**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington,D.C.  20549**

 

**FORM 10-Q**

 

**(MarkOne)**

 
| **ý**                                                  | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934.**  |
|-------------------------------------------------------------|-----------------------------------------------------------------------------------------------------------|
|                                                        |                                                                                                      |
| **For the quarterly period ended  September 30, 2005** |
|                                                        |                                                                                                      |
| **OR**                                                      |
|                                                        |                                                                                                      |
| **o**                                                       | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934.** |

 

**CommissionFile Number 0-18832**

 

**First Financial Service Corporation**

(ExactName of Registrant as specified in its charter)

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

 

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

 

Yesý  No o

 

Indicate by check markwhether the registrant is an accelerated filer (as defined in Rule 12b-2of the Exchange Act).

 

Yesý No o

 

Indicate by a check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act)

 

Yes o No ý

 

Indicate the number ofshares outstanding of each of the issuer’s classes of common stock, as of thelatest practicable date.

 
| **Class**     | ** ** | **Outstanding as of October 31, 2005** |
|---------------|------------|---------------------------------------------|
|          |       |                                        |
| Common  Stock |       | 3,626,188  shares                           |

 

 

----

 

## **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 the Consolidated Statements 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 2. Changes In Securities, Use of Proceeds and Issuer Purchases of Equity Securities**                                            |
|                                                                                                                                    |
| **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                                                                                                                              |
|                                                                                                                                    |
| CERTIFICATIONS                                                                                                                          |

 

2

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**Item 1.**

 

**FIRSTFINANCIAL SERVICE CORPORATION**

**ConsolidatedStatements of Financial Condition**

**(Unaudited)**

 
| **(Dollars  In thousands, except share data)**                                                                                                             | ** ** | **September 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| **ASSETS**                                                                                                                                                 |       |                         |       |                        |       |
| Cash and due from banks                                                                                                                                    |       | $                            | 21,321     |                        | $          | 27,910 |   |
| Federal  funds sold                                                                                                                                        |       | —                       |       | 8,000                       |       |
| Cash and cash equivalents                                                                                                                                  |       | 21,321                       |       | 35,910                      |       |
|                                                                                                                                                       |       |                         |       |                        |       |
| Securities  available-for-sale                                                                                                                             |       | 37,187                       |       | 21,928                      |       |
| Securities held-to-maturity,  fair value of $33,043 Sep (2005) and $34,557 Dec (2004)                                                                      |       | 33,577                       |       | 34,915                      |       |
| Total securities                                                                                                                                           |       | 70,764                       |       | 56,843                      |       |
|                                                                                                                                                       |       |                         |       |                        |       |
| Loans  held for sale                                                                                                                                       |       | 1,134                        |       | 1,219                       |       |
| Loans receivable, net of  unearned fees                                                                                                                    |       | 625,223                      |       | 604,698                     |       |
| Allowance  for loan losses                                                                                                                                 |       | (7,089                       | )          | (6,489                      | )          |
| Net loans receivable                                                                                                                                       |       | 619,268                      |       | 599,428                     |       |
|                                                                                                                                                       |       |                         |       |                        |       |
| Federal Home Loan Bank stock                                                                                                                               |       | 7,091                        |       | 6,845                       |       |
| Cash surrender value of life  insurance                                                                                                                    |       | 7,566                        |       | 7,353                       |       |
| Premises  and equipment, net                                                                                                                               |       | 19,180                       |       | 17,469                      |       |
| Real  estate owned:                                                                                                                                        |       |                         |       |                        |       |
| Acquired through foreclosure                                                                                                                               |       | 893                          |       | 681                         |       |
| Held for development                                                                                                                                       |       | 337                          |       | 389                         |       |
| Other  repossessed assets                                                                                                                                  |       | 83                           |       | 40                          |       |
| Goodwill                                                                                                                                                   |       | 8,384                        |       | 8,384                       |       |
| Accrued  interest receivable                                                                                                                               |       | 2,934                        |       | 2,487                       |       |
| Other  assets                                                                                                                                              |       | 1,437                        |       | 1,817                       |       |
|                                                                                                                                                       |       |                         |       |                        |       |
| **TOTAL ASSETS**                                                                                                                                           |       | $                            | 759,258    |                        | $          | 737,646 |   |
|                                                                                                                                                       |       |                         |       |                        |       |
| **LIABILITIES AND STOCKHOLDERS’  EQUITY**                                                                                                             |       |                         |       |                        |       |
| **LIABILITIES:**                                                                                                                                           |       |                         |       |                        |       |
| Deposits:                                                                                                                                                  |       |                         |       |                        |       |
| Non-interest bearing                                                                                                                                       |       | $                            | 41,770     |                        | $          | 38,441 |   |
| Interest bearing                                                                                                                                           |       | 553,795                      |       | 547,945                     |       |
| Total deposits                                                                                                                                             |       | 595,565                      |       | 586,386                     |       |
|                                                                                                                                                       |       |                         |       |                        |       |
| Federal  funds purchased                                                                                                                                   |       | 9,000                        |       | —                      |       |
| Advances from Federal Home  Loan Bank                                                                                                                      |       | 78,415                       |       | 78,904                      |       |
| Subordinated  debentures                                                                                                                                   |       | 10,000                       |       | 10,000                      |       |
| Accrued  interest payable                                                                                                                                  |       | 355                          |       | 413                         |       |
| Accounts payable and other  liabilities                                                                                                                    |       | 1,346                        |       | 637                         |       |
| Deferred  income taxes                                                                                                                                     |       | 1,187                        |       | 1,505                       |       |
|                                                                                                                                                       |       |                         |       |                        |       |
| **TOTAL LIABILITIES**                                                                                                                                      |       | 695,868                      |       | 677,845                     |       |
|                                                                                                                                                       |       |                         |       |                        |       |
| **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, 3,626,188 shares Sep (2005), and 3,645,438 shares Dec  (2004) |       | 3,626                        |       | 3,645                       |       |
| Common stock to be  distributed 362,619 shares                                                                                                             |       | 363                          |       | —                      |       |
| Additional  paid-in capital                                                                                                                                |       | 16,564                       |       | 8,226                       |       |
| Retained  earnings                                                                                                                                         |       | 42,698                       |       | 47,174                      |       |
| Accumulated other  comprehensive income, net of tax                                                                                                        |       | 139                          |       | 756                         |       |
|                                                                                                                                                       |       |                         |       |                        |       |
| **TOTAL STOCKHOLDERS’ EQUITY**                                                                                                                        |       | 63,390                       |       | 59,801                      |       |
| **TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                        |       | $                            | 759,258    |                        | $          | 737,646 |   |

 

***See notes to the unaudited consolidated financial statements.***

 

3

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**FIRSTFINANCIAL SERVICE CORPORATION**

**ConsolidatedStatements of Income**

**(Unaudited)**

 
| ** **                                           | ** ** | **Three  Months Ended  September 30,** | ** ** | **Nine  Months Ended  September 30,** | ** ** |
|------------------------------------------------------|------------|---------------------------------------------|------------|--------------------------------------------|------------|
| **(Dollars  in thousands, except per share data)**   | ** ** | **2005**                                    | ** ** | **2004**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                           |       |                                        |       |                                       |       |   |   |   |   |
| **Interest  Income:**                                |       |                                        |       |                                       |       |   |   |   |   |
| Interest and fees on loans                           |       | $                                           | 10,839     |                                       | $          | 9,374 |   | $ | 31,065 |   | $ | 27,502 |   |
| Interest and dividends on investments and deposits   |       | 754                                         |       | 410                                        |       | 2,185 |   | 1,273 |   |
| Total interest income                                |       | 11,593                                      |       | 9,784                                      |       | 33,250 |   | 28,775 |   |
|                                                 |       |                                        |       |                                       |       |   |   |   |   |
| **Interest  Expense:**                               |       |                                        |       |                                       |       |   |   |   |   |
| Deposits                                             |       | 3,482                                       |       | 2,489                                      |       | 9,519 |   | 7,741 |   |
| Federal funds purchased                              |       | 12                                          |       | 22                                         |       | 12 |   | 23 |   |
| Federal Home Loan Bank advances                      |       | 956                                         |       | 943                                        |       | 2,851 |   | 2,792 |   |
| Subordinated debentures                              |       | 184                                         |       | 136                                        |       | 517 |   | 385 |   |
| Total interest expense                               |       | 4,634                                       |       | 3,590                                      |       | 12,899 |   | 10,941 |   |
|                                                 |       |                                        |       |                                       |       |   |   |   |   |
| Net  interest income                                 |       | 6,959                                       |       | 6,194                                      |       | 20,351 |   | 17,834 |   |
| Provision  for loan losses                           |       | 440                                         |       | 824                                        |       | 756 |   | 1,473 |   |
| Net interest income after  provision for loan losses |       | 6,519                                       |       | 5,370                                      |       | 19,595 |   | 16,361 |   |
|                                                 |       |                                        |       |                                       |       |   |   |   |   |
| **Non-interest  Income:**                            |       |                                        |       |                                       |       |   |   |   |   |
| Customer service fees on deposit accounts            |       | 1,371                                       |       | 1,271                                      |       | 3,810 |   | 3,674 |   |
| Gain on sale of mortgage loans                       |       | 251                                         |       | 221                                        |       | 602 |   | 683 |   |
| Brokerage commissions                                |       | 79                                          |       | 82                                         |       | 236 |   | 268 |   |
| Gain on sale of real estate held for development     |       | —                                      |       | 150                                        |       | 143 |   | 526 |   |
| Gain on sale of investments                          |       | —                                      |       | 26                                         |       | 381 |   | 26 |   |
| Other income                                         |       | 360                                         |       | 372                                        |       | 887 |   | 978 |   |
| Total non-interest income                            |       | 2,061                                       |       | 2,122                                      |       | 6,059 |   | 6,155 |   |
|                                                 |       |                                        |       |                                       |       |   |   |   |   |
| **Non-interest  Expense:**                           |       |                                        |       |                                       |       |   |   |   |   |
| Employee compensation and  benefits                  |       | 2,769                                       |       | 2,611                                      |       | 8,403 |   | 7,666 |   |
| Office occupancy expense and equipment               |       | 519                                         |       | 460                                        |       | 1,517 |   | 1,351 |   |
| Marketing and advertising                            |       | 197                                         |       | 187                                        |       | 580 |   | 539 |   |
| Outside services and data processing                 |       | 609                                         |       | 558                                        |       | 1,837 |   | 1,628 |   |
| Bank franchise tax                                   |       | 195                                         |       | 201                                        |       | 593 |   | 620 |   |
| Other expense                                        |       | 867                                         |       | 953                                        |       | 2,648 |   | 2,622 |   |
| Total non-interest expense                           |       | 5,156                                       |       | 4,970                                      |       | 15,578 |   | 14,426 |   |
|                                                 |       |                                        |       |                                       |       |   |   |   |   |
| Income  before income taxes                          |       | 3,424                                       |       | 2,522                                      |       | 10,076 |   | 8,090 |   |
| Income  taxes                                        |       | 1,113                                       |       | 808                                        |       | 3,285 |   | 2,611 |   |
| **Net  Income**                                      |       | $                                           | 2,311      |                                       | $          | 1,714 |   | $ | 6,791 |   | $ | 5,479 |   |
|                                                 |       |                                        |       |                                       |       |   |   |   |   |
| Shares applicable to basic  income per share         |       | 3,988,806                                   |       | 4,009,982                                  |       | 4,002,584 |   | 4,029,782 |   |
| **Basic  income per share**                          |       | $                                           | 0.58       |                                       | $          | 0.43 |   | $ | 1.70 |   | $ | 1.36 |   |
|                                                 |       |                                        |       |                                       |       |   |   |   |   |
| Shares applicable to diluted  income per share       |       | 4,027,271                                   |       | 4,027,356                                  |       | 4,035,646 |   | 4,042,815 |   |
| **Diluted  income per share**                        |       | $                                           | 0.57       |                                       | $          | 0.43 |   | $ | 1.68 |   | $ | 1.35 |   |

 

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

 

4

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**FIRSTFINANCIAL SERVICE CORPORATION**

**Consolidated Statementsof Comprehensive Income**

**(Unaudited)**

 
| ** **                                                    | ** ** | **Three  Months Ended  September 30,** | ** ** | **Nine  Months Ended  September 30,** | ** ** |
|---------------------------------------------------------------|------------|---------------------------------------------|------------|--------------------------------------------|------------|
| **(Dollars in thousands)**                                    | ** ** | **2005**                                    | ** ** | **2004**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                          |       |                                        |       |                                       |       |   |   |   |   |
| **Net  Income**                                               |       | $                                           | 2,311      |                                       | $          | 1,714 |   | $ | 6,791 |   | $ | 5,479 |   |
| Other  comprehensive income (loss):                           |       |                                        |       |                                       |       |   |   |   |   |
| Change in unrealized gain (loss) on securities                |       | (405                                        | )          | 117                                        |       | (554 | ) | 131 |   |
| Reclassification of realized  amount                          | ** ** | **—**                                  |       | (26                                        | )          | (381 | ) | (26 | ) |
| Net unrealized gain (loss) recognized in comprehensive income |       | (405                                        | )          | 91                                         |       | (935 | ) | 105 |   |
| Tax effect                                                    |       | 138                                         |       | (31                                        | )          | 318 |   | (36 | ) |
| Total other comphrehensive income (loss)                      |       | (267                                        | )          | 60                                         |       | (617 | ) | 69 |   |
|                                                          |       |                                        |       |                                       |       |   |   |   |   |
| **Comprehensive  Income**                                     |       | $                                           | 2,044      |                                       | $          | 1,774 |   | $ | 6,174 |   | $ | 5,548 |   |

