** **

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

** **

**FORM 10-Q**

**(Mark One)**

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

** **

**For the quarterly periodended September 30, 2006**

** **

**OR**

** **

**o**                                 TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

** **

**Commission File Number0-18832**

** **

**First Financial Service Corporation**

(Exact Name of Registrantas specified in its charter)
| **Kentucky**                                                    | **61-1168311**                     |
|-----------------------------------------------------------------|------------------------------------|
| (State or other  jurisdiction of incorporation or organization) | (IRS Employer  Identification No.) |
|                                                            |                               |
| **2323 Ring Road  Elizabethtown, Kentucky 42701**               |
| (Address of principal executive offices)                        |
| (Zip Code)                                                      |
|                                                            |
| **(270) 765-2131**                                              |
| (Registrant’s telephone number, including area code)       |

 

Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days. Yes x**Noo

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer, or a non-accelerated filer. Seedefinition of “accelerated filer and large accelerated filer” in Rule 12b-2 ofthe Exchange Act.

Large Accelerated Filer o      AcceleratedFiler x      Non-Accelerated Filer o

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

Indicate the number of shares outstanding of each ofthe issuer’s classes of common stock, as of the latest practicable date.
| Class        | ** ** | **Outstanding as of October 31, 2006** |
|--------------|------------|----------------------------------------|
| Common Stock |       | 4,384,443shares                        |

 

 

 

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## **FIRST FINANCIAL SERVICE CORPORATION**

**TABLE OF CONTENTS**
| **PART I**— FINANCIAL INFORMATION |   |
|---------------------------------------------|--------|
| ** **                                  |   |   |   |
| **Item 1.**                            |   | Consolidated Financial Statements and  Notes to Consolidated Financial Statements |   |
| ** **                                  |   |   |   |
| **Item 2.**                            |   | Management’s Discussion and Analysis  of Financial Condition and Results of Operations |   |
| ** **                                  |   |   |   |
| **Item 3.**                            |   | Quantitative  and Qualitative Disclosures about Market Risk |   |
| ** **                                  |   |   |   |
| **Item 4.**                            |   | Controls and  Procedures |   |
| ** **                                  |   |   |   |
| **PART II — OTHER INFORMATION**   |   |
| ** **                                  |   |   |   |
| **Item 1.**                            |   | Legal Proceedings |   |
| ** **                                  |   |   |   |
| **Item 1A.**                           |   | Risk Factors |   |
| ** **                                  |   |   |   |
| **Item 2.**                            |   | Unregistered  Sales of Equity Securities and Use of Proceeds |   |
| ** **                                  |   |   |   |
| **Item 3.**                            |   | Defaults upon  Senior Securities |   |
| ** **                                  |   |   |   |
| **Item 4.**                            |   | Submission of  Matters to a Vote of Security Holders |   |
| ** **                                  |   |   |   |
| **Item 5.**                            |   | Other Information |   |
| ** **                                  |   |   |   |
| **Item 6.**                            |   | Exhibits |   |
| ** **                                  |   |   |   |
|                                        |   | SIGNATURES |   |

2

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### **FORWARD-LOOKING STATEMENTS**

Statements contained inthis report that are not statements of historical fact constituteforward-looking statements within the meaning of Section 21E of the SecuritiesExchange Act of 1934, as amended. In addition, First Financial ServiceCorporation (the “Corporation”) may make forward-looking statements in futurefilings with the Securities and Exchange Commission, in press releases, and inoral and written statements made by or with the approval of the Corporation.Forward-looking statements include, but are not limited to: (1) projections ofrevenues, income or loss, earnings or loss per share, capital structure andother financial items; (2) statements of plans and objectives of theCorporation or its management or Board of Directors; (3) statements regardingfuture events, actions or economic performance; and (4) statements of assumptionsunderlying such statements. Words such as “estimate,” “strategy,” “believes,” “anticipates,”“expects,” “intends,” “plans,” “targeted,” and similar expressions are intendedto identify forward-looking statements, but are not the exclusive means of identifyingsuch statements.

Forward-lookingstatements involve risks and uncertainties that may cause actual results todiffer materially from those indicated by the forward-looking statements. Inaddition to those risks described under “Item 1A Risk Factors” of this reportand our Annual Report on Form 10-K for the year ended December 31, 2005, someof the events or circumstances that could cause such differences include thefollowing: changes in general economic conditions and economic conditions inKentucky and the markets served by the Corporation any of which may affect,among other things, the level of non-performing assets, charge-offs, andprovision for loan loss expense; changes in interest rates that may reduceinterest margins and impact funding sources; changes in market rates and priceswhich may adversely impact the value of financial products includingsecurities, loans and deposit; changes in tax laws, rules and regulations;various monetary and fiscal policies and regulations, including those determinedby the Federal Reserve Board, the Federal Deposit Insurance Corporation and theKentucky Office of Financial Institutions; competition with other local andregional commercial banks, savings banks, credit unions and other non-bankfinancial institutions; our ability to grow core businesses; our ability todevelop and introduce new banking-related products, services and enhancementsand gain market acceptance of such products; and management’s ability to managethese and other risks.

3

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**Item 1.**

**FIRSTFINANCIAL SERVICE CORPORATIONConsolidated Balance Sheets(Unaudited)**
| ** **                                                                                                                                                | ** ** | **September 30,  2006**                                           | ** ** | **December 31,  2005** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                                | ** ** | **(Dollars in thousands, except share data)** | ** ** |
| **ASSETS**                                                                                                                                                |       |                                                                   |       |                        |       |
| Cash and due from banks                                                                                                                                   |       | $                                                                      | 15,570     |                        | $          | 20,451 |   |
|                                                                                                                                                      |       |                                                                   |       |                        |       |
| Securities available-for-sale                                                                                                                             |       | 27,938                                                                 |       | 28,324                      |       |
| Securities  held-to-maturity, fair value of $25,894 Sep (2006) and $32,434 Dec (2005)                                                                     |       | 26,453                                                                 |       | 33,231                      |       |
| Total securities                                                                                                                                          |       | 54,391                                                                 |       | 61,555                      |       |
|                                                                                                                                                      |       |                                                                   |       |                        |       |
| Loans held for sale                                                                                                                                       |       | 1,733                                                                  |       | 597                         |       |
| Loans, net of unearned  fees                                                                                                                              |       | 685,715                                                                |       | 642,520                     |       |
| Allowance for loan  losses                                                                                                                                |       | (7,577                                                                 | )          | (7,377                      | )          |
| Net loans  receivable                                                                                                                                     |       | 679,871                                                                |       | 635,740                     |       |
| ** **                                                                                                                                                | ** ** | ** **                                                             | ** ** | ** **                  | ** ** |
| Federal Home Loan Bank  stock                                                                                                                             |       | 7,508                                                                  |       | 7,194                       |       |
| Cash surrender value of  life insurance                                                                                                                   |       | 7,858                                                                  |       | 7,637                       |       |
| Premises and equipment,  net                                                                                                                              |       | 21,037                                                                 |       | 19,134                      |       |
| Real estate owned:                                                                                                                                        |       |                                                                   |       |                        |       |
| Acquired through  foreclosure                                                                                                                             |       | 789                                                                    |       | 1,022                       |       |
| Held for  development                                                                                                                                     |       | 337                                                                    |       | 337                         |       |
| Other repossessed  assets                                                                                                                                 |       | 117                                                                    |       | 119                         |       |
| Goodwill                                                                                                                                                  |       | 8,384                                                                  |       | 8,384                       |       |
| Accrued interest  receivable                                                                                                                              |       | 3,633                                                                  |       | 3,051                       |       |
| Other assets                                                                                                                                              |       | 1,601                                                                  |       | 1,889                       |       |
|                                                                                                                                                      |       |                                                                   |       |                        |       |
| **TOTAL  ASSETS**                                                                                                                                         |       | $                                                                      | 801,096    |                        | $          | 766,513 |   |
|                                                                                                                                                      |       |                                                                   |       |                        |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                            |       |                                                                   |       |                        |       |
| **LIABILITIES:**                                                                                                                                          |       |                                                                   |       |                        |       |
| Deposits:                                                                                                                                                 |       |                                                                   |       |                        |       |
| Non-interest  bearing                                                                                                                                     |       | $                                                                      | 41,171     |                        | $          | 39,145 |   |
| NOW demand                                                                                                                                                |       | 71,126                                                                 |       | 76,848                      |       |
| Savings                                                                                                                                                   |       | 83,176                                                                 |       | 99,879                      |       |
| Money market                                                                                                                                              |       | 56,547                                                                 |       | 66,175                      |       |
| Certificates of  deposit                                                                                                                                  |       | 361,196                                                                |       | 309,059                     |       |
| Total deposits                                                                                                                                            |       | 613,216                                                                |       | 591,106                     |       |
|                                                                                                                                                      |       |                                                                   |       |                        |       |
| Short-term borrowings                                                                                                                                     |       | 76,000                                                                 |       | 19,500                      |       |
| Advances from Federal  Home Loan Bank                                                                                                                     |       | 28,261                                                                 |       | 78,375                      |       |
| Subordinated debentures                                                                                                                                   |       | 10,000                                                                 |       | 10,000                      |       |
| Accrued interest  payable                                                                                                                                 |       | 377                                                                    |       | 389                         |       |
| Accounts payable and  other liabilities                                                                                                                   |       | 1,854                                                                  |       | 1,023                       |       |
| Deferred income taxes                                                                                                                                     |       | 1,325                                                                  |       | 1,379                       |       |
|                                                                                                                                                      |       |                                                                   |       |                        |       |
| **TOTAL  LIABILITIES**                                                                                                                                    |       | 731,033                                                                |       | 701,772                     |       |
|                                                                                                                                                      |       |                                                                   |       |                        |       |
| **STOCKHOLDERS’ EQUITY:**                                                                                                                            |       |                                                                   |       |                        |       |
| Serial preferred stock,  5,000,000 shares authorized and unissued                                                                                         |       | —                                                                 |       | —                      |       |
| Common stock, $1 par  value per share; authorized 10,000,000 shares; issued and outstanding,  4,384,443 shares Sep (2006) and 3,983,530 shares Dec (2005) |       | 4,384                                                                  |       | 3,984                       |       |
| Additional paid-in  capital                                                                                                                               |       | 27,356                                                                 |       | 16,409                      |       |
| Retained earnings                                                                                                                                         |       | 38,371                                                                 |       | 44,291                      |       |
| Accumulated other  comprehensive income (loss)                                                                                                            |       | (48                                                                    | )          | 57                          |       |
|                                                                                                                                                      |       |                                                                   |       |                        |       |
| **TOTAL  STOCKHOLDERS’ EQUITY**                                                                                                                      |       | 70,063                                                                 |       | 64,741                      |       |
| **TOTAL LIABILITIES AND  STOCKHOLDERS’ EQUITY**                                                                                                      |       | $                                                                      | 801,096    |                        | $          | 766,513 |   |

 

***See notes to the unaudited consolidated financialstatements.***

4

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**FIRSTFINANCIAL SERVICE CORPORATIONConsolidated Statements of Income(Unaudited)**
| ** **                                                                      | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|---------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| **(Dollars in thousands, except per share data)** | ** ** | **2006**                                             | ** ** | **2005**                                            | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                                                      |       |                                                 |       |                                                |       |   |   |   |   |
| **Interest Income:**                                                            |       |                                                 |       |                                                |       |   |   |   |   |
| Interest and  fees on loans                                                     |       | $                                                    | 13,104     |                                                | $          | 10,839 |   | $ | 37,106 |   | $ | 31,065 |   |
| Interest and  dividends on investments and deposits                             |       | 718                                                  |       | 754                                                 |       | 2,319 |   | 2,185 |   |
| Total interest  income                                                          |       | 13,822                                               |       | 11,593                                              |       | 39,425 |   | 33,250 |   |
|                                                                            |       |                                                 |       |                                                |       |   |   |   |   |
| **Interest Expense:**                                                           |       |                                                 |       |                                                |       |   |   |   |   |
| Deposits                                                                        |       | 4,898                                                |       | 3,482                                               |       | 13,503 |   | 9,519 |   |
| Short-term  borrowings                                                          |       | 801                                                  |       | 12                                                  |       | 889 |   | 12 |   |
| Federal Home  Loan Bank advances                                                |       | 407                                                  |       | 956                                                 |       | 2,280 |   | 2,851 |   |
| Subordinated  debentures                                                        |       | 235                                                  |       | 184                                                 |       | 665 |   | 517 |   |
| Total interest  expense                                                         |       | 6,341                                                |       | 4,634                                               |       | 17,337 |   | 12,899 |   |
|                                                                            |       |                                                 |       |                                                |       |   |   |   |   |
| Net interest income                                                             |       | 7,481                                                |       | 6,959                                               |       | 22,088 |   | 20,351 |   |
| Provision for loan  losses                                                      |       | 249                                                  |       | 440                                                 |       | 346 |   | 756 |   |
| Net interest income  after provision for loan losses                            |       | 7,232                                                |       | 6,519                                               |       | 21,742 |   | 19,595 |   |
|                                                                            |       |                                                 |       |                                                |       |   |   |   |   |
| **Non-interest Income:**                                                        |       |                                                 |       |                                                |       |   |   |   |   |
| Customer service  fees on deposit accounts                                      |       | 1,481                                                |       | 1,371                                               |       | 4,108 |   | 3,810 |   |
| Gain on sale of  mortgage loans                                                 |       | 204                                                  |       | 251                                                 |       | 608 |   | 602 |   |
| Brokerage  commissions                                                          |       | 79                                                   |       | 79                                                  |       | 250 |   | 236 |   |
| Gain on sale of  real estate held for development                               |       | —                                               |       | —                                              |       | — |   | 143 |   |
| Gain on sale of  investments                                                    |       | —                                               |       | —                                              |       | — |   | 381 |   |
| Other income                                                                    |       | 269                                                  |       | 360                                                 |       | 856 |   | 887 |   |
| Total  non-interest income                                                      |       | 2,033                                                |       | 2,061                                               |       | 5,822 |   | 6,059 |   |
|                                                                            |       |                                                 |       |                                                |       |   |   |   |   |
| **Non-interest Expense:**                                                       |       |                                                 |       |                                                |       |   |   |   |   |
| Employee  compensation and benefits                                             |       | 2,968                                                |       | 2,769                                               |       | 8,763 |   | 8,403 |   |
| Office occupancy  expense and equipment                                         |       | 523                                                  |       | 519                                                 |       | 1,589 |   | 1,517 |   |
| Marketing and advertising                                                       |       | 209                                                  |       | 197                                                 |       | 628 |   | 580 |   |
| Outside services  and data processing                                           |       | 650                                                  |       | 609                                                 |       | 1,907 |   | 1,837 |   |
| Bank franchise  tax                                                             |       | 224                                                  |       | 195                                                 |       | 667 |   | 593 |   |
| Other expense                                                                   |       | 863                                                  |       | 867                                                 |       | 2,607 |   | 2,648 |   |
| Total  non-interest expense                                                     |       | 5,437                                                |       | 5,156                                               |       | 16,161 |   | 15,578 |   |
|                                                                            |       |                                                 |       |                                                |       |   |   |   |   |
| Income before income  taxes                                                     |       | 3,828                                                |       | 3,424                                               |       | 11,403 |   | 10,076 |   |
| Income taxes                                                                    |       | 1,257                                                |       | 1,113                                               |       | 3,738 |   | 3,285 |   |
| **Net Income**                                                                  |       | $                                                    | 2,571      |                                                | $          | 2,311 |   | $ | 7,665 |   | $ | 6,791 |   |
|                                                                            |       |                                                 |       |                                                |       |   |   |   |   |
| Shares applicable to  basic income per share                                    |       | 4,384,084                                            |       | 4,387,687                                           |       | 4,382,840 |   | 4,402,842 |   |
| **Basic income per share**                                                      |       | $                                                    | 0.59       |                                                | $          | 0.53 |   | $ | 1.75 |   | $ | 1.54 |   |
|                                                                            |       |                                                 |       |                                                |       |   |   |   |   |
| Shares applicable to  diluted income per share                                  |       | 4,430,204                                            |       | 4,429,998                                           |       | 4,423,118 |   | 4,439,211 |   |
| **Diluted income per share**                                                    |       | $                                                    | 0.58       |                                                | $          | 0.52 |   | $ | 1.73 |   | $ | 1.53 |   |

