UNITED
STATES
 SECURITIES
AND EXCHANGE COMMISSION
 Washington,
D.C.  20549
 
 FORM
10-Q
 (Mark
One)
 
 x
              QUARTERLY
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934.
 
 For
      the quarterly period ended March 31,
2009
 
 OR
 
  ̈
              TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934.
 
 Commission
File Number 0-18832
 
 First
Financial Service Corporation
 (Exact
Name of Registrant as specified in its charter)
 
 Kentucky
              61-1168311(State
      or other jurisdiction
              (IRS
      Employer Identification No.)of
      incorporation or organization)2323
      Ring Road
              (270)
      765-2131Elizabethown,
      Kentucky 42701
              (Registrant's
      telephone number,(Address
      of principal executive offices)
              including
      area code)(Zip
      Code)
 
 (270)
765-2131
 (Registrant's
telephone number, including area code)
 
 Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days.Yes
x  No
 ̈
 
 Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such files). Yes  ̈  No
  ̈
 
 Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting
company.  See definition of “accelerated filer”, “large accelerated
filer” and “smaller reporting company” in Rule 12b-2 of the Exchange
Act.
 
 Large
      Accelerated Filer ̈Accelerated Filer x
                    Non-Accelerated
      Filer ̈      
      Smaller Reporting Companyo(Do
      not check if a smallerreporting
      company)
 
 Indicate
by a check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).  Yes  ̈  No
x
 
 Indicate
the number of shares outstanding of each of the issuer's classes of common
stock, as of the latest practicable date.
 
 Class
                Outstanding as of April 30,
      2009Common
      Stock
                4,772,669shares
  
  FIRST
FINANCIAL SERVICE CORPORATION
 FORM
10-Q
 TABLE
OF CONTENTS
 
 PART I – FINANCIAL
      INFORMATIONPreliminary
      Note Regarding Forward-Looking Statements
                      
                      3Item
      1.
                      Consolidated
      Financial Statements and Notes to Consolidated Financial
      Statements
                      
                      4Item
      2.
                      Management's
      Discussion and Analysis of Financial Condition and Results of
      Operations
                      
                      23Item
      3.
                      Quantitative
      and Qualitative Disclosures about Market Risk
                      
                      37Item
      4.
                      Controls
      and Procedures
                      
                      39PART II – OTHER
      INFORMATIONItem
      1.
                      Legal
      Proceedings
                      
                      39Item 1A.
                      Risk
      Factors
                      
                      39Item
      2.
                      Unregistered
      Sales of Equity Securities and Use of Proceeds
                      
                      40Item
      3.
                      Defaults
      upon Senior Securities
                      
                      40Item
      4.
                      Submission
      of Matters to a Vote of Security Holders
                      
                      40Item
      5.
                      Other
      Information
                      
                      40Item
      6.
                      Exhibits
                      
                      40SIGNATURES
                      
                      41
  2
  PRELIMINARY
NOTE REGARDING
 FORWARD-LOOKING
STATEMENTS
 
 Statements
in this report that are not statements of historical fact are forward-looking
statements. First Financial Service Corporation (the “Corporation”) may make
forward-looking statements in future filings with the Securities and Exchange
Commission (“SEC”), in press releases, and in oral and written statements made
by or with the approval of the Corporation.  Forward-looking
statements include, but are not limited to: (1) projections of revenues, income
or loss, earnings or loss per share, capital structure and other financial
items; (2) plans and objectives of the Corporation or its management or Board of
Directors; (3) statements regarding future events, actions or economic
performance; and (4) statements of assumptions underlying such
statements.  Words such as “estimate,” “strategy,” “believes,”
“anticipates,” “expects,” “intends,” “plans,” “targeted,” and similar
expressions are intended to identify forward-looking statements, but are not the
exclusive means of identifying such statements.
 
 Various
risks and uncertainties may cause actual results to differ materially from those
indicated by our forward-looking statements.  In addition to those
risks described under “Item 1A Risk Factors,” of this report and our Annual
Report on Form 10-K, the following factors could cause such differences: changes
in general economic conditions and economic conditions in Kentucky and the
markets we serve, any of which may affect, among other things, our level of
non-performing assets, charge-offs, and provision for loan loss expense; changes
in interest rates that may reduce interest margins and impact funding sources;
changes in market rates and prices which may adversely impact the value of
financial products including securities, loans and deposits; changes in tax
laws, rules and regulations; various monetary and fiscal policies and
regulations, including those determined by the Federal Reserve Board, the
Federal Deposit Insurance Corporation (“FDIC”) and the Kentucky Office of
Financial Institutions (“KOFI”); competition with other local and regional
commercial banks, savings banks, credit unions and other non-bank financial
institutions; our ability to grow core businesses; our ability to develop and
introduce new banking-related products, services and enhancements and gain
market acceptance of such products; and management’s ability to manage these and
other risks.
 
 Our
forward-looking statements speak only as of the date on which they are made, and
we undertake no obligation to update any forward-looking statement to reflect
events or circumstances after the date of the statement to reflect the
occurrence of unanticipated events.
  3


Item 1.
                  FIRST
      FINANCIAL SERVICE CORPORATIONConsolidated
      Balance Sheets(Unaudited)


March
      31,
                  
                  
                  December
      31,(Dollars
      in thousands, except share data)
                  
                  2009
                  
                  
                  2008ASSETS:Cash
      and due from banks
                  
                  $
                  15,198
                  
                  
                  $
                  17,310Interest
      bearing deposits
                  
                  
                  2,839
                  
                  
                  
                  3,595Total
      cash and cash equivalents
                  
                  
                  18,037
                  
                  
                  
                  20,905Securities
      available-for-sale
                  
                  
                  15,673
                  
                  
                  
                  15,775Securities
      held-to-maturity, fair value of $6,123 Mar (2009)and $6,846 Dec
      (2008)
                  
                  
                  6,097
                  
                  
                  
                  7,022Total
      securities
                  
                  
                  21,770
                  
                  
                  
                  22,797Loans
      held for sale
                  
                  
                  10,728
                  
                  
                  
                  9,567Loans,
      net of unearned fees
                  
                  
                  943,336
                  
                  
                  
                  903,434Allowance
      for loan losses
                  
                  
                  (15,072
                  )
                  
                  
                  (13,565
                  )Net
      loans
                  
                  
                  938,992
                  
                  
                  
                  899,436Federal
      Home Loan Bank stock
                  
                  
                  8,515
                  
                  
                  
                  8,515Cash
      surrender value of life insurance
                  
                  
                  8,745
                  
                  
                  
                  8,654Premises
      and equipment, net
                  
                  
                  30,635
                  
                  
                  
                  30,068Real
      estate owned:Acquired
      through foreclosure
                  
                  
                  5,348
                  
                  
                  
                  5,925Held
      for development
                  
                  
                  45
                  
                  
                  
                  45Other
      repossessed assets
                  
                  
                  92
                  
                  
                  
                  91Goodwill
                  
                  
                  11,931
                  
                  
                  
                  11,931Core
      deposit intangible
                  
                  
                  1,602
                  
                  
                  
                  1,703Accrued
      interest receivable
                  
                  
                  3,999
                  
                  
                  
                  4,379Deferred
      income taxes
                  
                  
                  1,090
                  
                  
                  
                  1,147Other
      assets
                  
                  
                  2,393
                  
                  
                  
                  1,451TOTAL
      ASSETS
                  
                  $
                  1,053,194
                  
                  
                  $
                  1,017,047LIABILITIES
      AND STOCKHOLDERS' EQUITYLIABILITIES:Deposits:Non-interest
      bearing
                  
                  $
                  57,499
                  
                  
                  $
                  55,668Interest
      bearing
                  
                  
                  764,019
                  
                  
                  
                  719,731Total
      deposits
                  
                  
                  821,518
                  
                  
                  
                  775,399Short-term
      borrowings
                  
                  
                  65,000
                  
                  
                  
                  94,869Advances
      from Federal Home Loan Bank
                  
                  
                  52,841
                  
                  
                  
                  52,947Subordinated
      debentures
                  
                  
                  18,000
                  
                  
                  
                  18,000Accrued
      interest payable
                  
                  
                  279
                  
                  
                  
                  288Accounts
      payable and other liabilities
                  
                  
                  2,718
                  
                  
                  
                  2,592TOTAL
      LIABILITIES
                  
                  
                  960,356
                  
                  
                  
                  944,095Commitments
      and contingent liabilities
                  
                  
                  -
                  
                  
                  
                  -STOCKHOLDERS'
      EQUITY:Series
      A preferred stock, $1 par value per share; authorized 5,000,000 shares;
      issued and outstanding, 20,000 shares with a liquidation preference of
      $20,000 Mar (2009)
                  
                  
                  19,740
                  
                  
                  
                  -Common
      stock, $1 par value per share; authorized 10,000,000 shares; issued and
      outstanding, 4,679,504 shares Mar (2009), and 4,668,030 shares Dec
      (2008)
                  
                  
                  4,680
                  
                  
                  
                  4,668Additional
      paid-in capital
                  
                  
                  34,578
                  
                  
                  
                  34,145Retained
      earnings
                  
                  
                  36,069
                  
                  
                  
                  36,476Accumulated
      other comprehensive loss
                  
                  
                  (2,229
                  )
                  
                  
                  (2,337
                  )TOTAL
      STOCKHOLDERS' EQUITY
                  
                  
                  92,838
                  
                  
                  
                  72,952TOTAL
      LIABILITIES AND STOCKHOLDERS' EQUITY
                  
                  $
                  1,053,194
                  
                  
                  $
                  1,017,047
 
 See
notes to the unaudited consolidated financial statements.
  4
 
 FIRST
FINANCIAL SERVICE CORPORATION
 Consolidated
Statements of Income
 (Unaudited)
 Three
      Months Ended(Dollars
      in thousands, except per share data)
                                              
                                              March
      31,2009
                                              
                                              
                                              2008Interest
      and Dividend Income:Loans,
      including fees
                                              
                                              $
                                              13,944
                                              
                                              
                                              $
                                              14,032Taxable
      securities
                                              
                                              
                                              308
                                              
                                              
                                              
                                              384Tax
      exempt securities
                                              
                                              
                                              106
                                              
                                              
                                              
                                              100Total
      interest income
                                              
                                              
                                              14,358
                                              
                                              
                                              
                                              14,516Interest
      Expense:Deposits
                                              
                                              
                                              4,500
                                              
                                              
                                              
                                              5,686Short-term
      borrowings
                                              
                                              
                                              43
                                              
                                              
                                              
                                              322Federal
      Home Loan Bank advances
                                              
                                              
                                              597
                                              
                                              
                                              
                                              596Subordinated
      debentures
                                              
                                              
                                              329
                                              
                                              
                                              
                                              167Total
      interest expense
                                              
                                              
                                              5,469
                                              
                                              
                                              
                                              6,771Net
      interest income
                                              
                                              
                                              8,889
                                              
                                              
                                              
                                              7,745Provision
      for loan losses
                                              
                                              
                                              2,045
                                              
                                              
                                              
                                              584Net
      interest income after provision for loan losses
                                              
                                              
                                              6,844
                                              
                                              
                                              
                                              7,161Non-interest
      Income:Customer
      service fees on deposit accounts
                                              
                                              
                                              1,477
                                              
                                              
                                              
                                              1,416Gain
      on sale of mortgage loans
                                              
                                              
                                              177
                                              
                                              
                                              
                                              148Total
      other-than-temporary impairment losses
                                              
                                              
                                              (1,183
                                              )
                                              
                                              
                                              -Portion
      of loss recognized in other comprehensive income (before
      taxes)
                                              
                                              
                                              1,028
                                              
                                              
                                              
                                              -Net
      impairment losses recognized in earnings
                                              
                                              
                                              (155
                                              )
                                              
                                              
                                              -Write
      down on real estate acquired through foreclosure
                                              
                                              
                                              (17
                                              )
                                              
                                              
                                              -Brokerage
      commissions
                                              
                                              
                                              93
                                              
                                              
                                              
                                              118Other
      income
                                              
                                              
                                              428
                                              
                                              
                                              
                                              272Total
      non-interest income
                                              
                                              
                                              2,003
                                              
                                              
                                              
                                              1,954Non-interest
      Expense:Employee
      compensation and benefits
                                              
                                              
                                              4,002
                                              
                                              
                                              
                                              3,418Office
      occupancy expense and equipment
                                              
                                              
                                              848
                                              
                                              
                                              
                                              653Marketing
      and advertising
                                              
                                              
                                              265
                                              
                                              
                                              
                                              214Outside
      services and data processing
                                              
                                              
                                              793
                                              
                                              
                                              
                                              717Bank
      franchise tax
                                              
                                              
                                              264
                                              
                                              
                                              
                                              250FDIC
      insurance premiums
                                              
                                              
                                              179
                                              
                                              
                                              
                                              90Amortization
      of core deposit intangible
                                              
                                              
                                              101
                                              
                                              
                                              
                                              -Other
      expense
                                              
                                              
                                              1,331
                                              
                                              
                                              
                                              993Total
      non-interest expense
                                              
                                              
                                              7,783
                                              
                                              
                                              
                                              6,335Income
      before income taxes
                                              
                                              
                                              1,064
                                              
                                              
                                              
                                              2,780Income
      taxes
                                              
                                              
                                              303
                                              
                                              
                                              
                                              897Net
      Income
                                              
                                              
                                              761
                                              
                                              
                                              
                                              1,883Less:Dividends
      on preferred stock
                                              
                                              
                                              (267
                                              )
                                              
                                              
                                              -Accretion
      on preferred stock
                                              
                                              
                                              (11
                                              )
                                              
                                              
                                              -Net
      income available to common shareholders
                                              
                                              $
                                              483
                                              
                                              
                                              $
                                              1,883Shares
      applicable to basic income per share
                                              
                                              
                                              4,676,587
                                              
                                              
                                              
                                              4,663,447Basic
      income per share
                                              
                                              $
                                              0.10
                                              
                                              
                                              $
                                              0.40Shares
      applicable to diluted income per share
                                              
                                              
                                              4,676,690
                                              
                                              
                                              
                                              4,697,876Diluted
      income per share
                                              
                                              $
                                              0.10
                                              
                                              
                                              $
                                              0.40Cash
      dividends declared per share
                                              
                                              $
                                              0.190
                                              
                                              
                                              $
                                              0.190
  See
notes to the unaudited consolidated financial statements.
  5
 
 FIRST
FINANCIAL SERVICE CORPORATION
 Consolidated
Statements of Comprehensive Income
 (Unaudited)
 
 Three
      Months EndedMarch
      31,(Dollars in thousands)
                                        
                                        2009
                                        
                                        
                                        2008Net Income
                                        
                                        $
                                        761
                                        
                                        
                                        $
                                        1,883Other
      comprehensive income (loss):Change
      in unrealized gain (loss)on
      securities available-for-sale
                                        
                                        
                                        224
                                        
                                        
                                        
                                        181Reclassification
      of realized amount onsecurities
      available-for-sale
                                        
                                        
                                        140
                                        
                                        
                                        
                                        -Reclassification
      of realized amount onsecurities
      held-to-maturity
                                        
                                        
                                        15
                                        
                                        
                                        
                                        -Non-credit
      component of other-than-temporary
      impairment on held-to-maturitysecurities
                                        
                                        
                                        (215
                                        )
                                        
                                        
                                        -Net
      unrealized gain (loss) recognized incomprehensive
      income
                                        
                                        
                                        164
                                        
                                        
                                        
