**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

** **

**FORM 10-Q**

** **

**(Mark One)**

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

** **

**For the quarterly periodended June 30, 2007**

** **

**OR**

** **

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

** **

**Commission File Number0-18832**

** **

**First Financial Service Corporation**

(Exact Name of Registrantas specified in its charter)
| **Kentucky**                                                    | **61-1168311**                     |
|-----------------------------------------------------------------|------------------------------------|
| (State or other  jurisdiction of incorporation or organization) | (IRS Employer  Identification No.) |

 

**2323 Ring RoadElizabethtown, Kentucky 42701**

(Address of principal executive offices)

(Zip Code)

 

**(270) 765-2131**

(Registrant’s telephone number, including area code)

 

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

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

Large Accelerated Filer o   AcceleratedFiler**x   Non-Accelerated Filer o

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

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

| **Class**    |   | **Outstanding  as of July 31, 2007** |
|--------------|--------|--------------------------------------|
| Common Stock |   | 4,257,610 shares                     |

 

 

----

**FIRST****FINANCIAL****SERVICE CORPORATION**

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

 

2

----

**PRELIMINARY NOTE REGARDINGFORWARD-LOOKING STATEMENTS**

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

Various risks anduncertainties may cause actual results to differ materially from thoseindicated by our forward-looking statements. In addition to those risksdescribed under “Item 1A Risk Factors,” of our 2006 Annual Report on Form 10-Kand of this report, the following factors could cause such differences: changesin general economic conditions and economic conditions in Kentucky and themarkets we serve, any of which may affect, among other things, our level ofnon-performing assets, charge-offs, and provision for loan loss expense;changes in interest rates that may reduce interest margins and impact fundingsources; changes in market rates and prices which may adversely impact thevalue of financial products including securities, loans and deposits; changesin tax laws, rules and regulations; various monetary and fiscal policies andregulations, including those determined by the Federal Reserve Board, theFederal Deposit Insurance Corporation (“FDIC”) and the Kentucky Office ofFinancial Institutions (“KOFI”); competition with other local and regionalcommercial banks, savings banks, credit unions and other non-bank financialinstitutions; our ability to grow core businesses; our ability to develop andintroduce new banking-related products, services and enhancements and gainmarket acceptance of such products; and management’s ability to manage theseand other risks.

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

3

----

**Part I—FINANCIAL INFORMATION**

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

 
| **(Dollars in thousands, except share data)**                                                                                     | ** ** | **June 30,  2007** | ** ** | **December 31,  2006** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
|                                                                                                                                                       | ** ** | ** **              | ** ** | ** **                  | ** ** |
| **ASSETS**                                                                                                                                                 |       |                    |       |                        |       |
| Cash and due from banks                                                                                                                                    |       | $                       | 15,577     |                        | $          | 19,082 |   |
|                                                                                                                                                       |       |                    |       |                        |       |
| Securities  available-for-sale                                                                                                                             |       | 23,354                  |       | 28,223                      |       |
| Securities  held-to-maturity, fair value of $21,444 Jun (2007) and $23,817 Dec (2006)                                                                      |       | 21,768                  |       | 24,224                      |       |
| Total securities                                                                                                                                           |       | 45,122                  |       | 52,447                      |       |
|                                                                                                                                                       |       |                    |       |                        |       |
| Loans held for sale                                                                                                                                        |       | 1,329                   |       | 673                         |       |
| Loans, net of unearned  fees                                                                                                                               |       | 729,705                 |       | 705,037                     |       |
| Allowance for loan  losses                                                                                                                                 |       | (7,822                  | )          | (7,684                      | )          |
| Net loans  receivable                                                                                                                                      |       | 723,212                 |       | 698,026                     |       |
| ** **                                                                                                                                                 |       |                    |       |                        |       |
| Federal Home Loan Bank  stock                                                                                                                              |       | 7,621                   |       | 7,621                       |       |
| Cash surrender value of  life insurance                                                                                                                    |       | 8,112                   |       | 7,947                       |       |
| Premises and equipment,  net                                                                                                                               |       | 24,076                  |       | 22,500                      |       |
| Real estate owned:                                                                                                                                         |       |                    |       |                        |       |
| Acquired through  foreclosure                                                                                                                              |       | 508                     |       | 918                         |       |
| Held for  development                                                                                                                                      |       | 91                      |       | 337                         |       |
| Other repossessed  assets                                                                                                                                  |       | 34                      |       | 82                          |       |
| Goodwill                                                                                                                                                   |       | 8,384                   |       | 8,384                       |       |
| Accrued interest  receivable                                                                                                                               |       | 4,362                   |       | 4,094                       |       |
| Other assets                                                                                                                                               |       | 1,567                   |       | 1,388                       |       |
|                                                                                                                                                       |       |                    |       |                        |       |
| **TOTAL  ASSETS**                                                                                                                                          |       | $                       | 838,666    |                        | $          | 822,826 |   |
|                                                                                                                                                       |       |                    |       |                        |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                             |       |                    |       |                        |       |
| **LIABILITIES:**                                                                                                                                           |       |                    |       |                        |       |
| Deposits:                                                                                                                                                  |       |                    |       |                        |       |
| Non-interest  bearing                                                                                                                                      |       | $                       | 44,812     |                        | $          | 40,349 |   |
| Interest bearing                                                                                                                                           |       | 639,641                 |       | 600,688                     |       |
| Total deposits                                                                                                                                             |       | 684,453                 |       | 641,037                     |       |
|                                                                                                                                                       |       |                    |       |                        |       |
| Short-term borrowings                                                                                                                                      |       | 40,500                  |       | 68,500                      |       |
| Advances from Federal  Home Loan Bank                                                                                                                      |       | 28,152                  |       | 28,224                      |       |
| Subordinated debentures                                                                                                                                    |       | 10,000                  |       | 10,000                      |       |
| Accrued interest  payable                                                                                                                                  |       | 661                     |       | 273                         |       |
| Accounts payable and  other liabilities                                                                                                                    |       | 1,801                   |       | 1,321                       |       |
| Deferred income taxes                                                                                                                                      |       | 1,183                   |       | 1,373                       |       |
|                                                                                                                                                       |       |                    |       |                        |       |
| **TOTAL  LIABILITIES**                                                                                                                                     |       | 766,750                 |       | 750,728                     |       |
| Commitments and  contingent liabilities                                                                                                                    |       | —                  |       | —                      |       |
|                                                                                                                                                       |       |                    |       |                        |       |
| **STOCKHOLDERS’ EQUITY:**                                                                                                                             |       |                    |       |                        |       |
| Serial preferred stock,  5,000,000 shares authorized and unissued                                                                                          |       | —                  |       | —                      |       |
| Common stock, $1 par  value per share; authorized 10,000,000 shares; issued and outstanding,  4,279,610 shares Jun (2007), and 4,384,088 shares Dec (2006) |       | 4,280                   |       | 4,384                       |       |
| Additional paid-in  capital                                                                                                                                |       | 24,493                  |       | 27,419                      |       |
| Retained earnings                                                                                                                                          |       | 43,428                  |       | 40,210                      |       |
| Accumulated other  comprehensive income/ (loss)                                                                                                            |       | (285                    | )          | 85                          |       |
|                                                                                                                                                       |       |                    |       |                        |       |
| **TOTAL  STOCKHOLDERS’ EQUITY**                                                                                                                       |       | 71,916                  |       | 72,098                      |       |
| **TOTAL LIABILITIES AND  STOCKHOLDERS’ EQUITY**                                                                                                       |       | $                       | 838,666    |                        | $          | 822,826 |   |

 

*Seenotes to consolidated financial statements.*

4

----

**FIRST FINANCIAL SERVICE CORPORATIONConsolidated Statements of Income(Unaudited)**
| ** **                                                                      | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|---------------------------------------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| **(Dollars in thousands, except per share data)** | ** ** | **2007**                                        | ** ** | **2006**                                      | ** ** | **2007** | ** ** | **2006** | ** ** |
| ** **                                                                      |       |                                            |       |                                          |       |   |   |   |   |
| **Interest and Dividend Income:**                                               |       |                                            |       |                                          |       |   |   |   |   |
| Loans, including  fees                                                          |       | $                                               | 14,364     |                                          | $          | 12,287 |   | $ | 28,305 |   | $ | 24,002 |   |
| Taxable  securities                                                             |       | 536                                             |       | 756                                           |       | 1,148 |   | 1,471 |   |
| Tax exempt  securities                                                          |       | 107                                             |       | 68                                            |       | 215 |   | 130 |   |
| Total interest  income                                                          |       | 15,007                                          |       | 13,111                                        |       | 29,668 |   | 25,603 |   |
|                                                                            |       |                                            |       |                                          |       |   |   |   |   |
| **Interest Expense:**                                                           |       |                                            |       |                                          |       |   |   |   |   |
| Deposits                                                                        |       | 6,440                                           |       | 4,561                                         |       | 12,387 |   | 8,606 |   |
| Short-term  borrowings                                                          |       | 413                                             |       | 15                                            |       | 988 |   | 88 |   |
| Federal Home  Loan Bank advances                                                |       | 341                                             |       | 941                                           |       | 676 |   | 1,874 |   |
| Subordinated  debentures                                                        |       | 154                                             |       | 223                                           |       | 382 |   | 429 |   |
| Total interest  expense                                                         |       | 7,348                                           |       | 5,740                                         |       | 14,433 |   | 10,997 |   |
|                                                                            |       |                                            |       |                                          |       |   |   |   |   |
| Net interest income                                                             |       | 7,659                                           |       | 7,371                                         |       | 15,235 |   | 14,606 |   |
| Provision for loan  losses                                                      |       | 127                                             |       | 9                                             |       | 208 |   | 97 |   |
| Net interest income  after provision for loan losses                            |       | 7,532                                           |       | 7,362                                         |       | 15,027 |   | 14,509 |   |
|                                                                            |       |                                            |       |                                          |       |   |   |   |   |
| **Non-interest Income:**                                                        |       |                                            |       |                                          |       |   |   |   |   |
| Customer service  fees on deposit accounts                                      |       | 1,489                                           |       | 1,396                                         |       | 2,763 |   | 2,627 |   |
| Gain on sale of  mortgage loans                                                 |       | 166                                             |       | 240                                           |       | 292 |   | 403 |   |
| Gain on sale of  real estate held for development                               |       | —                                          |       | —                                        |       | 227 |   | — |   |
| Brokerage  commissions                                                          |       | 106                                             |       | 88                                            |       | 202 |   | 171 |   |
| Other income                                                                    |       | 278                                             |       | 352                                           |       | 500 |   | 587 |   |
| Total  non-interest income                                                      |       | 2,039                                           |       | 2,076                                         |       | 3,984 |   | 3,788 |   |
|                                                                            |       |                                            |       |                                          |       |   |   |   |   |
| **Non-interest Expense:**                                                       |       |                                            |       |                                          |       |   |   |   |   |
| Employee  compensation and benefits                                             |       | 3,105                                           |       | 2,817                                         |       | 6,229 |   | 5,794 |   |
| Office occupancy  expense and equipment                                         |       | 596                                             |       | 514                                           |       | 1,162 |   | 1,067 |   |
| Marketing and  advertising                                                      |       | 217                                             |       | 214                                           |       | 449 |   | 419 |   |
| Outside services  and data processing                                           |       | 670                                             |       | 641                                           |       | 1,336 |   | 1,257 |   |
| Bank franchise  tax                                                             |       | 234                                             |       | 224                                           |       | 465 |   | 443 |   |
| Write off of  issuance cost of Trust Preferred Securities                       |       | —                                          |       | —                                        |       | 229 |   | — |   |
| Other expense                                                                   |       | 979                                             |       | 904                                           |       | 1,946 |   | 1,743 |   |
| Total  non-interest expense                                                     |       | 5,801                                           |       | 5,314                                         |       | 11,816 |   | 10,723 |   |
|                                                                            |       |                                            |       |                                          |       |   |   |   |   |
| Income before income  taxes                                                     |       | 3,770                                           |       | 4,124                                         |       | 7,195 |   | 7,574 |   |
| Income taxes                                                                    |       | 1,226                                           |       | 1,369                                         |       | 2,334 |   | 2,481 |   |
| **Net Income**                                                                  |       | $                                               | 2,544      |                                          | $          | 2,755 |   | $ | 4,861 |   | $ | 5,093 |   |
|                                                                            |       |                                            |       |                                          |       |   |   |   |   |
| Shares applicable to  basic income per share                                    |       | 4,305,741                                       |       | 4,382,268                                     |       | 4,334,385 |   | 4,382,103 |   |
| **Basic income per share**                                                      |       | $                                               | 0.59       |                                          | $          | 0.63 |   | $ | 1.12 |   | $ | 1.16 |   |
|                                                                            |       |                                            |       |                                          |       |   |   |   |   |
| Shares applicable to  diluted income per share                                  |       | 4,348,300                                       |       | 4,421,958                                     |       | 4,382,923 |   | 4,419,839 |   |
| **Diluted income per share**                                                    |       | $                                               | 0.59       |                                          | $          | 0.62 |   | $ | 1.11 |   | $ | 1.15 |   |
|                                                                            |       |                                            |       |                                          |       |   |   |   |   |
| **Cash dividends declared per share**                                           |       | $                                               | 0.190      |                                          | $          | 0.173 |   | $ | 0.380 |   | $ | 0.346 |   |

