FIRST FINANCIAL SERVICE CORP - FORM 10-K/A

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EX-23 - FIRST FINANCIAL SERVICE CORP	v221869_ex23.htm
EX-32 - FIRST FINANCIAL SERVICE CORP	v221869_ex32.htm
EX-31.2 - FIRST FINANCIAL SERVICE CORP	v221869_ex31-2.htm
EX-31.1 - FIRST FINANCIAL SERVICE CORP	v221869_ex31-1.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K/A

Amendment No. 1

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2010

Commission File Number: 0-18832

FIRST FINANCIAL SERVICE CORPORATION

(Exact name of registrant as specified in its charter)

Kentucky		61-1168311
(State or other jurisdiction of incorporation		(I.R.S. Employer
or organization)		Identification No.)

2323 Ring Road, Elizabethtown, Kentucky		42701
(Address of principal executive offices)		Zip Code

Registrant's telephone number, including area code: (270) 765-2131

Securities registered pursuant to Section 12(b) of the Act:

Common Stock, par value $1.00 per share

(Title of Class)

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No x

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past ninety days. Yes x No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “accelerated filer”, “large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large Accelerated Filer ¨ Accelerated Filer ¨ Non-Accelerated Filer x Smaller Reporting Company ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ¨ No ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K/A or any amendment to this Form 10-K/A. ¨

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

The aggregate market value of the outstanding voting stock held by non-affiliates of the registrant based on a June 30, 2010 closing price of $7.24 as quoted on the NASDAQ Global Market was $28,167,770. Solely for purposes of this calculation, the shares held by directors and executive officers of the registrant and by any stockholder beneficially owning more than 5% of the registrant's outstanding common stock are deemed to be shares held by affiliates.

As of March 15, 2011 there were issued and outstanding 4,739,622 shares of the registrant's common stock.

FIRST FINANCIAL SERVICE CORPORATION

Amendment No. 1 to Annual Report on Form 10-K

For the year ended December 31, 2010

TABLE OF CONTENTS

EXPLANATORY NOTE

PART I.

ITEM 1.	Business	1

PART II.

ITEM 6.	Selected Financial Data	13

ITEM 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	13

ITEM 8.	Financial Statements and Supplementary Data	34

ITEM 9A.	Controls and Procedures	76

PART IV.

ITEM 15.	Exhibits and Financial Statement Schedules	76

SIGNATURES		78

EXPLANATORY NOTE

First Financial Service Corporation (the “Corporation”) is filing this Amendment No. 1 to its Form 10-K for the year ended December 31, 2010, originally filed on April 4, 2011, in order to restate previously reported financial results for the quarter and year ended December 31, 2010. On May 9, 2011, after discussions between management, the Risk Management Committee of the Board of Directors, and our independent accountant, we concluded that our financial statements for the quarter and year ended December 31, 2010 needed to be restated. The restatement increases the net loss recorded for the quarter and year ended December 31, 2010 by approximately $1.1million. Our results for the quarter and year ended December 31, 2010 have been adjusted to reflect an additional loss on sale and write downs on real estate acquired through foreclosure of $796,817. These adjustments are the result of new information obtained after December 31, 2010 but before the filing date of the Form 10-K about conditions that existed at December 31, 2010. These adjustments were made in accordance with Financial Accounting Standards Board Account Standards Codification (“ASC”) Topic 855, “Subsequent Events”. In addition, management recorded three additional items that prior to the previously mentioned entry were considered immaterial. These were entries to record additional bank franchise tax expense of $249,193, legal expense of $83,000 and additional health insurance of $56,100.

The primary reason for restatement was the receipt of appraisals after December 31, 2010, on three properties held at year end as other real estate owned acquired through foreclosure. The appraisals indicated that the property values of the three properties had decreased since the date of the prior appraisals. In addition, after December 31, 2010, we sold a fourth property held at year end as other real estate owned acquired through foreclosure. The sale provided new information regarding the fair value of this property at December 31, 2010.

In the process of preparing our financial statements for the quarter ended March 31, 2011, we concluded that under ASC Topic 855, the lower property values should more appropriately have been recorded in the quarter and year ended December 31, 2010, rather than the quarter ended March 31, 2011. The following table provides additional information about the values of the affected properties:

	Balance Prior				Balance After		Prior Appraisal	Subsequent
	to Restatement		Write down		Restatement		Date	Information
Property One	$	701,400	$	231,400	$	470,000	January 25,2010	Appraisal
Property Two		322,579		221,779		100,800	July 12, 2010	Appraisal
Property Three		2,445,747		255,547		2,190,200	March 30, 2010	Appraisal
Property Four		178,091		88,091		90,000		Sale of Property
Total	$	3,647,817	$	796,817	$	2,851,000

As a result of the changes noted above and as reflected in the restated financial statements and related disclosures included in this Amendment No. 1, we recognized a net loss attributable to common shareholders of $7.9 million, or $1.66 per diluted common share, for the quarter ended December 31, 2010, compared to the previously reported net loss attributable to common shareholders of $6.7 million, or $1.42 per diluted common share. For the year ended December 31, 2010 we recognized a net loss available to common shareholders of $10.5 million, or $2.21 per diluted common share compared to the previously reported net loss attributable to common shareholders of $9.3 million or $1.97 per diluted common share.

As a result of the restatement of the audited consolidated financial statements for the quarter and year ended December 31, 2010, our management and the Risk Management Committee of the Board of Directors reevaluated our internal control over financial reporting and have concluded there is a material weakness in the design of such controls. The weakness mainly relates to the receipt of new appraisals or other valuation information on foreclosed assets after the period ends not being evaluated timely and recorded in the proper period. We have implemented steps to improve the process for timely identification and improved communication in connection with quarter and year-end closing procedures. See Item 9A – Controls and Procedures.

This Amendment No. 1 does not reflect events occurring after the date of the original Form 10-K filing or modify or update any of the other disclosures contained therein in any way other than as required to reflect the matters discussed above and expressly set forth below. Accordingly, you should read this Amendment No. 1 in conjunction with the original Form 10-K filing and the Corporation's other filings with the SEC.

PRELIMINARY NOTE REGARDING

FORWARD-LOOKING STATEMENTS

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

Various risks and uncertainties may cause actual results to differ materially from those indicated by our forward-looking statements. In addition to those risks described under “Item 1A Risk Factors,” of our Annual Report on Form 10-K, the following factors could cause such differences: changes in general economic conditions and economic conditions in Kentucky and the markets we serve, any of which may affect, among other things, our level of non-performing assets, charge-offs, and provision for loan loss expense; changes in interest rates that may reduce interest margins and impact funding sources; changes in market rates and prices which may adversely impact the value of financial products including securities, loans and deposits; changes in tax laws, rules and regulations; various monetary and fiscal policies and regulations, including those determined by the Federal Reserve Board, the Federal Deposit Insurance Corporation (“FDIC”) and the Kentucky Department of Financial Institutions (“KDFI”); competition with other local and regional commercial banks, savings banks, credit unions and other non-bank financial institutions; our ability to grow core businesses; our ability to develop and introduce new banking-related products, services and enhancements and gain market acceptance of such products; and management’s ability to manage these and other risks.

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

PART I

ITEM 1. BUSINESS

General Business Overview

First Financial Service Corporation was incorporated in August 1989 under Kentucky law and became the holding company for First Federal Savings Bank of Elizabethtown (the “Bank’), effective on June 1, 1990. Since that date, we have engaged in no significant activity other than holding the stock of the Bank and directing, planning and coordinating its business activities. Unless the text clearly suggests otherwise, references to "us," "we," or "our" include First Financial Service Corporation and its wholly owned subsidiary, the Bank. Accordingly, the information set forth in this report, including financial statements and related data, relates primarily to the Bank and its subsidiaries. In 2004 we amended our articles of incorporation to change our name from First Federal Financial Corporation of Kentucky to First Financial Service Corporation.

We are headquartered in Elizabethtown, Kentucky and were originally founded in 1923 as a state-chartered institution and became federally chartered in 1940. In 1987, we converted to a federally chartered savings bank and converted from mutual to stock form. We are a member of the Federal Home Loan Bank (“FHLB”) of Cincinnati and, since converting to a state charter in 2003, have been subject to regulation, examination and supervision by the FDIC and the KDFI. Our deposits are insured by the Deposit Insurance Fund and administered by the FDIC.

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

Our full complement of lending services includes:

a broad array of residential mortgage products, both fixed and adjustable rate;

consumer loans, including home equity lines of credit, auto loans, recreational vehicle, and other secured and unsecured loans;

specialized financing programs to support community development;

mortgages for multi-family real estate;

commercial real estate loans;

commercial loans to businesses, including revolving lines of credit and term loans;

real estate development;

construction lending; and

agricultural lending.

We also provide a broad selection of deposit instruments. These include:

multiple checking and NOW accounts for both personal and business accounts;

various savings accounts, including those for minors;

money market accounts;

tax qualified deposit accounts such as Health Savings Accounts and Individual Retirement Accounts; and

a broad array of certificate of deposit products.

We also support our customers by providing services such as:

providing access to merchant bankcard services;

supplying various forms of electronic funds transfer;

providing debit cards and credit cards; and

providing telephone and Internet banking.

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

Our results of operations depend primarily on net interest income, which is the difference between interest income from interest-earning assets and interest expense on interest-bearing liabilities. Our operations are also affected by non-interest income, such as service charges, loan fees, gains and losses from the sale of mortgage loans and revenue earned from bank owned life insurance. Our principal operating expenses, aside from interest expense, consist of compensation and employee benefits, occupancy costs, data processing expense, FDIC insurance premiums and provisions for loan losses.

Recent Developments

In 2009, as part of an informal regulatory agreement with the FDIC, the Bank agreed to maintain a Tier 1 leverage ratio of 8%. At December 31, 2010, we were not in compliance the Tier 1 capital requirement. On January 27, 2011, the Bank entered into a Consent Order, a formal agreement with the FDIC and KDFI. A copy of the Consent Order is set forth as Exhibit 10.1 of the Form 8-K filed with the SEC on January 27, 2011. Under the terms of the Consent Order, the Bank cannot declare dividends without the prior written approval of the FDIC and KDFI. Other material provisions of the Consent Order require the Bank to:

obtain an independent assessment of executive management and senior commercial lending staff;

increase the Bank’s capital ratios;

develop and implement a plan to reduce the level of non-performing assets;

develop and implement a plan to reduce concentrations of credit in commercial real estate loans;

maintain adequate reserves for loan and lease losses;

implement revised credit risk management practices and credit administration policies and procedures;

implement procedures to ensure compliance with applicable laws, rules, regulations and policy statements;

periodically evaluate the Bank’s strategic plan and budget for fiscal 2011;

develop revisions to the Bank’s funding contingency plan, which identifies available sources of liquidity and plans for dealing with potential adverse economic and market conditions; and

prepare and submit progress reports to the FDIC and KDFI.

The Consent Order requires the Bank to achieve certain minimum capital ratios as set forth below:

				Ratio Required			Ratio Required
	Actual as of			by the Order			by the Order
	12/31/2010			at 3/31/2011			at 6/30/2011
	Restated
Total capital to risk-weighted assets		11.38	%		11.50	%		12.00	%
Tier 1 capital to average total assets		7.18	%		8.50	%		9.00	%

The Consent Order will remain in effect until modified or terminated by the FDIC and KDFI.

Market Area

We operate 22 full-service banking centers and a commercial private banking center in eight contiguous counties in central Kentucky along the Interstate 65 corridor and within the Louisville metropolitan area, including southern Indiana. Our markets range from Louisville in Jefferson County, Kentucky approximately 40 miles north of our headquarters in Elizabethtown, Kentucky to Hart County, Kentucky, approximately 30 miles south of Elizabethtown to Harrison County, Indiana approximately 60 miles northwest of our headquarters. Our markets are supported by a diversified industry base and have a regional population of over 1 million. We operate in Hardin, Nelson, Hart, Bullitt, Meade and Jefferson counties in Kentucky and in Harrison and Floyd counties in southern Indiana. We control in the aggregate 23% of the deposit market share in our central Kentucky markets outside of Louisville.

In our markets surrounding the Ft. Knox military base, residential activity remains robust as a result of the increase in 3,200 civilian families relocating to Ft. Knox with the Base Realignment and Closure Act. The Army’s Human Resource Command is being relocated to the Ft. Knox military base, resulting in a substantial economic benefit to this area. Fort Knox is located in Hardin County, where we have a 26% market share. Growth in deposits, coupled with positive signs of economic growth in our home markets, which is fueled by the Ft. Knox base realignment, will provide a sound basis for us as the local economy recovers.

The following table shows our market share and rank in terms of deposits as of June 30, 2010, in each Kentucky and Indiana county where we have offices. We have four offices in Jefferson County, which is Louisville, Kentucky. The Louisville metropolitan area has a population of more than one million.

County	Number of Offices	FFKY Market Share %		FFKY Rank
Meade	3		55.0	1
Hardin	5		26.0	1
Bullitt	3		21.0	3
Hart	1		17.0	3
Harrison	3		13.0	4
Nelson	2		8.0	5
Floyd	1		2.0	10
Jefferson	4		1.0	11

Lending Activities

Commercial Real Estate & Construction Lending. The largest portion of our lending activity is the origination of commercial loans that are primarily secured by real estate, including construction loans. We generate loans primarily in our market area. In recent years, we have put greater emphasis on originating loans for small and medium-sized businesses from our various locations. We make commercial loans to a variety of industries. Substantially all of the commercial real estate loans we originate have adjustable interest rates with maturities of 25 years or less or are loans with fixed interest rates and maturities of five years or less. At December 31, 2010, we had $557.8 million outstanding in commercial real estate loans. The security for commercial real estate loans includes retail businesses, warehouses, churches, apartment buildings and motels. In addition, the payment experience of loans secured by income producing properties typically depends on the success of the related real estate project and thus may be more vulnerable to adverse conditions in the real estate market or in the economy generally.

Loans secured by multi-family residential property, consisting of properties with more than four separate dwelling units, amounted to $32.1 million of the loan portfolio at December 31, 2010. These loans are included in the $557.8 million outstanding in commercial real estate loans discussed above. We generally do not lend above 75% of the appraised values of multi-family residences on first mortgage loans. The mortgage loans we currently offer on multi-family dwellings are generally one or five year

ARMs with maturities of 25 years or less.

Construction loans involve additional risks because loan funds are advanced upon the security of the project under construction, which is of uncertain value before the completion of construction. The uncertainties inherent in estimating construction costs, delays arising from labor problems, material shortages, and other unpredictable contingencies make it relatively difficult to evaluate accurately the total loan funds required to complete a project and related loan-to-value ratios. The analysis of prospective construction loan projects requires significantly different expertise from that required for permanent residential mortgage lending. At December 31, 2010, we had $11.0 million outstanding in construction loans.

Our underwriting criteria are designed to evaluate and minimize the risks of each construction loan. Among other things, we consider evidence of the availability of permanent financing or a takeout commitment to the borrower; the reputation of the borrower and his or her financial condition; the amount of the borrower's equity in the project; independent appraisals and cost estimates; pre-construction sale and leasing information; and cash flow projections of the borrower.

Commercial Business Lending. The commercial business loan portfolio has grown in recent years as a result of our focus on small business lending. We make secured and unsecured loans for commercial, corporate, business, and agricultural purposes, including issuing letters of credit and engaging in inventory financing and commercial leasing activities. Commercial loans generally are made to small-to-medium size businesses located within our defined market area. Commercial loans generally carry a higher yield and are made for a shorter term than real estate loans. Commercial loans, however, involve a higher degree of risk than residential real estate loans due to potentially greater volatility in the value of the assigned collateral, the need for more technical analysis of the borrower’s financial position, the potentially greater impact that changing economic conditions may have on the borrower’s ability to retire debt, and the additional expertise required for commercial lending personnel. Commercial business loans outstanding at December 31, 2010, totaled $42.3 million.

Residential Real Estate. Residential mortgage loans are secured primarily by single-family homes. The majority of our mortgage loan portfolio is secured by real estate in our markets outside of Louisville and our residential mortgage loans do not have sub-prime characteristics. Fixed rate residential real estate loans we originate have terms ranging from ten to thirty years. Interest rates are competitively priced within the primary geographic lending market and vary according to the term for which they are fixed. At December 31, 2010, we had $164.0 million in residential mortgage loans outstanding.

We generally emphasize the origination of adjustable-rate mortgage loans ("ARMs") when possible. We offer seven ARM products with an annual adjustment, which is tied to a national index with a maximum adjustment of 2% annually, and a lifetime maximum adjustment cap of 6%. As of December 31, 2010, approximately 44.3% of our residential real estate loans were adjustable rate loans with adjustment periods ranging from one to seven years and balloon loans of seven years or less. The origination of these ARMs can be more difficult in a low interest rate environment where there is a significant demand for fixed rate mortgages. We limit the maximum loan-to-value ratio on one-to-four-family residential first mortgages to 90% of the appraised value and generally limit the loan-to-value ratio on second mortgages on one-to-four-family dwellings to 90%.

Consumer Lending. Consumer loans include loans on automobiles, boats, recreational vehicles and other consumer goods, as well as loans secured by savings accounts, home improvement loans, and unsecured lines of credit. As of December 31, 2010, consumer loans outstanding were $107.4 million. These loans involve a higher risk of default than loans secured by one-to-four-family residential loans. We believe, however, that the shorter term and the normally higher interest rates available on various types of consumer loans help maintain a profitable spread between the average loan yield and cost of funds. Home equity lines of credit as of December 31, 2010, totaled $58.5 million.

Our underwriting standards reflect the greater risk in consumer lending than in residential real estate lending. Among other things, the capacity of individual borrowers to repay can change rapidly, particularly during an economic downturn, collection costs can be relatively higher for smaller loans, and the value of collateral may be more likely to depreciate. Our Consumer Lending Policy establishes the appropriate consumer lending authority for all loan officers based on experience, training, and past performance for approving high quality loans. Loans beyond the authority of individual officers must be approved by additional officers, the Executive Loan Committee or the Board of Directors, based on the size of the loan. We require detailed financial information and credit bureau reports for each consumer loan applicant to establish the applicant’s credit history, the adequacy of income for debt retirement, and job stability based on the applicant’s employment records. Co-signers are required for applicants who are determined marginal or who fail to qualify individually under these standards. Adequate collateral is required on the majority of consumer loans. The Executive Loan Committee monitors and evaluates unsecured lending activity by each loan officer.

The indirect consumer loan portfolio is comprised of new and used automobile, motorcycle and all terrain vehicle loans originated on our behalf by a select group of auto dealers within the service area. Indirect consumer loans are considered to have greater risk of loan losses than direct consumer loans due to, among other things: borrowers may have no existing relationship with us; borrowers may not be residents of the lending area; less detailed financial statement information may be collected at application; collateral values can be more difficult to determine; and the condition of vehicles securing the loan can deteriorate rapidly. To address the additional risks associated with indirect consumer lending, the Executive Loan Committee continually evaluates data regarding the dealers enrolled in the program, including monitoring turn down and delinquency rates. All applications are approved by specific lending officers, selected based on experience in this field, who obtain credit bureau reports on each application to assist in the decision. Aggressive collection procedures encourage more timely recovery of late payments. At December 31, 2010, total loans under the indirect consumer loan program totaled $29.6 million.

Subsidiary Activities

First Service Corporation of Elizabethtown (“First Service”), our licensed brokerage affiliate, provides investment services to our customers and offers tax-deferred annuities, government securities, mutual funds, and stocks and bonds. First Service employs four full-time employees. The net income of First Service was $95,000 for the year ended December 31, 2010.

First Federal Office Park, LLC, holds commercial lots adjacent to our home office on Ring Road in Elizabethtown, that are available for sale. Currently, one of the original nine lots held for sale remains unsold.

We provide title insurance coverage for mortgage borrowers through two subsidiaries: First Heartland Title, LLC, and First Federal Title Services, LLC. First Heartland Title is a joint venture with a title insurance company in Hardin County and First Federal Title Services is a joint venture with a title insurance company in Louisville. We hold a 48% interest in First Heartland Title and a 49% interest in First Federal Title Services. The subsidiaries generated $171,000 in income for the year ended December 31, 2010, of which our portion was $82,000.

Heritage Properties, LLC, holds real estate acquired through foreclosure which is available for sale. Currently, fifty-two properties valued at $25.8 million are held for sale.

Competition

We face substantial competition both in attracting and retaining deposits and in lending. Direct competition for deposits comes from commercial banks, savings institutions, and credit unions located in north-central Kentucky and southern Indiana, and less directly from money market mutual funds and from sellers of corporate and government debt securities.

The primary competitive factors in lending are interest rates, loan origination fees and the range of services offered by the various financial institutions. Competition for origination of real estate loans normally comes from commercial banks, savings institutions, mortgage bankers, mortgage brokers, and insurance companies. Retail establishments effectively compete for loans by offering credit cards and retail installment contracts for the purchase of goods, merchandise and services (for example, Home Depot, Lowe’s, etc.). We believe that we have been able to compete effectively in our primary market area.

We have offices in nine cities in six central Kentucky counties and offices in four cities in two southern Indiana counties. In addition to the financial institutions with offices in these counties, we compete with several commercial banks and savings institutions in surrounding counties, many of which have assets substantially greater than we have. These competitors attempt to gain market share through their financial product mix, pricing strategies, internet banking and banking center locations. In addition, Kentucky's interstate banking statute, which permits banks in all states to enter the Kentucky market if they have reciprocal interstate banking statutes, has further increased competition for us. We believe that competition from both bank and non-bank entities will continue to remain strong in the near future.

Employees

As of December 31, 2010, we employed 335 employees, of which 315 were full-time and 20 part-time. None of our employees are subject to a collective bargaining agreement, and we believe that we enjoy good relations with our personnel.

Regulation

General Regulatory Matters. The Bank is a Kentucky chartered commercial bank and is subject to supervision and regulation, which involves regular bank examinations, by both the FDIC and the KDFI. Our deposits are insured by the FDIC. Kentucky’s banking statutes contain a “super-parity” provision that permits a well-rated Kentucky bank to engage in any banking activity in which a national bank operating in any state, a state bank, thrift or savings bank operating in any other state, or a federally chartered thrift or federal savings association meeting the qualified thrift lender test and operating in any state could engage, provided the Kentucky bank first obtains a legal opinion specifying the statutory or regulatory provisions that permit the activity.

In connection with our conversion, we registered to become a bank holding company under the Bank Holding Company Act of 1956, and are subject to supervision and regulation by the Federal Reserve Board. As a bank holding company, we are required to file with the Federal Reserve Board annual and quarterly reports and other information regarding our business operations and the business operations of our subsidiaries. We are also subject to examination by the Federal Reserve Board and to its operational guidelines. We are subject to the Bank Holding Company Act and other federal laws and regulations regarding the types of activities in which we may engage, and to other supervisory requirements, including regulatory enforcement actions for violations of laws and regulations.

Regulators have broad enforcement powers over bank holding companies and banks, including, but not limited to, the power to mandate or restrict particular actions, activities, or divestitures, impose monetary fines and other penalties for violations of laws and regulations, issue cease and desist or removal orders, seek injunctions, publicly disclose such actions and prohibit unsafe or unsound practices. This authority includes both informal actions and formal actions to effect corrective actions or sanctions.

Certain regulatory requirements applicable to the Corporation and the Bank are referred to below or elsewhere in this filing. The description of statutory provisions and regulations applicable to banks and their holding companies set forth in this filing does not purport to be a complete description of such statutes and regulations and their effect on the Corporation and is qualified in its entirety by reference to the actual laws and regulations.

We are required by regulation to maintain adequate levels of capital to support our operations. As part of an informal regulatory agreement with the FDIC, the Bank was required to maintain a Tier 1 leverage ratio of 8%. At December 31, 2010, we were not in compliance with the Tier 1 capital requirement. On January 27, 2011, the Bank entered into a Consent Order, a formal agreement with the FDIC and KDFI, under which, among other things, the Bank has agreed to achieve and maintain a Tier 1 leverage ratio of at least 8.5% by March 31, 2011 and 9.0% by June 30, 2011. The Consent Order supersedes the prior informal regulatory agreement.

Acquisitions, Change in Control and Branching. As a bank holding company, we must obtain Federal Reserve Board approval before acquiring, directly or indirectly, ownership or control of more than 5% of the voting stock of a bank, and before engaging in, or acquiring a company that is not a bank but is engaged in certain non-banking activities. In approving these acquisitions, the Federal Reserve Board considers a number of factors, and weighs the expected benefits to the public such as greater convenience, increased competition and gains in efficiency, against the risks of possible adverse effects such as undue concentration of resources, decreased or unfair competition, conflicts of interest or unsound banking practices. The Federal Reserve Board also considers the financial and managerial resources of the bank holding company, its subsidiaries and any company to be acquired, and the effect of the proposed transaction on these resources. It also evaluates compliance by the holding company's financial institution subsidiaries and the target institution with the Community Reinvestment Act. The Community Reinvestment Act generally requires each financial institution to take affirmative steps to ascertain and meet the credit needs of its entire community, including low and moderate income neighborhoods.

Federal law also prohibits a person or group of persons from acquiring “control” of a bank holding company without notifying the Federal Reserve Board in advance and then only if the Federal Reserve Board does not object to the proposed transaction. The Federal Reserve Board has established a rebuttable presumptive standard that the acquisition of 10% or more of the voting stock of a bank holding company, in the absence of a larger shareholder, would constitute an acquisition of control of the bank holding company. In addition, any company is required to obtain the approval of the Federal Reserve Board before acquiring 25% (5% in the case of an acquirer that is a bank holding company) or more of any class of a bank holding company’s voting securities, or otherwise obtaining control or a “controlling influence” over a bank holding company.

Kentucky law generally permits a Kentucky chartered bank to establish a branch office in any county in Kentucky. A Kentucky bank may also, subject to regulatory approval and certain restrictions, establish a branch office outside of Kentucky. Well-capitalized Kentucky banks that have been in operation at least three years and that satisfy certain criteria relating to, among other things, their composite and management ratings, may establish a branch in Kentucky without the approval of the Executive Director of the KDFI, upon notice to the KDFI and any other state bank with its main office located in the county where the new branch will be located. Branching by all other banks requires the approval of the Executive Director of the KDFI, who must ascertain and determine that the public convenience and advantage will be served and promoted and that there is a reasonable probability of the successful operation of the branch. In any case, the transaction must also be approved by the FDIC, which considers a number of factors, including financial history, capital adequacy, earnings prospects, character of management, needs of the community and consistency with corporate powers.

Section 613 of the Dodd-Frank Act effectively eliminated the interstate branching restrictions set forth in the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994. Banks located in any state may now de novo branch in any other state, including Kentucky. Such unlimited branching power will likely increase competition within the markets in which the Corporation and the Bank operate.

Other Financial Activities. The Gramm-Leach-Bliley Act of 1999 permits a bank holding company to elect to become a financial holding company, which permits the holding company to conduct activities that are “financial in nature.” To become and maintain its status as a financial holding company, the bank holding company and all of its affiliated depository institutions must be well-capitalized, well managed, and have at least a satisfactory Community Reinvestment Act rating. We have not filed an election to become a financial holding company and are ineligible to do so due to the Bank’s “troubled institution” designation and entering into the Consent Order.

Subject to certain exceptions, insured state banks are permitted to control or hold an interest in a financial subsidiary that engages in a broader range of activities than are permissible for national banks to engage in directly, subject to any restrictions imposed on a bank under the laws of the state under which it is organized. Conducting financial activities through a bank subsidiary can impact capital adequacy and regulatory restrictions may apply to affiliate transactions between the bank and its financial subsidiaries.

Other Holding Company Regulations. Federal law substantially restricts transactions between financial institutions and their affiliates. As a result, a bank is limited in extending credit to its holding company (or any non-bank subsidiary), in investing in the stock or other securities of the bank holding company or its non-bank subsidiaries, and/or in taking such stock or securities as collateral for loans to any borrower. Moreover, transactions between a bank and a bank holding company (or any non-bank subsidiary) for loans to any borrower ,must generally be on terms and under circumstances at least as favorable to the bank as those prevailing in comparable transactions with independent third parties or, in the absence of comparable transactions, on terms and under circumstances that in good faith would be available to nonaffiliated companies.