                                        181Tax
      effect
                                        
                                        
                                        (56
                                        )
                                        
                                        
                                        (61
                                        )Total
      other comphrehensive income (loss)
                                        
                                        
                                        108
                                        
                                        
                                        
                                        120Comprehensive Income
                                        
                                        $
                                        869
                                        
                                        
                                        $
                                        2,003
  See
notes to the unaudited consolidated financial statements.
  6
 
 FIRST
FINANCIAL SERVICE CORPORATION
 Consolidated
Statement of Changes in Stockholders' Equity
 Three
Months Ended March 31, 2009
 (Dollars
In Thousands, Except Per Share Amounts)
 (Unaudited)
  Shares
                                            
                                            
                                            Amount
                                            
                                            
                                            Additional
                                              Paid-in
                                            
                                            
                                            Retained
                                            
                                            
                                            Accumulated
                                              Other
                                              Comprehensive
                                              (Loss),
      Net ofPreferred
                                            
                                            
                                            Common
                                            
                                            
                                            Preferred
                                            
                                            
                                            Common
                                            
                                            
                                            Capital
                                            
                                            
                                            Earnings
                                            
                                            
                                            Tax
                                            
                                            
                                            TotalBalance,
      January 1, 2009
                                            
                                            
                                            -
                                            
                                            
                                            
                                            4,668
                                            
                                            
                                            $
                                            -
                                            
                                            
                                            $
                                            4,668
                                            
                                            
                                            $
                                            34,145
                                            
                                            
                                            $
                                            36,476
                                            
                                            
                                            $
                                            (2,337
                                            )
                                            
                                            $
                                            72,952Net
      income
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            761
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            761Issuance
      of preferred stock and a common stock warrant
                                            
                                            
                                            20,000
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            19,729
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            271
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            20,000Shares
      issued under dividend reinvestment
    program
                                            
                                            
                                            
                                            
                                            
                                            
                                            1
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            1
                                            
                                            
                                            
                                            2
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            3Stock
      issued for employee benefitplans
                                            
                                            
                                            
                                            
                                            
                                            
                                            11
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            11
                                            
                                            
                                            
                                            134
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            145Stock-based
      compensation expense
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            26
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            26Net
      change in unrealized gains (losses) on securities available-for-sale, net
      of tax
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            108
                                            
                                            
                                            
                                            108Dividends
      on preferred stock
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            (267
                                            )
                                            
                                            
                                            
                                            
                                            
                                            
                                            (267
                                            )Accretion
      of preferred stock discount
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            11
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            (11
                                            )
                                            
                                            
                                            
                                            
                                            
                                            
                                            -Cash
      dividends declared ($.19 per share)
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            (890
                                            )
                                            
                                            
                                            -
                                            
                                            
                                            
                                            (890
                                            )Balance,
      March 31, 2009
                                            
                                            
                                            20,000
                                            
                                            
                                            
                                            4,680
                                            
                                            
                                            $
                                            19,740
                                            
                                            
                                            $
                                            4,680
                                            
                                            
                                            $
                                            34,578
                                            
                                            
                                            $
                                            36,069
                                            
                                            
                                            $
                                            (2,229
                                            )
                                            
                                            $
                                            92,838
  See
notes to the unaudited consolidated financial statements.
  7





FIRST
FINANCIAL SERVICE CORPORATION


Consolidated
Statements of Cash Flows


(Dollars
In Thousands)


(Unaudited)





Three Months EndedMarch 31,2009
                
                
                2008Operating Activities:Net
      income
                
                $
                761
                
                
                $
                1,883Adjustments
      to reconcile net income to net cash provided by operating
      activities:Provision
      for loan losses
                
                
                2,045
                
                
                
                584Depreciation
      on premises and equipment
                
                
                413
                
                
                
                361Federal
      Home Loan Bank stock dividends
                
                
                -
                
                
                
                (100
                )Core
      deposit intangible amortization
                
                
                101
                
                
                
                -Net
      amortization (accretion) available-for-sale
                
                
                1
                
                
                
                1Net
      amortization (accretion) held-to-maturity
                
                
                5
                
                
                
                3Impairment
      loss on securities available-for-sale
                
                
                140
                
                
                
                -Impairment
      loss on securities held-to-maturity
                
                
                15
                
                
                
                -Gain
      on sale of mortgage loans
                
                
                (177
                )
                
                
                (148
                )Origination
      of loans held for sale
                
                
                (36,010
                )
                
                
                (11,983
                )Proceeds
      on sale of loans held for sale
                
                
                35,026
                
                
                
                7,988Stock-based
      compensation expense
                
                
                26
                
                
                
                36Changes
      in:Cash
      surrender value of life insurance
                
                
                (91
                )
                
                
                (91
                )Interest
      receivable
                
                
                380
                
                
                
                438Other
      assets
                
                
                (1,562
                )
                
                
                (749
                )Interest
      payable
                
                
                (9
                )
                
                
                (439
                )Accounts
      payable and other liabilities
                
                
                126
                
                
                
                768Net
      cash from operating activities
                
                
                1,190
                
                
                
                (1,448
                )Investing
      Activities:Maturities
      of securities available-for-sale
                
                
                341
                
                
                
                484Maturities
      of securities held-to-maturity
                
                
                690
                
                
                
                11,260Net
      change in loans
                
                
                (39,244
                )
                
                
                (12,118
                )Net
      purchases of premises and equipment
                
                
                (980
                )
                
                
                (1,332
                )Net
      cash from investing activities
                
                
                (39,193
                )
                
                
                (1,706
                )Financing
      ActivitiesNet
      change in deposits
                
                
                46,119
                
                
                
                15,762Change
      in short-term borrowings
                
                
                (29,869
                )
                
                
                (8,400
                )Repayments
      to Federal Home Loan Bank
                
                
                (106
                )
                
                
                (34
                )Issuance
      of preferred stock, net
                
                
                20,000
                
                
                
                -Issuance
      of common stock
                
                
                3
                
                
                
                -Issuance
      of common stock for employee benefit plans
                
                
                145
                
                
                
                68Dividends
      paid on common stock
                
                
                (890
                )
                
                
                (886
                )Dividends
      paid on preferred stock
                
                
                (267
                )
                
                
                -Net
      cash from financing activities
                
                
                35,135
                
                
                
                6,510(Decrease)
      Increase in cash and cash equivalents
                
                
                (2,868
                )
                
                
                3,356Cash
      and cash equivalents, beginning of period
                
                
                20,905
                
                
                
                14,948Cash
      and cash equivalents, end of period
                
                $
                18,037
                
                
                $
                18,304





See
notes to the unaudited consolidated financial statements.


8





NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS





1.
            BASIS
      OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING
    POLICIES





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





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





Adoption of New
Accounting Standards– In early April 2009, the FASB issued the following
FSPs that are intended to provide additional guidance on interim fair value
disclosures, fair value measurements and other-than-temporary impairment
(OTTI):





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





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


9


NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS





1.
            BASIS
      OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING
    POLICIES





Additionally,
if the reporting entity elects to adopt early this FSP, FSP FAS 115-2 and FAS
124-2 also must be accounted for as a change in accounting estimate according to
paragraph 19 of SFAS No. 154, Accounting Changes and Error
Corrections.  We early adopted this FSP for our first quarter
ended March 31, 2009.





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





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


10


NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS





1.
            BASIS
      OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING
    POLICIES




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





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





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





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





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


11





NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS





1.
            BASIS
      OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING
    POLICIES





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





2.
            SECURITIES





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





Gross
                                
                                
                                Gross(Dollars
      in thousands)
                                
                                Amortized
                                
                                
                                Unrealized
                                
                                
                                UnrealizedCost
                                
                                
                                Gains
                                
                                
                                Losses
                                
                                
                                Fair ValueSecurities
      available-for-sale:March
      31, 2009:Mortgage-backed
                                
                                $
                                5,730
                                
                                
                                $
                                113
                                
                                
                                $
                                (1
                                )
                                
                                $
                                5,842Equity
                                
                                
                                933
                                
                                
                                
                                7
                                
                                
                                
                                (17
                                )
                                
                                
                                923State
      and municipal
                                
                                
                                9,549
                                
                                
                                
                                2
                                
                                
                                
                                (683
                                )
                                
                                
                                8,868Corporate
                                
                                
                                2,609
                                
                                
                                
                                -
                                
                                
                                
                                (2,569
                                )
                                
                                
                                40Total
                                
                                $
                                18,821
                                
                                
                                $
                                122
                                
                                
                                $
                                (3,270
                                )
                                
                                $
                                15,673December
      31, 2008:Mortgage-backed
                                
                                $
                                6,079
                                
                                
                                $
                                70
                                
                                
                                $
                                (10
                                )
                                
                                $
                                6,139Equity
                                
                                
                                933
                                
                                
                                
                                17
                                
                                
                                
                                (2
                                )
                                
                                
                                948State
      and municipal
                                
                                
                                9,558
                                
                                
                                
                                3
                                
                                
                                
                                (946
                                )
                                
                                
                                8,615Corporate
                                
                                
                                2,732
                                
                                
                                
                                -
                                
                                
                                
                                (2,659
                                )
                                
                                
                                73Total
                                
                                $
                                19,302
                                
                                
                                $
                                90
                                
                                
                                $
                                (3,617
                                )
                                
                                $
                                15,775





Gross
                  
                  
                  GrossAmortized
                  
                  
                  Unrecognized
                  
                  
                  UnrecognizedCost
                  
                  
                  Gains
                  
                  
                  Losses
                  
                  
                  Fair ValueSecurities
      held-to-maturity:March
      31, 2009:U.S.
      Treasury and agencies
                  
                  $
                  4,000
                  
                  
                  $
                  14
                  
                  
                  $
                  -
                  
                  
                  $
                  4,014Mortgage-backed
                  
                  
                  1,588
                  
                  
                  
                  8
                  
                  
                  
                  -
                  
                  
                  
                  1,596State
      and municipal
                  
                  
                  481
                  
                  
                  
                  4
                  
                  
                  
                  -
                  
                  
                  
                  485Corporate
                  
                  
                  28
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  28Total
                  
                  $
                  6,097
                  
                  
                  $
                  26
                  
                  
                  $
                  -
                  
                  
                  $
                  6,123December
      31, 2008:U.S.
      Treasury and agencies
                  
                  $
                  4,503
                  
                  
                  $
                  54
                  
                  
                  $
                  -
                  
                  
                  $
                  4,557Mortgage-backed
                  
                  
                  1,780
                  
                  
                  
                  -
                  
                  
                  
                  (7
                  )
                  
                  
                  1,773State
      and municipal
                  
                  
                  481
                  
                  
                  
                  2
                  
                  
                  
                  -
                  
                  
                  
                  483Corporate
                  
                  
                  258
                  
                  
                  
                  -
                  
                  
                  
                  (225
                  )
                  
                  
                  33Total
                  
                  $
                  7,022
                  
                  
                  $
                  56
                  
                  
                  $
                  (232
                  )
                  
                  $
                  6,846


12


NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
  2.
              SECURITIES
      – (Continued)
 
 The
amortized cost and fair value of securities at March 31, 2009, by contractual
maturity, are shown below.  Securities not due at a single maturity
date, primarily equity securities, are shown separately.
  Amortized
              
              
              Fair(Dollars
      in thousands)
              
              Cost
              
              
              ValueSecurities
      available-for-sale:Due
      in one year or less
              
              $
              110
              
              
              $
              111Due
      after one year through five years
              
              
              2,054
              
              
              
              2,098Due
      after five years through ten years
              
              
              2,016
              
              
              
              2,074Due
      after ten years
              
              
              13,708
              
              
              
              10,467Equity
              
              
              933
              
              
              
              923Total
              
              $
              18,821
              
              
              $
              15,673Amortized
              
              
              Fair(Dollars
      in thousands)
              
              Cost
              
              
              ValueSecurities
      held-to-maturity:Due
      in one year or less
              
              $
              4,235
              
              
              $
              4,249Due
      after one year through five years
              
              
              1,699
              
              
              
              1,711Due
      after five years through ten years
              
              
              87
              
              
              
              87Due
      after ten years
              
              
              76
              
              
              
              76Total
              
              $
              6,097
              
              
              $
              6,123
  There
were not any sales of available-for-sale securities for the March 31, 2009 and
2008 periods.
 
 Investment
securities pledged to secure public deposits and FHLB advances had an amortized
cost of $18.6 million and fair value of $18.1 million at March 31, 2009 and a
$19.6 million amortized cost and fair value of $18.8 million at December 31,
2008.
  13
  NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
  2.
              SECURITIES
      – (Continued)
 
 The
following table summarizes the investment securities with unrealized losses at
March 31, 2009 and December 31, 2008 by aggregated major security type and
length of time in a continuous unrealized loss position.  Trust
preferred securities are included in the corporate category:
 
 March
      31, 2009
                                
                                Less
      than 12 Months
                                
                                
                                12
      Months or More
                                
                                
                                TotalFair
                                
                                
                                Unrealized
                                
                                
                                Fair
                                
                                
                                Unrealized
                                
                                
                                Fair
                                
                                
                                UnrealizedDescription of Securities
                                
                                Value
                                
                                
                                Loss
                                
                                
                                Value
                                
                                
                                Loss
                                
                                
                                Value
                                
                                
                                LossMortgage-backed
                                
                                $
                                77
                                
                                
                                $
                                -
                                
                                
                                $
                                524
                                
                                
                                $
                                (1
                                )
                                
                                $
                                601
                                
                                
                                $
                                (1
                                )Equity
                                
                                
                                491
                                
                                
                                
                                (17
                                )
                                
                                
                                -
                                
                                
                                
                                -
                                
                                
                                
                                491
                                
                                
                                
                                (17
                                )State
      and municipal
                                
                                
                                -
                                
                                
                                
                                -
                                
                                
                                
                                8,641
                                
                                
                                
                                (683
                                )
                                
                                
                                8,641
                                
                                
                                
                                (683
                                )Corporate
                                
                                
                                39
                                
                                
                                
                                (2,569
                                )
                                
                                
                                -
                                
                                
                                
                                -
                                
                                
                                
                                39
                                
                                
                                
                                (2,569
                                )Total
      temporarily impaired
                                
                                $
                                607
                                
                                
                                $
                                (2,586
                                )
                                
                                $
                                9,165
                                
                                
                                $
                                (684
                                )
                                
                                $
                                9,772
                                
                                
                                $
                                (3,270
                                )December
      31, 2008
                                
                                Less
      than 12 Months
                                
                                
                                12
      Months or More
                                
                                
                                TotalFair
                                
                                
                                Unrealized
                                
                                
                                Fair
                                
                                
                                Unrealized
                                
                                
                                Fair
                                
                                
                                UnrealizedDescription of Securities
                                
                                Value
                                
                                
                                Loss
                                
                                
                                Value
                                
                                
                                Loss
                                
                                
                                Value
                                
                                
                                LossMortgage-backed
                                
                                $
                                3,944
                                
                                
                                $
                                (15
                                )
                                
                                $
                                526
                                
                                
                                $
                                (2
                                )
                                
                                $
                                4,470
                                
                                
                                $
                                (17
                                )Equity
                                
                                
                                6
                                
                                
                                
                                (2
                                )
                                
                                
                                -
                                
                                
                                
                                -
                                
                                
                                
                                6
                                
                                
                                
                                (2
                                )State
      and municipal
                                
                                
                                938
                                
                                
                                
                                (99
                                )
                                
                                
                                7,450
                                
                                
                                
                                (847
                                )
                                
                                
                                8,388
                                
                                
                                
                                (946
                                )Corporate
                                
                                
                                106
                                
                                
                                
                                (2,884
                                )
                                
                                
                                -
                                
                                
                                
                                -
                                
                                
                                
                                106
                                
                                
                                
                                (2,884
                                )Total
      temporarily impaired
                                
                                $
                                4,994
                                
                                
                                $
                                (3,000
                                )
                                
                                $
                                7,976
                                
                                
                                $
                                (849
                                )
                                
                                $
                                12,970
                                
                                
                                $
                                (3,849
                                )
  Each
quarter we review all investments with an unrealized loss position for other
than temporary impairment (“OTTI”) under SFAS No. 115, “Accounting for Certain
Investments in Debt and Equity Securities”(“SFAS No. 115”) and
EITF 99-20-1, “Amendments to the Impairment Guidance of EITF 99-20. EITF 99-20-1
revises the impairment guidance for beneficial interests in EITF 99-20 to better
align with the requirements of SFAS No. 115 for determining whether an
impairment of debt securities has occurred.
 