 

*Seenotes to the unaudited consolidated financial statements.*

5

----

**FIRST FINANCIAL SERVICE CORPORATIONConsolidated Statements of Comprehensive Income(Unaudited)**
| ** **                                                     | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|----------------------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| **(Dollars in thousands)**                           | ** ** | **2007**                                        | ** ** | **2006**                                      | ** ** | **2007** | ** ** | **2006** | ** ** |
|                                                           |       |                                            |       |                                          |       |   |   |   |   |
| **Net Income**                                                 |       | $                                               | 2,544      |                                          | $          | 2,755 |   | $ | 4,861 |   | $ | 5,093 |   |
| Other comprehensive  income (loss):                            |       |                                            |       |                                          |       |   |   |   |   |
| Change in  unrealized gain (loss) on securities                |       | (551                                            | )          | (393                                          | )          | (560 | ) | (503 | ) |
| Reclassification  of realized amount                           |       | —                                          |       | —                                        |       | — |   | — |   |
| Net unrealized  gain (loss) recognized in comprehensive income |       | (551                                            | )          | (393                                          | )          | (560 | ) | (503 | ) |
| Tax effect                                                     |       | 187                                             |       | 133                                           |       | 190 |   | 171 |   |
| Total other  comphrehensive income (loss)                      |       | (364                                            | )          | (260                                          | )          | (370 | ) | (332 | ) |
|                                                           |       |                                            |       |                                          |       |   |   |   |   |
| **Comprehensive Income**                                       |       | $                                               | 2,180      |                                          | $          | 2,495 |   | $ | 4,491 |   | $ | 4,761 |   |

 

*Seenotes to the unaudited consolidated financial statements.*

6

----

**FIRST FINANCIAL SERVICE CORPORATIONConsolidated Statement of Changes in Stockholders’ EquitySix Months Ended June 30, 2007(Dollars In Thousands, Except Per Share Amounts)(Unaudited)**
| ** **                                                                            | ** ** | **Common Stock** | ** ** | **Additional  Paid-in** | ** ** | **Retained** | ** ** | **Accumulated  Other  Comprehensive  Income/(Loss),** | ** ** | ** **               | ** ** |
|---------------------------------------------------------------------------------------|------------|-----------------------|------------|-------------------------|------------|--------------|------------|-------------------------------------------------------|------------|--------------------------|------------|
| ** **                                                                            | ** ** | **Shares**            | ** ** | **Amount**              | ** ** | **Capital**  | ** ** | **Earnings**                                          | ** ** | **Net of Tax** | ** ** | **Total** | ** ** |
|                                                                                  |       |                  |       |                    |       |         |       |                                                  |       |                     |       |   |   |
| **Balance, December 31, 2006**                                                        |       | 4,384                 |       | $                       | 4,384      |         | $          | 27,419                                                |       | $                        | 40,210     |   | $ | 85 |   | $ | 72,098 |   |
| Net income                                                                            |       |                  |       |                    |       |         |       | 4,861                                                 |       |                     |       | 4,861 |   |
| Stock issued for stock  options exercised and employee benefit plans                  |       | 6                     |       | 6                       |       | 98           |       |                                                  |       |                     |       | 104 |   |
| Compensation expense  for stock options                                               |       |                  |       |                    |       | 52           |       |                                                  |       |                     |       | 52 |   |
| Net change in  unrealized gains (losses) on securities available-for-sale, net of tax |       |                  |       |                    |       |         |       |                                                  |       | (370                     | )          | (370 | ) |
| Cash dividends declared  ($.38 per share)                                             |       |                  |       |                    |       |         |       | (1,643                                                | )          |                     |       | (1,643 | ) |
| Stock repurchased                                                                     |       | (110                  | )          | (110                    | )          | (3,076       | )          | —                                                |       | —                   |       | (3,186 | ) |
| **Balance, June 30, 2007**                                                            |       | 4,280                 |       | $                       | 4,280      |         | $          | 24,493                                                |       | $                        | 43,428     |   | $ | (285 | ) | $ | 71,916 |   |

 

*Seenotes to the unaudited consolidated financial statements.*

7

----

**FIRST FINANCIAL SERVICE CORPORATIONConsolidated Statements of Cash Flows(Dollars In Thousands)(Unaudited)**
| ** **                                                                         | ** ** | **Six Months Ended  June 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                         | ** ** | **2007**                                      | ** ** | **2006** | ** ** |
| **Operating Activities:**                                                          |       |                                          |       |   |   |
| Net income                                                                         |       | $                                             | 4,861      |   | $ | 5,093 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities: |       |                                          |       |   |   |
| Provision for  loan losses                                                         |       | 208                                           |       | 97 |   |
| Depreciation on  premises and equipment                                            |       | 742                                           |       | 681 |   |
| Federal Home  Loan Bank stock dividends                                            |       | —                                        |       | (206 | ) |
| Net amortization  (accretion) available-for-sale                                   |       | 7                                             |       | 2 |   |
| Net amortization  (accretion) held-to-maturity                                     |       | 11                                            |       | 17 |   |
| Gain on sale of  real estate held for development                                  |       | (227                                          | )          | — |   |
| Gain on sale of  mortgage loans                                                    |       | (292                                          | )          | (403 | ) |
| Origination of  loans held for sale                                                |       | (17,138                                       | )          | (20,867 | ) |
| Proceeds on sale  of loans held for sale                                           |       | 16,774                                        |       | 20,829 |   |
| Compensation  expense for stock options                                            |       | 52                                            |       | 31 |   |
| Changes in:                                                                        |       |                                          |       |   |   |
| Cash surrender  value of life insurance                                            |       | (165                                          | )          | (147 | ) |
| Interest  receivable                                                               |       | (268                                          | )          | (111 | ) |
| Other assets                                                                       |       | (178                                          | )          | 245 |   |
| Interest payable                                                                   |       | 388                                           |       | 55 |   |
| Accounts payable  and other liabilities                                            |       | 480                                           |       | 854 |   |
| Net cash from operating  activities                                                |       | 5,255                                         |       | 6,170 |   |
|                                                                               |       |                                          |       |   |   |
| **Investing Activities:**                                                          |       |                                          |       |   |   |
| Purchases of  securities available-for-sale                                        |       | (395                                          | )          | (2,211 | ) |
| Maturities of  securities available-for-sale                                       |       | 4,697                                         |       | 3,197 |   |
| Maturities of  securities held-to-maturity                                         |       | 2,445                                         |       | 4,502 |   |
| Net change in  loans                                                               |       | (24,281                                       | )          | (22,322 | ) |
| Net purchases of  premises and equipment                                           |       | (2,318                                        | )          | (1,921 | ) |
| Sales of real  estate for development                                              |       | 473                                           |       | — |   |
| Net cash from investing  activities                                                |       | (19,379                                       | )          | (18,755 | ) |
|                                                                               |       |                                          |       |   |   |
| **Financing Activities**                                                           |       |                                          |       |   |   |
| Net change in  deposits                                                            |       | 43,416                                        |       | 23,892 |   |
| Change in  short-term borrowings                                                   |       | (28,000                                       | )          | (12,500 | ) |
| Repayments to  Federal Home Loan Bank                                              |       | (72                                           | )          | (78 | ) |
| Proceeds from  issuance of subordinated debentures                                 |       | 10,000                                        |       | — |   |
| Payoff of  subordinated debentures                                                 |       | (10,000                                       | )          | — |   |
| Issuance of  common stock for options and employee benefit plans                   |       | 104                                           |       | 9 |   |
| Dividends paid                                                                     |       | (1,643                                        | )          | (1,513 | ) |
| Common stock  repurchased                                                          |       | (3,186                                        | )          | — |   |
| Net cash from financing  activities                                                |       | 10,619                                        |       | 9,810 |   |
|                                                                               |       |                                          |       |   |   |
| **(Decrease) Increase in cash and  cash equivalents**                              |       | (3,505                                        | )          | (2,775 | ) |
| **Cash and cash equivalents,  beginning of period**                                |       | 19,082                                        |       | 20,451 |   |
| **Cash and cash equivalents, end of period**                                       |       | $                                             | 15,577     |   | $ | 17,676 |   |

 

*Seenotes to the unaudited consolidated financial statements.*

8

----

**Notes ToUnaudited Consolidated Financial Statements**

**1.             BASIS OFPRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**

***Basis of Presentation***—The accompanying unaudited consolidated financial statements includethe accounts of First Financial Service Corporation and its wholly ownedsubsidiary, First Federal Savings Bank. First Federal Savings Bank has twowholly owned subsidiaries, First Service Corporation of Elizabethtown and FirstFederal Office Park, LLC. Unless the text clearly suggests otherwise,references to “us,” “we,” or “our” include First Financial Service Corporationand its wholly-owned subsidiary. All significant intercompany transactions andbalances have been eliminated.

The accompanying unaudited consolidated financial statements have beenprepared in accordance with U.S. generally accepted accounting principles forinterim financial information and with the instructions to Form 10-Q and Rule10-01 of Regulation S-X. Accordingly, they do not include all of theinformation and footnotes required by U.S. generally accepted accountingprinciples for complete financial statements. In the opinion of management, alladjustments (consisting of normal recurring accruals) considered necessary fora fair presentation have been included. Operating results for the three and sixmonth periods ending June 30, 2007 are not necessarily indicative of theresults that may occur for the year ending December 31, 2007. For furtherinformation, refer to the consolidated financial statements and footnotes theretoincluded in the Corporation’s annual report on Form 10-K for the period endedDecember 31, 2006.

***Stock Dividends****—*We declared a 10% stock dividend on August15, 2006 to our shareholders of record as of August 29, 2006, payable onSeptember 14, 2006. The payment of this dividend was in addition to the regularquarterly cash dividend. Per share amounts have been restated for the impact ofthe stock dividend.

***Adoption of New Accounting Standards****—*We adopted the provisions of FASBInterpretation No. 48, Accounting for Uncertainty in Income Taxes (“FIN 48”),on January 1, 2007. The adoption of FIN 48 had no affect on our financialstatements. We have no unrecognized tax benefits and do not anticipate anyincrease in unrecognized benefits during 2007 relative to any tax positionstaken prior to January 1, 2007. Should the accrual of any interest or penaltiesrelative to unrecognized tax benefits be necessary, it is our policy to recordsuch accruals in our income tax accounts; no such accruals exist as of January1, 2007. We file a consolidated U.S. federal income tax return and the Companyand its non-bank subsidiaries file an income tax return in the state ofKentucky. These returns are subject to examination by taxing authorities forall years after 2002.

***Reclassifications***—Some items in the prior period financial statements were reclassifiedto conform to the current period presentation.

9

----

**NotesTo Unaudited Consolidated Financial Statements (Continued)**

**2.**             **SECURITIES**

The amortized cost basis and fair values of securities are as follows:
| **(Dollars in thousands)** | ** ** | **Amortized  Cost** | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Fair Value** | ** ** |
|--------------------------------------|------------|---------------------|------------|------------------------------|------------|-------------------------------|------------|---------------------|------------|
|                                 |       |                |       |                         |       |                          |       |                |       |
| **Securities available-for-sale:**   |       |                |       |                         |       |                          |       |                |       |
| **June  30, 2007:**                  |       |                |       |                         |       |                          |       |                |       |
| U. S. Treasury  and agencies         |       | $                   | 497        |                         | $          | —                        |       | $                   | (12        | ) | $ | 485 |   |
| Mortgage-backed                      |       | 8,397               |       | 4                            |       | (223                          | )          | 8,178               |       |
| Equity                               |       | 1,553               |       | 563                          |       | (63                           | )          | 2,053               |       |
| State and  municipal                 |       | 10,525              |       | 2                            |       | (702                          | )          | 9,825               |       |
| Corporate                            |       | 2,813               |       | —                       |       | —                        |       | 2,813               |       |
|                                 |       |                |       |                         |       |                          |       |                |       |
| Total                                |       | $                   | 23,785     |                         | $          | 569                           |       | $                   | (1,000     | ) | $ | 23,354 |   |
|                                 |       |                |       |                         |       |                          |       |                |       |
| **December  31, 2006:**              |       |                |       |                         |       |                          |       |                |       |
| U.S. Treasury  and agencies          |       | $                   | 3,497      |                         | $          | —                        |       | $                   | (13        | ) | $ | 3,484 |   |
| Mortgage-backed                      |       | 9,425               |       | 8                            |       | (189                          | )          | 9,244               |       |
| Equity                               |       | 1,553               |       | 629                          |       | (36                           | )          | 2,146               |       |
| State and  municipal                 |       | 10,299              |       | 7                            |       | (277                          | )          | 10,029              |       |
| Corporate                            |       | 3,320               |       | —                       |       | —                        |       | 3,320               |       |
|                                 |       |                |       |                         |       |                          |       |                |       |
| Total                                |       | $                   | 28,094     |                         | $          | 644                           |       | $                   | (515       | ) | $ | 28,223 |   |

 
| ** **                       | ** ** | **Amortized**  Cost | ** ** | **Gross**  Unrecognized  Gains | ** ** | **Gross**  Unrecognized  Losses | ** ** | **Fair Value** | ** ** |
|----------------------------------|------------|---------------------|------------|--------------------------------|------------|---------------------------------|------------|---------------------|------------|
|                             |       |                |       |                           |       |                            |       |                |       |
| **Securities held-to-maturity:** |       |                |       |                           |       |                            |       |                |       |
| **June  30, 2007:**              |       |                |       |                           |       |                            |       |                |       |
| U.S. Treasury  and agencies      |       | $                   | 16,097     |                           | $          | —                          |       | $                   | (245       | ) | $ | 15,852 |   |
| Mortgage-backed                  |       | 3,671               |       | 2                              |       | (89                             | )          | 3,584               |       |
| Corporate                        |       | 2,000               |       | 8                              |       | —                          |       | 2,008               |       |
|                             |       |                |       |                           |       |                            |       |                |       |
| Total                            |       | $                   | 21,768     |                           | $          | 10                              |       | $                   | (334       | ) | $ | 21,444 |   |
|                             |       |                |       |                           |       |                            |       |                |       |
| **December  31, 2006:**          |       |                |       |                           |       |                            |       |                |       |
| U.S. Treasury  and agencies      |       | $                   | 18,097     |                           | $          | 4                               |       | $                   | (318       | ) | $ | 17,783 |   |
| Mortgage-backed                  |       | 4,127               |       | 3                              |       | (111                            | )          | 4,019               |       |
| Corporate                        |       | 2,000               |       | 15                             |       | —                          |       | 2,015               |       |
|                             |       |                |       |                           |       |                            |       |                |       |
| Total                            |       | $                   | 24,224     |                           | $          | 22                              |       | $                   | (429       | ) | $ | 23,817 |   |

