**UNITED STATESSECURITIES AND EXCHANGE COMMISSION****Washington, D.C. 20549**

**FORM 10-Q**

**(Mark One)**
| **x**      | ** ** | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.**  |
|------------|------------|----------------------------------------------------------------------------------------------------------|
| ** ** | ** ** | ** **                                                                                               |
| ** ** |       | **For the  quarterly period ended March 31, 2006**                                                  |
| ** ** |       | ** **                                                                                               |
|       |       | **OR**                                                                                                   |
|       |       | ** **                                                                                               |
| **o**      | ** ** | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.** |

** **

**Commission File Number 0-18832**

**First Financial Service Corporation**(Exact Name of Registrant as specified in its charter)

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

 

**2323 Ring RoadElizabethtown, Kentucky  42701**(Addressof principal executive offices)(Zip Code)

**(270) 765-2131**(Registrant’stelephone number, including area code)

Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days.  Yes  x  No  o

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-2of the Exchange Act.

LargeAccelerated Filer  o  AcceleratedFiler  x  Non-Accelerated Filer  o

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

Indicatethe number of shares outstanding of each of the issuer’s classes of commonstock, as of the latest practicable date.

| **Class**    |   | **Outstanding  as of April 30, 2006** |
|--------------|--------|--------------------------------------------|
| Common Stock |   | 3,983,530** **shares                  |

 

 

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## **FIRST FINANCIAL SERVICE CORPORATION**

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

###  

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###  

### **FORWARD-LOOKINGSTATEMENTS**

Statements contained in thisreport that are not statements of historical fact constitute forward-lookingstatements within the meaning of Section 21E of the Securities ExchangeAct of 1934, as amended. In addition, the Corporation may make forward-lookingstatements in future filings with the Securities and Exchange Commission, inpress releases, and in oral and written statements made by or with the approvalof the Corporation. Forward-looking statements include, but are not limited to:(1) projections of revenues, income or loss, earnings or loss per share,capital structure and other financial items; (2) statements of plans andobjectives of the Corporation or its management or Board of Directors; (3) statementsregarding 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.

Forward-looking statements involve risks and uncertaintiesthat may cause actual results to differ materially from those indicated by theforward-looking statements. In addition to those risks described under “Item 1ARisk Factors” of this report and our Annual Report on Form 10-K forthe year ended December 31, 2005, some of the events or circumstances thatcould cause such differences include the following: changes in general economicconditions and economic conditions in Kentucky and the markets served by theCorporation any of which may affect, among other things, the level ofnon-performing assets, charge-offs, and provision expense; changes in theinterest rate environment which 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 deposit; changes intax laws, rules and regulations; various monetary and fiscal policies andregulations, including those determined by the Federal Reserve Board, theFederal Deposit Insurance Corporation and the Kentucky Office of FinancialInstitutions; competition with other local and regional commercial banks,savings banks, credit unions and other non-bank financial institutions; abilityto grow core businesses; ability to develop and introduce new banking-relatedproducts, services and enhancements and gain market acceptance of suchproducts; and management’s ability to manage these and other risks.

3

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## **Item1.**

## **FIRST FINANCIAL SERVICE CORPORATIONConsolidated Balance Sheets(Unaudited)**

| ** **                                                                                                                               | ** ** | **March 31,**                                                     | ** ** | **December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                               | ** ** | **2006**                                                               | ** ** | **2005**              | ** ** |
| ** **                                                                                                                               | ** ** | **(Dollars in thousands, except share data)** | ** ** |
| **ASSETS**                                                                                                                               |       |                                                                   |       |                  |       |
| Cash and due  from banks                                                                                                                 |       | $                                                                      | 20,841     |                  | $          | 20,451 |   |
| Federal funds  sold                                                                                                                      |       | 13,000                                                                 |       | —                |       |
| Cash and cash equivalents                                                                                                                |       | 33,841                                                                 |       | 20,451                |       |
|                                                                                                                                     |       |                                                                   |       |                  |       |
| Securities  available-for-sale                                                                                                           |       | 29,518                                                                 |       | 28,324                |       |
| Securities  held-to-maturity, fair value of $32,196 Mar (2006)                                                                           |       |                                                                   |       |                  |       |
| and $32,434 Dec  (2005)                                                                                                                  |       | 33,004                                                                 |       | 33,231                |       |
| Total securities                                                                                                                         |       | 62,522                                                                 |       | 61,555                |       |
|                                                                                                                                     |       |                                                                   |       |                  |       |
| Loans held for  sale                                                                                                                     |       | 743                                                                    |       | 597                   |       |
| Loans, net of  unearned fees                                                                                                             |       | 650,497                                                                |       | 642,520               |       |
| Allowance for  loan losses                                                                                                               |       | (7,420                                                                 | )          | (7,377                | )          |
| Net loans receivable                                                                                                                     |       | 643,820                                                                |       | 635,740               |       |
|                                                                                                                                     |       |                                                                   |       |                  |       |
| Federal Home  Loan Bank stock                                                                                                            |       | 7,296                                                                  |       | 7,194                 |       |
| Cash surrender  value of life insurance                                                                                                  |       | 7,711                                                                  |       | 7,637                 |       |
| Premises and  equipment, net                                                                                                             |       | 19,114                                                                 |       | 19,134                |       |
| Real estate owned:                                                                                                                       |       |                                                                   |       |                  |       |
| Acquired through foreclosure                                                                                                             |       | 861                                                                    |       | 1,022                 |       |
| Held for development                                                                                                                     |       | 337                                                                    |       | 337                   |       |
| Other  repossessed assets                                                                                                                |       | 60                                                                     |       | 119                   |       |
| Goodwill                                                                                                                                 |       | 8,384                                                                  |       | 8,384                 |       |
| Accrued interest  receivable                                                                                                             |       | 3,208                                                                  |       | 3,051                 |       |
| Other assets                                                                                                                             |       | 1,887                                                                  |       | 1,889                 |       |
|                                                                                                                                     |       |                                                                   |       |                  |       |
| **TOTAL ASSETS**                                                                                                                         |       | $                                                                      | 789,041    |                  | $          | 766,513 |   |
|                                                                                                                                     |       |                                                                   |       |                  |       |
| **LIABILITIES  AND STOCKHOLDERS' EQUITY**                                                                                                | ** ** | ** **                                                             | ** ** | ** **            | ** ** |
| **LIABILITIES:**                                                                                                                         |       |                                                                   |       |                  |       |
| Deposits:                                                                                                                                |       |                                                                   |       |                  |       |
| Non-interest bearing                                                                                                                     |       | $                                                                      | 48,468     |                  | $          | 39,145 |   |
| NOW demand                                                                                                                               |       | 77,672                                                                 |       | 76,848                |       |
| Savings                                                                                                                                  |       | 93,566                                                                 |       | 99,879                |       |
| Money market                                                                                                                             |       | 56,191                                                                 |       | 66,175                |       |
| Certificates of deposit                                                                                                                  |       | 354,674                                                                |       | 309,059               |       |
| Total deposits                                                                                                                           |       | 630,571                                                                |       | 591,106               |       |
|                                                                                                                                     |       |                                                                   |       |                  |       |
| Federal funds  purchased                                                                                                                 |       | -                                                                      |       | 19,500                |       |
| Advances from  Federal Home Loan Bank                                                                                                    |       | 78,334                                                                 |       | 78,375                |       |
| Subordinated  debentures                                                                                                                 |       | 10,000                                                                 |       | 10,000                |       |
| Accrued interest  payable                                                                                                                |       | 381                                                                    |       | 389                   |       |
| Accounts payable  and other liabilities                                                                                                  |       | 2,147                                                                  |       | 1,023                 |       |
| Deferred income  taxes                                                                                                                   |       | 1,341                                                                  |       | 1,379                 |       |
|                                                                                                                                     |       |                                                                   |       |                  |       |
| **TOTAL LIABILITIES**                                                                                                                    |       | 722,774                                                                |       | 701,772               |       |
|                                                                                                                                     |       |                                                                   |       |                  |       |
| **STOCKHOLDERS' EQUITY:**                                                                                                                |       |                                                                   |       |                  |       |
| Serial preferred  stock, 5,000,000 shares authorized and unissued                                                                        |       | —                                                                 |       | —                |       |
| Common stock, $1  par value per share; authorized 10,000,000 shares; issued and outstanding,  3,983,530 shares Mar (2006) and Dec (2005) |       | 3,984                                                                  |       | 3,984                 |       |
| Additional  paid-in capital                                                                                                              |       | 16,425                                                                 |       | 16,409                |       |
| Retained  earnings                                                                                                                       |       | 45,873                                                                 |       | 44,291                |       |
| Accumulated  other comprehensive income                                                                                                  |       | (15                                                                    | )          | 57                    |       |
|                                                                                                                                     |       |                                                                   |       |                  |       |
| **TOTAL STOCKHOLDERS' EQUITY**                                                                                                           |       | 66,267                                                                 |       | 64,741                |       |
| **TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY**                                                                                           |       | $                                                                      | 789,041    |                  | $          | 766,513 |   |

 

## ***See notes to the unaudited consolidatedfinancial statements.***

*** ***

 

 

4

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## **FIRST FINANCIAL SERVICE CORPORATIONConsolidated Statements of Income(Unaudited)**

| ** **                                                                      | ** ** | **Three Months Ended** | ** ** |
|---------------------------------------------------------------------------------|------------|----------------------------------|------------|
| **(Dollars in thousands, except per share data)** | ** ** | **March 31,**               | ** ** |
| ** **                                                                      | ** ** | **2006**                         | ** ** | **2005** | ** ** |
| **Interest Income:**                                                            | ** ** | ** **                       | ** ** | ** ** | ** ** |
| Interest and fees on loans                                                      |       | $                                | 11,716     |   | $ | 9,954 |   |
| Interest and dividends on investments and deposits                              |       | 776                              |       | 676 |   |
| Total interest income                                                           |       | 12,492                           |       | 10,630 |   |
|                                                                            |       |                             |       |   |   |
| **Interest Expense:**                                                           | ** ** | ** **                       | ** ** | ** ** | ** ** |
| Deposits                                                                        |       | 4,044                            |       | 2,892 |   |
| Federal Home Loan Bank advances                                                 |       | 1,005                            |       | 944 |   |
| Subordinated debentures                                                         |       | 207                              |       | 158 |   |
| Total interest expense                                                          |       | 5,256                            |       | 3,994 |   |
|                                                                            |       |                             |       |   |   |
| Net interest  income                                                            |       | 7,236                            |       | 6,636 |   |
| Provision for  loan losses                                                      |       | 89                               |       | 275 |   |
| Net interest  income after provision for loan losses                            |       | 7,147                            |       | 6,361 |   |
|                                                                            |       |                             |       |   |   |
| **Non-interest Income:**                                                        | ** ** | ** **                       | ** ** | ** ** | ** ** |
| Customer service fees on deposit accounts                                       |       | 1,232                            |       | 1,120 |   |
| Gain on sale of mortgage loans                                                  |       | 163                              |       | 184 |   |
| Brokerage commissions                                                           |       | 82                               |       | 78 |   |
| Gain on sale of investments                                                     |       | —                           |       | 381 |   |
| Other income                                                                    |       | 235                              |       | 258 |   |
| Total non-interest income                                                       |       | 1,712                            |       | 2,021 |   |
|                                                                            |       |                             |       |   |   |
| **Non-interest Expense:**                                                       | ** ** | ** **                       | ** ** | ** ** | ** ** |
| Employee compensation and benefits                                              |       | 2,977                            |       | 2,778 |   |
| Office occupancy expense and equipment                                          |       | 552                              |       | 494 |   |
| Marketing and advertising                                                       |       | 206                              |       | 188 |   |
| Outside services and data processing                                            |       | 616                              |       | 597 |   |
| Bank franchise tax                                                              |       | 219                              |       | 203 |   |
| Other expense                                                                   |       | 839                              |       | 884 |   |
| Total non-interest expense                                                      |       | 5,409                            |       | 5,144 |   |
|                                                                            |       |                             |       |   |   |
| Income before  income taxes                                                     |       | 3,450                            |       | 3,238 |   |
| Income taxes                                                                    |       | 1,112                            |       | 1,052 |   |
| **Net  Income**                                                                 |       | $                                | 2,338      |   | $ | 2,186 |   |
|                                                                            |       |                             |       |   |   |
| Shares  applicable to basic income per share                                    |       | 3,983,530                        |       | 4,012,250 |   |
| **Basic  income per share**                                                     |       | $                                | 0.59       |   | $ | 0.54 |   |
|                                                                            |       |                             |       |   |   |
| Shares  applicable to diluted income per share                                  |       | 4,015,975                        |       | 4,032,046 |   |
| **Diluted  income per share**                                                   |       | $                                | 0.58       |   | $ | 0.54 |   |