 As
discussed in Note 1, in early April 2009, the FASB issued FSP FAS 115-2,
and FAS 124-2, Recognition and
Presentation of Other-Than-Temporary Impairments. Among other provisions,
the FSP requires entities to split other than temporarily impaired charges
between credit losses (i.e., the loss based on the entity’s estimate of the
decrease in cash flows, including those that result from expected voluntary
prepayments), which are charged to earnings, and the remainder of the impairment
charge (non-credit component) to accumulated other comprehensive income. This
requirement pertains to both securities held to maturity and securities
available for sale. The FSP is effective for interim and annual reporting
periods ending after June 15, 2009 with early adoption permitted for
periods ending after March 15, 2009. We incorporated this guidance in our
review of impairment as of March 31, 2009.
 
 The
unrealized losses on the state and municipal securities were caused primarily by
interest rate decreases.  The contractual terms of those investments
do not permit the issuer to settle the securities at a price less than the
amortized cost of the investment.  Because we do not have the intent
to sell these securities and it is likely that we will not be required to sell
the securities before their anticipated recovery, we do not consider these
investments to be other-than-temporarily impaired at March 31,
2009.
 
 As
discussed in Note 6 - Fair Value, the fair value of our portfolio of trust
preferred securities, which are included in the corporate category, has
decreased significantly as a result of the current credit crisis and lack of
liquidity in the financial markets.  There are limited trades in trust
preferred securities and the majority
of holders of such instruments have elected not to participate in the market
unless they are required to sell as a result of liquidation, bankruptcy, or
other forced or distressed conditions.
  14
 
 NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
  2.
              SECURITIES
      – (Continued)
  To
determine if the five trust preferred securities were other than temporarily
impaired as of March 31, 2009, we used a discounted cash flow
analysis.  The cash flow models used were used to determine if the
current present value of the cash flows expected on each security were still
equivalent to the original cash flows projected on the security when
purchased.   The cash flow analysis takes into consideration
assumptions for prepayments, defaults and deferrals for the underlying pool of
banks, insurance companies and REITs.
 
 In making
our determination, we considered all available market information that could be
obtained without undue cost and effort, and considered the unique
characteristics of each trust preferred security individually by assessing the
available market information and the various risks associated with that security
including:
 
 ·
              Valuation
      estimates provided by our investment
broker;
 ·
              The
      amount of fair value decline;
 ·
              How
      long the decline in fair value has
existed;
 ·
              Significant
      rating agency changes on the
issuer;
 ·
              Level
      of interest rates and any movement in pricing for credit and other
      risks;
 ·
              Information
      about the performance of the underlying institutions that issued the debt
      instruments, such as net income, return on equity, capital adequacy,
      non-performing assets, Texas ratios,
etc;
 ·
              Our
      intent to sell the security or whether it is more likely than not that we
      will be required to sell the security before its anticipated recovery;
      and
 ·
              Other
      relevant observable inputs.
 
 Upon
completion of our analysis at March 31, 2009, our models indicated
other-than-temporary impairment on two of our trust preferred securities, all of
which experienced additional defaults or deferrals during the
period.  These two securities had other-than-temporary impairment
losses of $1.2 million, of which $155,000 was recorded as expense and $1.0
million was recorded in other comprehensive income.  We will continue
to evaluate the portfolio of trust preferred securities for OTTI on a quarterly
basis.
 
 The
following table details the two debt securities with other-than-temporary
impairment, their credit rating at March 31, 2009 and the related credit losses
recognized in earnings:
  PreTSL
      XXI
                        
                        
                        PreTSL
      VI(Dollars
      in thousands)
                        
                        Rated
      Ca
                        
                        
                        Rated
      Caa1
                        
                        
                        TotalAmount
      of other-than-temporary impairment related to credit loss at
      January 1, 2009
                        
                        $
                        -
                        
                        
                        $
                        -
                        
                        
                        $
                        -Addition
                        
                        
                        140
                        
                        
                        
                        15
                        
                        
                        
                        155Amount
      of other-than-temporary impairmentrelated to credit loss at March
      31, 2009
                        
                        $
                        140
                        
                        
                        $
                        15
                        
                        
                        $
                        155
  15
  NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
  3.
              LOANS
 
 Loans are
summarized as follows:
 
 March
      31,
                        
                        
                        December
      31,(Dollars
      in thousands)
                        
                        2009
                        
                        
                        2008Commercial
                        
                        $
                        56,331
                        
                        
                        $
                        56,863Real
      estate commercial
                        
                        
                        590,537
                        
                        
                        
                        563,314Real
      estate construction
                        
                        
                        19,344
                        
                        
                        
                        17,387Residential
      mortgage
                        
                        
                        173,058
                        
                        
                        
                        165,337Consumer
      and home equity
                        
                        
                        70,192
                        
                        
                        
                        69,649Indirect
      consumer
                        
                        
                        34,739
                        
                        
                        
                        31,754Loans
      held for sale
                        
                        
                        10,728
                        
                        
                        
                        9,567954,929
                        
                        
                        
                        913,871Less:Net
      deferred loan origination fees
                        
                        
                        (865
                        )
                        
                        
                        (870
                        )Allowance
      for loan losses
                        
                        
                        (15,072
                        )
                        
                        
                        (13,565
                        )(15,937
                        )
                        
                        
                        (14,435
                        )Loans
      Receivable
                        
                        $
                        938,992
                        
                        
                        $
                        899,436
  The
allowance for loan loss is summarized as follows:
 
 As of and For theThree Months EndedMarch 31,(Dollars
      in thousands)
                      
                      2009
                      
                      
                      2008Balance,
      beginning of period
                      
                      $
                      13,565
                      
                      
                      $
                      7,922Provision
      for loan losses
                      
                      
                      2,045
                      
                      
                      
                      584Charge-offs
                      
                      
                      (593
                      )
                      
                      
                      (149
                      )Recoveries
                      
                      
                      55
                      
                      
                      
                      38Balance,
      end of period
                      
                      $
                      15,072
                      
                      
                      $
                      8,395
  Impaired
loans are summarized below.  There were no impaired loans for the
periods presented without an allowance allocation.
 
 As of and For the
                        
                        
                        As of and For theThree Months Ended
                        
                        
                        Year EndedMarch 31,
                        
                        
                        December 31,(Dollars in thousands)
                        
                        2009
                        
                        
                        2008End
      of period impaired loans
                        
                        $
                        21,657
                        
                        
                        $
                        16,769Amount
      of allowance for loan loss allocated
                        
                        
                        3,126
                        
                        
                        
                        3,090
  16
  NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
  3.
              LOANS–
    (Continued)
 
 We report
non-performing loans as impaired.  Our non-performing loans were as
follows:
 
 March
      31,
                    
                    
                    December
      31,(Dollars
      in thousands)
                    
                    2009
                    
                    
                    2008Restructured
                    
                    $
                    2,434
                    
                    
                    $
                    1,182Loans
      past due over 90 days still on accrual
                    
                    
                    -
                    
                    
                    
                    -Non
      accrual loans
                    
                    
                    19,223
                    
                    
                    
                    15,587Total
                    
                    $
                    21,657
                    
                    
                    $
                    16,769
  4.
              EARNINGS
      PER SHARE
 
 The
reconciliation of the numerators and denominators of the basic and diluted EPS
is as follows:
 
 Three Months Ended(Dollars in thousands,
                              
                              March 31,except per share data)
                              
                              2009
                              
                              
                              2008Basic:Net
      income
                              
                              $
                              761
                              
                              
                              $
                              1,883Less:Preferred
      stock dividends
                              
                              
                              (267
                              )
                              
                              
                              -Accretion
      on preferred stock discount
                              
                              
                              (11
                              )
                              
                              
                              -Net
      income available to common shareholders
                              
                              $
                              483
                              
                              
                              $
                              1,883Weighted
      average common shares
                              
                              
                              4,676
                              
                              
                              
                              4,663Diluted:Weighted
      average common shares
                              
                              
                              4,676
                              
                              
                              
                              4,663Dilutive
      effect of stock options and warrants
                              
                              
                              1
                              
                              
                              
                              35Weighted
      average common and incrementalshares
                              
                              
                              4,677
                              
                              
                              
                              4,698Earnings
      Per Common Share:Basic
                              
                              $
                              0.10
                              
                              
                              $
                              0.40Diluted
                              
                              $
                              0.10
                              
                              
                              $
                              0.40
  Stock
options for 197,536 and 40,600 shares of common stock were not included in the
March 31, 2009 and 2008 computation of diluted earnings per share because their
impact was anti-dilutive.  Warrants to purchase 215,983 shares at
March 31, 2009 were not included in the computation because their impact was
also anti-dilutive.
 
 5.
              STOCK
      OPTION PLAN
 
 Our 2006
Stock Incentive Plan, which is shareholder approved, succeeded our 1998 Stock
Option and Incentive Plan. Under the 2006 Plan, we may grant either incentive or
non-qualified stock options tokey employees and directorsfor a total of 647,350 shares
of our common stock at not less than fair value at the date such options are
granted.Options
available for future grant under the 1998 Plan totaled 38,500 shares and were
rolled into the 2006 Plan.We believe that the ability to award stock options and other forms of
stock-based incentive compensation can assist us in attracting and retaining key
employees. Stock-based incentive compensation is also a means to align the
interests of key employees with those of our shareholders by providing awards
intended to reward recipients for our long-term growth.The option to purchase shares
vest over periods of one to five years and expire ten years after the date of
grant.We issue new
shares of common stock upon the exercise of stock options. At March 31, 2009
options available for future grant under the 2006 Plan totaled 590,750.Compensation cost related to
options granted under the 1998 and 2006 Plans that was charged against earnings
for the periods ended March 31, 2009and 2008 was $26,000 and
$28,000.
  17
 
 NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
  5.
              STOCK
      OPTION PLAN - (Continued)
 
 The fair
value of each option award is estimated on the date of grant using the
Black-Scholes option valuation model that uses various weighted-average
assumptions.  The risk-free interest rate is based on the U.S.
Treasury yield curve in effect at the time of grant.  The expected
volatility is based on the fluctuation in the price of a share of stock over the
period for which the option is being valued and the expected life of the options
granted represents the period of time the options are expected to be
outstanding.  There were no stock option grants for the March 31, 2009
period.
 
 A summary
of option activity under the 1998 and 2006 Plans as of March 31, 2009 is
presented below:
 
 WeightedWeighted
                      
                      
                      AverageNumber
                      
                      
                      Average
                      
                      
                      Remaining
                      
                      
                      Aggregateof
                      
                      
                      Exercise
                      
                      
                      Contractual
                      
                      
                      IntrinsicOptions
                      
                      
                      Price
                      
                      
                      Term
                      
                      
                      Value(Dollars
      In Thousands)Outstanding,
      beginning of period
                      
                      
                      208,517
                      
                      
                      $
                      19.19Granted
      during period
                      
                      
                      -
                      
                      
                      
                      -Forfeited
      during period
                      
                      
                      (1,464
                      )
                      
                      
                      16.74Exercised
      during period
                      
                      
                      -
                      
                      
                      
                      -Outstanding,
      end of period
                      
                      
                      207,053
                      
                      
                      $
                      19.21
                      
                      
                      
                      4.7
                      
                      
                      $
                      -Eligible
      for exercise at period end
                      
                      
                      157,873
                      
                      
                      $
                      17.93
                      
                      
                      
                      3.6
                      
                      
                      $
                      -
 
 There
were no options exercised, modified or settled in cash for the periods ended
March 31, 2009 and 2008.  Management expects all outstanding unvested
options will vest.
 
 As of
March 31, 2009 there was $230,000 of total unrecognized compensation cost
related to non-vested share-based compensation arrangements granted under the
1998 and 2006 Plans.  That cost is expected to be recognized over a
weighted-average period of 3.2 years.
 
 6.
              FAIR
      VALUE
 
 SFAS No.
157 defines fair value as the price that would be received to sell an asset or
paid to transfer a liability in an orderly transaction between market
participants at the measurement date.  SFAS No. 157 establishes a fair
value hierarchy that prioritizes the use of inputs used in valuation
methodologies into the following three levels:
 
 Level 1: Quoted prices
(unadjusted) for identical assets or liabilities in active markets.  A
quoted         price in an active
market provides the most reliable evidence of fair value and shall be used to
measure fair value whenever available.
 
 Level 2:Significant other
observable inputs other than Level 1 prices such as quoted prices for similar
assets or liabilities; quoted prices in markets that are not active; or other
inputs that are observable or can be corroborated by observable market
data.
 
 Level 3: Significant
unobservable inputs that reflect a reporting entity’s own assumptions about the
assumptions that market participants would use in pricing an asset or
liability.
  18
 
 NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
  6.
              FAIR
      VALUE - (Continued)
 
 We used
the following methods and significant assumptions to estimate the fair value of
available-for-sale-securities.
 
 Available-for-sale
securities: The fair values of equity securities are determined by
obtaining quoted prices on nationally recognized securities exchanges (Level 1
inputs).  The fair values of debt securities are determined by a
matrix pricing, which is a mathematical technique widely used in the industry to
value debt securities without relying exclusively on quoted prices for the
specific securities but rather by relying on the securities’ relationship to
other benchmark quoted securities (Level 2 inputs).  In certain cases
where there is limited activity or less transparency around inputs to the
valuation, securities are classified within (Level 3) of the valuation
hierarchy.  Discounted cash flows are calculated using spread to swap
and LIBOR curves that are updated to incorporate loss severities, volatility,
credit spread and optionality.  Rating agency and industry research
reports as well as defaults and deferrals on individual securities are reviewed
and incorporated into the calculations.
 