 

10

----

**NotesTo Unaudited Consolidated Financial Statements (Continued)**

**3.             LOANS**

Loans are summarized as follows:
| **(Dollars in thousands)** | ** ** | **June 30,  2007** | ** ** | **December 31,  2006** | ** ** |
|--------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
|                                 |       |                    |       |                        |       |
| Commercial                           |       | $                       | 47,824     |                        | $          | 40,902 |   |
| Real estate commercial               |       | 431,558                 |       | 410,146                     |       |
| Real estate  construction            |       | 24,651                  |       | 23,953                      |       |
| Residential mortgage                 |       | 132,547                 |       | 137,334                     |       |
| Consumer and home  equity            |       | 64,374                  |       | 62,805                      |       |
| Indirect consumer                    |       | 29,506                  |       | 30,857                      |       |
| Loans held for sale                  |       | 1,329                   |       | 673                         |       |
|                                 |       | 731,789                 |       | 706,670                     |       |
| Less:                                |       |                    |       |                        |       |
| Net deferred  loan origination fees  |       | (755                    | )          | (960                        | )          |
| Allowance for  loan losses           |       | (7,822                  | )          | (7,684                      | )          |
|                                 |       | (8,577                  | )          | (8,644                      | )          |
|                                 |       |                    |       |                        |       |
| Loans                                |       | $                       | 723,212    |                        | $          | 698,026 |   |

 

The allowance forloan loss is summarized as follows:
| ** **                           | ** ** | **As of and For the  Three Months Ended  June 30,** | ** ** | **As of and For the  Six Months Ended  June 30,** | ** ** |
|--------------------------------------|------------|----------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------|------------|
| **(Dollars in thousands)** | ** ** | **2007**                                                                               | ** ** | **2006**                                                                             | ** ** | **2007** | ** ** | **2006** | ** ** |
|                                 |       |                                                                                   |       |                                                                                 |       |   |   |   |   |
| Balance, beginning of  period        |       | $                                                                                      | 7,730      |                                                                                 | $          | 7,420 |   | $ | 7,684 |   | $ | 7,377 |   |
| Provision for loan  losses           |       | 127                                                                                    |       | 9                                                                                    |       | 208 |   | 97 |   |
| Charge-offs                          |       | (95                                                                                    | )          | (178                                                                                 | )          | (201 | ) | (285 | ) |
| Recoveries                           |       | 60                                                                                     |       | 157                                                                                  |       | 131 |   | 219 |   |
| Balance, end of period               |       | $                                                                                      | 7,822      |                                                                                 | $          | 7,408 |   | $ | 7,822 |   | $ | 7,408 |   |

 

Impaired loans are summarized below. There were no impaired loans forthe periods presented without an allowance allocation.
| **(Dollars in thousands)**        | ** ** | **As of and For the  Six Months Ended  June 30,  2007** | ** ** | **As of and For the  Year Ended  December 31,  2006** | ** ** |
|---------------------------------------------|------------|--------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------|------------|
|                                        |       |                                                                                       |       |                                                                                |       |
| End of period impaired  loans               |       | $                                                                                          | 7,598      |                                                                                | $          | 4,838 |   |
| Amount of allowance for loan loss allocated |       | 212                                                                                        |       | 128                                                                                 |       |
|                                             |            |                                                                                            |            |                                                                                     |            |  |  |

 

11

----

**NotesTo Unaudited Consolidated Financial Statements (Continued)**

**3.             LOANS—(Continued)**

We report non-performing loans as impaired. Our non-performing loans bysource were as follows:
| **(Dollars in thousands)**          | ** ** | **June 30  2007** | ** ** | **December 31,  2006** | ** ** |
|-----------------------------------------------|------------|------------------------|------------|-----------------------------|------------|
|                                          |       |                   |       |                        |       |
| Restructured                                  |       | $                      | 2,412      |                        | $          | 2,470 |   |
| Loans past due over 90  days still on accrual |       | —                 |       | —                      |       |
| Non accrual loans                             |       | 5,186                  |       | 2,368                       |       |
| Total                                         |       | $                      | 7,598      |                        | $          | 4,838 |   |

 

**4.             EARNINGS PER SHARE**

The reconciliation of the numerators and denominators of the basic anddiluted EPS is as follows:
| ** **                                                                | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|---------------------------------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| **(Dollars in thousands,except per share data)** | ** ** | **2007**                                        | ** ** | **2006**                                      | ** ** | **2007** | ** ** | **2006** | ** ** |
|                                                                      |       |                                            |       |                                          |       |   |   |   |   |
| Net income available to  common shareholders                              |       | $                                               | 2,544      |                                          | $          | 2,755 |   | $ | 4,861 |   | $ | 5,093 |   |
| Basic EPS:                                                                |       |                                            |       |                                          |       |   |   |   |   |
| Weighted average  common shares                                           |       | 4,306                                           |       | 4,382                                         |       | 4,334 |   | 4,382 |   |
| Diluted EPS:                                                              |       |                                            |       |                                          |       |   |   |   |   |
| Weighted average  common shares                                           |       | 4,306                                           |       | 4,382                                         |       | 4,334 |   | 4,382 |   |
| Dilutive effect  of stock options                                         |       | 42                                              |       | 40                                            |       | 49 |   | 38 |   |
| Weighted average  common and incremental shares                           |       | 4,348                                           |       | 4,422                                         |       | 4,383 |   | 4,420 |   |
| Earnings Per Share:                                                       |       |                                            |       |                                          |       |   |   |   |   |
| Basic                                                                     |       | $                                               | 0.59       |                                          | $          | 0.63 |   | $ | 1.12 |   | $ | 1.16 |   |
| Diluted                                                                   |       | $                                               | 0.59       |                                          | $          | 0.62 |   | $ | 1.11 |   | $ | 1.15 |   |

 

Stock options for 26,000 shares of common stock were not included inthe June 30, 2007 computation of diluted earnings per share because they wereanti-dilutive. All outstanding stock options for the June 30, 2006 period wereincluded in diluted earnings per share.

**5.             STOCKOPTION PLAN**

Our 2006 Stock Incentive Plan, which isshareholder approved, succeeded our 1998 Stock Option and Incentive Plan. Underthe 2006 Plan, we may grant either incentive or non-qualified stock options to****key employees and directors****for a total of 588,500 shares of ourcommon stock at not less than fair value at the date such options are granted.****Options available for future grant underthe 1998 Plan totaled 35,000 shares and were rolled into the 2006 Plan.****We believe that the ability to award stockoptions and other forms of stock-based incentive compensation can assist us inattracting and retaining key employees. Stock-based incentive compensation isalso a means to align the interests of key employees with those of ourshareholders by providing awards intended to reward recipients for ourlong-term growth.****The option topurchase shares vest over periods of one to five years and expire ten yearsafter the date of grant.****We issuenew shares of common stock upon the exercise of stock options. At June 30, 2007options available for future grant under the 2006 Plan totaled 562,500.****Compensation cost related to options grantedunder the 1998 and 2006 Plans that was charged against earnings for the sixmonth periods ended June 30, 2007****and 2006 was$52,006 and $31,000.

12

----

**NotesTo Unaudited Consolidated Financial Statements (Continued)**

**5.             STOCKOPTION PLAN—(Continued)**

The fair value of each option award isestimated on the date of grant using the Black-Scholes option valuation modelthat uses various weighted-average assumptions. The risk-free interest rate isbased on the U.S. Treasury yield curve in effect at the time of grant. Theexpected volatility is based on the fluctuation in the price of a share ofstock over the period for which the option is being valued and the expectedlife of the options granted represents the period of time the options areexpected to be outstanding.

A summary of option activity under the 1998and 2006 Plans as of June 30, 2007 is presented below:
| **(Dollars In Thousands)** | ** ** | **Number  of Options** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Weighted  Average  Remaining  Contractual  Term** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
|--------------------------------------|------------|-----------------------------|------------|----------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------|------------|
|                                 |       |                        |       |                                   |       |                                                |       |                            |       |
| Outstanding, beginning  of period    |       | 169,160                     |       | $                                      | 20.35      | ** **                                          | ** ** | ** **                      | ** ** | ** ** |
| Granted during period                |       | —                      |       | —                                 | ** ** | ** **                                          | ** ** | ** **                      | ** ** |
| Exercised during the  period         |       | (4,554                      | )          | 15.86                                  | ** ** | ** **                                          | ** ** | ** **                      | ** ** |
| Outstanding, end of  period          |       | 164,606                     |       | $                                      | 20.47      |                                                | 5.8        |                            | $          | 1,311 |   |
|                                 | ** ** | ** **                  | ** ** | ** **                             | ** ** | ** **                                          | ** ** | ** **                      | ** ** |
| Eligible for exercise at period end  |       | 103,676                     |       | $                                      | 18.05      |                                                | 4.4        |                            | $          | 1,077 |   |

 

There were no options granted for the periodsended June 30, 2007 and 2006. The total intrinsic value of options exercisedduring the periods ended June 30, 2007 and 2006 was $66,908 and $8,778. Therewas no tax benefit recognized from the option exercises as they are consideredincentive stock options.

As of June 30, 2007 there was $302,303 oftotal unrecognized compensation cost related to non-vested share-basedcompensation arrangements granted under the 1998 and 2006 Plans. That cost isexpected to be recognized over a weighted-average period of 3.8 years. Cashreceived from option exercises under all share-based payment arrangements forthe periods ended June 30, 2007 and 2006 was $72,228 and $9,835.

13

----

**Item 2.**                          MANAGEMENT’SDISCUSSION AND ANALYSISOF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

**GENERAL**

Weconduct operations in 15 full-service banking centers in six contiguouscounties in Central Kentucky along the Interstate 65 corridor. Our markets rangefrom the major metropolitan area of Louisville in Jefferson County, Kentuckyapproximately 40 miles north of our headquarters in Elizabethtown, Kentucky toHart County, Kentucky, approximately 30 miles south of Elizabethtown. Ourmarkets are supported by a diversified industry base and have a regionalpopulation of over 1 million.

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

Through****our personal investment financial counselingservices, we offer a wide variety of mutual funds, equity investments, andfixed and variable annuities. We invest in the wholesale capital markets tomanage a portfolio of securities and use various forms of wholesale funding.The security portfolio contains a variety of instruments, including callabledebentures, taxable and non-taxable debentures, fixed and adjustable ratemortgage backed securities, and collateralized mortgage obligations.

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

This discussion andanalysis covers material changes in the financial condition since December 31,2006 and material changes in the results of operations for the three and sixmonth periods ending, June 30, 2007 as compared to 2006. It should be read inconjunction with “Management’s Discussion and Analysis of Financial Conditionand Results of Operations” included in the Annual Report on Form 10-K for theperiod ended December 31, 2006.

**OVERVIEW**

Overthe past several years we have focused on enhancing and expanding our retailand commercial banking network in our core markets as well as establishing ourpresence in the Louisville market. Our core markets, five counties other thanLouisville/Jefferson County where we have a combined 21% market share, havebecome increasingly competitive as several new banks have entered these marketsin the past few years. In order to protect and grow our market share, wereplaced existing branches with newer, enhanced facilities and anticipateconstructing several new facilities over the next few years. In addition to theenhancement and expansion in our core markets, we have been increasing ourpresence in the Louisville market. Approximately 75% of the deposit base in theLouisville market is controlled by six out-of-state banks. While the market isvery competitive, we believe this creates an opportunity for smaller communitybanks with more power to make decisions locally. We believe our investment inthese initiatives along with our continued commitment to a high level ofcustomer service will continue to enhance our market share in our core marketsand our development in the Louisville market.