 

***See notes to the unaudited consolidated financialstatements.***

5

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**FIRSTFINANCIAL SERVICE CORPORATIONConsolidated Statements of Comprehensive Income(Unaudited)**
| ** **                                                     | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|----------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| **(Dollars in thousands)**                           | ** ** | **2006**                                             | ** ** | **2005**                                            | ** ** | **2006** | ** ** | **2005** | ** ** |
| **Net Income**                                                 |       | $                                                    | 2,571      |                                                | $          | 2,311 |   | $ | 7,665 |   | $ | 6,791 |   |
| Other comprehensive  income (loss):                            |       |                                                 |       |                                                |       |   |   |   |   |
| Change in  unrealized gain (loss) on securities                |       | 344                                                  |       | (405                                                | )          | (159 | ) | (554 | ) |
| Reclassification  of realized amount                           |       | —                                               |       | —                                              |       | — |   | (381 | ) |
| Net unrealized  gain (loss) recognized in comprehensive income |       | 344                                                  |       | (405                                                | )          | (159 | ) | (935 | ) |
| Tax effect                                                     |       | (117                                                 | )          | 138                                                 |       | 54 |   | 318 |   |
| Total other  comphrehensive income (loss)                      |       | 227                                                  |       | (267                                                | )          | (105 | ) | (617 | ) |
|                                                           |       |                                                 |       |                                                |       |   |   |   |   |
| **Comprehensive Income**                                       |       | $                                                    | 2,798      |                                                | $          | 2,044 |   | $ | 7,560 |   | $ | 6,174 |   |

 

***See notes to the unaudited consolidated financialstatements.***

6

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**FIRSTFINANCIAL SERVICE CORPORATIONConsolidated Statements of Changes in Stockholders’ EquityNine Months Ended September 30, 2006(Dollars In Thousands, Except Per Share Amounts)(Unaudited)**
| ** **                                                                            | ** ** | **Common Stock** | ** ** | **Additional  Paid-in** | ** ** | **Retained** | ** ** | **Accumulated  Other  Comprehensive  Income (Loss),** | ** ** | ** **               | ** ** |
|---------------------------------------------------------------------------------------|------------|-----------------------|------------|-------------------------|------------|--------------|------------|------------------------------------------------------------|------------|--------------------------|------------|
| ** **                                                                            | ** ** | **Shares**            | ** ** | **Amount**              | ** ** | **Capital**  | ** ** | **Earnings**                                               | ** ** | **Net of Tax** | ** ** | **Total** | ** ** |
| **Balance, December 31, 2005**                                                        |       | 3,984                 |       | $                       | 3,984      |         | $          | 16,409                                                     |       | $                        | 44,291     |   | $ | 57 |   | $ | 64,741 |   |
| Net income                                                                            |       |                  |       |                    |       |         |       | 7,665                                                      |       |                     |       | 7,665 |   |
| Stock Dividend-10%                                                                    |       | 398                   |       | 398                     |       | 10,835       |       | (11,233                                                    | )          |                     |       | — |   |
| Stock issued for stock  options exercised and employee benefit plans                  |       | 2                     |       | 2                       |       | 59           |       |                                                       |       |                     |       | 61 |   |
| Compensation expense  for stock options                                               |       |                  |       |                    |       | 53           |       |                                                       |       |                     |       | 53 |   |
| Net change in  unrealized gains (losses) on securities available-for-sale, net of tax |       |                  |       |                    |       |         |       |                                                       |       | (105                     | )          | (105 | ) |
| Cash dividends declared  ($.53 per share)                                             |       | —                |       | —                  |       | —       |       | (2,352                                                     | )          | —                   |       | (2,352 | ) |
| **Balance, September 30, 2006**                                                       |       | 4,384                 |       | $                       | 4,384      |         | $          | 27,356                                                     |       | $                        | 38,371     |   | $ | (48 | ) | $ | 70,063 |   |

 

***See notes to the unaudited consolidated financialstatements.***

7

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**FIRSTFINANCIAL SERVICE CORPORATIONConsolidated Statements of Cash Flows(Dollars In Thousands)(Unaudited)**
| ** **                                                                         | ** ** | **Nine Months Ended  September 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                         | ** ** | **2006**                                            | ** ** | **2005** | ** ** |
| **Operating Activities:**                                                          | ** ** | ** **                                          | ** ** | ** ** | ** ** |
| Net income                                                                         |       | $                                                   | 7,665      |   | $ | 6,791 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities: |       |                                                |       |   |   |
| Provision for  loan losses                                                         |       | 346                                                 |       | 756 |   |
| Depreciation on  premises and equipment                                            |       | 1,034                                               |       | 963 |   |
| Federal Home  Loan Bank stock dividends                                            |       | (314                                                | )          | (246 | ) |
| Net amortization  (accretion) available-for-sale                                   |       | 8                                                   |       | 28 |   |
| Net amortization  (accretion) held-to-maturity                                     |       | 24                                                  |       | 44 |   |
| Gain on sale of  investments available-for-sale                                    |       | —                                              |       | (381 | ) |
| Gain on sale of  mortgage loans                                                    |       | (608                                                | )          | (602 | ) |
| Gain on sale of  real estate held for development                                  |       | —                                              |       | (143 | ) |
| Origination of  loans held for sale                                                |       | (31,272                                             | )          | (33,470 | ) |
| Proceeds on sale  of loans held for sale                                           |       | 30,744                                              |       | 34,157 |   |
| Changes in:                                                                        |       |                                                |       |   |   |
| Cash surrender  value of life insurance                                            |       | (221                                                | )          | (213 | ) |
| Interest  receivable                                                               |       | (582                                                | )          | (447 | ) |
| Other assets                                                                       |       | 287                                                 |       | 380 |   |
| Interest payable                                                                   |       | (12                                                 | )          | (58 | ) |
| Accounts payable  and other liabilities                                            |       | 832                                                 |       | 709 |   |
| Net cash from operating  activities                                                |       | 7,931                                               |       | 8,268 |   |
|                                                                               |       |                                                |       |   |   |
| **Investing Activities:**                                                          | ** ** | ** **                                          | ** ** | ** ** | ** ** |
| Sales of  securities available-for-sale                                            |       | —                                              |       | 1,431 |   |
| Purchases of  securities available-for-sale                                        |       | (4,866                                              | )          | (36,393 | ) |
| Maturities of securities  available-for-sale                                       |       | 5,084                                               |       | 19,121 |   |
| Maturities of  securities held-to-maturity                                         |       | 6,754                                               |       | 1,294 |   |
| Net change in  loans                                                               |       | (43,105                                             | )          | (20,936 | ) |
| Net purchases of  premises and equipment                                           |       | (2,937                                              | )          | (2,674 | ) |
| Sales of real  estate held for development                                         |       | —                                              |       | 195 |   |
| Net cash from investing  activities                                                |       | (39,070                                             | )          | (37,962 | ) |
|                                                                               |       |                                                |       |   |   |
| **Financing Activities**                                                           | ** ** | ** **                                          | ** ** | ** ** | ** ** |
| Net change in  deposits                                                            |       | 22,110                                              |       | 9,179 |   |
| Change in  short-term borrowings                                                   |       | 56,500                                              |       | 9,000 |   |
| Repayments to  Federal Home Loan Bank                                              |       | (50,114                                             | )          | (489 | ) |
| Compensation  expense for stock options                                            |       | 53                                                  |       | — |   |
| Issuance of  common stock for options and employee benefit plans                   |       | 61                                                  |       | 57 |   |
| Dividends paid                                                                     |       | (2,352                                              | )          | (2,071 | ) |
| Common stock  repurchased                                                          |       | —                                              |       | (571 | ) |
| Net cash from financing  activities                                                |       | 26,258                                              |       | 15,105 |   |
|                                                                               |       |                                                |       |   |   |
| **(Decrease) in cash and cash  equivalents**                                       |       | (4,881                                              | )          | (14,589 | ) |
| **Cash and cash equivalents,  beginning of period**                                |       | 20,451                                              |       | 35,910 |   |
| **Cash and cash equivalents, end of period**                                       |       | $                                                   | 15,570     |   | $ | 21,321 |   |

 

***See notes to the unaudited consolidated financialstatements.***

8

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**NotesTo Unaudited Consolidated Financial Statements**

**1.             BASIS OF PRESENTATION AND SUMMARYOF SIGNIFICANT ACCOUNTING POLICIES**

***Basis of Presentation*** — Theaccompanying unaudited consolidated financial statements include the accountsof First Financial Service Corporation and its wholly owned subsidiary, FirstFederal Savings Bank. First Federal Savings Bank has two wholly ownedsubsidiaries, First Service Corporation of Elizabethtown and First FederalOffice Park, LLC.****Unless the textclearly suggests otherwise, references to “us,” “we,” or “our” include FirstFinancial Service Corporation and its wholly-owned subsidiary. All significantintercompany transactions and balances have been eliminated.

The accompanyingunaudited consolidated financial statements have been prepared in accordancewith U.S. generally accepted accounting principles for interim financialinformation and with the instructions to Form 10-Q and Rule 10-01 of RegulationS-X. Accordingly, they do not include all of the information and footnotesrequired by U.S. generally accepted accounting principles for completefinancial statements. In the opinion of management, all adjustments (consistingof normal recurring accruals) considered necessary for a fair presentation havebeen included. Operating results for the nine month period ending September 30,2006****are not necessarilyindicative of the results that may occur for the year ending December 31, 2006.For further information, refer to the consolidated financial statements andfootnotes thereto included in the Corporation’s annual report on Form 10-K forthe period ended December 31, 2005.

***Stock Dividends***— We declared a 10%stock dividend on August 15, 2006 to our shareholders of record as of August29, 2006, payable on September 14, 2006. In addition, we declared another 10%stock dividend on September 20, 2005 to our shareholders of record as ofOctober 7, 2005, payable on October 21, 2005. The payments of these dividendswere in addition to the regular quarterly cash dividends. Per share amountshave been restated for the impact of the stock dividends.

***Recently Issued Accounting Standards*** —We adopted (“SFAS No. 123R”), “Share-Based Payment” on January 1, 2006. SFASNo. 123R is a revision of Financial Accounting Standards Board (FASB) Statement123, “Accounting for Stock-Based Compensation” and supersedes APB Opinion No.25, “Accounting for Stock Issued to Employees,” and its related implementationguidance. SFAS No. 123R requires all public companies to record compensationcost for stock options provided to employees in return for employee service.The cost is measured at the fair value of the options when granted, and thiscost is expensed over the employee service period, which is normally thevesting period of the options. Compensation cost is recorded for prior optiongrants that vest after the date of adoption. The effect on results ofoperations will depend on the level of future option grants and the calculationof the fair value of the options granted at such future date, as well as the vestingperiods provided, and so they cannot currently be predicted. Existing optionsthat will vest after adoption date are expected to result in compensationexpense of approximately $71,000 in 2006, $66,000 in 2007, $66,000 in 2008 and$40,000 in 2009. For the nine month period ended September 30, 2006, werecorded $53,000 in compensation expense related to stock options. There willbe no significant effect on financial position as total equity will not change.

In March 2006, the FASB issued Statement No. 156, “Accountingfor Servicing of Financial Assets, an amendment of FASB Statement No. 140”,which changes the accounting for all servicing rights recorded as the result ofpurchasing or originating a loan servicing right. SFAS No. 156 amends thecurrent accounting guidance for servicing rights in that it allows companies tocarry their servicing rights at fair value, where presently servicing rightsare recorded at cost allocated on a fair value basis at inception and assessedfor impairment based on their fair value at each reporting date, using lower ofcost or market value. This pronouncement is effective beginning January 1,2007.

In June 2006, the FASB issued Interpretation No. 48, “Accountingfor Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109”(FIN 48), which prescribes a recognition threshold and measurement attributefor the financial statement recognition and measurement of a tax position takenor expected to be taken in a tax return. FIN 48 also provides guidance on derecognition,classification, interest and penalties, accounting in interim periods,disclosure and transition. FIN 48 is effective beginning in 2007. We are in theprocess of evaluating the impact, if any, the adoption of FIN 48 will have onour financial statements.

In September 2006, the FASB issued SFAS No. 157, “FairValue Measurements” (“SFAS No. 157”), which defines fair value, establishes aframework for measuring fair value in generally accepted accounting principals(GAAP), and expands disclosures about fair value measurements. Morespecifically, this statement clarifies the definition of fair value,establishes a fair valuation hierarchy based upon observable (e.g. quotedprices, interest rates, yield curves) and unobservable market inputs, and expandsdisclosure requirements to include the inputs used to develop estimates of fairvalue and the effects of the estimates on income for the period. This statementdoes not require any new fair value measurements. This pronouncement iseffective for fiscal years beginning after November 15, 2007, and interimperiods within those fiscal years. We are in the process of evaluating theimpact, if any; the adoption of SFAS No. 157 will have on our financialstatements.

In September 2006, the FASB ratified the EmergingIssues Task Force’s (EITF) consensus on Issue 06-5, “Accounting for Purchasesof Life Insurance” Determining the Amount That Could Be Realized in Accordancewith FASB Technical Bulletin No. 85-4, “Accounting for Purchases of LifeInsurance”. FASB Technical Bulletin No. 85-4 requires that assets such as bankowned life insurance be carried at their cash surrender value (CSV) or theamount that could be realized, with changes in CSV reported in earnings. Issue06-5 requires that a policyholder consider any additional amounts (e.g. claimsstabilization reserves and deferred acquisition costs) included in thecontractual terms of the policy in determining the amount that could berealized under the insurance contract. Certain life insurance contracts providethe policyholder with an amount that, upon surrender, is greater if allindividual policies are surrendered at the same time rather than if thepolicies were surrendered over a period of time. The Issue requires thatpolicyholders determine the amount that could be realized under the lifeinsurance contract assuming the surrender of an individual-life byindividual-life policy. 

This Issue is effective for us beginning January 1,2007. The Issue can be applied as either (a) a change in accounting principlethrough a cumulative-effect adjustment to retained earnings as of the beginningof the year of adoption, or (b) a change in accounting principle throughretrospective application to all periods. We are in the process of evaluatingthe impact, if any; the adoption of Issue 06-5 will have on our financialstatements.