Under Federal Reserve Board policy, a bank holding company is expected to act as a source of financial strength to each of its banking subsidiaries and to commit resources for their support. Such support may restrict the Corporation’s ability to pay dividends, and may be required at times when, absent this Federal Reserve Board policy, a holding company may not be inclined to provide it. A bank holding company may also be required to guarantee the capital restoration plan of an undercapitalized banking subsidiary. In addition, any capital loans by the Corporation to the Bank are subordinate in right of payment to deposits and to certain other indebtedness of the Bank. In the event of a bank holding company’s bankruptcy, any commitment by the bank holding company to a federal bank regulatory agency to maintain the capital of subsidiary banks will be assumed by the bankruptcy trustee and entitled to a priority of payment. The Dodd-Frank Act codifies the Federal Reserve Board’s existing “source of strength” policy that holding companies act as a source of strength to their insured institution subsidiaries by providing capital, liquidity and other support in times of distress.

Regulatory Capital Requirements. The Federal Reserve Board and the FDIC have substantially similar risk-based and leverage capital guidelines applicable to the banking organizations they supervise. Under the risk-based capital requirements, we are generally required to maintain a minimum ratio of total capital to risk-weighted assets (including certain off-balance sheet activities, such as standby letters of credit) of 8%. At least half of the total capital (4%) must be composed of common equity, retained earnings and qualifying perpetual preferred stock and certain hybrid capital instruments, less certain intangibles (“Tier 1 capital”). The remainder may consist of certain subordinated debt, certain hybrid capital instruments, qualifying preferred stock and a limited amount of the loan loss allowance (“Tier 2 capital” which, together with Tier 1 capital, composes “total capital”). To be considered well-capitalized under the risk-based capital guidelines, an institution must maintain a total risk-weighted capital ratio of at least 10% and a Tier 1 risk-weighted ratio of 6% or greater.

The Federal Deposit Insurance Corporation Act of 1991 (“FDICIA”), among other things, identifies five capital categories for insured depository institutions: well-capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized. Although the Corporation and the Bank remain above the regulatory capital levels for “well-capitalized” standards, because of the losses we have incurred in recent quarters, our elevated levels of non-performing loans and other real estate, and the ongoing economic stress in Jefferson and Oldham Counties, Kentucky, the FDIC, KDFI and the Bank entered into the Consent Order referred to above under the section “Recent Developments.” The Consent Order resulted in the Bank being categorized as a "troubled institution" by bank regulators, which by definition does not permit the Bank to be considered "well-capitalized" despite its current capital levels. The "troubled institution" designation also prohibits the Bank from accepting, renewing or rolling over brokered deposits and restricts the amount of interest the Bank may pay on deposits. Unless the Bank is granted a waiver because it resides in a market that the FDIC determines is a high rate market, the Bank is limited to paying deposit interest rates within .75% of the average rates computed by the FDIC.

FDICIA also requires the bank regulatory agencies to implement systems for “prompt corrective action” for institutions that fail to meet minimum capital requirements within these five categories, with progressively more severe restrictions on operations, management and capital distributions according to the category in which an institution is placed. Failure to meet capital requirements can also cause an institution to be directed to raise additional capital. FDICIA also mandates that the agencies adopt safety and soundness standards relating generally to operations and management, asset quality and executive compensation, and authorizes administrative action against an institution that fails to meet such standards.

In addition, the Federal Reserve Board and the FDIC have each adopted risk-based capital standards that explicitly identify concentrations of credit risk and the risk arising from non-traditional activities, as well as an institution’s ability to manage these risks, as important factors to be taken into account by each agency in assessing an institution’s overall capital adequacy. The capital guidelines also provide that an institution’s exposure to a decline in the economic value of its capital due to changes in interest rates be considered by the agency as a factor in evaluating a banking organization’s capital adequacy. In addition to the “prompt corrective action” directives, failure to meet capital guidelines can subject a banking organization to a variety of other enforcement remedies, including additional substantial restrictions on its operations and activities, termination of deposit insurance by the FDIC, and under some conditions the appointment of a conservator or receiver.

Dividends. The Corporation is a legal entity separate and distinct from the Bank. The majority of our revenue is from dividends we receive from the Bank. The Bank is subject to laws and regulations that limit the amount of dividends it can pay. If, in the opinion of a federal regulatory agency, an institution under its jurisdiction is engaged in or is about to engage in an unsafe or unsound practice, the agency may require, after notice and a hearing, that the institution cease and desist from such practice. The federal banking agencies have indicated that paying dividends that deplete an institution's capital base to an inadequate level would be an unsafe and unsound banking practice. Under FDICIA, an insured institution may not pay a dividend if payment would cause it to become undercapitalized or if it already is undercapitalized. Moreover, the Federal Reserve Board and the FDIC have issued policy statements providing that bank holding companies and banks should generally pay dividends only out of current operating earnings.

Under Kentucky law, dividends by Kentucky banks may be paid only from current or retained net profits. Before any dividend may be declared for any period (other than with respect to preferred stock), a bank must increase its capital surplus by at least 10% of the net profits of the bank for the period until the bank's capital surplus equals the amount of its stated capital attributable to its common stock. Moreover, the KDFI Commissioner must approve the declaration of dividends if the total dividends to be declared by a bank for any calendar year would exceed the bank's total net profits for such year combined with its retained net profits for the preceding two years, less any required transfers to surplus or a fund for the retirement of preferred stock or debt. We are also subject to the Kentucky Business Corporation Act, which generally prohibits dividends to the extent they result in the insolvency of the corporation from a balance sheet perspective or if becoming unable to pay debts as they come due. According to the terms of the Consent Order referred to above under the section “Recent Developments,” the Bank cannot pay any dividends or distributions without prior regulatory approval.

Consumer Protection Laws. We are subject to a number of federal and state laws designed to protect borrowers and promote lending to various sectors of the economy and population. These laws include the Equal Credit Opportunity Act, the Fair Credit Reporting Act, the Truth in Lending Act, the Home Mortgage Disclosure Act, and the Real Estate Settlement Procedures Act, and state law counterparts.

Home Mortgage Disclosure Act (“HMDA”). The HMDA has grown out of public concern over credit shortages in certain urban neighborhoods. One purpose of HMDA is to provide public information that will help show whether financial institutions are serving the housing credit needs of the neighborhoods and communities in which they are located. HMDA also includes a “fair lending” aspect that requires the collection and disclosure of data about applicant and borrower characteristics, as a way of identifying possible discriminatory lending patterns and enforcing anti-discrimination statutes. The HMDA requires institutions to report data regarding applications for loans for the purchase or improvement of single family and multi-family dwellings, as well as information concerning originations and purchases of such loans. Federal bank regulators rely, in part, upon data provided under HMDA to determine whether depository institutions engage in discriminatory lending practices. The appropriate federal banking agency, or in some cases the Department of Housing and Urban Development, enforces compliance with HMDA and implements its regulations. Administrative sanctions, including civil money penalties, may be imposed by supervisory agencies for violations of the HMDA.

Equal Credit Opportunity Act (“ECOA”). The ECOA prohibits discrimination against an applicant in any credit transaction, whether for consumer or business purposes, on the basis of race, color, religion, national origin, sex, marital status, age (except in limited circumstances), receipt of income from public assistance programs or good faith exercise of any rights under the Consumer Credit Protection Act. Under the Fair Housing Act, it is unlawful for any lender to discriminate in its housing-related lending activities against any person because of race, color, religion, national origin, sex, handicap or familial status. Among other things, these laws prohibit a lender from denying or discouraging credit on a discriminatory basis, making excessively low appraisals of property based on racial considerations, or charging excessive rates or imposing more stringent loan terms or conditions on a discriminatory basis. In addition to private actions by aggrieved borrowers or applicants for actual and punitive damages, the U.S. Department of Justice and other regulatory agencies can take enforcement action seeking injunctive and other equitable relief or sanctions for alleged violations.

Truth in Lending Act (“TILA”). The TILA is designed to ensure that credit terms are disclosed in a meaningful way so that consumers may compare credit terms more readily and knowledgeably. As result of the TILA, all creditors must use the same credit terminology and expressions of rates, and disclose the annual percentage rate, the finance charge, the amount financed, the total of payments and the payment schedule for each proposed loan. Violations of the TILA may result in regulatory sanctions and in the imposition of both civil and, in the case of willful violations, criminal penalties. Under certain circumstances, the TILA also provides a consumer with a right of rescission, which if exercised within three business days would require the creditor to reimburse any amount paid by the consumer to the creditor or to a third party in connection with the loan, including finance charges, application fees, commitment fees, title search fees and appraisal fees. Consumers may also seek actual and punitive damages for violations of the TILA.

Real Estate Settlement Procedures Act (“RESPA”). The RESPA requires lenders to provide borrowers with disclosures regarding the nature and cost of real estate settlements. The RESPA also prohibits certain abusive practices, such as kickbacks, and places limitations on the amount of escrow accounts. Violations of the RESPA may result in imposition of penalties, including: (1) civil liability equal to three times the amount of any charge paid for the settlement services or civil liability of up to $1,000 per claimant, depending on the violation; (2) awards of court costs and attorneys’ fees; and (3) fines of not more than $10,000 or imprisonment for not more than one year, or both.

Fair Credit Reporting Act (“FACT”). The FCRA requires the Bank to adopt and implement a written identity theft prevention program, paying particular attention to several identified “red flag” events. The program must assess the validity of address change requests for card issuers and for users of consumer reports to verify the subject of a consumer report in the event of notice of an address discrepancy. The FCRA gives consumers the ability to challenge banks with respect to credit reporting information provided by the bank. The FCRA also prohibits banks from using certain information it may acquire from an affiliate to solicit the consumer for marketing purposes unless the consumer has been given notice and an opportunity to opt out of such solicitation for a period of five years.

Loans to One Borrower. Under current limits, loans and extensions of credit outstanding at one time to a single borrower and not fully secured generally may not exceed 15% of an institution’s unimpaired capital and unimpaired surplus. Loans and extensions of credit fully secured by certain readily marketable collateral may represent an additional 10% of unimpaired capital and unimpaired surplus.

Federal law currently contains extensive customer privacy protection provisions. Under these provisions, a financial institution must provide to its customers, at the inception of the customer relationship and annually thereafter, the institution’s policies and procedures regarding the handling of customers’ nonpublic personal financial information. These provisions also provide that, except for certain limited exceptions, an institution may not provide such personal information to unaffiliated third parties unless the institution discloses to the customer that such information may be so provided and the customer is given the opportunity to opt out of such disclosure. Federal law makes it a criminal offense, except in limited circumstances, to obtain or attempt to obtain customer information of a financial nature by fraudulent or deceptive means.

The Community Reinvestment Act (“CRA”) requires the FDIC to assess our record in meeting the credit needs of the communities we serve, including low- and moderate-income neighborhoods and persons. The FDIC's assessment of our record is made available to the public. The assessment also is part of the Federal Reserve Board's consideration of applications to acquire, merge or consolidate with another banking institution or its holding company, to establish a new branch office or to relocate an office. The Federal Reserve Board will also assess the CRA record of the subsidiary banks of a bank holding company in its consideration of any application to acquire a bank or other bank holding company, which may be the basis for denying the application.

Bank Secrecy Act. The Bank Secrecy Act of 1970 (“BSA”) was enacted to deter money laundering, establish regulatory reporting standards for currency transactions and improve detection and investigation of criminal, tax and other regulatory violations. BSA and subsequent laws and regulations require us to take steps to prevent the use of the Bank in the flow of illegal or illicit money, including, without limitation, ensuring effective management oversight, establishing sound policies and procedures, developing effective monitoring and reporting capabilities, ensuring adequate training and establishing a comprehensive internal audit of BSA compliance activities.

In recent years, federal regulators have increased the attention paid to compliance with the provisions of BSA and related laws, with particular attention paid to “Know Your Customer” practices. Banks have been encouraged by regulators to enhance their identification procedures prior to accepting new customers in order to deter criminal elements from using the banking system to move and hide illegal and illicit activities.

USA Patriot Act. The USA PATRIOT Act of 2001 (the “Patriot Act”) contains anti-money laundering measures affecting insured depository institutions, broker-dealers and certain other financial institutions. The Patriot Act requires financial institutions to implement policies and procedures to combat money laundering and the financing of terrorism, including standards for verifying customer identification at account opening, and rules to promote cooperation among financial institutions, regulators and law enforcement entities in identifying parties that may be involved in terrorism or money laundering. The Patriot Act also grants the Secretary of the Treasury broad authority to establish regulations and to impose requirements and restrictions on financial institutions’ operations. In addition, the Patriot Act requires the federal bank regulatory agencies to consider the effectiveness of a financial institution’s anti-money laundering activities when reviewing bank mergers and bank holding company acquisitions.

The Corporation and the Bank, like all U.S. companies and individuals, are prohibited from transacting business with certain individuals and entities named on the Office of Foreign Asset Control's ("OFAC") list of Specially Designated Nationals and Blocked Persons. Failure to comply may result in fines and other penalties. The OFAC issued guidance for financial institutions in which it asserted that it may, in its discretion, examine institutions determined to be high risk or to be lacking in their efforts to comply with these prohibitions.

Federal Deposit Insurance Assessments. The deposits of our bank subsidiary are insured up to applicable limits by the Deposit Insurance Fund, or the DIF, of the FDIC and are subject to deposit insurance assessments to maintain the DIF. The FDIC utilizes a risk-based assessment system that imposes insurance premiums based upon a risk matrix that takes into account a bank's capital level and supervisory rating.

Effective January 1, 2007, the FDIC imposed deposit assessment rates based on the risk category of the bank subsidiary. Risk Category I is the lowest risk category while Risk Category IV is the highest risk category. Because of favorable loss experience and a healthy reserve ratio in the Bank Insurance Fund, or the BIF, of the FDIC at that time, well-capitalized and well-managed banks, have in recent years paid minimal premiums for FDIC insurance.

On October 16, 2008, the FDIC published a restoration plan designed to replenish the Deposit Insurance Fund over a period of five years and to increase the deposit insurance reserve ratio, which decreased to 1.01% of insured deposits on June 30, 2008, to the statutory minimum of 1.15% of insured deposits by December 31, 2013. In order to implement the restoration plan, the FDIC proposed to change both its risk-based assessment system and its base assessment rates. For the first quarter of 2009 only, the FDIC increased all FDIC deposit assessment rates by 7 basis points. These new rates range from 12 to 14 basis points for Risk Category I institutions to 50 basis points for Risk Category IV institutions.

Under the FDIC's restoration plan, the FDIC proposed to establish new initial base assessment rates that will be subject to adjustment as described below. Beginning April 1, 2009, the base assessment rates would range from 12 to 16 basis points for Risk Category I institutions to 45 basis points for Risk Category IV institutions.

Changes to the risk-based assessment system include increasing premiums for institutions that rely on excessive amounts of brokered deposits, increasing premiums for excessive use of secured liabilities (including Federal Home Loan Bank advances), lowering premiums for smaller institutions with very high capital levels, and adding financial ratios and debt issuer ratings to the premium calculations for banks with over $10 billion in assets, while providing a reduction for their unsecured debt.

Either an increase in the Risk Category of the Company’s bank subsidiary or adjustments to the base assessment rates could result in a material increase in our expense for federal deposit insurance. Because the Bank entered into the Consent Order and is designated a “troubled institution” it is in a higher risk category and now pays one of the highest deposit assessment rates.

In addition, all institutions with deposits insured by the FDIC are required to pay assessments to fund interest payments on bonds issued by the Financing Corporation (FICO), a mixed-ownership government corporation established to recapitalize a predecessor to the Deposit Insurance Fund. The current annualized assessment rate is 1.14 basis points, or approximately .285 basis points per quarter. These assessments will continue until the Financing Corporation bonds mature in 2019.

The FDIC implemented a five basis point emergency special assessment on insured depository institutions as of June 30, 2009. The special assessment was paid on September 30, 2009. This assessment resulted in a cost of $477,000 and is reflected in our income statement for 2009. The interim rule also authorizes the FDIC to impose an additional emergency assessment of up to 10 basis points in respect to deposits for quarters ended after June 30, 2009 if necessary to maintain public confidence in federal deposit insurance. In addition, during the fourth quarter of 2009, the FDIC approved that all banks prepay three and a quarter years worth of FDIC assessments on December 31, 2009. The prepayment is based on average third quarter deposits. The prepaid amount will be amortized over the prepayment period. Our prepayment was $7.5 million of which $2.7 million was reflected in our 2010 income statement.

On February 7, 2011, the FDIC Board of Directors adopted a final rule (with changes to go into effect beginning with the second quarter 2011), which redefines the deposit insurance assessment base as required by the Dodd-Frank Act; makes changes to assessment rates; implements Dodd-Frank’s DIF dividend provisions; and revises the risk-based assessment system for all large insured depository institutions (“IDIs”), generally, those institutions with at least $10 billion in total assets. Nearly all of the 7,600-plus institutions with assets less than $10 billion will pay smaller assessments as a result of this final rule. The final rule:

•

Redefines the deposit insurance assessment base as average consolidated total assets minus average tangible equity (defined as Tier I Capital);

•

Makes generally conforming changes to the unsecured debt and brokered deposit adjustments to assessment rates;

•

Creates a depository institution debt adjustment;

•

Eliminates the secured liability adjustment; and

•

Adopts a new assessment rate schedule effective April 1, 2011, and, in lieu of dividends, other rate schedules when the reserve ratio reaches certain levels.

The FDIC is authorized to set the reserve ratio for the DIF annually at between 1.15% and 1.50% of estimated insured deposits. The Dodd-Frank Act mandates that the statutory minimum reserve ratio of the DIF increase from 1.15% to 1.35% of insured deposits by September 30, 2020. Banks with assets of less than $10 billion are exempt from any additional assessments necessary to increase the reserve fund above 1.15%.

The FDIC may terminate the deposit insurance of any insured depository institution, including the Bank, if it determines after a hearing that the institution has engaged or is engaging in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, order or any condition imposed by an agreement with the FDIC. It also may suspend deposit insurance temporarily during the hearing process for the permanent termination of insurance, if the institution has no tangible capital. If insurance of accounts is terminated, the accounts at the institution at the time of the termination, less subsequent withdrawals, shall continue to be insured for a period of six months to two years, as determined by the FDIC. Management is aware of no existing circumstances which would result in termination of the Bank's deposit insurance.

Emergency Economic Stabilization Act. In October 2008, the Emergency Economic Stabilization Act of 2008 (“EESA”) was enacted. The EESA authorizes the Treasury Department to purchase from financial institutions and their holding companies up to $700 billion in mortgage loans, mortgage-related securities and certain other financial instruments, including debt and equity securities issued by financial institutions and their holding companies in a troubled asset relief program (“TARP”). The purpose of TARP is to restore confidence and stability to the U.S. banking system and to encourage financial institutions to increase their lending to customers and to each other. The Treasury Department has allocated $250 billion towards the TARP Capital Purchase Program (“CPP”). Under the CPP, Treasury has purchased debt or equity securities from participating institutions, including us.

The TARP also includes direct purchases or guarantees of troubled assets of financial institutions. Participants in the CPP are subject to executive compensation limits and are encouraged to expand their lending and mortgage loan modifications. For details regarding our sale of $20 million of preferred stock to the Treasury Department through the CPP, see “Item7 – Management’s Discussion and Analysis of Financial Condition and Results of Operation – Capital and Note 13 of the Notes to Consolidated Financial Statements.”

EESA also increased FDIC deposit insurance on most accounts from $100,000 to $250,000. This increase is in place until December 31, 2013 and is not covered by deposit insurance premiums paid by the banking industry.

Temporary Liquidity Guarantee Program. The FDIC established a Temporary Liquidity Guarantee Program (“TLGP”) on October 14, 2008. The TLGP includes the Transaction Account Guarantee Program (“TAGP”), which provides unlimited deposit insurance coverage through December 31, 2012 for noninterest-bearing transaction accounts (typically business checking accounts) and certain funds swept into noninterest-bearing savings accounts. Institutions participating in the TAGP pay a 10 basis points fee (annualized) on the balance of each covered account in excess of $250,000, while the extra deposit insurance is in place. The TLGP also includes the Debt Guarantee Program (“DGP”), under which the FDIC guarantees certain senior unsecured debt of FDIC-insured institutions and their holding companies. The unsecured debt must be issued on or after October 14, 2008 and not later than October 31, 2009, and the guarantee is effective through the earlier of the maturity date or June 30, 2012. The DGP coverage limit is generally 125% of the eligible entity’s eligible debt outstanding on September 30, 2008 and scheduled to mature on or before June 30, 2009 or, for certain insured institutions, 2% of their liabilities as of September 30, 2008. Depending on the term of the debt maturity, the nonrefundable DGP fee ranges from 50 to 100 basis points (annualized) for covered debt outstanding until the earlier of maturity or June 30, 2012. The TAGP and DGP are in effect for all eligible entities, unless the entity opted out on or before December 5, 2008. First Financial Service Corporation’s bank subsidiary elected to participate in the TAGP and both the bank subsidiary and the holding company are eligible to participate in DGP.

Certificate of Deposit Account Registry Service. To mitigate the risks associated with carrying balances in excess of federally insured limits, we are participating in the Certificate of Deposit Account Registry Service (“CDARS”). CDARS is a system that allows certificates of deposit that would be in excess of FDIC coverage in a single financial institution to be redistributed to other financial institutions within the CDARS network in increments under the current FDIC coverage limit. Consequently, the full amount of the certificates of deposit becomes eligible for FDIC protection. Even though we have deposits that will remain in the CDARS network, those deposits are considered brokered deposits and the Bank’s “troubled institution” designation prevents us from accepting, renewing or rolling over brokered deposits. Therefore, as long as the Consent Order remains in effect, we will be able to retain only our deposits within the CDARS network that do not come up for renewal or roll over.

American Recovery and Reinvestment Act. On February 17, 2009, the American Recovery and Reinvestment Act of 2009 (“ARRA”) was signed into law by President Obama. ARRA includes a wide variety of programs intended to stimulate the economy and provide for extensive infrastructure, energy, health, and education needs. In addition, ARRA imposes certain new executive compensation and corporate expenditure limits on all current and future CPP recipients, including First Financial Service Corporation, until the institution has repaid the Treasury. ARRA also permits CPP participants to redeem the preferred shares held by the Treasury Department without penalty and without the need to raise new capital, subject to the Treasury’s consultation with the recipient’s appropriate regulatory agency.

Dodd–Frank Act. The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”) was signed into law on July 21, 2010. The Dodd-Frank Act is intended to effect a fundamental restructuring of federal banking regulation. Among other things, the Dodd-Frank Act creates a new Financial Stability Oversight Council to identify systemic risks in the financial system and gives federal regulators new authority to take control of and liquidate financial firms. The Dodd-Frank Act additionally creates a new independent federal regulator to administer federal consumer protection laws.

It is difficult to predict at this time what impact the new legislation and implementing regulations will have on community banks like the Bank, including the lending and credit practices of such banks. Moreover, many of the provisions of the Dodd-Frank Act will not take effect for several months, and the legislation requires various federal agencies to promulgate numerous and extensive implementing regulations over the next several years. Although the substance and scope of these regulations cannot be determined at this time, it is expected that the legislation and implementing regulations, particularly those provisions relating to the new Consumer Financial Protection Bureau will increase our operating and compliance costs and restrict our ability to pay dividends.

The Dodd-Frank Act is expected to have a significant impact on the Corporation's business operations as its provisions take effect. Among the provisions that are likely to affect the Corporation are the following:

Corporate Governance. The Dodd-Frank Act will require publicly traded companies to give stockholders a non-binding vote on executive compensation at their first annual meeting taking place six months after the date of enactment and at least every three years thereafter and on so-called “golden parachute” payments in connection with approvals of mergers and acquisitions. The new legislation also authorizes the SEC to promulgate rules that would allow stockholders to nominate their own candidates using a company’s proxy materials. Additionally, the Dodd-Frank Act directs the federal banking regulators to promulgate rules prohibiting excessive compensation paid to executives of depository institutions and their holding companies with assets in excess of $1 billion, regardless of whether the company is publicly traded or not. The Dodd-Frank Act gives the SEC authority to prohibit broker discretionary voting on elections of directors and executive compensation matters.

Transactions with Affiliates and Insiders. The Dodd-Frank Act will apply Section 23A and Section 22(h) of the Federal Reserve Act (governing transactions with insiders) to derivative transactions, repurchase agreements and securities lending and borrowing transactions that create credit exposure to an affiliate or an insider. Any such transactions with affiliates must be fully secured. The current exemption from Section 23A for transactions with financial subsidiaries will be eliminated. The Dodd-Frank Act will additionally prohibit an insured depository institution from purchasing an asset from or selling an asset to an insider unless the transaction is on market terms and, if representing more than 10% of capital, is approved in advance by the disinterested directors.

Consumer Financial Protection Bureau. The Dodd-Frank Act creates a new, independent federal agency called the Consumer Financial Protection Bureau (“CFPB”), which is granted broad rulemaking, supervisory and enforcement powers under various federal consumer financial protection laws, including the ECOA, TILA, RESPA, FCRA, Fair Debt Collection Act, the Consumer Financial Privacy provisions of the Gramm-Leach Bliley Act ("GLBA") and certain other statutes. The CFPB will have examination and primary enforcement authority with respect to depository institutions with $10 billion or more in assets. Smaller institutions will be subject to rules promulgated by the CFPB, but will continue to be examined and supervised by federal banking regulators for consumer compliance purposes. The CFPB will have authority to prevent unfair, deceptive or abusive practices in connection with the offering of consumer financial products. The Dodd-Frank Act authorizes the CFPB to establish certain minimum standards for the origination of residential mortgages including a determination of the borrower’s ability to repay. In addition, the Dodd-Frank Act will allow borrowers to raise certain defenses to foreclosure if they receive any loan other than a “qualified mortgage” as defined by the CFPB. The Dodd-Frank Act permits states to adopt consumer protection laws and standards that are more stringent than those adopted at the federal level and, in certain circumstances, permits state attorneys general to enforce compliance with both the state and federal laws and regulations. Federal preemption of state consumer protection law requirements, traditionally an attribute of the federal savings association charter, has also been modified by the Dodd-Frank Act and now requires a case-by-case determination of preemption by the Office of the Comptroller of the Currency (“OCC”) and eliminates preemption for subsidiaries of a bank. Depending on the implementation of this revised federal preemption standard, the operations of the Bank could become subject to additional compliance burdens in the states in which it operates.

Deposit Insurance. The Dodd-Frank Act permanently increases the maximum deposit insurance amount for banks, savings institutions and credit unions to $250,000 per depositor, retroactive to January 1, 2009, and extends unlimited deposit insurance to non interest-bearing transaction accounts through December 1, 2012. The Dodd-Frank Act also broadens the base for FDIC insurance assessments. Assessments will now be based on the average consolidated total assets less tangible equity capital of a financial institution. The Dodd-Frank Act requires the FDIC to increase the reserve ratio of the Deposit Insurance Fund from 1.15% to 1.35% of insured deposits by 2020 and eliminates the requirement that the FDIC pay dividends to insured depository institutions when the reserve ratio exceeds certain thresholds. The Dodd-Frank Act also eliminates the federal statutory prohibition against the payment of interest on business checking accounts.

Capital. Under the Dodd-Frank Act, the proceeds of trust preferred securities are excluded from Tier 1 capital unless such securities were issued prior to May 19, 2010 by bank or savings and loan holding companies with less than $15 billion of assets. The legislation also establishes a floor for capital of insured depository institutions that cannot be lower than the standards in effect today, and directs the federal banking regulators to implement new leverage and capital requirements within 18 months that take into account off-balance sheet activities and other risks, including risks relating to securitized products and derivatives.

Uncertainty remains as to ultimate impact of the Dodd-Frank Act, but the Board and management anticipates that the provisions summarized above, as well as others set forth in the Dodd-Frank Act, could have an adverse impact on the financial services industry as a whole and our business, results of operations and financial condition.

Available Information

Our internet website address is http://www.ffsbky.com. Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act are available or may be accessed free of charge through the Investor Relations section of our internet website as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission, or SEC.

