Observable Inputs
                    
                    
                    Unobservable Inputs(Dollars in thousands)
                    
                    2009
                    
                    
                    (Level 1)
                    
                    
                    (Level 2)
                    
                    
                    (Level 3)Assets:Impaired
      Loans
                    
                    $
                    22,795
                    
                    
                    $
                    -
                    
                    
                    $
                    -
                    
                    
                    $
                    22,795Real
      estate acquired through foreclosure
                    
                    
                    8,319
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    8,319





Quoted Prices inActive Markets for
                    
                    
                    Significant Other
                    
                    
                    SignificantDecember 31,
                    
                    
                    Identical Assets
                    
                    
                    Observable Inputs
                    
                    
                    Unobservable Inputs(Dollars in thousands)
                    
                    2008
                    
                    
                    (Level 1)
                    
                    
                    (Level 2)
                    
                    
                    (Level 3)Assets:Impaired
      Loans
                    
                    $
                    13,679
                    
                    
                    $
                    -
                    
                    
                    $
                    -
                    
                    
                    $
                    13,679Real
      estate acquired through foreclosure
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -





Impaired
loans, which are measured for impairment using the fair value of the collateral
for collateral dependent loans, had a carrying amount of $26.2 million, with a
valuation allowance of $3.4 million, resulting in an additional provision for
loan losses of $314,000 and $350,000 for the three and six month periods ended
June 30, 2009.  Values for collateral dependent loans are generally
based on appraisals obtained from licensed real estate appraisals and in certain
circumstances consideration of offers obtained to purchase properties prior to
foreclosure.  Appraisals for commercial real estate generally use
three methods to derive value: cost, sales or market comparison and income
approach.  The cost method bases value on the estimated cost to
replace the current property after considering adjustments for
depreciation.  Values of the market comparison approach evaluate the
sales price of similar properties in the same market area.  The income
approach considers net operating income generated by the property and an
investors required return.  The final value is a reconciliation of
these three approaches and takes into consideration any other factors management
deems relevant to arrive at a representative fair value.





Real
estate owned acquired through foreclosure is recorded at lower of cost or fair
value less estimated selling costs at the date of foreclosure.  Fair
value is based on the appraised market value of the property  based on
sales of similar assets.  The fair value may be subsequently reduced
if the estimated fair value declines below the original appraised value. Fair
value adjustments of $233,000 and $250,000 were made to real estate owned during
the three and six month periods ended June 30, 2009.




23


NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS





6.
            FAIR
      VALUE - (Continued)





Fair Value of Financial
Instruments





The
estimated fair value of financial instruments not previously presented is as
follows:




(Dollars in thousands)
                    
                    June 30, 2009
                    
                    
                    December 31, 2008Carrying
                    
                    
                    Fair
                    
                    
                    Carrying
                    
                    
                    FairValue
                    
                    
                    Value
                    
                    
                    Value
                    
                    
                    ValueFinancial
      assets:Cash
      and due from banks
                    
                    $
                    20,036
                    
                    
                    $
                    20,036
                    
                    
                    $
                    20,905
                    
                    
                    $
                    20,905Securities
      held-to-maturity
                    
                    
                    1,804
                    
                    
                    
                    1,803
                    
                    
                    
                    7,022
                    
                    
                    
                    6,846Loans
      held for sale
                    
                    
                    6,140
                    
                    
                    
                    6,179
                    
                    
                    
                    9,567
                    
                    
                    
                    9,702Loans,
      net
                    
                    
                    961,476
                    
                    
                    
                    996,928
                    
                    
                    
                    889,869
                    
                    
                    
                    925,817Accrued
      interest receivable
                    
                    
                    4,443
                    
                    
                    
                    4,443
                    
                    
                    
                    4,379
                    
                    
                    
                    4,379FHLB
      stock
                    
                    
                    8,515
                    
                    
                    
                    N/A
                    
                    
                    
                    8,515
                    
                    
                    
                    N/AFinancial
      liabilities:Deposits
                    
                    
                    820,977
                    
                    
                    
                    816,837
                    
                    
                    
                    775,399
                    
                    
                    
                    777,743Short-term
      borrowings
                    
                    
                    114,600
                    
                    
                    
                    114,600
                    
                    
                    
                    94,869
                    
                    
                    
                    94,869Advances
      from Federal Home Loan Bank
                    
                    
                    52,809
                    
                    
                    
                    56,295
                    
                    
                    
                    52,947
                    
                    
                    
                    57,757Subordinated
      debentures
                    
                    
                    18,000
                    
                    
                    
                    12,743
                    
                    
                    
                    18,000
                    
                    
                    
                    12,804Accrued
      interest payable
                    
                    
                    263
                    
                    
                    
                    263
                    
                    
                    
                    288
                    
                    
                    
                    288





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





Carrying
amount is the estimated fair value for cash and cash equivalents, interest
bearing deposits, accrued interest receivable and payable, demand deposits,
short-term debt and variable rate loans or deposits that reprice frequently and
fully.  Held-to-maturity securities fair values are based on market
prices or dealer quotes and if no such information is available, on the rate and
term of the security and information about the issuer.  The value of
loans held for sale is based on the underlying sale commitments.  For
fixed rate loans or deposits and for variable rate loans or deposits with
infrequent reprising or reprising limits, fair value is based on discounted cash
flows using current market rates applied to the estimated life and credit
risk.  Fair values of advances from Federal Home Loan Bank and
subordinated debentures are based on current rates for similar
financing.  The fair value of off-balance-sheet items is based on the
current fees or cost that would be charged to enter into or terminate such
arrangements and is not material.  It is not practicable to determine
the fair value of FHLB stock due to restrictions placed on its
transferability.





7.
            PREFERRED
      STOCK





On
October 3, 2008, Congress passed the Emergency Economic Stabilization Act
of 2008 (EESA), which creates the Troubled Asset Relief Program (“TARP”) and
provides the U.S. Secretary of the Treasury with broad authority to implement
certain actions to help restore stability and liquidity to U.S. markets. The
Capital Purchase Program (the “CPP”) was announced by the U.S. Treasury on
October 14, 2008 as part of TARP. Pursuant to the CPP, the U.S. Treasury will
purchase up to $250 billion of senior preferred shares on standardized
terms from qualifying financial institutions. The purpose of the CPP is to
encourage U.S. financial institutions to build capital to increase the flow of
financing to U.S. businesses and consumers and to support the U.S.
economy.


24





NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS





7.
            PREFERRED
      STOCK - (Continued)





The CPP
is voluntary and requires a participating institution to comply with a number of
restrictions and provisions, including standards for executive compensation and
corporate governance and limitations on share repurchases and the declaration
and payment of dividends on common shares. The standard terms of the CPP require
that a participating financial institution limit the payment of dividends to the
most recent quarterly amount prior to October 14, 2008, which is $0.19 per
share in our case. This dividend limitation will remain in effect until the
earlier of three years or such time that the preferred shares are
redeemed.





Eligible
financial institutions could generally apply to issue senior preferred shares to
the U.S. Treasury in aggregate amounts ranging from 1% to 3% of the
institution’s risk-weighted assets. We applied for an investment by the U.S.
Treasury of $20 million, which was approved by the U.S. Treasury on
December 8, 2008.  On January 9, 2009, we issued $20 million
of cumulative perpetual preferred shares, with a liquidation preference of
$1,000 per share (the “Senior Preferred Shares”). The Senior Preferred Shares
constitute Tier 1 capital and rank senior to our common shares. The Senior
Preferred Shares pay cumulative dividends quarterly at a rate of 5% per annum
for the first five years and will reset to a rate of 9% per annum after five
years. The Senior Preferred Shares may be redeemed at any time, at our
option.





We also
issued a warrant to purchase 215,983 common shares to the U.S. Treasury at a
purchase price of $13.89 per share. The aggregate purchase price equals 15% of
the aggregate amount of the Senior Preferred Shares purchased by the U.S.
Treasury or $3 million. The initial purchase price per share for the warrant and
the number of common shares subject to the warrant were determined by reference
to the market price of the common shares (calculated on a 20-day trailing
average) on December 8, 2008, the date the U.S. Treasury approved our TARP
application. The warrant has a term of 10 years and is potentially dilutive
to earnings per share.





On
February 17, 2009, the American Recovery and Reinvestment Act of 2009 (“ARRA”)
was  enacted. As required by ARRA, the U.S. Treasury has issued
additional compensation standards on  companies receiving financial
assistance from the U.S. government. In addition, ARRA imposes  certain
 new executive compensation and corporate expenditure limits on each
current and future  CPP recipient,  including First
Financial Service Corporation, until the recipient has repaid the
Treasury.  ARRA  also  permits CPP participants to
redeem the preferred shares held by the Treasury Department  without
penalty and without the need to raise new capital, subject to the
 Treasury’s consultation with  the recipient’s appropriate regulatory
agency.


25


MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION


AND
RESULTS OF OPERATIONS





GENERAL





We
operate 23 banking centers in eight contiguous counties in Central Kentucky
along the Interstate 65 corridor and in the Louisville Metropolitan area,
including southern Indiana.  Our markets range from Metro Louisville
in Jefferson County, Kentucky approximately 40 miles north of our headquarters
in Elizabethtown, Kentucky to Hart County, Kentucky, approximately 30 miles
south of Elizabethtown to Harrison County, Indiana approximately 60 miles
northwest of our headquarters.  Our markets are supported by a
diversified industry base and have a regional population of over 1
million.  Based on the current economic slow-down, management
anticipates that our markets may not continue to grow at the rate experienced
over the last few years.  However, we believe we will still be well
positioned to benefit from growth in our local markets when the economy rebounds
in the future.





We serve
the needs and cater to the economic strengths of the local communities in which
we operate, and we strive to provide a high level of personal and professional
customer service. We offer a variety of financial services to our retail and
commercial banking customers. These services include personal and corporate
banking services and personal investment financial counseling
services.





Throughour personal investment
financial counseling services, we offer a wide variety of mutual funds, equity
investments, and fixed and variable annuities.  We invest in the
wholesale capital markets to manage a portfolio of securities and use various
forms of wholesale funding. The security portfolio contains a variety of
instruments, including callable debentures, taxable and non-taxable debentures,
fixed and adjustable rate mortgage backed securities, and collateralized
mortgage obligations.





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





The
discussion and analysis in this report covers material changes in the financial
condition since December 31, 2008 and material changes in the results of
operations for the three and six month periods ending June 30, 2009 as compared
to the same periods in 2008.  It should be read in conjunction with
"Management’s Discussion and Analysis of Financial Condition and Results of
Operations" included in the Annual Report on Form 10-K for the period ended
December 31, 2008.





OVERVIEW





On June
25, 2008, we expanded our operations into southern Indiana with the acquisition
of FSB Bancshares, Inc., the bank holding company for The Farmers State
Bank.  The Farmers State Bank had approximately $65.7 million in total
assets and $55.8 million in deposits.  The Farmers State Bank had four
banking offices in Harrison and Floyd Counties in Indiana, which are adjacent to
four Kentucky counties where we currently operate and are part of the Louisville
MSA.  Upon completion of the acquisition, these four offices became
branches of First Federal Savings Bank.  The acquisition is
anticipated to be accretive to our earnings during the first full year of the
combined operations.





Over the
past several years we have focused on enhancing and expanding our retail and
commercial banking network in our core markets as well as establishing our
presence in the Louisville market.  Our core markets, where we have a
combined 23% market share, have become increasingly competitive as several new
banks have entered those markets during the past few years.  In order
to protect and grow our market share, we are replacing existing branches with
newer, enhanced facilities and anticipate constructing new facilities over the
next few years.  In addition to the enhancement and expansion in our
core markets, we have been increasing our presence in the Louisville
market.  Our acquisition of FSB Bancshares, Inc. has broadened our
retail branch network in the Louisville market, which now extends into Southern
Indiana.  Approximately 73% of the deposit base in the Louisville
market is controlled by six out-of-state banks.  While the market is
very competitive, we believe this creates an opportunity for smaller community
banks with more power to make decisions locally.  We believe our
investment in these initiatives along with our continued commitment to a high
level of customer service will enhance our market share in our core markets and
our development in the Louisville market.