 

***See notes to the unaudited consolidated financial statements.***

 

5

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**FIRSTFINANCIAL SERVICE CORPORATION**

**ConsolidatedStatements of Changes in Stockholders’ Equity**

**Nine MonthsEnded September 30, 2005**

**(Dollars InThousands, Except Per Share Amounts)**

**(Unaudited)**

 
| ** **                                                                             | ** ** | ** **       | ** ** | ** **      | ** ** | ** **      | ** ** | ** **     | ** ** | ** **         | ** ** | **Accumulated**   | ** ** | ** ** | ** ** |
|----------------------------------------------------------------------------------------|------------|------------------|------------|-----------------|------------|-----------------|------------|----------------|------------|--------------------|------------|-------------------|------------|------------|------------|
| ** **                                                                             | ** ** | ** **       | ** ** | ** **      | ** ** | ** **      | ** ** | ** **     | ** ** | ** **         | ** ** | **Other**         | ** ** | ** ** | ** ** |
| ** **                                                                             | ** ** | ** **       | ** ** | ** **      | ** ** | **Common**      | ** ** | **Additional** | ** ** | ** **         | ** ** | **Comprehensive** | ** ** | ** ** | ** ** |
| ** **                                                                             | ** ** | **Common Stock** | ** ** | **Stock to be** | ** ** | **Paid-in**     | ** ** | **Retained**   | ** ** | **Income, Net of** | ** ** | ** **        | ** ** |
| ** **                                                                             | ** ** | **Shares**       | ** ** | **Amount**      | ** ** | **Distributed** | ** ** | **Capital**    | ** ** | **Earnings**       | ** ** | **Tax**           | ** ** | **Total**  | ** ** |
|                                                                                   |       |             |       |            |       |            |       |           |       |               |       |              |       |       |       |
| **Balance, December 31, 2004**                                                    |       | 3,645            |       | $               | 3,645      |            | $          | —         |       | $                  | 8,226      |              | $          | 47,174     |       | $ | 756 |   | $ | 59,801 |   |
| Net income                                                                             |       |             |       |            |       |            |       |           |       | 6,791              |       |              |       | 6,791      |       |
| Stock dividend-10%                                                                     |       |             |       |            |       | 363             |       | 8,833          |       | (9,196             | )          |              |       | —     |       |
| Exercise of stock options                                                              |       | 3                |       | 3               |       |            |       | 54             |       |               |       |              |       | 57         |       |
| Net change in unrealized gains (losses) on securities available- for-sale,  net of tax |       |             |       |            |       |            |       |           |       |               |       | (617              | )          | (617       | )          |
| Cash dividends declared ($.52 per share)                                               |       |             |       |            |       |            |       |           |       | (2,071             | )          |              |       | (2,071     | )          |
| Stock repurchased                                                                      |       | (22              | )          | (22             | )          | —          |       | (549           | )          | —             |       | —            |       | (571       | )          |
|                                                                                   |       |             |       |            |       |            |       |           |       |               |       |              |       |       |       |
| **Balance, September 30,  2005**                                                  |       | 3,626            |       | $               | 3,626      |            | $          | 363            |       | $                  | 16,564     |              | $          | 42,698     |       | $ | 139 |   | $ | 63,390 |   |

 

***See notes to the unaudited consolidated financial statements.***

 

6

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**FIRSTFINANCIAL SERVICE CORPORATION**

**ConsolidatedStatements of Cash Flows**

**(Dollars InThousands)**

**(Unaudited)**

 
| ** **                                                                         | ** ** | **Nine  Months Ended  September 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                         | ** ** | **2005**                                   | ** ** | **2004** | ** ** |
| **Operating Activities:**                                                          |       |                                       |       |   |   |
| Net income                                                                         |       | $                                          | 6,791      |   | $ | 5,479 |   |
| Adjustments to reconcile net income to net cash provided by operating  activities: |       |                                       |       |   |   |
| Provision for loan losses                                                          |       | 756                                        |       | 1,473 |   |
| Depreciation on premises and equipment                                             |       | 963                                        |       | 818 |   |
| Federal Home Loan Bank stock dividends                                             |       | (246                                       | )          | (203 | ) |
| Net amortization (accretion)  available-for-sale                                   |       | 28                                         |       | 17 |   |
| Net amortization (accretion) held-to-maturity                                      |       | 44                                         |       | 37 |   |
| Gain on sale of investments available-for-sale                                     |       | (381                                       | )          | (26 | ) |
| Gain on sale of mortgage loans                                                     |       | (602                                       | )          | (683 | ) |
| Gain on sale of real estate held for development                                   |       | (143                                       | )          | (526 | ) |
| Origination of loans held for sale                                                 |       | (33,470                                    | )          | (41,577 | ) |
| Proceeds on sale of loans held for sale                                            |       | 34,157                                     |       | 41,863 |   |
| Changes in:                                                                        |       |                                       |       |   |   |
| Cash surrender value of life insurance                                             |       | (213                                       | )          | (217 | ) |
| Interest receivable                                                                |       | (447                                       | )          | (213 | ) |
| Other assets                                                                       |       | 380                                        |       | 1,542 |   |
| Interest payable                                                                   |       | (58                                        | )          | (17 | ) |
| Accounts payable and other liabilities                                             |       | 709                                        |       | 23 |   |
| Net cash from operating activities                                                 |       | 8,268                                      |       | 7,790 |   |
|                                                                               |       |                                       |       |   |   |
| **Investing Activities:**                                                          |       |                                       |       |   |   |
| Sales of securities available-for-sale                                             |       | 1,431                                      |       | 88 |   |
| Purchases of securities available-for-sale                                         |       | (36,393                                    | )          | (4,640 | ) |
| Maturities of securities available-for-sale                                        |       | 19,121                                     |       | — |   |
| Purchases of securities held-to-maturity                                           |       | —                                     |       | (24,100 | ) |
| Maturities of securities held-to-maturity                                          |       | 1,294                                      |       | 19,635 |   |
| Net change in loans                                                                |       | (20,936                                    | )          | (50,384 | ) |
| Net purchases of premises and equipment                                            |       | (2,674                                     | )          | (2,253 | ) |
| Sales of real estate held for development                                          |       | 195                                        |       | 213 |   |
| Net cash from investing activities                                                 |       | (37,962                                    | )          | (61,441 | ) |
|                                                                               |       |                                       |       |   |   |
| **Financing Activities**                                                           |       |                                       |       |   |   |
| Net change in deposits                                                             |       | 9,179                                      |       | 5,758 |   |
| Change in federal funds purchased                                                  |       | 9,000                                      |       | 20,000 |   |
| Advances from Federal Home Loan Bank                                               |       | —                                     |       | 821 |   |
| Repayments to Federal Home Loan Bank                                               |       | (489                                       | )          | (156 | ) |
| Proceeds from stock options exercised                                              |       | 57                                         |       | — |   |
| Dividends paid                                                                     |       | (2,071                                     | )          | (2,016 | ) |
| Common stock repurchased                                                           |       | (571                                       | )          | (1,560 | ) |
| Net cash from financing activities                                                 |       | 15,105                                     |       | 22,847 |   |
|                                                                               |       |                                       |       |   |   |
| **(Decrease) in cash and cash equivalents**                                        |       | (14,589                                    | )          | (30,804 | ) |
| **Cash and cash equivalents, beginning of period**                                 |       | 35,910                                     |       | 48,030 |   |
| **Cash and cash equivalents, end of period**                                       |       | $                                          | 21,321     |   | $ | 17,226 |   |

 

***See notes to the unaudited consolidated financial statements.***

 

7

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**Notes ToUnaudited Consolidated Financial Statements**

 

**1.****                                     ****BASIS OF PRESENTATION ANDSUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**

 

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

 

The accompanying unaudited consolidated financial statements have beenprepared in accordance with accounting principles generally accepted in theUnited States of America for interim financial information and with the instructionsto Form 10-Q and Rule 10-01 of Regulation S-X.  Accordingly, they do not include all of theinformation and footnotes required by accounting principles generally acceptedin the United States of America for complete financial statements.  In the opinion of management, all adjustments(consisting of normal recurring accruals) considered necessary for a fairpresentation have been included. Operating results for the nine-month period ending September 30,2005 are not necessarily indicative of the results that may occur for the yearending December 31, 2005.  Forfurther 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, 2004.

 

***Stock Dividend*** – The Corporation declared a 10% stockdividend on September 22, 2005, payable on October 21, 2005 toshareholders of record at the close of business on October 7, 2005.  The payment of this dividend is in additionto the regular quarterly cash dividends. All share and per share amounts have been restated for the impact of thestock dividend.

 

***Stock Option Plans*** – Employeecompensation expense under stock option plans is reported using the intrinsicvalue method.  No stock-basedcompensation cost is reflected in net income, as all options granted had anexercise price equal to the market price of the underlying common stock at dateof grant.  The following tableillustrates the effect on net income and earnings per share if expense wasmeasured using the fair value recognition provisions of FASB Statement No. 123,Accounting for Stock-Based Compensation.

 
| ** **                                                                         | ** **  | **Three  Months Ended  September 30,**        | ** ** | **Nine  Months Ended  September 30,** | ** ** |
|------------------------------------------------------------------------------------|-------------|----------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                         | ** **  | **2005**                                           | ** ** | **2004**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                                         | ** **  | **(Dollars In Thousands, Except  Per Share Data)** | ** ** |
| Net income:                                                                        |        |                                               |       |                                       |       |   |   |   |   |
| As reported                                                                        |        | $                                                  | 2,311      |                                       | $          | 1,714 |   | $ | 6,791 |   | $ | 5,479 |   |
| Deduct: Stock-based compensation expense determined under fair value  based method |        | (20                                                | )          | (30                                        | )          | (76 | ) | (92 | ) |
| Pro-forma                                                                          |        | $                                                  | 2,291      |                                       | $          | 1,684 |   | $ | 6,715 |   | $ | 5,387 |   |
| ** **                                                                         | ** **  | ** **                                         | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** |
| Earnings per share:                                                                | ** **  | ** **                                         | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** |
| Basic                                                                              | As Reported |                                               | $          | 0.58                                       |       | $ | 0.43 |   | $ | 1.70 |   | $ | 1.36 |   |
|                                                                               | Pro-forma   |                                               | 0.57       |                                       | 0.42       |   | 1.68 |   | 1.34 |   |
| Diluted                                                                            | As Reported |                                               | $          | 0.57                                       |       | $ | 0.43 |   | $ | 1.68 |   | $ | 1.35 |   |
|                                                                               | Pro-forma   |                                               | 0.57       |                                       | 0.42       |   | 1.66 |   | 1.34 |   |

 

**Effect of Newly Issued But Not YetEffective Accounting Standards** – In December 2004, the Financial Accounting Standards Board(“FASB”) issued Statement of Financial Accounting Standard (“SFAS”) No. 123(Revised 2004) (“SFAS No. 123R”), “Share-Based Payment.”  SFAS No. 123R is a revision of FASBStatement 123, “Accounting for Stock-Based Compensation” and supersedes APBOpinion No. 25, “Accounting for Stock Issued to Employees,” and itsrelated implementation guidance.  SFAS No. 123Rrequires all public companies to record compensation cost for stock optionsprovided to employees in return for employee service. The cost is measured atthe fair value of the options when granted, and this cost is expensed over theemployee service period, which is normally the vesting period

 

8

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of theoptions.  This will apply to awardsgranted or modified for the year beginning January 1, 2006.** **Compensationcost will also be recorded for prior option grants that vest after the date ofadoption.  The effect on results ofoperations will depend on the level of future option grants and the calculationof the fair value of the options granted at such future date, as well as thevesting periods provided, and so they cannot currently be predicted. ** **Existingoptions that will vest after adoption date are expected to result in additionalcompensation expense of approximately $66,000 in 2006, $60,000 in 2007, $60,000in 2008 and $45,000 in 2009.  There willbe no significant effect on financial position as total equity will not change.

 

***Reclassifications*** – Certain amounts have been reclassified inthe prior period financial statements to conform to the current periodclassifications.