 Assets and Liabilities
Measured at Fair Value on a Recurring Basis
 
 Assets
measured at fair value on a recurring basis are summarized below:
 
 Quoted Prices inActive Markets for
                      
                      
                      Significant Other
                      
                      
                      SignificantMarch 31,
                      
                      
                      Identical Assets
                      
                      
                      Observable Inputs
                      
                      
                      Unobservable Inputs(Dollars in thousands)
                      
                      2009
                      
                      
                      (Level 1)
                      
                      
                      (Level 2)
                      
                      
                      (Level 3)Assets:Available-for-sale
      securities
                      
                      $
                      15,673
                      
                      
                      $
                      632
                      
                      
                      $
                      14,711
                      
                      
                      $
                      330
 
 Quoted Prices inActive Markets for
                                  
                                  
                                  Significant Other
                                  
                                  
                                  SignificantDecember 31,
                                  
                                  
                                  Identical Assets
                                  
                                  
                                  Observable Inputs
                                  
                                  
                                  Unobservable Inputs(Dollars in thousands)
                                  
                                  2008
                                  
                                  
                                  (Level 1)
                                  
                                  
                                  (Level 2)
                                  
                                  
                                  (Level 3)Assets:Available-for-sale
      securities
                                  
                                  $
                                  15,775
                                  
                                  
                                  $
                                  657
                                  
                                  
                                  $
                                  14,754
                                  
                                  
                                  $
                                  364
  Between
June 2002 and July 2006, we invested in four AFS and one HTM investment grade
tranches of trust preferred collateralized debt obligation (“CDO”)
securities.  The securities were issued and are referred to as
Preferred Term Securities Limited (“PreTSL”).  The underlying
collateral for the PreTSL is unguaranteed pooled trust preferred securities
issued by banks, insurance companies and REITs geographically dispersed across
the United States.  We hold five PreTSL securities, none of which are
currently investment grade.  Prior to September 30, 2008, we
determined the fair value of the trust preferred securities using a valuation
technique based on Level 2 inputs.  The Level 2 inputs included
estimates of the market value for each security provided through our investment
broker.
 
 Since
late 2007, the markets for collateralized debt obligations and trust preferred
securities have become increasingly inactive.  The inactivity was
first evidenced in late 2007 when new issues of similar securities were
discounted in order to complete the offering.  Beginning in the second
quarter of 2008, the purchase and sale activity of these securities
substantially decreased as investors elected to hold the securities instead of
selling them at substantially depressed prices.  Our brokers have
indicated that little if any activity is occurring in this sector and that the
PreTSL securities trades that are taking place are primarily distressed sales
where the seller must liquidate as a result of insolvency, redemptions or
closure of a fund holding the security, or other distressed
conditions.  As a result, the bid-ask spreads have widened
significantly and the volume of trades decreased significantly compared to
historical volumes.
  19
 
 NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
  6.
              FAIR
      VALUE - (Continued)
 
 As of
March 31, 2009, we determined that the market for the trust preferred securities
that we hold and for similar CDO securities (such as higher-rated tranches
within the same CDO security) are also not active.  That determination
was made considering that there are few observable transactions for the trust
preferred securities or similar CDO securities and the observable prices for
those transactions have varied substantially over time.  Consequently,
we have considered those observable inputs and determined that our trust
preferred securities are classified within Level 3 of the fair value
hierarchy.
 
 We have
determined that an income approach valuation technique (using cash flows and
present value techniques) that maximizes the use of relevant observable inputs
and minimizes the use of unobservable inputs is equally or more representative
of fair value then relying on the estimation of market value technique used at
prior measurement dates, which now has few observable inputs and relies on an
inactive market with distressed sales conditions that would require significant
adjustments.
 
 We
received valuation estimates on our trust preferred securities for March 31,
2009.  Those valuation estimates were based on proprietary pricing
models utilizing significant unobservable inputs in an inactive market with
distressed sales, Level 3 inputs, rather than actual transactions in an active
market.
 
 In
accordance with the requirements of SFAS 157, we determined that a risk-adjusted
discount rate appropriately reflects the reporting entity’s estimate of the
assumptions that market participants would use in an active market to estimate
the selling price of the asset at the measurement date.
 
 We
conduct a thorough review of fair value hierarchy classifications on a quarterly
basis.  Reclassification of certain financial instruments may occur
when input observability changes.
 
 The table
below presents a reconciliation and income statement classification of gains and
losses for all assets measured at fair value on a recurring basis using
significant unobservable inputs (Level 3) for the period ended March 31,
2009:
 
 Fair ValueMeasurementsUsing SignificantUnobservable Inputs(Level 3)(Dollars in thousands)
                    
                    Asset/LiabilityBeginning
      balance, January 1, 2009
                    
                    $
                    364Total
      gains or losses realized:Included
      in earningsImpairment
      charge on security
                    
                    
                    (140
                    )Increase
      in fair value of securities
                    
                    
                    106Transfers
      in and/or out of Level 3
                    
                    
                    -Ending
      balance, March 31, 2009
                    
                    $
                    330
  20
  NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
  6.
              FAIR
      VALUE - (Continued)
 
 Assets and Liabilities
Measured at Fair Value on a Nonrecurring Basis
 
 Assets
measured at fair value on a nonrecurring basis are summarized
below:
 
 Quoted Prices inActive Markets for
                      
                      
                      Significant Other
                      
                      
                      SignificantMarch 31,
                      
                      
                      Identical Assets
                      
                      
                      Observable Inputs
                      
                      
                      Unobservable Inputs(Dollars in thousands)
                      
                      2009
                      
                      
                      (Level 1)
                      
                      
                      (Level 2)
                      
                      
                      (Level 3)Assets:Impaired
      Loans
                      
                      $
                      18,531
                      
                      
                      $
                      -
                      
                      
                      $
                      -
                      
                      
                      $
                      18,531Real
      estate acquired through foreclosure
                      
                      
                      6,754
                      
                      
                      
                      -
                      
                      
                      
                      6,754
                      
                      
                      
                      -
 
 Quoted Prices inActive Markets for
                    
                    
                    Significant Other
                    
                    
                    SignificantDecember 31,
                    
                    
                    Identical Assets
                    
                    
                    Observable Inputs
                    
                    
                    Unobservable Inputs(Dollars in thousands)
                    
                    2008
                    
                    
                    (Level 1)
                    
                    
                    (Level 2)
                    
                    
                    (Level 3)Assets:Impaired
      Loans
                    
                    $
                    13,679
                    
                    
                    $
                    -
                    
                    
                    $
                    -
                    
                    
                    $
                    13,679Real
      estate acquired through foreclosure
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
  Impaired
loans, which are measured for impairment using the fair value of the collateral
for collateral dependent loans, had a carrying amount of $21.7 million, with a
valuation allowance of $3.1 million, resulting in an additional provision for
loan losses of $36,000 for the 2009 period.  Values for collateral
dependent loans are generally based on appraisals obtained from licensed real
estate appraisals and in certain circumstances consideration of offers obtained
to purchase properties prior to foreclosure.  Appraisals for
commercial real estate generally use three methods to derive value: cost, sales
or market comparison and income approach.  The cost method bases value
on the estimated cost to replace the current property after considering
adjustments for depreciation.  Values of the market comparison
approach evaluate the sales price of similar properties in the same market
area.  The income approach considers net operating income generated by
the property and an investors required return.  The final value is a
reconciliation of these three approaches and takes into consideration any other
factors management deems relevant to arrive at a representative fair
value.
 
 Real
estate owned acquired through foreclosure is recorded at lower of cost or fair
value less estimated selling costs at the date of foreclosure.  Fair
value is based on the appraised market value of the property based on sales of
similar assets.  The fair value may be subsequently reduced if the
estimated fair value declines below the original appraised value. Fair value
adjustments of $17,000 were made to real estate owned during the quarter ended
March 31, 2009.
 
 7.
              PREFERRED
      STOCK
 
 On
October 3, 2008, Congress passed the Emergency Economic Stabilization Act
of 2008 (EESA), which creates the Troubled Asset Relief Program (“TARP”) and
provides the U.S. Secretary of the Treasury with broad authority to implement
certain actions to help restore stability and liquidity to U.S. markets. The
Capital Purchase Program (the “CPP”) was announced by the U.S. Treasury on
October 14, 2008 as part of TARP. Pursuant to the CPP, the U.S. Treasury will
purchase up to $250 billion of senior preferred shares on standardized
terms from qualifying financial institutions. The purpose of the CPP is to
encourage U.S. financial institutions to build capital to increase the flow of
financing to U.S. businesses and consumers and to support the U.S.
economy.
  21
  NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
  7.
              PREFERRED
      STOCK - (Continued)
 
 The CPP
is voluntary and requires a participating institution to comply with a number of
restrictions and provisions, including standards for executive compensation and
corporate governance and limitations on share repurchases and the declaration
and payment of dividends on common shares. The standard terms of the CPP require
that a participating financial institution limit the payment of dividends to the
most recent quarterly amount prior to October 14, 2008, which is $0.19 per
share in our case. This dividend limitation will remain in effect until the
earlier of three years or such time that the preferred shares are
redeemed.
 
 Eligible
financial institutions could generally apply to issue senior preferred shares to
the U.S. Treasury in aggregate amounts ranging from 1% to 3% of the
institution’s risk-weighted assets. We applied for an investment by the U.S.
Treasury of $20 million, which was approved by the U.S. Treasury on
December 8, 2008.  On January 9, 2009, we issued $20 million
of cumulative perpetual preferred shares, with a liquidation preference of
$1,000 per share (the “Senior Preferred Shares”). The Senior Preferred Shares
constitute Tier 1 capital and rank senior to our common shares. The Senior
Preferred Shares pay cumulative dividends quarterly at a rate of 5% per annum
for the first five years and will reset to a rate of 9% per annum after five
years. The Senior Preferred Shares may be redeemed at any time, at our
option.
 
 We also
issued a warrant to purchase 215,983 common shares to the U.S. Treasury at a
purchase price of $13.89 per share. The aggregate purchase price equals 15% of
the aggregate amount of the Senior Preferred Shares purchased by the U.S.
Treasury or $3 million. The initial purchase price per share for the warrant and
the number of common shares subject to the warrant were determined by reference
to the market price of the common shares (calculated on a 20-day trailing
average) on December 8, 2008, the date the U.S. Treasury approved our TARP
application. The warrant has a term of 10 years and is potentially dilutive
to earnings per share.
 
 On February 17, 2009, the American
Recovery and Reinvestment Act of 2009 (“ARRA”)was enacted. ARRA requires the U.S.
Treasury to enact additional compensation standards on companies receiving
financial assistance from the U.S. government. In addition, ARRA imposes certain new
executive compensation and corporate expenditure limits oneachcurrent and future CPP
recipient,including First Financial
ServiceCorporation, until therecipienthas repaid theTreasury.ARRA also permits CPP participants to
redeem the preferred shares held by the TreasuryDepartmentwithout penalty and without the need to
raise new capital, subject to the Treasury’s consultation with the recipient’s
appropriate regulatory agency.
  22


Item 2.
 MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
 AND
RESULTS OF OPERATIONS
 
 GENERAL
 
 We
operate 21 banking centers in eight contiguous counties in Central Kentucky
along the Interstate 65 corridor and the Louisville Metropolitan area, including
southern Indiana.  Our markets range from Metro Louisville in
Jefferson County, Kentucky approximately 40 miles north of our headquarters in
Elizabethtown, Kentucky to Hart County, Kentucky, approximately 30 miles south
of Elizabethtown to Harrison County, Indiana approximately 60 miles northwest of
our headquarters.  Our markets are supported by a diversified industry
base and have a regional population of over 1 million.  Based on the
current economic slow-down, management anticipates that our markets may not
continue to grow at the rate experienced over the last few
years.  However, we believe we will still be well positioned to
benefit from growth in our local markets when the economy rebounds in the
future.
 
 We serve
the needs and cater to the economic strengths of the local communities in which
we operate, and we strive to provide a high level of personal and professional
customer service. We offer a variety of financial services to our retail and
commercial banking customers. These services include personal and corporate
banking services and personal investment financial counseling
services.
 
 Throughour personal investment
financial counseling services, we offer a wide variety of mutual funds, equity
investments, and fixed and variable annuities.  We invest in the
wholesale capital markets to manage a portfolio of securities and use various
forms of wholesale funding. The security portfolio contains a variety of
instruments, including callable debentures, taxable and non-taxable debentures,
fixed and adjustable rate mortgage backed securities, and collateralized
mortgage obligations.
 
 Our
results of operations depend primarily on net interest income, which is the
difference between interest income from interest-earning assets and interest
expense on interest-bearing liabilities. Our operations are also affected by
non-interest income, such as service charges, insurance agency revenue, loan
fees, gains and losses from the sale of mortgage loans and gains from the sale
of real estate held for development. Our principal operating expenses, aside
from interest expense, consist of compensation and employee benefits, occupancy
costs, data processing expense and provisions for loan losses.
 
 This
discussion and analysis covers material changes in the financial condition since
December 31, 2008 and material changes in the results of operations for the
three month period ending March 31, 2009 as compared to 2008.  It
should be read in conjunction with "Management’s Discussion and Analysis of
Financial Condition and Results of Operations" included in the Annual Report on
Form 10-K for the period ended December 31, 2008.
 
 OVERVIEW
 
 On June
25, 2008, we expanded our operations into southern Indiana with the acquisition
of FSB Bancshares, Inc., the bank holding company for The Farmers State
Bank.  The Farmers State Bank had approximately $65.7 million in total
assets and $55.8 million in deposits.  The Farmers State Bank had four
banking offices in Harrison and Floyd Counties in Indiana, which are adjacent to
four Kentucky counties where we currently operate and are part of the Louisville
MSA.  Upon completion of the acquisition, these four offices became
branches of First Federal Savings Bank.  The acquisition is
anticipated to be accretive to our earnings during the first full year of the
combined operations.
 
 Over the
past several years we have focused on enhancing and expanding our retail and
commercial banking network in our core markets as well as establishing our
presence in the Louisville market.  Our core markets, where we have a
combined 23% market share, have become increasingly competitive as several new
banks have entered those markets during the past few years.  In order
to protect and grow our market share, we are replacing existing branches with
newer, enhanced facilities and anticipate constructing several new facilities
over the next few years.  In addition to the enhancement and expansion
in our core markets, we have been increasing our presence in the Louisville
market.  Our acquisition of FSB Bancshares, Inc. has broadened our
retail branch network in the Louisville market, which now extends into Southern
Indiana.  Approximately 73% of the deposit base in the Louisville
market is controlled by six out-of-state banks.  While the market is
very competitive, we believe this creates an opportunity for smaller community
banks with more power to make decisions locally.  We believe our
investment in these initiatives along with our continued commitment to a high
level of customer service will enhance our market share in our core markets and
our development in the Louisville market.
  23
 
 Our
retail branch network continues to generate encouraging results.Total deposits have grown
28% over the past three years. Total deposits were $821.5 million at March 31,
2009, an increase of $46.1 million from December 31, 2008.  After our
acquisition of Farmers State Bank in 2008, our retail branch network in the
Louisville market has broadened to fifteen offices.  Additional sites
within the Louisville market are under development with another location
scheduled to open early in the third quarter of 2009. Competition for deposits
continues to be challenging in all of the markets we serve.  This
intense competition and any additional actions taken by the Federal Open Market
Committee (FOMC) to change interest rates could add to additional margin
compression as the rate environment remains uncertain.
 
 We have
developed a strong commercial real estate niche in our markets.  We
have an experienced team of bankers who focus on providing service and
convenience to our customers.  It is quite common for our bankers to
close loans at a customer’s place of business or even the customer’s personal
residence.   This high level of service has been especially well
received in our Louisville market, which is dominated by regional banks.To further develop our
commercial banking relationships in Louisville, we opened a private banking
office in April 2007.  This upscale facility complements our full
service centers in Louisville by attracting commercial deposit relationships in
conjunction with our commercial lending relationships.
 