ITEM 6. SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA

(Dollars in thousands, except per share data)	At December 31,
	2010		2009		2008		2007		2006
Financial Condition Data:	Restated
Total assets	$	1,319,507	$	1,209,504	$	1,017,047	$	872,691	$	822,826
Net loans outstanding (1)		865,657		985,390		899,436		760,114		698,026
Investments		196,153		46,931		22,797		39,685		52,447
Deposits		1,173,908		1,049,815		775,399		689,243		641,037
Borrowings		70,532		72,245		165,816		105,883		106,724
Stockholders' equity		71,311		85,132		72,952		73,460		72,098

Number of:
Offices		22		22		20		15		14
Full time equivalent employees		325		324		316		284		270

	Year Ended December 31,
	2010			2009			2008			2007			2006
Operations Data:	Restated
Interest income	$	59,565		$	58,856		$	57,564		$	60,545		$	53,832
Interest expense		23,485			21,792			24,799			29,751			24,108
Net interest income		36,080			37,064			32,765			30,794			29,724
Provision for loan losses		16,881			9,524			5,947			1,209			540
Non-interest income		7,304			8,519			8,449			8,203			7,739
Non-interest expense		34,119			43,917			28,286			23,790			21,952
Income tax expense/(benefit)		1,786			(1,149	)		2,184			4,646			4,634
Net income/(loss) attributable to common shareholders		(10,456	)		(7,741	)		4,797			9,352			10,337

Earnings/(loss) per common share: (2)
Basic		(2.21	)		(1.65	)	$	1.03		$	1.98		$	2.14
Diluted		(2.21	)		(1.65	)		1.02			1.96			2.12
Book value per common share (2)		10.89			13.87			15.63			15.76			14.95
Dividends paid per common share (2)		-			0.43			0.76			0.73			0.66

Return on average assets		(.74	)%		(.61	)%		0.51	%		1.10	%		1.31	%
Average equity to average assets		6.77	%		8.56	%		8.02	%		8.54	%		8.71	%
Return on average equity		(10.99	)%		(7.18	)%		6.37	%		12.88	%		15.03	%
Efficiency ratio (3)		79	%		70	%		69	%		61	%		59	%

(1) Includes loans held for sale.

(2) Amounts adjusted to reflect 10% stock dividends declared August 16, 2007.

(3) Excludes goodwill impairment

ITEM 7. MANAGEMENTS’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Management’s Discussion and Analysis of Financial Condition and Results of Operations analyzes the major elements of our balance sheets and statements of operations. This section should be read in conjunction with our Consolidated Financial Statements and accompanying Notes and other detailed information.

OVERVIEW

The unfavorable economic conditions that have persisted since 2007 continued to significantly impact the banking industry and our performance during 2010. During 2010 we continued to experience an increase in our non-performing assets and loan loss provisions. Our decline in credit quality impacted our operations during 2010 in the areas of net interest income, provision for loans losses, non-interest income, non-interest expense, and reversals of tax benefits.

Our net loss attributable to common shareholders for 2010 was $10.5 million, or $2.21 per diluted common share compared to a net loss attributable to common shareholders of $7.7 million or $1.65 per diluted common share in 2009. The 2010 results include provision for loans losses of $16.9 million, other than temporary securities impairment of $1.0 million, write downs on other real estate owned of $2.3 million, an increase in FDIC insurance expense of $813,000, and a charge to establish an allowance against the realization of our deferred tax asset of $4.8 million.

The increase in provision for loan losses was primarily attributable to residential housing development loans in Jefferson and Oldham Counties. Five individual loan relationships totaling $34.7 million make up 48% of our non-performing assets. Four of these relationships totaling $21.9 million represent 47% of our non-performing loans. These high-end subdivisions, while showing initial progress, have stalled due to the recession. At December 31, 2010, substantially all of the residential housing development loan portfolio concentration in these counties has been classified as impaired. The provision for loan loss expense exceeded net charge-offs by $4.9 million.

The allowance to total loans was 2.57% at December 31, 2010 while net charge-offs totaled 125 basis points for 2010, compared to 55 basis points in 2009. Non-performing loans were $46.1 million, or 5.22% of total loans at December 31, 2010 compared to $38.0 million, or 3.82% of total loans for December 31, 2009. The allowance for loan losses to non-performing loans was 49% at December 31, 2010 compared to 47% at December 31, 2009. Non-performing assets increased to $71.9 million or 5.45% of total assets compared to $46.5 million or 3.85% of total assets at December 31, 2009.

Net interest income was $36.1 million for 2010 compared to $37.1 million for 2009, while the net interest margin was 3.05% for 2010 compared to 3.66% in 2009. The net interest margin was negatively impacted by a higher level of non-accrual loans and due to our efforts to increase liquidity by placing assets into lower yielding investments other than loans. Non-interest income decreased $1.2 million primarily driven by an increase of $1.8 million in the loss on sale and write downs on real estate acquired through foreclosure for 2010. Offsetting this increase was an increase in the gain on the sale mortgage loans of $566,000. Non-interest expense decreased $9.8 million primarily due to the goodwill impairment charge of $11.9 million taken in 2009. The 2010 expenses include increases in FDIC insurance premiums of $813,000 and other real estate owned costs of $1.0 million.

Despite our recent losses, we remained well capitalized at December 31, 2010 under regulatory capital guidelines. Although, subsequent to December 31, 2010, we were classified as a troubled institution and cannot be considered well capitalized under that designation. In 2009, as part of an informal regulatory agreement with the FDIC, the Bank agreed to maintain a Tier 1 leverage ratio of 8%. At December 31, 2010, we were not in compliance with the Tier 1 capital requirement. On January 27, 2011, the Bank entered into a Consent Order, a formal agreement with the FDIC and KDFI, under which, among other things, the Bank has agreed to achieve and maintain a Tier 1 leverage ratio of at least 8.5% by March 31, 2011 and 9.0% by June 30, 2011. A copy of the Consent Order is set forth as Exhibit 10.1 of the Form 8-K filed with the SEC on January 27, 2011. The Consent Order supersedes the prior informal regulatory agreement.

In order to meet these capital requirements, the Board of Directors and management are continuing to evaluate strategies including the following:

Raising capital by selling capital stock through a public offering or private placement.

Continuing to operate the Company and the Bank in a safe and sound manner. Until we can complete a capital raise, this will most likely require us to reduce lending concentrations, potentially sell loans, and take significant operating expense reductions and other cost cutting measures aimed at lowering expenses. Additionally, we would adjust the mix of our assets to reduce the total risk weight of our assets, reduce total assets over time and potentially sell branches, deposits and loans.

Evaluating other strategic alternatives, such as a sale of assets, one or more branches, or the institution.

Bank regulatory agencies can exercise discretion when an institution does not meet the terms of a consent order. The agencies may initiate changes in management, issue mandatory directives, impose monetary penalties or refrain from formal sanctions, depending on individual circumstances.

Over the past several years we have focused on enhancing and expanding our retail and commercial banking network in our core central Kentucky markets as well as establishing our presence in the metropolitan Louisville market. Our core markets, where we have a combined 23% market share, have become increasingly competitive as several new banks have entered those markets during the past few years. In order to protect and grow our market share, we have replaced existing branches with newer, enhanced facilities. While the market is very competitive, we believe this creates an opportunity for smaller community banks with more power to make decisions locally. We believe our investment in these initiatives along with our continued commitment to a high level of customer service will enhance our market share in our core markets and our development in the Louisville market.

Although we had a disappointing year in our loan portfolio, we believe that the strength of our retail franchise will enhance our ability to persevere through this economic recovery. This is evidenced by our total deposits increasing $124.1 million, or 11.8% for 2010, continuing the momentum from 2009 where we achieved a record growth year in the amount of $274.4 million, or a 35.4% increase in total deposits over 2008. Growth in deposits, coupled with positive signs of economic growth in our home markets, which is fueled by the Ft. Knox base realignment, will provide a sound basis for us as the local economy recovers. While our concerns about economic conditions in our market continue, opportunities for deposit growth helps us progress towards our long-range financial objectives, including building additional core customer relationships, maintaining sufficient liquidity and capital levels, improving shareholder value and remediating our problem assets.

CRITICAL ACCOUNTING POLICIES

Our accounting and reporting policies comply with U.S. generally accepted accounting principles and conform to general practices within the banking industry. The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires us to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. These estimates, assumptions, and judgments are based on information available as of the date of the financial statements; accordingly, as this information changes, the financial statements could reflect different estimates, assumptions, and judgments. Certain policies inherently have a greater reliance on the use of estimates, assumptions, and judgments and as such have a greater possibility of producing results that could be materially different than originally reported. We consider our critical accounting policies to include the following:

Allowance for Loan Losses – We maintain an allowance sufficient to absorb probable incurred credit losses existing in the loan portfolio. Our Allowance for Loan Loss Review Committee, which is comprised of senior officers, evaluates the allowance for loan losses on a monthly basis. We estimate the allowance using past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of the underlying collateral, and current economic conditions. While we estimate the allowance for loan losses based in part on historical losses within each loan category, estimates for losses within the commercial real estate portfolio depend more on credit analysis and recent payment performance. Allocations of the allowance may be made for specific loans or loan categories, but the entire allowance is available for any loan that, in management’s judgment, should be charged off.

Based on our calculation, an allowance of $22.7 million or 2.57% of total loans was our estimate of probable incurred losses within the loan portfolio as of December 31, 2010. This estimate required a provision for loan losses on the income statement of $16.9 million for the 2010 period. If the mix and amount of future charge off percentages differ significantly from those assumptions used by management in making its determination, the allowance for loan losses and provision for loan losses on the income statement could materially increase.

Impairment of Investment Securities – We review all unrealized losses on our investment securities to determine whether the losses are other-than-temporary. We evaluate our investment securities on at least a quarterly basis and more frequently when economic or market conditions warrant, to determine whether a decline in their value below amortized cost is other-than-temporary. We evaluate a number of factors including, but not limited to: valuation estimates provided by investment brokers; how much fair value has declined below amortized cost; how long the decline in fair value has existed; the financial condition of the issuer; significant rating agency changes on the issuer; and management’s assessment that we do not intend to sell or will not be required to sell the security for a period of time sufficient to allow for any anticipated recovery in fair value.

The term “other-than-temporary” is not intended to indicate that the decline is permanent, but indicates that the possibility for a near-term recovery of value is not necessarily favorable, or that there is a lack of evidence to support a realizable value equal to or greater than the carrying value of the investment. Once a decline in value is determined to be other-than-temporary, the cost basis of the security is written down to fair value and a charge to earnings is recognized for the credit component and the non-credit component is recorded to other comprehensive income.

Real Estate Owned – The estimation of fair value is significant to real estate owned acquired through foreclosure. These assets are recorded at fair value less estimated selling costs at the date of foreclosure. Fair value is based on the appraised market value of the property based on sales of similar assets when available. The fair value may be subsequently reduced if the estimated fair value declines below the original appraised value.

Income Taxes – The provision for income taxes is based on income/(loss) as reported in the financial statements. Deferred income tax assets and liabilities are computed for differences between the financial statement and tax basis of assets and liabilities that will result in taxable or deductible amounts in the future. The deferred tax assets and liabilities are computed based on enacted tax laws and rates applicable to the periods in which the differences are expected to affect taxable income. An assessment is made as to whether it is more likely than not that deferred tax assets will be realized. Valuation allowances are established when necessary to reduce deferred tax assets to an amount expected to be realized. Income tax expense is the tax payable or refundable for the period plus or minus the change during the period in deferred tax assets and liabilities. Tax credits are recorded as a reduction to tax provision in the period for which the credits may be utilized. During 2010, we determined that it was more likely than not that we would not realize our deferred tax asset and recorded a $4.8 million valuation allowance.

RESULTS OF OPERATION

Net loss attributable to common shareholders for the period ended December 31, 2010 was $10.5 million or $2.21 per diluted common share compared to net loss attributable to common shareholders of $7.7 million or $1.65 per diluted common share for the same period in 2009. Contributing to the net loss for 2010 was a decrease in our net interest margin, an increase of $7.4 million in provision for loan losses, a valuation allowance against deferred tax assets of $4.8 million, write downs taken on investment securities that were other-than-temporarily impaired, write downs taken on real estate acquired through foreclosure, and higher FDIC insurance premiums. Net loss attributable to common shareholders was also impacted by dividends paid on preferred shares. Our book value per common share decreased from $13.87 at December 31, 2009 to $10.89 at December 31, 2010.

Net loss attributable to common shareholders for the period ended December 31, 2009 was $7.7 million or $1.65 per diluted common share compared to net income attributable to common shareholders of $4.8 million or $1.02 per diluted common share for the same period in 2008. Earnings decreased for 2009 compared to 2008 due to a decrease in our net interest margin, an increase in provision for loan loss expense, write downs taken on investment securities that were other-than-temporarily impaired, write downs taken on real estate acquired through foreclosure, higher FDIC insurance premiums, a goodwill impairment charge and higher operating expenses. Net income attributable to common shareholders was also impacted by dividends paid on preferred shares. Our book value per common share decreased from $15.63 at December 31, 2008 to $13.87 at December 31, 2009.

Net Interest Income – The principal source of our revenue is net interest income. Net interest income is the difference between interest income on interest-earning assets, such as loans and securities and the interest expense on liabilities used to fund those assets, such as interest-bearing deposits and borrowings. Net interest income is affected by both changes in the amount and composition of interest-earning assets and interest-bearing liabilities as well as changes in market interest rates.

The increase in the volume of interest earning assets was off-set by the change in the mix of interest earning assets, causing a negative impact on net interest income, which decreased $984,000 for 2010 compared to a year ago. Average interest earning assets increased $179.0 million for 2010 compared to 2009. The increase was primarily attributed to our efforts to increase liquidity which resulted in an increase of lower yielding investments, interest bearing deposits and cash. The result was a shift in the mix of assets with the addition of lower yielding assets lowering our net interest margin. Net interest margin was also negatively impacted by the increase in the amount of non-accrual loans. The yield on earning assets averaged 5.00% for 2010 compared to an average yield on earning assets of 5.79% for 2009. This decrease was offset somewhat by a decrease in our cost of funds. Net interest margin as a percent of average earning assets decreased 61 basis points to 3.05% for 2010 compared to 3.66% for the 2009 period.

Our cost of funds averaged 2.13% for the 2010 period compared to an average cost of funds of 2.33% for the same period in 2009. Competition for deposits combined with continued re-pricing of variable rate loans and our efforts to increase liquidity by placing assets into lower yielding investments other than loans is likely to compress our net interest margin in future quarters.

Comparative information regarding net interest income follows:

										2010/2009			2009/2008
(Dollars in thousands)	2010			2009			2008			Change			Change
Net interest income, tax equivalent basis	$	36,536		$	37,326		$	32,970			-2.1	%		13.2	%
Net interest spread		2.87	%		3.46	%		3.53	%		(59	)bp		(7	)bp
Net interest margin		3.05	%		3.66	%		3.78	%		(61	)bp		(12	)bp
Average earnings assets	$	1,199,777		$	1,020,803		$	871,940			17.5	%		17.1	%
bp = basis point = 1/100th of a percent

AVERAGE BALANCE SHEETS

The following table provides information relating to our average balance sheet and reflects the average yield on assets and average cost of liabilities for the indicated periods. Yields and costs for the periods presented are derived by dividing income or expense by the average balances of assets or liabilities, respectively.

	Year Ended December 31,
	2010								2009								2008
(Dollars in thousands)	Average					Average			Average					Average			Average					Average
	Balance			Interest		Yield/Cost			Balance			Interest		Yield/Cost			Balance			Interest		Yield/Cost

ASSETS
Interest earning assets:
U.S. Treasury and agencies	$	64,354		$	1,600		2.49	%	$	9,603		$	251		2.61	%	$	6,469		$	257		3.97	%
Mortgage-backed securities		36,203			1,403		3.88	%		6,963			290		4.16	%		9,006			390		4.33	%
Equity securities		502			57		11.35	%		959			106		11.05	%		1,543			67		4.34	%
State and political subdivision securities (1)		20,633			1,342		6.50	%		11,848			771		6.51	%		9,426			600		6.37	%
Corporate bonds		1,770			101		5.71	%		2,121			117		5.52	%		2,533			159		6.28	%
Loans (2) (3) (4)		954,354			54,977		5.76	%		971,750			57,113		5.88	%		830,748			55,739		6.71	%
FHLB stock		7,140			338		4.73	%		8,515			383		4.50	%		8,116			423		5.21	%
Interest bearing deposits		114,821			203		0.18	%		9,044			87		0.96	%		4,099			134		3.27	%
Total interest earning assets		1,199,777			60,021		5.00	%		1,020,803			59,118		5.79	%		871,940			57,769		6.63	%
Less: Allowance for loan losses		(19,223	)							(14,972	)							(9,114	)
Non-interest earning assets		82,625								86,398								76,343
Total assets	$	1,263,179							$	1,092,229							$	939,169

LIABILITIES AND STOCKHOLDERS' EQUITY
Interest bearing liabilities:
Savings accounts	$	113,438		$	883		0.78	%	$	119,745		$	905		0.76	%	$	106,901		$	1,666		1.56	%
NOW and money market accounts		267,144			3,022		1.13	%		179,917			1,402		0.78	%		136,796			1,307		0.96	%
Certificates of deposit and other time deposits		653,293			15,824		2.42	%		515,764			15,610		3.03	%		444,718			17,539		3.94	%
Short-term borrowings		523			38		7.27	%		50,602			152		0.30	%		44,454			896		2.02	%
FHLB advances		52,603			2,388		4.54	%		52,742			2,405		4.56	%		53,009			2,413		4.55	%
Subordinated debentures		18,000			1,330		7.39	%		18,000			1,318		7.32	%		14,667			978		6.67	%
Total interest bearing liabilities		1,105,001			23,485		2.13	%		936,770			21,792		2.33	%		800,545			24,799		3.10	%
Non-interest bearing liabilities:
Non-interest bearing deposits		69,434								58,945								57,962
Other liabilities		3,194								3,073								5,349
Total liabilities		1,177,629								998,788								863,856

Stockholders' equity		85,550								93,441								75,313
Total liabilities and stockholders' equity	$	1,263,179							$	1,092,229							$	939,169

Net interest income				$	36,536							$	37,326							$	32,970
Net interest spread							2.87	%							3.46	%							3.53	%
Net interest margin							3.05	%							3.66	%							3.78	%
Ratio of average interest earning assets to average interest bearing liabilities							108.58	%							108.97	%							108.92	%

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

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

(3) Calculations include non-accruing loans in the average loan amounts outstanding.

(4) Includes loans held for sale.

RATE/VOLUME ANALYSIS

The table below shows changes in interest income and interest expense for the periods indicated. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (1) changes in rate (changes in rate multiplied by old volume); (2) changes in volume (change in volume multiplied by old rate); and (3) changes in rate-volume (change in rate multiplied by change in volume). Changes in rate-volume are proportionately allocated between rate and volume variance.

	Year Ended									Year Ended
	December 31,									December 31,
	2010 vs. 2009									2009 vs. 2008
	Increase (decrease)									Increase (decrease)
	Due to change in									Due to change in
(Dollars in thousands)							Net									Net
	Rate			Volume			Change			Rate			Volume			Change

Interest income:
U.S. Treasury and agencies	$	(13	)	$	1,362		$	1,349		$	(106	)	$	100		$	(6	)
Mortgage-backed securities		(22	)		1,135			1,113			(14	)		(86	)		(100	)
Equity securities		3			(52	)		(49	)		72			(33	)		39
State and political subdivision securities		-			571			571			14			157			171
Corporate bonds		4			(20	)		(16	)		(18	)		(24	)		(42	)
Loans		(1,123	)		(1,013	)		(2,136	)		(7,409	)		8,783			1,374
FHLB stock		19			(64	)		(45	)		(60	)		20			(40	)
Interest bearing deposits		(125	)		241			116			(137	)		90			(47	)

Total interest earning assets		(1,257	)		2,160			903			(7,658	)		9,007			1,349

Interest expense:
Savings accounts		27			(49	)		(22	)		(942	)		181			(761	)
NOW and money market accounts		781			839			1,620			(269	)		364			95
Certificates of deposit and other time deposits		(3,473	)		3,687			214			(4,466	)		2,537			(1,929	)
Short-term borrowings		179			(293	)		(114	)		(853	)		109			(744	)
FHLB advances		(11	)		(6	)		(17	)		4			(12	)		(8	)
Subordinated debentures		12			-			12			103			237			340

Total interest bearing liabilities		(2,485	)		4,178			1,693			(6,423	)		3,416			(3,007	)

Net change in net interest income	$	1,228		$	(2,018	)	$	(790	)	$	(1,235	)	$	5,591		$	4,356

Non-Interest Income and Non-Interest Expense

The following tables compare the components of non-interest income and expenses for the years ended December 31, 2010, 2009 and 2008. The tables show the dollar and percentage change from 2009 to 2010 and from 2008 to 2009. Below each table is a discussion of significant changes and trends.

										2010/2009						2009/2008
(Dollars in thousands)	2010			2009			2008			Change			%			Change			%
	Restated									Restated
Non-interest income
Customer sevice fees on deposit accounts	$	6,479		$	6,677		$	6,601		$	(198	)		-3.0	%	$	76			1.2	%
Gain on sale of mortgage loans		1,760			1,194			697			566			47.4	%		497			71.3	%
Gain on sale of investments		37			-			55			37			100.0	%		(55	)		-100.0	%
Net impairment losses recognized in earnings		(1,048	)		(862	)		(516	)		(186	)		21.6	%		(346	)		67.1	%
Loss on sale and write downs of real estate acquired through foreclosure		(2,333	)		(578	)		(162	)		(1,755	)		303.6	%		(416	)		256.8	%
Brokerage commissions		413			373			469			40			10.7	%		(96	)		-20.5	%
Other income		1,996			1,715			1,305			281			16.4	%		410			31.4	%
	$	7,304		$	8,519		$	8,449		$	(1,215	)		-14.3	%	$	70			0.8	%

We originate qualified VA, KHC, RHC and conventional secondary market loans and sell them into the secondary market with servicing rights released. Prevailing mortgage interest rates remained at attractive levels during the period helping to contribute to the increase in the volume of loans closed for 2010.

We invest in various types of liquid assets, including United States Treasury obligations, securities of various federal agencies, obligations of states and political subdivisions, corporate bonds, mutual funds, stocks and others. During 2010 we recorded a gain on the sale of equity investment securities of $37,000. Gains on investment securities are infrequent and are not a consistent recurring core source of income.

We recognized other-than-temporary impairment charges of $1.0 million for the expected credit loss during the 2010 period on all five of our trust preferred securities compared to $862,000 of impairment charges for 2009. Management believes this impairment was primarily attributable to the current economic environment which caused the financial conditions of some of the issuers to deteriorate. During 2008, we recognized other-than-temporary impairment charges of $516,000 on certain equity securities with a cost basis of $840,000. Our remaining exposure related to these equity securities is $291,000.

Further reducing non-interest income for 2010 was an increase of $1.8 million in losses on the sale and write down of real estate owned properties.

The increase in other income is primarily the result of gains recorded on the sale of real estate owned properties.

							2010/2009						2009/2008
(Dollars in thousands)	2010		2009		2008		Change			%			Change			%
	Restated						Restated
Non-interest expenses
Employee compensation and benefits	$	15,718	$	15,834	$	14,600	$	(116	)		-0.7	%	$	1,234			8.5	%
Office occupancy expense and equipment		3,174		3,271		2,865		(97	)		-3.0	%		406			14.2	%
Marketing and advertising		715		844		782		(129	)		-15.3	%		62			7.9	%
Outside services and data processing		2,721		3,194		3,324		(473	)		-14.8	%		(130	)		-3.9	%
Bank franchise tax		2,059		960		1,010		1,099			114.5	%		(50	)		-5.0	%
FDIC insurance premiums		2,713		1,900		716		813			42.8	%		1,184			165.4	%
Goodwill impairment		-		11,931		-		(11,931	)		-100.0	%		11,931			100.0	%
Amortization of intangible assets		396		510		284		(114	)		-22.4	%		226			79.6	%
Real estate acquired through foreclosure expense		1,678		668		472		1,010			151.2	%		196			41.5	%
Other expense		4,945		4,805		4,233		140			2.9	%		572			13.5	%
	$	34,119	$	43,917	$	28,286	$	(9,798	)		-22.3	%	$	15,631			55.3	%

Employee compensation and benefits, office occupancy expense and equipment and marketing and advertising expense decreased in 2010 compared to 2009. These expenses were higher in 2009 due to additional operating expenses related to the opening of two new banking centers. We opened a full-service banking center at Fort Knox and another in the Middletown area of Jefferson County in 2009.

Outside services and data processing decreased due the renewal of our data processing contracts at a lower monthly cost.

During the fourth quarter of 2009, the FDIC adopted a requirement that all banks prepay three and a quarter years worth of FDIC assessments on December 31, 2009. The prepayment is based on average third quarter deposits. The prepaid amount will be amortized over the prepayment period. Our prepayment was $7.5 million of which $2.7 million was reflected in our 2010 income statement. Because the Bank entered into the Consent Order and is designated a “troubled institution” it is in a higher risk category and now pays one of the highest deposit assessment rates.

The second largest expense incurred in 2009 was a goodwill impairment charge of $11.9 million. Annual analysis of goodwill indicated an impairment charge was necessary due to continued market deterioration. While this charge flows through our income statement, it is a non-cash item that does not impact our liquidity or adversely affect regulatory or tangible capital ratios.

The increase in real estate acquired through foreclosure expense for 2010 and 2009 was primarily due to increase in expense relating to repair, maintenance and taxes due to increases in real estate we acquired through foreclosure and due to $375,000 in back taxes being paid on a commercial real estate property that was taken into other real estate owned for 2010.

Our efficiency ratio was 79% for 2010 compared to 70% for the 2009 period. The 2009 ratio excludes goodwill impairment.

Income Taxes

We recognized income tax expense of $1.8 million in 2010, as compared to income tax benefit of $1.1 million in 2009, and expense of $2.2 million in 2008. The recognition of income tax expense in 2010 resulted mainly from a non-cash charge of approximately $4.8 million to establish a valuation allowance for our deferred tax asset. The effective tax rate for the year ended December 31, 2009 was 15% compared to 31% for the year ended December 31, 2008. The decrease in the tax rate is related primarily to the loss generated from the goodwill impairment as a portion of this goodwill arose from a taxable business combination. The effective tax rate for the year ended December 31, 2010 is not meaningful due to the size of our operating loss relative to income tax expense recorded resulting from a charge to establish a valuation allowance.

Recording a valuation allowance does not have any impact on our liquidity, nor does it preclude us from using the tax losses, tax credits or other timing differences in the future. To the extent that we generate taxable income in a given quarter, the valuation allowance may be reduced to fully or partially offset the corresponding income tax expense. Any remaining deferred tax asset valuation allowance may be reversed through income tax expense once we can demonstrate a sustainable return to profitability and conclude that it is more likely than not the deferred tax asset will be utilized prior to expiration.

See Note 14 of the Notes to Consolidated Financial Statements for additional discussion of our income taxes.

ANALYSIS OF FINANCIAL CONDITION

Total assets at December 31, 2010 increased to $1.3 billion compared to $1.2 billion at December 31, 2009. The increase was due to an increase in cash and cash equivalents and building our investment portfolio to $196.2 million, an increase of $149.2 million since December 31, 2009. This increase was mainly off-set by a decline in gross loans, excluding loans held for sale, of $113.0 million. This shift in the balance sheet reflects a conscious effort by management to add on-balance sheet liquidity to protect us against any adverse changes to our current wholesale funding position.

Loans

Net loans decreased $119.7 million to $865.7 million at December 31, 2010 compared to $985.4 million at December 31, 2009. Our commercial real estate and commercial portfolios decreased $90.7 million to $600.0 million at December 31, 2010. Our residential mortgage loan, real estate construction and indirect consumer portfolios all decreased for the 2010 period while our consumer and home equity loan portfolio increased $2.9 million. The decline in our commercial real estate and commercial loan portfolios is a result of pay-offs and charge-offs on several large commercial relationships. The loan portfolio also declined due to our aggressive efforts to resolve problem loans. During 2010, we took deeds in lieu of foreclosure on several large commercial real estate properties, moving them to our other real estate owned portfolio. Although there remains a high demand for loans from quality borrowers, we have elected to shift our focus to preserve capital. We believe, however, we will still be well positioned to benefit from growth in our local markets as the economy rebounds.

Loan Portfolio Composition. The following table presents a summary of the loan portfolio, net of deferred loan fees, by type. There are no foreign loans in our portfolio and other than the categories noted; there is no concentration of loans in any industry exceeding 10% of total loans.