26





Our
retail branch network continues to generate encouraging results.Total deposits have grown
28% over the past three years. Total deposits were $821.0 million at June 30,
2009, an increase of $45.6 million from December 31, 2008.  After our
acquisition of Farmers State Bank in 2008, our retail branch network in the
Louisville market has broadened to sixteen offices.  In May 2009, we
opened the Fort Knox banking center, our twenty-first banking center, which
expanded our current footprint in Hardin County, Kentucky.  The Fort
Knox banking center complements our existing branch located in Radcliff,
Kentucky and is located just outside the main entrance to the Fort Knox military
base.   We also completed the construction of our twenty-second
banking center which opened in July 2009. The branch is located in the
Middletown area of Louisville, Kentucky.  Competition for deposits
continues to be challenging in all of the markets we serve. We believe this
intense competition combined with continued repricing of variable rate loans
could add to additional margin compression.





We have
developed a strong commercial real estate niche in our markets.  We
have an experienced team of bankers who focus on providing service and
convenience to our customers.  It is quite common for our bankers to
close loans at a customer’s place of business or even the customer’s personal
residence.   This high level of service has been well received in
our Louisville market, which is dominated by regional banks.To further develop our
commercial banking relationships in Louisville, we opened a private banking
office in April 2007.  This upscale facility complements our full
service centers in Louisville by attracting commercial deposit relationships in
conjunction with our commercial lending relationships.





Our
emphasis on commercial lending generated 39% growth in the total loan portfolio
and 46% growth in commercial loans over the past three years. Commercial loans were
$691.2 million at June 30, 2009, an increase of $53.6 million, or 8.4% from
December 31, 2008.





Although
we had growth in the loan portfolio during the first six months, credit quality
remained challenging in 2009.There was a significant
migration of loans into the Substandard loan categories during the period,
resulting in a higher provision for loan losses.At June 30, 2009, the
allowance for loan losses was $14.2 million compared to $13.6 million at
December 31, 2008.  The allowance for loan losses to non-performing
loans fell to 54% from 81% at June 30, 2009 compared to December 31,
2008.





Despite
the continued deterioration in economic conditions during the first half of
2009, the Corporation’s capital position remained well-capitalized as defined by
regulatory standards.  Our capital position was further bolstered in
the first quarter of 2009 by our participation in the U.S. Treasury Department
Capital Purchase Program.  Under the Capital Purchase Program, we sold
$20 million of cumulative perpetual preferred shares to the U.S. Treasury in a
transaction that closed on January 9, 2009.





We
believe that the economy is in a very deep and long lasting
recession.  During the last quarter of 2008, the continued economic
slowdown moved to sectors not previously impacted, including consumer,
commercial, industrial among others.  Credit issues are broadening in
these sectors and economic recovery is most likely several quarters
away.  We will continue to monitor credit quality very closely in 2009
as this recession persists.  As the economy and the financial sector
continue to struggle, probable losses in the loan portfolio could increase,
resulting in higher provision for loan losses during 2009.





CRITICAL
ACCOUNTING POLICIES





Our
accounting and reporting policies comply with U.S. generally accepted accounting
principles and conform to general practices within the banking
industry.  The accounting policy relating to the allowance for loan
losses is critical to the understanding of our results of operations since the
application of this policy requires significant management assumptions and
estimates that could result in materially different amounts to be reported if
conditions or underlying circumstances were to change.




Allowance for
Loan Losses–We
maintain an allowance sufficient to absorb probable incurred credit losses
existing in the loan portfolio. Our Allowance for Loan Loss Review Committee,
which is comprised of senior officers, evaluates the allowance for loan losses
on a quarterly basis.  We estimate the allowance using past loan loss
experience, known and inherent risks in the portfolio, adverse situations that
may affect the borrower’s ability to repay, estimated value of the underlying
collateral, and current economic conditions.  While we estimate the
allowance for loan losses based in part on historical losses within each loan
category, estimates for losses within the commercial real estate portfolio are
more dependent upon credit analysis and recent payment performance. Allocations
of the allowance may be made for specific loans or loan categories, but the
entire allowance is available for any loan that, in management’s judgment,
should be charged off.


27





The
allowance consists of specific and general components.  The specific
component relates to loans that are individually classified as impaired or loans
otherwise classified as substandard or doubtful.  The general
component covers non-classified loans and is based on historical loss experience
adjusted for current factors. Allowance estimates are developed with actual loss
experience adjusted for current economic conditions.  Allowance
estimates are considered a prudent measurement of the risk in the loan portfolio
and are applied to individual loans based on loan type.





Based on
our calculation, an allowance of $14.2 millionor 1.46% of total loans
was our estimate of probable losses within the loan portfolio as ofJune 30, 2009.This estimate resulted
in a provision for loan losses on the income statement of$4.0 million for the
2009 six month period.If the mix and amount of future charge off percentages differ
significantly from the assumptions used by management in making its
determination, the allowance for loan losses and provision for loan losses on
the income statement could materially increase.





Goodwill and
Other Intangible Assets– We record costs in
excess of the estimated fair value of identified assets acquired through
purchase transactions as an asset. In accordance with Statement of Financial
Accounting Standards No. 142, “Goodwill and Other Intangible Assets”, we perform
an annual impairment analysis to determine if the asset is impaired and needs to
be written down to its fair value. We may conduct this assessment annually or
more frequently if conditions warrant. No impairment was identified as a result
of the impairment analysis at March 31, 2009. In making these impairment
analyses, management must make subjective assumptions regarding the fair value
of our assets and liabilities. These judgments may change over time as market
conditions or our strategies change, and these changes may cause us to record
impairment changes to adjust the goodwill to its estimated fair
value.





Impairment of
Investment Securities–We reviewall unrealized losses to
determine whether the losses are other-than-temporary.  We evaluate
our investment securities for other-than-temporary impairment on at least a
quarterly basis and more frequently when economic or market conditions warrant
to determine whether a decline in the value of the securities below amortized
cost is other-than-temporary.  We evaluate a number of factors
including, but not limited to: a discounted cash flow analysis; valuation
estimates provided by investment brokers; how much fair value has declined below
amortized cost; how long the decline in fair value has existed; the financial
condition of the issuer; significant rating agency changes on the issuer; and
whether management has the intent to sell the debt security or whether it is
more likely than not that we will be required to sell the debt security before
its anticipated recovery.





The term
“other-than-temporary” is not intended to indicate that the decline is
permanent, but indicates that the possibility for a near-term recovery of value
is not necessarily favorable, or that there is a lack of evidence to support a
realizable value equal to or greater than the carrying value of the
investment.  Once a decline in value is determined to be
other-than-temporary, the cost basis of the security is written down to fair
value and a corresponding charge to earnings is recognized if the security is an
equity security.  If other-than-temporary impairment exists for a debt
security, the security’s carrying value is reduced by the amount of the credit
loss and is charged to earnings while the remainder of the loss remains in other
comprehensive income.





RESULTS
OF OPERATIONS





Net
income for the quarter ended June 30, 2009 was $715,000 or $0.10 per common
share diluted compared to $2.1 million or $0.45 per common share diluted for the
same period in 2008. Net income for the six
month period ended June 30, 2009 was $1.5 million or $.21 per common share
diluted compared to $4.0 million or $.85 per common share diluted for the same
period a year ago.  Earnings decreased for 2009 compared to 2008 due
to a decrease in our net interest margin, an increase in provision for loan loss
expense, write downs taken on real estate acquired through foreclosure, write
downs taken on investment securities that were other-than-temporary impaired,
and a higher level of non-interest expense related to our expansion efforts. Net
income available to common shareholders was also impacted by dividends paid on
preferred shares. Our book value per
common share decreased from $16.23 at June 30, 2008 to $15.60 at June 30,
2009.Annualized
net income for the first six months of 2009 represented a return on average
assets of .18% and a return on average equity of 2.12%.These compare with a
return on average assets of .90% and a return on average equity of 10.65% for
the first six months of 2008 also annualized.





Net Interest
Income–The
principal source of our revenue is net interest income.  Net interest
income is the difference between interest income on interest-earning assets,
such as loans and securities and the interest expense on liabilities used to
fund those assets, such as interest-bearing deposits and borrowings. Net
interest income is affected by both changes in the amount and composition of
interest-earning assets and interest-bearing liabilities as well as changes in
market interest rates.


28





The
growth in our commercial loan portfolio has increased net interest
income.  The increase in the volume of interest earning assets
increased net interest income by $1.3 million and $2.4 million for the three and
six month 2009 periods compared to the same prior year
periods.  Average interest earning assets increased $174.4 million for
the 2009 quarter and $164.6 million for the six months compared to
2008.  Despite the increase in interest earning assets, our net
interest margin realized a modest decline.  The yield on earning
assets averaged 5.82% and 5.91% for the three and six month 2009 periods
compared to an average yield on earning assets of 6.66% and 6.90% for the same
periods in 2008.  This decrease was offset by a decrease in our cost
of funds.  Net interest margin as a percent of average earning assets
decreased18 basis
points to 3.70% for the quarter ended June 30, 2009 and 15 basis points to 3.71%
for the six months ended June 30, 2009 compared to 3.88% and 3.86% for the same
periods in 2008.





Our cost
of funds averaged 2.31% and 2.40% for the quarter and six month periods of 2009
compared to an average cost of funds of 3.04% and 3.35% for the same period in
2008. Going forward, our cost of funds is expected to continue to decrease as
certificates of deposit re-price and roll off into new certificates of deposit
at lower interest rates.





Our net
interest margin is likely to compress in future quarters as a result of the FOMC
decreasing the Federal Funds rate by 500 basis points since September
2007.  The current Federal Funds rate is a range of 0.00% to
0.25%.  Correspondingly, variable rate loans that are tied to the
federal prime rate are immediately re-priced downward when the prime rate
decreases.  However, interest rates paid on customer deposits, which
are priced off of the London Interbank Offering Rate (LIBOR), have not adjusted
downward proportionately with the declining interest yields on loans and
investments.  LIBOR, which is a market driven rate, did not decline in
rate as much as the prime rate.  Therefore, we do not expect our
deposit costs to decline as fast as our yield on loans. Sixty percent of
deposits are time deposits that re-price over a longer period of
time.  This difference in the timing of the repricing of our assets
and deposits is expected to continue to lower our net interest
margin.


29





AVERAGE
BALANCE SHEET





The
following table provides information relating to our average balance sheet and
reflects the average yield on assets and average cost of liabilities for the
indicated periods.  Yields and costs for the periods presented are
derived by dividing income or expense by the average monthly balance of assets
or liabilities, respectively.