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In September 2006, the Securities and ExchangeCommission issued Staff Accounting Bulletin No. 108 Topic 1N, “FinancialStatements” Considering the Effects of Prior Year Misstatements When QuantifyingMisstatements in Current Year Financial Statements” (“SAB 108”). SAB 108requires that a dual approach be used to compute the amount of a financialstatement misstatement. More specifically, the amount should be computed usingboth the “rollover” (current year income statement perspective) and “ironcurtain” (year-end balance sheet perspective) methods. A registrant’s financialstatements require adjustment when either approach results in quantifying amisstatement that is material, after considering all relevant quantitative andqualitative factors. Registrants will not be required to restate prior periodfinancial statements when initially applying SAB 108 if management properlyapplied its previous approach (i.e. rollover or iron curtain) given that allrelevant qualitative factors were considered. SAB 108 states that, upon initialapplication, registrants may elect to (a) restate prior periods, or (b) recordthe cumulative effect of the initial application of SAB 108 in the carryingamounts of assets and liabilities, with the offsetting adjustment made toretained earnings. To the extent that registrants elect to record thecumulative effect of initially applying SAB 108, they will disclose the natureand amount of each individual error being corrected in the cumulativeadjustment. The disclosure will also include when and how each error beingcorrected arose and the fact that the errors had previously been consideredimmaterial. SAB 108 is effective for us for the fiscal year ending December 31,2006. We are in the process of evaluating the impact, if any; the adoption ofSAB 108 will have on our financial statements.

***Reclassifications*** — Certain amountshave been reclassified in the prior period financial statements to conform tothe current period classifications.

**2.**             **SECURITIES**

The amortized cost basisand fair values of securities are as follows:
| ** **                           | ** ** | ** **    | ** ** | **Gross**      | ** ** | **Gross**      | ** ** | ** **          | ** ** |
|--------------------------------------|------------|---------------|------------|----------------|------------|----------------|------------|---------------------|------------|
| ** **                           | ** ** | **Amortized** | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | ** **          | ** ** |
| **(Dollars in thousands)** | ** ** | **Cost**      | ** ** | **Gains**      | ** ** | **Losses**     | ** ** | **Fair Value** | ** ** |
| **Securities available-for-sale:**   | ** ** | ** **    | ** ** | ** **     | ** ** | ** **     | ** ** | ** **          | ** ** |
| **September  30, 2006:**             | ** ** | ** **    | ** ** | ** **     | ** ** | ** **     | ** ** | ** **          | ** ** |
| U. S. Treasury  and agencies         |       | $             | 3,497      |           | $          | —         |       | $                   | (23        | ) | $ | 3,474 |   |
| Mortgage-backed                      |       | 9,914         |       | —         |       | (261           | )          | 9,653               |       |
| Equity                               |       | 1,353         |       | 619            |       | —         |       | 1,972               |       |
| State and  municipal                 |       | 8,728         |       | 6              |       | (413           | )          | 8,321               |       |
| Corporate                            |       | 4,518         |       | —         |       | —         |       | 4,518               |       |
|                                 |       |          |       |           |       |           |       |                |       |
| Total                                |       | $             | 28,010     |           | $          | 625            |       | $                   | (697       | ) | $ | 27,938 |   |
|                                 |       |          |       |           |       |           |       |                |       |
| **December  31, 2005:**              | ** ** | ** **    | ** ** | ** **     | ** ** | ** **     | ** ** | ** **          | ** ** |
| U. S. Treasury  and agencies         |       | $             | 6,486      |           | $          | —         |       | $                   | (49        | ) | $ | 6,437 |   |
| Mortgage-backed                      |       | 11,558        |       | —         |       | (256           | )          | 11,302              |       |
| Equity                               |       | 1,353         |       | 638            |       | —         |       | 1,991               |       |
| State and  municipal                 |       | 5,803         |       | 14             |       | (259           | )          | 5,558               |       |
| Corporate                            |       | 3,036         |       | —         |       | —         |       | 3,036               |       |
|                                 |       |          |       |           |       |           |       |                |       |
| Total                                |       | $             | 28,236     |           | $          | 652            |       | $                   | (564       | ) | $ | 28,324 |   |

 
| ** **                       | ** ** | ** **    | ** ** | **Gross**        | ** ** | **Gross**        | ** ** | ** **          | ** ** |
|----------------------------------|------------|---------------|------------|------------------|------------|------------------|------------|---------------------|------------|
| ** **                       | ** ** | **Amortized** | ** ** | **Unrecognized** | ** ** | **Unrecognized** | ** ** | ** **          | ** ** |
| ** **                       | ** ** | **Cost**      | ** ** | **Gains**        | ** ** | **Losses**       | ** ** | **Fair Value** | ** ** |
| **Securities held-to-maturity:** | ** ** | ** **    | ** ** | ** **       | ** ** | ** **       | ** ** | ** **          | ** ** |
| **September  30, 2006:**         | ** ** | ** **    | ** ** | ** **       | ** ** | ** **       | ** ** | ** **          | ** ** |
| U.S. Treasury  and agencies      |       | $             | 20,096     |             | $          | —           |       | $                   | (430       | ) | $ | 19,666 |   |
| Mortgage-backed                  |       | 4,357         |       | 2                |       | (141             | )          | 4,218               |       |
| Corporate                        |       | 2,000         |       | 10               |       | —           |       | 2,010               |       |
|                             |       |          |       |             |       |             |       |                |       |
| Total                            |       | $             | 26,453     |             | $          | 12               |       | $                   | (571       | ) | $ | 25,894 |   |
|                             |       |          |       |             |       |             |       |                |       |
| **December  31, 2005:**          | ** ** | ** **    | ** ** | ** **       | ** ** | ** **       | ** ** | ** **          | ** ** |
| U.S. Treasury  and agencies      |       | $             | 26,095     |             | $          | —           |       | $                   | (607       | ) | $ | 25,488 |   |
| Mortgage-backed                  |       | 5,136         |       | 2                |       | (207             | )          | 4,931               |       |
| Corporate                        |       | 2,000         |       | 15               |       | —           |       | 2,015               |       |
|                             |       |          |       |             |       |             |       |                |       |
| Total                            |       | $             | 33,231     |             | $          | 17               |       | $                   | (814       | ) | $ | 32,434 |   |

 

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**3.             LOANS**

Loans are summarized asfollows:

|                                      | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|--------------------------------------|------------|------------------------|------------|-----------------------|------------|
| **(Dollars in thousands)** | ** ** | **2006**               | ** ** | **2005**              | ** ** |
| Commercial                           |       | $                      | 39,663     |                  | $          | 36,004 |   |
| Real estate  commercial              |       | 389,707                |       | 353,637               |       |
| Real estate  construction            |       | 22,066                 |       | 13,579                |       |
| Residential  mortgage                |       | 140,507                |       | 142,727               |       |
| Consumer and  home equity            |       | 62,963                 |       | 66,208                |       |
| Indirect  consumer                   |       | 31,850                 |       | 31,577                |       |
| Loans held for  sale                 |       | 1,733                  |       | 597                   |       |
|                                 |       | 688,489                |       | 644,329               |       |
| Less:                                |       |                   |       |                  |       |
| Net deferred loan origination fees   |       | (1,041                 | )          | (1,212                | )          |
| Allowance for loan losses            |       | (7,577                 | )          | (7,377                | )          |
|                                 |       | (8,618                 | )          | (8,589                | )          |
|                                 |       |                   |       |                  |       |
| Loans                                |       | $                      | 679,871    |                  | $          | 635,740 |   |

 

The allowance for loanloss is summarized as follows:
| ** **                           | ** ** | **As of and For the  Three Months Ended  September 30,** | ** ** | **As of and For the  Nine Months Ended  September 30,** | ** ** |
|--------------------------------------|------------|---------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------|------------|
| **(Dollars in thousands)** | ** ** | **2006**                                                                                    | ** ** | **2005**                                                                                   | ** ** | **2006** | ** ** | **2005** | ** ** |
| Balance,  beginning of period        |       | $                                                                                           | 7,408      |                                                                                       | $          | 6,714 |   | $ | 7,377 |   | $ | 6,489 |   |
| Provision for  loan losses           |       | 249                                                                                         |       | 440                                                                                        |       | 346 |   | 756 |   |
| Charge-offs                          |       | (157                                                                                        | )          | (141                                                                                       | )          | (443 | ) | (387 | ) |
| Recoveries                           |       | 77                                                                                          |       | 76                                                                                         |       | 297 |   | 231 |   |
| Balance, end of period               |       | $                                                                                           | 7,577      |                                                                                       | $          | 7,089 |   | $ | 7,577 |   | $ | 7,089 |   |

 

Impaired loans aresummarized as follows. There were no impaired loans for the periods presentedwithout an allowance allocation.

| (Dollars in thousands)             | ** ** | **As of and For the  Nine Months Ended  September 30,  2006** | ** ** | **As of and For the  Year Ended  December 31,  2005** | ** ** |
|----------------------------------------------|------------|--------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------|------------|
| End of period  impaired loans                |       | $                                                                                                | 5,357      |                                                                                | $          | 6,232 |   |
| Amount of allowance for  loan loss allocated |       | 1,217                                                                                            |       | 1,445                                                                               |       |
|                                              |            |                                                                                                  |            |                                                                                     |            |  |  |

 

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

| (Dollars in thousands)              | ** ** | **September 30,  2006** | ** ** | **December 31,  2005** | ** ** |
|-----------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| Restructured                                  |       | $                            | 3,025      |                        | $          | 3,104 |   |
| Loans past due over 90  days still on accrual |       | —                       |       | —                      |       |
| Non accrual loans                             |       | 2,332                        |       | 3,128                       |       |
| Total                                         |       | $                            | 5,357      |                        | $          | 6,232 |   |

 

**4.             EARNINGS PER SHARE**

The reconciliation of thenumerators and denominators of the basic and diluted EPS is as follows:
| **(Dollars in thousands,**            | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| **except per share data)**       | ** ** | **2006**                                             | ** ** | **2005**                                            | ** ** | **2006** | ** ** | **2005** | ** ** |
| Net income available to  common shareholders    |       | $                                                    | 2,571      |                                                | $          | 2,311 |   | $ | 7,665 |   | $ | 6,791 |   |
| Basic EPS:                                      |       |                                                 |       |                                                |       |   |   |   |   |
| Weighted average  common shares                 |       | 4,384                                                |       | 4,388                                               |       | 4,383 |   | 4,403 |   |
| Diluted EPS:                                    |       |                                                 |       |                                                |       |   |   |   |   |
| Weighted average  common shares                 |       | 4,384                                                |       | 4,388                                               |       | 4,383 |   | 4,403 |   |
| Dilutive effect  of stock options               |       | 46                                                   |       | 42                                                  |       | 40 |   | 36 |   |
| Weighted average  common and incremental shares |       | 4,430                                                |       | 4,430                                               |       | 4,423 |   | 4,439 |   |
| Earnings Per Share:                             |       |                                                 |       |                                                |       |   |   |   |   |
| Basic                                           |       | $                                                    | 0.59       |                                                | $          | 0.53 |   | $ | 1.75 |   | $ | 1.54 |   |
| Diluted                                         |       | $                                                    | 0.58       |                                                | $          | 0.52 |   | $ | 1.73 |   | $ | 1.53 |   |

 

All of the outstandingstock options for the September 30, 2006 and 2005 periods were included in thecomputation of diluted earnings per share.

**5.             STOCK OPTION PLAN**

At our AnnualMeeting of Shareholders held on May 10, 2006, our shareholders approved the2006 Stock Option and Incentive Compensation Plan which replaces our 1998 StockOption and Incentive Plan. Under the 2006 Stock Option and IncentiveCompensation Plan, we may grant either incentive or non-qualified stock optionsto****key employees and directors****for a total of 535,000 shares of ourcommon stock at not less than fair value at the date such options are granted.****Options available for future grant underthe 1998 plan totaled 35,000 shares and were rolled into the 2006 plan.****We believe that the ability to award stockoptions and other forms of stock-based incentive compensation can assist us inattracting and retaining key employees. Stock-based incentive compensation isalso a means to align the interests of key employees with those of ourshareholders by providing awards intended to reward recipients for ourlong-term growth.****The option topurchase shares vest over periods of one to five years and expire ten yearsafter the date of grant.****We issuenew shares of common stock upon the exercise of stock options. At September 30,2006 options available for future grant under the 2006 Plan totaled 535,000.****Compensation cost related to optionsgranted under the 1998 Plan that was charged against earnings for the periodended September 30, 2006****was $53,000.

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The fair value ofeach option award is estimated on the date of grant using the Black-Scholesoption valuation model that uses various weighted-average assumptions. Therisk-free interest rate is based on the U.S. Treasury yield curve in effect atthe time of grant. The expected volatility is based on the fluctuation in theprice of a share of stock over the period for which the option is being valuedand the expected life of the options granted represents the period of time theoptions are expected to be outstanding.

The following tableillustrates the effect on net income and earnings per share for the quarter andnine month periods ended September 30, 2005 if expense was measured using theBlack-Scholes option valuation model.
| **(Dollars In Thousands, Except Per Share Data) ** | ** ** | **Three Months Ended  September 30,  2005** | ** ** | **Nine Months Ended  September 30,  2005** | ** ** |
|---------------------------------------------------------------------------------------|------------|------------------------------------------------------------|------------|-----------------------------------------------------------|------------|
| Net income:                                                                           |       |                                                       |       |                                                      |       |
| As reported                                                                           |       | $                                                          | 2,311      |                                                      | $          | 6,791 |   |
| Deduct:  Stock-based compensation expense determined under fair value based method    |       | (20                                                        | )          | (76                                                       | )          |
| Pro-forma                                                                             |       | $                                                          | 2,291      |                                                      | $          | 6,715 |   |
|                                                                                  |       |                                                       |       |                                                      |       |
| Earnings per share:                                                                   |       |                                                       |       |                                                      |       |
| Basic                                                                                 |       |                                                       |       |                                                      |       |
| As Reported                                                                           |       | $                                                          | 0.53       |                                                      | $          | 1.54 |   |
| Pro-forma                                                                             |       | 0.52                                                       |       | 1.53                                                      |       |
| Diluted                                                                               |       |                                                       |       |                                                      |       |
| As Reported                                                                           |       | $                                                          | 0.52       |                                                      | $          | 1.53 |   |
| Pro-forma                                                                             |       | 0.52                                                       |       | 1.51                                                      |       |

 

A summary of optionactivity under the 1998 Plan as of September 30, 2006 is presented below:
| ** **                          | ** ** | **Number  of Options**          | ** ** | **Weighted Average  Exercise Price** | ** ** | **Weighted Average  Remaining  Contractual Term** | ** ** | **Aggregate  Intrinsic Value**  | ** ** |
|-------------------------------------|------------|--------------------------------------|------------|------------------------------------------------|------------|-------------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                          | ** ** | **(Dollars In Thousands)** | ** ** | ** **                                     | ** ** | ** **                                                  | ** ** | **(Dollars In Thousands)** | ** ** |
| Outstanding, beginning  of period   |       | 144,075                              |       | $                                              | 18.42      | ** **                                                  | ** ** | ** **                           | ** ** | ** ** |
| Granted during period               | ** ** | **—**                           | ** ** | **—**                                     | ** ** | ** **                                                  | ** ** | ** **                           | ** ** |
| Exercised during the  period        |       | (770                                 | )          | 12.77                                          | ** ** | ** **                                                  | ** ** | ** **                           | ** ** |
| Outstanding, end of  period         |       | 143,305                              |       | $                                              | 18.45      |                                                        | 5.7        |                                 | $          | 1,750 |   |
|                                | ** ** | ** **                           | ** ** | ** **                                     | ** ** | ** **                                                  |       |                                 |       |
| Eligible for exercise at period end |       | 95,510                               |       | $                                              | 17.02      |                                                        | 4.5        |                                 | $          | 1,303 |   |

 

There were nooptions granted for the periods ended September 30, 2006 and 2005.****The total intrinsic value of optionsexercised during the periods ended September 30, 2006 and 2005 was $10,641****and$17,811 respectively.