Ourretail branch network continues to generate encouraging results. Total depositshave grown at a 10% compound annual growth rate over the past three years.Total deposits were $684.5 million at June 30, 2007, an increase of $43.4million, or 7% from December 31, 2006. The continued development of the retailbranch network into the Louisville market also yielded positive results. Wehave a combined $50.8 million in deposits in our two full-service facilities inthe Louisville market representing a 30% increase in deposits for the first sixmonths and a 189% increase from December 31, 2004. We opened these facilitiesin the second quarter of 2004 to support our growing customer base in thismarket and in June 2007 we opened our third new full service-banking center inthe Louisville market.

Wehave developed a strong commercial real estate niche in our markets. We have anexperienced team of bankers who are focused on providing service andconvenience to our customers. It is quite common for our 

14

----

bankersto close loans at a customer’s place of business or even the customer’spersonal residence. This high level of service has been especially wellreceived in our Louisville market, which is dominated by regional banks.Currently, 24% percent of our loan portfolio resides in the Louisville market.To further develop our commercial banking relationships in Louisville, weopened a private banking office in April 2007. This office is an upscalefacility complementing our retail branch network in Louisville allowing us tofurther attract commercial deposit relationships in conjunction with our commerciallending relationships.

Thisemphasis on commercial lending generated an 8% compound annual growth rate inthe total loan portfolio and a 16% compound annual growth rate in commercialloans over the past three years. Commercial loans were $504 million at June 302007, an increase of $29.0 million, or 6% from December 31, 2006. The growth inour commercial and commercial real estate loan portfolio, coupled with ourefforts to fund these loans with lower cost customer deposits is our primarybusiness model and has substantially contributed to the growth in earnings overthe past several years.

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

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

***Allowance for Loan Losses*****—**We maintain an allowance sufficient to absorbprobable incurred credit losses existing in the loan portfolio. The Allowancefor Loan Loss Review Committee evaluates the allowance for loan losses on aquarterly basis. We estimate the allowance using past loan loss experience,known and inherent risks in the portfolio, adverse situations that may affectthe borrower’s ability to repay, estimated value of the underlying collateral,and current economic conditions. While we estimate the allowance for loanlosses based in part on historical losses within each loan category, estimatesfor losses within the commercial real estate portfolio are more dependent uponcredit analysis and recent payment performance. Allocations of the allowance may be made for specific loans or loancategories, but the entire allowance is available for any loan that, inmanagement’s judgment, should be charged off.

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

Basedon our calculation, an allowance of $7.8 million****or 1.07% of total loans was our estimate of probable losseswithin the loan portfolio as of****June30, 2007.****This estimate resultedin a provision for loan losses on the income statement of****$208,000 for the 2007 six month period.****If the mix and amount of future charge offpercentages differ significantly from those assumptions used by management inmaking its determination, the allowance for loan losses and provision for loanlosses on the income statement could be materially increased.

***Stock-based Compensation*****—**We adopted theprovisions of Statement of Financial Accounting Standards (“SFAS”) No. 123 (R) “Share-BasedPayment (Revised 2004),” on January 1, 2006. Among other things, SFAS No. 123(R) eliminates the ability to account for stock-based compensation using theintrinsic value based method of accounting and requires that such transactionsbe recognized as compensation expense in the income statement based on theirfair values on the date of the grant. SFAS No. 123 (R) requires that managementmake assumptions including stock price volatility and expected forfeitures thatare utilized to measure compensation expense. We estimate fair value of stockoptions granted at the date of grant using the Black-Scholes option pricingmodel, which requires the input of highly subjective assumptions, such asvolatility, risk free interest rates and dividend pay out rates.

15

----

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

Net income for thequarter ended June 30, 2007 was $2.5 million or $0.59 per share dilutedcompared to $2.8 million or $0.62 per share diluted for the same period in2006. Net income for the six monthperiod ended June 30, 2007 was $4.9 million or $1.11 per share diluted comparedto $5.1 million or $1.15 per share diluted for the same period a year ago. Earningsdecreased for 2007 compared to 2006 due to a decrease in our net interestmargin and a higher level of non-interest expense related to our expansionefforts. Our book value percommon share increased from $15.53 at June 30, 2006 to $16.80 at June 30, 2007.****Annualized net income for the first sixmonths of 2007 generated a return on average assets of 1.17% and a return onaverage equity of 13.55%.****Thesecompare with a return on average assets of 1.32% and a return on average equityof 15.35% for the first six months of 2006, also on an annualized basis.

***Net Interest Income*****—**The principal source of our revenue is netinterest income. Net interest income is the difference between interest incomeon interest-earning assets, such as loans and securities and the interestexpense on liabilities used to fund those assets, such as interest-bearingdeposits and borrowings. Net interest income is impacted by both changes in theamount and composition of interest-earning assets and interest-bearing liabilitiesas well as market interest rates.

Thegrowth in our commercial loan portfolio has increased the level of interestincome generated. Average interest earning assets increased $53.0 million forthe 2007 quarter and $56.8 million for the six months compared to 2006. Theyield on earning assets averaged 7.67% and 7.66% for the three and six month2007 periods compared to an average yield on earning assets of 7.18% and 7.11%for the same periods in 2006. This increase was slightly offset by a larger increasein our cost of funds. On an annualized basis, the net interest margin as apercent of average earning assets decreased****12basis points to 3.93% for the quarter ended June 30, 2007 and 12 basis pointsto 3.95% for the six months ended June 30, 2007 compared to 4.05% and 4.07% forthe same periods in 2006.

Ourcost of funds averaged 4.11% and 4.07% for the quarter and six month periodsended June 30, 2007 compared to an average cost of funds of 3.46% and 3.35% forthe same periods in 2006.****Depositcosts have accelerated due to the re-pricing of maturing certificates ofdeposit that roll off into new certificates of deposit at currently higherinterest rates. In addition, we are paying higher rates on our money marketproducts. Going forward, our cost of funds is expected to increase as interestrates paid on deposit products have become increasingly competitive with therecent upward trend in interest rates.

The increase in thevolume of interest earning assets as well as a shift in some of our money marketaccount balances into higher rate certificate of deposits has resulted in anincrease in net interest income of $288,000 and $629,000 for the quarter andsix month periods ended June 30, 2007 compared to the same periods a year ago.The net interest margin is likely to compress in future quarters as short terminterest rates peak and the cost of deposits continue to rise. The cost ofdeposits typically lags behind the increase in adjustable rate loans becausecertificates of deposit generally mature over longer periods than immediatelyadjustable rate loans.

16

----

**AVERAGEBALANCE SHEET**

The following tablesprovide information relating to our average balance sheet and reflect theaverage yield on assets and average cost of liabilities for the indicatedperiods. Yields and costs for the periods presented are derived by dividingincome or expense by the average monthly balance of assets or liabilities,respectively.
| ** **                                           | ** ** | **Quarter Ended June 30,** | ** ** |
|------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                           | ** ** | **2007**                                  | ** ** | **2006** | ** ** |
| **(Dollars in thousands)**                 | ** ** | **Average  Balance**                      | ** ** | **Interest** | ** ** | **Average**Yield/Cost(5) | ** ** | **Average**Balance | ** ** | **Interest** | ** ** | **Average  Yield/Cost(5)** | ** ** |
|                                                 | ** ** | ** **                                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **ASSETS**                                           | ** ** | ** **                                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Interest earning  assets:                            |       |                                      |       |   |   |   |   |   |   |   |   |   |   |
| U.S. Treasury  and agencies                          |       | $                                         | 20,009     |   | $ | 185 |   | 3.71 | % | $ | 29,589 |   | $ | 227 |   | 3.08 | % |
| Mortgage-backed  securities                          |       | 12,393                                    |       | 134 |   | 4.34 |   | 15,240 |   | 162 |   | 4.26 |   |
| Equity  securities                                   |       | 2,055                                     |       | 18 |   | 3.51 |   | 1,938 |   | 19 |   | 3.93 |   |
| State and  political subdivision securities**(1)**   |       | 10,353                                    |       | 163 |   | 6.31 |   | 6,500 |   | 103 |   | 6.36 |   |
| Corporate bonds                                      |       | 5,025                                     |       | 62 |   | 4.95 |   | 6,028 |   | 108 |   | 7.19 |   |
| Loans**(2)(3)(4)**                                   |       | 729,017                                   |       | 14,364 |   | 7.90 |   | 654,893 |   | 12,287 |   | 7.53 |   |
| FHLB stock                                           |       | 7,621                                     |       | 123 |   | 6.47 |   | 7,297 |   | 104 |   | 5.72 |   |
| Interest bearing  deposits                           |       | 787                                       |       | 14 |   | 7.14 |   | 12,742 |   | 136 |   | 4.28 |   |
| **Total  interest earning assets**                   |       | 787,260                                   |       | 15,063 |   | 7.67 |   | 734,227 |   | 13,146 |   | 7.18 |   |
| Less: Allowance for  loan losses                     |       | (7,699                                    | )          |   |   |   |   | (7,391 | ) |   |   |   |   |
| Non-interest earning  assets                         |       | 59,909                                    |       |   |   |   |   | 55,642 |   |   |   |   |   |
| **Total  assets**                                    |       | $                                         | 839,470    |   |   |   |   |   | $ | 782,478 |   |   |   |   |   |
|                                                 |       |                                      |       |   |   |   |   |   |   |   |   |   |   |
| **LIABILITIES AND STOCKHOLDERS’  EQUITY**       | ** ** | ** **                                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Interest bearing  liabilities:                       |       |                                      |       |   |   |   |   |   |   |   |   |   |   |
| Savings accounts                                     |       | $                                         | 100,564    |   | $ | 825 |   | 3.29 | % | $ | 94,670 |   | $ | 650 |   | 2.75 | % |
| NOW and money  market accounts                       |       | 118,851                                   |       | 490 |   | 1.65 |   | 131,858 |   | 506 |   | 1.54 |   |
| Certificates of  deposit and other time deposits     |       | 427,917                                   |       | 5,126 |   | 4.80 |   | 350,007 |   | 3,405 |   | 3.90 |   |
| Short term  borrowings                               |       | 27,992                                    |       | 413 |   | 5.92 |   | 1,173 |   | 15 |   | 5.13 |   |
| FHLB advances                                        |       | 31,473                                    |       | 340 |   | 4.33 |   | 78,312 |   | 941 |   | 4.82 |   |
| Subordinated  debentures                             |       | 10,000                                    |       | 154 |   | 6.18 |   | 10,000 |   | 223 |   | 8.94 |   |
| **Total  interest bearing liabilities**              |       | 716,797                                   |       | 7,348 |   | 4.11 |   | 666,020 |   | 5,740 |   | 3.46 |   |
|                                                 |       |                                      |       |   |   |   |   |   |   |   |   |   |   |
| Non-interest bearing  liabilities:                   |       |                                      |       |   |   |   |   |   |   |   |   |   |   |
| Non-interest  bearing deposits                       |       | 44,884                                    |       |   |   |   |   | 43,898 |   |   |   |   |   |
| Other  liabilities                                   |       | 5,396                                     |       |   |   |   |   | 4,809 |   |   |   |   |   |
| **Total  liabilities**                               |       | 767,077                                   |       |   |   |   |   | 714,727 |   |   |   |   |   |
|                                                 |       |                                      |       |   |   |   |   |   |   |   |   |   |   |
| Stockholders’ equity                            |       | 72,393                                    |       |   |   |   |   | 67,751 |   |   |   |   |   |
| **Total  liabilities and stockholders’ equity** |       | $                                         | 839,470    |   |   |   |   |   | $ | 782,478 |   |   |   |   |   |
|                                                 |       |                                      |       |   |   |   |   |   |   |   |   |   |   |
| **Net interest income**                              |       |                                      |       | $ | 7,715 |   |   |   |   |   | $ | 7,406 |   |   |   |
| **Net interest spread**                              |       |                                      |       |   |   | 3.56 | % |   |   |   |   | 3.72 | % |
| **Net interest margin**                              |       |                                      |       |   |   | 3.93 | % |   |   |   |   | 4.05 | % |