Quarter Ended June 30,2009
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            2008(Dollars
      in thousands)
                                                            
                                                            Average
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            Average
                                                            
                                                            
                                                            Average
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            AverageBalance
                                                            
                                                            
                                                            Interest
                                                            
                                                            
                                                            Yield/Cost (5)
                                                            
                                                            
                                                            Balance
                                                            
                                                            
                                                            Interest
                                                            
                                                            
                                                            Yield/Cost (5)ASSETSInterest
      earning assets:U.S.
      Treasury and agencies
                                                            
                                                            $
                                                            11,734
                                                            
                                                            
                                                            $
                                                            63
                                                            
                                                            
                                                            
                                                            2.15
                                                            %
                                                            
                                                            $
                                                            4,763
                                                            
                                                            
                                                            $
                                                            54
                                                            
                                                            
                                                            
                                                            4.56
                                                            %Mortgage-backed
      securities
                                                            
                                                            
                                                            7,109
                                                            
                                                            
                                                            
                                                            74
                                                            
                                                            
                                                            
                                                            4.17
                                                            
                                                            
                                                            
                                                            9,182
                                                            
                                                            
                                                            
                                                            97
                                                            
                                                            
                                                            
                                                            4.25Equity
      securities
                                                            
                                                            
                                                            942
                                                            
                                                            
                                                            
                                                            24
                                                            
                                                            
                                                            
                                                            10.22
                                                            
                                                            
                                                            
                                                            1,659
                                                            
                                                            
                                                            
                                                            16
                                                            
                                                            
                                                            
                                                            3.88State
      and political subdivision securities (1)
                                                            
                                                            
                                                            11,210
                                                            
                                                            
                                                            
                                                            178
                                                            
                                                            
                                                            
                                                            6.37
                                                            
                                                            
                                                            
                                                            9,494
                                                            
                                                            
                                                            
                                                            159
                                                            
                                                            
                                                            
                                                            6.74Corporate
      bonds
                                                            
                                                            
                                                            69
                                                            
                                                            
                                                            
                                                            26
                                                            
                                                            
                                                            
                                                            151.14
                                                            
                                                            
                                                            
                                                            3,076
                                                            
                                                            
                                                            
                                                            27
                                                            
                                                            
                                                            
                                                            3.53Loans
      (2) (3) (4)
                                                            
                                                            
                                                            967,067
                                                            
                                                            
                                                            
                                                            14,155
                                                            
                                                            
                                                            
                                                            5.87
                                                            
                                                            
                                                            
                                                            797,436
                                                            
                                                            
                                                            
                                                            13,348
                                                            
                                                            
                                                            
                                                            6.73FHLB
      stock
                                                            
                                                            
                                                            8,515
                                                            
                                                            
                                                            
                                                            91
                                                            
                                                            
                                                            
                                                            4.29
                                                            
                                                            
                                                            
                                                            7,917
                                                            
                                                            
                                                            
                                                            104
                                                            
                                                            
                                                            
                                                            5.28Interest
      bearing deposits
                                                            
                                                            
                                                            2,584
                                                            
                                                            
                                                            
                                                            27
                                                            
                                                            
                                                            
                                                            4.19
                                                            
                                                            
                                                            
                                                            1,345
                                                            
                                                            
                                                            
                                                            12
                                                            
                                                            
                                                            
                                                            3.59Total
      interest earning assets
                                                            
                                                            
                                                            1,009,230
                                                            
                                                            
                                                            
                                                            14,638
                                                            
                                                            
                                                            
                                                            5.82
                                                            
                                                            
                                                            
                                                            834,872
                                                            
                                                            
                                                            
                                                            13,817
                                                            
                                                            
                                                            
                                                            6.66Less:  Allowance
      for loan losses
                                                            
                                                            
                                                            (14,850
                                                            )
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            (8,522
                                                            )Non-interest
      earning assets
                                                            
                                                            
                                                            86,652
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            76,539Total
      assets
                                                            
                                                            $
                                                            1,081,032
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            $
                                                            902,889LIABILITIES AND STOCKHOLDERS'
      EQUITYInterest
      bearing liabilities:Savings
      accounts
                                                            
                                                            $
                                                            118,938
                                                            
                                                            
                                                            $
                                                            201
                                                            
                                                            
                                                            
                                                            0.68
                                                            %
                                                            
                                                            $
                                                            107,954
                                                            
                                                            
                                                            $
                                                            436
                                                            
                                                            
                                                            
                                                            1.62
                                                            %NOW
      and money market accounts
                                                            
                                                            
                                                            161,383
                                                            
                                                            
                                                            
                                                            260
                                                            
                                                            
                                                            
                                                            0.65
                                                            
                                                            
                                                            
                                                            136,268
                                                            
                                                            
                                                            
                                                            321
                                                            
                                                            
                                                            
                                                            0.95Certificates
      of deposit and other time deposits
                                                            
                                                            
                                                            490,522
                                                            
                                                            
                                                            
                                                            3,885
                                                            
                                                            
                                                            
                                                            3.18
                                                            
                                                            
                                                            
                                                            417,577
                                                            
                                                            
                                                            
                                                            4,051
                                                            
                                                            
                                                            
                                                            3.90Short
      term borrowings
                                                            
                                                            
                                                            83,421
                                                            
                                                            
                                                            
                                                            47
                                                            
                                                            
                                                            
                                                            0.23
                                                            
                                                            
                                                            
                                                            34,371
                                                            
                                                            
                                                            
                                                            183
                                                            
                                                            
                                                            
                                                            2.14FHLB
      advances
                                                            
                                                            
                                                            52,820
                                                            
                                                            
                                                            
                                                            600
                                                            
                                                            
                                                            
                                                            4.56
                                                            
                                                            
                                                            
                                                            53,026
                                                            
                                                            
                                                            
                                                            601
                                                            
                                                            
                                                            
                                                            4.56Subordinated
      debentures
                                                            
                                                            
                                                            18,000
                                                            
                                                            
                                                            
                                                            329
                                                            
                                                            
                                                            
                                                            7.33
                                                            
                                                            
                                                            
                                                            12,667
                                                            
                                                            
                                                            
                                                            167
                                                            
                                                            
                                                            
                                                            5.30Total
      interest bearing liabilities
                                                            
                                                            
                                                            925,084
                                                            
                                                            
                                                            
                                                            5,322
                                                            
                                                            
                                                            
                                                            2.31
                                                            
                                                            
                                                            
                                                            761,863
                                                            
                                                            
                                                            
                                                            5,759
                                                            
                                                            
                                                            
                                                            3.04Non-interest
      bearing liabilities:Non-interest
      bearing deposits
                                                            
                                                            
                                                            59,396
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            59,600Other
      liabilities
                                                            
                                                            
                                                            3,194
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            5,589Total
      liabilities
                                                            
                                                            
                                                            987,674
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            827,052Stockholders'
      equity
                                                            
                                                            
                                                            93,358
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            75,837Total liabilities and
      stockholders'
      equity
                                                            
                                                            $
                                                            1,081,032
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            $
                                                            902,889Net
      interest income
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            $
                                                            9,316
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            $
                                                            8,058Net
      interest spread
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            3.51
                                                            %
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            3.62
                                                            %Net
      interest margin
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            3.70
                                                            %
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            3.88
                                                            %





(1)Taxable equivalent yields
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 loans in the average loan amounts outstanding.


(4)Includes loans held for
sale.


(5)Annualized


30





Six Months Ended June 30,2009
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      2008(Dollars
      in thousands)
                                                      
                                                      Average
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      Average
                                                      
                                                      
                                                      Average
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      AverageBalance
                                                      
                                                      
                                                      Interest
                                                      
                                                      
                                                      Yield/Cost (5)
                                                      
                                                      
                                                      Balance
                                                      
                                                      
                                                      Interest
                                                      
                                                      
                                                      Yield/Cost (5)ASSETSInterest
      earning assets:U.S.
      Treasury and agencies
                                                      
                                                      $
                                                      7,947
                                                      
                                                      
                                                      $
                                                      102
                                                      
                                                      
                                                      
                                                      2.59
                                                      %
                                                      
                                                      $
                                                      8,023
                                                      
                                                      
                                                      $
                                                      160
                                                      
                                                      
                                                      
                                                      4.01
                                                      %Mortgage-backed
      securities
                                                      
                                                      
                                                      7,400
                                                      
                                                      
                                                      
                                                      156
                                                      
                                                      
                                                      
                                                      4.25
                                                      
                                                      
                                                      
                                                      9,715
                                                      
                                                      
                                                      
                                                      206
                                                      
                                                      
                                                      
                                                      4.26Equity
      securities
                                                      
                                                      
                                                      941
                                                      
                                                      
                                                      
                                                      57
                                                      
                                                      
                                                      
                                                      12.22
                                                      
                                                      
                                                      
                                                      1,636
                                                      
                                                      
                                                      
                                                      30
                                                      
                                                      
                                                      
                                                      3.69State
      and political subdivision securities (1)
                                                      
                                                      
                                                      10,152
                                                      
                                                      
                                                      
                                                      339
                                                      
                                                      
                                                      
                                                      6.73
                                                      
                                                      
                                                      
                                                      9,509
                                                      
                                                      
                                                      
                                                      311
                                                      
                                                      
                                                      
                                                      6.58Corporate
      bonds
                                                      
                                                      
                                                      201
                                                      
                                                      
                                                      
                                                      60
                                                      
                                                      
                                                      
                                                      60.20
                                                      
                                                      
                                                      
                                                      3,084
                                                      
                                                      
                                                      
                                                      76
                                                      
                                                      
                                                      
                                                      4.96Loans
      (2) (3) (4)
                                                      
                                                      
                                                      953,357
                                                      
                                                      
                                                      
                                                      28,099
                                                      
                                                      
                                                      
                                                      5.94
                                                      
                                                      
                                                      
                                                      785,939
                                                      
                                                      
                                                      
                                                      27,380
                                                      
                                                      
                                                      
                                                      7.01FHLB
      stock
                                                      
                                                      
                                                      8,515
                                                      
                                                      
                                                      
                                                      187
                                                      
                                                      
                                                      
                                                      4.43
                                                      
                                                      
                                                      
                                                      7,769
                                                      
                                                      
                                                      
                                                      204
                                                      
                                                      
                                                      
                                                      5.28Interest
      bearing deposits
                                                      
                                                      
                                                      2,770
                                                      
                                                      
                                                      
                                                      51
                                                      
                                                      
                                                      
                                                      3.71
                                                      
                                                      
                                                      
                                                      1,043
                                                      
                                                      
                                                      
                                                      18
                                                      
                                                      
                                                      
                                                      3.47Total
      interest earning assets
                                                      
                                                      
                                                      991,283
                                                      
                                                      
                                                      
                                                      29,051
                                                      
                                                      
                                                      
                                                      5.91
                                                      
                                                      
                                                      
                                                      826,718
                                                      
                                                      
                                                      
                                                      28,385
                                                      
                                                      
                                                      
                                                      6.90Less:  Allowance
      for loan losses
                                                      
                                                      
                                                      (14,322
                                                      )
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      (8,291
                                                      )Non-interest
      earning assets
                                                      
                                                      
                                                      83,421
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      70,660Total
      assets
                                                      
                                                      $
                                                      1,060,382
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      $
                                                      889,087LIABILITIES AND STOCKHOLDERS'
      EQUITYInterest
      bearing liabilities:Savings
      accounts
                                                      
                                                      $
                                                      115,043
                                                      
                                                      
                                                      $
                                                      398
                                                      
                                                      
                                                      
                                                      0.70
                                                      %
                                                      
                                                      $
                                                      101,482
                                                      
                                                      
                                                      $
                                                      947
                                                      
                                                      
                                                      
                                                      1.88
                                                      %NOW
      and money market accounts
                                                      
                                                      
                                                      159,628
                                                      
                                                      
                                                      
                                                      509
                                                      
                                                      
                                                      
                                                      0.64
                                                      
                                                      
                                                      
                                                      131,740
                                                      
                                                      
                                                      
                                                      756
                                                      
                                                      
                                                      
                                                      1.15Certificates
      of deposit and other time deposits
                                                      
                                                      
                                                      491,127
                                                      
                                                      
                                                      
                                                      7,939
                                                      
                                                      
                                                      
                                                      3.26
                                                      
                                                      
                                                      
                                                      417,315
                                                      
                                                      
                                                      
                                                      8,791
                                                      
                                                      
                                                      
                                                      4.24Short
      term borrowings
                                                      
                                                      
                                                      71,681
                                                      
                                                      
                                                      
                                                      90
                                                      
                                                      
                                                      
                                                      0.25
                                                      
                                                      
                                                      
                                                      36,502
                                                      
                                                      
                                                      
                                                      505
                                                      
                                                      
                                                      
                                                      2.78FHLB
      advances
                                                      
                                                      
                                                      52,712
                                                      
                                                      
                                                      
                                                      1,197
                                                      
                                                      
                                                      
                                                      4.58
                                                      
                                                      
                                                      
                                                      53,043
                                                      
                                                      
                                                      
                                                      1,197
                                                      
                                                      
                                                      
                                                      4.54Subordinated
      debentures
                                                      
                                                      
                                                      18,000
                                                      
                                                      
                                                      
                                                      658
                                                      
                                                      
                                                      
                                                      7.37
                                                      
                                                      
                                                      
                                                      11,333
                                                      
                                                      
                                                      
                                                      334
                                                      
                                                      
                                                      
                                                      5.93Total
      interest bearing liabilities
                                                      
                                                      
                                                      908,191
                                                      
                                                      
                                                      
                                                      10,791
                                                      
                                                      
                                                      
                                                      2.40
                                                      
                                                      
                                                      
                                                      751,415
                                                      
                                                      
                                                      
                                                      12,530
                                                      
                                                      
                                                      
                                                      3.35Non-interest
      bearing liabilities:Non-interest
      bearing deposits
                                                      
                                                      
                                                      56,757
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      56,967Other
      liabilities
                                                      
                                                      
                                                      2,899
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      5,513Total
      liabilities
                                                      
                                                      
                                                      967,847
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      813,895Stockholders'
      equity
                                                      
                                                      
                                                      92,535
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      75,192Total liabilities and
      stockholders'
      equity
                                                      
                                                      $
                                                      1,060,382
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      $
                                                      889,087Net
      interest income
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      $
                                                      18,260
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      $
                                                      15,855Net
      interest spread
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      3.51
                                                      %
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      3.55
                                                      %Net
      interest margin
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      3.71
                                                      %
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      3.86
                                                      %





(1)Taxable equivalent yields
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 loans in the average loan amounts outstanding.