 Our
emphasis on commercial lending generated 35% growth in the total loan portfolio
and 40% growth in commercial loans over the past three years. Commercial loans were
$666.2 million at March 31, 2009, an increase of $28.6 million, or 4.5% from
December 31, 2008.
 
 Although
we had growth in the loan portfolio during the quarter, credit quality remained
challenging in 2009.There was a significant
migration of loans into the Substandard loan categories during the quarter,
resulting in higher provision for loan losses.At March 31, 2009, the
allowance for loan losses was $15.1 million compared to $13.6 million at
December 31, 2008.  Allowance for loan loss to total loans increased
to 1.60% at March 31, 2009 compared to 1.50% at December 31, 2008.The allowance for loan
losses to non-performing loans fell to 70% from 81% at March 31, 2009 compared
to December 31, 2008.
 
 Despite
the continued deterioration in economic conditions during the first quarter, the
Corporation’s capital position remained well-capitalized as defined by
regulatory standards.  Our capital position was further bolstered in
the first quarter of 2009 by our participation in the U.S. Treasury Department
Capital Purchase Program.  Under the Capital Purchase Program, we sold
$20 million of cumulative perpetual preferred shares to the U.S. Treasury in a
transaction that closed on January 9, 2009.
 
 We
believe that the economy is in a very deep and long lasting
recession.  During the last quarter of 2008, the continued economic
slowdown moved to sectors not previously impacted, including consumer,
commercial, industrial among others.  Credit issues are broadening in
these sectors and economic recovery is most likely several quarters
away.  We will continue to monitor credit quality very closely in 2009
as this recession persists.  As the economy and the financial sector
continue to struggle, probable losses in the loan portfolio could increase,
resulting in higher provision for loan losses during 2009.
 
 CRITICAL
ACCOUNTING POLICIES
 
 Our
accounting and reporting policies comply with U.S. generally accepted accounting
principles and conform to general practices within the banking
industry.  The accounting policy relating to the allowance for loan
losses is critical to the understanding of our results of operations since the
application of this policy requires significant management assumptions and
estimates that could result in materially different amounts to be reported if
conditions or underlying circumstances were to change.
  Allowance for
Loan Losses–We
maintain an allowance sufficient to absorb probable incurred credit losses
existing in the loan portfolio. Our Allowance for Loan Loss Review Committee,
which is comprised of senior officers, evaluates the allowance for loan losses
on a quarterly basis.  We estimate the allowance using past loan loss
experience, known and inherent risks in the portfolio, adverse situations that
may affect the borrower’s ability to repay, estimated value of the underlying
collateral, and current economic conditions.  While we estimate the
allowance for loan losses based in part on historical losses within each loan
category, estimates for losses within the commercial real estate portfolio are
more dependent upon credit analysis and recent payment performance. Allocations
of the allowance may be made for specific loans or loan categories, but the
entire allowance is available for any loan that, in management’s judgment,
should be charged off.
 
 The
allowance consists of specific and general components.  The specific
component relates to loans that are individually classified as impaired or loans
otherwise classified as substandard or doubtful.  The general
component covers non-classified loans and is based on historical loss experience
adjusted for current factors. Allowance estimates are developed with actual loss
experience adjusted for current economic conditions.  Allowance
estimates are considered a prudent measurement of the risk in the loan portfolio
and are applied to individual loans based on loan type.
  24
  Based on
our calculation, an allowance of $15.1 millionor 1.60% of total loans
was our estimate of probable losses within the loan portfolio as ofMarch 31, 2009.This estimate resulted
in a provision for loan losses on the income statement of$2.0 million for the
2009 period.If
the mix and amount of future charge off percentages differ significantly from
those assumptions used by management in making its determination, the allowance
for loan losses and provision for loan losses on the income statement could be
materially increased.
 
 Goodwill and
Other Intangible Assets– Costs in excess of the
estimated fair value of identified assets acquired through purchase transactions
are recorded as an asset. As per Statement of Financial Accounting Standards No.
142, “Goodwill and Other Intangible Assets”, an annual impairment analysis is
required to be performed to determine if the asset is impaired and needs to be
written down to its fair value. This assessment is conducted annually or more
frequently if conditions warrant. No impairment was identified as a result of
the impairment analysis at December 31, 2008. In making these impairment
analyses, management must make subjective assumptions regarding the fair value
of our assets and liabilities. It is possible that these judgments may change
over time as market conditions or our strategies change, and these changes may
cause us to record impairment changes to adjust the goodwill to its estimated
fair value.
 
 Impairment of
Investment Securities–All unrealized losses are reviewed to determine whether the losses are
other-than-temporary.  Investment securities are evaluated for
other-than-temporary impairment on at least a quarterly basis and more
frequently when economic or market conditions warrant such an evaluation to
determine whether a decline in their value below amortized cost is
other-than-temporary.  We evaluate a number of factors including, but
not limited to: a discounted cash flow analysis; valuation estimates provided by
investment brokers; how much fair value has declined below amortized cost; how
long the decline in fair value has existed; the financial condition of the
issuer; significant rating agency changes on the issuer; and whether management
has the intent to sell the debt security or whether it is more likely than not
that we will be required to sell the debt security before its anticipated
recovery.
 
 The term
“other-than-temporary” is not intended to indicate that the decline is
permanent, but indicates that the possibility for a near-term recovery of value
is not necessarily favorable, or that there is a lack of evidence to support a
realizable value equal to or greater than the carrying value of the
investment.  Once a decline in value is determined to be
other-than-temporary, the cost basis of the security is written down to fair
value and a corresponding charge to earnings is recognized if the security is an
equity security.  If other-than-temporary impairment exists for a debt
security, the security’s carrying value is reduced by the amount of the credit
loss and is charged to earnings while the remainder of the loss remains in other
comprehensive income.
 
 RESULTS
OF OPERATIONS
 
 Net
income for the quarter ended March 31, 2009 was $761,000 or $0.10 per common
share diluted compared to $1.9 million or $0.40 per common share diluted for the
same period in 2008. Earnings decreased for
2009 compared to 2008 due to a decrease in our net interest margin, an increase
in provision for loan loss expense, a write down taken on investment securities
that were other-than-temporary impaired, and a higher level of non-interest
expense related to our expansion efforts. Net income available to common
shareholders was also impacted by dividends paid on preferred shares. Our book value per
common share decreased from $16.01 at March 31, 2008 to $15.62 at March 31,
2009.Annualized
net income for 2009 represented a return on average assets of .30% and a return
on average equity of 3.37%.These compare with a
return on average assets of .87% and a return on average equity of 10.16% for
the 2008 period also annualized.
 
 Net Interest
Income–The
principal source of our revenue is net interest income.  Net interest
income is the difference between interest income on interest-earning assets,
such as loans and securities and the interest expense on liabilities used to
fund those assets, such as interest-bearing deposits and borrowings. Net
interest income is affected by both changes in the amount and composition of
interest-earning assets and interest-bearing liabilities as well as changes in
market interest rates.
 
 The
growth in our commercial loan portfolio has increased net interest
income.  The increase in the volume of interest earning assets
increased net interest income by $1.1 million for the first three months of 2009
compared to the prior year period.  Average interest earning assets
increased $154.8 million for 2009 compared to 2008.  Despite the
increase in interest earning assets, our net interest margin realized a modest
decline of ten basis points.  The yield on earning assets averaged
6.01% for 2009 compared to an average yield on earning assets of 7.16% for the
same period in 2008.  This decrease was offset by a decrease in our
cost of funds.  Net interest margin as a percent of average earning
assets decreasedto
3.73% for 2009 compared to 3.83% for the 2008 period.
  25
  Our cost
of funds averaged 2.49% for the first three months of 2009 compared to an
average cost of funds of 3.68% for the same period in 2008. Going forward, our
cost of funds is expected to continue to decrease as certificates of deposit
re-price and roll off into new certificates of deposit at lower interest
rates.
  Our net
interest margin is likely to compress in future quarters as a result of the FOMC
decreasing the Federal Funds rate by 500 basis points since September
2007.  The current Federal Funds rate is a range of 0.00% to
0.25%.  Correspondingly, variable rate loans that are tied to the
federal prime rate are immediately re-priced downward when the prime rate
decreases.  However, interest rates paid on customer deposits, which
are priced off of the London Interbank Offering Rate (LIBOR), have not adjusted
downward proportionately with the declining interest yields on loans and
investments.  LIBOR, which is a market driven rate, did not decline in
rate as much as the prime rate.  Therefore, we do not expect our
deposit costs to decline as fast as our yield on loans. Sixty percent of
deposits are time deposits that re-price over a longer period of
time.  This difference in the timing of the repricing of our assets
and deposits is expected to continue to lower our net interest
margin.
  26
  AVERAGE
BALANCE SHEET
 
 The
following table provides information relating to our average balance sheet and
reflects the average yield on assets and average cost of liabilities for the
indicated periods.  Yields and costs for the periods presented are
derived by dividing income or expense by the average monthly balance of assets
or liabilities, respectively.
 
 Quarter
      Ended March 31,2009
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            2008(Dollars
      in thousands)
                                                                                                            
                                                                                                            Average
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            Average
                                                                                                            
                                                                                                            
                                                                                                            Average
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            AverageBalance
                                                                                                            
                                                                                                            
                                                                                                            Interest
                                                                                                            
                                                                                                            
                                                                                                            Yield/Cost (5)
                                                                                                            
                                                                                                            
                                                                                                            Balance
                                                                                                            
                                                                                                            
                                                                                                            Interest
                                                                                                            
                                                                                                            
                                                                                                            Yield/Cost (5)ASSETSInterest
      earning assets:U.S.
      Treasury and agencies
                                                                                                            
                                                                                                            $
                                                                                                            4,161
                                                                                                            
                                                                                                            
                                                                                                            $
                                                                                                            39
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            3.80
                                                                                                            %
                                                                                                            
                                                                                                            $
                                                                                                            11,283
                                                                                                            
                                                                                                            
                                                                                                            $
                                                                                                            106
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            3.78
                                                                                                            %Mortgage-backed
      securities
                                                                                                            
                                                                                                            
                                                                                                            7,691
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            82
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            4.32
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            10,248
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            109
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            4.28Equity
      securities
                                                                                                            
                                                                                                            
                                                                                                            940
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            33
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            14.23
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            1,613
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            14
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            3.49State
      and political subdivision securities (1)
                                                                                                            
                                                                                                            
                                                                                                            9,093
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            161
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            7.18
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            9,524
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            152
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            6.42Corporate
      bonds
                                                                                                            
                                                                                                            
                                                                                                            333
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            34
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            41.45
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            3,091
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            49
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            6.38Loans
      (2) (3)
      (4)
                                                                                                            
                                                                                                            
                                                                                                            939,647
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            13,944
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            6.02
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            774,443
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            14,032
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            7.29FHLB
      stock
                                                                                                            
                                                                                                            
                                                                                                            8,515
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            96
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            4.57
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            7,622
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            100
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            5.28Interest
      bearing deposits
                                                                                                            
                                                                                                            
                                                                                                            2,956
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            24
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            3.29
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            741
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            6
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            3.26Total interest earning
      assets
                                                                                                            
                                                                                                            
                                                                                                            973,336
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            14,413
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            6.01
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            818,565
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            14,568
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            7.16Less:  Allowance
      for loan losses
                                                                                                            
                                                                                                            
                                                                                                            (13,793
                                                                                                            )
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            (8,060
                                                                                                            )Non-interest
      earning assets
                                                                                                            
                                                                                                            
                                                                                                            80,188
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            64,781Total
    assets
                                                                                                            
                                                                                                            $
                                                                                                            1,039,731
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            $
                                                                                                            875,286LIABILITIES ANDSTOCKHOLDERS'
      EQUITYInterest
      bearing liabilities:Savings
      accounts
                                                                                                            
                                                                                                            $
                                                                                                            111,149
                                                                                                            
                                                                                                            
                                                                                                            $
                                                                                                            197
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            0.72
                                                                                                            %
                                                                                                            
                                                                                                            $
                                                                                                            95,009
                                                                                                            
                                                                                                            
                                                                                                            $
                                                                                                            511
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            2.16
                                                                                                            %NOW
      and money market accounts
                                                                                                            
                                                                                                            
                                                                                                            157,873
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            249
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            0.64
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            127,211
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            435
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            1.38Certificates
      of deposit and other time deposits
                                                                                                            
                                                                                                            
                                                                                                            491,731
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            4,054
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            3.34
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            417,054
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            4,740
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            4.57Short
      term borrowings
                                                                                                            
                                                                                                            
                                                                                                            59,942
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            43
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            0.29
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            38,634
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            322
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            3.35FHLB
      advances
                                                                                                            
                                                                                                            
                                                                                                            52,603
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            597
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            4.60
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            53,061
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            596
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            4.52Subordinated
      debentures
                                                                                                            
                                                                                                            
                                                                                                            18,000
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            329
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            7.41
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            10,000
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            167
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            6.72Total interest bearing
      liabilities
                                                                                                            
                                                                                                            
                                                                                                            891,298
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            5,469
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            2.49
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            740,969
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            6,771
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            3.68Non-interest
      bearing liabilities:Non-interest
      bearing deposits
                                                                                                            
                                                                                                            
                                                                                                            54,117
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            54,335Other
      liabilities
                                                                                                            
                                                                                                            
                                                                                                            2,605
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            5,435Total liabilities
                                                                                                            
                                                                                                            
                                                                                                            948,020
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            800,739Stockholders'
      equity
                                                                                                            
                                                                                                            
                                                                                                            91,711
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            74,547Total liabilities andstockholders'
      equity
                                                                                                            
                                                                                                            $
                                                                                                            1,039,731
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            $
                                                                                                            875,286Net interest
      income
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            $
                                                                                                            8,944
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            $
                                                                                                            7,797Net interest
      spread
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            3.52
                                                                                                            %
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            3.48
                                                                                                            %Net interest
      margin
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            3.73
                                                                                                            %
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            3.83
                                                                                                            %
 
 (1)
              Taxable
      equivalent yields are calculated assuming a 34% federal income tax
      rate.
 (2)
              Includes
      loan fees, immaterial in amount, in both interest income and the
      calculation of yield on loans.
 (3)
              Calculations
      include non-accruing loans in the average loan amounts
      outstanding.
 (4)
              Includes
      loans held for
      sale.
 (5)
              Annualized
  27
  RATE/VOLUME
ANALYSIS
 
 The table
below provides information regarding changes in interest income and interest
expense for the periods indicated.  For each category of
interest-earning assets and interest-bearing liabilities, information is
provided on changes attributable to (1) changes in rate (changes in rate
multiplied by old volume); (2) changes in volume (change in volume multiplied by
old rate); and (3) changes in rate-volume (change in rate multiplied by change
in volume).  Changes in rate-volume are proportionately allocated
between rate and volume variance.
 