As of September 30, 2006there was $188,485 of total unrecognized compensation cost related tonon-vested share-based compensation arrangements granted under the 1998 Plan.****That cost is expected to be recognizedover a weighted-average period of 3.3 years. The total fair value of sharesvested during the periods ended September 30, 2006 and 2005 was $56,240 and $47,656respectively.****Cash received fromoption exercise under all share-based payment arrangements for the periodsended September 30, 2006 and 2005 were $9,835 and $56,562 respectively.

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**Item 2.**

## **MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

##### **GENERAL**

We conduct operations in14 full-service banking centers in six contiguous counties in Central Kentuckyalong the Interstate 65 corridor. Our markets range from the major metropolitanarea of Louisville in Jefferson County, Kentucky approximately 40 miles northof our headquarters in Elizabethtown, Kentucky to Hart County, Kentucky,approximately 30 miles south of Elizabethtown. Our markets are supported by adiversified industry base and have a regional population of over 1 million.

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

Through****our personal investment financial counselingservices, we offer a wide variety of mutual funds, equity investments, andfixed and variable annuities. We invest in the wholesale capital marketsthrough the management of our security portfolio and use various forms ofwholesale funding. The security portfolio contains a variety of instruments,including callable debentures, taxable and non-taxable debentures, fixed andadjustable rate mortgage backed securities, and collateralized mortgageobligations.

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

This discussion andanalysis covers material changes in the financial condition since December 31,2005 and material changes in the results of operations for the three and ninemonth periods ending, September 30, 2006 as compared to 2005. It should be readin conjunction with “Management Discussion and Analysis of Financial Conditionand Results of Operations” included in the Annual Report on Form 10-K for theperiod ended December 31, 2005.

**OVERVIEW**

Our emphasis over thepast several years has been focused on enhancing and expanding our retail andcommercial banking network in our core markets as well as establishing ourpresence in the Metro Louisville market. Our five county core markets, where wehave a combined 22% market share, has become increasingly competitive asseveral new banks have entered our markets in the past few years. In order toprotect and grow our market share, we replaced existing branches with newer,enhanced facilities and anticipate constructing several new facilities over thenext few years. In addition to the enhancement and expansion in our coremarkets in recent years, we have been increasing our presence in the MetroLouisville market. Approximately 75% of the deposit base in the MetroLouisville market is controlled by six out-of-state banks. While the market isvery competitive, we believe this creates an opportunity for smaller communitybanks with more power to make decisions locally. We believe our investment inthese initiatives along with our continued commitment to a high level ofcustomer service will enhance our existing market share and our development inthe Metro Louisville market.

Our retail branch networkcontinues to generate encouraging results. Total deposits have grown at a 6%compound annual growth rate over the past three years. Total deposits were $613million at September 30, 2006, which included an increase of $38.0 million incommercial and retail deposits for the first nine months this year. The developmentof the retail branch network into the Metro Louisville market also yieldedpositive results. We have a combined $41.7 million in deposits in our twofull-service facilities in the Metro Louisville market experiencing a 39%increase in deposits for the first nine months of 2006 following a 71% increasein deposits for the year of 2005. We opened these facilities in the secondquarter of 2004 to support our growing customer base in this market. Twenty-onepercent of our loan portfolio currently resides in the Metro Louisville market.

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Our emphasis oncommercial lending generated an 8% compound annual growth rate in the totalloan portfolio and a 20% compound annual growth rate in commercial loans overthe past three years. Commercial loans were $451 million at September 30, 2006,an increase of 12%, or $48.2 million from December 31, 2005.

The growth in ourcommercial real estate loan portfolio, coupled with the rising interest rateenvironment, has favorably impacted the level of interest income generated. Netinterest margin increased to 4.05% for the nine months ended September 30,2006, compared to 3.90% for the same period a year ago. This has resulted in a$522,000 increase in net interest income to $7.5 million for the three monthsended September 30, 2006, and a $1.7 million increase in net interest income to$22.1 million for the nine months ended September 30, 2006, compared to therespective three and nine month periods in 2005. The increasing short-terminterest rate environment positively impacted net interest margin due to theadjustable rate commercial loans in our loan portfolio. However, the netinterest margin is likely to compress in future quarters as short-term interestrates peak and the cost of deposits continue to rise. The cost of depositstypically lag the increase in adjustable loan rates due to certificates ofdeposit, which mature over a longer period of time than immediately adjustableloan rates.

Net interest margin wasalso impacted during the quarter by the conversion of a fixed rate advance fromthe Federal Home Loan Bank (FHLB). During January 2001, we entered into a $50.0million convertible fixed rate advance with a maturity of ten years. Thisadvance was fixed for a period of two years. At the end of the fixed rate term andquarterly thereafter, the FHLB had the right to convert this advance to avariable rate advance tied to the three-month LIBOR index. Upon conversion, wecould prepay the advance at no penalty. This advance, fixed at a rate of 4.86%,was converted and prepaid in July 2006, without penalty. We replaced this fixedrate borrowing with overnight short-term borrowings, which averaged a rate of5.32% during the quarter. These borrowings will continue to float at anovernight rate until we replace the borrowings with deposits or other fixedrate and term borrowings. For the next several quarters, we anticipatemaintaining the borrowings at a floating rate. This floating rate will bettermatch the variable rate commercial loans in our loan portfolio and therefore reducethe volatility of net interest margin with future interest rate movements.

Our asset quality remainsfavorable. Net charge-offs as a percent of average total loans were 0.03% forthe nine months ended September 30, 2006 and September 30, 2005. The allowancefor loan losses as a percent of total loans, decreased to 1.10% at September30, 2006 compared to 1.15% at December 31, 2005. The percentage ofnon-performing loans to total loans was 0.78% at September 30, 2006, comparedto 0.97% at December 31, 2005.

Provision for loan lossexpense decreased $191,000 to $249,000 for the three months ended September 30,2006, and $410,000 to $346,000 for the nine months ended September 30, 2006compared to the same periods ended September 30, 2005. The decrease in provisionfor loan loss expense for the 2006 periods was due to higher provisions duringthe first nine months of 2005 resulting from loan downgrades during the firstquarter of 2005. In addition, improvements in our security and position ofcertain classified loans during 2006, resulted in a reduction in the reserveallocated to the loans, which decreased provision for loan loss expense for thethree and nine month periods ended September 30, 2006.

Non-interest incomedecreased $28,000 to $2.0 million for the three months ended September 30,2006. Non-interest income decreased $237,000 to $5.8 million for the ninemonths ended September 30, 2006. During the first nine months ended September30, 2005, a $381,000 gain was recorded on the sale of investment securities anda $143,000 gain was recorded on the sale of lots. No gains on the sale ofinvestments or lots were recorded for the nine months ended September 30, 2006.Customer service fees on deposit accounts increased $110,000 and $298,000 forthe respective three and nine months ended September 30, 2006, compared to therespective periods during 2005.

Non-interest expenseincreased $281,000 to $5.4 million for the quarter ended September 30, 2006,compared to the same quarter ended September 30, 2005. For the nine monthsended September 30, 2006, non-interest expense increased $583,000 to $16.2million, compared to the nine months ended September 30, 2005. The primarycontributing factors to this increase were the additional operating andemployee compensation expenses related to staffing increases as part of ourrecent expansion efforts. Our efficiency ratio was 58% for the nine monthsended September 30, 2006, compared to 59% for the nine months ended September30, 2005. The efficiency ratio is a supplemental financial measure utilized inmanagement’s internal evaluation of performance which measures a company’sallocation of resources. An increase in the efficiency ratio indicates thatmore resources are being utilized to generate the same volume of income, whilea decrease would indicate a more efficient allocation of resources.

15

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###### **CRITICAL ACCOUNTING POLICIES**

Our accounting andreporting policies comply with U.S. generally accepted accounting principlesand conform to general practices within the banking industry. The accountingpolicy relating to the allowance for loan losses is critical to theunderstanding of our results of operations since the application of this policyrequires significant management assumptions and estimates that could result inmaterially different amounts to be reported if conditions or underlyingcircumstances were to change.

**Allowancefor Loan Losses —**We maintain an allowance sufficient toabsorb probable incurred credit losses existing in the loan portfolio. TheAllowance for Loan Loss Review Committee evaluates the allowance for loanlosses on a quarterly basis. We estimate the allowance using past loan lossexperience, known and inherent risks in the portfolio, adverse situations thatmay affect the borrower’s ability to repay, estimated value of the underlyingcollateral, and current economic conditions. While we estimate the allowancefor loan losses based in part on historical losses within each loan category,estimates for losses within the commercial and commercial real estate portfolioare 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’sjudgment, should be charged off.

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

Based on our calculation,an allowance of $7.6 million****or1.10% of total loans was our estimate of probable losses within the loanportfolio as of****September 30,2006.****This estimate resulted in aprovision for loan losses on the income statement of****$346,000 for the 2006 nine month period.****If the mix and amount of future charge offpercentages differ significantly from those assumptions used by management inmaking its determination, the allowance for loan losses and provision for loanlosses on the income statement could be materially affected.

##### **RESULTS OF OPERATIONS**

Net income for thequarter ended September 30, 2006 was $2.6 million or $0.58 per share dilutedcompared to $2.3 million or $0.52 per share diluted for the same period in2005. Net income for the nine month period ended September 30, 2006 was $7.7million or $1.73 per share diluted compared to $6.8 million or $1.53 per sharediluted for the same period a year ago. The increase for the three and ninemonth periods was primarily the result of increases in net interest income of****$522,000 and $1.7 million and a decreasein provision for loan loss expense of $191,000, and $410,000 for the 2006periods compared to the same periods in 2005. Our book value per common shareincreased from $14.45 at September 30, 2005 to $15.98 at September 30, 2006.Annualized net income for the first nine months of 2006 generated a return onaverage assets of 1.31% and a return on average equity of 15.11%.****These compare with a return on averageassets of 1.21% and a return on average equity of 14.64% for the first ninemonths of 2005, also on an annualized basis.

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

On an annualized basis,the net interest margin as a percent of average earning assets increased 6basis points to 4.01% for the quarter ended September 30, 2006 and 15 basispoints to 4.05% for the nine months ended September 30, 2006 compared to 3.95%and 3.90% for the same periods in 2005. Increasing interest rates and anincrease in average earning assets improved net interest margin for the periodspresented.****Average interestearning assets increased $42.2 million for the quarter ended September 30, 2006and $34.4 million for the nine months ended September 30, 2006 when compared tothe same periods in 2005.****Theyield on earning assets averaged 7.39% and 7.21% for the three and nine monthperiods ended September 30, 2006, compared to an average yield on earningassets of 6.57% and 6.37% for the same periods in 2005.****The prime-lending rate has increased 425basis points from the time the Federal Open Market Committee began increasingshort-term 

16

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interest rates in June2004 through the end of the third quarter of 2006.****The increase in short-term interest rates favorably impactedthe yield on earning assets for 2006.

Our cost of fundsaveraged 3.72% and 3.47% for the three and nine month periods ended September30, 2006, compared to an average cost of funds of 2.86% and 2.68% for the sameperiods in 2005.****Deposit costshave accelerated due to the re-pricing of maturing certificates of deposit thatroll off into certificates of deposit at currently higher interest rates aswell as to our paying higher rates on our money market products. Going forward,our cost of funds is expected to increase as interest rates paid on depositproducts have become increasingly competitive with the recent upward trend in interestrates.

Net interest margin wasalso impacted during the quarter by the conversion of a fixed rate Federal HomeLoan Bank Advance (FHLB). During January 2001, we entered into a $50.0 millionconvertible fixed rate advance with a maturity of ten years. This advance wasfixed for a period of two years. At the end of the fixed rate term andquarterly thereafter, the FHLB had the right to convert this advance to avariable rate advance tied to the three-month LIBOR index. Upon conversion, wecould prepay the advance at no penalty. This advance, fixed at a rate of 4.86%,was converted and paid off in July 2006, at a rate of 5.25% without penalty. Wereplaced the borrowing with overnight short-term borrowings, which averaged arate of 5.32% during the quarter. These borrowings will continue to float at anovernight rate until we replace the borrowings with deposits or other fixedrate and term borrowings. For the next several quarters, we anticipatemaintaining the borrowings at a floating rate. This floating rate will bettermatch the variable rate commercial and commercial real estate loans in our loanportfolio and therefore reduce the volatility of net interest margin withfuture interest rate movements.

The net result of theabove factors was an increase in net interest income of $522,000 for thequarter ended and $1.7 million for the nine months ended September 30, 2006compared to the same periods in 2005. The net interest margin is likely tocompress in future quarters as short term interest rates peak and the cost ofdeposits continue to rise. The cost of deposits typically lags behind theincrease in adjustable rate loans because certificates of deposit generallymature over longer periods than immediately adjustable rate loans.