(4)Includes loans held for
sale.


(5)Annualized


31


RATE/VOLUME
ANALYSIS





The table
below shows changes in interest income and interest expense for the periods
indicated.  For each category of interest-earning assets and
interest-bearing liabilities, information is provided on changes attributable to
(1) changes in rate (changes in rate multiplied by old volume); (2) changes in
volume (change in volume multiplied by old rate); and (3) changes in rate-volume
(change in rate multiplied by change in volume).  Changes in
rate-volume are proportionately allocated between rate and volume
variance.





Three
      Months Ended
                        
                        
                        Six
      Months EndedJune
      30,
                        
                        
                        June
      30,2009 vs. 2008
                        
                        
                        2009 vs. 2008Increase
      (decrease)
                        
                        
                        Increase
      (decrease)Due
      to change in
                        
                        
                        Due
      to change in(Dollars
      in thousands)
                        
                        
                        
                        
                        
                        
                        
                        Net
                        
                        
                        
                        
                        
                        
                        
                        
                        NetRate
                        
                        
                        Volume
                        
                        
                        Change
                        
                        
                        Rate
                        
                        
                        Volume
                        
                        
                        ChangeInterest
      income:U.S.
      Treasury and agencies
                        
                        $
                        (39
                        )
                        
                        $
                        48
                        
                        
                        $
                        9
                        
                        
                        $
                        (57
                        )
                        
                        $
                        (1
                        )
                        
                        $
                        (58
                        )Mortgage-backed
      securities
                        
                        
                        (1
                        )
                        
                        
                        (22
                        )
                        
                        
                        (23
                        )
                        
                        
                        (1
                        )
                        
                        
                        (49
                        )
                        
                        
                        (50
                        )Equity
      securities
                        
                        
                        17
                        
                        
                        
                        (9
                        )
                        
                        
                        8
                        
                        
                        
                        44
                        
                        
                        
                        (17
                        )
                        
                        
                        27State
      and political subdivision securities
                        
                        
                        (9
                        )
                        
                        
                        28
                        
                        
                        
                        19
                        
                        
                        
                        7
                        
                        
                        
                        21
                        
                        
                        
                        28Corporate
      bonds
                        
                        
                        51
                        
                        
                        
                        (52
                        )
                        
                        
                        (1
                        )
                        
                        
                        116
                        
                        
                        
                        (132
                        )
                        
                        
                        (16
                        )Loans
                        
                        
                        (1,808
                        )
                        
                        
                        2,615
                        
                        
                        
                        807
                        
                        
                        
                        (4,592
                        )
                        
                        
                        5,311
                        
                        
                        
                        719FHLB
      stock
                        
                        
                        (20
                        )
                        
                        
                        7
                        
                        
                        
                        (13
                        )
                        
                        
                        (35
                        )
                        
                        
                        18
                        
                        
                        
                        (17
                        )Interest
      bearing deposits
                        
                        
                        2
                        
                        
                        
                        13
                        
                        
                        
                        15
                        
                        
                        
                        1
                        
                        
                        
                        32
                        
                        
                        
                        33Total
      interest earning assets
                        
                        
                        (1,807
                        )
                        
                        
                        2,628
                        
                        
                        
                        821
                        
                        
                        
                        (4,517
                        )
                        
                        
                        5,183
                        
                        
                        
                        666Interest
      expense:Savings
      accounts
                        
                        
                        (276
                        )
                        
                        
                        41
                        
                        
                        
                        (235
                        )
                        
                        
                        (662
                        )
                        
                        
                        113
                        
                        
                        
                        (549
                        )NOW
      and money market accounts
                        
                        
                        (113
                        )
                        
                        
                        52
                        
                        
                        
                        (61
                        )
                        
                        
                        (384
                        )
                        
                        
                        137
                        
                        
                        
                        (247
                        )Certificates of deposit and othertime
      deposits
                        
                        
                        (810
                        )
                        
                        
                        644
                        
                        
                        
                        (166
                        )
                        
                        
                        (2,251
                        )
                        
                        
                        1,399
                        
                        
                        
                        (852
                        )Short
      term borrowings
                        
                        
                        (254
                        )
                        
                        
                        118
                        
                        
                        
                        (136
                        )
                        
                        
                        (674
                        )
                        
                        
                        259
                        
                        
                        
                        (415
                        )FHLB
      advances
                        
                        
                        1
                        
                        
                        
                        (2
                        )
                        
                        
                        (1
                        )
                        
                        
                        7
                        
                        
                        
                        (7
                        )
                        
                        
                        -Subordinated
      debentures
                        
                        
                        77
                        
                        
                        
                        85
                        
                        
                        
                        162
                        
                        
                        
                        94
                        
                        
                        
                        230
                        
                        
                        
                        324Total
      interest bearing liabilities
                        
                        
                        (1,375
                        )
                        
                        
                        938
                        
                        
                        
                        (437
                        )
                        
                        
                        (3,870
                        )
                        
                        
                        2,131
                        
                        
                        
                        (1,739
                        )Net
      change in net interest income
                        
                        $
                        (432
                        )
                        
                        $
                        1,690
                        
                        
                        $
                        1,258
                        
                        
                        $
                        (647
                        )
                        
                        $
                        3,052
                        
                        
                        $
                        2,405





Non-Interest
Income and Non-Interest Expense





The
following tables compare the components of non-interest income and expenses for
the periods ended June 30, 2009 and 2008.  The tables show the dollar
and percentage change from 2008 to 2009.  Below each table is a
discussion of significant changes and trends.





Three
      Months EndedJune
      30,(Dollars in thousands)
                                  
                                  2009
                                  
                                  
                                  2008
                                  
                                  
                                  Change
                                  
                                  
                                  %Non-interest
      incomeCustomer
      service fees on deposit accounts
                                  
                                  $
                                  1,645
                                  
                                  
                                  $
                                  1,632
                                  
                                  
                                  $
                                  13
                                  
                                  
                                  
                                  0.8
                                  %Gain
      on sale of mortgage loans
                                  
                                  
                                  355
                                  
                                  
                                  
                                  239
                                  
                                  
                                  
                                  116
                                  
                                  
                                  
                                  48.5
                                  %Net
      impairment losses recognized in earnings
                                  
                                  
                                  (245
                                  )
                                  
                                  
                                  (216
                                  )
                                  
                                  
                                  (29
                                  )
                                  
                                  
                                  13.4
                                  %Write
      down on real estate acquired through foreclosure
                                  
                                  
                                  (233
                                  )
                                  
                                  
                                  -
                                  
                                  
                                  
                                  (233
                                  )
                                  
                                  
                                  100.0
                                  %Brokerage
      commissions
                                  
                                  
                                  99
                                  
                                  
                                  
                                  125
                                  
                                  
                                  
                                  (26
                                  )
                                  
                                  
                                  -20.8
                                  %Other
      income
                                  
                                  
                                  469
                                  
                                  
                                  
                                  360
                                  
                                  
                                  
                                  109
                                  
                                  
                                  
                                  30.3
                                  %$
                                  2,090
                                  
                                  
                                  $
                                  2,140
                                  
                                  
                                  $
                                  (50
                                  )
                                  
                                  
                                  -2.3
                                  %


32





Six
      Months EndedJune
      30,(Dollars in thousands)
                    
                    2009
                    
                    
                    2008
                    
                    
                    Change
                    
                    
                    %Non-interest
      incomeCustomer
      service fees on deposit accounts
                    
                    $
                    3,122
                    
                    
                    $
                    3,048
                    
                    
                    $
                    74
                    
                    
                    
                    2.4
                    %Gain
      on sale of mortgage loans
                    
                    
                    532
                    
                    
                    
                    387
                    
                    
                    
                    145
                    
                    
                    
                    37.5
                    %Net
      impairment losses recognized in earnings
                    
                    
                    (400
                    )
                    
                    
                    (216
                    )
                    
                    
                    (184
                    )
                    
                    
                    85.2
                    %Write
      down on real estate acquired through foreclosure
                    
                    
                    (250
                    )
                    
                    
                    -
                    
                    
                    
                    (250
                    )
                    
                    
                    100.0
                    %Brokerage
      commissions
                    
                    
                    192
                    
                    
                    
                    243
                    
                    
                    
                    (51
                    )
                    
                    
                    -21.0
                    %Other
      income
                    
                    
                    897
                    
                    
                    
                    632
                    
                    
                    
                    265
                    
                    
                    
                    41.9
                    %$
                    4,093
                    
                    
                    $
                    4,094
                    
                    
                    $
                    (1
                    )
                    
                    
                    0.0
                    %





Growth in
customer service fees on deposit accounts, our largest component of non-interest
income, is primarily due to growth in customer deposits and overdraft fee income
on retail checking accounts for 2009.  We continue to increase our
customer base through cross-selling opportunities and marketing initiatives and
promotions.  In addition, we continue to emphasize growing our
checking account base to better enhance our profitability and franchise
value.





We
originate qualified VA, KHC, RHC and conventional secondary market loans and
sell them into the secondary market with servicing rights
released.  For the quarter and year to date, gain on sale of mortgage
loans increased due to an increase in mortgage refinance activity.




We
recognized other-than-temporary impairment charges of $400,000 for the expected
credit loss during the 2009 six month period on four of our trust preferred
securities. Management believes this impairment was primarily attributable to
the current economic environment which caused the financial conditions of some
of the issuers to deteriorate. During 2008, we recognized other-than-temporary
impairment charges of $216,000 on certain equity securities with a cost basis of
$840,000.




Further
reducing non-interest income for the 2009 period was a 10% or $250,000
write-down of the carrying value of real estate owned properties that had been
held for twelve months.




Other
income increased during the quarter as a result of an increase in loan
underwriter fees due to increased loan demand and increased year to date due to
$147,000 in gains recorded on the sale of a real estate acquired through
foreclosure properties.