 Three
      Months EndedMarch
      31,2009 vs. 2008Increase
      (decrease)Due
      to change in(Dollars
      in thousands)
                            
                            
                            
                            
                            
                            
                            
                            NetRate
                            
                            
                            Volume
                            
                            
                            ChangeInterest
      income:U.S.
      Treasury and agencies
                            
                            $
                            -
                            
                            
                            $
                            (67
                            )
                            
                            $
                            (67
                            )Mortgage-backed
      securities
                            
                            
                            1
                            
                            
                            
                            (28
                            )
                            
                            
                            (27
                            )Equity
      securities
                            
                            
                            27
                            
                            
                            
                            (8
                            )
                            
                            
                            19State
      and political subdivisionsecurities
                            
                            
                            16
                            
                            
                            
                            (7
                            )
                            
                            
                            9Corporate
      bonds
                            
                            
                            63
                            
                            
                            
                            (78
                            )
                            
                            
                            (15
                            )Loans
                            
                            
                            (2,812
                            )
                            
                            
                            2,724
                            
                            
                            
                            (88
                            )FHLB
      stock
                            
                            
                            (15
                            )
                            
                            
                            11
                            
                            
                            
                            (4
                            )Interest
      bearing deposits
                            
                            
                            -
                            
                            
                            
                            18
                            
                            
                            
                            18Total
      interest earning assets
                            
                            
                            (2,720
                            )
                            
                            
                            2,565
                            
                            
                            
                            (155
                            )Interest
      expense:Savings
      accounts
                            
                            
                            (389
                            )
                            
                            
                            75
                            
                            
                            
                            (314
                            )NOW
      and money market accounts
                            
                            
                            (273
                            )
                            
                            
                            87
                            
                            
                            
                            (186
                            )Certificates
      of deposit and othertime deposits
                            
                            
                            (1,443
                            )
                            
                            
                            757
                            
                            
                            
                            (686
                            )Short
      term borrowings
                            
                            
                            (396
                            )
                            
                            
                            117
                            
                            
                            
                            (279
                            )FHLB
      advances
                            
                            
                            6
                            
                            
                            
                            (5
                            )
                            
                            
                            1Subordinated
      debentures
                            
                            
                            17
                            
                            
                            
                            145
                            
                            
                            
                            162Total
      interest bearing liabilities
                            
                            
                            (2,478
                            )
                            
                            
                            1,176
                            
                            
                            
                            (1,302
                            )Net
      change in net interest income
                            
                            $
                            (242
                            )
                            
                            $
                            1,389
                            
                            
                            $
                            1,147
  Non-Interest
Income and Non-Interest Expense
 
 The
following tables provide a comparison of the components of non-interest income
and expenses for the periods ended March 31, 2009 and 2008.  The
tables show the dollar and percentage change from 2008 to 2009.  Below
each table is a discussion of significant changes and trends.
 
 Three
      Months EndedMarch
      31,(Dollars in
thousands)
                                              
                                              2009
                                              
                                              
                                              2008
                                              
                                              
                                              Change
                                              
                                              
                                              %Non-interest
      incomeCustomer
      service fees on deposit accounts
                                              
                                              $
                                              1,477
                                              
                                              
                                              $
                                              1,416
                                              
                                              
                                              $
                                              61
                                              
                                              
                                              
                                              4.3
                                              %Gain
      on sale of mortgage loans
                                              
                                              
                                              177
                                              
                                              
                                              
                                              148
                                              
                                              
                                              
                                              29
                                              
                                              
                                              
                                              19.6
                                              %Net
      impairment losses recognized in earnings
                                              
                                              
                                              (155
                                              )
                                              
                                              
                                              -
                                              
                                              
                                              
                                              (155
                                              )
                                              
                                              
                                              100.0
                                              %Write
      down on real estate acquired through foreclosure
                                              
                                              
                                              (17
                                              )
                                              
                                              
                                              -
                                              
                                              
                                              
                                              (17
                                              )
                                              
                                              
                                              100.0
                                              %Brokerage
      commissions
                                              
                                              
                                              93
                                              
                                              
                                              
                                              118
                                              
                                              
                                              
                                              (25
                                              )
                                              
                                              
                                              -21.2
                                              %Other
      income
                                              
                                              
                                              428
                                              
                                              
                                              
                                              272
                                              
                                              
                                              
                                              156
                                              
                                              
                                              
                                              57.4
                                              %$
                                              2,003
                                              
                                              
                                              $
                                              1,954
                                              
                                              
                                              $
                                              49
                                              
                                              
                                              
                                              2.5
                                              %
  28
 
 Growth in
customer service fees on deposit accounts, our largest component of non-interest
income, is primarily due to growth in customer deposits, overdraft fee income on
retail checking accounts and the sale of fee-based products for
2009.  We continue to increase our customer base through cross-selling
opportunities and marketing initiatives and promotions.  In addition,
we continue to emphasize growing our checking account base to better enhance our
profitability and franchise value.
  We
originate qualified VA, KHC, RHC and conventional secondary market loans and
sell them into the secondary market with servicing rights
released.  For the quarter, gain on sale of mortgage loans increased
due to an increase in the volume of loans closed.
  We
recognized other-than-temporary impairment charges of $155,000 for the expected
credit loss during the first quarter of 2009 on two of our trust preferred
securities. Management believes this impairment was primarily attributable to
the current economic environment which caused the financial conditions of some
of the issuers to deteriorate.
  Further
reducing non-interest income for the 2009 period was a 10% or $17,000 write-down
of the carrying value of real estate owned properties that had been held for
twelve months.
  Other
income increased during the quarter due to $135,000 in gains recorded on the
sale of a real estate acquired through foreclosure properties.
  Three
      Months EndedMarch
      31,(Dollars in
thousands)
                          
                          2009
                          
                          
                          2008
                          
                          
                          Change
                          
                          
                          %Non-interest
      expensesEmployee
      compensation and benefits
                          
                          $
                          4,002
                          
                          
                          $
                          3,418
                          
                          
                          $
                          584
                          
                          
                          
                          17.1
                          %Office
      occupancy expense and equipment
                          
                          
                          848
                          
                          
                          
                          653
                          
                          
                          
                          195
                          
                          
                          
                          29.9
                          %Marketing
      and advertising
                          
                          
                          265
                          
                          
                          
                          214
                          
                          
                          
                          51
                          
                          
                          
                          23.8
                          %Outside
      services and data processing
                          
                          
                          793
                          
                          
                          
                          717
                          
                          
                          
                          76
                          
                          
                          
                          10.6
                          %Bank
      franchise tax
                          
                          
                          264
                          
                          
                          
                          250
                          
                          
                          
                          14
                          
                          
                          
                          5.6
                          %FDIC
      insurance premiums
                          
                          
                          179
                          
                          
                          
                          90
                          
                          
                          
                          89
                          
                          
                          
                          98.9
                          %Amortization
      of core deposit intangible
                          
                          
                          101
                          
                          
                          
                          -
                          
                          
                          
                          101
                          
                          
                          
                          100.0
                          %Other
      expense
                          
                          
                          1,331
                          
                          
                          
                          993
                          
                          
                          
                          338
                          
                          
                          
                          34.0
                          %$
                          7,783
                          
                          
                          $
                          6,335
                          
                          
                          $
                          1,448
                          
                          
                          
                          22.9
                          %
 
 Employee
compensation and benefits is the largest component of non-interest
expense.  Since 2006, we have added three commercial lending
associates and twenty-two retail associates with our expansion efforts. These
associates were hired for a commercial private banking center which opened in
April 2007, a new Louisville retail branch facility that opened in June 2007, a
new Bullitt County retail branch facility that opened in August 2008 and other
positions to support our growth.  We added twenty additional
associates in the second quarter of 2008 as a result of the recent
acquisition.  We look for a continued increase in employee
compensation and benefits expense in line with recent years, as we progress with
our retail expansion and market protection efforts.
 
 Office
occupancy expense and equipment and outside services and data processing
increased due to additional operating expenses related to our expansion efforts
and a system upgrade.  We anticipate the increased level of
non-interest expense to continue in 2009 with additional retail expansion.We will open a
full-service banking center at the main entrance to Fort Knox in our Hardin
County market during the second quarter of 2009 and open another full-service
banking center in the Middletown area of Jefferson County during the third
quarter of 2009.
  Other
expense increased due to increases in interchange expense, postage and courier,
REO expense, losses on NOW accounts and other operating
expenses.  Interchange expense increased due to the switch to
real-time debit card processing, which is more expensive per item than the batch
processing method we used previously.   REO expense relating to
repair, maintenance and taxes increased due to increases in real estate we
acquired through foreclosure.
  The FDIC
charges insured financial institutions premiums to maintain the Deposit
Insurance Fund at a certain level.  See Part I, Item 1, "Business –
Federal Deposit Insurance Assessments" in our 2008 Form
10-K for additional information.  On October 16, 2008, the FDIC
published a restoration plan designed to replenish the Deposit Insurance Fund
over a period of five years and to increase the deposit insurance reserve
ratio.   In order to implement the restoration plan, the FDIC
proposes to change both its risk-based assessment system and its base assessment
rates.  Either an increase in the Risk Category of our bank
subsidiary, or adjustments to the base assessment rates, could materially
increase our deposit insurance premiums and assessments.
  In
addition, under an interim rule adopted during the first quarter of 2009 subject
to public comment, the FDIC proposed to impose a one-time 20 basis point
emergency assessment on all insured depository institutions to be paid on
September 30, 2009, based on deposits at June 30, 2009.  The FDIC has
subsequently indicated the amount of this special assessment could decrease if
certain events transpire.  The interim rule also authorizes the FDIC
to impose an additional emergency assessment of up to 10 basis points in respect
of deposits for quarters ended after June 30, 2009 if necessary to maintain
public confidence in federal deposit insurance.  Each basis point of
any future special assessment during 2009, based on our most recent FDIC deposit
insurance assessment, would cost us, on a pre-tax basis, approximately $82,000
in additional FDIC deposit insurance premium expense.   While the
interim rules are subject to change and the exact  amount of the
special assessment is reportedly under legislative and
regulatory  study,  we expect that a material special
assessment
will  be  assessed  by  the  FDIC
in respect of the insured deposits of all
banks  as  of  June  30,
2009.  Given the enacted and proposed increases in
assessments  for  insured  financial  institutions  in  2009,  we
anticipate  that  FDIC  assessments  on
deposits will have a significantly greater impact upon operating expenses in
2009 compared to 2008.
  29
  Our
efficiency ratio was 71% for 2009 compared to 65% for the 2008
period.  The increase principally reflects our recent expansion
efforts.
 
 ANALYSIS
OF FINANCIAL CONDITION
 
 Total
assets at March 31, 2009 increased by $36.1 million from December 31, 2008. The
increase was primarily driven by an increase in loans of $39.6
million.  The growth in loans was funded with deposits, which
increased $46.1 million for the period.
 
 Loans
 
 Net loans
increased $39.6 million to $939.0 million at March 31, 2009 compared to $899.4
million at December 31, 2008.  Our commercial real estate portfolio
increased $27.2 million to $590.5 million at March 31, 2009.  Our
residential mortgage loan, real estate construction, consumer, home equity and
indirect consumer portfolios all increased for the 2009 period, while the
commercial loan portfolio remained relatively constant.  For 2009, the
growth in commercial real estate loans may not continue at the rate experienced
over the last few years due to the current economic
slow-down.  However, we believe we will still be well positioned to
benefit from growth in our local markets when the economy rebounds.
 
 March
      31,
                      
                      
                      December
      31,(Dollars
      in thousands)
                      
                      2009
                      
                      
                      2008Commercial
                      
                      $
                      56,331
                      
                      
                      $
                      56,863Real
      estate commercial
                      
                      
                      590,537
                      
                      
                      
                      563,314Real
      estate construction
                      
                      
                      19,344
                      
                      
                      
                      17,387Residential
      mortgage
                      
                      
                      173,058
                      
                      
                      
                      165,337Consumer
      and home equity
                      
                      
                      70,192
                      
                      
                      
                      69,649Indirect
      consumer
                      
                      
                      34,739
                      
                      
                      
                      31,754Loans
      held for sale
                      
                      
                      10,728
                      
                      
                      
                      9,567954,929
                      
                      
                      
                      913,871Less:Net
      deferred loan origination fees
                      
                      
                      (865
                      )
                      
                      
                      (870
                      )Allowance
      for loan losses
                      
                      
                      (15,072
                      )
                      
                      
                      (13,565
                      )(15,937
                      )
                      
                      
                      (14,435
                      )Loans
      Receivable
                      
                      $
                      938,992
                      
                      
                      $
                      899,436
 
 Allowance
and Provision for Loan Losses
 
 Our
financial performance depends on the quality of the loans we originate and
management’s ability to assess the degree of risk in existing loans when it
determines the allowance for loan losses.  An increase in loan
charge-offs or non-performing loans or an inadequate allowance for loan losses
could reduce net interest income, net income and capital and limit the range of
products and services we can offer.
 
 The
Allowance for Loan Loss Review Committee evaluates the allowance for loan losses
quarterly to maintain a level sufficient to absorb probable incurred credit
losses existing in the loan portfolio.  Periodic provisions to the
allowance are made as needed.  The Committee determines the allowance
by applying loss estimates to graded loans by categories, as described
below.  In addition, the Committee analyzes such factors as changes in
lending policies and procedures; underwriting standards; collection; charge-off
and recovery history; changes in national and local economic business conditions
and developments; changes in the characteristics of the portfolio; ability and
depth of lending management and staff; changes in the trend of the volume and
severity of past due, non-accrual and classified loans; troubled debt
restructuring and other loan modifications; and results of regulatory
examinations.
 
 2008 was
a tumultuous year for the U.S. economy and the financial service industry.
Deteriorating property values led to declining valuations for loan
portfolios.  The property value declines, which began in the second
half of 2007, have continued into 2009.  The markets we serve have
generally avoided the severe property value declines experienced in other parts
of the country; nonetheless, the impact in our markets was still
significant.  In response to these adverse economic conditions, we
took the opportunity to strengthen our allowance for loan losses substantially
during the second half of 2008 and the first quarter of 2009.  2009
will continue to be a challenging time for our financial institution as we
manage the overall level of our credit quality.
  30
 
 The
following table analyzes our loan loss experience for the periods
indicated.
 
 Three
      Months EndedMarch
      31,(Dollars
      in thousands)
                      
                      2009
                      
                      
                      2008Balance
      at beginning of period
                      
                      $
                      13,565
                      
                      
                      $
                      7,922Loans
      charged-off:Real
      estate mortgage
                      
                      
                      -
                      
                      
                      
                      -Consumer
                      
                      
                      316
                      
                      
                      
                      128Commercial
                      
                      
                      277
                      
                      
                      
                      21Total
      charge-offs
                      
                      
                      593
                      
                      
                      
                      149Recoveries:Real
      estate mortgage
                      
                      
                      3
                      
                      
                      
                      -Consumer
                      
                      
                      52
                      
                      
                      
                      38Commercial
                      
                      
                      -
                      
                      
                      
                      -Total
      recoveries
                      
                      
                      55
                      
                      
                      
                      38Net
      loans charged-off
                      
                      
                      538
                      
                      
                      
                      111Provision
      for loan losses
                      
                      
                      2,045
                      
                      
                      
                      584Balance
      at end of period
                      
                      $
                      15,072
                      
                      
                      $
                      8,395Allowance
      for loan losses to total loans(excluding
      loans held for sale)
                      
                      
                      1.60
                      %
                      
                      
                      1.08
                      %Annualized
      net charge-offs to average loans outstanding
                      
                      
                      0.23
                      %
                      
                      
                      0.06
                      %Allowance
      for loan losses to total non-performing loans
                      
                      
                      70
                      %
                      
                      
                      151
                      %
 
 The
provision for loan losses increased by $1.5 million to $2.0 million in 2009
compared to 2008.  The increase was related to growth in the loan
portfolio and from the specific reserves set aside for loans classified during
2009.  The higher provision was also due to our increasing the general
reserve factors for commercial real estate loans during the period as the level
of classified loans has increased sharply.  The allowance for loan
losses increased $6.7 million to $15.1 million from March 31, 2008 to March 31,
2009. The increase
was due to an increase in net loans for 2009, as well as the provision recorded
to reflect a $42.8 million increase in classified loans for the 2009 period.
 