 

## ***See notes to the unaudited consolidatedfinancial statements.***

 

 

5

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##  

## **FIRST FINANCIAL SERVICE CORPORATIONConsolidated Statements of Comprehensive Income(Unaudited)**

| ** **                                                     | ** ** | **Three Months Ended** | ** ** |
|----------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                     | ** ** | **March 31,**               | ** ** |
| **(Dollars in thousands)**                           | ** ** | **2006**                         | ** ** | **2005** | ** ** |
|                                                           |       |                             |       |   |   |
| **Net  Income**                                                |       | $                                | 2,338      |   | $ | 2,186 |   |
| Other comprehensive  income (loss):                            |       |                             |       |   |   |
| Change in unrealized gain (loss) on securities                 |       | (109                             | )          | (248 | ) |
| Reclassification of realized amount                            |       | —                           |       | (381 | ) |
| Net unrealized gain (loss) recognized in comprehensive  income |       | (109                             | )          | (629 | ) |
| Tax effect                                                     |       | 37                               |       | 214 |   |
| Total other comphrehensive income (loss)                       |       | (72                              | )          | (415 | ) |
|                                                           |       |                             |       |   |   |
| **Comprehensive  Income**                                      |       | $                                | 2,266      |   | $ | 1,771 |   |

 

## ***See notes to the unaudited consolidatedfinancial statements.***

 

 

6

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## **FIRST FINANCIAL SERVICE CORPORATIONConsolidated Statements of Changes in Stockholders' EquityThree Months Ended March 31, 2006(Dollars In Thousands, Except Per Share Amounts)(Unaudited)**

| ** **                                                                            | ** ** | ** **            | ** ** | ** **  | ** ** | ** **     | ** ** | ** **                   | ** ** | **Accumulated**   | ** ** | ** ** | ** ** |
|---------------------------------------------------------------------------------------|------------|-----------------------|------------|-------------|------------|----------------|------------|------------------------------|------------|-------------------|------------|------------|------------|
| ** **                                                                            | ** ** | ** **            | ** ** | ** **  | ** ** | ** **     | ** ** | ** **                   | ** ** | **Other**         | ** ** | ** ** | ** ** |
| ** **                                                                            | ** ** | ** **            | ** ** | ** **  | ** ** | **Additional** | ** ** | ** **                   | ** ** | **Comprehensive** | ** ** | ** ** | ** ** |
| ** **                                                                            | ** ** | **Common Stock** | ** ** | **Paid-in** | ** ** | **Retained**   | ** ** | **Income, Net of** | ** ** | ** **        | ** ** |
| ** **                                                                            | ** ** | **Shares**            | ** ** | **Amount**  | ** ** | **Capital**    | ** ** | **Earnings**                 | ** ** | **Tax**           | ** ** | **Total**  | ** ** |
|                                                                                  |       |                  |       |        |       |           |       |                         |       |              |       |       |       |
| **Balance,  December 31, 2005**                                                       |       | 3,984                 |       | $           | 3,984      |           | $          | 16,409                       |       | $                 | 44,291     |       | $          | 57 |   | $ | 64,741 |   |
| Net income                                                                            |       |                  |       |        |       |           |       | 2,338                        |       |              |       | 2,338      |       |
| Compensation  expense for stock options                                               |       |                  |       |        |       | 16             |       |                         |       |              |       | 16         |       |
| Net change in  unrealized gains (losses) on securities available-for-sale, net of tax |       |                  |       |        |       |           |       |                         |       | (72               | )          | (72        | )          |
| Cash dividends  declared ($.19 per share)                                             |       | —                |       | —      |       | —         |       | (756                         | )          | —            |       | (756       | )          |
| **Balance, March 31, 2006**                                                           |       | 3,984                 |       | $           | 3,984      |           | $          | 16,425                       |       | $                 | 45,873     |       | $          | (15 | ) | $ | 66,267 |   |

 

## ***See notes to the unaudited consolidatedfinancial statements.***

 

 

 

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## **FIRST FINANCIAL SERVICE CORPORATIONConsolidated Statements of Cash Flows(Dollars In Thousands)(Unaudited)**

| ** **                                            | ** ** | **Three Months Ended** | ** ** |
|-------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                            | ** ** | **March 31,**               | ** ** |
| ** **                                            | ** ** | **2006**                         | ** ** | **2005** | ** ** |
| **Operating Activities:**                             | ** ** | ** **                       | ** ** | ** ** | ** ** |
| Net income                                            |       | $                                | 2,338      |   | $ | 2,186 |   |
| Adjustments to  reconcile net income to net           |       |                             |       |   |   |
| cash provided by  operating activities:               |       |                             |       |   |   |
| Provision for loan losses                             |       | 89                               |       | 275 |   |
| Depreciation on premises and equipment                |       | 342                              |       | 301 |   |
| Federal Home Loan Bank stock dividends                |       | (102                             | )          | (76 | ) |
| Net amortization (accretion) available-for-sale       |       | 3                                |       | 91 |   |
| Net amortization (accretion) held-to-maturity         |       | 8                                |       | 15 |   |
| Gain on sale of investments available-for-sale        |       | —                           |       | (381 | ) |
| Gain on sale of mortgage loans                        |       | (163                             | )          | (184 | ) |
| Origination of loans held for sale                    |       | (9,183                           | )          | (9,758 | ) |
| Proceeds on sale of loans held for sale               |       | 9,200                            |       | 10,440 |   |
| Changes in:                                           |       |                             |       |   |   |
| Cash surrender value of life insurance                |       | (74                              | )          | (72 | ) |
| Interest receivable                                   |       | (157                             | )          | (76 | ) |
| Other assets                                          |       | 2                                |       | (486 | ) |
| Interest payable                                      |       | (8                               | )          | (20 | ) |
| Accounts payable and other liabilities                |       | 1,123                            |       | 1,306 |   |
| Net cash from  operating activities                   |       | 3,418                            |       | 3,561 |   |
|                                                  |       |                             |       |   |   |
| **Investing Activities:**                             | ** ** | ** **                       | ** ** | ** ** | ** ** |
| Sales of securities available-for-sale                |       | —                           |       | 1,431 |   |
| Purchases of securities available-for-sale            |       | (1,851                           | )          | (18,185 | ) |
| Maturities of securities available-for-sale           |       | 545                              |       | — |   |
| Maturities of securities held-to-maturity             |       | 219                              |       | 574 |   |
| Net change in loans                                   |       | (7,803                           | )          | 4,539 |   |
| Net purchases of premises and equipment               |       | (322                             | )          | (912 | ) |
| Net cash from  investing activities                   |       | (9,212                           | )          | (12,553 | ) |
|                                                  |       |                             |       |   |   |
| **Financing Activities**                              | ** ** | ** **                       | ** ** | ** ** | ** ** |
| Net change in deposits                                |       | 39,465                           |       | 2,663 |   |
| Change in federal funds purchased                     |       | (19,500                          | )          | — |   |
| Repayments to Federal Home Loan Bank                  |       | (41                              | )          | (44 | ) |
| Compensation expense for stock options                |       | 16                               |       | — |   |
| Proceeds from stock options exercised                 |       | —                           |       | 57 |   |
| Dividends paid                                        |       | (756                             | )          | (694 | ) |
| Net cash from  financing activities                   |       | 19,184                           |       | 1,982 |   |
|                                                  |       |                             |       |   |   |
| **(Decrease)  Increase in cash and cash equivalents** |       | 13,390                           |       | (7,010 | ) |
| **Cash  and cash equivalents, beginning of period**   |       | 20,451                           |       | 35,910 |   |
| **Cash and cash equivalents, end  of period**         |       | $                                | 33,841     |   | $ | 28,900 |   |

 

## ***See notes to the unaudited consolidatedfinancial statements.***

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**Notes To UnauditedConsolidated Financial Statements**

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

***Basis ofPresentation*** — The accompanying unaudited consolidatedfinancial statements include the accounts of First Financial ServiceCorporation and its wholly owned subsidiary, First Federal Savings Bank. FirstFederal Savings Bank has three wholly owned subsidiaries, First ServiceCorporation of Elizabethtown, First Heartland Mortgage Company 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 financialstatements have been prepared in accordance with U.S. generally acceptedaccounting principles for interim financial information and with theinstructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly,they do not include all of the information and footnotes required by U.S.generally accepted accounting principles for complete financial statements. Inthe opinion of management, all adjustments (consisting of normal recurringaccruals) considered necessary for a fair presentation have been included. Operatingresults for the three-month period ending March 31, 2006 are not necessarilyindicative of the results that may occur for the year ending December 31, 2006.For further information, refer to the consolidated financial statements andfootnotes thereto included in the Corporation’s annual report on Form 10-Kfor the period ended December 31, 2005.

***Stock Dividends***—We declared a 10% stock dividend on September 20, 2005 to our shareholders ofrecord as of October 7, 2005, payable on October 21, 2005. The payment of thisdividend is in addition to the regular quarterly cash dividend. Per shareamounts have been restated for the impact of the stock dividend.