	December 31,
(Dollars in thousands)	2010					2009					2008					2007					2006
	Amount		%			Amount		%			Amount		%			Amount		%			Amount		%
Type of Loan:
Real Estate:
Residential	$	164,090		18.47	%	$	179,130		17.86	%	$	165,318		18.11	%	$	132,209		17.21	%	$	137,155		19.44	%
Construction		11,034		1.24			14,567		1.45			17,387		1.90			21,383		2.78			23,953		3.39
Commercial		557,764		62.79			627,788		62.58			563,314		61.70			470,929		61.32			410,146		58.12
Consumer and home equity		77,781		8.76			74,844		7.46			69,649		7.63			63,090		8.21			62,805		8.90
Indirect consumer		29,588		3.33			36,628		3.65			31,754		3.48			27,721		3.61			30,857		4.37
Commercial, other		41,677		4.69			61,969		6.18			56,012		6.13			51,924		6.76			40,121		5.68
Loans held for sale		6,388		0.72			8,183		0.82			9,567		1.05			780		0.10			673		0.10

Total loans	$	888,322		100.00	%	$	1,003,109		100.00	%	$	913,001		100.00	%	$	768,036		100.00	%	$	705,710		100.00	%

Loan Maturity Schedule. The following table shows at December 31, 2010, the dollar amount of loans, net of deferred loan fees, maturing in the loan portfolio based on their contractual terms to maturity.

			Due after
	Due during		1 through		Due after 5
	the year ended		5 years after		years after
	December 31,		December 31,		December 31,		Total
	2011		2010		2010		Loans
	(Dollars in thousands)

Residential mortgage	$	7,184	$	36,703	$	120,203	$	164,090
Real estate construction		8,928		2,106		-		11,034
Real estate commercial		141,885		386,604		29,275		557,764
Consumer & home equity		14,954		23,117		39,710		77,781
Indirect consumer		623		26,224		2,741		29,588
Commercial, other		14,895		25,175		1,607		41,677
Loans held for sale		6,388		-		-		6,388
Total	$	194,857	$	499,929	$	193,536	$	888,322

The following table breaks down loans maturing after one year, by fixed and adjustable rates.

			Floating or
	Fixed Rates		Adjustable Rates		Total
	(Dollars in thousands)

Residential mortgage	$	87,358	$	69,548	$	156,906
Real estate construction		2,106		-		2,106
Real estate commercial		285,625		130,254		415,879
Consumer & home equity		15,474		47,353		62,827
Indirect consumer		28,965		-		28,965
Commercial, other		19,049		7,733		26,782
Total	$	438,577	$	254,888	$	693,465

Allowance and Provision for Loan Losses

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

The Allowance for Loan Loss Review Committee evaluates the allowance for loan losses monthly to maintain a level sufficient to absorb probable incurred credit losses existing in the loan portfolio. Periodic provisions to the allowance are made as needed. The Committee determines the allowance by applying loss estimates to graded loans by categories, as described below. In addition, the Committee analyzes such factors as changes in lending policies and procedures; underwriting standards; collection; charge-off and recovery history; changes in national and local economic business conditions and developments; changes in the characteristics of the portfolio; ability and depth of lending management and staff; changes in the trend of the volume and severity of past due, non-accrual and classified loans; troubled debt restructuring and other loan modifications; and results of regulatory examinations.

Further declines in collateral values, including commercial real estate, may impact our ability to collect on certain loans when borrowers are dependent on the values of the real estate as a source of cash flow. During the second half of 2008, 2009 and continuing throughout 2010, we substantially increased our provision for loan losses for our general and specific reserves as we identified adverse conditions. The foreseeable future will continue to be a challenging time for our financial institution as we manage the overall level of our credit quality. It is likely that provision for loan losses will remain elevated in the near term.

As discussed in Note 2 to the consolidated financial statements, we entered into a Consent Order with bank regulatory agencies. In addition to increasing capital ratios, we agreed to maintain adequate reserves for loan losses, develop and implement a plan to reduce the level of non-performing assets through collection, disposition, charge-off or improvement in the credit quality of the loans, develop and implement a plan to reduce concentrations of credit in commercial real estate loans, implement revised credit risk management practices and credit administration policies and procedures and to report our progress to the regulators.

The following table analyzes loan loss experience for the periods indicated.

	Year Ended December 31,
(Dollars in thousands)	2010			2009			2008			2007			2006

Balance at beginning of period	$	17,719		$	13,565		$	7,922		$	7,684		$	7,377
Allowance related to acquisition		-			-			327			-			-
Loans charged-off:
Residential mortgage		222			127			15			18			3
Consumer & home equity		535			778			515			385			446
Commercial & commercial real estate		11,438			4,721			364			807			165
Total charge-offs		12,195			5,626			894			1,210			614
Recoveries:
Residential mortgage		-			2			4			10			7
Consumer & home equity		188			205			239			222			287
Commercial & commercial real estate		72			49			20			7			87
Total recoveries		260			256			263			239			381

Net loans charged-off		11,935			5,370			631			971			233

Provision for loan losses		16,881			9,524			5,947			1,209			540

Balance at end of period	$	22,665		$	17,719		$	13,565		$	7,922		$	7,684

Allowance for loan losses to total loans (excluding loans held for sale)		2.57	%		1.78	%		1.50	%		1.03	%		1.09	%
Net charge-offs to average loans outstanding		1.25	%		0.55	%		0.08	%		0.13	%		0.03	%
Allowance for loan losses to total non-performing loans		49	%		47	%		81	%		89	%		159	%

The provision for loan losses increased $7.4 million to $16.9 million in 2010 compared to 2009. The increase in provision for loan losses was primarily attributable to residential housing development loans in Jefferson and Oldham Counties. During 2010, we continued our efforts to ensure the adequacy of the allowance by adding specific reserves to several large commercial real estate relationships based on updated appraisals of the underlying collateral. We require appraisals on real estate at the time of initial application and subsequently assess the transaction and market conditions to determine if updated appraisals are periodically needed. Additionally, we evaluate the collateral condition and value upon classification as an impaired loan and upon foreclosure. The higher provision was also due to our increasing the general reserve provisioning levels for commercial real estate loans due to the increase in classified loans for the 2010 period. The allowance for loan losses increased $4.9 million to $22.7 million from December 31, 2009 to December 31, 2010. The increase was due to specific reserves placed on loans due to updated appraisal information obtained as part of our on-going monitoring of the loan portfolio, as well as the provision recorded to reflect an increase in classified loans for the 2010 period. Specific reserves as allocated to substandard loans made up 56% of the total allowance for loan loss at December 31, 2010. The increase in charge-offs for 2010 was primarily attributed to charging down previously recorded specific reserves on non-performing loans whose condition worsened during 2010.

The provision for loan losses increased by $3.6 million to $9.5 million in 2009 compared to 2008. The increase was partially related to growth in the loan portfolio, but primarily from the specific reserves set aside for loans classified during 2009 and increases in general reserve provisioning levels. During the fourth quarter of 2009, we added specific reserves to several large commercial real estate relationships based on updated appraisals of the underlying collateral. The higher provision was also due to our increasing the general reserve factors for commercial real estate loans during the period as the level of classified loans has increased sharply since 2008. The allowance for loan losses increased $4.1 million to $17.7 million from December 31, 2008 to December 31, 2009. The increase was due to an increase in net loans for 2009, as well as the provision recorded to reflect a $24.9 million increase in classified loans for the 2009 period. The increase in charge-offs for the 2009 period was primarily attributed to a charge-down of $2.0 million on one large commercial real estate relationship that we foreclosed on during the second quarter of 2009. $1.7 million of the $2.0 million charge-down was previously reserved during the prior year. Also, during the fourth quarter of 2009, we took a write-down of $500,000 on a commercial real estate relationship that was classified and recorded a charge-off of $822,000 on another commercial real estate relationship. Additionally, charge-offs were generally higher in all areas of the loan portfolio for 2009.

The following table depicts management’s allocation of the allowance for loan losses by loan type. Allowance and allocation is based on management’s current evaluation of risk in each category, economic conditions, past loss experience, loan volume, past due history and other factors. Since these factors and management’s assumptions are subject to change, the allocation is not a prediction of future portfolio performance.

	December 31,
	2010					2009					2008					2007					2006
	Amount of		Percent of			Amount of		Percent of			Amount of		Percent of			Amount of		Percent of			Amount of		Percent of
(Dollars in thousands)	Allowance		Total loans			Allowance		Total loans			Allowance		Total loans			Allowance		Total loans			Allowance		Total loans

Residential mortgage	$	751		19	%	$	517		19	%	$	455		19	%	$	348		17	%	$	340		20	%
Consumer		1,504		12			1,634		11			1,415		11			1,293		12			1,298		13
Commercial		20,410		69			15,568		70			11,695		70			6,281		71			6,046		67
Total	$	22,665		100	%	$	17,719		100	%	$	13,565		100	%	$	7,922		100	%	$	7,684		100	%

Federal regulations require banks to classify their own assets on a regular basis. The regulations provide for three categories of classified loans – substandard, doubtful and loss.

The following table provides information with respect to classified loans for the periods indicated:

	December 31,		December 31,		December 31,
(Dollars in thousands)	2010		2009		2008
Criticized Loans:
Total Criticized	$	28,309	$	63,456	$	81,207

Classified Loans:
Substandard	$	95,663	$	65,408	$	41,901
Doubtful		583		370		-
Loss		64		1,178		114
Total Classified	$	96,310	$	66,956	$	42,015

Total Criticized and Classified	$	124,619	$	130,412	$	123,222

As we focused on credit quality during 2008, 2009 and 2010, there was a significant migration of loans into the substandard loan category. If economic conditions continue to put stress on our borrowers going forward, this may require higher provisions for loan losses in future periods. Credit quality will continue to be a primary focus during 2011 and going forward.

The $30.3 million increase in substandard assets for 2010 was primarily the result of downgrading loans with thirteen borrowers with balances ranging from $1.5 million to $10.3 million. Offsetting this increase was the transfer of five classified loans totaling $12.6 million to real estate acquired through foreclosure, the upgrades of three classified loans totaling $7.5 million whose cash flow is adequate to service the debt and a $3.8 million pay down on another commercial real estate loan. Approximately $87.5 million, or 91% of the total classified loans were related to real estate development or real estate construction loans in our market area. Several of the non-performing loans that were added during the period were adequately collateralized and therefore did not require additional reserves. Classified consumer loans totaled $1.3 million, classified mortgage loans totaled $5.6 million and classified commercial loans totaled $1.9 million. The change in our level of allowance for loan losses is a result of a consistent allowance methodology that is driven by risk ratings. For more information on collection efforts, evaluation of collateral and how loss amounts are estimated, see “Non-Performing Assets,” below.

Although we may allocate a portion of the allowance to specific loans or loan categories, the entire allowance is available for active charge-offs. We develop our allowance estimates based on actual loss experience adjusted for current economic conditions. Allowance estimates represent a prudent measurement of the risk in the loan portfolio, which we apply to individual loans based on loan type.

Non-Performing Assets

Non-performing assets consist of certain restructured loans for which interest rate or other terms have been renegotiated, loans on which interest is no longer accrued, real estate acquired through foreclosure and repossessed assets. We do not have any loans longer than 90 days past due still on accrual. Loans, including impaired loans, are placed on non-accrual status when they become past due 90 days or more as to principal or interest, unless they are adequately secured and in the process of collection. Loans are considered impaired when we no longer anticipate full principal or interest payments in accordance with the contractual loan terms. If a loan is impaired, we allocate a portion of the allowance so that the loan is reported, net, at the present value of estimated future cash flows using the loan’s existing rate, or at the fair value of collateral if repayment is expected solely from collateral.

We review our loans on a regular basis and implement normal collection procedures when a borrower fails to make a required payment on a loan. If the delinquency on a mortgage loan exceeds 90 days and is not cured through normal collection procedures or an acceptable arrangement is not worked out with the borrower, we institute measures to remedy the default, including commencing a foreclosure action. We generally charge off consumer loans when management deems a loan uncollectible and any available collateral has been liquidated. We handle commercial business and real estate loan delinquencies on an individual basis with the advice of legal counsel.

We recognize interest income on loans on the accrual basis except for those loans in a non-accrual of income status. We discontinue accruing interest on impaired loans when management believes, after consideration of economic and business conditions and collection efforts that the borrowers’ financial condition is such that collection of interest is doubtful, typically after the loan becomes 90 days delinquent. When we discontinue interest accrual, we reverse existing accrued interest and subsequently recognize interest income only to the extent we receive cash payments.

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

Real estate owned acquired through foreclosure is recorded at fair value less estimated selling costs at the date of foreclosure. Fair value is based on the appraised market value of the property based on sales of similar assets. The fair value may be subsequently reduced if the estimated fair value declines below the original appraised value. We monitor market information and the age of appraisals on existing real estate owned properties and obtain new appraisals as circumstances warrant. Real estate acquired through foreclosure increased $17.4 million to $25.8 million at December 31, 2010. The increase was primarily the result of foreclosures on residential housing development loans in Jefferson and Oldham Counties involving nine commercial real estate properties totaling $21.2 million that were transferred during 2010. Offsetting this increase was the sale of four commercial real estate properties totaling $3.0 million. We anticipate that our level of real estate acquired through foreclosure will remain at elevated levels for some period of time as foreclosures reflecting both weak economic conditions and soft commercial real estate values continue. All properties held in other real estate owned are listed for sale with various independent real estate agents.

A summary of the real estate acquired through foreclosure activity is as follows:

	December 31,
(Dollars in thousands)	2010			2009			2008
	Restated
Beginning balance	$	8,428		$	5,925		$	1,749
Additions		24,622			6,011			4,781
Sales		(4,928	)		(2,930	)		(443	)
Writedowns		(2,315	)		(578	)		(162	)
Ending balance	$	25,807		$	8,428		$	5,925

The following table provides information with respect to non-performing assets for the periods indicated.

	December 31,
(Dollar in thousands)	2010			2009			2008			2007			2006
	Restated
Restructured	$	3,906		$	9,812		$	1,182		$	2,335		$	2,470
Past due 90 days still on accrual		-			-			-			-			-
Loans on non-accrual status		42,169			28,186			15,587			6,554			2,368

Total non-performing loans		46,075			37,998			16,769			8,889			4,838
Real estate acquired through foreclosure		25,807			8,428			5,925			1,749			918
Other repossessed assets		40			103			91			52			82
Total non-performing assets	$	71,922		$	46,529		$	22,785		$	10,690		$	5,838

Interest income that would have been earned on non-performing loans	$	2,654		$	2,234		$	825		$	696		$	368
Interest income recognized on non-performing loans		277			211			75			188			227
Ratios: Non-performing loans to total loans (excluding loans held for sale)		5.22	%		3.82	%		1.86	%		1.16	%		0.69	%
Non-performing assets to total loans (excluding loans held for sale)		8.16	%		4.68	%		2.52	%		1.39	%		0.83	%

Non-performing loans increased $8.1 million to $46.1 million at December 31, 2010 compared to $38.0 million at December 31, 2009. Our exposure to residential subdivision developments in Jefferson and Oldham Counties was the primary cause of the increase in non-performing loans and non-performing assets for 2010 and 2009. At December 31, 2010, substantially all of the residential housing development loan portfolio concentration in these counties has been classified as impaired. The remaining credits in this concentration are smaller credits with strong guarantor strength. Five individual loan relationships totaling $34.7 million make up 48% of our non-performing assets. These high-end subdivisions, while showing initial progress, have stalled due to the recession. Non-accrual loans increased due to the addition of six credit relationships totaling $26.4 million. These credit relationships are secured by real estate and we have provided adequate allowance based on current information. Offsetting this increase was a $5.1 credit relationship being removed from the non-accrual category when the loan was re-written with new guarantors and four non-accrual relationships totaling $8.0 million were transferred to real estate acquired through foreclosure. All non-performing loans are considered impaired.

Non-performing assets for the 2010 period include $3.9 million in restructured commercial, mortgage and consumer loans. One credit relationship comprises $3.1 million of our restructured loans. The terms of our restructured loans have been renegotiated to reduce the rate of interest or extend the term, thus reducing the amount of cash flow required from the borrower to service the loans. The borrowers are currently meeting the terms of the restructured loans. The decrease in restructured loans from December 31, 2009 is due in part to the transfer of a credit relationship totaling $6.1 million to non-accrual status. In addition, we removed two credit relationships totaling $3.2 million from the restructured category since the terms of the loans are now substantially equivalent to terms on which loans with comparable risks are being made and the borrowers have performed according to the terms of the contract for the past 18 to 24 months.

Investment Securities

Interest on securities provides us our largest source of interest income after interest on loans, constituting 7.7% of the total interest income for the year ended December 31, 2010. The securities portfolio serves as a source of liquidity and earnings and contributes to the management of interest rate risk. We have the authority to invest in various types of liquid assets, including short-term United States Treasury obligations and securities of various federal agencies, obligations of states and political subdivisions, corporate bonds, certificates of deposit at insured savings and loans and banks, bankers' acceptances, and federal funds. We may also invest a portion of our assets in certain commercial paper and corporate debt securities. We are also authorized to invest in mutual funds and stocks whose assets conform to the investments that we are authorized to make directly. The available-for-sale investment portfolio increased by $150.3 million due to the purchase of a government-sponsored mortgage-backed securities, U.S. Government agency securities and state and municipal obligations. Offsetting this increase was the sale of equity securities. The held-to-maturity investment portfolio decreased $1.0 million as securities were called for redemption in accordance with their terms due to decreasing rates.

We evaluate investment securities with significant declines in fair value on a quarterly basis to determine whether they should be considered other-than-temporarily impaired under current accounting guidance, which generally provides that if a security is in an unrealized loss position, whether due to general market conditions or industry or issuer-specific factors, the holder of the securities must assess whether the impairment is other-than-temporary. We consider the length of time and the extent to which the fair value has been less than cost, the financial condition and near-term prospects of the issuer, and whether management has the intent to sell the debt security or whether it is more likely than not that we will be required to sell the debt security before its anticipated recovery. In analyzing an issuer’s financial condition, we may consider whether the securities are issued by the federal government or its agencies, whether downgrades by bond rating agencies have occurred, and the results of reviews of the issuer’s financial condition.

The unrealized losses on our U. S. Treasury and agency securities and our government sponsored mortgage-backed residential securities were a result of changes in interest rates for fixed-rate securities where the interest rate received is less than the current rate available for new offerings of similar securities. Because the decline in market value is attributable to changes in interest rates and not credit quality, and because we have the ability and intent to hold these investments until recovery of fair value, which may be maturity, we do not consider these investments to be other-than-temporarily impaired at December 31, 2010.

The unrealized losses on the state and municipal securities were caused primarily by interest rate decreases. The contractual terms of those investments do not permit the issuer to settle the securities at a price less than the amortized cost of the investment. Because we do not have the intent to sell these securities and it is likely that we will not be required to sell the securities before their anticipated recovery, we do not consider these investments to be other-than-temporarily impaired at December 31, 2010. We also considered the financial condition and near term prospects of the issuer and identified no matters that would indicate less than full recovery.

We have evaluated the decline in the fair value of our trust preferred securities, which are directly related to the credit and liquidity crisis that the financial services industry has experienced in recent years. The trust preferred securities market is currently inactive making the valuation of trust preferred securities very difficult. We value trust preferred securities using unobservable inputs through a discounted cash flow analysis as permitted under current accounting guidance and using the expected cash flows appropriately discounted using present value techniques. Refer to Note 5 – Fair Value for more information.

We recognized other-than-temporary impairment charges of $1.0 million for the expected credit loss during the 2010 period and $1.9 million during the time we have held these securities on five of our trust preferred securities with an original cost basis of $3.0 million. All of our trust preferred securities are currently rated below investment grade. One of our trust preferred securities continues to pay interest as scheduled through December 31, 2010, and is expected to continue paying interest as scheduled. The other four trust preferred securities are paying either partial or full interest in kind instead of full cash interest. See Note 3 – Securities for more information. Management will continue to evaluate these securities for impairment quarterly.

The following table provides the carrying value of our securities portfolio at the dates indicated.

	December 31,
(Dollars in thousands)	2010		2009		2008

Securities available-for-sale:
U.S. Treasury and agencies	$	113,893	$	20,080	$	-
Government-sponsored mortgage-backed residential		59,170		9,752		6,139
Equity		293		990		948
State and municipal		22,618		14,893		8,615
Trust preferred securities		55		49		73
Total	$	196,029	$	45,764	$	15,775

Securities held-to-maturity:
U.S. Treasury and agencies	$	-	$	-	$	4,503
Government-sponsored mortgage-backed residential		102		902		1,780
State and municipal		-		245		481
Trust preferred securities		22		20		258
Total	$	124	$	1,167	$	7,022

					Weighted
	Amortized		Fair		Average
(Dollars in thousands)	Cost		Value		Yield*
Securities available-for-sale:
Due after one year through five years	$	11,824	$	11,915		1.96	%
Due after five years through ten years		29,655		29,469		2.87
Due after ten years		159,365		154,352		3.62
Equity		299		293		6.32
Total	$	201,143	$	196,029		3.41

					Weighted
	Amortized		Fair		Average
(Dollars in thousands)	Cost		Value		Yield*
Securities held-to-maturity:
Due after five years through ten years	$	67	$	68		2.76	%
Due after ten years		57		58		3.27
Total	$	124	$	126		3.00

*The weighted average yields are calculated on amortized cost on a non tax-equivalent basis.

Deposits

We rely primarily on providing excellent customer service and long-standing relationships with customers to attract and retain deposits. Market interest rates and rates on deposit products offered by competing financial institutions can significantly affect our ability to attract and retain deposits. We attract both short-term and long-term deposits from the general public by offering a wide range of deposit accounts and interest rates. In recent years market conditions have caused us to rely increasingly on short-term certificate accounts and other deposit alternatives that are more responsive to market interest rates. We use forecasts based on interest rate risk simulations to assist management in monitoring our use of certificates of deposit and other deposit products as funding sources and the impact of the use of those products on interest income and net interest margin in various rate environments.

In conjunction with our initiatives to expand and enhance our retail branch network, we emphasize growing our customer checking account base to better enhance profitability and franchise value. Total deposits increased $124.1 million compared to December 31, 2009 due to several successful deposit promotions. Retail and commercial deposits increased $232.5 million during 2010. Public funds, brokered deposits and Certificate of Deposits Account Registry Service (“CDARS”) certificates decreased $108.4 million. Brokered deposits were $50.3 million at December 31, 2010 compared to $127.8 million at December 31, 2009.

To evaluate our funding needs in light of deposit trends resulting from these changing conditions, management and Board committees evaluate simulated performance reports that forecast changes in margins. We continue to offer attractive certificate rates for various terms to allow us to retain deposit customers and reduce interest rate risk during the current rate environment, while protecting the margin. However, the Consent Order issued in January 2011, resulted in the Bank being categorized as a "troubled institution" by bank regulators. The "troubled institution" designation restricts the amount of interest the Bank may pay on deposits. Unless the Bank is granted a waiver because it resides in a market that the FDIC determines is a high rate market, the Bank is limited to paying deposit interest rates within .75% of the average rates computed by the FDIC.

We offer a broad selection of deposit instruments, including non-interest bearing checking, statement and passbook savings accounts, health savings accounts, NOW accounts, money market accounts and fixed and variable rate certificates with varying maturities. We also offer tax-deferred individual retirement accounts. The flow of deposits is influenced significantly by general economic conditions, changes in interest rates and competition. As of December 31, 2010, approximately 40% of our deposits consisted of various savings and demand deposit accounts from which customers can withdraw funds at any time without penalty. Management periodically adjusts interest rates paid on our deposit products, maturity terms, service fees and withdrawal penalties.

We also offer certificates of deposit with a variety of terms, interest rates and minimum deposit requirements. The variety of deposit accounts allows us to compete more effectively for funds and to respond with more flexibility to the flow of funds away from depository institutions into direct investment vehicles such as government and corporate securities. However, market conditions and regulatory restrictions continue to significantly affect our ability to attract and maintain deposits and our cost of funds.

The following table breaks down our deposits.

	December 31,
(Dollars in thousands)	2010		2009

Non-interest bearing	$	73,566	$	63,950
NOW demand		129,887		117,319
Savings		109,349		131,401
Money market		157,135		127,885
Certificates of deposit		703,971		609,260
Total	$	1,173,908	$	1,049,815

As of December 31, 2010, certificates of deposits in amounts of $100,000 or more total $347.3 million, with $287.4 million held by persons residing within our service areas. An additional $50.3 million of certificates of deposits in amounts of $100,000 or more were obtained from deposit brokers and $9.6 million were obtained from our participation in the Certificate of Deposit Account Registry Service (“CDARS”) at December 31, 2010. CDARS is a system that allows certificates of deposit that would be in excess of FDIC coverage in a single financial institution to be redistributed to other financial institutions within the CDARS network in increments under the current FDIC coverage limit. Brokered deposits consist of certificates of deposit placed by deposit brokers for a fee and can be utilized to support our asset growth. However, due to our agreement with bank regulatory agencies, we are not allowed to accept, renew or rollover brokered deposits (including deposits through the CDARs program) without prior regulatory approval.

The following table shows at December 31, 2010 the amount of our certificates of deposit of $100,000 or more by time remaining until maturity.

	Certificates
Maturity Period	of Deposit
	(In Thousands)

Three months or less	$	51,187
Three through six months		30,376
Six through twelve months		49,944
Over twelve months		215,837
Total	$	347,344

Short-term Borrowings

Our short-term borrowings consist of a loan agreement with a correspondent bank for 2010 and primarily federal funds purchased from the FHLB of Cincinnati for 2009. The loan was paid off in full during the fourth quarter of 2010 and the loan agreement has terminated. Short-term borrowings were at an average rate of 7.27% and .30% for 2010 and 2009.

Advances from Federal Home Loan Bank

Deposits are the primary source of funds for our lending and investment activities and for our general business purposes. We can also use advances (borrowings) from the Federal Home Loan Bank (FHLB) of Cincinnati to compensate for reductions in deposits or deposit inflows at less than projected levels. At December 31, 2010 we had $52.5 million in advances outstanding from the FHLB. However, we did not have sufficient collateral available for additional borrowings from the FHLB. Advances from the FHLB are secured by our stock in the FHLB, certain securities, certain commercial real estate loans and substantially all of our first mortgage, multi-family and open end home equity loans.

The FHLB of Cincinnati functions as a central reserve bank providing credit for savings banks and other member financial institutions. As a member, we are required to own capital stock in the FHLB and are authorized to apply for advances on the security of such stock and certain of our home mortgages, other real estate loans and other assets (principally, securities which are obligations of, or guaranteed by, the United States) provided that we meet certain creditworthiness standards. For further information, see Note 11 of the Notes to Consolidated Financial Statements in this Annual Report.

The following table provides information about our FHLB advances and short-term borrowings as of and for the periods ended.

	December 31,
	2010			2009			2008
	(Dollars in thousands)

Average balance outstanding	$	53,126		$	103,344		$	97,463
Maximum amount outstanding at any month-end during the period		53,734			167,409			147,816
Year end balance		52,532			54,245			147,816
Weighted average interest rate:
At end of year		4.36	%		4.36	%		1.81	%
During the year		4.57	%		2.47	%		3.40	%

Subordinated Debentures

In 2008, First Federal Statutory Trust III, an unconsolidated trust subsidiary of First Financial Service Corporation, issued $8.0 million in trust preferred securities. The trust loaned the proceeds of the offering to us in exchange for junior subordinated deferrable interest debentures which we used to finance the purchase of FSB Bancshares, Inc. The subordinated debentures, which mature on June 24, 2038, can be called at par in whole or in part on or after June 24, 2018. The subordinated debentures pay a fixed rate of 8% for thirty years. We have the option to defer interest payments on the subordinated debt from time to time for a period not to exceed five consecutive years. The subordinated debentures are considered as Tier I capital for the Corporation under current regulatory guidelines.

A different trust subsidiary issued 30 year cumulative trust preferred securities totaling $10 million at a 10 year fixed rate of 6.69% adjusting quarterly thereafter at LIBOR plus 160 basis points. The subordinated debentures, which mature March 22, 2037, can be called at par in whole or in part on or after March 15, 2017. We have the option to defer interest payments on the subordinated debt from time to time for a period not to exceed five consecutive years. The subordinated debentures are considered as Tier I capital for the Corporation under current regulatory guidelines.

Our trust subsidiaries loaned the proceeds of their offerings of trust preferred securities to us in exchange for junior subordinated deferrable interest debentures. In accordance with current accounting guidance, these trusts are not consolidated with our financial statements but rather the subordinated debentures are shown as a liability.