 

**2.**             **SECURITIES**

 

The amortized cost basis and fair values ofsecurities are as follows:

 
| ** **                          | ** ** | ** **    | ** ** | **Gross**        | ** ** | **Gross**        | ** ** | ** **      | ** ** |
|-------------------------------------|------------|---------------|------------|------------------|------------|------------------|------------|-----------------|------------|
| ** **                          | ** ** | **Amortized** | ** ** | **Unrealized**   | ** ** | **Unrealized**   | ** ** | ** **      | ** ** |
| **(Dollars in thousands)**          | ** ** | **Cost**      | ** ** | **Gains**        | ** ** | **Losses**       | ** ** | **Fair  Value** | ** ** |
| **Securities  available-for-sale:** |       |          |       |             |       |             |       |            |       |
| **September 30, 2005:**        |       |          |       |             |       |             |       |            |       |
| U. S. Treasury and agencies         |       | $             | 15,482     |             | $          | —           |       | $               | (53        | ) | $ | 15,429 |   |
| Mortgage-backed                     |       | 12,316        |       | 1                |       | (109             | )          | 12,208          |       |
| Equity                              |       | 1,353         |       | 579              |       | —           |       | 1,932           |       |
| State and municipal                 |       | 5,803         |       | 22               |       | (230             | )          | 5,595           |       |
| Corporate                           |       | 2,023         |       | —           |       | —           |       | 2,023           |       |
|                                |       |          |       |             |       |             |       |            |       |
| Total                               |       | $             | 36,977     |             | $          | 602              |       | $               | (392       | ) | $ | 37,187 |   |
|                                |       |          |       |             |       |             |       |            |       |
| **December 31, 2004:**         |       |          |       |             |       |             |       |            |       |
| U. S. Treasury and agencies         |       | $             | 15,985     |             | $          | —           |       | $               | (56        | ) | $ | 15,929 |   |
| Mortgage-backed                     |       | 1,901         |       | —           |       | (22              | )          | 1,879           |       |
| Equity                              |       | 1,898         |       | 1,181            |       | —           |       | 3,079           |       |
| State and municipal                 |       | 999           |       | 42               |       | —           |       | 1,041           |       |
|                                |       |          |       |             |       |             |       |            |       |
| Total                               |       | $             | 20,783     |             | $          | 1,223            |       | $               | (78        | ) | $ | 21,928 |   |
|                                |       |          |       |             |       |             |       |            |       |
| ** **                          | ** ** | ** **    | ** ** | **Gross**        | ** ** | **Gross**        | ** ** | ** **      | ** ** |
| ** **                          | ** ** | **Amortized** | ** ** | **Unrecognized** | ** ** | **Unrecognized** | ** ** | ** **      | ** ** |
| ** **                          | ** ** | **Cost**      | ** ** | **Gains**        | ** ** | **Losses**       | ** ** | **Fair  Value** | ** ** |
| **Securities  held-to-maturity:**   | ** ** | ** **    | ** ** | ** **       | ** ** | ** **       | ** ** | ** **      | ** ** |
| **September 30, 2005:**        |       |          |       |             |       |             |       |            |       |
| U.S. Treasury and agencies          |       | $             | 26,095     |             | $          | 1                |       | $               | (381       | ) | $ | 25,715 |   |
| Mortgage-backed                     |       | 5,482         |       | 3                |       | (157             | )          | 5,328           |       |
| Corporate                           |       | 2,000         |       | —           |       | —           |       | 2,000           |       |
|                                |       |          |       |             |       |             |       |            |       |
| Total                               |       | $             | 33,577     |             | $          | 4                |       | $               | (538       | ) | $ | 33,043 |   |
|                                |       |          |       |             |       |             |       |            |       |
| **December 31, 2004:**         |       |          |       |             |       |             |       |            |       |
| U.S. Treasury and agencies          |       | $             | 26,095     |             | $          | 3                |       | $               | (244       | ) | $ | 25,854 |   |
| Mortgage-backed                     |       | 6,820         |       | 7                |       | (124             | )          | 6,703           |       |
| Corporate                           |       | 2,000         |       | —           |       | —           |       | 2,000           |       |
|                                |       |          |       |             |       |             |       |            |       |
| Total                               |       | $             | 34,915     |             | $          | 10               |       | $               | (368       | ) | $ | 34,557 |   |

 

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**3.****                                     ****LOANS RECEIVABLE**

 

Loans receivable are summarized as follows:

 
| ** **                         | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|------------------------------------|------------|------------------------|------------|-----------------------|------------|
| **(Dollars in thousands)**         | ** ** | **2005**               | ** ** | **2004**              | ** ** |
|                               |       |                   |       |                  |       |
| Commercial                         |       | $                      | 35,260     |                  | $          | 32,228 |   |
| Real  estate commercial            |       | 334,085                |       | 302,567               |       |
| Real  estate construction          |       | 10,239                 |       | 10,850                |       |
| Residential  mortgage              |       | 145,754                |       | 159,550               |       |
| Consumer  and home equity          |       | 69,369                 |       | 70,143                |       |
| Indirect  consumer                 |       | 31,708                 |       | 30,798                |       |
| Loans  held for sale               |       | 1,134                  |       | 1,219                 |       |
|                               |       | 627,549                |       | 607,355               |       |
| Less:                              |       |                   |       |                  |       |
| Net deferred loan origination fees |       | (1,192                 | )          | (1,438                | )          |
| Allowance for loan losses          |       | (7,089                 | )          | (6,489                | )          |
|                               |       | (8,281                 | )          | (7,927                | )          |
|                               |       |                   |       |                  |       |
| Loans  Receivable                  |       | $                      | 619,268    |                  | $          | 599,428 |   |

 

Theallowance for losses on loans is summarized as follows:

 
| ** **                    | ** ** | **As of and For the  Three Months Ended  September 30,** | ** ** | **As of and For the  Nine Months Ended  September 30,** | ** ** |
|-------------------------------|------------|---------------------------------------------------------------|------------|--------------------------------------------------------------|------------|
| **(Dollars in thousands)**    | ** ** | **2005**                                                      | ** ** | **2004**                                                     | ** ** | **2005** | ** ** | **2004** | ** ** |
|                          |       |                                                          |       |                                                         |       |   |   |   |   |
| Balance,  beginning of period |       | $                                                             | 6,714      |                                                         | $          | 5,822 |   | $ | 6,489 |   | $ | 5,568 |   |
| Provision  for loan losses    |       | 440                                                           |       | 824                                                          |       | 756 |   | 1,473 |   |
| Charge-offs                   |       | (141                                                          | )          | (318                                                         | )          | (387 | ) | (809 | ) |
| Recoveries                    |       | 76                                                            |       | 63                                                           |       | 231 |   | 159 |   |
| Balance,  end of period       |       | $                                                             | 7,089      |                                                         | $          | 6,391 |   | $ | 7,089 |   | $ | 6,391 |   |

 

Investment in impaired loans is summarizedbelow.  There were no impaired loans forthe periods presented without an allowance allocation.

 
| ** **                                   | ** ** | **As of and For the  Nine Months Ended  September 30,** | ** ** | **As of and For the  Year Ended  December 31,** | ** ** |
|----------------------------------------------|------------|--------------------------------------------------------------|------------|------------------------------------------------------|------------|
| **(Dollars in thousands)**                   | ** ** | **2005**                                                     | ** ** | **2004**                                             | ** ** |
|                                         |       |                                                         |       |                                                 |       |
| End of period impaired loans                 |       | $                                                            | 6,454      |                                                 | $          | 5,240 |   |
| Amount of allowance for loan  loss allocated |       | 1,388                                                        |       | 928                                                  |       |
|                                              |            |                                                              |            |                                                      |            |  |  |

 

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

 
| ** **                                    | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|-----------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| **(Dollars in thousands)**                    | ** ** | **2005**               | ** ** | **2004**              | ** ** |
|                                          |       |                   |       |                  |       |
| Restructured                                  |       | $                      | 3,142      |                  | $          | 3,218 |   |
| Loans past due over 90 days  still on accrual | ** ** | **—**             |       | —                |       |
| Non  accrual loans                            |       | 3,312                  |       | 2,022                 |       |
| Total                                         |       | $                      | 6,454      |                  | $          | 5,240 |   |

 

**4.****                                     ****EARNINGS PER SHARE**

 

Thereconciliation of the numerators and denominators of the basic and diluted EPSis as follows:

 
| **(Dollars in thousands,**                     | ** ** | **Three  Months Ended  September 30,** | ** ** | **Nine  Months Ended  September 30,** | ** ** |
|------------------------------------------------|------------|---------------------------------------------|------------|--------------------------------------------|------------|
| **except per share data)**                     | ** ** | **2005**                                    | ** ** | **2004**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                           |       |                                        |       |                                       |       |   |   |   |   |
| Net income available to  common shareholders   |       | $                                           | 2,311      |                                       | $          | 1,714 |   | $ | 6,791 |   | $ | 5,479 |   |
| Basic  EPS:                                    |       |                                        |       |                                       |       |   |   |   |   |
| Weighted average common shares                 |       | 3,989                                       |       | 4,010                                      |       | 4,003 |   | 4,030 |   |
| Diluted  EPS:                                  |       |                                        |       |                                       |       |   |   |   |   |
| Weighted average common shares                 |       | 3,989                                       |       | 4,010                                      |       | 4,003 |   | 4,030 |   |
| Dilutive effect of stock options               |       | 38                                          |       | 17                                         |       | 33 |   | 13 |   |
| Weighted average common and incremental shares |       | 4,027                                       |       | 4,027                                      |       | 4,036 |   | 4,043 |   |
| Earnings  Per Share:                           |       |                                        |       |                                       |       |   |   |   |   |
| Basic                                          |       | $                                           | 0.58       |                                       | $          | 0.43 |   | $ | 1.70 |   | $ | 1.36 |   |
| Diluted                                        |       | $                                           | 0.57       |                                       | $          | 0.43 |   | $ | 1.68 |   | $ | 1.35 |   |

 

All stock options wereincluded in the 2005 and 2004 computations of diluted earnings per share.

 

**Item 2.**

 

## **MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION**

**AND RESULTS OF OPERATIONS**

 

##### **GENERAL**

##### ** **

Weconduct operations in 14 full-service banking centers in six contiguouscounties in Central Kentucky along the Interstate 65 corridor.  Our market presence ranges from the majormetropolitan market of Louisville in Jefferson County, Kentucky approximately40 miles north of our headquarters in Elizabethtown, Kentucky to Hart County,Kentucky, approximately 30 miles south of Elizabethtown.  Our market is supported by a diversifiedindustry base and consists of a regional population of over 1 million.

 

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

 

Through****our personalinvestment financial counseling services, we offer a wide variety of mutualfunds, equity investments, and fixed and variable annuities.

 

We invest in the wholesalecapital markets through the management of our security portfolio and usevarious forms of wholesale funding. The security portfolio contains a varietyof instruments, including callable

 

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debentures, taxable andnon-taxable debentures, fixed and adjustable rate mortgage backed securities,and collateralized mortgage obligations.

 

Our results of operations depend primarily on net interest income,which is the difference between interest income we earn on loans, investmentsecurities and other interest-earning assets and interest expense we pay ondeposits and other interest-bearing liabilities. Our operations are alsoaffected by non-interest income, such as service charges, insurance agencyrevenue, loan fees, gains and losses from the sale of mortgage loans and gainsfrom the sale of real estate held for development. Our principal operatingexpenses, aside from interest expense, consist of compensation and employeebenefits, occupancy costs, data processing expense and provisions for loanlosses.

 

This discussion andanalysis covers material changes in the financial condition since December 31,2004 and material changes in the results of operations for the three andnine-month periods ending, September 30, 2005 as compared to 2004.  It should be read in conjunction with «ManagementDiscussion and Analysis of Financial Condition and Results of Operations»included in the Annual Report on Form 10-K for the period ended December 31,2004.

 

# **Business Risk**

#  

We, like other financialcompanies, are subject to a number of risks, many of which are outside ofmanagement’s control, though we strive to manage those risks while optimizingreturns.  Among the risks assumed are: (a) creditrisk, which is the risk that loan and lease customers or other counter partieswill be unable to perform their contractual obligations, (b) market risk,which is the risk that changes in market rates and prices will adversely affectour financial condition or results of operation, (c) liquidity risk, whichis the risk that we will have insufficient cash or access to cash to meet ouroperating needs, and (d) operational risk, which is the risk of lossresulting from inadequate or failed internal processes, people, and systems, orfrom external events.

 

In addition to the otherinformation included or incorporated by reference into this report, readersshould consider that the following important factors, among others, couldmaterially impact our business, future results of operations, and future cashflows.

 

**(a)****         ****Credit Risk**

 

We extend credit to avariety of customers based on internally set standards and the judgment ofmanagement.  We manage the credit risk bymaintaining a program of underwriting standards that we update periodically,the review of certain credit decisions, and an on-going process of assessmentof the quality of the credit we have already extended.  Despite our credit standards and our on-goingprocess of credit assessment we may incur significant credit losses.

 

Our loans and deposits arefocused in central Kentucky and adverse economic conditions in that state, inparticular, could negatively impact results from operations, cash flows, andfinancial condition.  Adverse economicconditions and other factors, such as political or business development ornatural hazards that may affect Kentucky, may reduce demand for credit or fee-basedproducts and could negatively affect real estate and other collateral values,interest rate levels, and the availability of credit to refinance loans at orprior to maturity.

 

**(b)****         ****Market Risk**

 

Changes in interest ratescould negatively impact our financial condition or results of operations.

 

Our results of operationsdepend substantially on net interest income, the difference between interestearned on interest-earning assets (such as investments and loans) and interestpaid on interest-bearing liabilities (such as deposits and borrowings).  Interest rates are highly sensitive to manyfactors, including governmental monetary policies and domestic andinternational economic and political conditions.  Conditions such as inflation, recession,unemployment, money supply, and other factors beyond our control may alsoaffect interest rates.  If ourinterest-earning assets mature or reprice more quickly than interest-bearingliabilities in a given period, a decrease in market rates could adverselyaffect net interest income.  Likewise, ifinterest-bearing liabilities mature or reprice more quickly thaninterest-earning assets in a given period, an increase in market rates couldadversely affect net interest income.