----

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

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

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

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

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

17

----

| ** **                                           | ** ** | **Six Months Ended June 30,** | ** ** |
|------------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                           | ** ** | **2007**                                          | ** ** | **2006** | ** ** |
| **(Dollars in thousands)**                 | ** ** | **Average  Balance**                              | ** ** | **Interest** | ** ** | **Average  Yield/Cost(5)** | ** ** | **Average  Balance** | ** ** | **Interest** | ** ** | **Average  Yield/Cost(5)** | ** ** |
|                                                 | ** ** | ** **                                        | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **ASSETS**                                           | ** ** | ** **                                        | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Interest earning  assets:                            |       |                                              |       |   |   |   |   |   |   |   |   |   |   |
| U.S. Treasury  and agencies                          |       | $                                                 | 20,587     |   | $ | 373 |   | 3.65 | % | $ | 31,061 |   | $ | 476 |   | 3.09 | % |
| Mortgage-backed  securities                          |       | 12,745                                            |       | 273 |   | 4.32 |   | 15,660 |   | 332 |   | 4.28 |   |
| Equity  securities                                   |       | 2,103                                             |       | 37 |   | 3.55 |   | 1,969 |   | 37 |   | 3.79 |   |
| State and  political subdivision securities**(1)**   |       | 10,350                                            |       | 326 |   | 6.35 |   | 6,188 |   | 197 |   | 6.42 |   |
| Corporate bonds                                      |       | 5,172                                             |       | 185 |   | 7.21 |   | 5,660 |   | 189 |   | 6.73 |   |
| Loans**(2)(3)(4)**                                   |       | 724,400                                           |       | 28,305 |   | 7.88 |   | 649,486 |   | 24,002 |   | 7.45 |   |
| FHLB stock                                           |       | 7,621                                             |       | 243 |   | 6.43 |   | 7,246 |   | 206 |   | 5.73 |   |
| Interest bearing  deposits                           |       | 1,376                                             |       | 37 |   | 5.42 |   | 10,309 |   | 231 |   | 4.52 |   |
| **Total  interest earning assets**                   |       | 784,354                                           |       | 29,779 |   | 7.66 |   | 727,579 |   | 25,670 |   | 7.11 |   |
| Less: Allowance for  loan losses                     |       | (7,731                                            | )          |   |   |   |   | (7,376 | ) |   |   |   |   |
| Non-interest earning  assets                         |       | 60,403                                            |       |   |   |   |   | 57,067 |   |   |   |   |   |
| **Total  assets**                                    |       | $                                                 | 837,026    |   |   |   |   |   | $ | 777,270 |   |   |   |   |   |
|                                                 |       |                                              |       |   |   |   |   |   |   |   |   |   |   |
| **LIABILITIES AND STOCKHOLDERS’  EQUITY**       | ** ** | ** **                                        | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Interest bearing  liabilities:                       |       |                                              |       |   |   |   |   |   |   |   |   |   |   |
| Savings accounts                                     |       | $                                                 | 101,903    |   | $ | 1,686 |   | 3.34 | % | $ | 96,670 |   | $ | 1,282 |   | 2.67 | % |
| NOW and money  market accounts                       |       | 119,802                                           |       | 968 |   | 1.63 |   | 131,654 |   | 987 |   | 1.51 |   |
| Certificates of  deposit and other time deposits     |       | 417,627                                           |       | 9,733 |   | 4.70 |   | 342,222 |   | 6,337 |   | 3.73 |   |
| Short term  borrowings                               |       | 36,135                                            |       | 988 |   | 5.51 |   | 3,865 |   | 88 |   | 4.59 |   |
| FHLB advances                                        |       | 29,834                                            |       | 676 |   | 4.57 |   | 78,331 |   | 1,874 |   | 4.82 |   |
| Subordinated  debentures                             |       | 10,000                                            |       | 382 |   | 7.70 |   | 10,000 |   | 429 |   | 8.65 |   |
| **Total  interest bearing liabilities**              |       | 715,301                                           |       | 14,433 |   | 4.07 |   | 662,742 |   | 10,997 |   | 3.35 |   |
|                                                 |       |                                              |       |   |   |   |   |   |   |   |   |   |   |
| Non-interest bearing  liabilities:                   |       |                                              |       |   |   |   |   |   |   |   |   |   |   |
| Non-interest  bearing deposits                       |       | 44,041                                            |       |   |   |   |   | 43,158 |   |   |   |   |   |
| Other  liabilities                                   |       | 5,316                                             |       |   |   |   |   | 4,470 |   |   |   |   |   |
| **Total  liabilities**                               |       | 764,658                                           |       |   |   |   |   | 710,370 |   |   |   |   |   |
|                                                 |       |                                              |       |   |   |   |   |   |   |   |   |   |   |
| Stockholders’ equity                            |       | 72,368                                            |       |   |   |   |   | 66,900 |   |   |   |   |   |
| **Total  liabilities and stockholders’ equity** |       | $                                                 | 837,026    |   |   |   |   |   | $ | 777,270 |   |   |   |   |   |
|                                                 |       |                                              |       |   |   |   |   |   |   |   |   |   |   |
| **Net interest income**                              |       |                                              |       | $ | 15,346 |   |   |   |   |   | $ | 14,673 |   |   |   |
| **Net interest spread**                              |       |                                              |       |   |   | 3.59 | % |   |   |   |   | 3.76 | % |
| **Net interest margin**                              |       |                                              |       |   |   | 3.95 | % |   |   |   |   | 4.07 | % |

----

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

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

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

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

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

18

----

**RATE/VOLUME ANALYSIS**

Thetable below provides information regarding changes in interest income andinterest expense for the indicated periods. For each category ofinterest-earning assets and interest-bearing liabilities, information isprovided on changes attributable to (1) changes in rate (changes in ratemultiplied by old volume); (2) changes in volume (change in volume multipliedby old rate); and (3) changes in rate-volume (change in rate multiplied bychange in volume). Changes in rate-volume are proportionately allocated betweenrate and volume variance.
| ** **                                       | ** ** | **Three Months Ended  June 30,  2007 vs. 2006** | ** ** | **Six Months Ended  June 30,  2007 vs. 2006** | ** ** |
|--------------------------------------------------|------------|--------------------------------------------------------------------------|------------|------------------------------------------------------------------------|------------|
| ** **                                       | ** ** | **Increase (decrease)  Due to change in**            | ** ** | **Increase (decrease)  Due to change in**          | ** ** |
| **(Dollars in thousands)**             | ** ** | **Rate**                                                                 | ** ** | **Volume**                                                             | ** ** | **Net  Change** | ** ** | **Rate** | ** ** | **Volume** | ** ** | **Net  Change** | ** ** |
|                                             | ** ** | ** **                                                               | ** ** | ** **                                                             | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Interest income:**                             | ** ** | ** **                                                               | ** ** | ** **                                                             | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| U.S. Treasury  and agencies                      |       | $                                                                        | 41         |                                                                   | $          | (83 | ) | $ | (42 | ) | $ | 77 |   | $ | (180 | ) | $ | (103 | ) |
| Mortgage-backed  securities                      |       | 3                                                                        |       | (31                                                                    | )          | (28 | ) | 3 |   | (62 | ) | (59 | ) |
| Equity  securities                               |       | (2                                                                       | )          | 1                                                                      |       | (1 | ) | (2 | ) | 2 |   | — |   |
| State and  political subdivision securities      |       | (1                                                                       | )          | 61                                                                     |       | 60 |   | (2 | ) | 131 |   | 129 |   |
| Corporate bonds                                  |       | (46                                                                      | )          | —                                                                 |       | (46 | ) | (4 | ) | — |   | (4 | ) |
| Loans                                            |       | 638                                                                      |       | 1,439                                                                  |       | 2,077 |   | 1,428 |   | 2,875 |   | 4,303 |   |
| FHLB stock                                       |       | 14                                                                       |       | 5                                                                      |       | 19 |   | 26 |   | 11 |   | 37 |   |
| Interest bearing  deposits                       |       | 55                                                                       |       | (177                                                                   | )          | (122 | ) | 39 |   | (233 | ) | (194 | ) |
|                                             |       |                                                                     |       |                                                                   |       |   |   |   |   |   |   |   |   |
| **Total interest earning assets**                |       | 702                                                                      |       | 1,215                                                                  |       | 1,917 |   | 1,565 |   | 2,544 |   | 4,109 |   |
|                                             |       |                                                                     |       |                                                                   |       |   |   |   |   |   |   |   |   |
| **Interest expense:**                            | ** ** | ** **                                                               | ** ** | ** **                                                             | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Savings accounts                                 |       | 133                                                                      |       | 42                                                                     |       | 175 |   | 332 |   | 72 |   | 404 |   |
| NOW and money  market accounts                   |       | 36                                                                       |       | (52                                                                    | )          | (16 | ) | 74 |   | (93 | ) | (19 | ) |
| Certificates of  deposit and other time deposits |       | 877                                                                      |       | 844                                                                    |       | 1,721 |   | 1,833 |   | 1,563 |   | 3,396 |   |
| Short term  borrowings                           |       | 398                                                                      |       | —                                                                 |       | 398 |   | 900 |   | — |   | 900 |   |
| FHLB advances                                    |       | (87                                                                      | )          | (514                                                                   | )          | (601 | ) | (94 | ) | (1,104 | ) | (1,198 | ) |
| Subordinated  debentures                         |       | (69                                                                      | )          | —                                                                 |       | (69 | ) | (47 | ) | — |   | (47 | ) |
|                                             |       |                                                                     |       |                                                                   |       |   |   |   |   |   |   |   |   |
| **Total interest bearing  liabilities**          |       | 1,288                                                                    |       | 320                                                                    |       | 1,608 |   | 2,998 |   | 438 |   | 3,436 |   |
|                                             |       |                                                                     |       |                                                                   |       |   |   |   |   |   |   |   |   |
| **Net change in net interest income**            |       | $                                                                        | (586       | )                                                                      | $          | 895 |   | $ | 309 |   | $ | (1,433 | ) | $ | 2,106 |   | $ | 673 |   |

 

***Non-Interest Income and Non-InterestExpense***

Thefollowing tables provide a comparison of the components of non-interest incomeand expenses for the periods ended June 30, 2007 and 2006. The tables show thedollar and percentage change from 2006 to 2007. Below each table is adiscussion of significant changes and trends.
| ** **                                 | ** ** | **Three Months Ended June 30,** | ** ** |
|--------------------------------------------|------------|-----------------------------------------------------|------------|
| **(Dollars in thousands)**       | ** ** | **2007**                                            | ** ** | **2006** | ** ** | **Change** | ** ** | **%** | ** ** |
| **Non-interest income**                    | ** ** | ** **                                          | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Customer service  fees on deposit accounts |       | $                                                   | 1,489      |   | $ | 1,396 |   | $ | 93 |   | 6.7 | % |
| Gain on sale of  mortgage loans            |       | 166                                                 |       | 240 |   | (74 | ) | -30.8 | % |
| Brokerage  commissions                     |       | 106                                                 |       | 88 |   | 18 |   | 20.5 | % |
| Other income                               |       | 278                                                 |       | 352 |   | (74 | ) | -21.0 | % |
|                                       |       | $                                                   | 2,039      |   | $ | 2,076 |   | $ | (37 | ) | -1.8 | % |

 

19

----

 
| ** **                                       | ** ** | **Six Months Ended June 30,** | ** ** |
|--------------------------------------------------|------------|---------------------------------------------------|------------|
| **(Dollars in thousands)**             | ** ** | **2007**                                          | ** ** | **2006** | ** ** | **Change** | ** ** | **%** | ** ** |
| **Non-interest  income**                         | ** ** | ** **                                        | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Customer service fees on deposit accounts        |       | $                                                 | 2,763      |   | $ | 2,627 |   | $ | 136 |   | 5.2 | % |
| Gain on sale of mortgage loans                   |       | 292                                               |       | 403 |   | (111 | ) | -27.5 | % |
| Gain on sale of real estate held for development |       | 227                                               |       | — |   | 227 |   | 100.0 | % |
| Brokerage commissions                            |       | 202                                               |       | 171 |   | 31 |   | 18.1 | % |
| Other income                                     |       | 500                                               |       | 587 |   | (87 | ) | -14.8 | % |
|                                             |       | $                                                 | 3,984      |   | $ | 3,788 |   | $ | 196 |   | 5.2 | % |

 

Growthin customer service fees on deposit accounts, our largest component ofnon-interest income, is primarily due to growth in customer deposits, overdraftfee income on retail checking accounts and the sale of fee-based products for2007. We continue to increase our customer base through cross-sellingopportunities and marketing initiatives and promotions. In addition, wecontinue to emphasize growing our checking account base to better enhance ourprofitability and franchise value.

Weoriginate qualified VA, KHC, RHC and conventional secondary market loans andsell them into the secondary market with servicing rights released. For thequarter and the first six months of 2007, gain on sale of mortgage loansdecreased due to a decrease in the volume of loans closed.