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**AVERAGEBALANCE SHEET**

The following tableprovides information relating to our average balance sheet and reflects theaverage yield on assets and average cost of liabilities for the periodsindicated. Dividing income or expense by the average monthly balance of assetsor liabilities, respectively, derives such yields and costs for the periodspresented.
| ** **                                           | ** ** | **Quarter Ended September 30,** | ** **  |
|------------------------------------------------------|------------|------------------------------------------------|-------------|
| ** **                                           | ** ** | **2006**                                       | ** **  | **2005** | ** ** |
| **(Dollars in thousands)**                 | ** ** | **Average  Balance**                           | ** **  | **Interest** | ** ** | **Average  Yield/Cost (5)** | ** ** | **Average  Balance** | ** ** | **Interest** | ** ** | **Average  Yield/Cost (5)** | ** ** |
| **ASSETS**                                           |       |                                           |        |   |   |   |   |   |   |   |   |   |   |
| Interest earning assets:                             |       |                                           |        |   |   |   |   |   |   |   |   |   |   |
| U.S. Treasury and  agencies                          |       | $                                              | 25,880      |   | $ | 212 |   | 3.25 | % | $ | 48,361 |   | $ | 335 |   | 2.75 | % |
| Mortgage-backed  securities                          |       | 14,315                                         |        | 153 |   | 4.24 |   | 16,583 |   | 173 |   | 4.14 |   |
| Equity securities                                    |       | 1,867                                          |        | 15 |   | 3.19 |   | 1,906 |   | 17 |   | 3.54 |   |
| State and political  subdivision securities **(1)**  |       | 7,261                                          |        | 119 |   | 6.50 |   | 4,341 |   | 66 |   | 6.03 |   |
| Corporate bonds                                      |       | 6,377                                          |        | 115 |   | 7.15 |   | 4,026 |   | 56 |   | 5.52 |   |
| Loans receivable **(2) (3) (4)**                     |       | 677,359                                        |        | 13,104 |   | 7.68 |   | 614,116 |   | 10,839 |   | 7.00 |   |
| FHLB stock                                           |       | 7,401                                          |        | 107 |   | 5.74 |   | 7,006 |   | 86 |   | 4.87 |   |
| Interest bearing  deposits                           |       | 3,324                                          |        | 37 |   | 4.42 |   | 5,202 |   | 43 |   | 3.28 |   |
| **Total interest earning assets**                    | ** ** | **743,784**                                    | ** **  | **13,862** | ** ** | **7.39** | ** ** | **701,541** | ** ** | **11,615** | ** ** | **6.57** | ** ** |
| Less: Allowance for loan losses                      |       | (7,449                                         | )           |   |   |   |   | (6,878 | ) |   |   |   |   |
| Non-interest earning assets                          |       | 56,326                                         |        |   |   |   |   | 57,643 |   |   |   |   |   |
| **Total assets**                                     | ** ** | **$**                                          | **792,661** |   |   | ** ** | ** ** |   | **$** | **752,306** |   |   |   |   |   |
|                                                 |       |                                           |        |   |   |   |   |   |   |   |   |   |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**        |       |                                           |        |   |   |   |   |   |   |   |   |   |   |
| Interest bearing liabilities:                        |       |                                           |        |   |   |   |   |   |   |   |   |   |   |
| Savings accounts                                     |       | $                                              | 88,454      |   | $ | 650 |   | 2.92 | % | $ | 101,846 |   | $ | 539 |   | 2.10 | % |
| NOW and money market  accounts                       |       | 128,322                                        |        | 534 |   | 1.65 |   | 142,615 |   | 536 |   | 1.49 |   |
| Certificates of deposit  and other time deposits     |       | 356,313                                        |        | 3,714 |   | 4.14 |   | 307,933 |   | 2,407 |   | 3.10 |   |
| Short-term borrowings                                |       | 59,722                                         |        | 801 |   | 5.32 |   | 1,461 |   | 12 |   | 3.26 |   |
| FHLB advances                                        |       | 33,113                                         |        | 407 |   | 4.88 |   | 78,428 |   | 956 |   | 4.84 |   |
| Subordinated debentures                              |       | 10,000                                         |        | 235 |   | 9.32 |   | 10,000 |   | 184 |   | 7.30 |   |
| **Total interest bearing  liabilities**              | ** ** | **675,924**                                    | ** **  | **6,341** | ** ** | **3.72** | ** ** | **642,283** | ** ** | **4,634** | ** ** | **2.86** | ** ** |
|                                                 |       |                                           |        |   |   |   |   |   |   |   |   |   |   |
| Non-interest bearing liabilities:                    |       |                                           |        |   |   |   |   |   |   |   |   |   |   |
| Non-interest bearing  deposits                       |       | 42,091                                         |        |   |   |   |   | 42,944 |   |   |   |   |   |
| Other liabilities                                    |       | 5,006                                          |        |   |   |   |   | 3,997 |   |   |   |   |   |
| **Total liabilities**                                |       | 723,021                                        |        |   |   |   |   | 689,224 |   |   |   |   |   |
|                                                 |       |                                           |        |   |   |   |   |   |   |   |   |   |   |
| Stockholders’ equity                            |       | 69,640                                         |        |   |   |   |   | 63,082 |   |   |   |   |   |
| **Total liabilities and  stockholders’ equity** | ** ** | **$**                                          | **792,661** |   |   | ** ** | ** ** |   | **$** | **752,306** |   |   |   |   |   |
|                                                 | ** ** | ** **                                     | ** **  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Net interest income**                              | ** ** | ** **                                     | ** **  | **$** | **7,521** | ** ** | ** ** | ** ** | ** ** | ** ** | **$** | **6,981** | ** ** | ** ** | ** ** |
| **Net interest spread**                              | ** ** | ** **                                     | ** **  | ** ** | ** ** | **3.67** | **%** | ** ** | ** ** | ** ** | ** ** | **3.71** | **%** |
| **Net interest margin**                              | ** ** | ** **                                     | ** **  | ** ** | ** ** | **4.01** | **%** | ** ** | ** ** | ** ** | ** ** | **3.95** | **%** |

----

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

**(2)****           **Includes loanfees, immaterial in amount, in both interest income and the calculation ofyield on loans.

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

**(4)****           **Includes loansheld for sale.

**(5)****           **Annualized

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| ** **                                           | ** ** | **Nine Months Ended September 30,** | ** **  |
|------------------------------------------------------|------------|---------------------------------------------------------|-------------|
| ** **                                           | ** ** | **2006**                                                | ** **  | **2005** | ** ** |
| **(Dollars in thousands)**                 | ** ** | **Average  Balance**                                    | ** **  | **Interest** | ** ** | **Average  Yield/Cost (5)** | ** ** | **Average  Balance** | ** ** | **Interest** | ** ** | **Average  Yield/Cost (5)** | ** ** |
| **ASSETS**                                           |       |                                                    |        |   |   |   |   |   |   |   |   |   |   |
| Interest earning  assets:                            |       |                                                    |        |   |   |   |   |   |   |   |   |   |   |
| U.S. Treasury  and agencies                          |       | $                                                       | 29,334      |   | $ | 687 |   | 3.13 | % | $ | 51,831 |   | $ | 1,050 |   | 2.71 | % |
| Mortgage-backed  securities                          |       | 15,211                                                  |        | 485 |   | 4.26 |   | 11,222 |   | 337 |   | 4.01 |   |
| Equity  securities                                   |       | 1,935                                                   |        | 52 |   | 3.59 |   | 2,108 |   | 75 |   | 4.76 |   |
| State and  political subdivision ecurities **(1)**   |       | 6,546                                                   |        | 316 |   | 6.45 |   | 2,096 |   | 97 |   | 6.19 |   |
| Corporate bonds                                      |       | 5,899                                                   |        | 304 |   | 6.89 |   | 3,374 |   | 130 |   | 5.15 |   |
| Loans receivable  **(2) (3) (4)**                    |       | 658,777                                                 |        | 37,106 |   | 7.53 |   | 606,838 |   | 31,065 |   | 6.84 |   |
| FHLB stock                                           |       | 7,298                                                   |        | 314 |   | 5.75 |   | 6,925 |   | 246 |   | 4.75 |   |
| Interest bearing  deposits                           |       | 7,981                                                   |        | 268 |   | 4.49 |   | 14,178 |   | 282 |   | 2.66 |   |
| **Total  interest earning assets**                   | ** ** | **732,981**                                             | ** **  | **39,532** | ** ** | **7.21** | ** ** | **698,572** | ** ** | **33,282** | ** ** | **6.37** | ** ** |
| Less: Allowance for  loan losses                     |       | (7,401                                                  | )           |   |   |   |   | (6,695 | ) |   |   |   |   |
| Non-interest earning  assets                         |       | 56,820                                                  |        |   |   |   |   | 57,484 |   |   |   |   |   |
| **Total  assets**                                    | ** ** | **$**                                                   | **782,400** |   |   |   |   | ** ** | **$** | **749,361** |   |   |   |   |   |
|                                                 |       |                                                    |        |   |   |   |   |   |   |   |   |   |   |
| **LIABILITIES AND STOCKHOLDERS’  EQUITY**       |       |                                                    |        |   |   |   |   |   |   |   |   |   |   |
| Interest bearing  liabilities:                       |       |                                                    |        |   |   |   |   |   |   |   |   |   |   |
| Savings accounts                                     |       | $                                                       | 93,932      |   | $ | 1,932 |   | 2.75 | % | $ | 89,326 |   | $ | 1,111 |   | 1.66 | % |
| NOW and money  market accounts                       |       | 130,543                                                 |        | 1,521 |   | 1.56 |   | 149,734 |   | 1,546 |   | 1.38 |   |
| Certificates of  deposit and other time deposits     |       | 346,919                                                 |        | 10,050 |   | 3.87 |   | 314,359 |   | 6,862 |   | 2.92 |   |
| Short-term  borrowings                               |       | 22,485                                                  |        | 889 |   | 5.29 |   | 487 |   | 12 |   | 3.29 |   |
| FHLB advances                                        |       | 63,258                                                  |        | 2,280 |   | 4.82 |   | 78,666 |   | 2,851 |   | 4.85 |   |
| Subordinated  debentures                             |       | 10,000                                                  |        | 665 |   | 8.89 |   | 10,000 |   | 517 |   | 6.91 |   |
| **Total  interest bearing liabilities**              | ** ** | **667,137**                                             | ** **  | **17,337** | ** ** | **3.47** | ** ** | **642,572** | ** ** | **12,899** | ** ** | **2.68** | ** ** |
|                                                 |       |                                                    |        |   |   |   |   |   |   |   |   |   |   |
| Non-interest bearing  liabilities:                   |       |                                                    |        |   |   |   |   |   |   |   |   |   |   |
| Non-interest  bearing deposits                       |       | 42,802                                                  |        |   |   |   |   | 41,059 |   |   |   |   |   |
| Other  liabilities                                   |       | 4,648                                                   |        |   |   |   |   | 3,721 |   |   |   |   |   |
| **Total  liabilities**                               |       | 714,587                                                 |        |   |   |   |   | 687,352 |   |   |   |   |   |
|                                                 |       |                                                    |        |   |   |   |   |   |   |   |   |   |   |
| Stockholders’ equity                            |       | 67,813                                                  |        |   |   |   |   | 62,009 |   |   |   |   |   |
| **Total  liabilities and stockholders’ equity** | ** ** | **$**                                                   | **782,400** |   |   |   |   | ** ** | **$** | **749,361** |   |   |   |   |   |
|                                                 | ** ** | ** **                                              | ** **  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Net interest income**                              |       |                                                    | ** **  | **$** | **22,195** |   |   |   |   | ** ** | **$** | **20,383** | ** ** | ** ** | ** ** |
| **Net interest spread**                              |       |                                                    |        |   | ** ** | **3.76** | **%** |   |   |   | ** ** | **3.69** | **%** |
| **Net interest margin**                              |       |                                                    |        |   | ** ** | **4.05** | **%** |   |   |   | ** ** | **3.90** | **%** |

----

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

**(2)****           **Includes loanfees, immaterial in amount, in both interest income and the calculation ofyield on loans.

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

**(4)****           **Includes loansheld for sale.

**(5)****           **Annualized

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**RATE/VOLUMEANALYSIS**

The table below providesinformation regarding changes in interest income and interest expense for theperiods indicated. For each category of interest-earning assets andinterest-bearing liabilities, information is provided on changes attributableto (1) changes in rate (changes in rate multiplied by old volume); (2) changesin volume (change in volume multiplied by old rate); and (3) changes inrate-volume (change in rate multiplied by change in volume). Changes inrate-volume are proportionately allocated between rate and volume variance.
| ** **                                       | ** ** | **Three Months Ended  September 30,  2006 vs. 2005** | ** ** | **Nine Months Ended  September 30,  2006 vs. 2005** | ** ** |
|--------------------------------------------------|------------|-------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------|------------|
| ** **                                       | ** ** | **Increase (decrease)**                                                  | ** ** | **Increase (decrease)**                                                 | ** ** |
| ** **                                       | ** ** | **Due to change in**                                           | ** ** | **Due to change in**                                          | ** ** |
| **(Dollars in thousands)**             | ** ** | **Rate**                                                                      | ** ** | **Volume**                                                                   | ** ** | **Net  Change** | ** ** | **Rate** | ** ** | **Volume** | ** ** | **Net  Change** | ** ** |
| **Interest income:**                             | ** ** | ** **                                                                    | ** ** | ** **                                                                   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| U.S. Treasury  and agencies                      |       | $                                                                             | 53         |                                                                         | $          | (176 | ) | $ | (123 | ) | $ | 145 |   | $ | (508 | ) | $ | (363 | ) |
| Mortgage-backed  securities                      |       | 4                                                                             |       | (24                                                                          | )          | (20 | ) | 22 |   | 126 |   | 148 |   |
| Equity  securities                               |       | (2                                                                            | )          | —                                                                       |       | (2 | ) | (17 | ) | (6 | ) | (23 | ) |
| State and  political subdivision securities      |       | 6                                                                             |       | 47                                                                           |       | 53 |   | 4 |   | 215 |   | 219 |   |
| Corporate bonds                                  |       | 59                                                                            |       | —                                                                       |       | 59 |   | 174 |   | — |   | 174 |   |
| Loans                                            |       | 1,093                                                                         |       | 1,172                                                                        |       | 2,265 |   | 3,259 |   | 2,782 |   | 6,041 |   |
| FHLB stock                                       |       | 16                                                                            |       | 5                                                                            |       | 21 |   | 55 |   | 13 |   | 68 |   |
| Interest bearing  deposits                       |       | 12                                                                            |       | (18                                                                          | )          | (6 | ) | 142 |   | (156 | ) | (14 | ) |
|                                             |       |                                                                          |       |                                                                         |       |   |   |   |   |   |   |   |   |
| **Total  interest earning assets**               |       | 1,241                                                                         |       | 1,006                                                                        |       | 2,247 |   | 3,784 |   | 2,466 |   | 6,250 |   |
|                                             |       |                                                                          |       |                                                                         |       |   |   |   |   |   |   |   |   |
| **Interest expense:**                            | ** ** | ** **                                                                    | ** ** | ** **                                                                   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Savings accounts                                 |       | 189                                                                           |       | (78                                                                          | )          | 111 |   | 761 |   | 60 |   | 821 |   |
| NOW and money  market accounts                   |       | 54                                                                            |       | (56                                                                          | )          | (2 | ) | 186 |   | (211 | ) | (25 | ) |
| Certificates of  deposit and other time deposits |       | 888                                                                           |       | 419                                                                          |       | 1,307 |   | 2,421 |   | 767 |   | 3,188 |   |
| Short-term  borrowings                           |       | 789                                                                           |       | —                                                                       |       | 789 |   | 877 |   | — |   | 877 |   |
| FHLB advances                                    |       | 8                                                                             |       | (557                                                                         | )          | (549 | ) | (15 | ) | (556 | ) | (571 | ) |
| Subordinated  debentures                         |       | 51                                                                            |       | —                                                                       |       | 51 |   | 148 |   | — |   | 148 |   |
|                                             |       |                                                                          |       |                                                                         |       |   |   |   |   |   |   |   |   |
| **Total interest bearing  liabilities**          |       | 1,979                                                                         |       | (272                                                                         | )          | 1,707 |   | 4,378 |   | 60 |   | 4,438 |   |
|                                             |       |                                                                          |       |                                                                         |       |   |   |   |   |   |   |   |   |
| **Net change in net interest income**            |       | $                                                                             | (738       | )                                                                            | $          | 1,278 |   | $ | 540 |   | $ | (594 | ) | $ | 2,406 |   | $ | 1,812 |   |

 

20

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***Non-Interest Income and Non-Interest Expense***