On October 29, 2010, we exercised our right to defer regularly scheduled interest payments on both issues of junior subordinated notes, together having an outstanding principal amount of $18 million, relating to outstanding trust preferred securities. We have the right to defer payments of interest for up to 20 consecutive quarterly periods without default or penalty. After such period, we must pay all deferred interest and resume quarterly interest payments or we will be in default. During the deferral period, the respective statutory trusts, which are wholly owned subsidiaries of First Financial Service Corporation, that were formed to issue the trust preferred securities, will likewise suspend the declaration and payment of dividends on the trust preferred securities. The regular scheduled interest payments will continue to be accrued for payment in the future and reported as an expense for financial statement purposes.

LIQUIDITY

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

Our banking centers provide access to retail deposit markets. If large certificate depositors shift to our competitors or other markets in response to interest rate changes, we have the ability to replenish those deposits through alternative funding sources. In addition to maintaining a stable core deposit base, we maintain adequate liquidity primarily through the use of investment securities. We also secured federal funds borrowing lines from two of our correspondent bank. One line is for $15 million and the other is for $10 million. Traditionally, we have also borrowed from the FHLB to supplement our funding requirements. At December 31, 2010, we did not have sufficient collateral available for additional borrowings from the FHLB. In addition, due to our agreement with bank regulatory agencies, we are not allowed to accept, renew or rollover brokered deposits (including deposits through the CDARs program) without prior regulatory approval and we are limited in the rates we may pay on deposits. We believe that we have adequate funding sources through unused borrowing capacity from our correspondent banks, unpledged investment securities, loan principal repayment and potential asset maturities and sales to meet our foreseeable liquidity requirements.

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

The primary source of funding for the Corporation has been dividends and returns of investment from the Bank. Kentucky banking laws limit the amount of dividends that may be paid to the Corporation by the Bank without prior approval of the KDFI. Under these laws, the amount of dividends that may be paid in any calendar year is limited to current year’s net income, as defined in the laws, combined with the retained net income of the preceding two years, less any dividends declared during those periods. The Bank currently has a regulatory agreement with the FDIC and KDFI that requires us to obtain the consent of the Regional Director of the FDIC and the Commissioner of the KDFI to declare and pay cash dividends. The Corporation has also entered into an agreement with the Federal Reserve to obtain regulatory approval before declaring any dividends. We may not redeem shares or obtain additional borrowings without prior approval. Because of these limitations, consolidated cash flows as presented in the consolidated statements of cash flows may not represent cash immediately available to the Corporation. During 2010, the Bank declared and paid dividends of $587,000 to the Corporation. At December 31, 2010, cash held by the Corporation is $240,000.

CAPITAL

Stockholders’ equity decreased $13.8 million during 2010, primarily due to a net loss recorded during the period and an increase in unrealized loss on securities available-for-sale. Our average stockholders’ equity to average assets ratio decreased to 6.77% at December 31, 2010 compared to 8.56% at the end of 2009.

On January 9, 2009, we sold $20 million of cumulative perpetual preferred shares, with a liquidation preference of $1,000 per share (the “Senior Preferred Shares”) to the U.S. Treasury under the terms of its Capital Purchase Program. The Senior Preferred Shares constitute Tier 1 capital and rank senior to our common shares. The Senior Preferred Shares pay cumulative dividends at a rate of 5% per year for the first five years and will reset to a rate of 9% per year after five years.

Under the terms of our CPP stock purchase agreement, we also issued the U.S. Treasury a warrant to purchase an amount of our common stock equal to 15% of the aggregate amount of the Senior Preferred Shares, or $3 million. The warrant entitles the U.S. Treasury to purchase 215,983 common shares at a purchase price of $13.89 per share. The initial exercise price for the warrant and the number of shares subject to the warrant were determined by reference to the market price of our common stock calculated on a 20-day trailing average as of December 8, 2008, the date the U.S. Treasury approved our application. The warrant has a term of 10 years and is potentially dilutive to earnings per share.

On October 29, 2010, we gave written notice to the United States Treasury that we were suspending the payment of regular quarterly cash dividends on our fixed rate cumulative perpetual preferred stock, Series A (“Series A Preferred Stock”). Since the dividends are cumulative, failure to pay dividends for six quarters would trigger board appointment rights for the holder of the Series A Preferred Stock. The dividends will continue to be accrued for payment in the future and reported as a preferred dividend requirement that is deducted from income to common shareholders for financial statement purposes.

In addition to our agreement with the Federal Reserve that requires prior written consent to repurchase common shares, the terms of our Senior Preferred Shares do not allow us to repurchase shares of our common stock without the consent of the holder until the Senior Preferred Shares are redeemed. During 2010, we did not purchase any shares of our own common stock.

Each of the federal bank regulatory agencies has established minimum leverage capital requirements for banks. Banks must maintain a minimum ratio of Tier 1 capital to adjusted average quarterly assets ranging from 3% to 5%, subject to federal bank regulatory evaluation of an organization’s overall safety and soundness. We intend to maintain a capital position that meets or exceeds the “well capitalized” requirements established for banks by the FDIC. As part of an informal regulatory agreement with the FDIC, the Bank was required to maintain a Tier 1 leverage ratio of 8%. At December 31, 2010, we were not in compliance with the Tier 1 capital requirement. On January 27, 2011, the Bank entered into a Consent Order, a formal agreement with the FDIC and KDFI, under which, among other things, the Bank has agreed to achieve and maintain a Tier 1 leverage ratio of 8.5% and a total risk-based capital ratio of 11.5% by March 31, 2011 and achieve and maintain a Tier 1 leverage ratio of 9.0% and a total risk-based capital ratio of 12.0% by June 30, 2011. The Consent Order supersedes the prior informal regulatory agreement. To achieve the capital requirements that we have agreed to with the FDIC and KDFI, we are working on various specific initiatives to increase our regulatory capital and to reduce our total assets such as sales of loans, raising common stock, or the sale of branch offices or the institution.

The following table shows the ratios of Tier 1 capital, total capital to risk-adjusted assets and the leverage ratios for the Corporation and the Bank as of December 31, 2010.

	Capital Adequacy Ratios as of
	December 31, 2010
	Restated
	Regulatory			Well-Capitalized
Risk-Based Capital Ratios	Minimums			Minimums			The Bank			The Corporation
Tier 1 capital (1)		4.00	%		6.00	%		10.12	%		10.07	%
Total risk-based capital (2)		8.00	%		10.00	%		11.38	%		11.34	%
Tier 1 leverage ratio (3)		4.00	%		5.00	%		7.18	%		7.16	%

(1)

Shareholders’ equity plus corporation-obligated mandatory redeemable capital securities, less unrealized gains (losses) on debt securities available for sale, net of deferred income taxes, less non-qualifying intangible assets; computed as a ratio of risk-weighted assets, as defined in the risk-based capital guidelines.

(2)	Tier 1 capital plus qualifying loan loss allowance and subordinated debt; computed as a ratio of risk-weighted assets, as defined in the risk-based capital guidelines.

(3)	Tier 1 capital computed as a percentage of fourth quarter average assets less non-qualifying intangibles.

Although the Corporation and the Bank remain above the regulatory capital levels for “well-capitalized” standards, the Consent Order entered into between the FDIC, KDFI and the Bank has resulted in the Bank being categorized as a "troubled institution" by bank regulators, which by definition does not permit the Bank to be considered "well-capitalized" despite its current capital levels.

The Consent Order requires the Bank to achieve certain minimum capital ratios as set forth below:

				Ratio Required			Ratio Required
	Actual as of			by the Order			by the Order
	12/31/2010			at 3/31/2011			at 6/30/2011
	Restated
Total capital to risk-weighted assets		11.38	%		11.50	%		12.00	%
Tier 1 capital to average total assets		7.18	%		8.50	%		9.00	%

OFF BALANCE SHEET ARRANGEMENTS

Our off balance sheet arrangements consist of commitments to make loans, unused borrower lines of credit, and standby letters of credit, which are disclosed in Note 20 to the consolidated financial statements.

AGGREGATE CONTRACTUAL OBLIGATIONS

					Greater than		Greater than
			Less than		one year to		3 years to		More than
December 31, 2010	Total		one year		3 years		5 years		5 years
					(Dollars in thousands)
Aggregate Contractual Obligations:
Time deposits	$	703,971	$	278,617	$	360,856	$	32,036	$	32,462
FHLB borrowings		52,532		25,138		257		10,698		16,439
Subordinated debentures		18,000		-		-		-		18,000
Lease commitments		5,592		593		800		548		3,651

FHLB borrowings represent the amounts that are due to the FHLB of Cincinnati. These amounts have fixed maturity dates. Four of these borrowings, although fixed, are subject to conversion provisions at the option of the FHLB. The FHLB has the right to convert these advances to a variable rate or we can prepay the advances at no penalty. There is a substantial penalty if we prepay the advances before the FHLB exercises its right. In January 2011, one of these borrowings, a $25 million convertible fixed rate advance with an interest rate of 5.05%, matured and was paid in full. We do not believe the other three convertible fixed rate advances will be converted in the near term.

The subordinated debentures, which mature June 24, 2038 and March 22, 2037, are redeemable before the maturity date at our option on or after June 24, 2018 and March 15, 2017 at their principal amount plus accrued interest. The subordinated debentures are also redeemable in whole or in part from time to time, upon the occurrence of specific events defined within the trust indenture. The interest rate on the subordinated debentures is at a 30 year fixed rate of 8.00% and a 10 year fixed rate of 6.69% adjusting quarterly thereafter at LIBOR plus 1.60%.

Lease commitments represent the total future minimum lease payments under non-cancelable operating leases.

IMPACT OF INFLATION & CHANGING PRICES

The consolidated financial statements and related financial data presented in this filing have been prepared in accordance with U.S. generally accepted accounting principles, which require the measurement of financial position and operating results in historical dollars without considering changes in the relative purchasing power of money over time due to inflation.

The primary impact of inflation on our operations is reflected in increasing operating costs. Unlike most industrial companies, virtually all of the assets and liabilities of a financial institution are monetary in nature. As a result, changes in interest rates have a more significant impact on our performance than the effects of general levels of inflation and changes in prices. Periods of high inflation are often accompanied by relatively higher interest rates, and periods of low inflation are accompanied by relatively lower interest rates. As market interest rates rise or fall in relation to the rates earned on our loans and investments, the value of these assets decreases or increases respectively.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Asset /Liability Management and Market Risk

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

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

Our interest sensitivity profile was asset sensitive at December 31, 2010 and December 31, 2009. Given a sustained 100 basis point decrease in rates, our base net interest income would decrease by an estimated .84% at December 31, 2010 compared to a decrease of 2.84% at December 31, 2009. Given a 100 basis point increase in interest rates our base net interest income would increase by an estimated 2.69% at December 31, 2010 compared to an increase of 2.70% at December 31, 2009.

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

We use various asset/liability strategies to manage the re-pricing characteristics of our assets and liabilities designed to ensure that exposure to interest rate fluctuations is limited within our guidelines of acceptable levels of risk-taking. As demonstrated by the December 31, 2010 and December 31, 2009 sensitivity tables, our balance sheet has an asset sensitive position. This means that our earning assets, which consist of loans and investment securities, will change in price at a faster rate than our deposits and borrowings. Therefore, if short term interest rates increase, our net interest income will increase. Likewise, if short term interest rates decrease, our net interest income will decrease.

Our sensitivity to interest rate changes is presented based on data as of December 31, 2010 and 2009.

	December 31, 2010
	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	$	51,538		$	52,676		$	53,694	$	54,888		$	56,060
Investments		7,122			7,287			6,909		7,808			8,745
Total interest income		58,660			59,963			60,603		62,696			64,805

Projected interest expense
Deposits		17,668			17,764			18,068		19,048			19,278
Borrowed funds		2,491			2,491			2,490		2,525			2,554
Total interest expense		20,159			20,255			20,558		21,573			21,832

Net interest income	$	38,501		$	39,708		$	40,045	$	41,123		$	42,973
Change from base	$	(1,544	)	$	(337	)			$	1,078		$	2,928
% Change from base		(3.86	)%		(0.84	)%				2.69	%		7.31	%

	December 31, 2009
	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	$	55,484		$	56,942		$	58,564	$	60,162		$	61,850
Investments		2,271			2,116			2,150		2,552			2,953
Total interest income		57,755			59,058			60,714		62,714			64,803

Projected interest expense
Deposits		15,938			16,077			16,587		16,920			18,043
Borrowed funds		3,753			3,753			3,752		4,329			4,905
Total interest expense		19,691			19,830			20,339		21,249			22,948

Net interest income	$	38,064		$	39,228		$	40,375	$	41,465		$	41,855
Change from base	$	(2,311	)	$	(1,147	)			$	1,090		$	1,480
% Change from base		(5.72	)%		(2.84	)%				2.70	%		3.67	%

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

FIRST FINANCIAL SERVICE CORPORATION

Table of Contents

Audited Consolidated Financial Statements:

	·	Report on Management’s Assessment of Internal Control Over Financial Reporting	35
	·	Report of Independent Registered Public Accounting Firm	36
	·	Consolidated Balance Sheets	37
	·	Consolidated Statements of Operations	38
	·	Consolidated Statements of Comprehensive Income (Loss)	39
	·	Consolidated Statements of Changes in Stockholders’ Equity	40
	·	Consolidated Statements of Cash Flows	41
	·	Notes to Consolidated Financial Statements	42

Report on Management’s Assessment of Internal Control Over Financial Reporting

First Financial Service Corporation is responsible for the preparation, integrity, and fair presentation of the consolidated financial statements included in this annual report. We, as management of First Financial Service Corporation, are responsible for establishing and maintaining effective internal control over financial reporting that is designed to produce reliable financial statements in conformity with U. S. generally accepted accounting principles. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

Management assessed the system of internal control over financial reporting as of December 31, 2010, in relation to criteria for effective internal control over financial reporting as described in "Internal Control - Integrated Framework," issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment, management concludes that, as of December 31, 2010, its system of internal control over financial reporting was not effective. See “Item 9A. Controls and Procedures” for further discussion of the material weakness related to controls over the appraisal review process. This annual report does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by our registered public accounting firm pursuant to rules of the Securities and Exchange Commission that permit us to provide only management’s report in this annual report.

Date: May 13, 2011	By:	B. Keith Johnson
		Chief Executive Officer

Date: May 13, 2011	By:	Gregory S. Schreacke
		President
		Chief Financial Officer &
		Principal Accounting Officer

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Board of Directors and Stockholders

First Financial Service Corporation

Elizabethtown, Kentucky

We have audited the accompanying consolidated balance sheets of First Financial Service Corporation as of December 31, 2010 and 2009, and the related consolidated statements of operations, comprehensive income (loss), changes in stockholders' equity and cash flows for each of the three years in the period ended December 31, 2010. The financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purposes of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2010 and 2009, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2010, in conformity with U.S. generally accepted accounting principles.

As discussed in Note 2 to the consolidated financial statements, the Company has incurred substantial losses in 2010 and 2009. In addition, on January 27, 2011, the Company’s subsidiary, First Federal Savings Bank, entered into a consent order with its regulators which requires among other things, that First Federal Savings Bank achieve and maintain elevated regulatory capital levels. Management’s plans with regard to these matters are also discussed in Note 2.

As discussed in Note 23, the Company restated its 2010 financial statements to correct errors related to other real estate acquired through foreclosure, bank franchise tax expense, legal expense and health insurance.



	Crowe Horwath LLP

Louisville, Kentucky

March 31, 2011, except for Notes 2,5,6,14,15,16,19,22,23 as to which the date is May 11, 2011

FIRST FINANCIAL SERVICE CORPORATION

Consolidated Balance Sheets

	December 31,
(Dollars in thousands, except per share data)	2010			2009
	Restated (1)
ASSETS:
Cash and due from banks	$	14,840		$	21,253
Interest bearing deposits		151,336			77,280
Total cash and cash equivalents		166,176			98,533

Securities available-for-sale		196,029			45,764
Securities held-to-maturity, fair value of $126 (2010) and $1,176 (2009)		124			1,167
Total securities		196,153			46,931

Loans held for sale		6,388			8,183
Loans, net of unearned fees		881,934			994,926
Allowance for loan losses		(22,665	)		(17,719	)
Net loans		865,657			985,390

Federal Home Loan Bank stock		4,909			8,515
Cash surrender value of life insurance		9,354			9,008
Premises and equipment, net		31,988			31,965
Real estate owned:
Acquired through foreclosure		25,807			8,428
Held for development		45			45
Other repossessed assets		40			103
Core deposit intangible		994			1,300
Accrued interest receivable		6,404			5,658
Accrued income taxes		2,161			-
Deferred income taxes		2,982			4,515
Prepaid FDIC premium		4,449			7,022
Other assets		2,388			2,091

TOTAL ASSETS	$	1,319,507		$	1,209,504

LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Deposits:
Non-interest bearing	$	73,566		$	63,950
Interest bearing		1,100,342			985,865
Total deposits		1,173,908			1,049,815

Short-term borrowings		-			1,500
Advances from Federal Home Loan Bank		52,532			52,745
Subordinated debentures		18,000			18,000
Accrued interest payable		594			360
Accounts payable and other liabilities		3,162			1,952

TOTAL LIABILITIES		1,248,196			1,124,372
Commitments and contingent liabilities (See Note 20)		-			-

STOCKHOLDERS' EQUITY:
Serial preferred stock, $1 par value per share; authorized 5,000,000 shares; issued and outstanding, 20,000 shares with a liquidation preference of $20,000		19,835			19,781
Common stock, $1 par value per share; authorized 35,000,000 shares; issued and outstanding, 4,726,329 shares (2010), and 4,709,839 shares (2009)		4,726			4,710
Additional paid-in capital		35,201			34,984
Retained earnings		16,264			26,720
Accumulated other comprehensive loss		(4,715	)		(1,063	)

TOTAL STOCKHOLDERS' EQUITY		71,311			85,132
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY	$	1,319,507		$	1,209,504

See notes to the consolidated financial statements.

(1) Refer to Note 23.

FIRST FINANCIAL SERVICE CORPORATION

Consolidated Statements of Operations

(Dollars in thousands, except per share data)	Year Ended December 31,
	2010			2009			2008
Interest and Dividend Income:	Restated (1)
Loans, including fees	$	54,977		$	57,113		$	55,739
Taxable securities		3,703			1,234			1,429
Tax exempt securities		885			509			396
Total interest income		59,565			58,856			57,564

Interest Expense:
Deposits		19,729			17,917			20,512
Short-term borrowings		38			152			896
Federal Home Loan Bank advances		2,388			2,405			2,413
Subordinated debentures		1,330			1,318			978
Total interest expense		23,485			21,792			24,799

Net interest income		36,080			37,064			32,765
Provision for loan losses		16,881			9,524			5,947
Net interest income after provision for loan losses		19,199			27,540			26,818

Non-interest Income:
Customer service fees on deposit accounts		6,479			6,677			6,601
Gain on sale of mortgage loans		1,760			1,194			697
Gain on sale of investments		37			-			55
Other than temporary impairment loss:
Total other-than-temporary impairment losses		(1,048	)		(1,077	)		(516	)
Portion of loss recognized in other comprehensive income/(loss) (before taxes)		-			215			-
Net impairment losses recognized in earnings		(1,048	)		(862	)		(516	)
Loss on sale and write downs on real estate acquired through foreclosure		(2,333	)		(578	)		(162	)
Brokerage commissions		413			373			469
Other income		1,996			1,715			1,305
Total non-interest income		7,304			8,519			8,449

Non-interest Expense:
Employee compensation and benefits		15,718			15,834			14,600
Office occupancy expense and equipment		3,174			3,271			2,865
Marketing and advertising		715			844			782
Outside services and data processing		2,720			3,194			3,324
Bank franchise tax		2,060			960			1,010
FDIC insurance premiums		2,713			1,900			716
Goodwill impairment		-			11,931			-
Amortization of intangible assets		396			510			284
Real estate acquired through foreclosure expense		1,678			668			472
Other expense		4,945			4,805			4,233
Total non-interest expense		34,119			43,917			28,286

Income/(loss) before income taxes		(7,616	)		(7,858	)		6,981
Income taxes/(benefits)		1,786			(1,149	)		2,184
Net income/(loss)		(9,402	)		(6,709	)		4,797
Less:
Dividends on preferred stock		(1,000	)		(980	)		-
Accretion on preferred stock		(54	)		(52	)		-
Net income/(loss) attributable to common shareholders	$	(10,456	)	$	(7,741	)	$	4,797

Shares applicable to basic income per common share		4,724			4,695			4,666
Basic income/(loss) per common share	$	(2.21	)	$	(1.65	)	$	1.03

Shares applicable to diluted income per common share		4,724			4,695			4,686
Diluted income/(loss) per common share	$	(2.21	)	$	(1.65	)	$	1.02

Cash dividends declared per common share	$	-		$	0.43		$	0.76

See notes to the consolidated financial statements.

(1) Refer to Note 23.

FIRST FINANCIAL SERVICE CORPORATION

Consolidated Statements of Comprehensive Income/(Loss)

	Year Ended December 31,
(Dollars in thousands)	2010			2009			2008
	Restated (1)
Net Income/(Loss)	$	(9,402	)	$	(6,709	)	$	4,797
Other comprehensive income (loss):
Change in unrealized gain (loss) on securities available-for-sale		(4,590	)		1,215			(3,529	)
Change in unrealized gain (loss) on securities available-for-sale for which a portion of other-than-temporary impairment has been recognized into earnings		(84	)		62			-
Reclassification of realized amount on securities available-for-sale losses (gains)		961			831			461
Non-credit component of other-than- temporary impairment on held-to-maturity securities		-			(215	)		-
Reclassification of unrealized loss on held-to-maturity security recognized in income		50			31			-
Accretion (amortization) of non-credit component of other-than-temporary impairment on held-to-maturity securities		(2	)		6			-
Net unrealized gain (loss) recognized in comprehensive income		(3,665	)		1,930			(3,068	)
Tax effect		13			(656	)		1,043
Total other comphrehensive income (loss)		(3,652	)		1,274			(2,025	)

Comprehensive Income/(Loss)	$	(13,054	)	$	(5,435	)	$	2,772

The following is a summary of the accumulated other comprehensive income balances, net of tax:

	Balance			Current			Balance
	at			Period			at
	12/31/2009			Change			12/31/2010
Unrealized gains (losses) on securities available-for-sale	$	(1,404	)	$	(4,287	)	$	(5,691	)
Unrealized gains (losses) on available-for-sale securities for which OTTI has been recorded,		479			603			1,082
Unrealized gains (losses) on held-to-maturity securities for which OTTI has been recorded, net of accretion		(138	)		32			(106	)

Total	$	(1,063	)	$	(3,652	)	$	(4,715	)

See notes to the consolidated financial statements.

(1) Refer to Note 23.

FIRST FINANCIAL SERVICE CORPORATION

Consolidated Statements of Changes in Stockholders' Equity

Years Ending December 31, 2010, 2009 and 2008

(Dollars In Thousands, Except Per Share Amounts)

	Shares				Amount				Additional Paid-in		Retained			Accumulated Other Comprehensive (Loss), Net of
	Preferred		Common		Preferred		Common		Capital		Earnings			Tax			Total
Balance, January 1, 2008		-		4,661	$	-	$	4,661	$	33,886	$	35,225		$	(312	)	$	73,460
Net income												4,797						4,797
Stock issued for employee benefit plans				7				7		137								144
Stock-based compensation expense										122								122
Net change in unrealized gains (losses) on securities available- for-sale, net of tax															(2,025	)		(2,025	)
Cash dividends declared ($.76 per share)		-		-		-		-		-		(3,546	)		-			(3,546	)
Balance, December 31, 2008		-		4,668		-		4,668		34,145		36,476			(2,337	)		72,952
Net loss												(6,709	)					(6,709	)
Issuance of preferred stock and a common stock warrant		20,000				19,729				271								20,000
Shares issued under dividend reinvestment program				22				22		281								303
Stock issued for stock options exercised				12				12		89								101
Stock issued for employee benefit plans				8				8		95								103
Stock-based compensation expense										103								103
Net change in unrealized gains (losses) on securities available- for-sale, net of tax															933			933
Unrealized loss on held-to-maturity securities for which an other-than-temporary impairment charge has been recorded, net of tax															(138	)		(138	)
Change in unrealized gains (losses) on securities available-for-sale for which a portion of an other-than-temporary impairment charge has been recognized into earnings, net of reclassification and taxes															479			479
Dividends on preferred stock												(980	)					(980	)
Accretion of preferred stock discount						52						(52	)					-
Cash dividends declared ($.43 per share)		-		-		-		-		-		(2,015	)		-			(2,015	)
Balance, December 31, 2009		20,000		4,710		19,781		4,710		34,984		26,720			(1,063	)		85,132
Net loss - Restated												(9,402	)					(9,402	)
Shares issued under dividend reinvestment program				2				2		15								17
Stock issued for employee benefit plans				14				14		102								116
Stock-based compensation expense										100								100
Net change in unrealized gains (losses) on securities available-for-sale															(4,287	)		(4,287	)
Change in unrealized gains (losses) on held-to-maturity securities for which an other-than-temporary impairment charge has been recorded															32			32
Change in unrealized gains (losses) on securities available-for-sale for which a portion of an other-than-temporary impairment charge has been recognized into earnings, net of reclassification															603			603
Dividends on preferred stock												(1,000	)					(1,000	)
Accretion of preferred stock discount		-		-		54		-		-		(54	)		-			-
Balance, December 31, 2010-Restated (1)		20,000		4,726	$	19,835	$	4,726	$	35,201	$	16,264		$	(4,715	)	$	71,311

See notes to the consolidated financial statements.

(1) Refer to Note 23.

FIRST FINANCIAL SERVICE CORPORATION

Consolidated Statements of Cash Flows

(Dollars in thousands)	Year Ended December 31,
	2010			2009			2008
Operating Activities:	Restated (1)
Net income/(loss)	$	(9,402	)	$	(6,709	)	$	4,797
Adjustments to reconcile net income/(loss) to net cash provided by operating activities:
Provision for loan losses		16,881			9,524			5,947
Depreciation on premises and equipment		1,764			1,738			1,592
Income tax valuation allowance		6,024			-			-
Loss on impairment of goodwill		-			11,931			-
Federal Home Loan Bank stock dividends		-			-			(309	)
Intangible asset amortization		396			510			284
Net amortization (accretion) available-for-sale		(1,610	)		(101	)		(3	)
Net amortization (accretion) held-to-maturity		-			9			10
Impairment loss on securities available-for-sale		998			831			516
Impairment loss on securities held-to-maturity		50			31			-
Gain on sale of investments available-for-sale		(37	)		-			(55	)
Gain on sale of mortgage loans		(1,760	)		(1,194	)		(697	)
Origination of loans held for sale		(131,599	)		(130,893	)		(58,332	)
Proceeds on sale of loans held for sale		135,154			133,471			50,242
Deferred taxes		(4,478	)		(4,024	)		(1,785	)
Stock-based compensation expense		100			103			122
Prepaid FDIC premium		2,573			(7,022	)		-
Changes in:
Cash surrender value of life insurance		(346	)		(354	)		(364	)
Interest receivable		(746	)		(1,279	)		(55	)
Other assets		410			(747	)		54
Interest payable		234			72			(933	)
Accrued income tax		(2,161	)		(224	)		(129	)
Accounts payable and other liabilities		1,210			(416	)		83
Net cash from operating activities		13,655			5,257			985

Investing Activities:
Cash paid for acquisition of Farmers State Bank, net of cash acquired		-			-			(1,466	)
Sales of securities available-for-sale		685			-			669
Purchases of securities available-for-sale		(243,155	)		(30,811	)		(524	)
Maturities of securities available-for-sale		89,141			2,231			2,557
Maturities of securities held-to-maturity		1,041			5,606			13,161
Net change in loans		82,944			(99,377	)		(92,055	)
Redemption of Federal Home Loan Bank stock		3,606			-			-
Net purchases of premises and equipment		(1,787	)		(3,635	)		(4,306	)
Net cash from investing activities		(67,525	)		(125,986	)		(81,964	)

Financing Activities
Net change in deposits		124,093			274,416			30,405
Change in short-term borrowings		(1,500	)		(93,369	)		52,069
Repayments to Federal Home Loan Bank		(213	)		(202	)		(136	)
Proceeds from issuance of subordinated debentures		-			-			8,000
Issuance of preferred stock, net		-			20,000			-
Issuance of common stock under dividend reinvestment program		17			303			-
Issuance of common stock for stock options exercised		-			101			-
Issuance of common stock for employee benefit plans		116			103			144
Dividends paid on common stock		-			(2,015	)		(3,546	)
Dividends paid on preferred stock		(1,000	)		(980	)		-
Net cash from financing activities		121,513			198,357			86,936

Increase in cash and cash equivalents		67,643			77,628			5,957
Cash and cash equivalents, beginning of year		98,533			20,905			14,948
Cash and cash equivalents, end of year	$	166,176		$	98,533		$	20,905

See notes to the consolidated financial statements.