Throughour subsidiary, First Federal Office Park, we hold commercial lots adjacent toour home office on Ring Road in Elizabethtown, that are available for sale.During the March 2007 quarter we recorded $227,000 in gains from a lot sale.Currently, one of the original nine lots held for sale remain unsold.
| ** **                             | ** ** | **Three Months Ended June 30,** | ** ** |
|----------------------------------------|------------|-----------------------------------------------------|------------|
| **(Dollars in thousands)**   | ** ** | **2007**                                            | ** ** | **2006** | ** ** | **Change** | ** ** | **%** | ** ** |
| **Non-interest  expenses**             | ** ** | ** **                                          | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Employee compensation and benefits     |       | $                                                   | 3,105      |   | $ | 2,817 |   | $ | 288 |   | 10.2 | % |
| Office occupancy expense and equipment |       | 596                                                 |       | 514 |   | 82 |   | 16.0 | % |
| Marketing and advertising              |       | 217                                                 |       | 214 |   | 3 |   | 1.4 | % |
| Outside services and data processing   |       | 670                                                 |       | 641 |   | 29 |   | 4.5 | % |
| Bank franchise tax                     |       | 234                                                 |       | 224 |   | 10 |   | 4.5 | % |
| Other expense                          |       | 979                                                 |       | 904 |   | 75 |   | 8.3 | % |
|                                   |       | $                                                   | 5,801      |   | $ | 5,314 |   | $ | 487 |   | 9.2 | % |

 
| ** **                                                | ** ** | **Six Months Ended June 30,** | ** ** |
|-----------------------------------------------------------|------------|---------------------------------------------------|------------|
| **(Dollars in thousands)**                      | ** ** | **2007**                                          | ** ** | **2006** | ** ** | **Change** | ** ** | **%** | ** ** |
| **Non-interest  expenses**                                | ** ** | ** **                                        | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Employee compensation and benefits                        |       | $                                                 | 6,229      |   | $ | 5,794 |   | $ | 435 |   | 7.5 | % |
| Office occupancy expense and equipment                    |       | 1,162                                             |       | 1,067 |   | 95 |   | 8.9 | % |
| Marketing and advertising                                 |       | 449                                               |       | 419 |   | 30 |   | 7.2 | % |
| Outside services and data processing                      |       | 1,336                                             |       | 1,257 |   | 79 |   | 6.3 | % |
| Bank franchise tax                                        |       | 465                                               |       | 443 |   | 22 |   | 5.0 | % |
| Write off of issuance cost of Trust Preferred  Securities |       | 229                                               |       | — |   | 229 |   | 100.0 | % |
| Other expense                                             |       | 1,946                                             |       | 1,743 |   | 203 |   | 11.6 | % |
|                                                      |       | $                                                 | 11,816     |   | $ | 10,723 |   | $ | 1,093 |   | 10.2 | % |

 

20

----

Employeecompensation and benefits is the largest component of non-interest expense.Employee compensation increased for the quarter and six months ended June 30,2007. Three commercial lending associates and ten retail associates have beenadded with our expansion efforts. These associates were hired for a commercialprivate banking center which opened in April 2007 and a new Louisville retailbranch facility which opened in June 2007. We look for a continued increase inemployee compensation and benefits expense in line with recent trends, as weprogress with our retail expansion and market efforts.

Officeoccupancy expense and equipment as well as marketing and advertising increaseddue to additional operating expenses related to our expansion efforts. Weanticipate the increased level of non-interest expense to continue in 2007 withcontinued retail expansion.

Included in non-interest expense for the June 2007 six month period is$229,000 in unamortized trust preferred issuance cost from the redemption ofall of our $10.0 million issuance of cumulative trust preferred securities.These securities paid distributions at a quarterly adjustable rate of LIBORplus 360 basis points (8.97% on March 26, 2007). We re-issued new cumulativetrust preferred securities at a 10 year fixed rate of 6.69%.

Ourefficiency ratio was 61% for the six months ended June 30, 2007 compared to 58%for the 2006 period.

**ANALYSIS OF FINANCIAL CONDITION**

Total assets at June 30,2007 increased to $838.7 million compared to $822.8 million at December 31,2006, an increase of $15.9 million. The increase was primarily driven by anincrease in loans of $25.2 million. The growth in loans was funded withdeposits, which increased $43.4 million for the period.

##### **Loans**

Net loans increased $25.2 million to $723.2 million at June 30, 2007compared to $698.0 million at December 31, 2006. Our commercial, commercialreal estate and real estate construction portfolios increased $29.0 million to$504.0 million at June 30, 2007. For the 2007 period, these loans comprised 69%of the total loan portfolio compared to 64% at June 30, 2006. Consumer, homeequity and indirect consumer loans also increased for the 2007 period by$218,000 to $93.9 million at June 30, 2007. Offsetting this growth was a $4.8million decrease in the residential mortgage loan portfolio to $132.5 millionat June 30, 2007, compared to $137.3 million****atDecember 31, 2006.
| **(Dollars in thousands)** | ** ** | **June 30,  2007** | ** ** | **December 31,  2006** | ** ** |
|--------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
|                                 |       |                    |       |                        |       |
| Commercial                           |       | $                       | 47,824     |                        | $          | 40,902 |   |
| Real estate commercial               |       | 431,558                 |       | 410,146                     |       |
| Real estate  construction            |       | 24,651                  |       | 23,953                      |       |
| Residential mortgage                 |       | 132,547                 |       | 137,334                     |       |
| Consumer and home  equity            |       | 64,374                  |       | 62,805                      |       |
| Indirect consumer                    |       | 29,506                  |       | 30,857                      |       |
| Loans held for sale                  |       | 1,329                   |       | 673                         |       |
|                                 |       | 731,789                 |       | 706,670                     |       |
| Less:                                |       |                    |       |                        |       |
| Net deferred  loan origination fees  |       | (755                    | )          | (960                        | )          |
| Allowance for  loan losses           |       | (7,822                  | )          | (7,684                      | )          |
|                                 |       | (8,577                  | )          | (8,644                      | )          |
|                                 |       |                    |       |                        |       |
| Loans                                |       | $                       | 723,212    |                        | $          | 698,026 |   |

 

21

----

**Allowance and Provision for LoanLosses**

Ourfinancial performance depends on the quality of the loans we originate andmanagement’s ability to assess the degree of risk in existing loans when itdetermines the allowance for loan losses. An increase in loan charge-offs ornon-performing loans or an inadequate allowance for loan losses could reducenet interest income, net income and capital and limit the range of products andservices we can offer.

TheAllowance for Loan Loss Review Committee evaluates the allowance for loanlosses quarterly to maintain a level sufficient to absorb incurred creditlosses existing in the loan portfolio. Periodic provisions to the allowance aremade as needed. The allowance is determined based on the application of lossestimates to graded loans by categories. The amount of the provision for loanlosses necessary to maintain an adequate allowance is also based upon ananalysis of such factors as changes in lending policies and procedures;underwriting standards; collection; charge-off and recovery history; changes innational and local economic business conditions and developments; changes inthe characteristics of the portfolio; ability and depth of lending managementand staff; changes in the trend of the volume and severity of past due,non-accrual and classified loans; troubled debt restructuring and other loanmodifications; and results of regulatory examinations.

The following tableprovides an analysis of loan loss experience for the periods indicated.
| ** **                                                                | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|---------------------------------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| **(Dollars in thousands)**                                      | ** ** | **2007**                                        | ** ** | **2006**                                      | ** ** | **2007** | ** ** | **2006** | ** ** |
|                                                                      |       |                                            |       |                                          |       |   |   |   |   |
| **Balance at beginning of period**                                        |       | $                                               | 7,730      |                                          | $          | 7,420 |   | $ | 7,684 |   | $ | 7,377 |   |
| Loans charged-off:                                                        |       |                                            |       |                                          |       |   |   |   |   |
| Real estate  mortgage                                                     |       | —                                          |       | 1                                             |       | — |   | 3 |   |
| Consumer                                                                  |       | 95                                              |       | 92                                            |       | 184 |   | 197 |   |
| Commercial                                                                |       | —                                          |       | 85                                            |       | 17 |   | 85 |   |
| Total charge-offs                                                         |       | 95                                              |       | 178                                           |       | 201 |   | 285 |   |
| Recoveries:                                                               |       |                                            |       |                                          |       |   |   |   |   |
| Real estate  mortgage                                                     |       | 1                                               |       | 3                                             |       | 9 |   | 6 |   |
| Consumer                                                                  |       | 57                                              |       | 68                                            |       | 119 |   | 127 |   |
| Commercial                                                                |       | 2                                               |       | 86                                            |       | 3 |   | 86 |   |
| Total recoveries                                                          |       | 60                                              |       | 157                                           |       | 131 |   | 219 |   |
|                                                                      |       |                                            |       |                                          |       |   |   |   |   |
| **Net loans charged-off**                                                 |       | 35                                              |       | 21                                            |       | 70 |   | 66 |   |
|                                                                      |       |                                            |       |                                          |       |   |   |   |   |
| Provision for loan  losses                                                |       | 127                                             |       | 9                                             |       | 208 |   | 97 |   |
|                                                                      |       |                                            |       |                                          |       |   |   |   |   |
| **Balance at end of period**                                              |       | $                                               | 7,822      |                                          | $          | 7,408 |   | $ | 7,822 |   | $ | 7,408 |   |
|                                                                      |       |                                            |       |                                          |       |   |   |   |   |
| Allowance for loan  losses to total loans (excluding loans held for sale) |       |                                            |       |                                          |       | 1.07 | % | 1.11 | % |
| Annualized net  charge-offs to average loans outstanding                  |       |                                            |       |                                          |       | 0.02 | % | 0.02 | % |
| Allowance for loan  losses to total non-performing loans                  |       |                                            |       |                                          |       | 103 | % | 134 | % |

 

Theprovision for loan losses increased $118,000 to $127,000 for the quarter endedJune 30, 2007, and increased $111,000 to $208,000 for the six months ended June30, 2007 compared to the same periods in 2006. We recorded a smaller provisionfor 2006 due to the improved performance of certain credit relationships whichresulted in a reduction in the allowance allocated to the loans. The allowancefor loan losses increased $414,000 to $7.8 million from June 30, 2006 to June30, 2007. The increase in the allowance was related to a $24.7 million increasein net loans for 2007 compared to 2006, in conjunction with a $1.1 millionincrease in classified loans for the 2007 period.

Federalregulations require banks to classify their own assets on a regular basis. Theregulations provide for three categories of classified loans—substandard,doubtful and loss. A bank must establish general allowances for loan losses forany assets classified as substandard or doubtful. If an asset or portionthereof is classified as 

22

----

loss,the bank must either establish specified allowances for loan losses in theamount of 100% of the portion of the asset classified loss, or charge off theamount of the loss.

Thefollowing table provides information with respect to classified loans for theperiods indicated:
| ** **                           | ** ** | **June 30,** | ** ** |
|--------------------------------------|------------|-------------------|------------|
| **(Dollars in thousands)** | ** ** | **2007**          | ** ** | **2006** | ** ** |
| **Classified  Loans**                | ** ** | ** **        | ** ** | ** ** | ** ** |
| Substandard                          |       | $                 | 14,114     |   | $ | 12,106 |   |
| Doubtful                             |       | 25                |       | 916 |   |
| Loss                                 |       | 36                |       | 38 |   |
| Total Classified                     |       | $                 | 14,175     |   | $ | 13,060 |   |

 

The$2.0 million increase in substandard assets for 2007 was primarily the result****of the downgrading of loans with threeborrowers in the amount of a $1.8 million, $1.1 million and $667,000,****respectively.****Offsetting this increase were upgrades of two classified loanshaving balances of $1.2 million and $1.1 million. We remain well secured andadequately collateralized with these credits.

Althoughwe may allocate a portion of the allowance to specific loans or loancategories, the entire allowance is available for active charge-offs. Wedevelop our allowance estimates based on actual loss experience adjusted forcurrent economic conditions. Allowance estimates represent a prudentmeasurement of the risk in the loan portfolio, which we apply to individualloans based on loan type.

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

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

Wereview our loans on a regular basis and implement normal collection procedureswhen a borrower fails to make a required payment on a loan. If the delinquencyon a mortgage loan exceeds 90 days and is not cured through normal collectionprocedures or an acceptable arrangement is not worked out with the borrower, weinstitute measures to remedy the default, including commencing a foreclosureaction. We generally charge off consumer loans when management deems a loanuncollectible and any available collateral has been liquidated. We handlecommercial business and real estate loan delinquencies on an individual basiswith the advice of legal counsel.

Werecognize interest income on loans on the accrual basis except for those loansin a non-accrual of income status. We discontinue accruing interest on impairedloans when management believes, after consideration of economic and businessconditions and collection efforts that the borrowers’ financial condition issuch that collection of interest is doubtful, typically after the loan becomes90 days delinquent. When we discontinue interest accrual, we reverse existingaccrued interest and subsequently recognize interest income only to the extentwe receive cash payments.

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

23

----

Thefollowing table provides information with respect to non-performing assets forthe periods indicated.
| **(Dollar in thousands)**                                                                                                                              | ** ** | **June 30,  2007** | ** ** | **December 31,  2006** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
|                                                                                                                                                             |       |                    |       | ** **                  |       |
| Restructured                                                                                                                                                     |       | $                       | 2,412      |                        | $          | 2,470 |   |
| Past due 90 days still  on accrual                                                                                                                               |       | —                  |       | —                      |       |
| Loans on non-accrual  status                                                                                                                                     |       | 5,186                   |       | 2,368                       |       |
|                                                                                                                                                             |       |                    |       |                        |       |
| Total  non-performing loans                                                                                                                                      |       | 7,598                   |       | 4,838                       |       |
| Real estate acquired  through foreclosure                                                                                                                        |       | 508                     |       | 918                         |       |
| Other repossessed  assets                                                                                                                                        |       | 34                      |       | 82                          |       |
| Total  non-performing assets                                                                                                                                     |       | $                       | 8,140      |                        | $          | 5,838 |   |
|                                                                                                                                                             |       |                    |       |                        |       |
| Interest income that  would have been earned on non-performing loans                                                                                             |       | $                       | 462        |                        | $          | 368 |   |
| Interest income  recognized on non-performing loans                                                                                                              |       | 211                     |       | 227                         |       |
| Ratios:    Non-performing loans to total loans (excluding  loans held for sale)                                                                   | ** ** | 1.04                    | %          | 0.69                        | %          |
|                 Non-performing assets to total  loans (excluding loans held for sale) |       | 1.12                    | %          | 0.83                        | %          |

 

Non-performing loans increased $2.8 million to $7.6million at June 30, 2007 compared to $4.8 million at December 31, 2006. Theincrease was related to an increase in non-accrual loans of $2.8 million. Thiswas primarily the result of two commercial real estate credit relationshipstotaling $1.1 million and $1.3 million. These credit relationships arewell secured and no loss is expected.