The following tablesprovide a comparison of the components of non-interest income and expenses forthe quarter and nine month periods ended September 30, 2006 and 2005. Thetables show the dollar and percentage change from 2005 to 2006. Below thetables is a discussion of significant changes and trends.
| ** **                                 | ** ** | **Three Months Ended  September 30,** | ** ** |
|--------------------------------------------|------------|------------------------------------------------------|------------|
| **(Dollars in thousands)**       | ** ** | **2006**                                             | ** ** | **2005** | ** ** | **Change** | ** ** | **%** | ** ** |
| **Non-interest income**                    | ** ** | ** **                                           | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Customer service  fees on deposit accounts |       | $                                                    | 1,481      |   | $ | 1,371 |   | $ | 110 |   | 8.0 | % |
| Gain on sale of  mortgage loans            |       | 204                                                  |       | 251 |   | (47 | ) | -18.7 | % |
| Brokerage  commissions                     |       | 79                                                   |       | 79 |   | — |   | 0.0 | % |
| Other income                               |       | 269                                                  |       | 360 |   | (91 | ) | -25.3 | % |
|                                       |       | $                                                    | 2,033      |   | $ | 2,061 |   | $ | (28 | ) | -1.4 | % |

 
| ** **                                        | ** ** | **Nine Months Ended  September 30,** | ** ** |
|---------------------------------------------------|------------|-----------------------------------------------------|------------|
| **(Dollars in thousands)**              | ** ** | **2006**                                            | ** ** | **2005** | ** ** | **Change** | ** ** | **%** | ** ** |
| **Non-interest income**                           | ** ** | ** **                                          | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Customer service  fees on deposit accounts        |       | $                                                   | 4,108      |   | $ | 3,810 |   | $ | 298 |   | 7.8 | % |
| Gain on sale of  mortgage loans                   |       | 608                                                 |       | 602 |   | 6 |   | 1.0 | % |
| Brokerage  commissions                            |       | 250                                                 |       | 236 |   | 14 |   | 5.9 | % |
| Gain on sale of  real estate held for development |       | —                                              |       | 143 |   | (143 | ) | -100 | % |
| Gain on sale of  investments                      |       | —                                              |       | 381 |   | (381 | ) | -100 | % |
| Other income                                      |       | 856                                                 |       | 887 |   | (31 | ) | -3.5 | % |
|                                              |       | $                                                   | 5,822      |   | $ | 6,059 |   | $ | (237 | ) | -3.9 | % |

 

Growth in customerservice fees on deposit accounts, our largest component of non-interest income,is primarily due to growth in customer deposits, overdraft fee income on retailchecking accounts and the sale of fee-based products for 2006.****We continue to increase our customer basethrough cross-selling opportunities and marketing initiatives and promotions.In addition, we continue to emphasize growing our checking account base tobetter enhance our profitability and franchise value.

We originate qualifiedVA, KHC, RHC and conventional secondary market loans and sell them into thesecondary market with servicing rights released.****Gain on sale of mortgage loans decreased for the quarterended September 30, 2006 compared to the same period in 2005 due to a decreasein the volume of loans closed. However, during the nine month 2006 period, gainon sale of mortgage loans remained consistent with the levels reached in 2005.

Through our subsidiary,First Federal Office Park, we hold commercial lots adjacent to our home officeon Ring Road in Elizabethtown, that are available for sale. During 2005 werecorded $143,000 in gains from a lot sale. Currently, two of the initial ninelots held for sale remain unsold.

We invest in varioustypes of liquid assets, including United States Treasury obligations,securities of various federal agencies, obligations of states and politicalsubdivisions, corporate bonds, mutual funds, stocks and others. During the ninemonth 2006 period we did not record any gains on the sale of investmentscompared to $381,000 in recorded gains for the 2005 period. Gains on investmentsecurities are infrequent in nature and not a consistent source of income.

Other income decreasedfor the quarter and nine months ended September 30, 2006 due to decreases intrust income and write downs on real estate acquired through foreclosure.During the fourth quarter of 2004 we made the decision to outsource our trustoperations and implemented this plan during 2005. However, we still held someof these trust assets until June 2006. As of September 2006, all trust operationshave been outsourced. Included in other income for the quarter and nine monthsended September 30, 2006 is income from trust operations of $0 and $63,000 ascompared to $51,000 and $93,000 for the same periods in 2005. We also recordeda $73,000 gain recorded on the sale of our credit card portfolio during thethird quarter of 2006, in which a total of $610,000 in retail credit cardbalances were sold at a 12% premium.

21

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| ** **                              | ** ** | **Three Months Ended  September 30,** | ** ** |
|-----------------------------------------|------------|------------------------------------------------------|------------|
| **(Dollars in thousands)**    | ** ** | **2006**                                             | ** ** | **2005** | ** ** | **Change** | ** ** | **%** | ** ** |
| **Non-interest expenses**               | ** ** | ** **                                           | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Employee  compensation and benefits     |       | $                                                    | 2,968      |   | $ | 2,769 |   | $ | 199 |   | 7.2 | % |
| Office occupancy  expense and equipment |       | 523                                                  |       | 519 |   | 4 |   | 0.8 | % |
| Marketing and  advertising              |       | 209                                                  |       | 197 |   | 12 |   | 6.1 | % |
| Outside services  and data processing   |       | 650                                                  |       | 609 |   | 41 |   | 6.7 | % |
| Bank franchise  tax                     |       | 224                                                  |       | 195 |   | 29 |   | 14.9 | % |
| Other expense                           |       | 863                                                  |       | 867 |   | (4 | ) | -0.5 | % |
|                                    |       | $                                                    | 5,437      |   | $ | 5,156 |   | $ | 281 |   | 5.4 | % |

 
| ** **                             | ** ** | **Nine Months Ended  September 30,** | ** ** |
|----------------------------------------|------------|-----------------------------------------------------|------------|
| **(Dollars in thousands)**   | ** ** | **2006**                                            | ** ** | **2005** | ** ** | **Change** | ** ** | **%** | ** ** |
| **Non-interest  expenses**             | ** ** | ** **                                          | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Employee compensation and benefits     |       | $                                                   | 8,763      |   | $ | 8,403 |   | $ | 360 |   | 4.3 | % |
| Office occupancy expense and equipment |       | 1,589                                               |       | 1,517 |   | 72 |   | 4.7 | % |
| Marketing and advertising              |       | 628                                                 |       | 580 |   | 48 |   | 8.3 | % |
| Outside services and data processing   |       | 1,907                                               |       | 1,837 |   | 70 |   | 3.8 | % |
| Bank franchise tax                     |       | 667                                                 |       | 593 |   | 74 |   | 12.5 | % |
| Other expense                          |       | 2,607                                               |       | 2,648 |   | (41 | ) | -1.5 | % |
|                                   |       | $                                                   | 16,161     |   | $ | 15,578 |   | $ | 583 |   | 3.7 | % |

 

Employee compensation andbenefits is the largest component of non-interest expense.****Compensation expense increased for thequarter and nine months ended September 30, 2006 due to an increase in staffneeded for our continued growth and expansion as well as annual raises. We lookfor a continued increase in employee compensation and benefits expense in linewith recent trends, as we progress with our retail expansion and marketefforts. Also included in employee compensation and benefits expense for the2006 period is $53,000, due to a change in accounting rules in whichcompensation expense related to stock options is recorded.

Office occupancy expenseand equipment, marketing and advertising, and outside services and dataprocessing increased for the quarter and nine months ended September 30, 2006due to additional operating expenses related to our expansion efforts.****We anticipate the increased level of non-interestexpense to continue in 2006 with continued retail expansion and market shareefforts.****During the second quarterof 2006 we opened a new full service-banking center in Elizabethtown****and began construction on a third facilityin Jefferson County, which we expect to open in early 2007.****We are also considering other possiblelocations within the core market area to grow our 22% market share.****Our efficiency ratio was 58% for the ninemonths ended September 30, 2006, compared to 59% for the nine months endedSeptember 30, 2005.

**ANALYSIS OF FINANCIAL CONDITION**

Total assets at September30, 2006 increased to $801.1 million compared to $766.5 million at December 31,2005, an increase of $34.6 million. The increase was primarily driven by anincrease in loans of $44.1 million. The growth in loans was funded withdeposits, which increased $22.1 million for the period, $6.3 million inshort-term borrowings and $7.2 million in proceeds from investment securities.

##### **Loans**

Net loans receivable increased $44.1 million to $679.9 million atSeptember 30, 2006 compared to $635.7 million at December 31, 2005. Ourcommercial, commercial real estate and real estate construction portfoliosincreased $48.2 million to $451.4 million at September 30, 2006. For the 2006period, these loans comprised 66% of the total loan portfolio compared to 61%at September 30, 2005. Offsetting this growth was a $2.2 million decrease inthe residential mortgage loan portfolio to $140.5 million for the nine monthsended September 30, 2006. Consumer and home equity loans also decreased for the2006 period by $3.2 million, or 4.9% to $63.0 million at September 30, 2006,compared to $66.2 million at December 31, 2005.

22

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| (Dollars in thousands)  | ** ** | **September 30,**  2006 | ** ** | **December 31,**  2005 | ** ** |
|----------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| Commercial                             |       | $                            | 39,663     |                        | $          | 36,004 |   |
| Real estate  commercial                |       | 389,707                      |       | 353,637                     |       |
| Real estate  construction              |       | 22,066                       |       | 13,579                      |       |
| Residential  mortgage                  |       | 140,507                      |       | 142,727                     |       |
| Consumer and  home equity              |       | 62,963                       |       | 66,208                      |       |
| Indirect  consumer                     |       | 31,850                       |       | 31,577                      |       |
| Loans held for  sale                   |       | 1,733                        |       | 597                         |       |
|                                   |       | 688,489                      |       | 644,329                     |       |
|                                   |       |                         |       |                        |       |
| Less:                                  |       |                         |       |                        |       |
| Net deferred loan origination fees     |       | (1,041                       | )          | (1,212                      | )          |
| Allowance for loan losses              |       | (7,577                       | )          | (7,377                      | )          |
|                                   |       | (8,618                       | )          | (8,589                      | )          |
|                                   |       |                         |       |                        |       |
| Loans                                  |       | $                            | 679,871    |                        | $          | 635,740 |   |

 

**Allowance and Provision for Loan Losses**

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

The Allowance for LoanLoss Review Committee evaluates the allowance for loan losses quarterly tomaintain a level sufficient to absorb probable credit losses existing in theloan portfolio. Periodic provisions to the allowance are made as needed. Theallowance is determined based on the application of loss estimates to gradedloans by categories. The amount of the provision for loan losses necessary tomaintain an adequate allowance is also based upon an analysis of such factorsas changes in lending policies and procedures; underwriting standards;collection; charge-off and recovery history; changes in national and localeconomic business conditions and developments; changes in the characteristicsof the portfolio; ability and depth of lending management and staff; changes inthe trend of the volume and severity of past due, non-accrual and classifiedloans; troubled debt restructuring and other loan modifications; and regulatoryexaminations.

The methodology for allocating the allowance for loan and lease lossestakes into account our strategic plan to increase our emphasis on commercialand consumer lending. We increase the amount of the allowance allocated tocommercial loans and consumer loans in response to the growth of the commercialand consumer loan portfolios and management’s recognition of the higher risksand loan losses in these lending areas. The indirect consumer loan program iscomprised of new and used automobile, motorcycle and all terrain vehicle loansoriginated on our behalf by a select group of auto dealers within the ourservice area. The indirect loan program involves a greater degree of risk andis evaluated quarterly and monitored by the Board of Directors. In light of thegreater charge-offs from indirect consumer loans compared to direct consumerloans, proportionally more of the allowance for consumer loans is allocated forindirect loans than direct loans. As the indirect loan program has evolved,dealer analysis and underwriting standards have been refined to improve theloan loss experience of the program. Estimating the allowance is a continuousprocess. In this regard, the Allowance for Loan Loss Review Committee continuesto monitor the performance of indirect consumer loans as well as our other loanproducts and updates estimates as the evidence warrants.

23

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The following table showsan analysis of loan loss experience for the periods indicated.
| ** **                                                                | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|---------------------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| **(Dollars in thousands)**                                      | ** ** | **2006**                                             | ** ** | **2005**                                            | ** ** | **2006** | ** ** | **2005** | ** ** |
| **Balance at beginning of period**                                        |       | $                                                    | 7,408      |                                                | $          | 6,714 |   | $ | 7,377 |   | $ | 6,489 |   |
| Loans charged-off:                                                        |       |                                                 |       |                                                |       |   |   |   |   |
| Real estate  mortgage                                                     |       | —                                               |       | 10                                                  |       | 3 |   | 14 |   |
| Consumer                                                                  |       | 125                                                  |       | 131                                                 |       | 322 |   | 373 |   |
| Commercial                                                                |       | 32                                                   |       | —                                              |       | 118 |   | — |   |
| Total charge-offs                                                         |       | 157                                                  |       | 141                                                 |       | 443 |   | 387 |   |
| Recoveries:                                                               |       |                                                 |       |                                                |       |   |   |   |   |
| Real estate  mortgage                                                     |       | —                                               |       | 3                                                   |       | 7 |   | 4 |   |
| Consumer                                                                  |       | 76                                                   |       | 73                                                  |       | 203 |   | 227 |   |
| Commercial                                                                |       | 1                                                    |       | —                                              |       | 87 |   | — |   |
| Total recoveries                                                          |       | 77                                                   |       | 76                                                  |       | 297 |   | 231 |   |
|                                                                      |       |                                                 |       |                                                |       |   |   |   |   |
| **Net loans charged-off**                                                 |       | 80                                                   |       | 65                                                  |       | 146 |   | 156 |   |
|                                                                      |       |                                                 |       |                                                |       |   |   |   |   |
| Provision for loan  losses                                                |       | 249                                                  |       | 440                                                 |       | 346 |   | 756 |   |
|                                                                      |       |                                                 |       |                                                |       |   |   |   |   |
| **Balance at end of period**                                              |       | $                                                    | 7,577      |                                                | $          | 7,089 |   | $ | 7,577 |   | $ | 7,089 |   |
|                                                                      |       |                                                 |       |                                                |       |   |   |   |   |
| Allowance for loan  losses to total loans (excluding loans held for sale) | ** ** | ** **                                           | ** ** | ** **                                          |       | 1.10 | % | 1.13 | % |
| Net charge-offs to  average loans outstanding                             | ** ** | ** **                                           | ** ** | ** **                                          |       | 0.03 | % | 0.03 | % |
| Allowance for loan losses to total non-performing loans                   | ** ** | ** **                                           | ** ** | ** **                                          |       | 141 | % | 110 | % |

 

The provision for loan losses decreased $191,000 to $249,000 for thequarter ended September 30, 2006, and decreased $410,000 to $346,000 for thenine months ended September 30, 2006 compared to the same periods in 2005.****We recorded a smaller provision for the2006 periods due to****an improvementin our security and position of certain classified loans during the period,resulting in a reduction in the SFAS 114 allowance allocated to the loans. Inaddition, we experienced a higher provision for loan loss in the first ninemonths of 2005, resulting from two classified loans downgraded to substandard.****The combination resulted in a decrease inprovision expense for the quarter and nine months ended September 30, 2006compared to the same periods in 2005.****Thetotal allowance for loan losses increased $488,000 to $7.6 million fromSeptember 30, 2005 to September 30, 2006.****Theincrease in the allowance was related to a $44.1 million increase in net loansfor 2006 compared to 2005, in conjunction with a $2.3 million increase inclassified loans at September 30, 2006 compared to December 31, 2005.