Three
      Months EndedJune
      30,(Dollars in thousands)
                    
                    2009
                    
                    
                    2008
                    
                    
                    Change
                    
                    
                    %Non-interest
      expensesEmployee
      compensation and benefits
                    
                    $
                    4,149
                    
                    
                    $
                    3,480
                    
                    
                    $
                    669
                    
                    
                    
                    19.2
                    %Office
      occupancy expense and equipment
                    
                    
                    808
                    
                    
                    
                    679
                    
                    
                    
                    129
                    
                    
                    
                    19.0
                    %Marketing
      and advertising
                    
                    
                    245
                    
                    
                    
                    209
                    
                    
                    
                    36
                    
                    
                    
                    17.2
                    %Outside
      services and data processing
                    
                    
                    795
                    
                    
                    
                    766
                    
                    
                    
                    29
                    
                    
                    
                    3.8
                    %Bank
      franchise tax
                    
                    
                    257
                    
                    
                    
                    253
                    
                    
                    
                    4
                    
                    
                    
                    1.6
                    %FDIC
      insurance premiums
                    
                    
                    788
                    
                    
                    
                    94
                    
                    
                    
                    694
                    
                    
                    
                    738.3
                    %Amortization
      of core deposit intangible
                    
                    
                    100
                    
                    
                    
                    -
                    
                    
                    
                    100
                    
                    
                    
                    100.0
                    %Other
      expense
                    
                    
                    1,302
                    
                    
                    
                    1,036
                    
                    
                    
                    266
                    
                    
                    
                    25.7
                    %$
                    8,444
                    
                    
                    $
                    6,517
                    
                    
                    $
                    1,927
                    
                    
                    
                    29.6
                    %





Six
      Months EndedJune
      30,(Dollars in thousands)
                    
                    2009
                    
                    
                    2008
                    
                    
                    Change
                    
                    
                    %Non-interest
      expensesEmployee
      compensation and benefits
                    
                    $
                    8,151
                    
                    
                    $
                    6,898
                    
                    
                    $
                    1,253
                    
                    
                    
                    18.2
                    %Office
      occupancy expense and equipment
                    
                    
                    1,656
                    
                    
                    
                    1,332
                    
                    
                    
                    324
                    
                    
                    
                    24.3
                    %Marketing
      and advertising
                    
                    
                    510
                    
                    
                    
                    423
                    
                    
                    
                    87
                    
                    
                    
                    20.6
                    %Outside
      services and data processing
                    
                    
                    1,588
                    
                    
                    
                    1,483
                    
                    
                    
                    105
                    
                    
                    
                    7.1
                    %Bank
      franchise tax
                    
                    
                    521
                    
                    
                    
                    503
                    
                    
                    
                    18
                    
                    
                    
                    3.6
                    %FDIC
      insurance premiums
                    
                    
                    967
                    
                    
                    
                    184
                    
                    
                    
                    783
                    
                    
                    
                    425.5
                    %Amortization
      of core deposit intangible
                    
                    
                    201
                    
                    
                    
                    -
                    
                    
                    
                    201
                    
                    
                    
                    100.0
                    %Other
      expense
                    
                    
                    2,633
                    
                    
                    
                    2,029
                    
                    
                    
                    604
                    
                    
                    
                    29.8
                    %$
                    16,227
                    
                    
                    $
                    12,852
                    
                    
                    $
                    3,375
                    
                    
                    
                    26.3
                    %


33





Employee
compensation and benefits is the largest component of non-interest
expense.  Since early 2008, we have added sixteen associates with our
expansion efforts.  These associates were hired for a new Bullitt
County retail branch facility that opened in August 2008, a new Hardin County
retail branch facility that opened in May 2009, a new Louisville retail branch
facility that opened in July 2009 and to fill other positions to support our
growth.  We added twenty additional associates in the second quarter
of 2008 as a result of the recent acquisition in Southern Indiana.  We
look for a continued increase in employee compensation and benefits expense in
line with recent years, as we progress with our retail expansion and market
protection efforts.





Office
occupancy expense and equipment, marketing and advertising, and outside services
and data processing increased due to additional operating expenses related to
our expansion efforts and a system upgrade.  We anticipate the
increased level of non-interest expense to continue in 2009 with additional
retail expansion.We
opened full-service banking centers at Fort Knox and in the Middletown area of
Jefferson County since March 31, 2009.





Other
expense increased due to increases in interchange expense, postage and courier,
REO expense, losses on NOW accounts and other operating
expenses.  Interchange expense increased due to the switch to
real-time debit card processing, which is more expensive per item than the batch
processing method we used previously.   REO expense relating to
repair, maintenance and taxes increased due to increases in real estate we
acquired through foreclosure.





The FDIC
charges insured financial institutions premiums to maintain the Deposit
Insurance Fund at a certain level.  See Part I, Item 1, "Business –
Federal Deposit Insurance Assessments" in our 2008 Form
10-K for additional information.  On October 16, 2008, the FDIC
published a restoration plan designed to replenish the Deposit Insurance Fund
over a period of five years and to increase the deposit insurance reserve
ratio.   In order to implement the restoration plan, the FDIC
proposes to change both its risk-based assessment system and its base assessment
rates.  Either an increase in the Risk Category of our bank
subsidiary, or adjustments to the base assessment rates, could materially
increase our deposit insurance premiums and assessments.





In addition, under an interim rule, the
FDIC imposed a five basis point emergency special assessment on insured
depository institutions as of June 30, 2009.  The special assessment
is payable on September 30, 2009.  This assessment resulted in a cost
of $477,000 and is reflected in our income statement for the six months ended
June 30, 2009.  The interim rule also authorizes the FDIC to impose an
additional emergency assessment of up to 10 basis points in respect to deposits
for quarters ended after June 30, 2009 if necessary to maintain public
confidence in federal deposit insurance.  Given the enacted and
proposed increases in
assessments  for  insured  financial  institutions  in  2009,  we
anticipate  that  FDIC  assessments  on
deposits will have a significantly greater impact upon operating expenses in
2009 compared to 2008.





Our
efficiency ratio was 73% for the six months ended June 30, 2009 compared to 65%
for the 2008 period.  The increase principally reflects our recent
expansion efforts.





ANALYSIS
OF FINANCIAL CONDITION





Total
assets at June 30, 2009 increased by $85.3 million from December 31, 2008. The
increase was primarily driven by an increase in loans of $68.2 million and an
increase in investment securities of $13.0 million.  The growth in
loans and investment securities was funded with deposits, which increased $45.6
million for the period and short-term borrowings, which increased $19.7
million.





Loans





Net loans
increased $68.2 million to $967.6 million at June 30, 2009 compared to $899.4
million at December 31, 2008.  Our commercial real estate portfolio
increased $54.2 million to $617.5 million at June 30, 2009.  Our
residential mortgage loan, consumer, home equity and indirect consumer
portfolios all increased for the 2009 period, while the commercial and real
estate construction loan portfolios remained relatively constant.  For
2009, we believe the growth in commercial real estate loans may not continue at
the rate experienced over the last few years due to the current economic
slow-down.  However, we also believe we will be well positioned to
benefit from growth in our local markets when the economy
rebounds.


34





June
      30,
                                                          
                                                          
                                                          December
      31,(Dollars
      in thousands)
                                                          
                                                          2009
                                                          
                                                          
                                                          2008Commercial
                                                          
                                                          $
                                                          56,661
                                                          
                                                          
                                                          $
                                                          56,863Real
      estate commercial
                                                          
                                                          
                                                          617,528
                                                          
                                                          
                                                          
                                                          563,314Real
      estate construction
                                                          
                                                          
                                                          16,983
                                                          
                                                          
                                                          
                                                          17,387Residential
      mortgage
                                                          
                                                          
                                                          176,170
                                                          
                                                          
                                                          
                                                          165,337Consumer
      and home equity
                                                          
                                                          
                                                          72,649
                                                          
                                                          
                                                          
                                                          69,649Indirect
      consumer
                                                          
                                                          
                                                          36,601
                                                          
                                                          
                                                          
                                                          31,754Loans
      held for sale
                                                          
                                                          
                                                          6,140
                                                          
                                                          
                                                          
                                                          9,567982,732
                                                          
                                                          
                                                          
                                                          913,871Less:Net
      deferred loan origination fees
                                                          
                                                          
                                                          (880
                                                          )
                                                          
                                                          
                                                          (870
                                                          )Allowance
      for loan losses
                                                          
                                                          
                                                          (14,236
                                                          )
                                                          
                                                          
                                                          (13,565
                                                          )(15,116
                                                          )
                                                          
                                                          
                                                          (14,435
                                                          )Loans
      Receivable
                                                          
                                                          $
                                                          967,616
                                                          
                                                          
                                                          $
                                                          899,436





Allowance
and Provision for Loan Losses





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





The
Allowance for Loan Loss Review Committee evaluates the allowance for loan losses
quarterly to maintain a level sufficient to absorb probable incurred credit
losses existing in the loan portfolio.  Periodic provisions to the
allowance are made as needed.  The Committee determines the allowance
by applying loss estimates to graded loans by categories, as described
below.  In addition, the Committee analyzes such factors as changes in
lending policies and procedures; underwriting standards; collection; charge-off
and recovery history; changes in national and local economic business conditions
and developments; changes in the characteristics of the portfolio; ability and
depth of lending management and staff; changes in the trend of the volume and
severity of past due, non-accrual and classified loans; troubled debt
restructuring and other loan modifications; and results of regulatory
examinations.





2008 was
a tumultuous year for the U.S. economy and the financial service industry.
Deteriorating property values led to declining valuations for loan
portfolios.  The property value declines, which began in the second
half of 2007, have continued into 2009.  The markets we serve have
generally avoided the severe property value declines experienced in other parts
of the country; nonetheless, the impact in our markets was still
significant.  In response to these adverse economic conditions, we
took the opportunity to strengthen our allowance for loan losses substantially
during the second half of 2008 and the first half of 2009.  2009 will
continue to be a challenging time for our financial institution as we manage the
overall level of our credit quality.


35





The
following table analyzes our loan loss experience for the periods
indicated.





Three
      Months Ended
                          
                          
                          Six
      Months EndedJune
      30,
                          
                          
                          June
      30,(Dollars
      in thousands)
                          
                          2009
                          
                          
                          2008
                          
                          
                          2009
                          
                          
                          2008Balance
      at beginning of period
                          
                          $
                          15,072
                          
                          
                          $
                          8,395
                          
                          
                          $
                          13,565
                          
                          
                          $
                          7,922Allowance
      related to acquisition
                          
                          
                          -
                          
                          
                          
                          327
                          
                          
                          
                          -
                          
                          
                          
                          327Loans
      charged-off:Real
      estate mortgage
                          
                          
                          41
                          
                          
                          
                          15
                          
                          
                          
                          41
                          
                          
                          
                          15Consumer
                          
                          
                          170
                          
                          
                          
                          136
                          
                          
                          
                          486
                          
                          
                          
                          264Commercial
                          
                          
                          2,602
                          
                          
                          
                          274
                          
                          
                          
                          2,879
                          
                          
                          
                          295Total
      charge-offs
                          
                          
                          2,813
                          
                          
                          
                          425
                          
                          
                          
                          3,406
                          
                          
                          
                          574Recoveries:Real
      estate mortgage
                          
                          
                          -
                          
                          
                          
                          1
                          
                          
                          
                          2
                          
                          
                          
                          1Consumer
                          
                          
                          64
                          
                          
                          
                          87
                          
                          
                          
                          117
                          
                          
                          
                          125Commercial
                          
                          
                          -
                          
                          
                          
                          18
                          
                          
                          
                          -
                          
                          
                          
                          18Total
      recoveries
                          
                          
                          64
                          
                          
                          
                          106
                          
                          
                          
                          119
                          
                          
                          
                          144Net
      loans charged-off
                          
                          
                          2,749
                          
                          
                          
                          319
                          
                          
                          
                          3,287
                          
                          
                          
                          430Provision
      for loan losses
                          
                          
                          1,913
                          
                          
                          
                          514
                          
                          
                          
                          3,958
                          
                          
                          
                          1,098Balance
      at end of period
                          
                          $
                          14,236
                          
                          
                          $
                          8,917
                          
                          
                          $
                          14,236
                          
                          
                          $
                          8,917Allowance
      for loan losses to total loans (excluding loans held for
    sale)
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          1.46
                          %
                          
                          
                          1.06
                          %Annualized
      net charge-offs to average loans outstanding
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          0.70
                          %
                          
                          
                          0.11
                          %Allowance
      for loan losses to total non-performing loans
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          54
                          %
                          
                          
                          59
                          %





The
provision for loan losses increased $1.4 million to $1.9 million for the quarter
ended June 30, 2009, and increased $2.9 million to $4.0 million for the six
months ended June 30, 2009 compared to the same periods in 2008.  The
increase was related to growth in the loan portfolio and from the specific
reserves set aside for loans classified during 2009.  The higher
provision was also due to our increasing the general reserve factors for
commercial real estate loans during the period as the level of classified loans
has increased sharply.  The allowance for loan losses increased $5.3
million to $14.2 million from June 30, 2008 to June 30, 2009. The increase was due to
an increase in net loans for 2009, as well as the provision recorded to reflect
a $28.7 million increase in classified loans for the 2009 period.