Non-performing assets for the 2007 period include $2.4 million inrestructured commercial, residential mortgage and consumer loans.****The restructured loans primarily consistof two credit relationships with balances of $2.0 million, and $200,000. Theterms of these loans have been renegotiated to reduce the rate of interest andextend the term, thus reducing the amount of cash flow required from theborrower to service the loans. The borrowers are currently meeting the terms ofthe restructured loans.

**InvestmentSecurities**

Intereston securities provides us our largest source of interest income after intereston loans, constituting 4.6% of the total interest income for the six monthsended June 30, 2007. The securitiesportfolio serves as a source of liquidity and earnings and contributes to themanagement of interest rate risk. We have the authority to invest invarious types of liquid assets, including short-term United States Treasuryobligations and securities of various federal agencies, obligations of statesand political subdivisions, corporate bonds, certificates of deposit at insuredsavings and loans and banks, bankers’ acceptances, and federal funds. We mayalso invest a portion of our assets in certain commercial paper and corporatedebt securities. We are also authorized to invest in mutual funds and stockswhose assets conform to the investments that we are authorized to makedirectly. The available-for-sale and held-to-maturity investment portfoliosdecreased by $7.3 million during the 2007 period as securities were called forredemption in accordance with their terms due to increasing rates. During theperiod we made purchases of investments in state and municipal obligations. Thestate and municipal obligations have an average life of 10 years. We purchasedthese securities to enhance earnings.

We review unrealized lossesat least on a quarterly basis to determine whether the losses are other thantemporary and more frequently when economic or market concerns warrant suchevaluation. We consider the length of time and the extent to which the fairvalue has been less than cost, the financial condition and near-term prospectsof the issuer, and our intent and ability to retain the investment in theissuer for a period of time sufficient to allow for any anticipated recovery infair value. In analyzing an issuer’s financial condition, we may considerwhether the securities are issued by the federal government or its agencies,whether downgrades by bond rating agencies have occurred, and the results ofreviews of the issuer’s financial condition. The unrealized losses on our investmentsin U.S. Treasury and agencies, mortgage-backed securities and obligations ofstate and political subdivisions are due to interest rate increases. Becausethe decline in market value is attributable to changes in interest rates andnot credit quality, and because we have the ability and intent to hold these 

24

----

investments until recoveryof fair value, which may be maturity, we do not consider these investments tobe other than temporarily impaired at June 30, 2007.

###### **Deposits**

Werely primarily on customer service and long-standing relationships withcustomers to attract and retain deposits. Market interest rates and rates ondeposit products offered by competing financial institutions can significantlyaffect our ability to attract and retain deposits. In conjunction with ourinitiatives to expand and enhance our retail branch network, we emphasizegrowing our customer checking account base to better enhance profitability andfranchise value. Total deposits increased $43.4 million year to date compared toDecember 31, 2006. This was primarily the result of an increase in certificatesof deposit. Retail and commercial deposits increased $41.8 million and we added$1.6 million in public funds and brokered certificates of deposit.

Thefollowing table breaks down our deposits.
| ** **               | ** ** | **June 30,  2007** | ** ** | **December 31,  2006** | ** ** |
|--------------------------|------------|-------------------------|------------|-----------------------------|------------|
| **(In Thousands)**  | ** ** | ** **              | ** ** | ** **                  | ** ** |
|                     |       |                    |       |                        |       |
| Non-interest  bearing    |       | $                       | 44,812     |                        | $          | 40,349 |   |
| NOW demand               |       | 75,064                  |       | 73,552                      |       |
| Savings                  |       | 91,131                  |       | 84,994                      |       |
| Money market             |       | 45,898                  |       | 53,917                      |       |
| Certificates of  deposit |       | 427,548                 |       | 388,225                     |       |
|                     |       | $                       | 684,453    |                        | $          | 641,037 |   |

 

**Short-Term Borrowings**

Short-term borrowings consist of federal fundspurchased and securities sold under agreements to repurchase. We had short-termborrowings of $40.5 million and $68.5 million from the FHLB of Cincinnati atJune 30, 2007 and December 31, 2006. These borrowings averaged a rate of 5.51%and 5.31% for the respective periods.

**Advances from Federal Home Loan Bank**

Deposits are the primarysource of funds for our lending and investment activities and for our generalbusiness purposes. We can also use advances (borrowings) from the Federal HomeLoan Bank (FHLB) of Cincinnati to compensate for reductions in deposits ordeposit inflows at less than projected levels. Advances from the FHLB aresecured by our stock in the FHLB, certain securities, certain commercial realestate loans and substantially all of our first residential mortgage loans. AtJune 30, 2007 we had $28.2 million in advances outstanding from the FHLB.

**SubordinatedDebentures**

Wehave $10.0 million in outstanding subordinated debentures. A trust we formedcompleted a private placement of 10,000 shares of cumulative trust preferredsecurities with a liquidation preference of $1,000 per security for a totaloutstanding of $10.0 million. The proceeds of the offering were loaned to us inexchange for junior subordinated deferrable interest debentures.In accordance with FASB Interpretation 46,the trust is not consolidated with our financial statements but rather thesubordinated debentures are shown as a liability. These securities paiddistributions of interest. On March 26, 2007 we called the $10.0 million insubordinated debentures adjustable quarterly at LIBOR plus 360 basis points(8.97% on March 26, 2007) and were-issued new 30 year cumulative trust preferred securities at a 10 year fixedrate of 6.69% adjusting quarterly thereafter at LIBOR plus 160 basis points. Refinancing at a lower interest ratewill reduce interest expense approximately $226,000 per year based on currentrates. The subordinateddebentures are considered as Tier I capital for the Corporation under currentregulatory guidelines.

25

----

##### **LIQUIDITY**

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

Oursources of funds include the sale of securities in the available-for-saleportion of the investment portfolio, principal pay-downs on loans and mortgage-backedsecurities, proceeds realized from loans held for sale, brokered deposits andother wholesale funding. We also secured federal funds borrowing lines from twoof our correspondent banks of $15 million each. Our banking centers alsoprovide access to retail deposit markets. If large certificate depositors shiftto our competitors or other markets in response to interest rate changes, wehave the ability to replenish those deposits through alternative fundingsources. Traditionally, we have also borrowed from the FHLB to supplement ourfunding requirements. At June 30, 2007, we had an unused approved line ofcredit in the amount of $92.0 million and sufficient collateral available toborrow, approximately, an additional $46.7 million in advances from the FHLB.****We believe our sources of liquidity areadequate to meet expected cash needs for the foreseeable future.

Atthe holding company level, the Corporation uses cash to pay dividends tostockholders, repurchase common stock, make selected investments andacquisitions, and service debt. The main sources of funding for the Corporationinclude dividends from the Bank, borrowings and access to the capital markets.

Theprimary source of funding for the Corporation has been dividends and returns ofinvestment from the Bank. Kentucky banking laws limit the amount of dividendsthat may be paid to the Corporation by the Bank without prior approval of theKOFI. Under these laws, the amount ofdividends that may be paid in any calendar year is limited to current year’snet income, as defined in the laws, combined with the retained net income ofthe preceding two years, less any dividends declared during those periods.At June 30 2007, the Bank had approximately $17.6 million of retained earningsthat could be used to pay dividends without prior regulatory approval. Becauseof these limitations, consolidated cash flows as presented in the consolidatedstatements of cash flows may not represent cash immediately available to theCorporation. During the six month period ended June 30, 2007, the Bank declaredand paid dividends of $5.4 million to the Corporation.

##### **CAPITAL**

Stockholders’ equitydecreased $182,000 for the period ended June 30, 2007 compared to December 31,2006.****The decrease in capital wasprimarily due to the repurchase of our own common stock and cash dividendsdeclared during the period.****Thisdecrease was offset by net income earned during the period. Averagestockholders’ equity to average assets ratio increased to 8.65% for the sixmonth period ended June 30, 2007 compared to 8.61% for 2006.

Duringthe first six months of 2007, we purchased 110,101 shares of our own commonstock for $3.2 million.Therepurchase program authorizes the repurchase of 398,601 shares fromtime-to-time if market conditions are deemed favorable. The repurchase program will remain effectiveuntil the number of shares authorized is repurchased or until the programexpires September 19, 2008. Asof June 30, 2007, 288,000 shares could be repurchased under the current stockrepurchase program.

Each of the federal bankregulatory agencies has established minimum leverage capital requirements forbanks. Banks must maintain a minimum ratio of Tier 1 capital to adjustedaverage quarterly assets ranging from 3% to 5%, subject to federal bank regulatoryevaluation of an organization’s overall safety and soundness. We intend tomaintain a capital position that meets or exceeds the “well capitalized”requirements as defined for banks by the FDIC. The following table shows theratios of Tier 1 capital and total capital to risk-adjusted assets and theleverage ratios for the Corporation and the Bank as of June 30, 2007.

26

----

| ** **                                          | ** ** | **Actual** | ** ** | **For Capital  Adequacy Purposes** | ** ** | **To Be Considered  Well Capitalized  Under Prompt  Correction  Action Provisions** | ** ** |
|-----------------------------------------------------|------------|------------|------------|----------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------|------------|
| **(Dollars in thousands)**                | ** ** | **Amount** | ** ** | **Ratio**                                    | ** ** | **Amount**                                                                                                   | ** ** | **Ratio** | ** ** | **Amount** | ** ** | **Ratio** | ** ** |
| **As of June 30, 2007:**                            |       |       |       |                                         |       |                                                                                                         |       |   |   |   |   |   |   |
| Total risk-based  capital (to risk-weighted assets) |       |       |       |                                         |       |                                                                                                         |       |   |   |   |   |   |   |
| Consolidated                                        |       | $          | 81,869     |                                         | 11.2       | %                                                                                                            | $          | 58,321 |   | 8.0 | % | N/A |   | N/A |   |
| Bank                                                |       | 78,824     |       | 10.9                                         |       | 58,112                                                                                                       |       | 8.0 |   | 72,640 |   | 10 | % |
| Tier I capital  (to risk-weighted assets)           | ** ** | ** ** | ** ** | ** **                                   | ** ** | ** **                                                                                                   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Consolidated                                        |       | 73,817     |       | 10.1                                         |       | 29,160                                                                                                       |       | 4.0 |   | N/A |   | N/A |   |
| Bank                                                |       | 70,772     |       | 9.7                                          |       | 29,056                                                                                                       |       | 4.0 |   | 43,584 |   | 6 | % |
| Tier I capital  (to average assets)                 | ** ** | ** ** | ** ** | ** **                                   | ** ** | ** **                                                                                                   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Consolidated                                        |       | 83,817     |       | 8.9                                          |       | 33,243                                                                                                       |       | 4.0 |   | N/A |   | N/A |   |
| Bank                                                |       | 70,772     |       | 8.5                                          |       | 33,215                                                                                                       |       | 4.0 |   | 41,519 |   | 5 | % |
|                                                     |            |            |            |                                              |            |                                                                                                              |            |  |  |  |  |  |  |  |  |

 
| ** **                                          | ** ** | **Actual** | ** ** | **For Capital  Adequacy Purposes** | ** ** | **To Be Considered  Well Capitalized  Under Prompt  Correction  Action Provisions** | ** ** |
|-----------------------------------------------------|------------|------------|------------|----------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------|------------|
| **(Dollars in thousands)**                | ** ** | **Amount** | ** ** | **Ratio**                                    | ** ** | **Amount**                                                                                                   | ** ** | **Ratio** | ** ** | **Amount** | ** ** | **Ratio** | ** ** |
| **As of  December 31, 2006:**                       |       |       |       |                                         |       |                                                                                                         |       |   |   |   |   |   |   |
| Total  risk-based capital (to risk-weighted assets) |       |       |       |                                         |       |                                                                                                         |       |   |   |   |   |   |   |
| Consolidated                                        |       | $          | 81,583     |                                         | 11.6       | %                                                                                                            | $          | 56,504 |   | 8.0 | % | N/A |   | N/A |   |
| Bank                                                |       | 78,653     |       | 11.2                                         |       | 56,376                                                                                                       |       | 8.0 |   | 70,470 |   | 10.0 |   |
| Tier I capital  (to risk-weighted assets)           | ** ** | ** ** | ** ** | ** **                                   | ** ** | ** **                                                                                                   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Consolidated                                        |       | 73,639     |       | 10.4                                         |       | 28,252                                                                                                       |       | 4.0 |   | N/A |   | N/A |   |
| Bank                                                |       | 70,709     |       | 10.0                                         |       | 28,188                                                                                                       |       | 4.0 |   | 42,282 |   | 6.0 |   |
| Tier I capital  (to average assets)                 | ** ** | ** ** | ** ** | ** **                                   | ** ** | ** **                                                                                                   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Consolidated                                        |       | 73,639     |       | 9.2                                          |       | 32,014                                                                                                       |       | 4.0 |   | N/A |   | N/A |   |
| Bank                                                |       | 70,709     |       | 8.9                                          |       | 31,962                                                                                                       |       | 4.0 |   | 39,953 |   | 5.0 |   |
|                                                     |            |            |            |                                              |            |                                                                                                              |            |  |  |  |  |  |  |  |  |

 

**Item 3.**                          QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

**Asset/LiabilityManagement and Market Risk**

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

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

27

----

Our interest sensitivityprofile was slightly asset sensitive at June 30, 2007, compared to a liabilitysensitive position at December 31, 2006. Given a sustained 100 basis pointdecrease in rates, our base net interest income would increase by an estimated****.11% at June 30, 2007 compared to anincrease of .55% at December 31, 2006. Given a 100 basis point increase ininterest rates our base net interest income would increase by an****estimated .11% at June 30, 2007 comparedto a decrease of .48% at December 31, 2006.