**Recently Issued Accounting Standards**— We adopted (“SFAS No. 123R”), “Share-Based Payment” on January 1, 2006. SFAS No.123R is a revision of FASB Statement 123, “Accounting for Stock-BasedCompensation” and supersedes APB Opinion No. 25, “Accounting for Stock Issuedto Employees,” and its related implementation guidance. SFAS No. 123R requiresall public companies to record compensation cost for stock options provided toemployees in return for employee service. The cost is measured at the fairvalue of the options when granted, and this cost is expensed over the employeeservice period, which is normally the vesting period of the options.Compensation cost is recorded for prior option grants that vest after the dateof adoption. The effect on results of operations will depend on the level offuture option grants and the calculation of the fair value of the optionsgranted at such future date, as well as the vesting periods provided, and sothey cannot currently be predicted. Existing options that will vest afteradoption date are expected to result in additional compensation expense ofapproximately $62,000 in 2006, $56,000 in 2007, $56,000 in 2008 and $42,000 in2009. For the quarter ended March 31, 2006, we recorded $16,000 in additionalcompensation expense related to stock options. There will be no significanteffect on financial position as total equity will not change.

***Reclassifications***— Certain amounts have been reclassified in the prior period financialstatements to conform to the current period classifications.

9

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**2.**                 SECURITIES

The amortized cost basis and fair values of securitiesare as follows:

|                                      | ** ** | ** **    | ** ** | **Gross**      | ** ** | **Gross**      | ** ** | ** **          | ** ** |
|--------------------------------------|------------|---------------|------------|----------------|------------|----------------|------------|---------------------|------------|
| ** **                           | ** ** | **Amortized** | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | ** **          | ** ** |
| **(Dollars in thousands)** | ** ** | **Cost**      | ** ** | **Gains**      | ** ** | **Losses**     | ** ** | **Fair Value** | ** ** |
| ** **                           |       |          |       |           |       |           |       |                |       |
| **Securities  available-for-sale:**  |       |          |       |           |       |           |       |                |       |
| **March  31, 2006:**                 |       |          |       |           |       |           |       |                |       |
| U. S. Treasury and agencies          |       | $             | 6,490      |           | $          | —         |       | $                   | (43        | ) | $ | 6,447 |   |
| Mortgage-backed                      |       | 11,016        |       | —         |       | (301           | )          | 10,715              |       |
| Equity                               |       | 1,353         |       | 594            |       | —         |       | 1,947               |       |
| State and municipal                  |       | 6,652         |       | 12             |       | (285           | )          | 6,379               |       |
| Corporate                            |       | 4,030         |       | —         |       | —         |       | 4,030               |       |
| Total                                |       | $             | 29,541     |           | $          | 606            |       | $                   | (629       | ) | $ | 29,518 |   |
| ** **                           |       |          |       |           |       |           |       |                |       |
| **December  31, 2005:**              |       |          |       |           |       |           |       |                |       |
| U. S. Treasury and agencies          |       | $             | 6,486      |           | $          | —         |       | $                   | (49        | ) | $ | 6,437 |   |
| Mortgage-backed                      |       | 11,558        |       | —         |       | (256           | )          | 11,302              |       |
| Equity                               |       | 1,353         |       | 638            |       | —         |       | 1,991               |       |
| State and municipal                  |       | 5,803         |       | 14             |       | (259           | )          | 5,558               |       |
| Corporate                            |       | 3,036         |       | —         |       | —         |       | 3,036               |       |
| Total                                |       | $             | 28,236     |           | $          | 652            |       | $                   | (564       | ) | $ | 28,324 |   |

** **

|                                   | ** ** | ** **    | ** ** | **Gross**        | ** ** | **Gross**        | ** ** | ** **          | ** ** |
|-----------------------------------|------------|---------------|------------|------------------|------------|------------------|------------|---------------------|------------|
| ** **                        | ** ** | **Amortized** | ** ** | **Unrecognized** | ** ** | **Unrecognized** | ** ** | ** **          | ** ** |
| ** **                        | ** ** | **Cost**      | ** ** | **Gains**        | ** ** | **Losses**       | ** ** | **Fair Value** | ** ** |
| ** **                        |       |          |       |             |       |             |       |                |       |
| **Securities  held-to-maturity:** |       |          |       |             |       |             |       |                |       |
| **March  31, 2006:**              |       |          |       |             |       |             |       |                |       |
| U.S. Treasury and agencies        |       | $             | 26,096     |             | $          | —           |       | $                   | (601       | ) | $ | 25,495 |   |
| Mortgage-backed                   |       | 4,908         |       | 2                |       | (209             | )          | 4,701               |       |
| Corporate                         |       | 2,000         |       | —           |       | —           |       | 2,000               |       |
| Total                             |       | $             | 33,004     |             | $          | 2                |       | $                   | (810       | ) | $ | 32,196 |   |
|                              |       |          |       |             |       |             |       |                |       |
| **December  31, 2005:**           |       |          |       |             |       |             |       |                |       |
| U.S. Treasury and agencies        |       | $             | 26,095     |             | $          | —           |       | $                   | (607       | ) | $ | 25,488 |   |
| Mortgage-backed                   |       | 5,136         |       | 2                |       | (207             | )          | 4,931               |       |
| Corporate                         |       | 2,000         |       | 15               |       | —           |       | 2,015               |       |
| Total                             |       | $             | 33,231     |             | $          | 17               |       | $                   | (814       | ) | $ | 32,434 |   |

10

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**3.**                 LOANS

Loans are summarized as follows:

|                                      | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|--------------------------------------|------------|--------------------|------------|-----------------------|------------|
| **(Dollars in thousands)** | ** ** | **2006**           | ** ** | **2005**              | ** ** |
|                                 |       |               |       |                  |       |
| Commercial                           |       | $                  | 38,105     |                  | $          | 36,004 |   |
| Real estate  commercial              |       | 356,777            |       | 353,637               |       |
| Real estate  construction            |       | 17,088             |       | 13,579                |       |
| Residential  mortgage                |       | 143,514            |       | 142,727               |       |
| Consumer and  home equity            |       | 64,177             |       | 66,208                |       |
| Indirect  consumer                   |       | 31,951             |       | 31,577                |       |
| Loans held for  sale                 |       | 743                |       | 597                   |       |
|                                 |       | 652,355            |       | 644,329               |       |
|                                 |       |               |       |                  |       |
| Less:                                |       |               |       |                  |       |
| Net deferred loan origination fees   |       | (1,115             | )          | (1,212                | )          |
| Allowance for loan losses            |       | (7,420             | )          | (7,377                | )          |
|                                 |       | (8,535             | )          | (8,589                | )          |
|                                 |       |               |       |                  |       |
| Loans                                |       | $                  | 643,820    |                  | $          | 635,740 |   |

 

The allowance for loan loss is summarized as follows:

|                                      | ** ** | **As of and For the** | ** ** |
|--------------------------------------|------------|-------------------------------------------|------------|
| ** **                           | ** ** | **Three Months Ended**          | ** ** |
| ** **                           | ** ** | **March 31,**                        | ** ** |
| **(Dollars in thousands)** | ** ** | **2006**                                  | ** ** | **2005** | ** ** |
|                                 |       |                                      |       |   |   |
| Balance,  beginning of period        |       | $                                         | 7,377      |   | $ | 6,489 |   |
| Provision for  loan losses           |       | 89                                        |       | 275 |   |
| Charge-offs                          |       | (107                                      | )          | (140 | ) |
| Recoveries                           |       | 61                                        |       | 77 |   |
| Balance, end of period               |       | $                                         | 7,420      |   | $ | 6,701 |   |

 

Impaired loans are summarized as follows. There wereno impaired loans for the periods presented without an allowance allocation.

|                                              | ** ** | **As of and For the** | ** ** | **As of and For the** | ** ** |
|----------------------------------------------|------------|-------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                   | ** ** | **Three Months Ended**          | ** ** | **Year Ended**                       | ** ** |
| ** **                                   | ** ** | **March 31,**                        | ** ** | **December 31,**                     | ** ** |
| **(Dollars in thousands)**         | ** ** | **2006**                                  | ** ** | **2005**                                  | ** ** |
|                                         |       |                                      |       |                                      |       |
| End of period  impaired loans                |       | $                                         | 7,101      |                                      | $          | 6,232 |   |
| Amount of allowance for  loan loss allocated |       | 1,431                                     |       | 1,445                                     |       |
|                                              |            |                                           |            |                                           |            |  |  |

 

11

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

|                                               | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|-----------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| **(Dollars in thousands)**          | ** ** | **2006**           | ** ** | **2005**              | ** ** |
| Restructured                                  |       | $                  | 3,309      |                  | $          | 3,104 |   |
| Loans past due  over 90 days still on accrual |       | —             |       | —                |       |
| Non accrual  loans                            |       | 3,792              |       | 3,128                 |       |
| Total                                         |       | $                  | 7,101      |                  | $          | 6,232 |   |

 

**4.**                 EARNINGS PERSHARE

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

|                                                                                 | ** ** | **Three Months Ended** | ** ** |
|---------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                      | ** ** | **March 31,**               | ** ** |
| **(Dollars in thousands, except per share data)** | ** ** | **2006**                         | ** ** | **2005** | ** ** |
|                                                                            |       |                             |       |   |   |
| Net income  available to common shareholders                                    |       | $                                | 2,338      |   | $ | 2,186 |   |
| Basic EPS:                                                                      |       |                             |       |   |   |
| Weighted average common shares                                                  |       | 3,983                            |       | 4,012 |   |
| Diluted EPS:                                                                    |       |                             |       |   |   |
| Weighted average common shares                                                  |       | 3,983                            |       | 4,012 |   |
| Dilutive effect of stock options                                                |       | 33                               |       | 20 |   |
| Weighted average common and incremental shares                                  |       | 4,016                            |       | 4,032 |   |
| Earnings Per  Share:                                                            |       |                             |       |   |   |
| Basic                                                                           |       | $                                | 0.59       |   | $ | 0.54 |   |
| Diluted                                                                         |       | $                                | 0.58       |   | $ | 0.54 |   |

 

All of the outstanding stock options for the March 31,2006 and 2005 periods were included in the computation of diluted earnings pershare.

**5.**                 STOCK OPTION PLAN

Under the 1998 Stock Option and Incentive Plan (“thePlan”), we may grant either incentive or non-qualified stock options to keyemployees for an aggregate of 182,600 shares of our common stock at not lessthan fair value at the date such options are granted. We believe that theability to award stock options and other forms of stock-based incentivecompensation can assist us in attracting and retaining key employees. Stock-basedincentive compensation is also a means to align the interests of key employees withthose of our shareholders by providing awards intended to reward recipients forour long-term growth. The option to purchase shares vest over periods of one tofive years and expire ten years after the date of grant. We issue new shares ofcommon stock upon the exercise of stock options. At March 31, 2006 optionsavailable for future grant under the Plan totaled 35,640. Compensation costrelated to the Plan that was charged against earnings for the period ended March31, 2006 was $16,000.

The fair value of each option award is estimated onthe date of grant using the Black-Scholes option valuation model that usesvarious weighted-average assumptions. The risk-free interest rate is based onthe U.S. Treasury yield curve in effect at the time of grant. The expectedvolatility is based on the fluctuation in the price of a share of stock overthe period for which the option is being valued and the expected life of the optionsgranted represents the period of time the options are expected to beoutstanding.