Federal
regulations require banks to classify their own assets on a regular
basis.  The regulations provide for three categories of classified
loans — substandard, doubtful and loss.





The
following table provides information with respect to classified loans for the
periods indicated:





June
      30,(Dollars in thousands)
                      
                      2009
                      
                      
                      2008Classified
      LoansSubstandard
                      
                      $
                      63,134
                      
                      
                      $
                      35,746Doubtful
                      
                      
                      1,039
                      
                      
                      
                      -Loss
                      
                      
                      305
                      
                      
                      
                      52Total
      Classified
                      
                      $
                      64,478
                      
                      
                      $
                      35,798


36





As we
focused on credit quality during 2008 and the first six months of 2009, there
was a significant migration of loans into the Special Mention and Substandard
loan categories.  If economic conditions continue to put stress on our
borrowers going forward, this may result in higher provisions for loan
losses.  We expect that the economy will remain in a recession at
least for the next several quarters.  Credit quality will continue to
be a primary focus in 2009.





The $27.4
million increase in substandard assets for 2009 was primarily the resultof downgrading loans
withthirteen
borrowers with balances ranging from $927,000 to $6.1 million.Offsetting this increase
was the transfer of a classified loan having a balance of $4.1 million to real
estate acquired through foreclosure. Approximately $28.3 million of the total
classified loans were related to real estate development or real estate
construction loans in our market area.  Classified consumer loans
totaled $1.5 million, classified mortgage loans totaled $5.5 million andclassified commercial
loans totaled $29.2 million.  For more information on collection
efforts, evaluation of collateral and how loss amounts are estimated, see
“Non-Performing Assets,” below.





Although
we may allocate a portion of the allowance to specific loans or loan categories,
the entire allowance is available for active charge-offs.  We develop
our allowance estimates based on actual loss experience adjusted for current
economic conditions.  Allowance estimates represent a prudent
measurement of the risk in the loan portfolio, which we apply to individual
loans based on loan type.





Non-Performing
Assets





Non-performing
assets consist of certain restructured loans for which interest rate or other
terms have been renegotiated, loans on which interest is no longer accrued, real
estate acquired through foreclosure and repossessed assets.   We
do not have any loans longer than 90 days past due still on
accrual.  Loans, including impaired loans under SFAS 114, are placed
on non-accrual status when they become past due 90 days or more as to principal
or interest, unless they are adequately secured and in the process of
collection.  Loans are considered impaired when we no longer
anticipate full principal or interest payments in accordance with the
contractual loan terms.  If a loan is impaired, we allocate a portion
of the allowance so that the loan is reported, net, at the present value of
estimated future cash flows using the loan’s existing rate, or at the fair value
of collateral if repayment is expected solely from collateral.





We review
our loans on a regular basis and implement normal collection procedures when a
borrower fails to make a required payment on a loan.  If the
delinquency on a mortgage loan exceeds 90 days and is not cured through normal
collection procedures or an acceptable arrangement is not worked out with the
borrower, we institute measures to remedy the default, including commencing a
foreclosure action.  We generally charge off consumer loans when
management deems a loan uncollectible and any available collateral has been
liquidated.  We handle commercial business and real estate loan
delinquencies on an individual basis with the advice of legal
counsel.





We
recognize interest income on loans on the accrual basis except for those loans
in a non-accrual of income status. We discontinue accruing interest on impaired
loans when management believes, after consideration of economic and business
conditions and collection efforts that the borrowers’ financial condition is
such that collection of interest is doubtful, typically after the loan becomes
90 days delinquent.  When we discontinue interest accrual, we reverse
existing accrued interest and subsequently recognize interest income only to the
extent we receive cash payments.





We
classify real estate acquired as a result of foreclosure or by deed in lieu of
foreclosure as real estate owned until such time as it is sold. We classify new
and used automobile, motorcycle and all terrain vehicles acquired as a result of
foreclosure as repossessed assets until they are sold. When such property is
acquired we record it at the lower of the unpaid principal balance of the
related loan or its fair market value.  We charge any write-down of
the property at the time of acquisition to the allowance for loan
losses.  Subsequent gains and losses are included in non-interest
income and non-interest expense.





Real
estate owned acquired through foreclosure is recorded at lower of cost or fair
value less estimated selling costs at the date of foreclosure.  Fair
value is based on the appraised market value of the propertybased on sales of
similar assets.  The fair value may be subsequently reduced if the
estimated fair value declines below the original appraised value. Real estate
acquired through foreclosure increased $2.4 million to $8.3 million at June 30,
2009.  The increase was primarily the result of a commercial credit
relationship totaling $2.2 million that was transferred during the second
quarter of 2009.


37





The
following table provides information with respect to non-performing assets for
the periods indicated.





June
      30 ,
                        
                        
                        December
      31,(Dollar
      in thousands)
                        
                        2009
                        
                        
                        2008Restructured
                        
                        $
                        2,116
                        
                        
                        $
                        1,182Past
      due 90 days still on accrual
                        
                        
                        -
                        
                        
                        
                        -Loans
      on non-accrual status
                        
                        
                        24,119
                        
                        
                        
                        15,587Total
      non-performing loans
                        
                        
                        26,235
                        
                        
                        
                        16,769Real
      estate acquired through foreclosure
                        
                        
                        8,319
                        
                        
                        
                        5,925Other
      repossessed assets
                        
                        
                        93
                        
                        
                        
                        91Total
      non-performing assets
                        
                        $
                        34,647
                        
                        
                        $
                        22,785Interest
      income that would have been earnedon
      non-performing loans
                        
                        $
                        1,558
                        
                        
                        $
                        825Interest
      income recognized on non-performingloans
                        
                        
                        88
                        
                        
                        
                        75Ratios:  
      Non-performing loans to total loans (excluding loans held for
      sale)
                        
                        
                        2.69
                        %
                        
                        
                        1.86
                        %Non-performing
      assets to total loans (excluding loans held for sale)
                        
                        
                        3.55
                        %
                        
                        
                        2.52
                        %





Non-performing
loans increased $9.5 million to $26.2 million at June 30, 2009 compared to $16.8
million at December 31, 2008.  The increase in non-accrual loans
consist primarily of five credit relationships with balances ranging from
$617,000 to $5.6 million. Offsetting this increase was the transfer of a
non-accrual loan having a balance of $4.1 million to real estate acquired
through foreclosure. These credit relationships are secured by real estate and
we have provided adequate allowance based on current information.  All
non-performing loans are considered impaired.





Non-performing
assets for the 2009 period include $2.1 million in restructured commercial,
mortgage and consumer loans.  Restructured loans primarily consist of
four credit relationships with balances ranging from $110,000 to $1.6
million.  The terms of these loans have been renegotiated to reduce
the rate of interest and extend the term, thus reducing the amount of cash flow
required from the borrower to service the loans. The borrowers are currently
meeting the terms of the restructured loans.





Investment
Securities





Interest
on securities provides us our largest source of interest income after interest
on loans, constituting 2.9% of the total interest income for the six months
ended June 30, 2009.  The securities portfolio serves as a source of
liquidity 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
of various federal agencies, obligations of states and political subdivisions,
corporate bonds, certificates of deposit at insured savings and loans and banks,
bankers' acceptances, and federal funds.  We may also invest a portion
of our assets in certain commercial paper and corporate debt
securities.  We are also authorized to invest in mutual funds and
stocks whose assets conform to the investments that we are authorized to make
directly. The available-for-sale investment portfolio increased by $18.2 million
due to the purchase of a U.S. Government agency security and a state and
municipal obligation. The held-to-maturity investment portfolio decreased by
$5.2 million as securities were called for redemption in accordance with their
terms due to decreasing rates.





We review
all unrealized losses at least on a quarterly basis to determine whether the
losses are other than temporary and more frequently when economic or market
concerns warrant. We consider the length of time and the extent to which the
fair value has been less than cost, the financial condition and near-term
prospects of the issuer, and whether management has the intent to sell the debt
security or whether it is more likely than not that we will be required to sell
the debt security before its anticipated recovery.  In analyzing an
issuer’s financial condition, we may consider whether the securities are issued
by the federal government or its agencies, whether downgrades by bond rating
agencies have occurred, and the results of reviews of the issuer’s financial
condition.  The unrealized losses on the state and municipal
securities were caused primarily by interest rate decreases.  The
contractual terms of those investments do not permit the issuer to settle the
securities at a price less than the amortized cost of the
investment.  Because we do not have the intent to sell these
securities and it is likely that we will not be required to sell the securities
before their anticipated recovery, we do not consider these investments to be
other-than-temporarily impaired at June 30, 2009.  We also considered
the financial condition and near term prospects of the issuer and identified no
matters that would indicate less than full recovery.


38





We have
evaluated the decline in the fair value of our trust preferred securities, which
are included in corporate securities and are directly related to the credit and
liquidity crisis being experienced in the financial services industry over the
past year.   The trust preferred securities market is currently
inactive making the valuation of trust preferred securities very
difficult.  The trust preferred securities are valued by management
using unobservable inputs (i.e., Level 3 inputs under SFAS No. 157) through a
discounted cash flow analysis as permitted under SFAS 157 and using the expected
cash flows appropriately discounted using present value techniques.  
Refer to Note 6 – Fair Value for more information.





We
recognized other-than-temporary impairment charges of $400,000 for the expected
credit loss during the 2009 period on four of our trust preferred securities
with an original cost basis of $2.5 million.  All of our trust
preferred securities are below investment grade but have continued to pay
interest as scheduled through June 30, 2009, and are expected to continue paying
interest as scheduled.    See Note 2 – Securities for more
information.  Management will continue to evaluate these securities
for impairment quarterly.





As
discussed in Note 1, in early April 2009, the FASB issued FSP FAS 115-2,
and FAS 124-2, Recognition and
Presentation of Other-Than-Temporary Impairments. Among other provisions,
the FSP requires entities to split other than temporarily impaired charges
between credit losses (i.e., the loss based on the entity’s estimate of the
decrease in cash flows, including those that result from expected voluntary
prepayments), which are charged to earnings, and the remainder of the impairment
charge (non-credit component) to accumulated other comprehensive income. This
requirement pertains to both securities held to maturity and securities
available for sale. The FSP is effective for interim and annual reporting
periods ending after June 15, 2009 with early adoption permitted for
periods ending after March 15, 2009. We incorporated this guidance in our
review of impairment as of March 31, 2009.





Deposits





We rely
primarily on providing excellent customer service and long-standing
relationships with customers to attract and retain deposits. Market interest
rates and rates on deposit products offered by competing financial institutions
can significantly affect our ability to attract and retain
deposits.  In conjunction with our initiatives to expand and enhance
our retail branch network, we emphasize growing our customer checking account
base to better enhance profitability and franchise value.  Total
deposits increased by $45.6 million year to date compared to December 31, 2008.
Retail and commercial deposits increased $14.3 million, public funds decreased
$5.7 million and we added $37.0 in brokered
certificates.   Brokered deposits were $52.4 million at June 30,
2009 compared to $15.4 million at December 31, 2008.





The
following table breaks down our deposits.





June 30,
                        
                        
                        December 31,2009
                        
                        
                        2008(In Thousands)Non-interest
      bearing
                        
                        $
                        58,555
                        
                        
                        $
                        55,668NOW
      demand
                        
                        
                        113,479
                        
                        
                        
                        99,890Savings
                        
                        
                        108,623
                        
                        
                        
                        111,310Money
      market
                        
                        
                        50,797
                        
                        
                        
                        40,593Certificates
      of deposit
                        
                        
                        489,523
                        
                        
                        
                        467,938$
                        820,977
                        
                        
                        $
                        775,399





Short-Term
Borrowings





We have
the ability to obtain short-term borrowings, consisting of federal funds
purchased and securities sold under agreements to repurchase.  We had
short-term borrowings of $114.6 million and $33.0 million from the FHLB of
Cincinnati at June 30, 2009 and 2008.  These borrowings averaged a
rate of 0.25% and 2.78% for 2009 and 2008.