 

Fixed-rate loans increaseour exposure to interest rate risk in a rising rate environment becauseinterest-bearing liabilities would be subject to repricing before assets becomesubject to repricing.  Adjustable-rateloans decrease the risk associated with changes in interest rates but involveother risks, such as the inability of borrowers to make higher payments in anincreasing interest rate environment.  Atthe same time, for secured loans, the marketability of the

 

12

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underlying collateral maybe adversely affected by higher interests rates.  In a declining interest rate environment,there may be an increase in prepayments on loans as the borrowers refinancetheir loans at lower interest rates. Under these circumstances, our results of operations could be negativelyimpacted.

 

When evaluating short-terminterest rate risk exposure, the primary measurement represents scenarios thatmodel a 200 basis point increasing (decreasing) parallel shift in rates overthe next twelve-month period.  For theperiod ended September 30, 2005, that scenario modeled net interest incometo be approximately 5.8% lower than the internal forecast of net interestincome using the baseline scenario if rates were to decrease 200 basis pointsin a parallel shift and 4.8% higher than the internal forecast of net interestincome using the baseline scenario if rates were to increase 200 basis pointsin a parallel shift.

 

Although fluctuations inmarket interest rates are neither completely predictable nor controllable, ourAsset Liability Committee meets periodically to monitor our interest ratesensitivity position and oversee its financial risk management by establishingpolicies and operating limits.  Forfurther discussion, see the “Asset/Liability Management and Market Risk” section ofManagement’s Discussion and Analysis of Financial Condition and Results ofOperations.

 

**(c)****         ****Liquidity Risk**

 

If we are unable to borrowfunds through access to the capital markets, we may not be able to meet thecash flow requirements of our depositors and borrowers, or meet the operatingcash needs of the Corporation to fund corporate expansion or other activities.

 

Liquidity policies andlimits are established by the board of directors, with operating limits set bythe Asset Liability Committee (“ALCO”), based upon analyses of the ratio ofloans to deposits, the percentage of assets funded with non-core or wholesalefunding.  ALCO regularly monitors theoverall liquidity position of the Bank and holding company to ensure thatvarious alternative strategies exist to cover unanticipated events that couldaffect liquidity.  Liquidity is theability to meet cash flow needs on a timely basis at a reasonable cost.  The liquidity of the Bank is used to makeloans and to repay deposit liabilities as they become due or are demanded bycustomers.  The ALCO establishes boardapproved policies and monitors guidelines to diversify our wholesale fundingsources to avoid concentrations in any one-market source.  Wholesale funding sources include Federalfunds purchased, securities sold under repurchase agreements, non-core brokereddeposits, and medium and long-term debt, which includes Federal Home Loan Bank(FHLB) advances that are collateralized with mortgage-related assets.

 

We maintain a portfolio ofsecurities that can be used as a secondary source of liquidity. There are othersources of liquidity should they be needed. These include the sale or securitization of loans, the ability toacquire additional non-core brokered deposits, additional collateralized borrowingssuch as FHLB advances, the issuance of debt securities, and the issuance ofpreferred or common securities in public or private transactions.

 

If we were unable toaccess any of these funding sources when needed, we might be unable to meet theneeds of our customers, which could adversely impact our financial condition,our results of operations, cash flows, and our level of regulatory-qualifyingcapital.  For further discussion, see the“Liquidity” section of Management’s Discussion and Analysis of FinancialCondition and Results of Operations.

 

**(d)****         ****Operational Risk**

 

We have significantcompetition in both attracting and retaining deposits and in originating loans.

 

Competition is intense inmost of the markets we serve.  We competeon price and service with other banks and financial companies such as savingsand loans, credit unions, finance companies, mortgage banking companies, andbrokerage firms.  Competition couldintensify in the future as a result of industry consolidation, the increasing availabilityof products and services from non-banks, greater technological developments inthe industry, and banking reform.

 

Management maintainsinternal operational controls and we have invested in technology to help usprocess large volumes of transactions. However, there can be no assurance that we will be able to continueprocessing at the same or higher levels of transactions.  If our systems of internal controls should failto work as expected, if our systems were to be used in an unauthorized manner,or if employees were to subvert the system of internal controls, significantlosses could occur.

 

We process large volumesof transactions on a daily basis and are exposed to numerous types of operationrisk.  Operational risk resulting frominadequate or failed internal processes, people, and systems includes the riskof fraud

 

13

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by employees or personsoutside of our company, the execution of unauthorized transactions byemployees, errors relating to transaction processing and systems, and breachesof the internal control system and compliance requirements.  This risk of loss also includes potentiallegal actions that could arise as a result of the operational deficiency or asa result of noncompliance with applicable regulatory standards.

 

We establish and maintainsystems of internal operational controls that provide management with timelyand accurate information about our level of operational risk.  While not foolproof, these systems have beendesigned to manage operational risk at appropriate, cost effective levels.  We have also established procedures that aredesigned to ensure that policies relating to conduct, ethics, and businesspractices are followed.  From time totime, we experience loss from operational risk, including the effects ofoperational errors.

 

While managementcontinually monitors and improves our system of internal controls, dataprocessing systems, and corporate wide processes and procedures, there can beno assurance that we will not suffer such losses in the future.  New, or changes in existing tax, accounting,are regulatory laws, regulations, rules, standards, policies, andinterpretations could significantly impact strategic initiatives, results ofoperations, cash flows, and financial condition.

 

The financial servicesindustry is extensively regulated. Federal and state banking regulations are designed primarily to protectdeposit insurance funds and consumers, not to benefit a financial company’sshareholders.  These regulations maysometimes impose significant limitations on operations.  The significant federal and state bankingregulations that affect us are described in this report under the heading“Regulation”.  These regulations, alongwith currently existing tax, accounting, and monetary laws, regulations, rules,standards, policies and interpretations control the methods by which financialinstitutions conduct business, implement strategic initiatives and taxcompliance, and govern financial reporting and disclosures.  These laws, regulations, rules, standards,policies, and interpretations are constantly evolving and may changesignificantly over time.  Events that maynot have a direct impact on us, such as the bankruptcy of U.S. companies, haveresulted in legislators, regulators, and authoritative bodies, such as theFinancial Accounting Standards Board, the Securities and Exchange Commission,the Public Company Accounting Oversight Board, and other various taxingauthorities responding by adopting and or proposing substantive revisions tolaws, regulations, rules, standards, policies, and interpretations.  The nature, extent, and timing of theadoption of significant new laws and regulations, or changes in or repeal ofexisting laws and regulations may have a material impact on our business andresults of operations.  However, it isimpossible to predict at this time, the extent to which any such adoption,change, or repeal would impact us.

 

##### **OVERVIEW**

 

Our emphasis over the pastseveral years has been focused on the enhancement and expansion of our retailand commercial banking network in our core markets as well as in our MetroLouisville market.  We believe ourinvestment in these initiatives along with our continued commitment to superiorcustomer service will enhance our existing market share and effectively supportour development of the Louisville metropolitan market.

 

The enhancement of ourretail branch network continues to produce positive results.  Total deposits have grown at a 7% compoundannual growth rate over the past four years. Total deposits were $595.6 million at September 30, 2005, anincrease of $60.6 million, or 11% from September 30, 2004.

 

The development of theretail branch network into the Metro Louisville market has also generatedpositive results.  We have a combined$29.0 million in deposits in our two new full-service facilities in the MetroLouisville market.  We opened these newfacilities in the second quarter of 2004 to support our growing customer basein this market.  Twenty-one percent ofour loan portfolio resides in our Metro Louisville market.

 

We also have beensignificantly investing in our branch network in our five county core marketoutside the Metro Louisville market, where we have a combined 21% depositmarket share.  We have renovated severalof our existing branches and have under construction a new full-service bankingcenter in Hardin County opening in early 2006. Our new and enhanced facilities incorporate a state of the art prototypebranch with a retail-focused design, complimenting our commitment to providingsuperior customer service.  While weanticipate these facilities will significantly enhance the value of ourfranchise in the near future, the additional expense in operating these newfacilities will continue to place pressure on earnings for a period oftime.  We are optimistic that ourexpansion strategy will minimize this period and the long-term benefits willoutweigh the initial investment.

 

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Ouremphasis on commercial lending generated a 5% compound annual growth rate inthe total loan portfolio and a 33% compound annual growth rate in commercialloans over the past four years. Commercial loans were $379.6 million at September 30, 2005, anincrease of $32 million from September 30, 2004.

 

Thegrowth in our commercial loan portfolio, coupled with the rising interest rateenvironment, has favorably impacted the level of interest income wegenerate.  Net interest margin increasedto 3.90% for the nine months ended September 30, 2005, compared to 3.73%for the same nine months ended a year ago. This has resulted in an $765,000 increase in net interest income to $7.0million for the third quarter ended September 30, 2005 and a $2.5 millionincrease in net interest income to $20.4 million for the nine months ended September 30,2005, compared to the respective periods in 2004.  The increasing interest rate environmentpositively impacted net interest margin due to the growth in the adjustablerate commercial loans coupled with the decrease in residential fixed rate loansin the loan portfolio.  Net interestmargin has increased in each of the last six quarters and is likely to continueto benefit from continued increases in the prime-lending rate.  However, the increase in the cost of depositswill likely slow the increases in net interest margin over future quarters.

 

Ourasset quality remains favorable.  Netcharge-offs as a percent of total loans was 0.03% for the nine months ended September 30,2005, compared to 0.11% for the same period a year ago.  The allowance for loan losses as a percent oftotal loans, increased to 1.13% at September 30, 2005 compared to 1.07% atDecember 31, 2004.  The percentageof non-performing loans to total loans was 1.03% at September 30, 2005,compared to 0.87% at December 31, 2004.

 

Provision for loan lossexpense decreased $384,000 to $440,000 for the quarter ended September 30,2005, compared to $824,000 for the quarter ended September 30, 2004.  For the nine months ended September 30,2005, provision for loan loss expense decreased $717,000 to $756,000, comparedto $1.5 million for the same nine months ended a year ago.  The decrease in the provision was related tothe softer expansion in the commercial loan portfolio for the year, as comparedto a year ago, as well as a decrease in net charge offs of $494,000 to $156,000for the nine months ended September 30, 2005 compared to the prior year.

 

Non-interestincome decreased $61,000 to $2.1 million for the quarter ended September 30,2005.  For the nine months ended,non-interest income decreased $96,000 to $6.1 million. Non-interest expenseincreased $186,000, to $5.2 million for the quarter ended September 30,2005, and $1.2 million to $15.6 million for the nine months ended September 30,2005, compared to the same periods a year ago. The primary contributing factors to this increase were the additionaloperating and employee compensation expenses related to the recent expansionefforts.  Twenty-four retail staffpositions were added for the expansion into the Louisville metropolitan market,coupled with expanded facilities in Hardin County and Bullitt County,Kentucky.  Additional increases in staffhave taken place during 2004 and 2005 to continue the transformation towards astronger retail sales culture and to provide expanded products and services toour retail and commercial customers. Non-interest expense levels are often measured using an efficiency ratio(non-interest expense divided by the sum of net interest income and non-interestincome).  Our efficiency ratio was 59%for the nine months ended September 30, 2005 and 60% for the nine monthsended September 30, 2004, indicating an operationally efficient financialinstitution.

 

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

###### ** **

Our accounting and reporting policies comply withaccounting principles generally accepted in the United States of America andconform to general practices within 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 –**We maintain anallowance sufficient to absorb probable incurred credit losses existing in theloan portfolio, and our Executive Loan Committee evaluates the adequacy of theallowance for loan losses on a quarterly basis.  We estimate the allowancerequired 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. While we estimate the allowance for loan losses, in part, based on historicallosses within each loan category, estimates for losses within the commercialreal estate portfolio depend more on 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 ofspecific and general components.  Thespecific component relates to loans that are individually classified asimpaired or loans otherwise classified as substandard or doubtful.  The general component covers non-classifiedloans and is based on historical loss experience adjusted for current factors.The methodology

 

15

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for allocating theallowance for loan and lease losses takes into account our strategic plan toincrease our emphasis on commercial and consumer lending. We increase theamount of the allowance allocated to commercial loans and consumer loans inresponse to the growth of the commercial and consumer loan portfolios andmanagement’s recognition of the higher risks and loan losses in these lendingareas. Allowance estimates are developed in consultation with regulatoryauthorities and actual loss experience adjusted for current economicconditions.  Allowance estimates areconsidered a prudent measurement of the risk in the loan portfolio and areapplied to individual loans based on loan type.

 

Based on our calculation, an allowance of $7.1million or 1.13% of total loans was reserved for probable incurred losseswithin the loan portfolio as of September 30, 2005.** **This estimate resulted in aprovision for loan losses on the income statement of $756,000 for the 2005nine-month period.** **If themix and amount of future charge off percentages differ significantly from thoseassumptions used by management in making its determination, the allowance forloan losses and provision for loan losses on the income statement could bematerially and adversely affected.