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The followingtable illustrates the effect on net income and earnings per share for thequarter ended March 31, 2005 if expense was measured using the Black-Scholes optionvaluation model.

|                                                                                    | ** ** | **Three Months  Ended  March 31,  2005** | ** ** |
|------------------------------------------------------------------------------------|------------|----------------------------------------------------|------------|
| **(Dollars in Thousands, Except Per Share Data)**    | ** ** | ** **                                         | ** ** |
| Net income:                                                                        |       |                                               |       |
| As reported                                                                        |       | $                                                  | 2,186      |   |
| Deduct: Stock-based compensation expense determined  under fair value based method |       | (33                                                | )          |
| Pro-forma                                                                          |       | $                                                  | 2,153      |   |
| Earnings per  share:                                                               |       |                                               |       |
| Basic      As  Reported                                        |       | $                                                  | 0.54       |   |
| Pro-forma                                                                          |       | 0.53                                               |       |
|                                                                               |       |                                               |       |
| Diluted   As  Reported                                                   |       | $                                                  | 0.54       |   |
| Pro-forma                                                                          |       | 0.53                                               |       |

 

A summary of option activity under the Plan as of March31, 2006 is presented below:

|                                      | ** ** | ** **  | ** ** | ** **   | ** ** | **Weighted**    | ** ** | ** **    | ** ** |
|--------------------------------------|------------|-------------|------------|--------------|------------|-----------------|------------|---------------|------------|
| ** **                           | ** ** | ** **  | ** ** | **Weighted** | ** ** | **Average**     | ** ** | ** **    | ** ** |
| ** **                           | ** ** | **Number**  | ** ** | **Average**  | ** ** | **Remaining**   | ** ** | **Aggregate** | ** ** |
| ** **                           | ** ** | **of**      | ** ** | **Exercise** | ** ** | **Contractual** | ** ** | **Intrinsic** | ** ** |
| **(Dollars In Thousands)** | ** ** | **Options** | ** ** | **Price**    | ** ** | **Term**        | ** ** | **Value**     | ** ** |
| Outstanding,  beginning of period    |       | 130,977     |       | $            | 20.26      |            |       |          |       |   |
| Granted during  period               | ** ** | **—**  | ** ** | **—**   |       |            |       |          |       |
| Exercised during  the period         | ** ** | **—**  | ** ** | **—**   |       |            |       |          |       |
| Outstanding, end  of period          |       | 130,977     |       | $            | 20.26      |            | 6.2        |          | $          | 899,576 |   |
| Eligible for exercise  at period end |       | 87,527      |       | $            | 18.68      |            | 5.0        |          | $          | 433,336 |   |

 

There were no options granted for the periods ended March31, 2006 and 2005. The total intrinsic value of options exercised during theperiod ended March 31, 2005 was $15,864. There were no options exercised,modified or settled in cash for the period ended March 31, 2006.

As of March 31, 2006 there was $209,286 of totalunrecognized compensation cost related to nonvested share-based compensationarrangements granted under the Plan. That cost is expected to be recognizedover a weighted-average period of 3.9 years. The total fair value of sharesvested during the periods ended March 31, 2006 and 2005 was $56,240 and $43,007respectively. Cash received from option exercise under all share-based paymentarrangements for the period ended March 31, 2005 was $56,562. There were nooptions exercised for the period ended March 31, 2006.

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**Item 2.**

**MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONS**

**GENERAL**

We conduct operations in 14 full-service bankingcenters in six contiguous counties in Central Kentucky along the Interstate 65corridor. Our markets range from the major metropolitan area of Louisville inJefferson County, Kentucky approximately 40 miles north of our headquarters inElizabethtown, Kentucky to Hart County, Kentucky, approximately 30 miles southof Elizabethtown. Our markets are supported by a diversified industry base andhave a regional population of over 1 million.

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

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

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

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

This discussion and analysis covers material changesin the financial condition since December 31, 2005 and material changes in theresults of operations for the three-month period ending, March 31, 2006 ascompared to 2005. It should be read in conjunction with “Management Discussionand Analysis of Financial Condition and Results of Operations” included in theAnnual Report on Form 10-K for the period ended December 31, 2005.

**OVERVIEW**

Our emphasis over the past several years has beenfocused on the enhancement and expansion of our retail and commercial bankingnetwork in our core markets as well as establishing our presence in the MetroLouisville market. Our five county core markets, where we have a combined 22%market share, has become increasingly competitive with several new bankbranches entering our markets in the past few years. In order to protect andgrow our market share, we enhanced several of our new facilities and anticipateseveral new facilities over the next few years. In addition to the enhancementand expansion in our core markets, we began establishing our presence in theMetro Louisville market. The Metro Louisville market of Jefferson County iscontiguous to our five county core markets. Approximately 75% of the depositbase in the Metro Louisville market is controlled by six out-of-state banks. Whilethe market is very competitive, we believe this creates an opportunity forsmaller community banks with more power to make decisions locally. We believeour investment in these initiatives along with our continued commitment to ahigh level of customer service will enhance our existing market share and ourdevelopment in the Metro Louisville market.

The enhancement of our retail branch network continuesto produce encouraging results. Total deposits have grown at a 6% compoundannual growth rate over the past four years. Total deposits were $630.6 millionat March 31, 2006. The development of the retail branch network into the MetroLouisville market also yielded positive results. We have a combined $43.3million in deposits in our two new full-service facilities in the MetroLouisville market, representing a 44% increase in deposits by these offices forthe first quarter of 2006 following a 71% increase in deposits for the year of2005. We opened these new facilities in the second quarter of 2004 to supportour growing customer base in this market. Twenty-one percent of our loanportfolio is located in the Metro Louisville market.

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Our emphasis on commercial lending has resulted in a6% compound annual growth rate in the total loan portfolio and a 33% compoundannual growth rate in commercial loans over the past four years. Commercialloans were $412.0 million at March 31, 2006, an increase of $8.8 millionfrom December 31, 2005.

The growth in the commercial loan portfolio, coupledwith the rising interest rate environment, has favorably impacted the level ofinterest income generated. Net interest margin increased to 4.09% for thequarter ended March 31, 2006, compared to 3.90% a year ago. This has resultedin a $600,000 increase in net interest income to $7.2 million for the quarterended March 31, 2006, compared to the same period in 2005. The increasingshort-term interest rate environment positively impacted net interest margindue to the adjustable rate commercial loans in the loan portfolio. However, thenet 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 lag the increase in adjustable loan rates due tocertificates of deposit which mature over a longer period of time thanimmediately adjustable loan rates.

Our asset quality remains favorable. Net charge-offsas a percent of average total loans were 0.03% for the quarter ended March 31,2006, compare to 0.04% for the quarter ended a year ago. The allowance for loanlosses as a percent of total loans, decreased to 1.14% at March 31, 2006compared to 1.15% at December 31, 2005. The percentage of non-performing loansto total loans was 1.09% at March 31, 2006, compared to 0.97% at December 31,2005.

Provision for loan loss expense decreased $186,000 to$89,000 for the quarter ended March 31, 2006, compared to $275,000 for the quarterended March 31, 2005. We recorded a smaller provision for the first quarterended March 31, 2006 as a result of an improvement in the condition of one ourclassified loans. In addition, we experienced a higher provision for loan lossin the first quarter of the prior year resulting from two classified loans thatwere downgraded to substandard for the quarter ended March 31, 2005. Thisresulted in a decrease in provision expense for the first quarter ended March 31,2006, compared to the first quarter ended March 31, 2005.

Non-interest income decreased $309,000 to $1.7 millionfor the quarter ended March 31, 2006. The decrease was primarily the result ofa $381,000 gain on the sale of investment securities recorded in the firstquarter of 2005. No gains on the sale of investments were recorded for thefirst quarter of 2006. Customer service fees on deposit accounts increased$112,000, or 10% to $1.2 million for the quarter ended March 31, 2006, comparedto the $1.1 million for the same period a year ago.

Non-interest expense increased $265,000, or 5% to $5.4million for the quarter ended March 31, 2006, compared to the same period ayear ago. The primary contributing factors to this increase were the additionaloperating and employee compensation expenses related to the recent expansionefforts. Our efficiency ratio was 60% for the quarter ended March 31, 2006compared to 59% for the quarter ended March 31, 2005.

**CRITICALACCOUNTING POLICIES**

Our accounting and reporting policies comply with U.S.generally accepted accounting principles and conform to general practiceswithin the banking industry. The accounting policy relating to the allowancefor loan losses is critical to the understanding of our results of operationssince the application of this policy requires significant managementassumptions and estimates that could result in materially different amounts tobe reported if conditions or underlying circumstances were to change.

**Allowance for Loan Losses —**Wemaintain an allowance sufficient to absorb probable incurred credit lossesexisting in the loan portfolio. The Allowance for Loan Loss Review Committeeevaluates the allowance for loan losses on a quarterly basis. We estimate theallowance using past loan loss experience, known and inherent risks in theportfolio, adverse situations that may affect the borrower’s ability to repay,estimated value of the underlying collateral, and current economic conditions. Whilewe estimate the allowance for loan losses based in part on historical losseswithin each loan category, estimates for losses within the commercial realestate portfolio are more dependent upon credit analysis and recent paymentperformance. Allocations of the allowance may be made for specific loans orloan categories, but the entire allowance is available for any loan that, inmanagement’s judgment, should be charged off.

The allowance consists of specific and generalcomponents. The specific component relates to loans that are individuallyclassified as impaired or loans otherwise classified as substandard ordoubtful. The general component covers non-classified loans and is based onhistorical loss experience adjusted for current factors. The methodology forallocating the allowance for loan and lease losses takes into account ourstrategic plan to increase our emphasis on commercial and consumer lending. Weincrease the amount of the allowance allocated to commercial loans and

15

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consumer loans in response to the growth of thecommercial and consumer loan portfolios and management’s recognition of thehigher risks and loan losses in these lending areas. Allowance estimates aredeveloped with actual loss experience adjusted for current economic conditions.Allowance estimates are considered a prudent measurement of the risk in theloan portfolio and are applied to individual loans based on loan type.

Based on our calculation, an allowance of $7.4 million****or 1.14% of total loans was our estimateof probable losses within the loan portfolio as of****March 31, 2006.****Thisestimate resulted in a provision for loan losses on the income statement of****$89,000 for the quarter.****If the mix and amount of future charge offpercentages differ significantly from those assumptions used by management inmaking its determination, the allowance for loan losses and provision for loanlosses on the income statement could be materially affected.

**RESULTS OFOPERATIONS**

Net income for the quarter ended March 31, 2006 was$2.3 million or $0.58 per share diluted compared to $2.2 million or $0.54 pershare diluted for the same period in 2005. The increase was primarily theresult of an increase in net-interest income of $600,000, a decrease inprovision for loan loss expense of $186,000, and a decrease in the number ofshares outstanding.****Our book valueper common share increased from $15.18 at March 31, 2005 to $16.63 at March 31,2006.****Annualized net income for2006 generated a return on average assets of 1.23% and a return on averageequity of 14.36%.****These comparewith a return on average assets of 1.18% and a return on average equity of 14.35%for the 2005 period also annualized.