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

We have beenrestructuring our balance sheet so that our change to net interest income willbe relatively neutral whether interest rates increase or decrease in thefuture. As demonstrated by the June 30, 2007 sensitivity table, we transitionedfrom a liability sensitive to an asset sensitive position as compared toDecember 31, 2006. This means that our earning assets, which consist of loansand investment securities, will change in price at a faster rate than ourdeposits and borrowings. Therefore, if short term interest rates increase 200basis points, our net interest income will also increase. Likewise, if shortterm interest rates decrease 200 basis points, our net interest income willdecrease.

We continually monitorthe effects rate changes will have on our level of net interest income, andmanagement works to structure the maturity and pricing of loans and deposits tomitigate large swings in net interest income.****During 2007 and 2006, we made efforts to increase the level ofshort-term deposits offering more attractive rates on short-term certificatesof deposits. Also, during the third quarter of 2006, we paid off a fixed rateFHLB advance that had converted to a variable rate advance. We replaced thisborrowing initially with overnight short-term borrowings. In March 2007, we calledour $10.0 million in subordinated debentures adjustable quarterly at LIBOR plus360 basis points (8.97% on March 26, 2007) and we re-issued new 30 yearcumulative trust preferred securities at a 10 year fixed rate of 6.69%adjusting quarterly thereafter at LIBOR plus 160 basis points. In addition, themajority of the newly originated or renewed loans during 2007 and 2006 werefixed rates loans with the interest rate fixed from three to five years.

28

----

Our sensitivity tointerest rate changes is presented below based on data as of June 30, 2007 andDecember 31, 2006 annualized to a one year period.
| ** **                           | ** ** | **June 30, 2007**     | ** ** |
|--------------------------------------|------------|---------------------------------|------------|
| ** **                           | ** ** | **Decrease in Rates** | ** ** | ** ** | ** ** | **Increase in Rates** | ** ** |
| **(Dollars in thousands)** | ** ** | **200  Basis Points**      | ** ** | **100  Basis Points** | ** ** | **Base** | ** ** | **100  Basis Points** | ** ** | **200  Basis Points** | ** ** |
|                                 |       |                            |       |   |   |   |   |   |   |   |   |
| **Projected interest income**        | ** ** | ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Loans                                |       | $                               | 61,334     |   | $ | 62,765 |   | $ | 63,982 |   | $ | 65,164 |   | $ | 66,446 |   |
| Investments                          |       | 2,621                           |       | 2,734 |   | 2,833 |   | 2,916 |   | 3,002 |   |
| **Total interest income**            |       | 63,955                          |       | 65,499 |   | 66,815 |   | 68,080 |   | 69,448 |   |
|                                 |       |                            |       |   |   |   |   |   |   |   |   |
| **Projected interest expense**       | ** ** | ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Deposits                             |       | 23,578                          |       | 24,718 |   | 25,856 |   | 26,879 |   | 27,902 |   |
| Borrowed funds                       |       | 3,563                           |       | 3,783 |   | 4,002 |   | 4,205 |   | 4,407 |   |
| **Total interest expense**           |       | 27,141                          |       | 28,501 |   | 29,858 |   | 31,084 |   | 32,309 |   |
|                                 |       |                            |       |   |   |   |   |   |   |   |   |
| **Net interest income**              |       | $                               | 36,814     |   | $ | 36,998 |   | $ | 36,957 |   | $ | 36,996 |   | $ | 37,139 |   |
| Change from base                     |       | $                               | (143       | ) | $ | 41 |   |   |   | $ | 39 |   | $ | 182 |   |
| % Change from base                   |       | (.39                            | )%         | .11 | % |   |   | .11 | % | .49 | % |

 
| ** **                           | ** ** | **December 31, 2006** | ** ** |
|--------------------------------------|------------|---------------------------------|------------|
| ** **                           | ** ** | **Decrease in Rates** | ** ** | ** ** | ** ** | **Increase in Rates** | ** ** |
| **(Dollars in thousands)** | ** ** | **200  Basis Points**      | ** ** | **100  Basis Points** | ** ** | **Base** | ** ** | **100  Basis Points** | ** ** | **200  Basis Points** | ** ** |
|                                 |       |                            |       |   |   |   |   |   |   |   |   |
| **Projected interest income**        | ** ** | ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Loans                                |       | $                               | 58,262     |   | $ | 59,517 |   | $ | 60,592 |   | $ | 61,623 |   | $ | 62,759 |   |
| Investments                          |       | 2,342                           |       | 2,482 |   | 2,535 |   | 2,625 |   | 2,653 |   |
| **Total interest income**            |       | 60,604                          |       | 61,999 |   | 63,127 |   | 64,248 |   | 65,412 |   |
|                                 |       |                            |       |   |   |   |   |   |   |   |   |
| **Projected interest expense**       | ** ** | ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Deposits                             |       | 20,643                          |       | 21,500 |   | 22,356 |   | 23,124 |   | 23,891 |   |
| Borrowed funds                       |       | 5,071                           |       | 5,628 |   | 6,090 |   | 6,608 |   | 7,040 |   |
| **Total interest expense**           |       | 25,714                          |       | 27,128 |   | 28,446 |   | 29,732 |   | 30,931 |   |
|                                 |       |                            |       |   |   |   |   |   |   |   |   |
| **Net interest income**              |       | $                               | 34,890     |   | $ | 34,871 |   | $ | 34,681 |   | $ | 34,516 |   | $ | 34,481 |   |
| Change from base                     |       | $                               | 209        |   | $ | 190 |   |   |   | $ | (165 | ) | $ | (200 | ) |
| % Change from base                   |       | .60                             | %          | .55 | % |   |   | (.48 | )% | (.58 | )% |

 

**Item 4.**                          CONTROLSAND PROCEDURES

*Evaluation of disclosure controls and procedures*

Ourmanagement, with the participation of our Chief Executive Officer and our ChiefFinancial Officer, evaluated the effectiveness of our disclosure controls andprocedures as of the end of the period covered by this Quarterly Report on Form10-Q. Based on this evaluation, our Chief Executive Officer and our ChiefFinancial Officer have concluded that our disclosure controls and procedureswere effective as of the end of the period covered by this Quarterly Report onForm 10-Q to ensure that information we are required to disclose in reportsthat we file or submit under the Securities Exchange Act of 1934 is recorded,processed, summarized and reported within the time periods specified inSecurities and Exchange Commission rules and forms.

29

----

*Limitations on the Effectiveness of Controls*

A control system, no matter how well designed andoperated, can provide only reasonable, not absolute, assurance that the controlsystem’s objectives will be met. Further, the design of a control system mustreflect the fact that there are resource constraints, and the benefits ofcontrols must be considered relative to their costs. Because of the inherentlimitations in all control systems, no evaluation of controls can provideabsolute assurance that all control issues and instances of fraud, if any, withour company have been detected. These inherent limitations include therealities that judgments in decision making can be faulty, that breakdowns canoccur because of simple errors or mistakes, and that controls can becircumvented by the acts of individuals or groups. Because of the inherentlimitations in a cost effective control system, misstatements due to error orfraud may occur and not be detected.

*Changes in internal control over financial reporting*

Therewas no change in our internal control over financial reporting that occurredduring the period covered by this Quarterly Report on Form 10-Q that hasmaterially affected, or is reasonably likely to materially affect, our internalcontrol over financial reporting.

30

----

##### **Part II—OTHERINFORMATION**

**Item 1.**                                                           LegalProceedings

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

**Item 1A.**                                                  RiskFactors

We did not have any changes to our risk factorspreviously disclosed in our Annual Report on Form 10-K for the year endedDecember 31, 2006.

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

(e)                                  IssuerPurchases of Equity Securities
| **Period**       | ** ** | **Total  Number  of Shares  Purchased** | ** ** | **Average  Price  Paid  per Share** | ** ** | **Total Number of  Shares Purchased  as Part of  Publicly Announced  Plans** | ** ** | **Maxium  Number of Shares  that May Yet Be  Purchased Under  the Plan** | ** ** |
|------------------|------------|----------------------------------------------|------------|------------------------------------------|------------|------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------|------------|
| April 1-April 30 |       | —                                       |       | $                                        | —     |                                                                                                       | —     |                                                                                                        | 337,101    |   |
| May 1-May 31     |       | 39,101                                       |       | 28.28                                    |       | 39,101                                                                                                     |       | 298,000                                                                                                     |       |
| June 1-June 30   |       | 10,000                                       |       | 28.01                                    |       | 10,000                                                                                                     |       | 288,000                                                                                                     |       |
|             |       |                                         |       |                                     |       |                                                                                                       |       |                                                                                                        |       |
| Total            |       | 49,101                                       |       | $                                        | 28.23      |                                                                                                       | 49,101     |                                                                                                        |       |   |

 

**Item 3.**                                                           DefaultsUpon Senior Securities

Not Applicable

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

Our 2007 AnnualMeeting of Shareholders was held on May 9, 2007. At the meeting, the directorslisted below were elected as directors of the Corporation for terms expiring atthe annual meeting in the year set forth to each of their names. The votingresults for the matters brought before the 2007 Annual Meeting are as follows:

1.                                       Electionof Directors.
| **Name**        | ** ** | **Term Expires** | ** ** | **Votes For** | ** ** | **Abstentions** | ** ** | **Broker Non-Votes** | ** ** |
|-----------------|------------|-----------------------|------------|--------------------|------------|-----------------|------------|---------------------------|------------|
| Robert M. Brown |       | 2010                  |       | 3,375,273          |       | 34,178          |       | 9,328                     |       |
| J. Alton Rider  |       | 2010                  |       | 3,354,133          |       | 34,178          |       | 9,328                     |       |
| Gail L. Schomp  |       | 2010                  |       | 3,378,083          |       | 34,178          |       | 9,328                     |       |

 

In addition, the following directors will continue inoffice until the annual meeting of the year set forth beside each of theirnames.
| **Name**             | ** ** | **Term Expires** | ** ** |
|----------------------|------------|-----------------------|------------|
| Wreno M. Hall        |       | 2008                  |       |
| Walter D. Huddleston |       | 2008                  |       |
| B. Keith Johnson     |       | 2009                  |       |
| Diane E. Logsdon     |       | 2009                  |       |
| J. Stephen Mouser    |       | 2008                  |       |
| John L. Newcomb, Jr. |       | 2009                  |       |
| Donald Scheer        |       | 2009                  |       |
| Michael L. Thomas    |       | 2008                  |       |

 

31

----

**Item 5.**                                                           OtherInformation

None

**Item 6.**                                                           Exhibits:

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

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

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

32

----

**FIRST FINANCIAL SERVICE CORPORATION**

## **SIGNATURES**

Pursuant to therequirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, theregistrant has duly caused this report to be signed on its behalf by theundersigned, thereunto duly authorized.
| Date: August 9, 2007 | By:    | /s/ B. Keith Johnson                  |
|----------------------|--------|---------------------------------------|
|                 |   | B. Keith Johnson                      |
|                 |   | President and Chief Executive Officer |
|                 |   |                                  |
| Date: August 9, 2007 | By:    | /s/ Gregory S. Schreacke              |
|                 |   | Gregory S. Schreacke                  |
|                 |   | Chief Financial Officer               |
|                 |   | Principal Accounting Officer          |

 

33

----

## **INDEX TO EXHIBITS**

| Exhibit No. | ** ** | **Description** | ** ** |
|------------------|------------|-----------------|------------|
|             |       |            |       |   |   |
|             | 31         | .1              |       | Certification  of Chief Executive Officer Pursuant to Section 302 of Sarbanes-Oxley Act |   |
|             | 31         | .2              |       | Certification  of Chief Financial Officer Pursuant to Section 302 of Sarbanes-Oxley Act |   |
|             | 32         |            |       | Certification of Chief  Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section  1350 (As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002) |   |

 

34

----