 

##### **RESULTSOF OPERATIONS**

##### ** **

Net income for the quarterended September 30, 2005 was $2.3 million or $0.57 per share dilutedcompared to $1.7 million or $0.43 per share diluted for the same period in2004.  Net income for the nine-monthperiod ended September 30, 2005 was $6.8 million or $1.68 per sharediluted compared to $5.5 million or $1.35 per share diluted for the same perioda year ago.  The increase in dilutedearnings per share for the three and nine-month periods were primarily theresult of an increase in net interest income of $765,000 and $2.5 million and adecrease in provision for loan loss expense of $384,000 and $717,000 for the2005 respective periods compared to 2004.** **Our book value per common shareincreased from $14.54 at September 30, 2004 to $15.89 at September 30,2005.  Annualized net income for 2005generated a return on average assets of 1.21% and a return on average equity of14.60%.  These compare with a return onaverage assets of 1.06% and a return on average equity of 12.76% for the 2004period also annualized.

 

***Net Interest Income***-On an annualized basis, the net interestmargin as a percent of average earning assets increased 11 basis points to3.95% for the quarter ended September 30, 2005 and 17 basis points to3.90% for the nine months ended September 30, 2005 compared to 3.84% and3.73% for the respective three-month and nine-month periods ended September 30,2004. ** **Theincreasing interest rate environment in conjunction with an increase in averageearning assets positively impacted net interest margin for the periodspresented.  Average interest earningassets increased $58.9 million for the three months ended September 30,2005 and $59.2 million for the nine months ended September 30, 2005 whencompared to the same three and nine months ended in 2004. ** **Theyield on earning assets averaged 6.57% and 6.37% for the respective three-monthand nine-month 2005 periods compared to an average yield on earning assets of6.06% and 6.02% for the same periods in 2004.The prime-lending rate increased275 basis points since the Federal Open Market Committee began increasingshort-term interest rates in June 2004. ** **Management expects its yield onloans to improve with additional increases in the prime-lending rate.

 

Ourcost of funds averaged 2.86% and 2.68% for the respective three-month andnine-month 2005 periods compared to an average cost of funds of 2.40% and 2.46%for the same periods in 2004. ** **Deposit costs have accelerated dueto the re-pricing of certificate of deposit maturities rolling off at lowerrates into current higher interest rates in addition to our higher rates paidon our money market products.  Goingforward, our cost of funds is expected to increase as the general market depositrates have become increasingly competitive with the recent upward trend ininterest rates.

 

Net interest margin hasincreased in each of the last seven quarters resulting from increases in shortterm interest rates.  However, theincreases in net interest margin will slow and net interest margin will beginto decrease slightly in future quarters when the Federal Open Market Committeestops increasing the short term interest rates and our longer datedcertificates of deposit continue to mature and re-price at higher interestrates.

 

16

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**AVERAGE BALANCE SHEETS**

 

The following tables setforth information relating to the Bank’s average balance sheet and reflect theaverage yield on assets and average cost of liabilities for the periodsindicated.  Dividing income or expense bythe average monthly balance of assets or liabilities, respectively, derivessuch yields and costs for the periods presented.

 
| ** **                                              | ** ** | **Quarter  Ended September 30,** | ** ** |
|---------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                              | ** ** | **2005**                              | ** ** | **2004** | ** ** |
| ** **                                              | ** ** | **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                              |       | $                                     | 48,361     |   | $ | 335 |   | 2.75 | % | $ | 28,267 |   | $ | 167 |   | 2.35 | % |
| Mortgage-backed securities                              |       | 16,583                                |       | 173 |   | 4.14 |   | 9,540 |   | 95 |   | 3.96 |   |
| Equity securities                                       |       | 1,906                                 |       | 17 |   | 3.54 |   | 3,611 |   | 37 |   | 4.08 |   |
| State and political subdivision securities **(1)** |       | 4,341                                 |       | 66 |   | 6.03 |   | 1,047 |   | 17 |   | 6.46 |   |
| Corporate bonds                                         |       | 4,026                                 |       | 56 |   | 5.52 |   | 2,000 |   | 16 |   | 3.18 |   |
| Loans receivable **(2) (3) (4)**              |       | 614,116                               |       | 10,839 |   | 7.00 |   | 588,078 |   | 9,374 |   | 6.34 |   |
| FHLB stock                                              |       | 7,006                                 |       | 86 |   | 4.87 |   | 6,703 |   | 72 |   | 4.27 |   |
| Interest bearing deposits                               |       | 5,202                                 |       | 43 |   | 3.28 |   | 3,428 |   | 12 |   | 1.39 |   |
| **Total interest earning  assets**                      |       | 701,541                               |       | 11,615 |   | 6.57 |   | 642,674 |   | 9,790 |   | 6.06 |   |
| Less: Allowance for loan losses                         |       | (6,878                                | )          |   |   |   |   | (5,837 | ) |   |   |   |   |
| Non-interest earning assets                             |       | 57,643                                |       |   |   |   |   | 55,934 |   |   |   |   |   |
| **Total assets**                                        |       | $                                     | 752,306    |   |   |   |   |   | $ | 692,771 |   |   |   |   |   |
|                                                    |       |                                  |       |   |   |   |   |   |   |   |   |   |   |
| **LIABILITIES AND STOCKHOLDERS’  EQUITY**          |       |                                  |       |   |   |   |   |   |   |   |   |   |   |
| Interest bearing liabilities:                           |       |                                  |       |   |   |   |   |   |   |   |   |   |   |
| Savings accounts                                        |       | $                                     | 101,846    |   | $ | 539 |   | 2.10 | % | $ | 79,755 |   | $ | 167 |   | 0.83 | % |
| NOW and money market accounts                           |       | 142,615                               |       | 536 |   | 1.49 |   | 136,987 |   | 300 |   | 0.87 |   |
| Certificates of deposit and other time deposits         |       | 307,933                               |       | 2,407 |   | 3.10 |   | 284,961 |   | 2,022 |   | 2.82 |   |
| Federal funds purchased                                 |       | 1,461                                 |       | 12 |   | 3.26 |   | 5,607 |   | 22 |   | 1.56 |   |
| FHLB advances                                           |       | 78,428                                |       | 956 |   | 4.84 |   | 78,937 |   | 943 |   | 4.75 |   |
| Trust preferred securities                              |       | 10,000                                |       | 184 |   | 7.30 |   | 10,000 |   | 136 |   | 5.41 |   |
| **Total interest bearing  liabilities**                 |       | 642,283                               |       | 4,634 |   | 2.86 |   | 596,247 |   | 3,590 |   | 2.40 |   |
| Non-interest bearing  liabilities:                      |       |                                  |       |   |   |   |   |   |   |   |   |   |   |
| Non-interest bearing deposits                           |       | 42,944                                |       |   |   |   |   | 35,310 |   |   |   |   |   |
| Other liabilities                                       |       | 3,997                                 |       |   |   |   |   | 2,994 |   |   |   |   |   |
| **Total liabilities**                                   |       | 689,224                               |       |   |   |   |   | 634,551 |   |   |   |   |   |
|                                                    |       |                                  |       |   |   |   |   |   |   |   |   |   |   |
| Stockholders’ equity                               |       | 63,082                                |       |   |   |   |   | 58,220 |   |   |   |   |   |
| **Total liabilities and stockholders’ equity**     |       | $                                     | 752,306    |   |   |   |   |   | $ | 692,771 |   |   |   |   |   |
|                                                    |       |                                  |       |   |   |   |   |   |   |   |   |   |   |
| **Net interest income**                                 |       |                                  |       | $ | 6,981 |   |   |   |   |   | $ | 6,200 |   |   |   |
| **Net interest spread**                                 |       |                                  |       |   |   | 3.71 | % |   |   |   |   | 3.66 | % |
| **Net interest margin**                                 |       |                                  |       |   |   | 3.95 | % |   |   |   |   | 3.84 | % |

 

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**(1)** Taxable equivalent yields are calculatedassuming a 34% federal income tax rate.

**(2) **Includes loan fees, immaterial in amount, inboth interest income and the calculation of yield on loans.

**(3)** Calculations include non-accruing loans in theaverage loan amounts outstanding.

**(4)** Includes loans held for sale.

**(5)** Annualized

 

17

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| ** **                                              | ** ** | **Nine  Months Ended September 30,** | ** ** |
|---------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                              | ** ** | **2005**                                  | ** ** | **2004** | ** ** |
| ** **                                              | ** ** | **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                              |       | $                                         | 51,831     |   | $ | 1,050 |   | 2.71 | % | $ | 24,119 |   | $ | 505 |   | 2.80 | % |
| Mortgage-backed securities                              |       | 11,222                                    |       | 337 |   | 4.01 |   | 9,459 |   | 265 |   | 3.74 |   |
| Equity securities                                       |       | 2,108                                     |       | 75 |   | 4.76 |   | 3,176 |   | 101 |   | 4.25 |   |
| State and political subdivision securities **(1)** |       | 2,096                                     |       | 97 |   | 6.19 |   | 1,063 |   | 50 |   | 6.28 |   |
| Corporate bonds                                         |       | 3,374                                     |       | 130 |   | 5.15 |   | 2,000 |   | 46 |   | 3.07 |   |
| **Loans receivable****(2) (3) (4)**           |       | 606,838                                   |       | 31,065 |   | 6.84 |   | 575,371 |   | 27,502 |   | 6.38 |   |
| FHLB stock                                              |       | 6,925                                     |       | 246 |   | 4.75 |   | 6,637 |   | 203 |   | 4.09 |   |
| Interest bearing deposits                               |       | 14,178                                    |       | 282 |   | 2.66 |   | 17,550 |   | 120 |   | 0.91 |   |
| **Total interest earning  assets**                      |       | 698,572                                   |       | 33,282 |   | 6.37 |   | 639,375 |   | 28,792 |   | 6.02 |   |
| Less: Allowance for loan losses                         |       | (6,695                                    | )          |   |   |   |   | (5,714 | ) |   |   |   |   |
| Non-interest earning assets                             |       | 57,484                                    |       |   |   |   |   | 55,292 |   |   |   |   |   |
| **Total assets**                                        |       | $                                         | 749,361    |   |   |   |   |   | $ | 688,953 |   |   |   |   |   |
|                                                    |       |                                      |       |   |   |   |   |   |   |   |   |   |   |
| **LIABILITIES AND STOCKHOLDERS’  EQUITY**          |       |                                      |       |   |   |   |   |   |   |   |   |   |   |
| Interest bearing liabilities:                           |       |                                      |       |   |   |   |   |   |   |   |   |   |   |
| Savings accounts                                        |       | $                                         | 89,326     |   | $ | 1,111 |   | 1.66 | % | $ | 86,371 |   | $ | 594 |   | 0.92 | % |
| NOW and money market accounts                           |       | 149,734                                   |       | 1,546 |   | 1.38 |   | 128,743 |   | 681 |   | 0.71 |   |
| Certificates of deposit and other time deposits         |       | 314,359                                   |       | 6,862 |   | 2.92 |   | 288,909 |   | 6,466 |   | 2.99 |   |
| Federal funds purchased                                 |       | 487                                       |       | 12 |   | 3.29 |   | 2,564 |   | 23 |   | 1.20 |   |
| FHLB advances                                           |       | 78,666                                    |       | 2,851 |   | 4.85 |   | 78,418 |   | 2,792 |   | 4.76 |   |
| Trust preferred securities                              |       | 10,000                                    |       | 517 |   | 6.91 |   | 10,000 |   | 385 |   | 5.14 |   |
| **Total interest bearing  liabilities**                 |       | 642,572                                   |       | 12,899 |   | 2.68 |   | 595,005 |   | 10,941 |   | 2.46 |   |
| Non-interest bearing  liabilities:                      |       |                                      |       |   |   |   |   |   |   |   |   |   |   |
| Non-interest bearing deposits                           |       | 41,059                                    |       |   |   |   |   | 33,670 |   |   |   |   |   |
| Other liabilities                                       |       | 3,721                                     |       |   |   |   |   | 3,041 |   |   |   |   |   |
| **Total liabilities**                                   |       | 687,352                                   |       |   |   |   |   | 631,716 |   |   |   |   |   |
|                                                    |       |                                      |       |   |   |   |   |   |   |   |   |   |   |
| Stockholders’ equity                               |       | 62,009                                    |       |   |   |   |   | 57,237 |   |   |   |   |   |
| **Total liabilities and stockholders’ equity**     |       | $                                         | 749,361    |   |   |   |   |   | $ | 688,953 |   |   |   |   |   |
|                                                    |       |                                      |       |   |   |   |   |   |   |   |   |   |   |
| **Net interest income**                                 |       |                                      |       | $ | 20,383 |   |   |   |   |   | $ | 17,851 |   |   |   |
| **Net interest spread**                                 |       |                                      |       |   |   | 3.69 | % |   |   |   |   | 3.56 | % |
| **Net interest margin**                                 |       |                                      |       |   |   | 3.90 | % |   |   |   |   | 3.73 | % |

 

----

**(1) **Taxable equivalent yields are calculated assuming a 34% federal income taxrate.

**(2) **Includes loan fees, immaterial in amount, in both interest income and thecalculation of yield on loans.

**(3) **Calculations include non-accruing loans in the average loan amountsoutstanding.

**(4) **Includes loans held for sale.

**(5) **Annualized

 

18

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Thetable below sets forth certain information regarding changes in interest incomeand interest expense of the Bank for the periods indicated.  For each category of interest-earning assetsand interest-bearing liabilities, information is provided on changesattributable to (1) changes in rate (changes in rate multiplied by oldvolume); (2) changes in volume (change in volume multiplied by old rate);and (3) changes in rate-volume (change in rate multiplied by change involume).  Changes in rate-volume areproportionately allocated between rate and volume variance.