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

On an annualized basis, the net interest margin as apercent of average earning assets increased****19basis points to 4.09% for the quarter ended March 31, 2006 compared to 3.90%for the 2005 period.****Increasinginterest rates and an increase in average earning assets improved net interestmargin for the periods presented. Average interest earning assets increased$30.9 million for the 2006 period compared to 2005. The yield on earning assetsaveraged 7.05% for the 2006 period compared to an average yield on earningassets of 6.25% for the same period in 2005. The prime-lending rate hasincreased 375 basis points from the time the Federal Open Market Committeebegan increasing short-term interest rates in June 2004 through the end of thefirst quarter of 2006. However, the net interest margin is likely to compressin future quarters as short-term interest rates peak and the cost of depositscontinue to rise. The cost of deposits typically lags behind the increase inadjustable rate loans because certificates of deposit generally mature overlonger periods than immediately adjustable rate loans.

Our cost of funds averaged 3.23% during the 2006quarter compared to an average cost of funds of 2.53% for the same period in2005.****Deposit costs haveaccelerated due to the re-pricing of certificate of deposit maturities rollingoff at lower rates into current higher interest rates in addition to our higherrates paid on our money market products. Going forward, our cost of funds isexpected to increase as interest rates paid on deposit products have becomeincreasingly competitive with the recent upward trend in interest rates.

The net result of the above factors was an increase innet interest income of $600,000 for the quarter ended March 31, 2006 comparedto the same three-month period a year ago.

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**AVERAGE BALANCESHEET**

The following table provides information relating toour average balance sheet and reflects the average yield on assets and averagecost of liabilities for the periods indicated. Dividing income or expense bythe average monthly balance of assets or liabilities, respectively, derivessuch yields and costs for the periods presented.
| ** **                                      | ** ** | **Quarter Ended March 31,** | ** ** |
|-------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                      | ** ** | **2006**                                   | ** ** | **2005** | ** ** |
| ** **                                      | ** ** | **Average**                                | ** ** | ** ** | ** ** | **Average** | ** ** | **Average** | ** ** | ** ** | ** ** | **Average** | ** ** |
| **(Dollars in thousands)**            | ** ** | **Balance**                                | ** ** | **Interest** | ** ** | **Yield/Cost(5)** | ** ** | **Balance** | ** ** | **Interest** | ** ** | **Yield/Cost(5)** | ** ** |
|                                            |       |                                       |       |   |   |   |   |   |   |   |   |   |   |
| **ASSETS**                                      |       |                                       |       |   |   |   |   |   |   |   |   |   |   |
| Interest earning  assets:                       |       |                                       |       |   |   |   |   |   |   |   |   |   |   |
| U.S. Treasury and agencies                      |       | $                                          | 32,533     |   | $ | 249 |   | 3.10 | % | $ | 49,623 |   | $ | 324 |   | 2.65 | % |
| Mortgage-backed securities                      |       | 16,079                                     |       | 170 |   | 4.29 |   | 8,445 |   | 80 |   | 3.84 |   |
| Equity securities                               |       | 1,999                                      |       | 18 |   | 3.65 |   | 2,673 |   | 40 |   | 6.07 |   |
| State and political subdivision securities(1)   |       | 5,876                                      |       | 94 |   | 6.49 |   | 991 |   | 15 |   | 6.14 |   |
| Corporate bonds                                 |       | 5,292                                      |       | 81 |   | 6.21 |   | 2,065 |   | 23 |   | 4.52 |   |
| Loans(2)(3)(4)                                  |       | 644,079                                    |       | 11,716 |   | 7.38 |   | 599,006 |   | 9,954 |   | 6.74 |   |
| FHLB stock                                      |       | 7,195                                      |       | 102 |   | 5.75 |   | 6,846 |   | 76 |   | 4.5 |   |
| Interest bearing deposits                       |       | 7,877                                      |       | 94 |   | 4.89 |   | 20,409 |   | 123 |   | 2.44 |   |
| **Total interest earning assets**               |       | 720,930                                    |       | 12,524 |   | 7.05 |   | 690,058 |   | 10,635 |   | 6.25 |   |
| Less: Allowance  for loan losses                |       | (7,362                                     | )          |   |   |   |   | (6,502 | ) |   |   |   |   |
| Non-interest  earning assets                    |       | 58,493                                     |       |   |   |   |   | 59,880 |   |   |   |   |   |
| **Total assets**                                |       | $                                          | 772,061    |   |   |   |   |   | $ | 743,436 |   |   |   |   |   |
|                                            |       |                                       |       |   |   |   |   |   |   |   |   |   |   |
| **LIABILITIES  AND STOCKHOLDERS' EQUITY**       |       |                                       |       |   |   |   |   |   |   |   |   |   |   |
| Interest bearing  liabilities:                  |       |                                       |       |   |   |   |   |   |   |   |   |   |   |
| Savings accounts                                |       | $                                          | 98,670     |   | $ | 632 |   | 2.60 | % | $ | 78,122 |   | $ | 222 |   | 1.15 | % |
| NOW and money market accounts                   |       | 131,450                                    |       | 481 |   | 1.48 |   | 155,938 |   | 512 |   | 1.33 |   |
| Certificates of deposit and other time deposits |       | 333,919                                    |       | 2,931 |   | 3.56 |   | 316,494 |   | 2,158 |   | 2.77 |   |
| Federal funds purchased                         |       | 7,076                                      |       | 74 |   | 4.24 |   | — |   | — |   | — |   |
| FHLB advances                                   |       | 78,350                                     |       | 931 |   | 4.82 |   | 78,877 |   | 944 |   | 4.85 |   |
| Trust preferred securities                      |       | 10,000                                     |       | 207 |   | 8.40 |   | 10,000 |   | 158 |   | 6.41 |   |
| **Total interest bearing liabilities**          |       | 659,465                                    |       | 5,256 |   | 3.23 |   | 639,431 |   | 3,994 |   | 2.53 |   |
|                                            |       |                                       |       |   |   |   |   |   |   |   |   |   |   |
| Non-interest  bearing liabilities:              |       |                                       |       |   |   |   |   |   |   |   |   |   |   |
| Non-interest bearing deposits                   |       | 42,418                                     |       |   |   |   |   | 39,442 |   |   |   |   |   |
| Other liabilities                               |       | 4,130                                      |       |   |   |   |   | 3,617 |   |   |   |   |   |
| **Total liabilities**                           |       | 706,013                                    |       |   |   |   |   | 682,490 |   |   |   |   |   |
|                                            |       |                                       |       |   |   |   |   |   |   |   |   |   |   |
| Stockholders'  equity                           |       | 66,048                                     |       |   |   |   |   | 60,946 |   |   |   |   |   |
| **Total liabilities and stockholders' equity**  |       | $                                          | 772,061    |   |   |   |   |   | $ | 743,436 |   |   |   |   |   |
| ** **                                      |       |                                       |       |   |   |   |   |   |   |   |   |   |   |
| **Net  interest income**                        |       |                                       |       | $ | 7,268 |   |   |   |   |   | $ | 6,641 |   |   |   |
| **Net  interest spread**                        |       |                                       |       |   |   | 3.82 | % |   |   |   |   | 3.72 | % |
| **Net interest margin**                         |       |                                       |       |   |   | 4.09 | % |   |   |   |   | 3.90 | % |

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

(2)             Includesloan fees, 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)             Includesloans held for sale.

(5)             Annualized

17

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**RATE/VOLUMEANALYSIS**

The table below provides information regarding changesin interest income and interest expense for the periods indicated. For eachcategory of interest-earning assets and interest-bearing liabilities,information is provided on changes attributable to (1) changes in rate(changes in rate multiplied by old volume); (2) changes in volume (change involume multiplied by old rate); and (3) changes in rate-volume (change in ratemultiplied by change in volume). Changes in rate-volume are proportionatelyallocated between rate and volume variance.
| ** **                                 | ** ** | **Three Months Ended**    | ** ** |
|--------------------------------------------|------------|-------------------------------------|------------|
| ** **                                 | ** ** | **March 31,**                  | ** ** |
| ** **                                 | ** ** | **2006 vs. 2005**         | ** ** |
| ** **                                 | ** ** | **Increase (decrease)**        | ** ** |
| ** **                                 | ** ** | **Due to change in** | ** ** |
| ** **                                 | ** ** | ** **                          | ** ** | ** ** | ** ** | **Net** | ** ** |
| **(Dollars in thousands)**       | ** ** | **Rate**                            | ** ** | **Volume** | ** ** | **Change** | ** ** |
| **Interest  income:**                      |       |                                |       |   |   |   |   |
| U.S. Treasury and agencies                 |       | $                                   | 49         |   | $ | (124 | ) | $ | (75 | ) |
| Mortgage-backed securities                 |       | 10                                  |       | 80 |   | 90 |   |
| Equity securities                          |       | (13                                 | )          | (9 | ) | (22 | ) |
| State and political subdivision securities |       | 1                                   |       | 78 |   | 79 |   |
| Corporate bonds                            |       | 58                                  |       | — |   | 58 |   |
| Loans                                      |       | 981                                 |       | 780 |   | 1,761 |   |
| FHLB stock                                 |       | 22                                  |       | 4 |   | 26 |   |
| Interest bearing deposits                  |       | 76                                  |       | (104 | ) | (28 | ) |
| ** **                                 |       |                                |       |   |   |   |   |
| **Total interest earning assets**          |       | 1,184                               |       | 705 |   | 1,889 |   |
| ** **                                 |       |                                |       |   |   |   |   |
| **Interest  expense:**                     |       |                                |       |   |   |   |   |
| Savings accounts                           |       | 339                                 |       | 71 |   | 410 |   |
| NOW and money market accounts              |       | 55                                  |       | (86 | ) | (31 | ) |
| Certificates of deposit and other          |       |                                |       |   |   |   |   |
| time deposits                              |       | 649                                 |       | 124 |   | 773 |   |
| Federal funds purchased                    |       | 56                                  |       | 18 |   | 74 |   |
| FHLB advances                              |       | (7                                  | )          | (6 | ) | (13 | ) |
| Trust Preferred Securities                 |       | 49                                  |       | — |   | 49 |   |
| ** **                                 |       |                                |       |   |   |   |   |
| **Total  interest bearing liabilities**    |       | 1,141                               |       | 121 |   | 1,262 |   |
| ** **                                 |       |                                |       |   |   |   |   |
| **Net change in net interest  income**     |       | $                                   | 43         |   | $ | 584 |   | $ | 627 |   |

 

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

The following tables provide a comparison of thecomponents of non-interest income and expenses for the periods ended March 31,2006 and 2005. The tables show the dollar and percentage change from 2005 to2006. Below each table is a discussion of significant changes and trends.
| **(Dollars in thousands)**      | ** ** | **2006** | ** ** | **2005** | ** ** | **Change** | ** ** | **%**  | ** ** |
|-------------------------------------------|------------|----------|------------|----------|------------|------------|------------|--------|------------|
| **Non-interest  income**                  |       |     |       |     |       |       |       |   |       |
| Customer service fees on deposit accounts |       | $        | 1,232      |     | $          | 1,120      |       | $      | 112        |   | 10.0 | % |
| Gain on sale of mortgage loans            |       | 163      |       | 184      |       | (21        | )          | (11.4  | )%         |
| Gain on sale of investments               |       | -        |       | 381      |       | (381       | )          | (100.0 | )%         |
| Brokerage commissions                     |       | 82       |       | 78       |       | 4          |       | 5.1    | %          |
| Other income                              |       | 235      |       | 258      |       | (23        | )          | (8.9   | )%         |
|                                      |       | $        | 1,712      |     | $          | 2,021      |       | $      | (309       | ) | (15.3 | )% |

 

18

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Growth in customer service fees on deposit accounts,our largest component of non-interest income, is primarily due to growth incustomer deposits, overdraft fee income on retail checking accounts and thesale of fee-based products for 2006. We continue to increase our customer basethrough cross-selling opportunities and marketing initiatives and promotions. Weundertook a renewed emphasis on growing our checking account base during 2005to better enhance our profitability and franchise value and will continue thisemphasis. This initiative initially began in late 2004 with the introduction of10 new checking account products and/or significant enhancements to existingproducts. We also introduced two new checking account products in 2005 gearedtoward customers on check systems who would not normally qualify for a standardchecking account. We expect the increase in checking accounts we experienced in2005 and the first quarter of 2006 to continue. This will positively impact ourlevel of customer service fees on deposit accounts.