Federal regulationsrequire insured institutions to classify their own assets on a regular basis.The regulations provide for three categories of classified loans — substandard,doubtful and loss.****Assetsclassified as substandard or doubtful require the institution to establishgeneral allowances for loan losses. If an asset or portion thereof isclassified as loss, the insured institution must either establish specifiedallowances for loan losses in the amount of 100% of the portion of the assetclassified loss, or charge off the amount of the loss.

The following tableprovides information with respect to classified loans for the periodsindicated:

|                                      | ** ** | **September 30,** | ** ** |
|--------------------------------------|------------|------------------------|------------|
| **(Dollars in thousands)** | ** ** | **2006**               | ** ** | **2005** | ** ** |
| **Classified Loans**                 | ** ** | ** **             | ** ** | ** ** | ** ** |
| Substandard                          |       | $                      | 12,144     |   | $ | 8,657 |   |
| Doubtful                             |       | 911                    |       | 942 |   |
| Loss                                 |       | 28                     |       | 54 |   |
| Total Classified                     |       | $                      | 13,083     |   | $ | 9,653 |   |

 

24

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The $3.5 million increasein substandard assets for September 30, 2006 was primarily the result****of three credit relationships.****These credit relationships were a $2.5million commercial relationship,****a$1.1 million****commercialrelationship and a $680,000 commercial real estate relationship.****Offsetting this increase was a pay off ofa $763,000 commercial relationship. We remain well secured and adequatelycollateralized with these credits.

Although we may allocatea portion of the allowance to specific loans or loan categories, the entireallowance is available for active charge-offs. Allowance estimates aredeveloped with actual loss experience adjusted for current economic conditions.Allowance estimates are considered a prudent measurement of the risk in theloan portfolio and are applied to individual loans based on loan type.

##### **Non-Performing Assets**

Non-performing assetsconsist of certain restructured loans for which interest rate or other termshave been renegotiated, loans on which interest is no longer accrued, realestate acquired through foreclosure and repossessed assets. We do not have anyloans greater than 90 days past due still on accrual. Loans, including impairedloans under SFAS 114, are placed on non-accrual status when they become pastdue 90 days or more as to principal or interest, unless they are adequatelysecured and in the process of collection. Loans are considered impaired if fullprincipal or interest payments are not anticipated in accordance with thecontractual loan terms. Impaired loans are carried at the present value ofexpected future cash flows discounted at the loan’s effective interest rate orat the fair value of the collateral if the loan is secured by collateral.

Loans are reviewed on aregular basis and normal collection procedures are implemented when a borrowerfails to make a required payment on a loan. If the delinquency on a mortgageloan exceeds 90 days and is not cured through normal collection procedures oran acceptable arrangement is not worked out with the borrower, we institutemeasures to remedy the default, including commencing a foreclosure action.Consumer loans generally are charged off when a loan is deemed uncollectible bymanagement and any available collateral has been disposed of. Commercialbusiness and real estate loan delinquencies are handled on an individual basisby management with the advice of legal counsel.

Interest income on loansis recognized on the accrual basis except for those loans in a non-accrual ofincome status. The accrual of interest on impaired loans is discontinued whenmanagement believes, after consideration of economic and business conditionsand collection efforts that the borrowers’ financial condition is such thatcollection of interest is doubtful, typically after the loan becomes 90 daysdelinquent. When interest accrual is discontinued, existing accrued interest isreversed and interest income is subsequently recognized only to the extent cashpayments are received.

Real estate acquired as aresult of foreclosure or by deed in lieu of foreclosure is classified as realestate owned until such time as it is sold. New and used automobile, motorcycleand all terrain vehicles acquired as a result of foreclosure are classified asrepossessed assets until they are sold. When such property is acquired, it isrecorded at the lower of the unpaid principal balance of the related loan orits fair market value. Any write-down of the property at the time ofacquisition is charged to the allowance for loan losses. Subsequent gains andlosses are included in non-interest income and non-interest expense.

25

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The following tableprovides information with respect to non-performing assets for the periodsindicated.
| **(Dollar in thousands)**                                   | ** ** | **September 30,  2006** | ** ** | **December 31,  2005** | ** ** |
|-----------------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| Restructured                                                          |       | $                            | 3,025      |                        | $          | 3,104 |   |
| Past due 90 days still  on accrual                                    |       | —                       |       | —                      |       |
| Loans on non-accrual status                                           |       | 2,332                        |       | 3,128                       |       |
|                                                                  |       |                         |       |                        |       |
| Total  non-performing loans                                           |       | 5,357                        |       | 6,232                       |       |
| Real estate acquired  through foreclosure                             |       | 789                          |       | 1,022                       |       |
| Other repossessed  assets                                             |       | 117                          |       | 119                         |       |
| Total  non-performing assets                                          |       | $                            | 6,263      |                        | $          | 7,373 |   |
|                                                                  |       |                         |       |                        |       |
| Interest income that  would have been earned on non-performing loans  |       | $                            | 403        |                        | $          | 432 |   |
| Interest income  recognized on non-performing loans                   |       | 235                          |       | 219                         |       |
| Ratios:                                                               | ** ** | ** **                   |       |                        |       |
| Non-performing  loans to total loans (excluding loans held for sale)  | ** ** | 0.78                         | %          | 0.97                        | %          |
| Non-performing assets  to total loans (excluding loans held for sale) |       | 0.91                         | %          | 1.15                        | %          |

 

Non-performing assets for the 2006 period include $3.0 million inrestructured commercial, residential mortgage and consumer loans.****The restructured loans primarily consistof three credit relationships aggregating $2.8 million, including a $2.1million commercial relationship, a $205,000 commercial relationship and a$446,000 residential mortgage relationship. The terms of these loans have beenrenegotiated to reduce the rate of interest and extend the term, thus reducingthe amount of cash flow required from the borrower to service the loans. Theterms of the restructured loans are currently being met.

**InvestmentSecurities**

Interest on securitiesprovides us our largest source of interest income after interest on loans,constituting 5.9% of the total interest income for the nine months endedSeptember 30, 2006. The securitiesportfolio serves as a source of liquidity and earnings and contributes to themanagement of interest rate risk. We have the authority to invest in varioustypes of liquid assets, including short-term United States Treasury obligationsand securities of various federal agencies, obligations of states and politicalsubdivisions, corporate bonds, certificates of deposit at insured savings andloans and banks, bankers’ acceptances, and federal funds. We may also invest aportion of our assets in certain commercial paper and corporate debtsecurities. We are also authorized to invest in mutual funds and stocks whoseassets conform to the investments that we are authorized to make directly. Theavailable-for-sale and held-to-maturity investment portfolios decreased by $7.2million during the 2006 period as securities were called for redemption inaccordance with their terms due to increasing interest rates. During the yearwe made purchases of****investmentsin state and municipal obligations and a corporate bond. The corporate bondre-prices quarterly with three-month LIBOR and was purchased to enhance ourearnings. The state and municipal obligations have an average life of 10 years.We purchased these securities to enhance earnings and manage interest rate riskby placing assets with longer terms on the balance sheet.

All unrealized losses are reviewed at least on aquarterly basis to determine whether the losses are other than temporary andmore frequently when economic or market concerns warrant such evaluation.Consideration is given to the length of time and the extent to which the fairvalue has been less than cost, the financial condition and near-term prospectsof the issuer, and our intent and ability to retain the investment in theissuer for a period of time sufficient to allow for any anticipated recovery infair value. In analyzing an issuer’s financial condition, we may considerwhether the securities are issued by the federal government or its agencies,whether downgrades by bond rating agencies have occurred, and the results ofreviews of the issuer’s financial condition. The unrealized losses on ourinvestments in U.S. Treasury and agencies, mortgage-backed securities andobligations of state and political subdivisions were caused by interest rateincreases. Because the decline in market value is attributable to changes ininterest rates and not credit quality, and because we have the ability and intentto hold these investments until recovery of fair value, which may be maturity,we do not consider these investments to be other-than-temporarily impaired atSeptember 30, 2006.

###### **Deposits**

We rely primarily oncustomer service and long-standing relationships with customers to attract andretain deposits. Market interest rates and rates on deposit products offered bycompeting financial institutions can significantly affect our ability toattract and retain deposits. In conjunction with our initiatives to expand andenhance our retail branch network, we emphasize growing our customer checkingaccount base to better enhance profitability and franchise value.****Retail and commercial deposits increased$38.1 million and we added $7.9 million in brokered certificates of deposit forthe year. These increases were offset by a $23.9 million decrease in publicfund deposits, resulting in an increase in total deposits of $22.1 million forthe period. The increase in retail deposits was primarily in certificate of depositbalances due to a promotion and customers moving from money market and savingsproducts into more attractive certificate of deposit products.

26

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The following tablebreaks down our deposits.

|                          | ** ** | **September 30,  2006** | ** ** | **December 31,  2005** | ** ** |
|--------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **               | ** ** | **(In Thousands)**      | ** ** |
| Non-interest  bearing    |       | $                            | 41,171     |                        | $          | 39,145 |   |
| NOW demand               |       | 71,126                       |       | 76,848                      |       |
| Savings                  |       | 83,176                       |       | 99,879                      |       |
| Money market             |       | 56,547                       |       | 66,175                      |       |
| Certificates of  deposit |       | 361,196                      |       | 309,059                     |       |
|                     |       | $                            | 613,216    |                        | $          | 591,106 |   |

 

**Short-termBorrowings**

Short-termborrowings consist of federal funds purchased and securities sold underagreements to repurchase. We had short-term borrowings of $76 million from theFHLB of Cincinnati at September 30, 2006. These borrowings averaged arate of 5.32% for the quarter.

**Advancesfrom Federal Home Loan Bank**

We had borrowings of$28.3 million from the FHLB at September 30, 2006.****During January 2001, we entered into a $25.0 millionconvertible fixed rate advance with a fixed rate of 5.05% and a maturity of tenyears. This advance was fixed for a period of three years.****At the end of the fixed rate term andquarterly thereafter, the FHLB has the right to convert this advance to avariable rate advance tied to the three-month LIBOR index. Upon conversion, wecan prepay the advance at no penalty.

**SubordinatedDebentures**

In March 2002, atrust we formed completed the private placement of 10,000 shares of cumulativetrust preferred securities with a liquidation preference of $1,000 persecurity. The proceeds of the offering were loaned to us in exchange forfloating rate junior subordinated deferrable interest debentures. Distributionson the Trust Preferred Securities are payable quarterly in arrears at theannual rate (adjusted quarterly) of three-month LIBOR plus 3.60%, and are includedin interest expense. The subordinated debentures are considered as Tier Icapital for the Corporation under current regulatory guidelines.

The subordinateddebentures, which mature March 26, 2032, are redeemable prior to the maturitydate at our option on or after March 26, 2007, at their principal amount plusaccrued interest. Similar subordinated debentures are currently being offeredat approximately 1.70% plus three-month LIBOR. Since we are currently paying3.60% plus three-month LIBOR, we anticipate calling our current subordinateddebentures and refinancing at a lower interest rate after the March 26, 2007,redemption date.

##### **LIQUIDITY**

Liquidity risk arisesfrom the possibility that we may not be able to satisfy current or futurefinancial commitments, or may become unduly reliant on alternative fundingsources. The objective of liquidity risk management is to ensure that the cashflow requirements of depositors and borrowers, as well as our operating cashneeds, are met, taking into account all on- and off-balance sheet fundingdemands. Liquidity risk management also includes ensuring cash flow needs aremet at a reasonable cost. We maintain an investment and funds managementpolicy, which identifies the primary sources of liquidity, establishes proceduresfor monitoring and measuring liquidity, and establishes minimum liquidityrequirements in compliance with regulatory guidance. The liquidity position iscontinually monitored and reviewed by the Asset Liability Committee.

Funds are available froma number of sources, including the sale of securities in the available-for-saleportion of the investment portfolio, principal pay-downs on loans andmortgage-backed securities, proceeds realized from loans held for sale,brokered deposits and other wholesale funding. We also secured federal fundsborrowing lines from two of our correspondent banks of $15 million each. Ourbanking centers also provide access to retail deposit markets. If largecertificate depositors shift to our competitors or other markets in response tointerest 

27

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rate changes, we have theability to replenish those deposits through alternative funding sources.Traditionally, we have also utilized borrowings from the FHLB to supplement ourfunding requirements. At September 30, 2006, we had an unused approved line ofcredit in the amount of $105.1 million and sufficient collateral available toborrow approximately $28.9 million in additional advances from the FHLB.****We believe our sources of liquidity areadequate to meet expected cash needs for the foreseeable future.

At the holding companylevel, the Corporation uses cash to pay dividends to stockholders, repurchasecommon stock, make selected investments and acquisitions, and service debt. Themain sources of funding for the holding company include dividends, borrowingsand access to the capital markets.

###### Theprimary source of funding for the Corporation has been dividends and returns ofinvestment from the Bank. Kentucky banking laws limit the amount of dividendsthat may be paid to the Corporation by the Bank without prior approval of theKentucky Office of Financial Institutions. Under these laws, the amount ofdividends that may be paid in any calendar year is limited to current year’snet income, as defined in the laws, combined with the retained net income ofthe preceding two years, less any dividends declared during those periods. AtSeptember 30, 2006, without prior regulatory approval, we had approximately$17.2 million of retained earnings that could be utilized for payment of dividendsif authorized by our board of directors. Accordingly, consolidated cash flowsas presented in the consolidated statements of cash flows may not representcash immediately available to the Corporation. During the nine month periodended September 30, 2006, the Bank declared and paid dividends to theCorporation of $3.1 million.

##### **CAPITAL**

Stockholders’ equityincreased $5.3 million for the period ended September 30, 2006 compared toDecember 31, 2005.****The increase incapital was primarily attributable to net income during the period.****This increase was offset by cash dividendsdeclared and a decline in accumulated other comprehensive income, a result oftemporary unrealized losses recorded on securities.****Our averagestockholders’ equity to average assets ratio increased to 8.67% for the ninemonth period ended September 30, 2006 compared to 8.27% for 2005.

Each of thefederal bank regulatory agencies has established minimum leverage capitalrequirements for banking organizations. Banking organizations must maintain aminimum ratio of Tier 1 capital to adjusted average quarterly assets equal to3% to 5% subject to federal bank regulatory evaluation of an organization’soverall safety and soundness. We intend to maintain a capital position thatmeets or exceeds the “well capitalized” requirements as defined for banks bythe FDIC. The following table shows the ratios of Tier 1 capital and totalcapital to risk-adjusted assets and the leverage ratios for the Corporation andthe Bank as of September 30, 2006.