39





Advances
from Federal Home Loan Bank





Deposits
are the primary source of funds for our lending and investment activities and
for our general business purposes.  We can also use advances
(borrowings) from the Federal Home Loan Bank (FHLB) of Cincinnati to compensate
for reductions in deposits or deposit inflows at less than projected
levels.  Advances from the FHLB are secured by our stock in the FHLB,
certain securities, certain commercial real estate loans and substantially all
of our first mortgage, multi-family and open end home equity
loans.  At June 30, 2009 we had $52.8 million in advances outstanding
from the FHLB, and the capacity to increase our borrowings an additional $6.2
million.





Subordinated
Debentures





In 2008,
First Federal Statutory Trust III, an unconsolidated trust subsidiary of First
Financial Service Corporation, issued $8.0 million in trust preferred
securities.  The trust loaned the proceeds of the offering to us in
exchange for junior subordinated deferrable interest debentures which we used to
finance the purchase of FSB Bancshares, Inc. The subordinated debentures, which
mature on June 24, 2038, can be called at par in whole or in part on or after
June 24, 2018. The subordinated debentures pay a fixed rate of 8% for thirty
years.  We have the option to defer interest payments on the
subordinated debt from time to time for a period not to exceed five consecutive
years.  The subordinated debentures are considered as Tier I capital
for the Corporation under current regulatory guidelines.





A
different trust subsidiary issued 30 year cumulative trust preferred securities
at a 10 year fixed rate of 6.69% adjusting quarterly thereafter at LIBOR plus
160 basis points.  The subordinated debentures, which mature March 22,
2037, can be called at par in whole or in part on or after March 15,
2017.  We have the option to defer interest payments on the
subordinated debt from time to time for a period not to exceed five consecutive
years. The subordinated debentures are considered as Tier I capital for the
Corporation under current regulatory guidelines.





Our trust
subsidiaries loaned the proceeds of their offerings of trust preferred
securities to us in exchange for junior subordinated deferrable interest
debentures. In accordance with FASB Interpretation 46, these trusts are not
consolidated with our financial statements but rather the subordinated
debentures are shown as a liability.





LIQUIDITY





Liquidity
risk arises from the possibility we may not be able to satisfy current or future
financial commitments, or may become unduly reliant on alternative funding
sources. The objective of liquidity risk management is to ensure that we can
meet the cash flow requirements of depositors and borrowers, as well as our
operating cash needs, at a reasonable cost, taking into account all on- and
off-balance sheet funding demands. We maintain an investment and funds
management policy, which identifies the primary sources of liquidity,
establishes procedures for monitoring and measuring liquidity, and establishes
minimum liquidity requirements in compliance with regulatory guidance. The Asset
Liability Committee continually monitors our liquidity position.





Our
sources of funds include the sale of securities in the available-for-sale
portion of the investment portfolio, the payment of principal on loans and
mortgage-backed securities, proceeds realized from loans held for sale, brokered
deposits and other wholesale funding.  We also secured federal funds
borrowing lines from three of our correspondent banks.  Two of the
lines are for $15 million each and the other one is for $5
million.  Our banking centers also provide access to retail deposit
markets.  If large certificate depositors shift to our competitors or
other markets in response to interest rate changes, we have the ability to
replenish those deposits through alternative funding
sources.  Traditionally, we have also borrowed from the FHLB to
supplement our funding requirements.  At June 30, 2009, we had
sufficient collateral available to borrow, approximately, an additional $6.2
million in advances from the FHLB. We believe we have the
ability to raise deposits, when needed, by offering rates at or slightly above
market rates.





At the
holding company level, the Corporation uses cash to pay dividends to
stockholders, repurchase common stock, make selected investments and
acquisitions, and service debt. The main sources of funding for the Corporation
include dividends from the Bank, borrowings and access to the capital
markets.  Also, the Corporation has lines of credit of $18 million
with a correspondent bank.  The Corporation borrowed $1.5 million from
this line of credit to pay its second quarter cash dividend.





The
primary source of funding for the Corporation has been dividends and returns of
investment from the Bank. Kentucky banking laws limit the amount of dividends
that may be paid to the Corporation by the Bank without prior approval of the
KOFI.  Under these laws, the amount of dividends that may be paid in
any calendar year is limited to current year’s net income, as defined in the
laws, combined with the retained net income of the preceding two years, less any
dividends declared during those periods.As a result of a $6
million dividend in 2008 used to finance the purchase of FSB Bancshares, Inc.,
the Bank needed and obtained partial approval for its second quarter 2009
dividend. Because of these limitations, consolidated cash flows as presented in
the consolidated statements of cash flows may not represent cash immediately
available to the Corporation.  During 2009, the Bank declared and paid
dividends of $1.9 million to the Corporation.


40





CAPITAL





Stockholders’
equity increased $20.1 million for the period ended June 30, 2009 compared to
December 31, 2008 primarily due to the sale of $20 million of preferred stock to
the U.S. Treasury Department under the Capital Purchase
Program.  Average stockholders’ equity to average assets ratio
increased to 8.73% for the six months ended June 30, 2009 compared to 8.46% for
2008.





On
January 9, 2009, we sold $20 million of cumulative perpetual preferred shares,
with a liquidation preference of $1,000 per share (the “Senior Preferred
Shares”) to the U.S. Treasury under the terms of its Capital Purchase
Plan.  Under CPP, the U.S. Treasury may purchase up to $250 billion of
senior preferred shares on standardized terms from qualifying financial
institutions as part of the Troubled Asset Relief Program authorized by the
Emergency Economic Stabilization Act of 2008.  The Senior Preferred
Shares constitute Tier 1 capital and rank senior to our common
shares.  The Senior Preferred Shares pay cumulative dividends at a
rate of 5% per year for the first five years and will reset to a rate of 9% per
year after five years. The Senior Preferred Shares may be redeemed at any time,
at our option.





Under the
terms of our CPP stock purchase agreement, we also issued the U.S. Treasury a
warrant to purchase an amount of our common stock equal to 15% of the aggregate
amount of the Senior Preferred Shares, or $3 million.  The warrant
entitles the U.S. Treasury to purchase 215,983 common shares at a purchase price
of $13.89 per share.  The initial exercise price for the warrant and
the number of shares subject to the warrant were determined by reference to the
market price of our common stock calculated on a 20-day trailing average as of
December 8, 2008, the date the U.S. Treasury approved our
application.  The warrant has a term of 10 years and is
potentially dilutive to earnings per share.





During
the first half of 2009, we did not purchase any shares of our own common
stock.However, the
terms of our Senior Preferred Shares do not allow us to repurchase shares of our
common stock without the consent of the U.S. Treasury until the Senior Preferred
Shares are redeemed.





Each of
the federal bank regulatory agencies has established minimum leverage capital
requirements for banks. Banks must maintain a minimum ratio of Tier 1 capital to
adjusted average quarterly assets ranging from 3% to 5%, subject to federal bank
regulatory evaluation of an organization’s overall safety and
soundness.  We intend to maintain a capital position that meets or
exceeds the “well capitalized” requirements established for banks by the
FDIC.  The following table shows the ratios of Tier 1 capital and
total capital to risk-adjusted assets and the leverage ratios for the
Corporation and the Bank as of June 30, 2009.


41





To Be ConsideredWell CapitalizedUnder Prompt(Dollars in thousands)
                  
                  
                  
                  
                  
                  
                  
                  For Capital
                  
                  
                  CorrectionActual
                  
                  
                  Adequacy Purposes
                  
                  
                  Action ProvisionsAs of June 30, 2009:
                  
                  Amount
                  
                  
                  Ratio
                  
                  
                  Amount
                  
                  
                  Ratio
                  
                  
                  Amount
                  
                  
                  RatioTotal
      risk-based capital(to
                    risk-weighted
      assets)Consolidated
                  
                  $
                  111,559
                  
                  
                  
                  11.50
                  %
                  
                  $
                  77,617
                  
                  
                  
                  8.00
                  %
                  
                  
                  N/A
                  
                  
                  
                  N/ABank
                  
                  
                  110,528
                  
                  
                  
                  11.41
                  
                  
                  
                  77,529
                  
                  
                  
                  8.00
                  
                  
                  
                  96,911
                  
                  
                  
                  10.00Tier
      I capital (to risk-
                    weighted assets)Consolidated
                  
                  
                  99,416
                  
                  
                  
                  10.25
                  
                  
                  
                  38,808
                  
                  
                  
                  4.00
                  
                  
                  
                  N/A
                  
                  
                  
                  N/ABank
                  
                  
                  98,397
                  
                  
                  
                  10.15
                  
                  
                  
                  38,764
                  
                  
                  
                  4.00
                  
                  
                  
                  58,146
                  
                  
                  
                  6.00Tier
      I capital (to average assets)Consolidated
                  
                  
                  99,416
                  
                  
                  
                  9.31
                  
                  
                  
                  42,704
                  
                  
                  
                  4.00
                  
                  
                  
                  N/A
                  
                  
                  
                  N/ABank
                  
                  
                  98,397
                  
                  
                  
                  9.21
                  
                  
                  
                  42,734
                  
                  
                  
                  4.00
                  
                  
                  
                  53,417
                  
                  
                  
                  5.00





To Be ConsideredWell CapitalizedUnder Prompt(Dollars in thousands)
                  
                  
                  
                  
                  
                  
                  
                  For Capital
                  
                  
                  CorrectionActual
                  
                  
                  Adequacy Purposes
                  
                  
                  Action ProvisionsAs of December 31, 2008:
                  
                  Amount
                  
                  
                  Ratio
                  
                  
                  Amount
                  
                  
                  Ratio
                  
                  
                  Amount
                  
                  
                  RatioTotal
      risk-based capital (to
                    risk-weighted
      assets)Consolidated
                  
                  $
                  90,890
                  
                  
                  
                  10.14
                  %
                  
                  $
                  71,717
                  
                  
                  
                  8.00
                  %
                  
                  
                  N/A
                  
                  
                  
                  N/ABank
                  
                  
                  89,224
                  
                  
                  
                  9.97
                  
                  
                  
                  71,625
                  
                  
                  
                  8.00
                  
                  
                  
                  89,531
                  
                  
                  
                  10.00Tier
      I capital (to risk-
                    weighted assets)Consolidated
                  
                  
                  79,655
                  
                  
                  
                  8.89
                  
                  
                  
                  35,859
                  
                  
                  
                  4.00
                  
                  
                  
                  N/A
                  
                  
                  
                  N/ABank
                  
                  
                  78,029
                  
                  
                  
                  8.72
                  
                  
                  
                  35,812
                  
                  
                  
                  4.00
                  
                  
                  
                  53,719
                  
                  
                  
                  6.00Tier
      I capital (to average assets)Consolidated
                  
                  
                  79,655
                  
                  
                  
                  8.09
                  
                  
                  
                  39,367
                  
                  
                  
                  4.00
                  
                  
                  
                  N/A
                  
                  
                  
                  N/ABank
                  
                  
                  78,029
                  
                  
                  
                  8.10
                  
                  
                  
                  38,546
                  
                  
                  
                  4.00
                  
                  
                  
                  48,182
                  
                  
                  
                  5.00





Item
3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK





Asset/Liability
Management and Market Risk





To
minimize the volatility of net interest income and exposure to economic loss
that may result from fluctuating interest rates, we manage our exposure to
adverse changes in interest rates through asset and liability management
activities within guidelines established by our Asset Liability Committee
(“ALCO”).  The ALCO, comprised of senior management representatives,
has the responsibility for approving and ensuring compliance with
asset/liability management policies.  Interest rate risk is the
exposure to adverse changes in the net interest income as a result of market
fluctuations in interest rates.  The ALCO, on an ongoing basis,
monitors interest rate and liquidity risk in order to implement appropriate
funding and balance sheet strategies.  Management considers interest
rate risk to be our most significant market risk.