Through our mortgage banking subsidiary, FirstHeartland Mortgage Company, we originate qualified VA, KHC, RHC andconventional secondary market loans and sell them into the secondary marketwith servicing rights released. For the first quarter of 2006, gain on sale ofmortgage loans decreased $21,000 compared to the 2005 quarter. However, weexpect the gain on sale of mortgage loans to remain consistent with the levelsreached in 2005.

We invest in various types of liquid assets, includingUnited States Treasury obligations, securities of various federal agencies,obligations of states and political subdivisions, corporate bonds, mutualfunds, stocks and others. During the first quarter of 2006 we did not recordany gains on the sale of investments compared to $381,000 in recorded gains forthe 2005 period. Gains on investment securities are infrequent in nature andare not a consistent recurring source of income.

During the fourth quarter of 2004 we made the decisionto outsource our trust operations and implemented this plan during 2005. Includedin other income for the three months ended March 31, 2006 and 2005 is incomefrom trust operations of $11,000 and $39,000 respectively. This source ofnon-interest income will largely be eliminated in future periods.
| **(Dollars in thousands)**   | ** ** | **2006** | ** ** | **2005** | ** ** | **Change** | ** ** | **%**  | ** ** |
|----------------------------------------|------------|----------|------------|----------|------------|------------|------------|--------|------------|
| **Non-interest  expenses**             |       |     |       |     |       |       |       |   |       |
| Employee compensation and benefits     |       | $        | 2,977      |     | $          | 2,778      |       | $      | 199        |   | 7.2 | % |
| Office occupancy expense and equipment |       | 552      |       | 494      |       | 58         |       | 11.7   | %          |
| Marketing and advertising              |       | 206      |       | 188      |       | 18         |       | 9.6    | %          |
| Outside services and data processing   |       | 616      |       | 597      |       | 19         |       | 3.2    | %          |
| Bank franchise tax                     |       | 219      |       | 203      |       | 16         |       | 7.9    | %          |
| Other expense                          |       | 839      |       | 884      |       | (45        | )          | (5.1   | )%         |
|                                   |       | $        | 5,409      |     | $          | 5,144      |       | $      | 265        |   | 5.2 | % |

 

Employee compensation and benefits is the largestcomponent of non-interest expense. The increase in compensation expense was dueto the increase in staff needed for our continued growth and expansion as wellas annual raises. We look for a continued increase in employee compensation andbenefits expense in line with recent trends, as we progress with our retailexpansion and market efforts. Also included in employee compensation andbenefits expense for the 2006 period is $16,000, due to a change in accounting rulesin which compensation expense related to stock options is recorded.

Office occupancy expense and equipment, marketing andadvertising, and outside services and data processing increased due toadditional operating expenses related to our expansion efforts. We anticipatethe increased level of non-interest expense to continue in 2006 with continuedretail expansion and market share efforts. We started construction on a newfull service-banking center in Elizabethtown, KY with plans of opening in May 2006.We will begin construction on a third facility in Jefferson County to begin inthe second quarter of 2006 with the anticipation of opening in early 2007. Weare also considering other possible locations within the core market area togrow our 22% market share. Our efficiency ratio was 60% for the quarter ended March31, 2006 compared to 59% for the 2005 quarter.

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**ANALYSIS OFFINANCIAL CONDITION**

Total assets at March 31, 2006 increased to $789.0million compared to $766.5 million at December 31, 2005, an increase of $22.5million. The increase was primarily driven by an increase in deposits of $39.5million. The growth in deposits was used to pay off $19.5 million in federalfunds purchased and to fund $8.1 million in loans. The remaining fundingincreased federal funds sold by $13.0 million.

**Loans**

Net loans increased $8.1 million to $643.8 million at March31, 2006 compared to $635.7 million at December 31, 2005. Our commercial,commercial real estate and real estate construction portfolios increased $8.8million to $412 million at March 31, 2006. For the 2006 period, these loanscomprised 63% of the total loan portfolio compared to 58% at March 31, 2005. Offsettingthis growth was a $2.0 million, or 3.1% decrease in the consumer and homeequity loan portfolio to $64.2 million at March 31, 2006, compared to $66.2million at December 31, 2005.
| ** **                           | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|--------------------------------------|------------|--------------------|------------|-----------------------|------------|
| **(Dollars in thousands)** | ** ** | **2006**           | ** ** | **2005**              | ** ** |
|                                 |       |               |       |                  |       |
| Commercial                           |       | $                  | 38,105     |                  | $          | 36,004 |   |
| Real estate  commercial              |       | 356,777            |       | 353,637               |       |
| Real estate  construction            |       | 17,088             |       | 13,579                |       |
| Residential  mortgage                |       | 143,514            |       | 142,727               |       |
| Consumer and  home equity            |       | 64,177             |       | 66,208                |       |
| Indirect  consumer                   |       | 31,951             |       | 31,577                |       |
| Loans held for  sale                 |       | 743                |       | 597                   |       |
|                                 |       | 652,355            |       | 644,329               |       |
|                                 |       |               |       |                  |       |
| Less:                                |       |               |       |                  |       |
| Net deferred loan origination fees   |       | (1,115             | )          | (1,212                | )          |
| Allowance for loan losses            |       | (7,420             | )          | (7,377                | )          |
|                                 |       | (8,535             | )          | (8,589                | )          |
|                                 |       |               |       |                  |       |
| Loans                                |       | $                  | 643,820    |                  | $          | 635,740 |   |

 

**Allowance andProvision for Loan Losses**

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

The Allowance for Loan Loss Review Committee evaluatesthe allowance for loan losses quarterly to maintain a level sufficient toabsorb probable incurred credit losses existing in the loan portfolio. Periodicprovisions to the allowance are made as needed. The allowance is determinedbased on the application of loss estimates to graded loans by categories. Theamount of the provision for loan losses necessary to maintain an adequateallowance is also based upon an analysis of such factors as changes in lendingpolicies and procedures; underwriting standards; collection; charge-off andrecovery history; changes in national and local economic business conditionsand developments; changes in the characteristics of the portfolio; ability anddepth of lending management and staff; changes in the trend of the volume andseverity of past due, non-accrual and classified loans; troubled debtrestructuring and other loan modifications; and results of regulatoryexaminations.

The methodology for allocating the allowance for loanand lease losses takes into account our strategic plan to increase our emphasison commercial and consumer lending. We increase the amount of the allowanceallocated to commercial loans and consumer loans in response to the growth ofthe commercial and consumer loan portfolios and management’s recognition of thehigher risks and loan losses in these lending areas. The indirect consumer loanprogram is comprised of new and used automobile, motorcycle and all terrainvehicle loans originated on our behalf by a select group of auto dealers withinthe our service area. The indirect loan program involves a greater degree ofrisk and is evaluated quarterly and monitored by the Board of Directors. Inlight of the greater charge-offs from indirect consumer loans compared todirect consumer loans, proportionally more of the allowance for consumer loansis allocated for indirect loans than direct loans. As the indirect loan programhas evolved, dealer analysis and underwriting standards have been refined toimprove the loan loss experience of the program. Estimating the allowance is acontinuous process. In this regard, the Allowance for Loan Loss ReviewCommittee continues to 

20

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monitor the performance of indirect consumer loans aswell as our other loan products and updates estimates as the evidence warrants.

The following table shows an analysis of loan lossexperience for the periods indicated.
| ** **                                                                | ** ** | **Three Months Ended** | ** ** |
|---------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                | ** ** | **March 31,**               | ** ** |
| **(Dollars in thousands)**                                      | ** ** | **2006**                         | ** ** | **2005** | ** ** |
| ** **                                                                |       |                             |       |   |   |
| **Balance  at beginning of period**                                       |       | $                                | 7,377      |   | $ | 6,489 |   |
| Loans  charged-off:                                                       |       |                             |       |   |   |
| Real estate mortgage                                                      |       | 2                                |       | 4 |   |
| Consumer                                                                  |       | 105                              |       | 136 |   |
| Commercial                                                                |       | —                           |       |   |   |
| Total  charge-offs                                                        |       | 107                              |       | 140 |   |
| Recoveries:                                                               |       |                             |       |   |   |
| Real estate mortgage                                                      |       | 2                                |       | 1 |   |
| Consumer                                                                  |       | 59                               |       | 76 |   |
| Commercial                                                                |       | —                           |       | — |   |
| Total recoveries                                                          |       | 61                               |       | 77 |   |
|                                                                      |       |                             |       |   |   |
| **Net loans  charged-off**                                                |       | 46                               |       | 63 |   |
| ** **                                                                |       |                             |       |   |   |
| Provision for  loan losses                                                |       | 89                               |       | 275 |   |
|                                                                      |       |                             |       |   |   |
| **Balance  at end of period**                                             |       | $                                | 7,420      |   | $ | 6,701 |   |
| ** **                                                                |       |                             |       |   |   |
| Allowance for  loan losses to total loans (excluding loans held for sale) |       | 1.14                             | %          | 1.12 | % |
| Annualized net  charge-offs to average loans outstanding                  |       | 0.03                             | %          | 0.04 | % |
| Allowance for loan  losses to total non-performing loans                  |       | 104                              | %          | 124 | % |

 

The provision for loan losses decreased $186,000, to$89,000 for the quarter ended March 31, 2006, compared to the 2005 period. Werecorded a smaller provision for the 2006 period. An improvement in thecondition of one of our classified loans offset an increase in provisionexpense related to higher levels of classified assets for the first quarter of2006. In addition, we experienced a higher provision for loan loss in the firstquarter of the prior year resulting from two classified loans downgraded tosubstandard. The combination resulted in a decrease in provision expense forthe first quarter ended March 31, 2006 compared to the first quarter ended March31, 2005. The total allowance for loan losses increased $719,000 to $7.4million from March 31, 2005 to March 31, 2006. The increase in the allowancewas related to an $8.1 million increase in net loans for 2006 compared to 2005,in conjunction with a $4.2 million increase in classified loans for the 2006period compared to the 2005 period.