(1) Refer to Note 23.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1.	SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The following is a description of the significant accounting policies First Financial Service Corporation follows in preparing and presenting its consolidated financial statements:

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

Our business consists primarily of attracting deposits from the general public and origination of mortgage loans on commercial property, single-family residences and multi-family housing. We also make home improvement loans, consumer loans and commercial business loans. Our primary lending area is a region within North Central Kentucky and Southern Indiana. The economy within this region is diversified with a variety of medical service, manufacturing, and agricultural industries, and Fort Knox, a military installation.

The principal sources of funds for our lending and investment activities are deposits, repayment of loans, Federal Home Loan Bank advances and other borrowings. Our principal source of income is interest on loans. In addition, other income is derived from loan origination fees, service charges, returns on investment securities, gain on sale of mortgage loans, and brokerage and insurance commissions.

Our subsidiary First Service Corporation is a licensed broker providing investment services and offering tax-deferred annuities, government securities and stocks and bonds to our customers. Heritage Properties, LLC holds real estate acquired through foreclosure which is available for sale. First Federal Office Park, LLC, another subsidiary, holds a commercial lot adjacent to our home office on Ring Road in Elizabethtown, which is available for sale.

Estimates and Assumptions – The preparation of consolidated financial statements in conformity with U.S. generally accepted accounting principles requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of the amount of revenues and expenses during the reporting period. Actual results could differ from those estimates. The allowance for loan losses, fair value of financial instruments, other real estate owned and deferred tax asset realization are particularly subject to change.

Cash Flows – For purposes of the statement of cash flows, we consider all highly liquid debt instruments purchased with an original maturity of three months or less to be cash equivalents. Cash and cash equivalents include cash on hand, amounts due from banks, federal funds sold and certain interest bearing deposits. Net cash flows are reported for interest-bearing deposits, loans, short-term borrowings and deposits.

Securities – We classify investments into held-to-maturity and available-for-sale. Debt securities in which management has a positive intent and ability to hold are classified as held-to-maturity and are carried at cost adjusted for the amortization of premiums and discounts using the interest method over the terms of the securities. Debt and equity securities, which do not fall into this category, are classified as available-for-sale. Unrealized holding gains and losses, net of tax, on available-for-sale securities are reported as a component of accumulated other comprehensive income.

Interest income includes amortization of purchase premium or discount. Premiums and discounts on securities are amortized on the level-yield method without anticipating prepayments, except for mortgage backed securities where prepayments are anticipated. Gains and losses on sales are recorded on the trade date and determined using the specific identification method.

Management evaluates securities for other-than-temporary impairment (“OTTI”) on at least a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. For securities in an unrealized loss position, management considers the extent and duration of the unrealized loss, and the financial condition and near-term prospects of the issuer. Management also assesses whether it intends to sell, or it is more likely than not that it will be required to sell, a security in an unrealized loss position before recovery of its amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the entire difference between amortized cost and fair value is recognized as impairment through earnings. For debt securities that do not meet the aforementioned criteria, the amount of impairment is split into two components as follows: 1) OTTI related to credit loss, which must be recognized in the income statement and 2) other-than-temporary impairment (OTTI) related to other factors, which is recognized in other comprehensive income. The credit loss is defined as the difference between the present value of the cash flows expected to be collected and the amortized cost basis. For equity securities, the entire amount of impairment is recognized through earnings.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1.	SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – (Continued)

Loans – Loans are stated at unpaid principal balances, less undistributed construction loans, and net deferred loan origination fees. We defer loan origination fees and discounts net of certain direct origination costs. These net deferred fees are amortized using the level yield method on a loan-by-loan basis over the lives of the underlying loans.

Interest income on mortgage and commercial loans is discontinued at the time the loan is 90 days delinquent unless the loan is well-secured and in process of collection. Consumer and credit card loans are typically charged off no later than 120 days past due. Past due status is based on the contractual terms of the loan. In all cases, loans are placed on nonaccrual or charged-off at an earlier date if collection of principal or interest is considered doubtful. Nonaccrual loans and loans past due 90 days still on accrual include both smaller balance homogeneous loans that are collectively evaluated for impairment and individually classified impaired loans. A loan is moved to non-accrual status in accordance with our policy, typically after 90 days of non-payment.

All interest accrued but not received for loans placed on nonaccrual is reversed against interest income. Interest received on such loans is accounted for on the cash-basis or cost recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

Allowance for Loan Losses –The allowance for loan losses is a valuation allowance for probable incurred credit losses. Loan losses are charged against the allowance when we believe the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. Our periodic evaluation of the allowance is based on our past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral, and current economic conditions. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management’s judgment, should be charged-off.

The allowance consists of specific and general components. The specific component relates to loans that are individually classified as impaired or loans otherwise classified as substandard or doubtful. The general component covers non-classified loans and is based on historical loss experience adjusted for current factors. The historical loss experience is determined by portfolio segment and is based on the actual loss history we have experienced over the most recent three years. This actual loss experience is supplemented with other economic factors based on the risks present for each portfolio segment. These economic factors include consideration of the following: levels of and trends in delinquencies and impaired loans; levels of and trends in charge-offs and recoveries; trends in volume and terms of loans; effects of any changes in risk selection and underwriting standards; other changes in lending policies, procedures, and practices; experience, ability, and depth of lending management and other relevant staff; national and local economic trends and conditions; industry conditions; and effects of changes in credit concentrations. The following portfolio segments have been identified: commercial, commercial real estate, construction real estate, residential mortgage, consumer and home equity, and indirect consumer.

Commercial, commercial real estate, construction real estate, residential mortgage, consumer and home equity, and indirect consumer loans are considered impaired when, based on current information and events, it is probable that full principal or interest payments are not anticipated in accordance with the contractual loan terms. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. We determine the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. If a loan is impaired, a portion of the allowance is allocated so that the loan is reported, net, at the present value of estimated future cash flows using the loan’s existing rate, or at the fair value of collateral if repayment is expected solely from collateral. If these allocations cause the allowance for loan losses to require an increase, such increase is reported in the provision for loan losses. We classify all substandard, doubtful and loss classified loans as impaired.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1.	SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – (Continued)

Commercial, commercial real estate and construction real estate loans are individually evaluated for impairment. Individual residential mortgage, consumer and home equity and indirect consumer loans are evaluated for impairment based on regulatory guidelines and are separately identified for impairment disclosures. When the ultimate collectability of the total principal of an impaired loan is in doubt and the loan is on nonaccrual status, all payments are applied to principal under the cost recovery method. When the ultimate collectability of the total principal of an impaired loan is not in doubt and the loan is on nonaccrual status, contractual interest is credited to interest income when received under the cash basis method. Troubled debt restructurings consist of loans in which terms have been modified due to adverse changes in the borrower’s financial position. Troubled debt restructurings are measured at the present value of estimated future cash flows using the loan’s effective rate at inception.

Mortgage Banking Activities – Mortgage loans originated and intended for sale in the secondary market are carried at the lower of aggregate cost or market value. To deliver closed loans to the secondary market and to control its interest rate risk prior to sale, we enter into “best efforts” agreements to sell loans. The aggregate market value of mortgage loans held for sale considers the price of the sales contracts. The loans are sold with servicing released.

Loan commitments related to the origination of mortgage loans held for sale are accounted for as derivative instruments. Our commitments are for fixed rate mortgage loans, generally lasting 60 to 90 days and are at market rates when initiated. Considered derivatives, we had commitments to originate $3.5 million and $5.8 million in loans at December 31, 2010 and 2009, which we intend to sell after the loans are closed.

The fair value was not material. Substantially all of the gain on sale generated from mortgage banking activities continues to be recorded when closed loans are delivered into the sales contracts.

Federal Home Loan Bank Stock – The Bank is a member of the FHLB system. Members are required to own a certain amount of stock based on the level of borrowings and other factors, and may invest in additional amounts. Investment in stock of Federal Home Loan Bank is carried at cost, and periodically evaluated for impairment. Both cash and stock dividends are reported as income.

Cash Surrender Value of Life Insurance – We have purchased life insurance policies on certain key executives. Company owned life insurance is recorded at the amount that can be realized under the insurance contract at the balance sheet date, which is the cash surrender value adjusted for other charges or other amounts due that are probable at settlement.

Premises and Equipment – Land is carried at cost. Premises and equipment are stated at cost less accumulated depreciation. Buildings and related components are depreciated using the straight-line method with useful lives ranging from 5 to 40 years. Furniture, fixtures and equipment are depreciated using the straight-line method with useful lives ranging from 3 to 15 years.

Real Estate Owned – Real estate properties acquired through foreclosure and in settlement of loans are stated at fair value less estimated selling costs at the date of foreclosure. The excess of cost over fair value less the estimated costs to sell at the time of foreclosure is charged to the allowance for loan losses. Costs relating to development and improvement of property are capitalized when such amounts do not exceed fair value. Costs relating to holding property are not capitalized and are charged against operations in the current period.

Real Estate Held for Development – Real estate properties held for development and sale are carried at the lower of cost, including cost of development and improvement subsequent to acquisition, or fair value less estimated selling costs. The portion of interest costs relating to the development of real estate is capitalized.

Other Repossessed Assets – Consumer assets acquired through repossession and in settlement of loans, typically automobiles, are carried at lower of cost or fair value at the date of repossession. The excess cost over fair value at time of repossession is charged to the allowance for loan losses.

Intangible Assets – Other intangible assets consist of core deposit and acquired customer relationship intangible assets arising from whole bank and branch acquisitions. They are initially measured at fair value and then are amortized on an accelerated method over their estimated useful lives, which range from 7 to 10 years.

Long-Term Assets – Premises and equipment, core deposit and other intangible assets, and other long-term assets are reviewed for impairment when events indicate their carrying amount may not be recoverable from future undiscounted cash flows. If impaired, the assets are recorded at fair value.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1.	SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – (Continued)

Brokerage and Insurance Commissions – Brokerage commissions are recognized as income on settlement date. Insurance commissions on loan products (credit life, mortgage life, accidental death, and guaranteed auto protection) are recognized as income over the life of the loan.

Stock Based Compensation – Compensation cost is recognized for stock options and restricted stock awards issued to employees, based on the fair value of these awards at the date of grant. A Black-Scholes model is utilized to estimate the fair value of stock options, while the market price of our common stock at the date of grant is used for restricted stock awards. Compensation cost is recognized over the required service period, generally defined as the vesting period. For awards with graded vesting, compensation cost is recognized on a straight-line basis over the requisite service period for the entire award.

Income Taxes – Income tax expense is the total of the current year income tax due or refundable and the change in deferred tax assets and liabilities. Deferred tax assets and liabilities are the expected future tax amounts for the temporary differences between carrying amounts and tax bases of assets and liabilities, computed using enacted tax rates. A valuation allowance, if needed, reduces deferred tax assets to the amount expected to be realized. A tax position is recognized as a benefit only if it is “more likely than not” that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being realized on examination. For tax positions not meeting the “more likely than not” test, no tax benefit is recorded. We recognize interest and penalties related to income tax matters in income tax expense.

Employee Stock Ownership Plan – Compensation expense is based on the market price of shares as they are committed to be released to participant accounts. Dividends on allocated ESOP shares reduce retained earnings. Since the ESOP has not acquired shares in advance of allocation to participant accounts, the plan has no unallocated shares.

Earnings/(Loss) Per Common Share – Basic earnings (loss) per common share is net income attributable to common shareholders divided by the weighted average number of common shares outstanding during the period. Diluted earnings per common share include the dilutive effect of additional potential common shares issuable under stock options and warrants. Earnings (loss) and dividends per share are restated for all stock dividends through the date of issuance of the financial statements.

Loss Contingencies – In the normal course of business, there are various outstanding legal proceedings and claims. In the opinion of management the disposition of such legal proceedings and claims will not materially affect our consolidated financial position, results of operations or liquidity.

Comprehensive Income/(Loss) – Comprehensive income (loss) consists of net income (loss) and other comprehensive income (loss). Other comprehensive income (loss) includes unrealized gains and losses on securities available-for-sale and the unrecognized loss on held-to-maturity securities for which an other-than-temporary charge has been recorded, which are also recognized as a separate component of equity, net of tax.

Loan Commitments and Related Financial Instruments – Financial instruments include off-balance sheet credit instruments, such as commitments to make loans and commercial letters of credit, issued to meet customer financing needs. The face amount for these items represents the exposure to loss, before considering customer collateral or ability to repay. Such financial instruments are recorded when they are funded.

Dividend Restriction – Banking regulations require maintaining certain capital levels and may limit the dividends paid by the bank to the holding company or by the holding company to shareholders.

Fair Value of Financial Instruments – Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed in a separate note. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments, and other factors, especially in the absence of broad markets for particular items. Changes in assumptions or in market conditions could significantly affect the estimates.

Operating Segments – Segments are parts of a company evaluated by management with separate financial information. Our internal financial information is primarily reported and evaluated in three lines of business, banking, mortgage banking, and brokerage. These segments are dominated by banking at a magnitude for which separate individual segment disclosures are not required.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1.	SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – (Continued)

Reclassifications – Some items in the prior year financial statements were reclassified to conform to the current presentation.

Adoption of New Accounting Standards – FASB ASU 2010-20, Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses, was issued in July 2010. The new disclosure guidance significantly expands the existing requirements and leads to greater transparency into a company’s exposure to credit losses from lending arrangements. The extensive new disclosures of information as of the end of a reporting period became effective for both interim and annual reporting periods ending after December 15, 2010. Specific items regarding activity that occurred before the issuance of the ASU, such as the allowance roll-forward and modification disclosures, will be required for periods beginning after December 15, 2010. The new standard did not have a material impact.

FASB ASC 860, Transfers and Servicing, was issued in June 2009. This statement amends and removes the concept of a qualifying special-purpose entity and limits the circumstances in which a financial asset, or portion of a financial asset, should be derecognized when the transferor has not transferred the entire financial asset to an entity that is not consolidated with the transferor in the financial statements being presented and/or when the transferor has continuing involvement with the transferred financial asset. The new standard became effective for us on January 1, 2010 and did not have a material impact.

FASB ASC 810, Consolidations, was also issued in June 2009 and amends tests for variable interest entities to determine whether a variable interest entity must be consolidated. This standard requires an entity to perform an analysis to determine whether an entity’s variable interest or interests give it a controlling financial interest in a variable interest entity. This statement requires ongoing reassessments of whether an entity is the primary beneficiary of a variable interest entity and enhanced disclosures that provide more transparent information about an entity’s involvement with a variable interest entity. The new standard became effective for us on January 1, 2010 and did not have a material impact.

2.	RECENT DEVELOPMENTS AND REGULATORY MATTERS

We recorded a net loss to common shareholders of $10.5 million in 2010, and $7.7 million in 2009. These losses were mainly a result of deterioration in our commercial real estate loan portfolio, goodwill impairment in 2009 of $11.9 million and a charge to establish an allowance against the realization of our deferred tax asset of $4.8million in 2010. See Note 14 for additional information regarding our deferred tax asset.

In 2009, as part of an informal regulatory agreement with the FDIC, the Bank agreed to maintain a Tier 1 leverage ratio of 8%. At December 31, 2010, we were not in compliance with the Tier 1 capital requirement. On January 27, 2011, the Bank entered into a Consent Order, a formal agreement with the FDIC and KDFI, under which, among other things, the Bank has agreed to achieve and maintain a Tier 1 leverage ratio of 8.5% and a total risk-based capital ratio of 11.5% by March 31, 2011 and achieve and maintain a Tier 1 leverage ratio of 9.0% and a total risk-based capital ratio of 12.0% by June 30, 2011. A copy of the Consent Order is set forth as Exhibit 10.1 of the Form 8-K filed with the SEC on January 27, 2011. The Consent Order supersedes the prior informal regulatory agreement.

In order to meet these capital requirements, the Board of Directors and management are continuing to evaluate strategies including the following:

Raising capital by selling capital stock through a public offering or private placement.

Evaluating other strategic alternatives, such as a sale of assets, one or more branches, or the institution.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

3.	SECURITIES

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

			Gross		Gross
(Dollars in thousands)	Amortized		Unrealized		Unrealized
	Cost		Gains		Losses			Fair Value
Securities available-for-sale:
December 31, 2010:
U.S. Treasury and agencies	$	117,886	$	97	$	(4,090	)	$	113,893
Government-sponsored mortgage-backed residential		59,320		448		(598	)		59,170
Equity		299		-		(6	)		293
State and municipal		22,564		264		(210	)		22,618
Trust preferred securities		1,074		-		(1,019	)		55

Total	$	201,143	$	809	$	(5,923	)	$	196,029

December 31, 2009:
U.S. Treasury and agencies	$	20,000	$	80	$	-		$	20,080
Government-sponsored mortgage-backed residential		9,632		171		(51	)		9,752
Equity		933		60		(3	)		990
State and municipal		14,604		399		(110	)		14,893
Trust preferred securities		1,983		-		(1,934	)		49

Total	$	47,152	$	710	$	(2,098	)	$	45,764

			Gross		Gross
	Amortized		Unrecognized		Unrecognized
	Cost		Gains		Losses		Fair Value
Securities held-to-maturity:
December 31, 2010:
Government-sponsored mortgage-backed residential	$	102	$	2	$	-	$	104
Trust preferred securities		22		-		-		22

Total	$	124	$	2	$	-	$	126

December 31, 2009:
Government-sponsored mortgage-backed residential	$	902	$	6	$	-	$	908
State and municipal		245		3		-		248
Trust preferred securities		20		-		-		20

Total	$	1,167	$	9	$	-	$	1,176

The amortized cost and fair value of securities at December 31, 2010, by contractual maturity, are shown below. Securities not due at a single maturity date, primarily mortgage-backed and equity securities, are shown separately.

	Available for Sale				Held-to-Maturity
	Amortized		Fair		Amortized		Fair
(Dollars in thousands)	Cost		Value		Cost		Value

Due in one year or less	$	-	$	-	$	-	$	-
Due after one year through five years		10,515		10,558		-		-
Due after five years through ten years		28,920		28,689		-		-
Due after ten years		102,089		97,319		22		22
Government-sponsored mortgage-backed residential		59,320		59,170		102		104
Equity		299		293		-		-
	$	201,143	$	196,029	$	124	$	126

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

3.	SECURITIES – (Continued)

The following schedule shows the proceeds from sales of available-for-sale securities and the gross realized gains on those sales:

	Year Ended December 31,
	2010		2009		2008
	(Dollars in thousands)

Proceeds from sales	$	685	$	-	$	669
Gross realized gains		37		-		55

Tax expense related to the realized gains was $13,000 $0, and $19,000, respectively.

Investment securities pledged to secure public deposits and FHLB advances had an amortized cost of $66.8 million and fair value of $65.1 million at December 31, 2010 and a $28.6 million amortized cost and a $28.8 fair value at December 31, 2009.

Securities with unrealized losses at year end 2010 and 2009 aggregated by major security type and length of time in a continuous unrealized loss position are as follows:

(Dollars in thousands)
December 31, 2010	Less than 12 Months					12 Months or More					Total
	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
Description of Securities	Value		Loss			Value		Loss			Value		Loss

U.S. Treasury and agencies	$	70,896	$	(4,090	)	$	-	$	-		$	70,896	$	(4,090	)
Government-sponsored mortgage-backed residential		22,084		(598	)		-		-			22,084		(598	)
Equity		3		(6	)		-		-			3		(6	)
State and municipal		11,095		(157	)		527		(53	)		11,622		(210	)
Trust preferred securities		-		-			55		(1,019	)		55		(1,019	)

Total temporarily impaired	$	104,078	$	(4,851	)	$	582	$	(1,072	)	$	104,660	$	(5,923	)

December 31, 2009	Less than 12 Months					12 Months or More					Total
	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
Description of Securities	Value		Loss			Value		Loss			Value		Loss

Government-sponsored mortgage-backed residential	$	5,141	$	(51	)	$	-	$	-		$	5,141	$	(51	)
Equity		75		(3	)		-		-			75		(3	)
State and municipal		1,161		(22	)		2,456		(88	)		3,617		(110	)
Trust preferred securities		-		-			49		(1,934	)		49		(1,934	)

Total temporarily impaired	$	6,377	$	(76	)	$	2,505	$	(2,022	)	$	8,882	$	(2,098	)

Accounting guidance requires entities to split other than temporary impairment charges between credit losses (i.e., the loss based on the entity’s estimate of the decrease in cash flows, including those that result from expected voluntary prepayments), which are charged to earnings, and the remainder of the impairment charge (non-credit component) to accumulated other comprehensive income. This requirement pertains to both securities held to maturity and securities available for sale.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

3.	SECURITIES – (Continued)

The unrealized losses on our U. S. Treasury and agency securities and our government sponsored mortgage-backed residential securities were a result of changes in interest rates for fixed-rate securities where the interest rate received is less than the current rate available for new offerings of similar securities. Because the decline in market value is attributable to changes in interest rates and not credit quality, and because we do not intend to sell and it is more likely than not that we will not be required to sell these investments until recovery of fair value, which may be maturity, we do not consider these investments to be other-than-temporarily impaired at December 31, 2010.

As discussed in Note 5 - Fair Value, the fair value of our portfolio of trust preferred securities, has decreased significantly as a result of the current credit crisis and lack of liquidity in the financial markets. There are limited trades in trust preferred securities and the majority of holders of such instruments have elected not to participate in the market unless they are required to sell as a result of liquidation, bankruptcy, or other forced or distressed conditions.

To determine if the five trust preferred securities were other than temporarily impaired as of December 31, 2010, we used a discounted cash flow analysis. The cash flow models were used to determine if the current present value of the cash flows expected on each security were still equivalent to the original cash flows projected on the security when purchased. The cash flow analysis takes into consideration assumptions for prepayments, defaults and deferrals for the underlying pool of banks, insurance companies and REITs.

Management works with independent third parties to identify its best estimate of the cash flow expected to be collected. If this estimate results in a present value of expected cash flows that is less than the amortized cost basis of a security (that is, credit loss exists), an OTTI is considered to have occurred. If there is no credit loss, any impairment is considered temporary. The cash flow analysis we performed included the following general assumptions:

We assume default rates on individual entities behind the pools based on Fitch ratings for financial institutions and A.M. Best ratings for insurance companies. These ratings are used to predict the default rates for the next several quarters. Two of the trust preferred securities hold a limited number of real estate investment trusts (REITs) in their pools. REITs are evaluated on an individual basis to predict future default rates.

We assume that annual defaults for the remaining life of each security will be 37.5 basis points.

We assume a recovery rate of 15% on deferrals after two years.

We assume 2% prepayments through the five year par call and then 2% per annum for the remaining life of the security.

Our securities have been modeled using the above assumptions by FTN Financial using the forward LIBOR curve plus original spread to discount projected cash flows to present values.

Additionally, in making our determination, we considered all available market information that could be obtained without undue cost and effort, and considered the unique characteristics of each trust preferred security individually by assessing the available market information and the various risks associated with that security including:

Valuation estimates provided by our investment broker;

The amount of fair value decline;

How long the decline in fair value has existed;

Significant rating agency changes on the issuer;

Level of interest rates and any movement in pricing for credit and other risks;

Information about the performance of the underlying institutions that issued the debt instruments, such as net income, return on equity, capital adequacy, non-performing assets, Texas ratios, etc;

Our intent to sell the security or whether it is more likely than not that we will be required to sell the security before its anticipated recovery; and

Other relevant observable inputs.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

3.	SECURITIES – (Continued)

The following table details the five debt securities with other-than-temporary impairment at December 31, 2010 and the related credit losses recognized in earnings:

		Moody's										% of Current
		Credit	Current							Current		Deferrals and
(Dollars in thousands)		Ratings	Moody's					Estimated		Deferrals		Defaults			Year to Date
		When	Credit	Par		Amortized		Fair		and		to Current			OTTI
Security	Tranche	Purchased	Ratings	Value		Cost		Value		Defaults		Collateral			Recognized

Preferred Term Securities IV	Mezzanine	A3	Ca	$	244	$	182	$	24	$	18,000		27	%	$	18
Preferred Term Securities VI	Mezzanine	A1	Caa1		259		22		22		33,000		81	%		50
Preferred Term Securities XV B1	Mezzanine	A2	Ca		1,004		415		19		211,700		35	%		423
Preferred Term Securities XXI C2	Mezzanine	A3	Ca		1,018		399		7		215,890		29	%		249
Preferred Term Securities XXII C1	Mezzanine	A3	Ca		503		78		5		412,500		30	%		308

Total				$	3,028	$	1,096	$	77						$	1,048

The table below presents a roll-forward of the credit losses recognized in earnings for the period ended December 31, 2010:

(Dollars in thousands)
	2010		2009

Beginning balance	$	862	$	-
Increases to the amount related to the credit loss for which other-than-temporary impairment was previously recognized		1,048		862
Ending balance	$	1,910	$	862

LOANS

Loans are summarized as follows:

	December 31,
(Dollars in thousands)	2010			2009

Commercial	$	42,265		$	62,940
Commercial Real Estate:
Land Development		56,086			31,236
Building Lots		11,333			15,775
Other		490,345			580,777
Real estate construction		11,034			14,567
Residential mortgage		163,975			178,985
Consumer and home equity		77,781			74,844
Indirect consumer		29,588			36,628
Loans held for sale		6,388			8,183
		888,795			1,003,935
Less:
Net deferred loan origination fees		(473	)		(826	)
Allowance for loan losses		(22,665	)		(17,719	)
		(23,138	)		(18,545	)

Net Loans	$	865,657		$	985,390

We utilize eligible real estate loans to collateralize advances and letters of credit from the Federal Home Loan Bank. We had $217 million in residential mortgage and multi-family loans pledged under this arrangement at December 31, 2010 and $553 million in residential mortgage, commercial real estate, multi-family and open end home equity loans pledged at December 31, 2009.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

4.	LOANS – (Continued)

The allowance for loan loss is summarized as follows:

	As of and For the
	Years Ended December 31,
(Dollars in thousands)	2010			2009			2008

Balance, beginning of year	$	17,719		$	13,565		$	7,922
Allowance related to acquisition		-			-			327
Provision for loan losses		16,881			9,524			5,947
Charge-offs		(12,195	)		(5,626	)		(894	)
Recoveries		260			256			263
Balance, end of year	$	22,665		$	17,719		$	13,565

The following table presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment excluding loans held for sale and based on the impairment method as of December 31, 2010:

			Commercial		Real Estate		Residential		Consumer &		Indirect
(Dollars in thousands)	Commercial		Real Estate		Construction		Mortgage		Home Equity		Consumer		Total

Allowance for loan losses:
Ending allowance balance attributable to loans:
Individually evaluated for impairment	$	691	$	11,872		24	$	334	$	147	$	29	$	13,097
Collectively evaluated for impairment		966		6,723		134		417		561		767		9,568

Total ending allowance balance	$	1,657	$	18,595		158	$	751	$	708	$	796	$	22,665

Loans:
Loans individually evaluated for impairment	$	1,870	$	86,250	$	1,267	$	1,609	$	337	$	91	$	91,424
Loans collectively evaluated for impairment		40,395		471,514		9,767		162,366		77,444		29,497		790,983
Loans acquired with deteriorated credit quality		-		-		-		-		-		-		-

Total ending loans balance	$	42,265	$	557,764	$	11,034	$	163,975	$	77,781	$	29,588	$	882,407

Impaired loans are summarized below. Impaired loans include all loans classified substandard, doubtful and loss. The table below includes impaired loans which are not individually evaluated for impairment.