We
utilize an earnings simulation model to analyze net interest income
sensitivity.  We then evaluate potential changes in market interest
rates and their subsequent effects on net interest income.  The model
projects the effect of instantaneous movements in interest rates of both 100 and
200 basis points.  We also incorporate assumptions based on the
historical behavior of our deposit rates and balances in relation to changes in
interest rates into the model.  These assumptions are inherently
uncertain and, as a result, the model cannot precisely measure future net
interest income or precisely predict the impact of fluctuations in market
interest rates on net interest income.  Actual results will differ
from the model’s simulated results due to timing, magnitude and frequency of
interest rate changes as well as changes in market conditions and the
application and timing of various management strategies.


42





Our
interest sensitivity profile was asset sensitive at June 30, 2009 and December
31, 2008.  Given a 100 basis point decrease in rates sustained for one
year, our base net interest income would decrease by an estimated2.71% at June 30, 2009
compared to a decrease of 2.67% at December 31, 2008. Given a 100 basis point
increase in interest rates sustained for one year, our base net interest income
would increase by anestimated 2.33% at June
30, 2009 compared to an increase of 1.49% at December 31, 2008.





Our
interest sensitivity at any point in time will be affected by a number of
factors.  These factors include the mix of interest sensitive assets
and liabilities, their relative pricing schedules, market interest rates,
deposit growth, loan growth, decay rates and prepayment speed
assumptions.





We use
various asset/liability strategies to manage the re-pricing characteristics of
our assets and liabilities designed to ensure that exposure to interest rate
fluctuations is limited within our guidelines of acceptable levels of
risk-taking.  As demonstrated by the June 30, 2009 and December 31,
2008 sensitivity tables, our balance sheet has an asset sensitive position. This
means that our earning assets, which consist of loans and investment securities,
will change in price at a faster rate than our deposits and
borrowings.  Therefore, if short term interest rates increase, our net
interest income will increase.  Likewise, if short term interest rates
decrease, our net interest income will decrease.





Our
sensitivity to interest rate changes is presented based on data as of June 30,
2009 and December 31, 2008 annualized to a one year period.





June 30, 2009Decrease in Rates
                                          
                                          
                                          
                                          
                                          
                                          Increase in Rates200
                                          
                                          
                                          100
                                          
                                          
                                          
                                          
                                          
                                          100
                                          
                                          
                                          200(Dollars in thousands)
                                          
                                          Basis Points
                                          
                                          
                                          Basis Points
                                          
                                          
                                          Base
                                          
                                          
                                          Basis Points
                                          
                                          
                                          Basis PointsProjected
      interest incomeLoans
                                          
                                          $
                                          54,453
                                          
                                          
                                          $
                                          55,912
                                          
                                          
                                          $
                                          57,474
                                          
                                          
                                          $
                                          58,995
                                          
                                          
                                          $
                                          60,590Investments
                                          
                                          
                                          1,548
                                          
                                          
                                          
                                          1,568
                                          
                                          
                                          
                                          1,588
                                          
                                          
                                          
                                          1,641
                                          
                                          
                                          
                                          1,693Total
      interest income
                                          
                                          
                                          56,001
                                          
                                          
                                          
                                          57,480
                                          
                                          
                                          
                                          59,062
                                          
                                          
                                          
                                          60,636
                                          
                                          
                                          
                                          62,283Projected
      interest expenseDeposits
                                          
                                          
                                          15,455
                                          
                                          
                                          
                                          15,584
                                          
                                          
                                          
                                          16,108
                                          
                                          
                                          
                                          16,201
                                          
                                          
                                          
                                          17,455Borrowed
      funds
                                          
                                          
                                          3,926
                                          
                                          
                                          
                                          3,925
                                          
                                          
                                          
                                          3,925
                                          
                                          
                                          
                                          4,497
                                          
                                          
                                          
                                          5,072Total
      interest expense
                                          
                                          
                                          19,381
                                          
                                          
                                          
                                          19,509
                                          
                                          
                                          
                                          20,033
                                          
                                          
                                          
                                          20,698
                                          
                                          
                                          
                                          22,527Net interest income
                                          
                                          $
                                          36,620
                                          
                                          
                                          $
                                          37,971
                                          
                                          
                                          $
                                          39,029
                                          
                                          
                                          $
                                          39,938
                                          
                                          
                                          $
                                          39,756Change
      from base
                                          
                                          $
                                          (2,409
                                          )
                                          
                                          $
                                          (1,058
                                          )
                                          
                                          
                                          
                                          
                                          
                                          $
                                          909
                                          
                                          
                                          $
                                          727%
      Change from base
                                          
                                          
                                          (6.17
                                          )%
                                          
                                          
                                          (2.71
                                          )%
                                          
                                          
                                          
                                          
                                          
                                          
                                          2.33
                                          %
                                          
                                          
                                          1.86
                                          %





December 31, 2008Decrease in Rates
                                        
                                        
                                        
                                        
                                        
                                        Increase in Rates200
                                        
                                        
                                        100
                                        
                                        
                                        
                                        
                                        
                                        100
                                        
                                        
                                        200(Dollars in thousands)
                                        
                                        Basis Points
                                        
                                        
                                        Basis Points
                                        
                                        
                                        Base
                                        
                                        
                                        Basis Points
                                        
                                        
                                        Basis PointsProjected
      interest incomeLoans
                                        
                                        $
                                        50,663
                                        
                                        
                                        $
                                        52,195
                                        
                                        
                                        $
                                        53,664
                                        
                                        
                                        $
                                        55,105
                                        
                                        
                                        $
                                        56,577Investments
                                        
                                        
                                        966
                                        
                                        
                                        
                                        985
                                        
                                        
                                        
                                        1,002
                                        
                                        
                                        
                                        1,033
                                        
                                        
                                        
                                        1,063Total
      interest income
                                        
                                        
                                        51,629
                                        
                                        
                                        
                                        53,180
                                        
                                        
                                        
                                        54,666
                                        
                                        
                                        
                                        56,138
                                        
                                        
                                        
                                        57,640Projected
      interest expenseDeposits
                                        
                                        
                                        15,815
                                        
                                        
                                        
                                        16,026
                                        
                                        
                                        
                                        16,419
                                        
                                        
                                        
                                        16,984
                                        
                                        
                                        
                                        17,523Borrowed
      funds
                                        
                                        
                                        3,559
                                        
                                        
                                        
                                        3,570
                                        
                                        
                                        
                                        3,743
                                        
                                        
                                        
                                        4,135
                                        
                                        
                                        
                                        4,525Total
      interest expense
                                        
                                        
                                        19,374
                                        
                                        
                                        
                                        19,596
                                        
                                        
                                        
                                        20,162
                                        
                                        
                                        
                                        21,119
                                        
                                        
                                        
                                        22,048Net interest income
                                        
                                        $
                                        32,255
                                        
                                        
                                        $
                                        33,584
                                        
                                        
                                        $
                                        34,504
                                        
                                        
                                        $
                                        35,019
                                        
                                        
                                        $
                                        35,592Change
      from base
                                        
                                        $
                                        (2,249
                                        )
                                        
                                        $
                                        (920
                                        )
                                        
                                        
                                        
                                        
                                        
                                        $
                                        515
                                        
                                        
                                        $
                                        1,088%
      Change from base
                                        
                                        
                                        (6.52
                                        )%
                                        
                                        
                                        (2.67
                                        )%
                                        
                                        
                                        
                                        
                                        
                                        
                                        1.49
                                        %
                                        
                                        
                                        3.15
                                        %


43





Item
4.  CONTROLS AND PROCEDURES





Management
is responsible for establishing and maintaining effective disclosure controls
and procedures, as defined under Rules 13a-15(e) and 15d-15(e) of the Securities
Exchange Act of 1934. As of June 30, 2009, an evaluation was performed under the
supervision and with the participation of management, including the Chief
Executive Officer and Chief Financial Officer, of the effectiveness of the
design and operation of our disclosure controls and procedures. Based on that
evaluation, management concluded that disclosure controls and procedures as of
June 30, 2009 were effective in ensuring material information required to be
disclosed in this Form 10-Q was recorded, processed, summarized, and reported in
a timely manner as specified in SEC rules and forms.





There
were no significant changes in our internal controls or in other factors that
could significantly affect these controls after the date of the Chief Executive
Officer and Chief Financial Officers evaluation, nor were there any significant
deficiencies or material weaknesses in the controls which required corrective
action.





Part
II - OTHER INFORMATION





Item 1.
            Legal
      Proceedings





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





Item 1A.
            Risk
      Factors





We did
not have any changes to our risk factors previously disclosed in our Annual
Report on Form 10-K for the year ended December 31, 2008.





Item 2.
            Unregistered
      Sales of Securities and Use of
Proceeds





We did
not repurchase any shares of our common stock during the quarter ended June 30,
2009.





Item 3.
            Defaults
      Upon Senior Securities





Not
Applicable





Item 4.
            Submission
      of Matters to a Vote of Security
Holders





Our 2009
Annual Meeting of Shareholders was held on May 20, 2009.  At the
meeting, the directors listed below were elected as directors of the Corporation
for terms expiring at the annual meeting in the year set forth to each of their
names.  The voting results for the matters brought before the 2009
Annual Meeting are as follows:





1.Election of
Directors.





BrokerName
                          
                          Term Expires
                          
                          Votes For
                          
                          
                          Abstentions
                          
                          
                          Non-VotesB.
      Keith Johnson
                          
                          2012
                          
                          
                          3,444,898
                          
                          
                          
                          58,174
                          
                          
                          
                          -Diane
      E. Logsdon
                          
                          2012
                          
                          
                          3,324,010
                          
                          
                          
                          179,062
                          
                          
                          
                          -John
      L. Newcomb, Jr.
                          
                          2012
                          
                          
                          3,390,048
                          
                          
                          
                          113,024
                          
                          
                          
                          -Donald
      Scheer
                          
                          2012
                          
                          
                          3,398,185
                          
                          
                          
                          104,887
                          
                          
                          
                          -


44





In
addition, the following directors will continue in office until the annual
meeting of the year set forth beside each of their names.





Name
                              
                              Term ExpiresRobert
      M. Brown
                              
                              2010Walter
      D. Huddleston
                              
                              2011J.
      Stephen Mouser
                              
                              2011J.
      Alton Rider
                              
                              2010Gail
      L. Schomp
                              
                              2010Michael
      L. Thomas
                              
                              2011





2.  Approval
of our executive compensation.





BrokerVotes For
                      
                      Against
                      
                      
                      Abstentions
                      
                      
                      Non-Votes3,226,312
                      
                      
                      124,182
                      
                      
                      
                      -
                      
                      
                      
                      -





Item 5.
            Other
      Information




None





Item 6.
            Exhibits:




31.1
                Certification
      of Chief Executive Officer Pursuant to Section 302 of Sarbanes- Oxley
      Act31.2
                Certification
      of Chief Financial Officer Pursuant to Section 302 of Sarbanes- Oxley
      Act32
                Certification
      of Chief Executive Officer and Chief Financial Officer Pursuant to Section
      18 U.S.C. Section 1350 (As Adopted Pursuant to Section 906 of the
      Sarbanes-Oxley Act of
2002)


45





FIRST
FINANCIAL SERVICE CORPORATION





SIGNATURES





Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange Act of
1934, the registrant has duly caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized.





Date:  August
      10, 2009
                By:
                /s/ B. Keith JohnsonB.
      Keith JohnsonChief
      Executive Officer





Date:  August
      10, 2009
              By:
              /s/ Steven M. ZagarSteven
      M. ZagarChief Financial Officer &Principal Accounting Officer


46


INDEX
TO EXHIBITS





Exhibit No.
                  
                  Description31.1
                  
                  Certification
      of Chief Executive Officer Pursuant to Section 302 of Sarbanes-Oxley
      Act31.2
                  
                  Certification
      of Chief Financial Officer Pursuant to Section 302 of Sarbanes-Oxley
      Act32
                  
                  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)


47