 

**RATE/VOLUME ANALYSIS**

 
| ** **                                      | ** ** | **Three Months Ended  September 30,  2005 vs. 2004  Increase (decrease)  Due to change in** | ** ** | **Nine Months Ended  September 30,  2005 vs. 2004  Increase (decrease)  Due to change in** | ** ** |
|-------------------------------------------------|------------|--------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------|------------|
| ** **                                      | ** ** | ** **                                                                                       | ** ** | ** **                                                                                      | ** ** | **Net** | ** ** | ** ** | ** ** | ** ** | ** ** | **Net** | ** ** |
| **(Dollars in thousands)**                      | ** ** | **Rate**                                                                                         | ** ** | **Volume**                                                                                      | ** ** | **Change** | ** ** | **Rate** | ** ** | **Volume** | ** ** | **Change** | ** ** |
| **Interest income:**                            |       |                                                                                             |       |                                                                                            |       |   |   |   |   |   |   |   |   |
| U.S. Treasury and agencies                      |       | $                                                                                                | 33         |                                                                                            | $          | 135 |   | $ | 168 |   | $ | (17 | ) | $ | 562 |   | $ | 545 |   |
| Mortgage-backed securities                      |       | 5                                                                                                |       | 73                                                                                              |       | 78 |   | 20 |   | 52 |   | 72 |   |
| Equity securities                               |       | (4                                                                                               | )          | (16                                                                                             | )          | (20 | ) | 11 |   | (37 | ) | (26 | ) |
| State and political subdivision  securities     |       | (1                                                                                               | )          | 50                                                                                              |       | 49 |   | (1 | ) | 48 |   | 47 |   |
| Corporate bonds                                 |       | 40                                                                                               |       | —                                                                                          |       | 40 |   | 84 |   | — |   | 84 |   |
| Loans                                           |       | 1,037                                                                                            |       | 428                                                                                             |       | 1,465 |   | 2,013 |   | 1,550 |   | 3,563 |   |
| FHLB stock                                      |       | 11                                                                                               |       | 3                                                                                               |       | 14 |   | 34 |   | 9 |   | 43 |   |
| Interest bearing deposits                       |       | 22                                                                                               |       | 9                                                                                               |       | 31 |   | 189 |   | (27 | ) | 162 |   |
|                                            |       |                                                                                             |       |                                                                                            |       |   |   |   |   |   |   |   |   |
| **Total interest earning  assets**              |       | 1,143                                                                                            |       | 682                                                                                             |       | 1,825 |   | 2,333 |   | 2,157 |   | 4,490 |   |
|                                            |       |                                                                                             |       |                                                                                            |       |   |   |   |   |   |   |   |   |
| **Interest expense:**                           |       |                                                                                             |       |                                                                                            |       |   |   |   |   |   |   |   |   |
| Savings accounts                                |       | 316                                                                                              |       | 56                                                                                              |       | 372 |   | 496 |   | 21 |   | 517 |   |
| NOW and money market accounts                   |       | 223                                                                                              |       | 13                                                                                              |       | 236 |   | 739 |   | 126 |   | 865 |   |
| Certificates of deposit and other time deposits |       | 216                                                                                              |       | 169                                                                                             |       | 385 |   | (163 | ) | 559 |   | 396 |   |
| Federal funds purchased                         |       | (10                                                                                              | )          | —                                                                                          |       | (10 | ) | (11 | ) | — |   | (11 | ) |
| FHLB advances                                   |       | 18                                                                                               |       | (5                                                                                              | )          | 13 |   | 50 |   | 9 |   | 59 |   |
| Trust Preferred Securities                      |       | 48                                                                                               |       | —                                                                                          |       | 48 |   | 132 |   | — |   | 132 |   |
|                                            |       |                                                                                             |       |                                                                                            |       |   |   |   |   |   |   |   |   |
| **Total interest bearing  liabilities**         |       | 811                                                                                              |       | 233                                                                                             |       | 1,044 |   | 1,243 |   | 715 |   | 1,958 |   |
|                                            |       |                                                                                             |       |                                                                                            |       |   |   |   |   |   |   |   |   |
| **Net change in net interest income**           |       | $                                                                                                | 332        |                                                                                            | $          | 449 |   | $ | 781 |   | $ | 1,090 |   | $ | 1,442 |   | $ | 2,532 |   |

 

***Non-Interest Income***-Non-interest income decreased $61,000 forthe quarter ended September 30, 2005 to $2.1 million.  For the nine months ended, non-interestincome decreased $96,000 to $6.1 million. The decreased level of non-interest income during the 2005 quarter wasprimarily related to lower recorded gains on the sale of real estate held fordevelopment. Offsetting this decrease was an increase in customer service feeson deposit accounts and the gain on sale of mortgage loans. For the 2005 ninemonth period the decreased level of non-interest income was also related tolower recorded gains on the sale of real estate held for development anddecreased gains on the sale of mortgage loans offset by an increase in customerservice fees on deposit accounts and gain on sale of investments

 

Werecorded $176,000 in gains on the sale of lots and investments during the thirdquarter of 2004, resulting in a decrease in non-interest income for the thirdquarter of 2005.  The nine months ended September 30,2005, includes $524,000 in gains on the sale of lots and investmentsecurities.  This compares to $552,000 ingains on the sale of lots, land and investment securities for the nine monthsended September 30, 2004.

 

***Non-Interest Expense -*** Non-interest expense increased $186,000 or4% during the quarter ended September 30, 2005 and 1.2 million, or 8% forthe nine months ended September 30, 2005 compared to the same periods in2004.

 

Theprimary factors impacting non-interest expense include additional operating andemployee compensation expenses relating to the recent retail expansionefforts.  Employee compensation andbenefits, the largest component of non-interest expense, increased $158,000 and$737,000 for the respective three and nine-month periods.  Twenty-four retail staff positions were addedfor the expansion into the Louisville market, coupled with expanded facilitiesin Hardin County and Bullitt County, Kentucky. Additional increases in staff have taken

 

19

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placeduring 2004 and 2005 as we strengthen our retail sales culture and provideexpanded products and services to our retail and commercial customers.

 

We anticipate the increased level on non-interest expense to continueduring 2005 with continued retail expansion and market share protectionefforts.  We started construction on anew full service-banking center in Elizabethtown, KY during the third quarterwith plans of opening in early 2006.  Weare also considering other possible locations within the core market area toprotect and grow our 21% market share.

 

Despite the increase in non-interest expense for 2005, our efficiencyratio was 59% for the nine months ended September 30, 2005 compared to 60%for the 2004 period.

 

**ANALYSIS OF FINANCIAL CONDITION**

 

Total assets at September 30,2005 increased to $759.3 million compared to $737.6 million at December 31,2004, an increase of $21.6 million.  Theincrease was primarily driven by an increase in investment securities of $13.9million and an increase in net loans receivable of $19.8 million.  The growth in investment securities and loanswas principally funded with cash and cash equivalents, which decreased by $14.6million, deposits, which increased by $9.2 million, and federal fundspurchased, which increased by $9.0 million.

 

##### **LoansReceivable**

##### ** **

Netloans receivable increased $19.8 million to $619.3 million at September 30,2005 compared to $599.4 million at December 31, 2004.  Our commercial, commercial real estate, andreal estate construction portfolios increased $33.9 million to $379.6 millionat September 30, 2005.  For the 2005period, these loans comprised 61% of the total loan portfolio compared to 57%at December 31, 2004, and 56% at September 30, 2004.

 

Offsettingthis growth was a $13.8 million, or 8.6% decrease in the residential mortgageloan portfolio to $145.8 million at September 30, 2005, compared to $159.6million at December 31, 2004.  For2005, the decline in mortgage loans is expected to slow from the decreasesexperienced in 2003 and early 2004.

 

**Allowance and Provision for Loan Losses**

 

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

 

The Executive Loan Committee evaluates the allowance for loan lossesquarterly to maintain a level sufficient to absorb probable incurred creditlosses existing in the loan portfolio. Periodic provisions to the allowance are made as needed.  The allowance is determined based on theapplication of loss estimates to graded loans by categories.  The amount of the provision for loan lossesnecessary to maintain an adequate allowance is also based upon an analysis ofsuch factors as changes in lending policies and procedures; underwritingstandards; collection; charge-off and recovery history; changes in national andlocal economic business conditions and developments; changes in thecharacteristics of the portfolio; ability and depth of lending management andstaff; changes in the trend of the volume and severity of past due, non-accrualand classified loans; troubled debt restructuring and other loan modifications;and results of regulatory examinations.

 

The methodology forallocating the allowance for loan and lease losses takes into account ourstrategic plan to increase our emphasis on commercial and consumerlending.  We increase the amount of theallowance allocated to commercial loans and consumer loans in response to thegrowth of the commercial and consumer loan portfolios and management’srecognition of the higher risks and loan losses in these lending areas.  The indirect consumer loan program iscomprised of new and used automobile, motorcycle and all terrain vehicle loansoriginated on our behalf by a select group of auto dealers within our servicearea.   The indirect loan programinvolves a greater degree of risk and is evaluated quarterly and monitored bythe Board of Directors.  In light of thegreater charge-offs from indirect consumer loans compared to direct consumerloans, proportionally more of the allowance for consumer loans is allocated forindirect loans than direct loans.  As theindirect loan program has evolved, dealer analysis and underwriting standardshave been refined to improve the loan loss experience of the program.  Estimating the allowance is a continuousprocess.  In this regard, the ExecutiveLoan Committee continues to monitor the performance of indirect consumer loansas well as our other loan products and updates estimates as the evidencewarrants.

 

The following table sets forthan analysis of the Bank’s loan loss experience for the periods indicated.

 

20

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| ** **                                                                | ** ** | **Three  Months Ended  September 30,** | ** ** | **Nine  Months Ended  September 30,** | ** ** |
|---------------------------------------------------------------------------|------------|---------------------------------------------|------------|--------------------------------------------|------------|
| **(Dollars in thousands)**                                                | ** ** | **2005**                                    | ** ** | **2004**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                                      |       |                                        |       |                                       |       |   |   |   |   |
| **Balance at beginning of  period**                                       |       | $                                           | 6,714      |                                       | $          | 5,822 |   | $ | 6,489 |   | $ | 5,568 |   |
| Loans  charged-off:                                                       |       |                                        |       |                                       |       |   |   |   |   |
| Real estate mortgage                                                      |       | 10                                          |       | —                                     |       | 14 |   | 41 |   |
| Consumer                                                                  |       | 131                                         |       | 154                                        |       | 373 |   | 562 |   |
| Commercial                                                                |       | —                                      |       | 164                                        |       | — |   | 206 |   |
| Total  charge-offs                                                        |       | 141                                         |       | 318                                        |       | 387 |   | 809 |   |
| Recoveries:                                                               |       |                                        |       |                                       |       |   |   |   |   |
| Real estate mortgage                                                      |       | 3                                           |       | —                                     |       | 4 |   | — |   |
| Consumer                                                                  |       | 73                                          |       | 63                                         |       | 227 |   | 159 |   |
| Commercial                                                                |       | —                                      |       | —                                     |       | — |   | — |   |
| Total  recoveries                                                         |       | 76                                          |       | 63                                         |       | 231 |   | 159 |   |
|                                                                      |       |                                        |       |                                       |       |   |   |   |   |
| **Net  loans charged-off**                                                |       | 65                                          |       | 255                                        |       | 156 |   | 650 |   |
|                                                                      |       |                                        |       |                                       |       |   |   |   |   |
| Provision  for loan losses                                                |       | 440                                         |       | 824                                        |       | 756 |   | 1,473 |   |
|                                                                      |       |                                        |       |                                       |       |   |   |   |   |
| **Balance at end of period**                                              |       | $                                           | 7,089      |                                       | $          | 6,391 |   | $ | 7,089 |   | $ | 6,391 |   |
|                                                                      |       |                                        |       |                                       |       |   |   |   |   |
| Allowance for loan losses to total loans  (excluding loans held for sale) |       |                                        |       |                                       |       | 1.13 | % | 1.07 | % |
| Net charge-offs to average loans  outstanding                             |       |                                        |       |                                       |       | 0.03 | % | 0.11 | % |
| Allowance for loan losses to  total non-performing loans                  |       |                                        |       |                                       |       | 110 | % | 138 | % |

 

The provision for loan losses decreased $384,000, or 47% to $440,000for the quarter ended September 30, 2005, and $717,000, or 49% to $756,000for the nine months ended September 30, 2005 compared to the same periodsin 2004.  The decrease in the provisionwas related to slower loan growth in the commercial loan portfolio for 2005compared to a year ago, as well as, a decrease in net charge-offs for the sameperiods. The total allowance for loan losses increased $698,000 to $7.1 millionfrom September 30, 2004 to September 30, 2005. ** **Theincrease in the allowance was related to a $20.2 million increase in net loansreceivable at September 30, 2005, compared to September 30, 2004, inconjunction with a $2.2 million increase in classified loans for the 2005period compared to the 2004 period. ** **Net loan charge-offs decreased$190,000 and $494,000 during the quarter and nine-month periods ended September 30,2005, compared to the 2004 respective periods.** **The decrease in charge-offs isprimarily related to a decrease in charge-offs of commercial and indirectconsumer loans during the periods.