(Dollars in thousands)	2010		2009		2008

Year-end impaired loans	$	96,310	$	66,956	$	42,015
Amount of allowance for loan loss allocated		13,297		7,101		4,893
Average impaired loans outstanding		80,764		60,858		29,200
Interest income recognized		2,461		2,173		1,246
Interest income received		2,461		2,173		1,246

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

4.	LOANS – (Continued)

The following table presents loans individually evaluated for impairment by class of loans as of December 31, 2010:

	Unpaid				Allowance for
	Principal		Recorded		Loan Losses
(Dollars in thousands)	Balance		Investment		Allocated

With no related allowance recorded:
Commercial	$	312	$	312	$	-
Commercial Real Estate:
Land Development		-		-		-
Building Lots		-		-		-
Other		30,337		32,332		-
Real Estate Construction		185		185		-
Residential Mortgage		-		-		-
Consumer and Home Equity		-		-		-
Indirect Consumer		-		-		-

With an allowance recorded:
Commercial		1,558		1,558		691
Commercial Real Estate:
Land Development		22,895		22,895		4,562
Building Lots		3,430		3,430		39
Other		27,593		27,593		7,271
Real Estate Construction		1,082		1,082		24
Residential Mortgage		1,609		1,609		334
Consumer and Home Equity		337		337		147
Indirect Consumer		91		91		29

Total	$	89,429	$	91,424	$	13,097

The difference between the unpaid principal balance and recorded investment represents partial write downs/charge offs taken on individual impaired credits.

We report non-performing loans which consist of restructured loans and nonaccrual loans as impaired. Our non-performing loans at year-end were as follows:

	December 31,
(Dollars in thousands)	2010		2009

Restructured	$	3,906	$	9,812
Loans past due over 90 days still on accrual		-		-
Non accrual loans		42,169		28,186
Total	$	46,075	$	37,998

The following table presents the recorded investment in restructured, nonaccrual and loans past due over 90 days still on accrual by class of loans as of December 31, 2010.

			Loans Past Due
			Over 90 Days
			Still
(Dollars in thousands)	Restructured		Accruing		Nonaccrual

Commercial	$	179		-	$	597
Commercial Real Estate:
Land Development		-		-		15,356
Building Lots		-				3,430
Other		3,394		-		19,939
Real Estate Construction		-				-
Residential Mortgage		306		-		2,294
Consumer and Home Equity		27				365
Indirect Consumer		-		-		188

Total	$	3,906		-	$	42,169

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

4.	LOANS – (Continued)

The following table presents the aging of the unpaid principal in past due loans as of December 31, 2010 by class of loans:

	30-59		60-89		Greater than
	Days		Days		90 Days		Total		Loans Not
(Dollars in thousands)	Past Due		Past Due		Past Due		Past Due		Past Due		Total

Commercial	$	719	$	683	$	574	$	1,976	$	40,289	$	42,265
Commercial Real Estate:
Land Development		-		-		7,682		7,682		48,404		56,086
Building Lots		-		-		3,430		3,430		7,903		11,333
Other		2,824		10,110		16,294		29,228		461,117		490,345
Real Estate Construction		1,082		-		-		1,082		9,952		11,034
Residential Mortgage		313		962		4,386		5,661		158,314		163,975
Consumer and Home Equity		527		70		680		1,277		76,504		77,781
Indirect Consumer		386		51		188		625		28,963		29,588

Total	$	5,851	$	11,876	$	33,234	$	50,961	$	831,446	$	882,407

Troubled Debt Restructurings:

We have allocated $151,000 and $493,000 of specific reserves to customers whose loan terms have been modified in troubled debt restructurings as of December 31, 2010 and 2009. We are not committed to lend additional funds to debtors whose loans have been modified in a troubled debt restructuring.

Credit Quality Indicators:

We categorize loans into risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. We analyze loans individually by classifying the loans as to credit risk. This analysis includes commercial and commercial real estate loans. We also evaluate credit quality on residential mortgage, consumer and home equity and indirect consumer loans based on the aging status and payment activity of the loan. This analysis is performed on a monthly basis. We use the following definitions for risk ratings:

Criticized: Loans classified as criticized have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or in our credit position at some future date.

Substandard: Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.

Doubtful: Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.

Loss: Loans classified as loss are considered non-collectible and their continuance as bankable assets is not warranted.

Loans not meeting the criteria above that are analyzed individually as part of the above described process are considered to be pass rated loans. Loans listed as not rated are included in groups of homogeneous loans.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

4.	LOANS – (Continued)

As of December 31, 2010, and based on the most recent analysis performed, the risk category of loans by class of loans is as follows:

(Dollars in thousands)	Not Rated		Pass		Criticized		Substandard		Doubtful		Loss		Total

Commercial	$	-	$	38,036	$	2,359	$	1,412	$	458	$	-	$	42,265
Commercial Real Estate:
Land Development		-		29,769		3,422		22,895		-		-		56,086
Building Lots		-		7,903		-		3,430		-		-		11,333
Other		-		409,387		21,012		59,800		125		21		490,345
Real Estate Construction		-		9,767		-		1,267		-		-		11,034
Residential Mortgage		157,498		-		917		5,560		-		-		163,975
Consumer and Home Equity		76,086		-		599		1,072		-		24		77,781
Indirect Consumer		29,342		-		-		227		-		19		29,588

Total	$	262,926	$	494,862	$	28,309	$	95,663	$	583	$	64	$	882,407

The following table presents the unpaid principal balance in residential mortgage, consumer and home equity and indirect consumer loans based on payment activity as of December 31, 2010:

	Residential		Consumer &		Indirect
(Dollars in thousands)	Mortgage		Home Equity		Consumer

Performing	$	161,375	$	77,389	$	29,400
Restructured & Non-accrual		2,600		392		188

Total	$	163,975	$	77,781	$	29,588

5.	REAL ESTATE ACQUIRED THROUGH FORECLOSURE

A summary of the real estate acquired through foreclosure activity is as follows:

	December 31,
(Dollars in thousands)	2010			2009			2008
	Restated
Beginning balance	$	8,428		$	5,925		$	1,749
Additions		24,622			6,011			4,781
Sales		(4,928	)		(2,930	)		(443	)
Writedowns		(2,315	)		(578	)		(162	)
Ending balance	$	25,807		$	8,428		$	5,925

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

6.	FAIR VALUE

U.S. GAAP defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date and establishes a fair value hierarchy that prioritizes the use of inputs used in valuation methodologies into the following three levels:

Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets. A quoted price in an active market provides the most reliable evidence of fair value and shall be used to measure fair value whenever available.

Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

Level 3: Significant unobservable inputs that reflect a reporting entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

We used the following methods and significant assumptions to estimate the fair value of available-for-sale-securities.

Securities: The fair values of most equity securities are determined by obtaining quoted prices on nationally recognized securities exchanges (Level 1 inputs). The fair values of most debt securities are determined by a matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities (Level 2 inputs). In certain cases where there is limited activity or less transparency around inputs to the valuation, securities are classified within (Level 3) of the valuation hierarchy. For trust preferred securities, discounted cash flows are calculated using spread to swap and LIBOR curves that are updated to incorporate loss severities, volatility, credit spread and optionality. Rating agency and industry research reports as well as defaults and deferrals on individual securities are reviewed and incorporated into the calculations. For other equity securities, discounted cash flows are calculated with available market information through processes using benchmark yields, market spreads sourced from new issues, dealer quotes and trade prices among other sources.

Assets and Liabilities Measured at Fair Value on a Recurring Basis

Assets measured at fair value on a recurring basis are summarized below. There were no significant transfers between Level1 and Level 2 during 2010.

			Quoted Prices in
			Active Markets for		Significant Other		Significant
	December 31,		Identical Assets		Observable Inputs		Unobservable Inputs
(Dollars in thousands)	2010		(Level 1)		(Level 2)		(Level 3)

Assets:
U.S. Treasury and agencies	$	113,893	$	-	$	113,893	$	-
Government-sponsored mortgage-backed residential		59,170		-		59,170		-
Equity		293		2		-		291
State and municipal		22,618		-		22,618		-
Trust preferred securities		55		-		-		55

Total	$	196,029	$	2	$	195,681	$	346

			Quoted Prices in
			Active Markets for		Significant Other		Significant
	December 31,		Identical Assets		Observable Inputs		Unobservable Inputs
(Dollars in thousands)	2009		(Level 1)		(Level 2)		(Level 3)

Assets:
U.S. Treasury and agencies	$	20,080	$	-	$	20,080	$	-
Government-sponsored mortgage-backed residential		9,752		-		9,752		-
Equity		990		699		-		291
State and municipal		14,893		-		14,893		-
Trust preferred securities		49		-		-		49

Total	$	45,764	$	699	$	44,725	$	340

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

6.	FAIR VALUE - (Continued)

Between June 2002 and July 2006, we invested in four AFS and one HTM investment grade tranches of trust preferred collateralized debt obligation (“CDO”) securities. The securities were issued and are referred to as Preferred Term Securities Limited (“PreTSL”). The underlying collateral for the PreTSL is unguaranteed pooled trust preferred securities issued by banks, insurance companies and REITs geographically dispersed across the United States. We hold five PreTSL securities, none of which are currently investment grade. Prior to September 30, 2008, we determined the fair value of the trust preferred securities using a valuation technique based on Level 2 inputs. The Level 2 inputs included estimates of the market value for each security provided through our investment broker.

Since late 2007, the markets for collateralized debt obligations and trust preferred securities have become increasingly inactive. The inactivity began in late 2007 when new issues of similar securities were discounted in order to complete the offering. Beginning in the second quarter of 2008, the purchase and sale activity of these securities substantially decreased as investors elected to hold the securities instead of selling them at substantially depressed prices. Our brokers have indicated that little if any activity is occurring in this sector and that the PreTSL securities trades that are taking place are primarily distressed sales where the seller must liquidate as a result of insolvency, redemptions or closure of a fund holding the security, or other distressed conditions. As a result, the bid-ask spreads have widened significantly and the volume of trades decreased significantly compared to historical volumes.

During 2008, we determined that the market for the trust preferred securities that we hold and for similar CDO securities (such as higher-rated tranches within the same CDO security) are also not active. That determination was made considering that there are few observable transactions for the trust preferred securities or similar CDO securities and the observable prices for those transactions have varied substantially over time. Consequently, we have considered those observable inputs and determined that our trust preferred securities are classified within Level 3 of the fair value hierarchy.

We have determined that an income approach valuation technique (using cash flows and present value techniques) that maximizes the use of relevant observable inputs and minimizes the use of unobservable inputs is equally or more representative of fair value than relying on the estimation of market value technique used at prior measurement dates, which now has few observable inputs and relies on an inactive market with distressed sales conditions that would require significant adjustments.

We received valuation estimates on our trust preferred securities for December 31, 2010. Those valuation estimates were based on proprietary pricing models utilizing significant unobservable inputs in an inactive market with distressed sales, Level 3 inputs, rather than actual transactions in an active market. In accordance with current accounting guidance, we determined that a risk-adjusted discount rate appropriately reflects the reporting entity’s estimate of the assumptions that market participants would use in an active market to estimate the selling price of the asset at the measurement date.

We conduct a thorough review of fair value hierarchy classifications on a quarterly basis. Reclassification of certain financial instruments may occur when input observability changes.

The table below presents a reconciliation for all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the periods ended December 31, 2010 and 2009:

	Fair Value Measurements
	Using Significant
	Unobservable Inputs
	(Level 3)

	Year Ended
	December 31,
(Dollars in thousands)	2010			2009

Beginning balance	$	340		$	364
Total gains or losses:
Impairment charges on securities		(998	)		(831	)
Included in other comprehensive income		1,004			807
Transfers in and/or out of Level 3		-			-
Ending balance	$	346		$	340

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

6.	FAIR VALUE - (Continued)

The table below summarizes changes in unrealized gains and losses recorded in earnings for the year ended December 31 for Level 3 assets and liabilities that are still held at December 31.

	Changes in Unrealized Gains/Losses
	Relating to Assets Still Held at Reporting
	Date for the Year Ended
	December 31,
(Dollars in thousands)	2010		2009

Interest income on securities	$	-	$	-
Other changes in fair value		915		725
Total	$	915	$	725

Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis

Assets measured at fair value on a nonrecurring basis are summarized below:

			Quoted Prices in
			Active Markets for		Significant Other		Significant
	December 31,		Identical Assets		Observable Inputs		Unobservable Inputs
(Dollars in thousands)	2010		(Level 1)		(Level 2)		(Level 3)
	Restated
Assets:
Impaired loans:
Commercial	$	1,092	$	-	$	-	$	1,092
Commercial Real Estate:
Land Development		18,333		-		-		18,333
Building Lots		3,391		-		-		3,391
Other		49,505		-		-		49,505
Real Estate Contruction		1,057		-		-		1,057
Residential Mortgage		4,821		-		-		4,821
Consumer and Home Equity		824		-		-		824
Indirect Consumer		171		-		-		171
Real estate acquired through foreclosure		8,578		-		-		8,578
Trust preferred security held-to-maturity		22		-		-		22

			Quoted Prices in
			Active Markets for		Significant Other		Significant
	December 31,		Identical Assets		Observable Inputs		Unobservable Inputs
(Dollars in thousands)	2009		(Level 1)		(Level 2)		(Level 3)

Assets:
Impaired loans	$	49,359	$	-	$	-	$	49,359
Real estate acquired through foreclosure		3,799		-		-		3,799
Trust preferred security held-to-maturity		20		-		-		20

Impaired loans, which are measured for impairment using the fair value of the collateral for collateral dependent loans, had a carrying amount of $96.3 million, with a valuation allowance of $13.3 million, resulting in an additional provision for loan losses of $6.5 million for the 2010 period. Values for collateral dependent loans are generally based on appraisals obtained from licensed real estate appraisals and in certain circumstances consideration of offers obtained to purchase properties prior to foreclosure. Appraisals for commercial real estate generally use three methods to derive value: cost, sales or market comparison and income approach. The cost method bases value on the estimated cost to replace the current property after considering adjustments for depreciation. Values of the market comparison approach evaluate the sales price of similar properties in the same market area. The income approach considers net operating income generated by the property and an investors required return. The final value is a reconciliation of these three approaches and takes into consideration any other factors management deems relevant to arrive at a representative fair value.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

6.	FAIR VALUE - (Continued)

Trust preferred securities which are held-to-maturity are valued using an income approach valuation technique (using cash flows and present value techniques) that maximizes the use of relevant observable inputs and minimizes the use of unobservable inputs. The income approach is equally or more representative of fair value than relying on the estimation of market value technique used at prior measurement dates, which now has few observable inputs and relies on an inactive market with distressed sales conditions that would require significant adjustments.

We received valuation estimates on our trust preferred security for December 31, 2010. Those valuation estimates were based on proprietary pricing models utilizing significant unobservable inputs in an inactive market with distressed sales, Level 3 inputs, rather than actual transactions in an active market.

Fair Value of Financial Instruments

The estimated fair value of financial instruments not previously presented is as follows:

(Dollars in thousands)	December 31, 2010				December 31, 2009
	Carrying		Fair		Carrying		Fair
	Value		Value		Value		Value
Financial assets:
Cash and due from banks	$	166,176	$	166,176	$	98,533	$	98,533
Securities held-to-maturity		102		104		1,147		1,156
Loans held for sale		6,388		6,472		8,183		8,257
Loans, net		780,075		789,889		927,848		933,225
Accrued interest receivable		6,404		6,404		5,658		5,658
FHLB stock		4,909		N/A		8,515		N/A

Financial liabilities:
Deposits		1,173,908		1,163,654		1,049,815		1,042,957
Short-term borrowings		-		-		1,500		1,500
Advances from Federal Home Loan Bank		52,532		55,190		52,745		55,856
Subordinated debentures		18,000		12,743		18,000		12,743
Accrued interest payable		594		594		360		360

The methods and assumptions used in estimating fair value disclosures for financial instruments are presented below:

Carrying amount is the estimated fair value for cash and cash equivalents, interest bearing deposits, accrued interest receivable and payable, demand deposits, short-term debt and variable rate loans or deposits that re-price frequently and fully. Held-to-maturity securities fair values are based on market prices or dealer quotes and if no such information is available, on the rate and term of the security and information about the issuer. The value of loans held for sale is based on the underlying sale commitments. For fixed rate loans or deposits and for variable rate loans or deposits with infrequent re-pricing or re-pricing limits, fair value is based on discounted cash flows using current market rates applied to the estimated life. Fair values of advances from Federal Home Loan Bank and subordinated debentures are based on current rates for similar financing. The fair value of off-balance-sheet items is based on the current fees or cost that would be charged to enter into or terminate such arrangements and is not material. It is not practicable to determine the fair value of FHLB stock due to restrictions placed on its transferability.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

7.	PREMISES AND EQUIPMENT

Premises and equipment consist of the following:

	December 31,
(Dollars in thousands)	2010			2009

Land	$	8,024		$	7,598
Buildings		27,151			27,020
Furniture, fixtures and equipment		13,109			11,976
		48,284			46,594
Less accumulated depreciation		(16,296	)		(14,629	)
	$	31,988		$	31,965

Certain premises are leased under various operating leases. Rental expense was $669,000, $751,000 and $432,000, for the years ended December 31, 2010, 2009 and 2008, respectively. Future minimum commitments under these leases are:

	Year Ended
(Dollars in thousands)	December 31,

2011	$	593
2012		494
2013		306
2014		274
2015		274
Thereafter		3,651
	$	5,592

8.	GOODWILL AND INTANGIBLE ASSETS

The change in the balance of goodwill is as follows.

	December 31,
(Dollars in thousands)	2010		2009			2008

Beginning of year	$	-	$	11,931		$	8,384
Acquisition of FSB Bancshares, Inc.		-		-			3,547
Goodwill impairment		-		(11,931	)		-
End of year	$	-	$	-		$	11,931

Impairment exists when a reporting unit’s carrying value of goodwill exceeds its fair value, which is determined through a two-step impairment test. Step 1 includes the determination of the carrying value of our single reporting unit, including the existing goodwill and intangible assets, and estimating the fair value of the reporting unit. We determined the fair value of our reporting unit and compared it to its carrying amount. If the carrying amount of a reporting unit exceeds its fair value, we are required to perform a second step to the impairment test.

Our annual impairment analysis as of December 31, 2009, indicated that the Step 2 analysis was necessary. Step 2 of the goodwill impairment test is performed to measure the impairment loss. Step 2 requires that the implied fair value of the reporting unit goodwill be compared to the carrying amount of that goodwill. If the carrying amount of the reporting unit goodwill exceeds the implied fair value of that goodwill, an impairment loss shall be recognized in an amount equal to that excess. After performing Step 2 it was determined that the implied value of goodwill was less than the carrying costs, resulting in an impairment charge of $11.9 million.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

8.	GOODWILL AND INTANGIBLE ASSETS - (Continued)

Acquired intangible assets were as follows at year end:

(Dollars in thousands)	December 31, 2010				December 31, 2009
	Gross				Gross
	Carrying		Accumulated		Carrying		Accumulated
	Amount		Amortization		Amount		Amortization
Amortized intangible assets:
Core deposit intangibles	$	1,910	$	916	$	1,910	$	610
Other customer relationship intangibles		669		274		669		184
	$	2,579	$	1,190	$	2,579	$	794

Aggregate amortization expense was $396,000, 510,000 and $284,000 for 2010, 2009 and 2008.

Estimated amortization expense for each of the next five years:

	Year Ended
(Dollars in thousands)	December 31,

2011	$	370
2012		322
2013		277
2014		145
2015		98
	$	1,212

DEPOSITS

Time Deposits of $100,000 or more were $347.3 million and $326.8 million at December 31, 2010 and 2009, respectively. At December 31, 2010, scheduled maturities of time deposits are as follows:

(Dollars in thousands)	Amount

2011	$	278,617
2012		240,490
2013		120,366
2014		14,904
2015		17,132
Thereafter		32,462
	$	703,971

Brokered deposits totaled $50.3 million and $127.8 million at year end 2010 and 2009. Due to our agreement with bank regulatory agencies, we are not allowed to accept, renew or rollover brokered deposits (including deposits through the CDARs program) without prior regulatory approval.

10.	SHORT-TERM BORROWINGS

Short-term borrowings consist of a loan agreement with a correspondent bank for 2010 and primarily federal funds purchased from the FHLB of Cincinnati for 2009. The loan was paid off in full during the fourth quarter of 2010 and the loan is now closed. These borrowings averaged a rate of 7.27% and .30% for 2010 and 2009.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

11.	ADVANCES FROM FEDERAL HOME LOAN BANK

Advances from the FHLB at year-end are as follows:

	December 31,
	2010					2009
	Weighted-					Weighted-
(Dollars in Thousands)	Average					Average
	Rate			Amount		Rate			Amount
Fixed rate advances:
Convertible fixed rate advances with interest rates from 3.99% to 5.05% due through 2017		4.55	%	$	50,000		4.55	%	$	50,000
Other fixed rate advances with interest rates from 4.19% to 5.72% due through 2020		4.91	%		2,532		4.92	%		2,745
Total borrowings				$	52,532				$	52,745

Our convertible fixed rate advances are fixed for periods ranging from one to three years. At the end of the fixed rate term and quarterly thereafter, the FHLB has the right to convert these advances to variable rate advances tied to the three-month LIBOR index. Upon conversion, we can prepay the advances at no penalty. In January 2011, a $25 million convertible fixed rate advance with an interest rate of 5.05% matured and was paid in full. Advances from the FHLB are secured by our stock in the FHLB, certain securities and substantially all of our first mortgage loans. At December 31, 2010, we had $217 million in loans pledged under this arrangement. However, due to increases in non-performing loans for 2010, we were not able to pledge our commercial real estate and our open end home equity loans. This resulted in no additional borrowing availability from the FHLB as of December 31, 2010.

The aggregate minimum annual repayments of borrowings as of December 31, 2010 are as follows:

	(Dollars in thousands)

2011	$	25,138
2012		128
2013		129
2014		10,202
2015		496
Thereafter		16,439
	$	52,532

12.	SUBORDINATED DEBENTURES

Our trust subsidiaries loaned the proceeds of their offerings of trust preferred securities to us in exchange for junior subordinated deferrable interest debentures. We are not considered the primary beneficiary of these trusts (variable interest entity), therefore the trusts are not consolidated in our financial statements, but rather the subordinated debentures are shown as a liability. Our investment in the common stock of the trusts was $310,000.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

12.	SUBORDINATED DEBENTURES - (Continued)

13.	PREFERRED STOCK

On January 9, 2009, we issued $20 million of cumulative perpetual preferred shares, with a liquidation preference of $1,000 per share (the “Senior Preferred Shares”) to the United States Treasury under its Capital Purchase Program (“CPP”). The Senior Preferred Shares constitute Tier 1 capital and rank senior to our common shares. The Senior Preferred Shares pay cumulative dividends quarterly at a rate of 5% per annum for the first five years and will reset to a rate of 9% per annum after five years. The Senior Preferred Shares may be redeemed at any time, at our option. We also have the ability to defer dividend payments at any time, at our option.

We also issued a warrant to purchase 215,983 common shares to the U.S. Treasury at a purchase price of $13.89 per share. The aggregate purchase price equals 15% of the aggregate amount of the Senior Preferred Shares purchased by the U.S. Treasury or $3 million. The initial purchase price per share for the warrant and the number of common shares subject to the warrant were determined by reference to the market price of the common shares (calculated on a 20-day trailing average) on December 8, 2008, the date the U.S. Treasury approved our TARP application. The warrant has a term of 10 years and is potentially dilutive to earnings per share.

On October 29, 2010, we gave written notice to the United States Treasury that we were suspending the payment of regular quarterly cash dividends on our fixed rate cumulative perpetual preferred stock, Series A (“Series A Preferred Stock”). Under the CPP provisions, failure to pay dividends for six quarters would trigger board appointment rights for the holder of the Series A Preferred Stock. The dividends will continue to be accrued for payment in the future and reported as a preferred dividend requirement that is deducted from income to common shareholders for financial statement purposes. As of December 31, 2010, these accrued but unpaid dividends totaled $380,000.

Participation in the CPP requires a participating institution to comply with a number of restrictions and provisions, including standards for executive compensation and corporate governance and limitations on share repurchases and the declaration and payment of dividends on common shares. The standard terms of the CPP require that a participating financial institution limit the payment of dividends to the most recent quarterly amount prior to October 14, 2008, which is $0.19 per share in our case. This dividend limitation will remain in effect until the earlier of three years or such time that the preferred shares are redeemed.

On February 17, 2009, the American Recovery and Reinvestment Act of 2009 (“ARRA”) was enacted. As required by ARRA, the U.S. Treasury has issued additional compensation standards on companies receiving financial assistance from the U.S. government. In addition, ARRA imposes certain new executive compensation and corporate expenditure limits on each CPP recipient, until the recipient has repaid the Treasury. ARRA also permits CPP participants to redeem the preferred shares held by the Treasury Department without penalty and without the need to raise new capital, subject to the Treasury’s consultation with the recipient’s appropriate regulatory agency.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

14.	INCOME TAXES

We file a consolidated federal income tax return and income tax is apportioned among all companies based on their taxable income or loss. Provision for income taxes is as follows:

	Year Ended December 31,
(Dollars in thousands)	2010			2009			2008
	Restated
Current	$	239		$	2,876		$	3,615
Deferred		(3,244	)		(4,025	)		(1,431	)

		(3,005	)		(1,149	)		2,184
Valuation allowance		4,791			-			-

Total income tax expense/(benefit)	$	1,786		$	(1,149	)	$	2,184

The provision for income taxes differs from the amount computed at the statutory rates as follows:

	Year Ended December 31,
(Dollars in thousands)	2010			2009			2008
	Restated
Federal statutory rate		34.0	%		34.0	%		34.0	%
Change in valuation allowance		(63.0	)		-			-
Goodwill impairment		-			(23.2	)		-
Tax-exempt interest income		3.8			2.2			(1.9	)
Increase in cash surrender value of life insurance		1.6			1.5			(1.8	)
Dividends to ESOP		-			0.3			(0.6	)
Stock option expense		(0.5	)		(0.5	)		0.6
Effect of state tax expense recorded		0.5			0.2			0.7
Other		0.1			0.1			0.3
Effective rate		-23.5	%		14.6	%		31.3	%

A valuation allowance related to deferred tax assets is required when it is considered more likely than not that all or part of the benefit related to such assets will not be realized. In assessing the need for a valuation allowance, we considered various factors including our three year cumulative loss position and the fact that we did not meet our forecast levels in 2010 that we set in the fourth quarter of 2009 due to higher levels of provision for loan loss expense. These factors represent the most significant negative evidence that we considered in concluding that a valuation allowance was necessary. The remaining deferred tax asset of $3.0 million is considered more likely than not to be realizable due to the availability of taxable income in open years.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

14.	INCOME TAXES - (Continued)

Temporary differences between the financial statement carrying amounts and tax bases of assets and liabilities that give rise to significant portions of deferred income taxes relate to the following:

	December 31,
(Dollars in thousands)	2010			2009
	Restated
Deferred tax assets:
Allowance for loan losses	$	7,824		$	6,024
Intangibles and fair value adjustments		226			348
Net unrealized loss on securities available-for-sale		1,794			547
Other than temporary impairment		780			469
Prepaid retirement benefits		-			179
Writedowns of real estate owned		831			205
Nonaccrual loan interest		896			580
Accrued liabilities and other		203			150
Total deferred tax assets		12,554			8,502

Deferred tax liabilities:
Depreciation	$	2,052		$	2,056
Federal Home Loan Bank stock		1,049			1,554
Deferred gain on like-kind exchange		8			8
Other		439			369
Total deferred tax liabilities		3,548			3,987

Net temporary differences		9,006			4,515

Valuation allowance		(6,024	)		-

Net deferred tax assets	$	2,982		$	4,515

We file a consolidated U.S. federal income tax return and the Corporation files income tax returns in Kentucky, Indiana and Tennessee. The Bank is subject to federal income tax and state income tax in Indiana and Tennessee. These returns are subject to examination by taxing authorities for all years after 2006.

Federal income tax laws provided savings banks with additional bad debt deductions through 1987, totaling $9.3 million for us. Accounting standards do not require a deferred tax liability to be recorded on this amount, which would otherwise total $3.2 million at December 31, 2010 and 2009. If we were liquidated or otherwise ceased to be a bank or if tax laws were to change, the $3.2 million would be recorded as a liability with an offset to expense.

There were no unrecognized tax benefits at December 31, 2010, and we do not expect the total of unrecognized tax benefits to significantly change in the next twelve months.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

15.	STOCKHOLDERS’ EQUITY

(a)

Regulatory Capital Requirements –The Corporation and the Bank are subject to regulatory capital requirements administered by federal banking agencies. Capital adequacy guidelines and, additionally for banks, prompt corrective action regulations involve quantitative measures of assets, liabilities, and certain off-balance-sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators. Failure to meet capital requirements can initiate regulatory action.