 Federal
regulations require banks to classify their own assets on a regular
basis.  The regulations provide for three categories of classified
loans — substandard, doubtful and loss.
 
 The
following table provides information with respect to classified loans for the
periods indicated:
 
 March
      31,(Dollars in
thousands)
                                
                                2009
                                
                                
                                2008Classified
      LoansSubstandard
                                
                                $
                                63,029
                                
                                
                                $
                                20,451Doubtful
                                
                                
                                -
                                
                                
                                
                                63Loss
                                
                                
                                271
                                
                                
                                
                                18Total
      Classified
                                
                                $
                                63,300
                                
                                
                                $
                                20,532
  31
 
 As we
focused on credit quality during 2008 and the first quarter of 2009, there was a
significant migration of loans into the Special Mention and Substandard loan
categories.  If economic conditions continue to put stress on our
borrowers going forward, this may result in higher provisions for loan
losses.  We expect that the economy will remain in a recession at
least for the next several quarters.  Credit quality will continue to
be a primary focus in 2009.
 
 The $42.8
million increase in substandard assets for 2009 was primarily the resultof downgrading loans
withsixteen
borrowers with balances ranging from $821,000 to $8.8 million.Offsetting this increase
was the transfer of a classified loan having a balance of $1.3 million to real
estate acquired through foreclosure. Approximately $32.3 million of the total
classified loans were related to real estate development or real estate
construction loans in our market area.  Classified consumer loans
totaled $ 1.5 million, classified mortgage loans totaled $5.7 million andclassified commercial
loans totaled $23.8 million.  For more information on collection
efforts, evaluation of collateral and how loss amounts are estimated, see
“Non-Performing Assets,” below.
 
 Although
we may allocate a portion of the allowance to specific loans or loan categories,
the entire allowance is available for active charge-offs.  We develop
our allowance estimates based on actual loss experience adjusted for current
economic conditions.  Allowance estimates represent a prudent
measurement of the risk in the loan portfolio, which we apply to individual
loans based on loan type.
 
 Non-Performing
Assets
 
 Non-performing
assets consist of certain restructured loans for which interest rate or other
terms have been renegotiated, loans on which interest is no longer accrued, real
estate acquired through foreclosure and repossessed assets.   We
do not have any loans longer than 90 days past due still on
accrual.  Loans, including impaired loans under SFAS 114, are placed
on non-accrual status when they become past due 90 days or more as to principal
or interest, unless they are adequately secured and in the process of
collection.  Loans are considered impaired when we no longer
anticipate full principal or interest payments in accordance with the
contractual loan terms.  If a loan is impaired, we allocate a portion
of the allowance so that the loan is reported, net, at the present value of
estimated future cash flows using the loan’s existing rate, or at the fair value
of collateral if repayment is expected solely from collateral.
 
 We review
our loans on a regular basis and implement normal collection procedures when a
borrower fails to make a required payment on a loan.  If the
delinquency on a mortgage loan exceeds 90 days and is not cured through normal
collection procedures or an acceptable arrangement is not worked out with the
borrower, we institute measures to remedy the default, including commencing a
foreclosure action.  We generally charge off consumer loans when
management deems a loan uncollectible and any available collateral has been
liquidated.  We handle commercial business and real estate loan
delinquencies on an individual basis with the advice of legal
counsel.
 
 We
recognize interest income on loans on the accrual basis except for those loans
in a non-accrual of income status. We discontinue accruing interest on impaired
loans when management believes, after consideration of economic and business
conditions and collection efforts that the borrowers’ financial condition is
such that collection of interest is doubtful, typically after the loan becomes
90 days delinquent.  When we discontinue interest accrual, we reverse
existing accrued interest and subsequently recognize interest income only to the
extent we receive cash payments.
 
 We
classify real estate acquired as a result of foreclosure or by deed in lieu of
foreclosure as real estate owned until such time as it is sold. We classify new
and used automobile, motorcycle and all terrain vehicles acquired as a result of
foreclosure as repossessed assets until they are sold. When such property is
acquired we record it at the lower of the unpaid principal balance of the
related loan or its fair market value.  We charge any write-down of
the property at the time of acquisition to the allowance for loan
losses.  Subsequent gains and losses are included in non-interest
income and non-interest expense.
 
 Real
estate acquired through foreclosure decreased $577,000 to $5.3 million at March
31, 2009.  The decrease was primarily the result of the sale of a
commercial property totaling $1.1 million offset by a commercial credit
relationship totaling $460,000 that was transferred during the first quarter of
2009.
  32
  The
following table provides information with respect to non-performing assets for
the periods indicated.
  March
      31,
                      
                      
                      December
      31,(Dollar
      in thousands)
                      
                      2009
                      
                      
                      2008Restructured
                      
                      $
                      2,434
                      
                      
                      $
                      1,182Past
      due 90 days still on accrual
                      
                      
                      -
                      
                      
                      
                      -Loans
      on non-accrual status
                      
                      
                      19,223
                      
                      
                      
                      15,587Total
      non-performing loans
                      
                      
                      21,657
                      
                      
                      
                      16,769Real
      estate acquired through foreclosure
                      
                      
                      5,348
                      
                      
                      
                      5,925Other
      repossessed assets
                      
                      
                      92
                      
                      
                      
                      91Total
      non-performing assets
                      
                      $
                      27,097
                      
                      
                      $
                      22,785Interest
      income that would have been earned on non-performing loans
                      
                      $
                      1,304
                      
                      
                      $
                      825Interest
      income recognized on non-performing loans
                      
                      
                      68
                      
                      
                      
                      75Ratios:  Non-performing
      loans to total loans(excluding
      loans held for sale)
                      
                      
                      2.30
                      %
                      
                      
                      1.86
                      %Non-performing
      assets to total loans(excluding
      loans held for sale)
                      
                      
                      2.87
                      %
                      
                      
                      2.52
                      %
 
 Non-performing
loans increased $4.9 million to $21.7 million at March 31, 2009 compared to
$16.8 million at December 31, 2008.  The increase in non-accrual loans
consist primarily of five credit relationships with balances ranging from
$121,000 to $999,000. These credit relationships are secured by real estate and
we have provided adequate allowance based on current information.  All
non-performing loans are considered impaired.
 
 Non-performing
assets for the 2009 period include $2.4 million in restructured commercial,
mortgage and consumer loans.  Restructured loans primarily consist of
five credit relationships with balances ranging from $110,000 to $1.6
million.  The terms of these loans have been renegotiated to reduce
the rate of interest and extend the term, thus reducing the amount of cash flow
required from the borrower to service the loans. The borrowers are currently
meeting the terms of the restructured loans.
 
 Investment
Securities
 
 Interest
on securities provides us our largest source of interest income after interest
on loans, constituting 2.9% of the total interest income for the quarter ended
March 31, 2009.  The securities portfolio serves as a source of
liquidity and earnings and contributes to the management of interest rate
risk.  We have the authority to invest in various types of liquid
assets, including short-term United States Treasury obligations and securities
of various federal agencies, obligations of states and political subdivisions,
corporate bonds, certificates of deposit at insured savings and loans and banks,
bankers' acceptances, and federal funds.  We may also invest a portion
of our assets in certain commercial paper and corporate debt
securities.  We are also authorized to invest in mutual funds and
stocks whose assets conform to the investments that we are authorized to make
directly. The available-for-sale and held-to-maturity investment portfolios
decreased by $1.0 million during the 2009 period as securities were called for
redemption in accordance with their terms due to decreasing rates.
 
 We review
all unrealized losses at least on a quarterly basis to determine whether the
losses are other than temporary and more frequently when economic or market
concerns warrant such evaluation. We consider the length of time and the extent
to which the fair value has been less than cost, the financial condition and
near-term prospects of the issuer, and whether management has the intent to sell
the debt security or whether it is more likely than not that we will be required
to sell the debt security before its anticipated recovery.  In
analyzing an issuer’s financial condition, we may consider whether the
securities are issued by the federal government or its agencies, whether
downgrades by bond rating agencies have occurred, and the results of reviews of
the issuer’s financial condition.
  33
  The
unrealized losses on the state and municipal securities were caused primarily by
interest rate decreases.  The contractual terms of those investments
do not permit the issuer to settle the securities at a price less than the
amortized cost of the investment.  Because we do not have the intent
to sell these securities and it is likely that we will not be required to sell
the securities before their anticipated recovery, we do not consider these
investments to be other-than-temporarily impaired at March 31,
2009.
 
 We have
evaluated the decline in the fair value of our trust preferred securities, which
are included in corporate securities and are directly related to the credit and
liquidity crisis being experienced in the financial services industry over the
past year.   The trust preferred securities market is currently
inactive making the valuation of trust preferred securities very
difficult.  The trust preferred securities are valued by management
using unobservable inputs (i.e., Level 3 inputs under SFAS No. 157) through a
discounted cash flow analysis as permitted under SFAS 157 and using the expected
cash flows appropriately discounted using present value techniques.  
Refer to Note 6 – Fair Value for more information.
 
 We
recognized other-than-temporary impairment charges of $155,000 for the expected
credit loss during the 2009 quarter on two of our trust preferred securities
with a cost basis of $1.3 million.  All of our trust preferred
securities are below investment grade but have continued to pay interest as
scheduled through March 31, 2009, and are expected to continue paying interest
as scheduled.    See Note 2 – Securities for more
information.  Management will continue to evaluate these securities
for impairment quarterly.
 
 As
discussed in Note 1, in early April 2009, the FASB issued FSP FAS 115-2,
and FAS 124-2, Recognition and
Presentation of Other-Than-Temporary Impairments. Among other provisions,
the FSP requires entities to split other than temporarily impaired charges
between credit losses (i.e., the loss based on the entity’s estimate of the
decrease in cash flows, including those that result from expected voluntary
prepayments), which are charged to earnings, and the remainder of the impairment
charge (non-credit component) to accumulated other comprehensive income. This
requirement pertains to both securities held to maturity and securities
available for sale. The FSP is effective for interim and annual reporting
periods ending after June 15, 2009 with early adoption permitted for
periods ending after March 15, 2009. We incorporated this guidance in our
review of impairment as of March 31, 2009.
 
 Deposits
 
 We rely
primarily on providing excellent customer service and long-standing
relationships with customers to attract and retain deposits. Market interest
rates and rates on deposit products offered by competing financial institutions
can significantly affect our ability to attract and retain
deposits.  In conjunction with our initiatives to expand and enhance
our retail branch network, we emphasize growing our customer checking account
base to better enhance profitability and franchise value.  Total
deposits increased by $46.1 million year to date compared to December 31, 2008.
Retail and commercial deposits increased $28.2 million and we added $17.9 in
public funds and brokered certificates.   Brokered deposits were
$34.5 million at March 31, 2009 compared to $15.4 million at December 31,
2008.
 
 The
following table breaks down our deposits.
  March
      31,
                      
                      
                      December
      31,2009
                      
                      
                      2008(In
      Thousands)Non-interest
      bearing
                      
                      $
                      57,499
                      
                      
                      $
                      55,668NOW
      demand
                      
                      
                      118,277
                      
                      
                      
                      99,890Savings
                      
                      
                      105,889
                      
                      
                      
                      111,310Money
      market
                      
                      
                      45,845
                      
                      
                      
                      40,593Certificates
      of deposit
                      
                      
                      494,008
                      
                      
                      
                      467,938$
                      821,518
                      
                      
                      $
                      775,399
 
 Short-Term
Borrowings
 
 We have
the ability to obtain short-term borrowings, consisting of federal funds
purchased and securities sold under agreements to repurchase.  We had
short-term borrowings of $65.0 million and $34.4 million from the FHLB of
Cincinnati at March 31, 2009 and 2008.  These borrowings averaged a
rate of 0.29% and 3.35% for 2009 and 2008.
  34
  Advances
from Federal Home Loan Bank
 
 Deposits
are the primary source of funds for our lending and investment activities and
for our general business purposes.  We can also use advances
(borrowings) from the Federal Home Loan Bank (FHLB) of Cincinnati to compensate
for reductions in deposits or deposit inflows at less than projected
levels.  Advances from the FHLB are secured by our stock in the FHLB,
certain securities, certain commercial real estate loans and substantially all
of our first mortgage, multi-family and open end home equity
loans.  At March 31, 2009 we had $52.8 million in advances outstanding
from the FHLB, and the capacity to increase our borrowings an additional $28.7
million.
 
 Subordinated
Debentures
 
 In 2008,
First Federal Statutory Trust III, an unconsolidated trust subsidiary of First
Financial Service Corporation, issued $8.0 million in trust preferred
securities.  The trust loaned the proceeds of the offering to us in
exchange for junior subordinated deferrable interest debentures which we used to
finance the purchase of FSB Bancshares, Inc. The subordinated debentures, which
mature on June 24, 2038, can be called at par in whole or in part on or after
June 24, 2018. The subordinated debentures pay a fixed rate of 8% for thirty
years.  We have the option to defer interest payments on the
subordinated debt from time to time for a period not to exceed five consecutive
years.  The subordinated debentures are considered as Tier I capital
for the Corporation under current regulatory guidelines.
 
 A
different trust subsidiary issued 30 year cumulative trust preferred securities
at a 10 year fixed rate of 6.69% adjusting quarterly thereafter at LIBOR plus
160 basis points.  The subordinated debentures, which mature March 22,
2037, can be called at par in whole or in part on or after March 15,
2017.  We have the option to defer interest payments on the
subordinated debt from time to time for a period not to exceed five consecutive
years. The subordinated debentures are considered as Tier I capital for the
Corporation under current regulatory guidelines.
 
 Our trust
subsidiaries loaned the proceeds of their offerings of trust preferred
securities to us in exchange for junior subordinated deferrable interest
debentures. In accordance with FASB Interpretation 46, these trusts are not
consolidated with our financial statements but rather the subordinated
debentures are shown as a liability.
 
 LIQUIDITY
 
 Liquidity
risk arises from the possibility we may not be able to satisfy current or future
financial commitments, or may become unduly reliant on alternative funding
sources. The objective of liquidity risk management is to ensure that we can
meet the cash flow requirements of depositors and borrowers, as well as our
operating cash needs, at a reasonable cost, taking into account all on- and
off-balance sheet funding demands. We maintain an investment and funds
management policy, which identifies the primary sources of liquidity,
establishes procedures for monitoring and measuring liquidity, and establishes
minimum liquidity requirements in compliance with regulatory guidance. The Asset
Liability Committee continually monitors our liquidity position.
 
 Our
sources of funds include the sale of securities in the available-for-sale
portion of the investment portfolio, the payment of principal on loans and
mortgage-backed securities, proceeds realized from loans held for sale, brokered
deposits and other wholesale funding.  We also secured federal funds
borrowing lines from three of our correspondent banks.  Two of the
lines are for $15 million each and the other one is for $5
million.  Our banking centers also provide access to retail deposit
markets.  If large certificate depositors shift to our competitors or
other markets in response to interest rate changes, we have the ability to
replenish those deposits through alternative funding
sources.  Traditionally, we have also borrowed from the FHLB to
supplement our funding requirements.  At March 31, 2009, we had
sufficient collateral available to borrow, approximately, an additional $28.7
million in advances from the FHLB. We believe our sources
of liquidity are adequate to meet expected cash needs for the foreseeable
future.
 