 

Federal regulationsrequire insured institutions to classify their own assets on a regularbasis.  The regulations provide for threecategories of classified loans — substandard, doubtful and loss.  Assets classified as substandard or doubtfulrequire the institution to establish general allowances for loan losses. If anasset or portion thereof is classified as loss, the insured institution musteither establish specified allowances for loan losses in the amount of 100% ofthe portion of the asset classified loss, or charge off such amount.  At September 30, 2005, on the basis ofmanagement’s review of the loan portfolio, we had****$8.7 million of assets classified substandard, $942,000classified as doubtful, and $54,000 of assets classified as loss.** **At September 30,2004, on the basis of management’s review of the loan portfolio, we had $6.3million assets classified substandard, $1.0 million classified as doubtful, and$102,000 of assets classified as loss.

 

Loansare classified according to estimated loss as follows:  Substandard-2.5% to 35%; Doubtful-5% to 75%;and Loss-100%;. We additionally provide a reserve estimate for probableincurred losses in non-classified loans ranging from .20% to 6.00%.  Although we may allocate a portion of theallowance to specific loans or loan categories, the entire allowance isavailable for active charge-offs. Allowance estimates are developed in consultation with regulatoryauthorities and actual loss experience adjusted for current economicconditions.

 

21

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Allowanceestimates are considered a prudent measurement of the risk in the loanportfolio and are applied to individual loans based on loan type.

 

##### **Non-PerformingAssets**

 

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

 

Loans are reviewed on aregular basis and normal collection procedures are implemented when a borrowerfails to make a required payment on a loan. If the delinquency on a mortgage loan exceeds 90 days and is not curedthrough normal collection procedures or an acceptable arrangement is not workedout with the borrower, we institute measures to remedy the default, includingcommencing a foreclosure action. Consumer loans generally are charged off when a loan is deemeduncollectible by management and any available collateral has been disposedof.  Commercial business and real estateloan delinquencies are handled on an individual basis by management with theadvice of legal counsel.

 

     Interestincome on loans is recognized on the accrual basis except for those loans in anon-accrual of income status. The accrual of interest on impaired loans isdiscontinued when management believes, after consideration of economic andbusiness conditions and collection efforts that the borrowers’ financialcondition is such that collection of interest is doubtful, typically after theloan becomes 90 days delinquent.  Wheninterest accrual is discontinued, existing accrued interest is reversed andinterest income is subsequently recognized only to the extent cash payments arereceived.

 

Real estate acquired as a result of foreclosure or by deed in lieu offoreclosure is classified as real estate owned until such time as it is sold.New and used automobile, motorcycle and all terrain vehicles acquired as a resultof foreclosure are classified as repossessed assets until they are sold. Whensuch property is acquired it is recorded at the lower of the unpaid principalbalance of the related loan or its fair market value.  Any write-down of the property at the time ofacquisition is charged to the allowance for loan losses.  Subsequent gains and losses are included innon-interest income and non-interest expense.

 

Thefollowing table sets forth information with respect to non-performing assetsfor the periods indicated.

 
| ** **                                                           | ** **                                  | **September 30,** | ** ** | **December 31,** | ** ** |
|----------------------------------------------------------------------|---------------------------------------------|------------------------|------------|-----------------------|------------|
| **(Dollar in thousands)**                                            | ** **                                  | **2005**               | ** ** | **2004**              | ** ** |
| ** **                                                           | ** **                                  | ** **             | ** ** | ** **            | ** ** |
| Restructured                                                         |                                        | $                      | 3,142      |                  | $          | 3,218 |   |
| Past due 90 days still on  accrual                                   |                                        | —                 |       | —                |       |
| Loans  on non-accrual status                                         |                                        | 3,312                  |       | 2,022                 |       |
|                                                                 |                                        |                   |       |                  |       |
| Total non-performing loans                                           |                                        | 6,454                  |       | 5,240                 |       |
| Real estate acquired through  foreclosure                            |                                        | 893                    |       | 681                   |       |
| Other  repossessed assets                                            |                                        | 83                     |       | 40                    |       |
| Total non-performing assets                                          |                                        | $                      | 7,430      |                  | $          | 5,961 |   |
|                                                                 |                                        |                   |       |                  |       |
| Interest income that would  have been earned on non-performing loans |                                        | $                      | 441        |                  | $          | 336 |   |
| Interest income recognized  on non-performing loans                  |                                        | 216                    |       | 197                   |       |
| Ratios:                                                              | Non-performing loans to  total loans        |                   |       |                  |       |   |
|                                                                 |   (excluding loans held  for sale)     |                   | 1.03       | %                     | 0.87       | % |
|                                                                 | Non-performing assets to  total loans       |                   |       |                  |       |   |
|                                                                 |   (excluding loans held for sale) |                   | 1.19       | %                     | 0.99       | % |

 

Included in non-performing assets for the 2005 period is $3.1 millionin restructured commercial and residential mortgage loans.** **Therestructured loans primarily consist of three credit relationships aggregating$2.9 million, including a $2.2 million commercial relationship, a $212,000commercial relationship****and a$454,000 residential

 

22

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mortgage relationship.****  The terms of these loans have beenrenegotiated to reduce the rate of interest and extend the term thus reducingthe amount of cash flow required from the borrower to service the loans.  The terms of the restructured loans arecurrently being met.

 

Non-accrual loansincreased $1.3 million from December 31, 2004.  Included in this increase was a $1.5 millioncommercial real estate relationship, which became non-accrual in September 2005.  The relationship is collateralized at a valueof $1.9 million and management does not anticipate a loss resulting from thecredit.

 

**InvestmentSecurities**

 

Intereston securities provides us our largest source of interest income after intereston loans, constituting 5.7% of the total interest income for the nine-monthsended September 30, 2005.  Thesecurities portfolio serves as a source of liquidity and earnings and contributesto the management of interest rate risk. We have the authority to invest in various types of liquid assets,including short-term United States Treasury obligations and securities ofvarious federal agencies, obligations of states and political subdivisions,corporate bonds, certificates of deposit at insured savings and loans andbanks, bankers’ acceptances, and federal funds. We may also invest a portion of our assets in certain commercial paperand corporate debt securities.  We arealso authorized to invest in mutual funds and stocks whose assets conform tothe investments that we are authorized to make directly. The available-for-saleand held-to-maturity investment portfolios increased by $13.9 million or 24%during the 2005 period due to investments in U.S. agencies, mortgage-backedsecurities, state and municipal obligations and a corporate bond.

 

###### **Deposits**

###### ** **

We rely primarily on customer service and long-standing relationshipswith customers to attract and retain deposits. Market interest rates and rateson deposit products offered by competing financial institutions cansignificantly affect our ability to attract and retain deposits. Theenhancement of our retail branch network continues to produce positive results.  Total deposits have grown at a 7% compoundannual growth rate over the past four years. During the period ended September 30, 2005, total depositsincreased by $9.2 million compared to December 31, 2004. The increase inretail deposits was primarily in non-interest bearing demand accounts andsavings accounts.  A new money marketpromotion generated $42.5 million for the 2005 period.  However, we also experienced a shifting ofcertain deposits from a money market account to a savings account during theperiod, which reduced the balance in money market accounts. We plan to continueour deposit gathering initiatives by utilizing pricing strategies and offeringcompetitive products in our existing markets.

 

The following table breaksdown our deposits.

 
| ** **               | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|--------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **               | ** ** | **2005**               | ** ** | **2004**              | ** ** |
| ** **               | ** ** | **(In  Thousands)**    | ** ** |
|                     |       |                   |       |                  |       |
| Non-interest  bearing    |       | $                      | 41,770     |                  | $          | 38,441 |   |
| NOW  demand              |       | 76,123                 |       | 73,801                |       |
| Savings                  |       | 93,642                 |       | 78,499                |       |
| Money  market            |       | 72,254                 |       | 85,418                |       |
| Certificates  of deposit |       | 311,776                |       | 310,227               |       |
|                     |       | $                      | 595,565    |                  | $          | 586,386 |   |

 

##### **LIQUIDITY**

 

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

 

23

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Funds are available from a number of sources, including the sale of securities in the available-for-sale portion of the investment portfolio, principal paydowns on loans and mortgage-backed securities, proceeds realized from loans held for sale, brokered deposits and other wholesale funding. ** **At September 30, 2005, we had brokered deposits totaling $492,000.  We also have secured federal funds borrowing lines from two of our correspondent banks totaling $10 million and $15 million respectively.** **Our banking centers also provide access to retail deposit markets.** **If large certificate depositors shift to our competitors or the stock market in response to interest rate changes, we have the ability to replenish those deposits through alternative funding sources.** **Traditionally, we have also utilized borrowings from the FHLB to supplement our funding requirements.  At September 30, 2005, we had an unused approved line of credit in the amount of $102.4 million****and sufficient collateral available to borrow, approximately, an additional****$41****million in advances from the FHLB.** **We believe our sources of liquidity are adequate to meet expected cash needs for the foreseeable future.

 

At the holding company level, the Corporation uses cash to pay dividends to stockholders, repurchase common stock, make selected investments and acquisitions, and service debt. The main sources of funding for the holding company include dividends and returns of investment from the Bank, a revolving credit agreement with an unaffiliated bank, and access to the capital markets.

 

##### **CAPITAL**

##### ** **

Stockholders’ equity increased $3.6 million for the period ended September 30,2005 compared to December 31, 2004.** **The increase in capital wasprimarily attributable to net income during the period.** **Thisincrease was offset by cash dividends declared, the purchase of 22,000 sharesof our own common stock in the second quarter of 2005, and a decrease inaccumulated other comprehensive income, a result of temporary unrealized lossesrecorded on securities.** **Average stockholders’ equity toaverage assets ratio declined to 8.27% for the nine-months ended September 30,2005 compared to 8.31% for 2004.

 

In March 2002, a trust formed by First Financial ServiceCorporation completed the private placement of 10,000 shares of cumulativetrust preferred securities with a liquidation preference of $1,000 persecurity.  The proceeds of the offeringwere loaned to us in exchange for floating rate junior subordinated deferrableinterest debentures.  Distributions onthe securities are payable quarterly at a rate per annum equal to the 3-monthLIBOR plus 3.60%.  We undertook theissuance of these securities to enhance our regulatory capital position, as thesecurities are considered as Tier I capital under current regulatoryguidelines.

 

###### **Kentucky banking laws limit the amount of dividends thatmay be paid to First Financial Service Corporation by First Federal SavingsBank without prior approval of the Kentucky Office of FinancialInstitutions.  Under these laws, theamount of dividends that may be paid in any calendar year is limited to currentyear’s net income, as defined in the laws, combined with the retained netincome of the preceding two years, less any dividends declared during thoseperiods.**  At September 30, 2005, without prior regulatory approval, we hadapproximately $9.0 million of retained earnings that could be utilized for paymentof dividends if authorized by our board of directors.

###### ** **

Each of the federal bankregulatory agencies has established minimum leverage capital requirements forbanking organizations. Banking organizations must maintain a minimum ratio ofTier 1 capital to adjusted average quarterly assets equal to 3% to 5% subjectto federal bank regulatory evaluation of an organization’s overall safety andsoundness.  We intend to maintain acapital position that meets or exceeds the “well capitalized” requirements asdefined 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 September 30,2005.

 

24

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| ** **                                          | ** ** | **Actual** | ** ** | **For  Capital  Adequacy Purposes** | ** ** | **To Be Considered  Well Capitalized  Under Prompt  Correction  Action Provisions** | ** ** |
|-----------------------------------------------------|------------|------------|------------|-------------------------------------|------------|-------------------------------------------------------------------------------------|------------|
| **(Dollars in thousands)**                          | ** ** | **Amount** | ** ** | **Ratio**                           | ** ** | **Amount**                                                                          | ** ** | **Ratio** | ** ** | **Amount** | ** ** | **Ratio** | ** ** |
| **As  of September 30, 2005:**                 | ** ** | ** ** | ** ** | ** **                          | ** ** | ** **                                                                          | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Total risk-based capital (to risk- weighted assets) |       |       |       |                                |       |                                                                                |       |   |   |   |   |   |   |
| Consolidated                                        |       | $          | 72,063     |                                | 11.6       | %                                                                                   | $          | 49,688 |   | 8.0 | % | $ | 62,109 |   | 10.0 | % |
| Bank                                                |       | 69,442     |       | 11.2                                |       | 49,486                                                                              |       | 8.0 |   | 61,858 |   | 10.0 |   |
| Tier I capital (to risk-weighted assets)            | ** ** | ** ** | ** ** | ** **                          | ** ** | ** **                                                                          | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Consolidated                                        |       | 64,867     |       | 10.4                                |       | 24,844                                                                              |       | 4.0 |   | 37,266 |   | 6.0 |   |
| Bank                                                |       | 62,246     |       | 10.1                                |       | 24,743                                                                              |       | 4.0 |   | 37,115 |   | 6.0 |   |
| Tier I capital (to average assets)                  | ** ** | ** ** | ** ** | ** **                          | ** ** | ** **                                                                          | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Consolidated                                        |       | 64,867     |       | 8.7                                 |       | 29,757                                                                              |       | 4.0 |   | 37,196 |   | 5.0 |   |
| Bank                                                |       | 62,246     |       | 8.4                                 |       | 29,711                                                                              |       | 4.0 |   | 37,138 |   | 5.0 |   |
|                                                |       |       |       |                                |       |                                                                                |       |   |   |   |   |   |   |
| ** **                                          | ** ** | **Actual** | ** ** | **For  Capital  Adequacy Purposes** | ** ** | **To Be Considered  Well Capitalized  Under Prompt  Correction  Action Provisions** | ** ** |
| **(Dollars in thousands)**                          | ** ** | **Amount** | ** ** | **Ratio**                           | ** ** | **Amount**                                                                          | ** ** | **Ratio** | ** ** | **Amount** | ** ** | **Ratio** | ** ** |
| **As  of December 31, 2004:**                  | ** ** | ** ** | ** ** | ** **                          | ** ** | ** **                                                                          | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Total risk-based capital (to risk- weighted assets) |       |       |       |                                |       |                                                                                |       |   |   |   |   |   |   |
| Consolidated                                        |       | $          | 67,798     |                                | 11.6       | %                                                                                   | $          | 46,793 |   | 8.0 | % | $ | 58,492 |   | 10.0 | % |
| Bank                                                |       | 65,087     |       | 11.2                                |       | 46,600                                                                              |       | 8.0 |   | 58,250 |   | 10.0 |   |
| Tier I capital (to risk-weighted assets)            |       |       |       |                                |       |                                                                                |       |   |   |   |   |   |   |
| Consolidated                                        |       | 61,029     |       | 10.4                                |       | 23,397                                                                              |       | 4.0 |   | 35,095 |   | 6.0 |   |
| Bank                                                |       | 58,318     |       | 10.0                                |       | 23,300                                                                              |       | 4.0 |   | 34,950 |   | 6.0 |   |
| Tier I capital (to average assets)                  |       |       |       |                                |       |                                                                                |       |   |   |   |   |   |   |
| Consolidated                                        |       | 61,029     |       | 8.5                                 |       | 28,860                                                                              |       | 4.0 |   | 36,075 |   | 5.0 |   |
| Bank                                                |       | 58,318     |       | 8.1                                 |       | 28,762                                                                              |       | 4.0 |   | 35,953 |   | 5.0 |   |