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| ** **                                          | ** ** | ** ** | ** ** | ** **                 | ** ** | ** **                 | ** ** | ** **     | ** ** | **To Be Considered  Well Capitalized  Under Prompt** | ** ** |
|-----------------------------------------------------|------------|------------|------------|----------------------------|------------|----------------------------|------------|----------------|------------|--------------------------------------------------------------------------|------------|
| ** **                                          | ** ** | ** ** | ** ** | ** **                 | ** ** | **For Capital**       | ** ** | **Correction** | ** ** |
| ** **                                          | ** ** | **Actual** | ** ** | **Adequacy Purposes** | ** ** | **Action Provisions** | ** ** |
| **(Dollars in thousands)**                | ** ** | **Amount** | ** ** | **Ratio**                  | ** ** | **Amount**                 | ** ** | **Ratio**      | ** ** | **Amount**                                                               | ** ** | **Ratio** | ** ** |
| **As of September 30, 2006:**                       |       |       |       |                       |       |                       |       |           |       |                                                                     |       |   |   |
| Total risk-based  capital (to risk-weighted assets) |       |       |       |                       |       |                       |       |           |       |                                                                     |       |   |   |
| Consolidated                                        |       | $          | 79,556     |                       | 11.6       | %                          | $          | 54,701         |       | 8.0                                                                      | %          | N/A |   | N/A |   |
| Bank                                                |       | 76,730     |       | 11.3                       |       | 54,485                     |       | 8.0            |       | $                                                                        | 68,106     |   | 10 | % |
| Tier I capital  (to risk-weighted assets)           | ** ** | ** ** | ** ** | ** **                 | ** ** | ** **                 | ** ** | ** **     | ** ** | ** **                                                               | ** ** | ** ** | ** ** |
| Consolidated                                        |       | 71,727     |       | 10.5                       |       | 27,350                     |       | 4.0            |       | N/A                                                                      |       | N/A |   |
| Bank                                                |       | 68,901     |       | 10.1                       |       | 27,242                     |       | 4.0            |       | $                                                                        | 40,863     |   | 6 | % |
| Tier I capital  (to average assets)                 | ** ** | ** ** | ** ** | ** **                 | ** ** | ** **                 | ** ** | ** **     | ** ** | ** **                                                               | ** ** | ** ** | ** ** |
| Consolidated                                        |       | 71,727     |       | 9.1                        |       | 31,374                     |       | 4.0            |       | N/A                                                                      |       | N/A |   |
| Bank                                                |       | 68,901     |       | 8.8                        |       | 31,312                     |       | 4.0            |       | $                                                                        | 39,139     |   | 5 | % |
|                                                     |            |            |            |                            |            |                            |            |                |            |                                                                          |            |  |  |  |  |  |

 
| ** **                                          | ** ** | ** ** | ** ** | ** **                 | ** ** | ** **                 | ** ** | ** **     | ** ** | **To Be Considered  Well Capitalized  Under Prompt** | ** ** |
|-----------------------------------------------------|------------|------------|------------|----------------------------|------------|----------------------------|------------|----------------|------------|--------------------------------------------------------------------------|------------|
| ** **                                          | ** ** | ** ** | ** ** | ** **                 | ** ** | **For Capital**       | ** ** | **Correction** | ** ** |
| ** **                                          | ** ** | **Actual** | ** ** | **Adequacy Purposes** | ** ** | **Action Provisions** | ** ** |
| **(Dollars in thousands)**                | ** ** | **Amount** | ** ** | **Ratio**                  | ** ** | **Amount**                 | ** ** | **Ratio**      | ** ** | **Amount**                                                               | ** ** | **Ratio** | ** ** |
| **As of December 31, 2005:**                        |       |       |       |                       |       |                       |       |           |       |                                                                     |       |   |   |
| Total risk-based  capital (to risk-weighted assets) |       |       |       |                       |       |                       |       |           |       |                                                                     |       |   |   |
| Consolidated                                        |       | $          | 73,678     |                       | 11.5       | %                          | $          | 51,185         |       | 8.0                                                                      | %          | N/A |   | N/A |   |
| Bank                                                |       | 71,070     |       | 11.1                       |       | 51,026                     |       | 8.0            |       | $                                                                        | 63,782     |   | 10 | % |
| Tier I capital  (to risk-weighted assets)           | ** ** | ** ** | ** ** | ** **                 | ** ** | ** **                 | ** ** | ** **     | ** ** | ** **                                                               | ** ** | ** ** | ** ** |
| Consolidated                                        |       | 66,300     |       | 10.4                       |       | 25,592                     |       | 4.0            |       | N/A                                                                      |       | N/A |   |
| Bank                                                |       | 63,692     |       | 10.0                       |       | 25,513                     |       | 4.0            |       | $                                                                        | 38,269     |   | 6 | % |
| Tier I capital  (to average assets)                 | ** ** | ** ** | ** ** | ** **                 | ** ** | ** **                 | ** ** | ** **     | ** ** | ** **                                                               | ** ** | ** ** | ** ** |
| Consolidated                                        |       | 66,300     |       | 8.8                        |       | 30,011                     |       | 4.0            |       | N/A                                                                      |       | N/A |   |
| Bank                                                |       | 63,692     |       | 8.5                        |       | 29,926                     |       | 4.0            |       | $                                                                        | 37,408     |   | 5 | % |
|                                                     |            |            |            |                            |            |                            |            |                |            |                                                                          |            |  |  |  |  |  |

 

**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 toeconomic loss that may result from fluctuating interest rates, we manage ourexposure to adverse changes in interest rates through asset and liabilitymanagement activities within guidelines established by our Asset LiabilityCommittee (“ALCO”). The ALCO, which includes senior management representatives,has the responsibility for approving and ensuring compliance withasset/liability management polices. Interest rate risk is the exposure toadverse changes in the net interest income as a result of market fluctuationsin interest rates. The ALCO, on an ongoing basis, monitors interest rate andliquidity risk in order to implement appropriate funding and balance sheet strategies.Management considers interest rate risk to be our most significant market risk.

We utilize an earningssimulation model to analyze net interest income sensitivity. Potential changesin market interest rates and their subsequent effects on net interest incomeare then evaluated. The model projects the effect of instantaneous movements ininterest rates of both 100 and 200 basis points. Assumptions based on thehistorical behavior of our deposit rates and balances in relation to changes ininterest rates are also incorporated into the model. These assumptions areinherently uncertain and, as a result, the model cannot precisely measurefuture net interest income or precisely predict the impact of fluctuations inmarket interest rates on net interest income. Actual results will differ fromthe model’s simulated results due to timing, magnitude and frequency ofinterest rate changes as well as changes in market conditions and theapplication and timing of various management strategies.

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Our interest sensitivityprofile was less asset sensitive at September 30, 2006, than December 31, 2005.Given a sustained 100 basis point decrease in rates, our base net interestincome would decrease by an estimated****.60%at September 30, 2006 compared to a decrease of 2.03% at December 31, 2005.Given a 100 basis point increase in interest rates our base net interest incomewould increase by an****estimated..73% at September 30, 2006 compared to an increase of 1.92% at December 31,2005.

Our interest sensitivityat any point in time will be affected by a number of factors. These factorsinclude the mix of interest sensitive assets and liabilities, their relativepricing schedules, market interest rates, deposit growth, loan growth, decayrates and prepayment speed assumptions.

As demonstrated by theSeptember 30, 2006 and December 31, 2005 sensitivity tables, we are in an assetsensitive position. This means that our earning assets, which consist of loansand investment securities, will change in price at a faster rate than ourdeposits and borrowings. Therefore, as short term interest rates increase, ournet interest income will also increase. Likewise, as short term interest ratesdecrease, our net interest income will decrease.

Our efforts to structurefunding and future liquidity needs has decreased our asset sensitivity and willlikely continue to do so. From June 2004 until June 2006, the Federal OpenMarket Committee increased short-term interest rates. We believe the FederalOpen Market Committee may decrease short term interest rates in 2007. Our netinterest margin and the level of net interest income would be negativelyaffected with a decrease in short term interest rates.****We continually monitor the effects ratechanges will have on our level of net interest income and management works tostructure the maturity and pricing of loans and deposits to mitigate largeswings in net interest income.****During2005, we made efforts to increase the level of short-term deposits with a moneymarket promotion as well as offering more attractive rates on short-termcertificates of deposit. Also, during the third quarter of 2006, we paid off afixed rate FHLB advance that had converted to a variable rate advance. Wereplaced this borrowing with overnight short-term borrowings. In addition, themajority of the newly originated or renewed loans during 2005 and 2006 werefixed rates loans with the interest rate fixed from three to five years Theseefforts will help decrease the negative impact that flat or decreasing short-terminterest rates may have on the level of net interest income.

Our sensitivity tointerest rate changes is presented based on data as of September 30, 2006 andDecember 31, 2005 annualized to a one year period.

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| ** **                           | ** ** | **September 30, 2006** | ** ** |
|--------------------------------------|------------|----------------------------------|------------|
| ** **                           | ** ** | **Decrease in Rates**  | ** ** | ** ** | ** ** | **Increase in Rates** | ** ** |
| **(Dollars in thousands)** | ** ** | **200  Basis Points**       | ** ** | **100  Basis Points** | ** ** | **Base** | ** ** | **100  Basis Points** | ** ** | **200  Basis Points** | ** ** |
| **Projected interest income**        |       |                             |       |   |   |   |   |   |   |   |   |
| Loans                                |       | $                                | 57,584     |   | $ | 59,106 |   | $ | 60,381 |   | $ | 61,682 |   | $ | 62,927 |   |
| Investments                          |       | 2,179                            |       | 2,309 |   | 2,397 |   | 2,452 |   | 2,474 |   |
| **Total interest income**            |       | 59,763                           |       | 61,415 |   | 62,778 |   | 64,134 |   | 65,401 |   |
|                                 |       |                             |       |   |   |   |   |   |   |   |   |
| **Projected interest expense**       |       |                             |       |   |   |   |   |   |   |   |   |
| Deposits                             |       | 17,601                           |       | 18,328 |   | 19,054 |   | 19,694 |   | 20,334 |   |
| Borrowed funds                       |       | 6,290                            |       | 6,763 |   | 7,179 |   | 7,628 |   | 7,939 |   |
| **Total interest expense**           |       | 23,891                           |       | 25,091 |   | 26,233 |   | 27,322 |   | 28,273 |   |
|                                 |       |                             |       |   |   |   |   |   |   |   |   |
| **Net interest income**              |       | $                                | 35,872     |   | $ | 36,324 |   | $ | 36,545 |   | $ | 36,812 |   | $ | 37,128 |   |
| Change from base                     |       | $                                | (673       | ) | $ | (221 | ) | ** ** |   | $ | 267 |   | $ | 583 |   |
| % Change from base                   |       | (1.84                            | )%         | (.60 | )% | ** ** |   | .73 | % | 1.59 | % |

 
| ** **                           | ** ** | **December 31, 2005** | ** ** |
|--------------------------------------|------------|---------------------------------|------------|
| ** **                           | ** ** | **Decrease in Rates** | ** ** | ** ** | ** ** | **Increase in Rates** | ** ** |
| **(Dollars in thousands)** | ** ** | **200  Basis Points**      | ** ** | **100  Basis Points** | ** ** | **Base** | ** ** | **100  Basis Points** | ** ** | **200  Basis Points** | ** ** |
| **Projected  interest income**       |       |                            |       |   |   |   |   |   |   |   |   |
| Loans                                |       | $                               | 48,350     |   | $ | 49,818 |   | $ | 51,077 |   | $ | 52,281 |   | $ | 53,539 |   |
| Investments                          |       | 2,703                           |       | 2,846 |   | 2,948 |   | 2,995 |   | 3,062 |   |
| **Total  interest income**           |       | 51,053                          |       | 52,664 |   | 54,025 |   | 55,276 |   | 56,601 |   |
|                                 | ** ** | ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Projected  interest expense**      | ** ** | ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Deposits                             |       | 12,738                          |       | 13,319 |   | 13,900 |   | 14,421 |   | 14,941 |   |
| Borrowed funds                       |       | 4,697                           |       | 4,782 |   | 4,845 |   | 4,896 |   | 4,947 |   |
| **Total  interest expense**          |       | 17,435                          |       | 18,101 |   | 18,745 |   | 19,317 |   | 19,888 |   |
|                                 | ** ** | ** **                      |       |   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Net  interest income**             |       | $                               | 33,618     |   | $ | 34,563 |   | $ | 35,280 |   | $ | 35,959 |   | $ | 36,713 |   |
| Change from base                     |       | $                               | (1,662     | ) | $ | (717 | ) | ** ** |   | $ | 679 |   | $ | 1,433 |   |
| % Change from base                   |       | (4.71                           | )%         | (2.03 | )% | ** ** |   | 1.92 | % | 4.06 | % |

 

**Item 4. CONTROLSAND PROCEDURES**

*Evaluationof disclosure controls and procedures*

Our management, with theparticipation of our Chief Executive Officer and our Chief Financial Officer,evaluated the effectiveness of our disclosure controls and procedures as of theend of the period covered by this Quarterly Report on Form 10-Q. Based on thisevaluation, our Chief Executive Officer and our Chief Financial Officer haveconcluded that our disclosure controls and procedures were effective as of theend of the period covered by this Quarterly Report on Form 10-Q to ensure thatinformation we are required to disclose in reports that we file or submit underthe Securities Exchange Act of 1934 is recorded, processed, summarized andreported within the time periods specified in Securities and ExchangeCommission rules and forms.

*Changesin internal control over financial reporting*

There was no change inour internal control over financial reporting that occurred during the periodcovered by this Quarterly Report on Form 10-Q that has materially affected, oris reasonably likely to materially affect, our internal control over financialreporting.

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**Part II - OTHER INFORMATION**

**Item 1.**                          LegalProceedings

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

**Item 1A.**                 Risk Factors

We did not have anychanges to our risk factors previously disclosed in our Annual Report on Form10-K for the year ended December 31, 2005.

**Item 2.**                          UnregisteredSales of Equity Securities and Use of Proceeds

(e)                                  IssuerPurchases of Equity Securities

                                                Wedid not repurchase any of our common stock during the period ended September30, 2006.

**Item 3.**                          DefaultsUpon Senior Securities

Not Applicable

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

Not Applicable

**Item 5.**                          OtherInformation

None

**Item 6.**                          Exhibits:

31.1                           Certificationof Chief Executive Officer Pursuant to Section 302 of Sarbanes- Oxley Act

31.2                           Certificationof Chief Financial Officer Pursuant to Section 302 of Sarbanes- Oxley Act

32                                    Certificationof Chief Executive Officer and Chief Financial Officer Pursuant to Section 18U.S.C. Section 1350 (As Adopted Pursuant to Section 906 of the Sarbanes-OxleyAct of 2002)

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**FIRSTFINANCIAL SERVICE CORPORATION**

**SIGNATURES**

Pursuant to therequirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, theregistrant has duly caused this report to be signed on its behalf by theundersigned, thereunto duly authorized.
| DATE: November 9, 2006 | BY: (S) | B. Keith Johnson                                      |
|------------------------|---------|-------------------------------------------------------|
|                   |    | B. Keith Johnson                                      |
|                   |    | President and Chief Executive Officer                 |
|                   |    |                                                  |
| DATE: November 9, 2006 | BY: (S) | Gregory S. Schreacke                                  |
|                   |    | Gregory S. Schreacke                                  |
|                   |    | Chief Financial Officer  Principal Accounting Officer |

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**INDEX TO EXHIBITS**
| Exhibit No. | ** ** | **Description**                                                                                                                                                                  | ** ** |
|------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
|             |       |                                                                                                                                                                             |       |
| 31.1             |       | Certification  of Chief Executive Officer Pursuant to Section 302 of Sarbanes-Oxley Act                                                                                          |       |
|             |       |                                                                                                                                                                             |       |
| 31.2             |       | Certification  of Chief Financial Officer Pursuant to Section 302 of Sarbanes-Oxley Act                                                                                          |       |
|             |       |                                                                                                                                                                             |       |
| 32               |       | Certification of Chief  Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section  1350 (As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002) |       |

 

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