 At the
holding company level, the Corporation uses cash to pay dividends to
stockholders, repurchase common stock, make selected investments and
acquisitions, and service debt. The main sources of funding for the Corporation
include dividends from the Bank, borrowings and access to the capital
markets.  Also, the Corporation has lines of credit of $18 million
with a correspondent bank.
 
 The
primary source of funding for the Corporation has been dividends and returns of
investment from the Bank. Kentucky banking laws limit the amount of dividends
that may be paid to the Corporation by the Bank without prior approval of the
KOFI.  Under these laws, the amount of dividends that may be paid in
any calendar year is limited to current year’s net income, as defined in the
laws, combined with the retained net income of the preceding two years, less any
dividends declared during those periods.As a result of a $6
million dividend in 2008 used to finance the purchase of FSB Bancshares, Inc.,
the Bank needed and obtained approval for its first quarter 2009 dividend.
Because of these limitations, consolidated cash flows as presented in the
consolidated statements of cash flows may not represent cash immediately
available to the Corporation.  During 2009, the Bank declared and paid
dividends of $1.3 million to the Corporation.
  35
 
 CAPITAL
 
 Stockholders’
equity increased $19.9 million for the period ended March 31, 2009 compared to
December 31, 2008 primarily due to the sale of $20 million of preferred stock to
the U.S. Treasury Department under the Capital Purchase
Program.  Average stockholders’ equity to average assets ratio
increased to 8.82% for the quarter ended March 31, 2009 compared to 8.52% for
2008.
 
 On
January 9, 2009, we sold $20 million of cumulative perpetual preferred shares,
with a liquidation preference of $1,000 per share (the “Senior Preferred
Shares”) to the U.S. Treasury under the terms of its Capital Purchase
Plan.  Pursuant to CPP, the U.S. Treasury will purchase up to $250
billion of senior preferred shares on standardized terms from qualifying
financial institutions as part of the Troubled Asset Relief Program authorized
by the Emergency Economic Stabilization Act of 2008.  The Senior
Preferred Shares constitute Tier 1 capital and rank senior to our common
shares.  The Senior Preferred Shares pay cumulative dividends at a
rate of 5% per annum for the first five years and will reset to a rate of 9% per
annum after five years. The Senior Preferred Shares may be redeemed at any time,
at our option.
 
 Under the
terms of the CPP stock purchase agreement, we also issued the U.S. Treasury a
warrant to purchase an amount of our common stock equal to 15% of the aggregate
amount of the Senior Preferred Shares, or $3 million.  The warrant
entitles the U.S. Treasury to purchase 215,983 common shares at a purchase price
of $13.89 per share.  The initial exercise price for the warrant and
the number of shares subject to the warrant were determined by reference to the
market price of our common stock calculated on a 20-day trailing average as of
December 8, 2008, the date the U.S. Treasury approved our
application.  The warrant has a term of 10 years and is
potentially dilutive to earnings per share.
 
 During
the first quarter of 2009, we did not purchase any shares of our own common
stock.However, the
terms of our Senior Preferred Shares do not allow us to repurchase shares of our
common stock without the consent of the U.S. Treasury until the Senior Preferred
Shares are redeemed.
 
 Each of
the federal bank regulatory agencies has established minimum leverage capital
requirements for banks. Banks must maintain a minimum ratio of Tier 1 capital to
adjusted average quarterly assets ranging from 3% to 5%, subject to federal bank
regulatory evaluation of an organization’s overall safety and
soundness.  We intend to maintain a capital position that meets or
exceeds the “well capitalized” requirements established for banks by the
FDIC.  The following table shows the ratios of Tier 1 capital and
total capital to risk-adjusted assets and the leverage ratios for the
Corporation and the Bank as of March 31, 2009.
  36





To Be ConsideredWell CapitalizedUnder Prompt(Dollars in thousands)
                                
                                
                                
                                
                                
                                
                                
                                For Capital
                                
                                
                                CorrectionActual
                                
                                
                                AdequacyPurposes
                                
                                
                                Action ProvisionsAs
      of March 31, 2009:
                                
                                Amount
                                
                                
                                Ratio
                                
                                
                                Amount
                                
                                
                                Ratio
                                
                                
                                Amount
                                
                                
                                RatioTotal
      risk-based capital (to risk-weighted assets)
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                N/AConsolidated
                                
                                $
                                111,033
                                
                                
                                
                                12.12
                                %
                                
                                $
                                73,302
                                
                                
                                
                                8.00
                                %
                                
                                
                                N/A
                                
                                
                                
                                N/ABank
                                
                                
                                109,477
                                
                                
                                
                                11.96
                                
                                
                                
                                73,212
                                
                                
                                
                                8.00
                                
                                
                                
                                91,515
                                
                                
                                
                                10.00Tier
      I capital (to risk-weighted assets)Consolidated
                                
                                
                                99,535
                                
                                
                                
                                10.86
                                
                                
                                
                                36,651
                                
                                
                                
                                4.00
                                
                                
                                
                                N/A
                                
                                
                                
                                N/ABank
                                
                                
                                97,983
                                
                                
                                
                                10.71
                                
                                
                                
                                36,606
                                
                                
                                
                                4.00
                                
                                
                                
                                54,909
                                
                                
                                
                                6.00Tier
      I capital (to average assets)Consolidated
                                
                                
                                99,535
                                
                                
                                
                                9.70
                                
                                
                                
                                41,048
                                
                                
                                
                                4.00
                                
                                
                                
                                N/A
                                
                                
                                
                                N/ABank
                                
                                
                                97,983
                                
                                
                                
                                9.55
                                
                                
                                
                                41,026
                                
                                
                                
                                4.00
                                
                                
                                
                                51,282
                                
                                
                                
                                5.00





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





Item
3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK





Asset/Liability
Management and Market Risk





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





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


37


Our
interest sensitivity profile was asset sensitive at March 31, 2009 and December
31, 2008.  Given a 100 basis point decrease in rates sustained for one
year, our base net interest income would decrease by an estimated2.97% at March 31, 2009
compared to a decrease of 2.67% at December 31, 2008. Given a 100 basis point
increase in interest rates sustained for one year, our base net interest income
would increase by anestimated 3.14% at March
31, 2009 compared to an increase of 1.49% at December 31, 2008.





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





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





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




March 31, 2009Decrease in Rates
                                    
                                    
                                    
                                    
                                    
                                    Increase in Rates200
                                    
                                    
                                    
                                    100
                                    
                                    
                                    
                                    
                                    
                                    
                                    100
                                    
                                    
                                    
                                    200(Dollars
      in thousands)
                                    
                                    Basis Points
                                    
                                    
                                    Basis Points
                                    
                                    
                                    Base
                                    
                                    
                                    Basis Points
                                    
                                    
                                    Basis PointsProjected
      interest incomeLoans
                                    
                                    $
                                    52,425
                                    
                                    
                                    $
                                    53,846
                                    
                                    
                                    $
                                    55,373
                                    
                                    
                                    $
                                    56,854
                                    
                                    
                                    $
                                    58,353Investments
                                    
                                    
                                    992
                                    
                                    
                                    
                                    991
                                    
                                    
                                    
                                    1,016
                                    
                                    
                                    
                                    1,047
                                    
                                    
                                    
                                    1,074Total
      interest income
                                    
                                    
                                    53,417
                                    
                                    
                                    
                                    54,837
                                    
                                    
                                    
                                    56,389
                                    
                                    
                                    
                                    57,901
                                    
                                    
                                    
                                    59,427Projected
      interest expenseDeposits
                                    
                                    
                                    16,706
                                    
                                    
                                    
                                    16,704
                                    
                                    
                                    
                                    17,203
                                    
                                    
                                    
                                    17,301
                                    
                                    
                                    
                                    18,317Borrowed
      funds
                                    
                                    
                                    3,785
                                    
                                    
                                    
                                    3,784
                                    
                                    
                                    
                                    3,784
                                    
                                    
                                    
                                    4,088
                                    
                                    
                                    
                                    4,394Total
      interest expense
                                    
                                    
                                    20,491
                                    
                                    
                                    
                                    20,488
                                    
                                    
                                    
                                    20,987
                                    
                                    
                                    
                                    21,389
                                    
                                    
                                    
                                    22,711Net
      interest income
                                    
                                    $
                                    32,926
                                    
                                    
                                    $
                                    34,349
                                    
                                    
                                    $
                                    35,402
                                    
                                    
                                    $
                                    36,512
                                    
                                    
                                    $
                                    36,716Change
      from base
                                    
                                    $
                                    (2,476
                                    )
                                    
                                    $
                                    (1,053
                                    )
                                    
                                    
                                    
                                    
                                    
                                    $
                                    1,110
                                    
                                    
                                    $
                                    1,314%
      Change from base
                                    
                                    
                                    (6.99
                                    )%
                                    
                                    
                                    (2.97
                                    )%
                                    
                                    
                                    
                                    
                                    
                                    
                                    3.14
                                    %
                                    
                                    
                                    3.71
                                    %
 
 December 31, 2008Decrease in Rates
                          
                          
                          
                          
                          
                          Increase in Rates200
                          
                          
                          
                          100
                          
                          
                          
                          
                          
                          
                          100
                          
                          
                          
                          200(Dollars in thousands)
                          
                          Basis Points
                          
                          
                          Basis Points
                          
                          
                          Base
                          
                          
                          Basis Points
                          
                          
                          Basis PointsProjected
      interest incomeLoans
                          
                          $
                          50,663
                          
                          
                          $
                          52,195
                          
                          
                          $
                          53,664
                          
                          
                          $
                          55,105
                          
                          
                          $
                          56,577Investments
                          
                          
                          966
                          
                          
                          
                          985
                          
                          
                          
                          1,002
                          
                          
                          
                          1,033
                          
                          
                          
                          1,063Total
      interest income
                          
                          
                          51,629
                          
                          
                          
                          53,180
                          
                          
                          
                          54,666
                          
                          
                          
                          56,138
                          
                          
                          
                          57,640Projected
      interest expenseDeposits
                          
                          
                          15,815
                          
                          
                          
                          16,026
                          
                          
                          
                          16,419
                          
                          
                          
                          16,984
                          
                          
                          
                          17,523Borrowed
      funds
                          
                          
                          3,559
                          
                          
                          
                          3,570
                          
                          
                          
                          3,743
                          
                          
                          
                          4,135
                          
                          
                          
                          4,525Total
      interest expense
                          
                          
                          19,374
                          
                          
                          
                          19,596
                          
                          
                          
                          20,162
                          
                          
                          
                          21,119
                          
                          
                          
                          22,048Net
      interest income
                          
                          $
                          32,255
                          
                          
                          $
                          33,584
                          
                          
                          $
                          34,504
                          
                          
                          $
                          35,019
                          
                          
                          $
                          35,592Change
      from base
                          
                          $
                          (2,249
                          )
                          
                          $
                          (920
                          )
                          
                          
                          
                          
                          
                          $
                          515
                          
                          
                          $
                          1,088%
      Change from base
                          
                          
                          (6.52
                          )%
                          
                          
                          (2.67
                          )%
                          
                          
                          
                          
                          
                          
                          1.49
                          %
                          
                          
                          3.15
                          %


38





Item
4.  CONTROLS AND PROCEDURES





Management
is responsible for establishing and maintaining effective disclosure controls
and procedures, as defined under Rules 13a-15(e) and 15d-15(e) of the Securities
Exchange Act of 1934. As of March 31, 2009, an evaluation was performed under
the supervision and with the participation of management, including the Chief
Executive Officer and Chief Financial Officer, of the effectiveness of the
design and operation of our disclosure controls and procedures. Based on that
evaluation, management concluded that disclosure controls and procedures as of
March 31, 2009 were effective in ensuring material information required to be
disclosed in this Form 10-Q was recorded, processed, summarized, and reported on
a timely basis.





During
the quarter ended March 31, 2009 management completed an internal review and
evaluation of its processes in order to better ensure proper financial reporting
of our allowance for loan losses and the application of SFAS No. 114 “Accounting
by Creditors for Impairment of a Loan”.  In connection with its review
and evaluation, management has initiated the following changes:





·
            Revised
      our procedures related to internal control over financial reporting with
      respect to classified commercial loans.  This includes more
      frequent reviews of criticized and classified loans and more detailed
      documentation;





·
            Created
      a new internal loan classification of “Watch” to be placed between the
      lowest classification of “Pass” and the classification of “Special
      Mention”.  This additional loan category will be useful for
      identifying and classifying loans as they begin to show signs of weakness,
      but are not to the full extent of being
  criticized;





·
            Strengthened
      the review process for determining the amount of specific reserve and/or
      level of impairment required on loan relationships warranting such
      charges; and





·
            Brought
      the function of loan review in-house.  Previously, the function
      of loan review was outsourced to an independent third
      party.  The third party conducted quarterly reviews and reported
      any issues identified to management.  As our loan portfolio has
      grown significantly over the past few years, it has become necessary to
      increase the volume of loans subjected to an independent loan review
      function and have the evaluation process be
      on-going.  Accordingly, the loan review function has been
      elevated to a full time position reporting directly to the Risk Management
      Committee of the Board of
Directors.





As a
result of taking the above actions, management has concluded that it has
remediated the material weakness described in Item 9A of our Form 10-K for the
year ended December 31, 2008.





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




Part
II - OTHER INFORMATION




Item
      1.
                Legal
      Proceedings
 
 Although,
from time to time, we are involved in various legal proceedings in the normal
course of business, there are no material pending legal proceedings to which we
are a party, or to which any of our property is subject.
 
 Item
      1A.
                Risk
      Factors
 
 We did
not have any changes to our risk factors previously disclosed in our Annual
Report on Form 10-K for the year ended December 31, 2008.
  39
  Item
      2.
                Unregistered
      Sales of Securities and Use of
Proceeds
 
 We did
not repurchase any shares of our common stock during the quarter
ended
 March 31,
2009.
 
 Item
      3.
                Defaults
      Upon Senior Securities
 
 Not
Applicable
 
 Item
      4.
                Submission
      of Matters to a Vote of Security
Holders
 
 There
were no matters submitted for shareholder approval during the first quarter of
2009.
 
 Item
      5.
                Other
      Information
 
 None
 
 Item
      6.
                Exhibits:


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 Section
      18 U.S.C. Section 1350 (As Adopted Pursuant to Section 906 of the
      Sarbanes-Oxley Act of 2002)


40


FIRST
FINANCIAL SERVICE CORPORATION





SIGNATURES





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





Date:  May
      11, 2009
              By:
              /s/
              B. Keith JohnsonB.
      Keith JohnsonChief
      Executive OfficerDate:  May
      11, 2009
              By:
              /s/
              Steven M. ZagarSteven
      M. ZagarChief
      Financial Officer &Principal
      Accounting Officer


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INDEX
TO EXHIBITS





Exhibit No.
                
                Description31.1
                
                Certification
      of Chief Executive Officer Pursuant to Section 302 of Sarbanes-Oxley
      Act31.2
                
                Certification
      of Chief Financial Officer Pursuant to Section 302 of Sarbanes-Oxley
      Act32
                
                Certification
      of Chief Executive Officer and Chief Financial Officer Pursuant to 18
      U.S.C. Section 1350 (As Adopted Pursuant to Section 906 of the
      Sarbanes-Oxley Act of
2002)


42