 

### **FORWARD-LOOKINGSTATEMENTS**

### ** **

Statementscontained in this report that are not statements of historical fact constituteforward-looking statements within the meaning of Section 21E of theSecurities Exchange Act of 1934, as amended.  In addition, the Corporation may makeforward-looking statements in future filings with the Securities and ExchangeCommission, in press releases, and in oral and written statements made by orwith the approval of the Corporation. Forward-looking statements include, but are not limited to: (1) projectionsof revenues, income or loss, earnings or loss per share, capital structure andother financial items; (2) statements of plans and objectives of theCorporation or its management or Board of Directors; (3) 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,” and similar expressions are intendedto identify forward-looking statements, but are not the exclusive means ofidentifying such statements.

 

Forward-looking statementsinvolve risks and uncertainties that may cause actual results to differmaterially from those indicated by the forward-looking statements.  See “Business Risks” above for an analysis ofsome of these risks and uncertainties. Some of the events or circumstances that could cause such differencesinclude the following: changes in general economic conditions and economicconditions in Kentucky and the markets served by the Corporation any of whichmay affect, among other things, the level of non-performing assets,charge-offs, and provision expense; changes in the interest rate environmentwhich may reduce interest margins and impact funding sources; changes in marketrates and prices which may adversely impact the value of financial productsincluding securities, loans and deposit; changes in tax laws, rules andregulations; various monetary and fiscal policies and regulations, includingthose determined by the Federal Reserve Board, the Federal Deposit InsuranceCorporation and the Kentucky Office of Financial Institutions; competition withother local and regional commercial banks, savings banks, credit unions andother non-bank financial institutions; ability to

 

25

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grow core businesses;ability to develop and introduce new banking-related products, services andenhancements and gain market acceptance of such products; and management’sability to manage these and other risks.

 

###### **Item3.  QUANTITATIVE AND QUALITATIVEDISCLOSURES ABOUT MARKET RISK**

###### ** **

###### **Asset/Liability Management and Market Risk**

###### ** **

To minimize the volatility of net interest income and exposure toeconomic loss that may result from fluctuating interest rates, we manage ourexposure to adverse changes in interest rates through asset and liabilitymanagement activities within guidelines established by our Asset LiabilityCommittee.  The ALCO, which includes seniormanagement representatives, has the responsibility for approving and ensuringcompliance with asset/liability management polices.  Interest rate risk is the exposure to adversechanges in the net interest income as a result of market fluctuations in interestrates.  The ALCO, on an ongoing basis,monitors interest rate and liquidity risk in order to implement appropriatefunding and balance sheet strategies. Management considers interest rate risk to be our most significantmarket risk.

 

We utilize an earningssimulation model to analyze net interest income sensitivity.  Potential changes in market interest ratesand their subsequent effects on net interest income are then evaluated.  The model projects the effect of parallelmovements in interest rates of both 100 and 200 basis points.  Assumptions based on the historical behaviorof our deposit rates and balances in relation to changes in interest rates arealso incorporated into the model.  Theseassumptions are inherently uncertain and, as a result, the model cannotprecisely measure future net interest income or precisely predict the impact offluctuations in market interest rates on net interest income.  Actual results will differ from the model’ssimulated results due to timing, magnitude and frequency of interest ratechanges as well as changes in market conditions and the application and timingof various management strategies.

 

Our interest sensitivityprofile was asset sensitive at both September 30, 2005 and December 31,2004.  Given a sustained 100 basis pointdecrease in rates, our base net interest income would decrease by an estimated2.48% at September 30, 2005 compared to a decrease of 2.38% at December 31,2004.  Given a 100 basis point increasein interest rates our base net interest income would increase by an estimated2.28% at September 30, 2005 compared to an increase of 2.19% at December 31,2004.

 

Our interest sensitivityat any point in time will be affected by a number of factors.  These factors include the mix of interestsensitive assets and liabilities as well as their relative pricingschedules.  It is also influenced bymarket interest rates, deposit growth, loan growth, decay rates and prepaymentspeed assumptions.

 

As demonstrated by the September 30,2005 and December 31, 2004 sensitivity tables presented below, we arecontinuing to transition away from a liability sensitive to an asset sensitiveposition as compared to prior periods in anticipation of rising interest ratesfor the next several months. The change in our asset sensitivity is a result ofchanges in the loan portfolio to a greater extent than changes in theinvestment portfolio.  While lendingpractices have shifted to shorter term, variable rate commercial and consumer loans,that impact will be evidenced in smaller degrees over time.

 

Our sensitivity tointerest rate changes is presented based on data as of September 30, 2005and December 31, 2004 annualized to a one year period.

 

26

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| ** **                      | ** ** | **September 30,  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                           |       | $                            | 45,152     |   | $ | 46,595 |   | $ | 47,822 |   | $ | 48,981 |   | $ | 50,180 |   |
| Investments                     |       | 3,246                        |       | 3,551 |   | 3,805 |   | 3,995 |   | 4,209 |   |
| **Total  interest income**      |       | 48,398                       |       | 50,146 |   | 51,627 |   | 52,976 |   | 54,389 |   |
|                            |       |                         |       |   |   |   |   |   |   |   |   |
| **Projected  interest expense** |       |                         |       |   |   |   |   |   |   |   |   |
| Deposits                        |       | 12,114                       |       | 12,676 |   | 13,237 |   | 13,742 |   | 14,247 |   |
| Borrowed funds                  |       | 4,677                        |       | 4,764 |   | 4,852 |   | 4,932 |   | 5,012 |   |
| **Total  interest expense**     |       | 16,791                       |       | 17,440 |   | 18,089 |   | 18,674 |   | 19,259 |   |
|                            |       |                         |       |   |   |   |   |   |   |   |   |
| **Net  interest income**        |       | $                            | 31,607     |   | $ | 32,706 |   | $ | 33,538 |   | $ | 34,302 |   | $ | 35,130 |   |
| Change  from base               |       | $                            | (1,931     | ) | $ | (832 | ) |   |   | $ | 764 |   | $ | 1,592 |   |
| %  Change from base             |       | (5.76                        | )%         | (2.48 | )% |   |   | 2.28 | % | 4.75 |   |
|                            |       |                         |       |   |   |   |   |   |   |   |   |
| ** **                      | ** ** | **December 31,  2004**  | ** ** |
| ** **                      | ** ** | **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                           |       | $                            | 38,503     |   | $ | 39,834 |   | $ | 40,943 |   | $ | 41,960 |   | $ | 42,995 |   |
| Investments                     |       | 1,963                        |       | 2,332 |   | 2,517 |   | 2,667 |   | 2,820 |   |
| **Total  interest income**      |       | 40,466                       |       | 42,166 |   | 43,460 |   | 44,627 |   | 45,815 |   |
|                            |       |                         |       |   |   |   |   |   |   |   |   |
| **Projected  interest expense** |       |                         |       |   |   |   |   |   |   |   |   |
| Deposits                        |       | 10,215                       |       | 10,805 |   | 11,395 |   | 11,914 |   | 12,433 |   |
| Borrowed funds                  |       | 4,262                        |       | 4,307 |   | 4,352 |   | 4,393 |   | 4,434 |   |
| **Total  interest expense**     |       | 14,477                       |       | 15,112 |   | 15,747 |   | 16,307 |   | 16,867 |   |
|                            |       |                         |       |   |   |   |   |   |   |   |   |
| **Net  interest income**        |       | $                            | 25,989     |   | $ | 27,054 |   | $ | 27,713 |   | $ | 28,320 |   | $ | 28,948 |   |
| Change  from base               |       | $                            | (1,724     | ) | $ | (659 | ) |   |   | $ | 607 |   | $ | 1,235 |   |
| %  Change from base             |       | (6.22                        | )%         | (2.38 | )% |   |   | 2.19 | % | 4.46 | % |

 

###### **Item4.  CONTROLS AND PROCEDURES**

 

*Evaluation of disclosure controlsand procedures*

 

Our management evaluated, with the participation ofour Chief Executive Officer and our Chief Financial Officer, 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, our ChiefExecutive Officer and our Chief Financial Officer have concluded that ourdisclosure controls and procedures are 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 in internal control overfinancial 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.

 

27

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##### **Part II - OTHER INFORMATION**

 
| **Item 1.** | **Legal Proceedings**                                                                                                                                                                                                               |
|-------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|        |                                                                                                                                                                                                                                |
|        | Although, from time to time, we are involved in various legal  proceedings in the normal course of business, there are no material pending  legal proceedings to which we are a party, or to which any of our property is  subject. |
|        |                                                                                                                                                                                                                                |
| **Item 2.** | **Changes in Securities and Use of Proceeds**                                                                                                                                                                                       |
|        |                                                                                                                                                                                                                                |
|        | (c) Issuer Purchases of Equity Securities                                                                                                                                                                                           |
|        |                                                                                                                                                                                                                                |
|        | The Corporation repurchased no shares of its  common stock during the quarter ended September 30, 2005.                                                                                                                        |
|        |                                                                                                                                                                                                                                |
| **Item 3.** | **Defaults Upon Senior Securities**                                                                                                                                                                                                 |
|        |                                                                                                                                                                                                                                |
|        | Not  Applicable                                                                                                                                                                                                                     |
|        |                                                                                                                                                                                                                                |
| **Item 4.** | **Submission of Matters to a Vote of Security Holders**                                                                                                                                                                             |
|        |                                                                                                                                                                                                                                |
|        | Not Applicable                                                                                                                                                                                                                      |
|        |                                                                                                                                                                                                                                |
| **Item 5.** | **Other Information**                                                                                                                                                                                                               |
| ** **  | ** **                                                                                                                                                                                                                          |
|        | None                                                                                                                                                                                                                                |
|        |                                                                                                                                                                                                                                |
| **Item 6.** | **Exhibits:**                                                                                                                                                                                                                       |
|        |                                                                                                                                                                                                                                |
|        | 31.1                                                                                                                                                                                                                                | Certification of Chief Executive Officer Pursuant to Section 302  of Sarbanes- Oxley Act |
|        |                                                                                                                                                                                                                                |   |
|        | 31.2                                                                                                                                                                                                                                | Certification of Chief Financial Officer Pursuant to Section 302  of Sarbanes- Oxley Act |
|        |                                                                                                                                                                                                                                |   |
|        | 32                                                                                                                                                                                                                                  | Certification of Chief  Executive Officer and Chief Financial Officer Pursuant to Section 18  U.S.C. Section 1350 (As Adopted Pursuant to Section 906 of the  Sarbanes- Oxley Act of 2002) |

 

28

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## **FIRST FINANCIAL SERVICE CORPORATION**

## ** **

## **SIGNATURES**

## ** **

Pursuant to therequirements of Section 13 or 15(d) of the Securities Exchange Act of1934, the registrant has duly caused this report to be signed on its behalf bythe undersigned, thereunto duly authorized.

 
| DATE: November 9, 2005 | BY:    | (S)    | B. Keith Johnson                      |   |
|-----------------------------|--------|--------|---------------------------------------|--------|
|                        |   |   | B. Keith Johnson                      |
|                        |   |   | President and Chief Executive Officer |
|                        |   |
|                        |   |
| DATE: November 9, 2005 | BY:    | (S)    | Gregory S. Schreacke                  |   |
|                        |   |   | Gregory S.  Schreacke                 |
|                        |   |   | Chief Financial Officer               |
|                        |   |   | Principal Accounting Officer          |

 

29

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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) |

 

30

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