Prompt corrective action regulations provide five classifications: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized, although these terms are not used to represent overall financial condition. If adequately capitalized, regulatory approval is required to accept brokered deposits. If undercapitalized, capital distributions are limited, as is asset growth and expansion, and capital restoration plans are required.

Quantitative measures established by regulation to ensure capital adequacy require the Corporation and the Bank to maintain minimum amounts and ratios (set forth in the following table) of Total and Tier I capital (as defined in the regulations) to risk weighted assets (as defined) and of Tier I capital (as defined) to average assets (as defined).

As part of an informal regulatory agreement with the FDIC and KDFI, the Bank was required to maintain a Tier 1 leverage ratio of 8%. At December 31, 2010, we were not in compliance with the Tier 1 capital requirement. Although the Corporation and the Bank remain above the regulatory capital levels for “well-capitalized” standards, because of the losses we have incurred in recent quarters, our elevated levels of non-performing loans and other real estate, and the ongoing economic stress in Jefferson and Oldham Counties, Kentucky, the FDIC, KDFI and the Bank entered into the Consent Order referred to in Note 2. The Consent Order resulted in the Bank being categorized as a "troubled institution" by bank regulators, which by definition does not permit the Bank to be considered "well-capitalized" despite its current capital levels.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

15.	STOCKHOLDERS’ EQUITY – (Continued)

Our actual and required capital amounts and ratios are presented below.

											To Be Considered
											Well Capitalized
											Under Prompt
(Dollars in thousands)						For Capital					Correction
	Actual					Adequacy Purposes					Action Provisions
As of December 31, 2010:	Amount		Ratio			Amount		Ratio			Amount		Ratio
Restated
Total risk-based capital (to risk- weighted assets)
Consolidated	$	104,717		11.34	%	$	73,890		8.00	%		N/A		N/A
Bank		105,116		11.38			73,880		8.00			92,350		10.00
Tier I capital (to risk-weighted assets)
Consolidated		93,034		10.07			36,945		4.00			N/A		N/A
Bank		93,423		10.12			36,940		4.00			55,410		6.00
Tier I capital (to average assets)
Consolidated		93,034		7.16			52,003		4.00			N/A		N/A
Bank		93,423		7.18			52,082		4.00			65,103		5.00

											To Be Considered
											Well Capitalized
											Under Prompt
(Dollars in thousands)						For Capital					Correction
	Actual					Adequacy Purposes					Action Provisions
As of December 31, 2009:	Amount		Ratio			Amount		Ratio			Amount		Ratio
Total risk-based capital (to risk- weighted assets)
Consolidated	$	115,702		11.35	%	$	81,550		8.00	%		N/A		N/A
Bank		114,514		11.25			81,467		8.00			101,834		10.00
Tier I capital (to risk-weighted assets)
Consolidated		102,894		10.09			40,775		4.00			N/A		N/A
Bank		101,719		9.99			40,734		4.00			61,100		6.00
Tier I capital (to average assets)
Consolidated		102,894		8.66			47,533		4.00			N/A		N/A
Bank		101,719		8.90			45,732		4.00			57,165		5.00

On January 27, 2011, the Bank entered into a Consent Order, a formal agreement with the FDIC and KDFI, under which, among other things, the Bank has agreed to achieve and maintain a Tier 1 leverage ratio of at least 8.5% by March 31, 2011 and 9.0% by June 30, 2011. The Consent Order supersedes the prior informal regulatory agreement. See Note 2 for additional requirements pertaining to the Consent Order.

The Consent Order requires the Bank to achieve certain minimum capital ratios as set forth below:

				Ratio Required			Ratio Required
	Actual as of			by the Order			by the Order
	12/31/2010			at 3/31/2011			at 6/30/2011
	Restated
Total capital to risk-weighted assets		11.38	%		11.50	%		12.00	%
Tier 1 capital to average total assets		7.18	%		8.50	%		9.00	%

(b)

Dividend Restrictions – Our principal source of funds for dividend payments is dividends received from the Bank. Banking regulations limit the amount of dividends that may be paid without prior approval of regulatory agencies. Under these regulations, the amount of dividends that may be paid in any calendar year is limited to the current year’s net profits, combined with the retained net profits of the preceding two years, subject to the capital requirements described above. The Bank currently has a regulatory agreement with the FDIC and KDFI that requires us to obtain the consent of the Regional Director of the FDIC and the Commissioner of the KDFI to declare and pay cash dividends. The Corporation has also entered into an agreement with the Federal Reserve to obtain regulatory approval before declaring any dividends. We may not redeem shares or obtain additional borrowings without prior approval.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

15.	STOCKHOLDERS’ EQUITY – (Continued)

(c)

Liquidation Account – In connection with our conversion from mutual to stock form of ownership during 1987, we established a “liquidation account”, currently in the amount of $521,000 for the purpose of granting to eligible deposit account holders a priority in the event of future liquidation. Only in such an event, an eligible account holder who continues to maintain a deposit account will be entitled to receive a distribution from the liquidation account. The total amount of the liquidation account decreases in an amount proportionately corresponding to decreases in the deposit account balances of the eligible account holders.

(d)

Capital Purchase Program – On January 9, 2009, we sold $20 million of cumulative perpetual preferred shares, with a liquidation preference of $1,000 per share (the “Senior Preferred Shares”) to the U.S. Treasury under the terms of its Capital Purchase Plan. The Senior Preferred Shares constitute Tier 1 capital and rank senior to our common shares. The Senior Preferred Shares pay cumulative dividends at a rate of 5% per annum for the first five years and will reset to a rate of 9% per annum after five years. The Senior Preferred Shares may be redeemed at any time, at our option. See Note 13 for additional information.

16.	EARNINGS (LOSS) PER SHARE

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

(Dollars in thousands, except per share data)	Year Ended December 31,
	2010			2009			2008
	Restated
Basic:
Net income/(loss)	$	(9,402	)	$	(6,709	)	$	4,797
Less:
Preferred stock dividends		(1,000	)		(980	)		-
Accretion on preferred stock discount		(54	)		(52	)		-
Net income (loss) available to common shareholders	$	(10,456	)	$	(7,741	)	$	4,797
Weighted average common shares		4,724			4,695			4,666

Diluted:
Weighted average common shares		4,724			4,695			4,666
Dilutive effect of stock options and warrants		-			-			20
Weighted average common and incremental shares		4,724			4,695			4,686

Earnings (Loss) Per Common Share:
Basic	$	(2.21	)	$	(1.65	)	$	1.03
Diluted	$	(2.21	)	$	(1.65	)	$	1.02

Stock options for 296,521, 279,706 and 124,928 shares of common stock were not included in the December 31, 2010, 2009 and 2008 computations of diluted earnings per share because their impact was anti-dilutive. The common stock warrant for 215,983 shares was not included in the 2010 and 2009 computations of diluted earnings per share because its impact was also anti-dilutive.

17.	EMPLOYEE BENEFIT PLANS

(a)

Pension Plan–We are a participant in the Pentegra Defined Benefit Plan for Financial Institutions (formerly known as Financial Institutions Retirement Fund) which is a non-contributory, multiple-employer defined benefit pension plan, covering employees hired before June 1, 2002. Because the plan was curtailed, employees hired on or after that date are not eligible for membership in the fund. Eligible employees are 100% vested at the completion of five years of participation in the plan. Our policy is to contribute annually the minimum funding amounts. Employer contributions and administrative expenses charged to operations for the years ended December 31, 2010, 2009 and 2008 totaled $1,000, $233,000, and $1,000, respectively. Accrued liabilities associated with the plan as of December 31, 2010 and 2009 were $324,000 and $527,000, respectively.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

17.	EMPLOYEE BENEFIT PLANS – (Continued)

(b)

KSOP–We have a combined 401(k)/Employee Stock Ownership Plan. The plan is available to all employees meeting certain eligibility requirements. The plan allows employee contributions up to 50% of their compensation up to the annual dollar limit set by the IRS. The employer matches 100% of the employee contributions up to 6% of the employee’s compensation. If the employee does not contribute at least 2% of the employee’s compensation, then the employer makes a minimum contribution for the employee of 2% of the employee’s compensation. Employees are 100% vested in matching contributions upon meeting the eligibility requirements of the plan. Shares of our common stock are acquired in non-leveraged transactions. At the time of purchase, the shares are released and allocated to eligible employees determined by a formula specified in the plan agreement. Accordingly, the plan has no unallocated shares. The number of shares to be purchased and allocated is at the Board of Directors discretion. For 2010 and 2009, the Board of Directors decided not to make a contribution to the KSOP plan. Employer matching contributions and administrative expenses charged to operations for the plan for the years ended December 31, 2010, 2009 and 2008 were $540,000, $552,000, and $494,000, respectively.

Shares in the plan and the fair value of shares released during the year charged to compensation expense were as follows:

	Year Ended
	December 31,
	2010		2009		2008

KSOP shares (ending)		236,625		205,289		224,956
Shares released		-		-		7,877
Compensation expense	$	-	$	-	$	110,500

(c)

Stock Based Compensation Plan – Our 2006 Stock Option and Incentive Compensation Plan, which is shareholder approved, succeeded our 1998 Stock Option and Incentive Compensation Plan. Under the 2006 Plan, we may grant restricted stock and incentive or non-qualified stock options to key employees and directors for a total of 647,350 shares of our common stock. Options available for future grant under the 1998 Plan totaled 38,500 shares and were rolled into the 2006 Plan. We believe that the ability to award stock options and other forms of stock-based incentive compensation can assist us in attracting and retaining key employees. Stock-based incentive compensation is also a means to align the interests of key employees with those of our shareholders by providing awards intended to reward recipients for our long-term growth. The option to purchase shares vest over periods of one to five years and expire ten years after the date of grant. We issue new shares of common stock upon the exercise of stock options. If options or awards granted under the 2006 Plan expire or terminate for any reason without having been exercised in full or released from restriction, the corresponding shares shall again be available for option or award for the purposes of the Plan. At December 31, 2010, options and restricted stock available for future grant under the 2006 Plan totaled 430,559.

Compensation cost related to options and restricted stock granted under the 1998 and 2006 Plans that was charged against earnings for the years ended December 31, 2010, 2009 and 2008 was $100,000, $103,000 and $122,000, respectively. As of December 31, 2010 there was $422,000 of total unrecognized compensation cost related to non-vested share-based compensation arrangements granted under the 1998 and 2006 Plans. That cost is expected to be recognized over a weighted-average period of 3.0 years.

Stock Options – The fair value of each option award is estimated on the date of grant using the Black-Scholes option valuation model that uses various weighted-average assumptions. The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of grant. The expected volatility is based on the fluctuation in the price of a share of stock over the period for which the option is being valued and the expected life of the options granted represents the period of time the options are expected to be outstanding.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

17.	EMPLOYEE BENEFIT PLANS – (Continued)

The weighted-average assumptions for options granted during the years ended December 31, 2010, 2009 and 2008 and the resulting estimated weighted average fair value per share is presented below.

	December 31,
	2010			2009			2008
Assumptions:
Risk-free interest rate		3.31	%		3.84	%		3.48	%
Expected dividend yield		-	%		6.83	%		3.49	%
Expected life (years)		10			10			10
Expected common stock market price volatility		37	%		36	%		24	%
Estimated fair value per share	$	1.68		$	1.51		$	4.84

A summary of option activity under the 1998 and 2006 Plans for the year ended December 31, 2010 is presented below:

				Weighted		Average
	Number			Average		Remaining		Aggregate
	of			Exercise		Contractual		Intrinsic
	Options			Price		Term		Value
								(Dollars In Thousands)

Outstanding, beginning of period		279,706		$	15.12
Granted during period		61,500			4.07
Forfeited during period		(4,685	)		11.61
Cancelled during period		(40,000	)		9.06
Exercised during period		-			-
Outstanding, end of period		296,521		$	13.70		7.2	$	-

Eligible for exercise at period end		125,793		$	18.97		5.0	$	-

The total intrinsic value of options exercised during the period ended December 31, 2009 was $119,000. There were no options exercised, modified or settled in cash during the 2010 and 2008 periods. There was no tax benefit recognized from the option exercises as they are considered incentive stock options. Management expects all outstanding unvested options will vest. Cash received from option exercises for the periods ended December 31, 2010, 2009 and 2008 was $0, $101,000 and $0 respectively.

Restricted Stock – In addition to the stock options reflected above, on December 31, 2010, we granted 36,855 shares of restricted common stock at the weighted average current market price of $4.07. No restricted stock had been granted prior to December 31, 2010. Restricted stock provides the grantee with voting, dividend and anti-dilution rights equivalent to common shareholders, but is restricted from transfer until vested, at which time all restrictions are removed. Vesting for restricted shares is on a straight-line basis and is for two years. The value of the restricted stock, estimated to be equal to the closing market price on the date of grant, will be amortized starting in the first quarter of 2011 on a straight-line basis over the two year period.

(d)

Employee Stock Purchase Plan – We maintain an Employee Stock Purchase Plan whereby eligible employees have the option to purchase common stock of the Corporation through payroll deduction at a 10% discount. The purchase price of the shares under the plan will be 90% of the closing price of the common stock at the date of purchase. The plan provides for the purchase of up to 100,000 shares of common stock, which may be obtained by purchases issued from a reserve. Funding for the purchase of common stock is from employee contributions. Total compensation cost charged against earnings for the Plan for the periods ended December 31, 2010, 2009 and 2008 totaled $9,000, $12,000 and $9,000, respectively.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

18.	CASH FLOW ACTIVITIES

The following information is presented as supplemental disclosures to the statement of cash flows.

	Year Ended
(a) Cash Paid for:	December 31,
(Dollars in thousands)	2010		2009		2008

Interest expense	$	23,251	$	21,720	$	25,604

Income taxes	$	1,950	$	3,014	$	3,649

(b) Supplemental disclosure of non-cash activities:
(Dollars in thousands)
	Year Ended
	December 31,
	2010		2009		2008

Loans to facilitate sales of real estate owned and repossessed assets	$	7,589	$	6,072	$	978

Transfers from loans to real estate acquired through foreclosure and repossessed assets	$	25,702	$	8,587	$	5,196

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

19.	CONDENSED FINANCIAL INFORMATION (PARENT COMPANY ONLY)

The following condensed statements summarize the balance sheets, operating results and cash flows of First Financial Service Corporation (Parent Company only).

Condensed Balance Sheets

	December 31,
(Dollars in thousands)	2010			2009
	Restated

Assets
Cash and interest bearing deposits	$	240		$	1,860
Investment in Bank		89,701			101,930
Securities available-for sale		291			978
Other assets		80			163
	$	90,312		$	104,931

Liabilities and Stockholders' Equity
Short-term borrowings	$	-		$	1,500
Subordinated debentures		18,000			18,000
Other liabilities		1,001			299
Stockholders' equity		71,311			85,132
	$	90,312		$	104,931

Condensed Statements of Income/(Loss)

	Year Ended
	December 31,
(Dollars in thousands)	2010			2009			2008
	Restated

Dividend from Bank	$	587		$	3,052		$	10,823
Interest income		57			107			70
Interest expense		(1,368	)		(1,353	)		(978	)
Gain on sale of investments		37			-			55
Losses on securities impairment		-			-			(516	)
Other income		-			1			5
Other expenses		(168	)		(378	)		(520	)
Income before income tax benefit		(855	)		1,429			8,939
Income tax benefit		(153	)		609			703
Income before equity in undistributed net income/(loss) of Bank		(1,008	)		2,038			9,642
Equity in undistributed net income/(loss) of Bank		(8,394	)		(8,747	)		(4,845	)
Net income/(loss)	$	(9,402	)	$	(6,709	)	$	4,797

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

19.	CONDENSED FINANCIAL INFORMATION (PARENT COMPANY ONLY) – (Continued)

Condensed Statements of Cash Flows

	Year Ended
(Dollars in thousands)	December 31,
	2010			2009			2008
	Restated
Operating Activities:
Net income/(loss)	$	(9,402	)	$	(6,709	)	$	4,797
Adjustments to reconcile net income/(loss) to cash provided by operating activities:
Equity in undistributed net income/(loss) of Bank		8,394			8,747			4,845
Losses on securities impairment		-			-			516
Gain on sale of investments available-for-sale		(37	)		-			(55	)
Stock-based compensation expense		100			103			122
Changes in:
Other assets		305			(107	)		(185	)
Accounts payable and other liabilities		702			1			177
Net cash from operating activities		62			2,035			10,217

Investing Activities:
Cash paid for acquisition of Farmers State Bank		-			-			(14,000	)
Capital contributed to Bank		-			(20,000	)		(1,100	)
Purchases of securities available-for-sale		-			-			(524	)
Sales of securities available-for-sale		685			-			669
Net cash from investing activities		685			(20,000	)		(14,955	)

Financing Activities:
Change in short-term borrowings		(1,500	)		1,500			-
Proceeds from issuance of subordinated debentures		-			-			8,000
Issuance of preferred stock, net		-			20,000			-
Issuance of common stock under dividend reinvestment program		17			303			-
Issuance of common stock for stock options exercised		-			101			-
Issuance of common stock for employee benefit plans		116			103			144
Dividends paid on common stock		-			(2,015	)		(3,546	)
Dividends paid on preferred stock		(1,000	)		(980	)		-
Net cash from financing activities		(2,367	)		19,012			4,598

Net change in cash and interest bearing deposits		(1,620	)		1,047			(140	)
Cash and interest bearing deposits, beginning of year		1,860			813			953
Cash and interest bearing deposits, end of year	$	240		$	1,860		$	813

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

20.	FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK

We are a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of our customers. These financial instruments primarily include commitments to extend credit, and lines and letters of credit, and involve, to varying degrees, elements of credit and interest-rate risk in excess of the amount recognized in the balance sheet. The contract or notional amounts of these instruments reflect the extent of our involvement in particular classes of financial instruments.

Our exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit is represented by the contractual notional amount of those instruments. Creditworthiness for all instruments is evaluated on a case-by-case basis in accordance with our credit policies. We use the same credit policies in making commitments and conditional obligations as we do for on-balance-sheet instruments. Collateral from the customer may be required based on management’s credit evaluation of the customer and may include business assets of commercial customers as well as personal property and real estate of individual customers or guarantors.

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.

The contractual amounts of financial instruments with off-balance-sheet risk at year end were as follows:

(Dollars in thousands)	December 31, 2010				December 31, 2009
	Fixed		Variable		Fixed		Variable
	Rate		Rate		Rate		Rate

Commitments to make loans	$	-	$	-	$	-	$	496
Unused lines of credit		-		87,475		-		110,484
Standby letters of credit		-		9,150		-		9,319
	$	-	$	96,625	$	-	$	120,299

At December 31, 2010 and 2009, we had $100.7 million, and $126.0 million in letters of credit from the Federal Home Loan Bank issued to collateralize public deposits. These letters of credit are secured by a blanket pledge of eligible one-to-four family residential mortgage loans. (For additional information see Note 4 on Loans and Note 11 on Advances from the Federal Home Loan Bank.)

21.	RELATED PARTY TRANSACTIONS

Certain directors, executive officers and principal shareholders of the Company, including associates of such persons, are our loan and deposit customers. Related party deposits at December 31, 2010 and 2009 were $3.3 million and $3.5 million. A summary of the related party loan activity, for loans aggregating $60,000 or more to any one related party, is as follows:

	December 31,
(Dollars in thousands)	2010			2009

Beginning of year	$	2,389		$	1,306
New loans		253			1,231
Other changes		15			978
Repayments		(917	)		(1,126	)
End of year	$	1,740		$	2,389

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

22.	SUMMARY OF QUARTERLY FINANCIAL DATA – (Unaudited)

(Dollars in thousands except per share data)

Year Ended December 31, 2010:	March 31,		June 30,			September 30,			December 31,
									Restated
Total interest income	$	14,711	$	15,347		$	14,915		$	14,592
Total interest expense		5,810		5,828			5,819			6,028
Net interest income		8,901		9,519			9,096			8,564
Provision for loan losses		1,752		3,274			6,327			5,528
Non-interest income		2,138		2,181			1,980			1,005
Non-interest expense		8,274		8,634			8,714			8,497
Net income/(loss) attributable to common shareholders		491		(325	)		(2,757	)		(7,865	)
Earnings/(loss) per common share:
Basic		0.10		(0.07	)		(0.58	)		(1.66	)
Diluted		0.10		(0.07	)		(0.58	)		(1.66	)

Year Ended December 31, 2009:	March 31,		June 30,			September 30,			December 31,

Total interest income	$	14,358	$	14,578		$	14,859		$	15,061
Total interest expense		5,469		5,322			5,472			5,529
Net interest income		8,889		9,256			9,387			9,532
Provision for loan losses		2,045		1,913			2,482			3,084
Non-interest income		2,003		2,090			1,895			2,531
Non-interest expense		7,783		8,444			8,028			19,662
Net income/(loss) attributable to common shareholders		483		488			312			(9,024	)
Earnings/(loss) per common share:
Basic		0.10		0.10			0.07			(1.92	)
Diluted		0.10		0.10			0.07			(1.92	)

Net income/(loss) attributable to common shareholders decreased for 2010 compared to 2009 due to a decrease in our net interest margin, an increase in provision for loan loss expense, write downs taken on investment securities that were other-than-temporarily impaired, write downs on real estate acquired through foreclosure and higher FDIC insurance premiums. Also, during the fourth quarter of 2010, we recorded a valuation allowance against deferred tax assets of $4.8 million.

The decrease in net income for the fourth quarter of 2009 was attributable to a goodwill impairment charge of $11.9 million.

23.	RESTATEMENT OF CONSOLIDATED FINANCIAL STATEMENTS

Certain adjustments have been made to restate previously reported results for the quarter and year ended December 31, 2010. The restatement of our results for the quarter and year ended December 31, 2010 is necessary to reflect additional write downs on real estate acquired through foreclosure of $796,817. These adjustments are the result of new information obtained after December 31, 2010 about conditions that existed at December 31, 2010, that was available prior to filing the Form 10-K. These adjustments were made in accordance with Financial Accounting Standards Board Account Standards Codification (“ASC”) Topic 855, “Subsequent Events”. In addition, management recorded three additional items that prior to the previously mentioned entry were considered immaterial. These entries to record additional bank franchise tax expense of $249,193 legal expense of $83,000 and additional health insurance of $56,100.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

23.	RESTATEMENT OF CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

The effects of the restatement on our consolidated balance sheet, consolidated statement of operations, and consolidated statement of cash flows are summarized as follows:

	At December 31, 2010
	As Previously
Consolidated Balance Sheet	Reported		Adjustment			Restated
Real estate owned:
Acquired through foreclosure	$	26,604	$	(797	)	$	25,807
Accrued income taxes		2,102		59			2,161
Other assets		2,638		(250	)		2,388
Total assets		1,320,495		(988	)		1,319,507
Accounts payable and other liabilities		3,023		139			3,162
Total liabilities		1,248,057		139			1,248,196
Retained earnings		17,391		(1,127	)		16,264
Total stockholders' equity		72,438		(1,127	)		71,311
Total liabilities and stockholders' equity		1,320,495		(988	)		1,319,507

	As of and for the Three Months Ended,									As of and for the Year Ended,
	December 31, 2010									December 31, 2010
Consolidated Statement	As Previously									As Previously
of Operations	Reported			Adjustment			Restated			Reported			Adjustment			Restated
Loss on sale and write downs on real estate acquired through foreclosure	$	(698	)	$	(797	)	$	(1,495	)	$	(1,536	)	$	(797	)	$	(2,333	)
Total non-interest income		1,802			(797	)		1,005			8,101			(797	)		7,304

Employee compensation and benefits		3,491			56			3,547			15,662			56			15,718
Outside services and data processing		617			83			700			2,637			83			2,720
Bank franchise tax		328			250			578			1,810			250			2,060
Total non-interest expense		8,108			389			8,497			33,730			389			34,119

Income/(loss) before income taxes		(3,270	)		(1,186	)		(4,456	)		(6,430	)		(1,186	)		(7,616	)
Income taxes/(benefits)		3,205			(59	)		3,146			1,845			(59	)		1,786

Net income/(loss)		(6,475	)		(1,127	)		(7,602	)		(8,275	)		(1,127	)		(9,402	)
Net income/(loss) attributable to common shareholders		(6,738	)		(1,127	)		(7,865	)		(9,329	)		(1,127	)		(10,456	)

Basic income/(loss) per common share		(1.42	)		(0.24	)		(1.66	)		(1.97	)		(0.24	)		(2.21	)
Diluted income/(loss) per common share		(1.42	)		(0.24	)		(1.66	)		(1.97	)		(0.24	)		(2.21	)

	As of and for the Year Ended,
	December 31, 2010
	As Previously
Consolidated Statement of Cash Flows	Reported			Adjustment			Restated
Net income/(loss)	$	(8,275	)	$	(1,127	)	$	(9,402	)
Income tax valuation allowance		5,675			349			6,024
Deferred taxes		(4,129	)		(349	)		(4,478	)
Other assets		(637	)		1,047			410
Accrued income tax		(2,102	)		(59	)		(2,161	)
Accounts payable and other liabilities		1,071			139			1,210

ITEM 9A. CONTROLS AND PROCEDURES

Management is responsible for establishing and maintaining effective disclosure controls and procedures, as defined under Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934. As of December 31, 2010, an evaluation was performed under the supervision and with the participation of management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based on the restatement of the Company’s financial statements for the quarter and year ended December 31, 2010, the Company’s management and the Risk Management Committee of its Board of Directors determined that the Company’s internal controls over financial reporting of subsequent events related to the appraisal review process for other real estate owned and the timeliness of obtaining and reviewing real estate acquired through foreclosure was not effective. The Company’s management, overseen by the Risk Management Committee, has implemented steps to improve the process for timely identification and improved communication of the events in the closing procedure that resulted in the material misstatement discovered in the closing procedure for the year and quarter ended December 31, 2010.

These enhanced procedures are expected to include:

Starting May 16, 2011, the executive loan committee will review on a weekly basis, any classified and/or collateral dependent loans as well as other real estate owned properties for new and updated appraisals, changes in market conditions and the status of the borrowers and/or guarantors; and

Establish a tracking system to be shared with the finance department, loan officers and special assets officers showing property name, loan/asset number, and the date that appraisals were ordered, received and reviewed, and what, if any, change in valuation occurred.

Management concluded that disclosure controls and procedures as of December 31, 2010, were not effective in ensuring material information required to be disclosed in this Annual Report on Form 10-K was recorded, processed, summarized, and reported in a timely manner as specified in SEC rules and forms. There were no changes in our internal control over financial reporting that occurred during the quarter ended December 31, 2010 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Management's responsibilities related to establishing and maintaining effective disclosure controls and procedures include maintaining effective internal controls over financial reporting that are designed to produce reliable financial statements in accordance with accounting principles generally accepted in the United States. As disclosed in the Management's Report on Internal Control Over Financial Reporting of this Annual Report, we assessed our system of internal control over financial reporting as of December 31, 2010, in relation to criteria for effective internal control over financial reporting as described in "Internal Control - Integrated Framework," issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment, management concludes that, as of December 31, 2010, its system of internal control over financial reporting was not effective.

PART IV

ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

Financial Statements Filed

(a)(1)

Report of Independent Registered Public Accounting Firm - Crowe Horwath, LLP

(b)

Consolidated Balance Sheets at December 31, 2010 and 2009.

(c)

Consolidated Statements of Operations for the years ended December 31, 2010, 2009 and 2008.

(d)

Consolidated Statements of Comprehensive Income (Loss) for the years ended December 31, 2010, 2009 and 2008.

(e)

Consolidated Statements of Changes in Stockholders' Equity for the years ended December 31, 2010, 2009 and 2008.

(f)

Consolidated Statements of Cash Flows for the years ended December 31, 2010, 2009 and 2008.

(g)

Notes to Consolidated Financial Statements

Financial Statements Schedules

All financial statement schedules have been omitted, as the required information is either inapplicable or included in the financial statements or related notes.

Exhibits

The following exhibits are filed with this Amendment No. 1

Exhibit No.		Description

23		Consent of Crowe Horwath LLP, Independent Registered Public Accounting Firm

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)

SIGNATURES

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

	FIRST FINANCIAL SERVICE CORPORATION

Date: 5/13/11	By:	/s/ B. Keith Johnson
		B. Keith Johnson
		Chief Executive Officer
		Duly Authorized Representative

INDEX TO EXHIBITS

Exhibit No.		Description

23		Consent of Crowe Horwath LLP, Independent Registered Public Accounting Firm

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

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

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

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