Federal regulations require insured institutions toclassify their own assets on a regular basis. The regulations provide for threecategories of classified loans — substandard, doubtful and loss. Assetsclassified as substandard or doubtful require the institution to establishgeneral allowances for loan losses. If an asset or portion thereof isclassified as loss, the insured institution must either establish specifiedallowances for loan losses in the amount of 100% of the portion of the assetclassified loss, or charge off such amount**.**AtMarch 31, 2006, on the basis of management’s review of the loan portfolio, wehad $12.2 million of assets classified substandard,****$924,000 classified as doubtful, and****$27,000 of assets classified as loss.****At March 31, 2005, on the basis ofmanagement’s review of the loan portfolio, we had $8.0 million assetsclassified substandard, $970,000 million classified as doubtful, and $89,000 ofassets classified as loss. The $4.2 million increase in substandard assets for March31, 2006****was primarily the resultof four credit relationships.****Thesecredit relationships were a $1.5 million commercial real estate relationship, a$1.2 million commercial relationship, a $763,000 commercial relationship and a$680,000 commercial real estate relationship.

Loans are classified according to estimated loss asfollows: Substandard-2.5% to 35%; Doubtful-5% to 50%; and Loss-100%.We additionally provide an allowance estimate for probable incurred losses innon-classified loans ranging from .20% to 3.50%. Although we may allocate aportion of the allowance to specific loans or 

21

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loan categories, the entire allowance is available foractive charge-offs. Allowance estimates are developed with actual lossexperience adjusted for current economic conditions. Allowance estimates areconsidered a prudent measurement of the risk in the loan portfolio and areapplied to individual loans based on loan type.

**Non-PerformingAssets**

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

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

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

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

22

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The following table sets forth information withrespect to non-performing assets for the periods indicated.
| ** **                                                                                     | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|------------------------------------------------------------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| **(Dollar in thousands)**                                                            | ** ** | **2006**           | ** ** | **2005**              | ** ** |
| Restructured                                                                                   |       | $                  | 3,309      |                  | $          | 3,104 |   |
| Past due 90 days still  on accrual                                                             |       | —             |       | —                |       |
| Loans on non-accrual  status                                                                   |       | 3,792              |       | 3,128                 |       |
| Total  non-performing loans                                                                    |       | 7,101              |       | 6,232                 |       |
|                                                                                           |       |               |       |                  |       |
| Real estate acquired  through foreclosure                                                      |       | 861                |       | 1,022                 |       |
| Other repossessed  assets                                                                      |       | 60                 |       | 119                   |       |
| Total  non-performing assets                                                                   |       | $                  | 8,022      |                  | $          | 7,373 |   |
|                                                                                           |       |               |       |                  |       |
| Interest income that  would have been earned on non-performing loans                           |       | $                  | 524        |                  | $          | 432 |   |
| Interest income  recognized on non-performing loans                                            |       | 235                |       | 219                   |       |
| Ratios:    Non-performing loans to total loans  (excluding loans held for sale) |       | 1.09               | %          | 0.97                  | %          |
| Non-performing assets  to total loans (excluding loans held for sale)                          |       | 1.23               | %          | 1.15                  | %          |

 

Non-performing assets for the 2006 period include $3.3million in restructured commercial, residential mortgage and consumer loans.****The restructured loans primarily consistof four credit relationships aggregating $3.1 million, including a $2.2 millioncommercial relationship, a $249,000 commercial relationship, a $208,000commercial relationship and a $449,000 residential mortgage relationship. 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 terms of the restructured loans arecurrently being met.

**InvestmentSecurities**

Interest on securities provides us our largest sourceof interest income after interest on loans, constituting 6.2% of the totalinterest income for the quarter ended March 31, 2006. The securities portfolio serves as a source of liquidity and earningsand contributes to the management of interest rate risk. We have theauthority to invest in various types of liquid assets, including short-termUnited States Treasury obligations and securities of various federal agencies,obligations of states and political subdivisions, corporate bonds, certificatesof deposit at insured savings and loans and banks, bankers’ acceptances, andfederal funds. We may also invest a portion of our assets in certain commercialpaper and corporate debt securities. We are also authorized to invest in mutualfunds and stocks whose assets conform to the investments that we are authorizedto make directly. The available-for-sale and held-to-maturity investmentportfolios increased by $967,000 during the 2006 period due to investments instate and municipal obligations and a corporate bond. The corporate bondre-prices quarterly with three-month LIBOR and was purchased to enhance ourearnings. The state and municipal obligations have an average life of 10 years.We purchased these securities to enhance earnings and manage interest rate riskby placing longer-dated assets on the balance sheet.

**Deposits**

We rely primarily on customer service andlong-standing relationships with customers to attract and retain deposits.Market interest rates and rates on deposit products offered by competing financialinstitutions can significantly affect our ability to attract and retaindeposits. In conjunction with our initiatives to expand and enhance our retailbranch network we have undertaken a renewed emphasis on growing our customerchecking account base to better enhance profitability and franchise value.****A heightened level of advertising andpromotions coupled with associate incentive plans designed to encourage thesale of checking accounts were successful in attracting deposits during thefirst quarter of 2006. During the quarter ended March 31, 2006, total depositsincreased by $39.5 million compared to December 31, 2005. The increase inretail deposits was primarily in certificate of deposit balances due to aValentines Day CD promotion. In addition, we experienced a $10.1 millionincrease in checking account deposits. Offsetting this growth were decreases insavings and money market deposits. We plan to continue our deposit gatheringinitiatives during 2006 and anticipate continued progress.

23

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Thefollowing table breaks down our deposits.
| ** **               | ** ** | **March 31,**      | ** ** | **December 31,** | ** ** |
|--------------------------|------------|-------------------------|------------|-----------------------|------------|
| ** **               | ** ** | **2006**                | ** ** | **2005**              | ** ** |
| ** **               | ** ** | **(In Thousands)** | ** ** |
| Non-interest  bearing    |       | $                       | 48,468     |                  | $          | 39,145 |   |
| NOW demand               |       | 77,672                  |       | 76,848                |       |
| Savings                  |       | 93,566                  |       | 99,879                |       |
| Money market             |       | 56,191                  |       | 66,175                |       |
| Certificates of  deposit |       | 354,674                 |       | 309,059               |       |
|                     |       | $                       | 630,571    |                  | $          | 591,106 |   |

 

**Advances fromFederal Home Loan Bank**

We have $78.3 million borrowed from the Federal HomeLoan Bank (FHLB) of Cincinnati at March 31, 2006. During January 2001, weentered into $75.0 million in convertible fixed rate advances with a maturityof ten years. These advances were fixed for periods of two to three years. Atthe end of the fixed rate term and quarterly thereafter, the FHLB has the rightto convert these advances to variable rate advances tied to the three-monthLIBOR index or we can prepay the advance at no penalty. There is a penalty ifwe prepay the advances before the FHLB exercises its right. One of the advancesis fixed at a rate of 4.86% for $50.0 million while the other advance is fixedat a rate of 5.05% for $25.0 million. The three-month LIBOR index at which theFHLB has the right to convert to was 5.00% at March 31, 2006. If thethree-month LIBOR index continues to increase, there is an increased likelihoodof one or both of these advances being converted to a variable rate advance.

**SubordinatedDebentures**

In March 2002, a trust formed by the First FinancialService Corporation completed the private placement of 10,000 shares ofcumulative trust preferred securities with a liquidation preference of $1,000per security. The proceeds of the offering were loaned to us in exchange forfloating rate junior subordinated deferrable interest debentures. Distributionson the Trust Preferred Securities are payable quarterly in arrears at theannual rate (adjusted quarterly) of three-month LIBOR plus 3.60%, and areincluded in interest expense. The Subordinated Debentures are considered asTier I capital for the Corporation under current regulatory guidelines.

**LIQUIDITY**

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

Funds are available from a number of sources,including the sale of securities in the available-for-sale portion of theinvestment portfolio, principal 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 utilized borrowings from the FHLB tosupplement our funding requirements. At March 31, 2006, we had an unusedapproved line of credit in the amount of $109.1 million and sufficientcollateral available to borrow, approximately, an additional $56 million inadvances from the FHLB.****We believeour sources of liquidity are adequate to meet expected cash needs for theforeseeable future.

24

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At the holding company level, the Corporation usescash to pay dividends to stockholders, repurchase common stock, make selectedinvestments and acquisitions, and service debt. The main sources of funding forthe holding company include dividends, borrowings and access to the capitalmarkets.

The primary source of funding for the Corporation hasbeen dividends and returns of investment from the Bank. Kentucky bankingregulations limit the amount of dividends that may be paid. At March 31, 2006,the maximum amount of dividends available from the Bank is $11.4 million. Accordingly,consolidated cash flows as presented in the consolidated statements of cashflows may not represent cash immediately available to the Corporation. Duringthe quarter ended March 31, 2006, the Bank declared and paid dividends to theCorporation of $965,000.

**CAPITAL**

Stockholders’ equity increased $1.5 million for thequarter ended March 31, 2006 compared to December 31, 2005.****The increase in capital was primarilyattributable to net income during the quarter.****This increase was offset by cash dividends declared and a decline inaccumulated other comprehensive income, a result of temporary unrealized lossesrecorded on securities.****Averagestockholders’ equity to average assets ratio increased to 8.55% for the quarterended March 31, 2006 compared to 8.20% for 2005.

Kentucky banking laws limit the amount of dividendsthat may be paid to First Financial Service Corporation by First FederalSavings Bank without prior approval of the Kentucky Office of FinancialInstitutions. Under these laws, the amount of dividends that may be paid in anycalendar year is limited to current year’s net income, as defined in the laws,combined with the retained net income of the preceding two years, less anydividends declared during those periods. At March 31, 2006, without priorregulatory approval, we had approximately $11.4 million of retained earningsthat could be utilized for payment of dividends if authorized by our board ofdirectors.

Each of the federal bank regulatory agencies hasestablished minimum leverage capital requirements for banking organizations.Banking organizations must maintain a minimum ratio of Tier 1 capital toadjusted average quarterly assets equal to 3% to 5% subject to federal bankregulatory evaluation of an organization’s overall safety and soundness. Weintend to maintain a capital position that meets or exceeds the “wellcapitalized” requirements as defined for banks by the FDIC. The following tableshows the ratios of Tier 1 capital and total capital to risk-adjusted assetsand the leverage ratios for the Corporation and the Bank as of March 31, 2006.

25

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| ** **                                         | ** ** | ** ** | ** ** | ** **                 | ** ** | ** **                 | ** ** | ** **     | ** ** | **To Be Considered** | ** ** |
|----------------------------------------------------|------------|------------|------------|----------------------------|------------|----------------------------|------------|----------------|------------|--------------------------------|------------|
| ** **                                         | ** ** | ** ** | ** ** | ** **                 | ** ** | ** **                 | ** ** | ** **     | ** ** | **Well Capitalized**      | ** ** |
| ** **                                         | ** ** | ** ** | ** ** | ** **                 | ** ** | ** **                 | ** ** | ** **     | ** ** | **Under Prompt**          | ** ** |
| ** **                                         | ** ** | ** ** | ** ** | ** **                 | ** ** | **For Capital**       | ** ** | **Correction** | ** ** |
| ** **                                         | ** ** | **Actual** | ** ** | **Adequacy Purposes** | ** ** | **Action Provisions** | ** ** |
| **(Dollars in thousands)**               | ** ** | **Amount** | ** ** | **Ratio**                  | ** ** | **Amount**                 | ** ** | **Ratio**      | ** ** | **Amount**                     | ** ** | **Ratio** | ** ** |
| ** **                                         |       |       |       |                       |       |                       |       |           |       |                           |       |   |   |
| **As of  March 31, 2006:**                         |       |       |       |                       |       |                       |       |           |       |                           |       |   |   |
| Total risk-based capital (to risk weighted assets) |       |       |       |                       |       |                       |       |           |       |                           |       |   |   |
| Consolidated                                       |       | $          | 75,550     |                       | 11.6       | %                          | $          | 52,054         |       | 8.0                            | %          | N/A |   | N/A |   |
| Bank                                               |       | 72,885     |       | 11.2                       |       | 51,860                     |       | 8.0            |       | $64,825                        |       | 10.0% |   |
| Tier I capital (to risk-weighted assets)           |       |       |       |                       |       |                       |       |           |       |                           |       |   |   |
| Consolidated                                       |       | 67,898     |       | 10.4                       |       | 26,027                     |       | 4.0            |       | N/A                            |       | N/A |   |
| Bank                                               |       | 65,233     |       | 10.1                       |       | 25,930                     |       | 4.0            |       | $38,895                        |       | 6.0% |   |
| Tier I capital (to average assets)                 |       |       |       |                       |       |                       |       |           |       |                           |       |   |   |
| Consolidated                                       |       | 67,898     |       | 8.9                        |       | 30,547                     |       | 4.0            |       | N/A                            |       | N/A |   |
| Bank                                               |       | 65,233     |       | 8.6                        |       | 30,471                     |       | 4.0            |       | $38,088                        |       | 5.0% |   |
|                                                    |            |            |            |                            |            |                            |            |                |            |                                |            |  |  |  |  |

 
| ** **                                         | ** ** | ** ** | ** ** | ** **                 | ** ** | ** **              | ** ** | ** **     | ** ** | **To Be Considered** | ** ** |
|----------------------------------------------------|------------|------------|------------|----------------------------|------------|-------------------------|------------|----------------|------------|--------------------------------|------------|
| ** **                                         | ** ** | ** ** | ** ** | ** **                 | ** ** | ** **              | ** ** | ** **     | ** ** | **Well Capitalized**      | ** ** |
| ** **                                         | ** ** | ** ** | ** ** | ** **                 | ** ** | ** **              | ** ** | ** **     | ** ** | **Under Prompt**          | ** ** |
| ** **                                         | ** ** | ** ** | ** ** | ** **                 | ** ** | **For Capital**    | ** ** | **Correction** | ** ** |
| ** **                                         | ** ** | **Actual** | ** ** | **Adequacy Purposes** | ** ** | **Action Provisi** | ** ** |
| **(Dollars in thousands)**               | ** ** | **Amount** | ** ** | **Ratio**                  | ** ** | **Amount**              | ** ** | **Ratio**      | ** ** | **Amount**                     | ** ** | **Ratio** | ** ** |
| ** **                                         |       |       |       |                       |       |                    |       |           |       |                           |       |   |   |
| **As of  December 31, 2005:**                      |       |       |       |                       |       |                    |       |           |       |                           |       |   |   |
| Total risk-based capital (to risk weighted assets) |       |       |       |                       |       |                    |       |           |       |                           |       |   |   |
| Consolidated                                       |       | $          | 73,678     |                       | 11.5       | %                       | $          | 51,185         |       | 8.0                            | %          | N/A |   | N/A |   |
| Bank                                               |       | 71,070     |       | 11.1                       |       | 51,026                  |       | 8.0            |       | $63,782                        |       | 10.0% |   |
| Tier I capital (to risk-weighted assets)           |       |       |       |                       |       |                    |       |           |       |                           |       |   |   |
| Consolidated                                       |       | 66,300     |       | 10.4                       |       | 25,592                  |       | 4.0            |       | N/A                            |       | N/A |   |
| Bank                                               |       | 63,692     |       | 10.0                       |       | 25,513                  |       | 4.0            |       | $38,269                        |       | 6.0% |   |
| Tier I capital (to average assets)                 |       |       |       |                       |       |                    |       |           |       |                           |       |   |   |
| Consolidated                                       |       | 66,300     |       | 8.8                        |       | 30,011                  |       | 4.0            |       | N/A                            |       | N/A |   |
| Bank                                               |       | 63,692     |       | 8.5                        |       | 29,926                  |       | 4.0            |       | $37,408                        |       | 5.0% |   |
|                                                    |            |            |            |                            |            |                         |            |                |            |                                |            |  |  |  |  |

 

**Item3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

**Asset/LiabilityManagement and Market Risk**

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

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

26

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Our interest sensitivity profile was asset sensitiveat both March 31, 2006 and December 31, 2005. Given a sustained 100 basis pointdecrease in rates, our base net interest income would decrease by an estimated1.67% at March 31, 2006 compared to a decrease of 2.03% at December 31, 2005. Givena 100 basis point increase in interest rates our base net interest income wouldincrease by an estimated 1.65% at March 31, 2006 compared to an increase of1.92% at December 31, 2005.

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

As demonstrated by the March 31, 2006 and December 31,2005 sensitivity tables, we are in an asset sensitive position. This means thatour earning assets, which consist of loans and investment securities, willchange in price at a faster rate than our deposits and borrowings. Therefore,as short term interest rates increase, our net interest income will alsoincrease. Likewise, as short term interest rates decrease, our net interest incomewill decrease.

The Federal Open Market Committee began increasingshort-term interest rates in June 2004. We believe the Federal Open MarketCommittee will stop increasing short term interest rates during 2006 and willlikely decrease short term interest rates in late 2006 or in 2007. Our netinterest margin and the level of net interest income would be negativelyaffected with a decrease in short-term interest rates. We continually 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 2005, we made efforts toincrease the level of short-term deposits with a money market promotion as wellas offering more attractive rates on short-term certificates of deposit. Inaddition, 78% of the newly originated or renewed loans during 2005 were fixedrates loans with the interest rate fixed from three to five years. Theseefforts, in addition to other initiatives to structure funding and futureliquidity needs will decrease our asset sensitivity. This will help decreasethe negative impact flat or decreasing short-term interest rates may have onthe level of net interest income.

Our sensitivity to interest rate changes is presentedbased on data as of March 31, 2006 and December 31, 2005 annualized to a oneyear period.

27

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| ** **                           | ** ** | **March 31, 2006**    | ** ** |
|--------------------------------------|------------|---------------------------------|------------|
| ** **                           | ** ** | **Decrease in Rates** | ** ** | ** ** | ** ** | **Increase in Rates** | ** ** |
| ** **                           | ** ** | **200**                         | ** ** | **100** | ** ** | ** ** | ** ** | **100** | ** ** | **200** | ** ** |
| **(Dollars in thousands)** | ** ** | **Basis Points**           | ** ** | **Basis Points** | ** ** | **Base** | ** ** | **Basis Points** | ** ** | **Basis Points** | ** ** |
| ** **                           | ** ** | ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Projected  interest income**       | ** ** | ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Loans                                |       | $                               | 50,886     |   | $ | 52,240 |   | $ | 53,395 |   | $ | 54,501 |   | $ | 55,687 |   |
| Investments                          |       | 3,116                           |       | 3,367 |   | 3,504 |   | 3,597 |   | 3,705 |   |
| **Total  interest income**           |       | 54,002                          |       | 55,607 |   | 56,899 |   | 58,098 |   | 59,392 |   |
| ** **                           |       |                            |       |   |   |   |   |   |   |   |   |
| **Projected  interest expense**      | ** ** | ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Deposits                             |       | 15,964                          |       | 16,612 |   | 17,260 |   | 17,833 |   | 18,407 |   |
| Borrowed funds                       |       | 4,524                           |       | 4,683 |   | 4,744 |   | 4,795 |   | 4,842 |   |
| **Total  interest expense**          |       | 20,488                          |       | 21,295 |   | 22,004 |   | 22,628 |   | 23,249 |   |
| ** **                           |       |                            |       |   |   |   |   |   |   |   |   |
| **Net  interest income**             |       | $                               | 33,514     |   | $ | 34,312 |   | $ | 34,895 |   | $ | 35,470 |   | $ | 36,143 |   |
| Change from base                     |       | $                               | (1,381     | ) | $ | (583 | ) |   |   | $ | 575 |   | $ | 1,248 |   |
| % Change from base                   |       | (3.96                           | )%         | (1.67 | )% |   |   | 1.65 | % | 3.58 | % |

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

** **

**Item 4. CONTROLSAND PROCEDURES**

*Evaluation ofdisclosure controls and procedures*

Our management, with the participation of our ChiefExecutive Officer and our Chief Financial Officer, evaluated the effectivenessof our disclosure controls and procedures as of the end of the period coveredby this Quarterly Report on Form 10-Q. Based on this evaluation, ourChief Executive Officer and our Chief Financial Officer have concluded that ourdisclosure controls and procedures were effective as of the end of the periodcovered by this Quarterly Report on Form 10-Q to ensure that informationwe are required to disclose in reports that we file or submit under theSecurities Exchange Act of 1934 is recorded, processed, summarized and reportedwithin the time periods specified in Securities and Exchange Commission rules andforms.

*Changes ininternal control over financial reporting*

There was no change in our internal control overfinancial reporting that occurred during the period covered by this QuarterlyReport on Form 10-Q that has materially affected, or is reasonably likelyto materially affect, our internal control over financial reporting.

28

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**Part II - OTHER INFORMATION**

**Item1.**                          LegalProceedings

Although, from time to time, we are involved invarious legal proceedings in the normal course of business, there are nomaterial pending legal proceedings to which we are a party, or to which any ofour property is subject.

**Item1A.**                 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, 2005.

**Item2.**                          UnregisteredSales of Securities and Use of Proceeds

(e)             IssuerPurchases of Equity Securities

We did not repurchase any of our common stock duringthe quarter ended March 31, 2006.

**Item3.**                          DefaultsUpon Senior Securities

Not Applicable

**Item4.**                          Submissionof Matters to a Vote of Security Holders

Not Applicable

**Item5.**                          OtherInformation

None

**Item6.**                          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)

29

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**FIRST FINANCIALSERVICE CORPORATION**

**SIGNATURES**

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

30

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

 

31

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