BANK OF KENTUCKY FINANCIAL CORP - FORM 10-Q

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EX-32.1 - EXHIBIT 32.1 - BANK OF KENTUCKY FINANCIAL CORP	v408601_ex32-1.htm
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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For quarterly period ended March 31, 2015

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

For the transition period from______________to___________________

Commission File Number: 001-34214

THE BANK OF KENTUCKY FINANCIAL CORPORATION

(Exact name of registrant as specified in its charter)

Kentucky		61-1256535
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification Number)

111 Lookout Farm Drive, Crestview Hills, Kentucky 41017

(Address of principal executive offices) (Zip Code)

Registrant’s telephone number: (859) 371-2340

Indicate by checkmark whether the registrant (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes 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 (Check one):

Large accelerated filer ¨	Accelerated filer x
Non-accelerated filer ¨	Smaller reporting company ¨
(do not check if a smaller reporting company)

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

As of May 7, 2015, 7,744,358 shares of the registrant's Common Stock, no par value, were issued and outstanding.

The Bank of Kentucky Financial Corporation

INDEX

		PAGE
Part I	FINANCIAL INFORMATION

Item 1 – Financial Statements		3

Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations		32

Item 3 – Quantitative and Qualitative Disclosures About Market Risk		48

Item 4 – Controls and Procedures		48

Part II	OTHER INFORMATION

Item 1 – Legal Proceedings		49

Item 1A – Risk Factors		49

Item 2 – Unregistered Sales of Equity Securities and Use of Proceeds		49

Item 3 – Defaults upon Senior Securities		49

Item 4 – Mine Safety Disclosures		49

Item 5 – Other Information		49

Item 6 – Exhibits		49

PART I FINANCIAL INFORMATION

Item 1. Financial Statements

THE BANK OF KENTUCKY FINANCIAL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

(Dollars in thousands, except per share data - unaudited)

	March 31, 2015		December 31, 2014
Assets
Cash and cash equivalents	$	151,143	$	185,376
Interest-bearing deposits with banks		252		252
Available-for-sale securities		290,939		301,138
Held-to-maturity securities		70,893		73,629
Loans held for sale		2,797		2,255
Total loans		1,276,642		1,258,905
Less: Allowance for loan losses		13,217		14,639
Net loans		1,263,425		1,244,266
Premises and equipment, net		22,015		22,300
FHLB stock, at cost		4,850		4,850
Goodwill		22,023		22,023
Acquisition intangibles, net		1,256		1,360
Cash surrender value of life insurance		41,200		40,925
Accrued interest receivable and other assets		31,544		33,282
Total assets	$	1,902,337	$	1,931,656

Liabilities & Shareholders’ Equity
Liabilities
Deposits	$	1,598,530	$	1,615,879
Short-term borrowings		29,148		45,703
Notes payable		50,262		50,325
Accrued interest payable and other liabilities		19,090		19,028
Total liabilities		1,697,030		1,730,935

Shareholders’ Equity
Common stock, no par value, 15,000,000 shares authorized, 7,739,548 (2015) and 7,717,928 (2014) shares issued		3,098		3,098
Additional paid-in capital		41,734		41,134
Retained earnings		157,217		154,498
Accumulated other comprehensive income		3,258		1,991
Total shareholders’ equity		205,307		200,721
Total liabilities and shareholders’ equity	$	1,902,337	$	1,931,656

See accompanying notes.

THE BANK OF KENTUCKY FINANCIAL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

FOR THE THREE MONTHS ENDED MARCH 31, 2015 AND 2014

(Dollars in thousands, except per share data - unaudited)

	2015		2014
INTEREST INCOME
Loans, including related fees	$	12,888	$	12,980
Securities and other		1,755		1,949
Total interest income		14,643		14,929
INTEREST EXPENSE
Deposits		960		824
Borrowings		236		236
Total interest expense		1,196		1,060

Net interest income		13,447		13,869
Provision for loan losses		0		900
Net interest income after provision for loan losses		13,447		12,969

NON-INTEREST INCOME
Service charges and fees		2,098		2,434
Mortgage banking income		248		165
Company owned life insurance earnings		275		290
Bankcard transaction revenue		1,056		999
Trust fee income		1,007		941
Other		688		753
Total non-interest income		5,372		5,582

NON-INTEREST EXPENSE
Salaries and benefits		5,318		5,873
Occupancy and equipment		1,456		1,435
Data processing		555		535
Advertising		401		374
Electronic banking processing fees		378		386
Outside service fees		293		244
State bank taxes		612		642
Amortization of intangible assets		104		133
Merger related expense		1,965		-
FDIC insurance		245		554
Other		1,708		1,942
Total non-interest expense		13,035		12,118

INCOME BEFORE INCOME TAXES		5,784		6,433
Less: income taxes		1,672		1,815
NET INCOME	$	4,112	$	4,618
Net income per common share:
Earnings per share, basic	$	0.53	$	0.60
Earnings per share, diluted	$	0.53	$	0.60

See accompanying notes.

THE BANK OF KENTUCKY FINANCIAL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

FOR THE THREE MONTHS ENDED MARCH 31, 2015 AND 2014

(Dollars in thousands - unaudited)

	2015			2014
Net income	$	4,112		$	4,618
Other comprehensive income:
Unrealized gains/losses on securities
Unrealized holding gain arising during the period		1,950			2,130
Tax effect		(683	)		(718	)
Total other comprehensive income (loss)		1,267			1,412
Comprehensive income	$	5,379		$	6,030

See accompanying notes.

THE BANK OF KENTUCKY FINANCIAL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

FOR THE THREE MONTHS ENDED MARCH 31

(Dollars in thousands, except per share data -unaudited)

	2015			2014

Balance as of January 1	$	200,721		$	181,139

Net income		4,112			4,618
Change in net unrealized gain(loss), net of tax		1,267			1,412

Cash dividends paid on common stock		(1,394	)		(1,379	)
Exercise of stock options (21,620 and 29,494 shares), including tax benefit		546			735
Stock-based compensation expense		55			106
Balance as of March 31	$	205,307		$	186,631
Dividends per share	$	0.18		$	0.18

See accompanying notes.

THE BANK OF KENTUCKY FINANCIAL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE THREE MONTHS ENDED MARCH 31, 2015 AND 2014

(Dollars in thousands - unaudited)

	2015			2014

Cash Flows from Operating Activities

Net income	$	4,112		$	4,618

Adjustments to reconcile net income to net cash from operating activities		1,502			(618	)
Net cash from operating activities		5,614			4,000

Cash Flows from Investing Activities

Proceeds from paydowns and maturities of held-to-maturity securities		2,726			2,836
Proceeds from paydowns and maturities of available-for-sale securities		11,687			20,991
Proceeds from retirement of FHLB stock		-			249
Purchases of held-to-maturity securities		-			(645	)
Net change in loans		(19,808	)		(14,031	)
Proceeds from the sale of other real estate		557			567
Property and equipment expenditures		(194	)		(848	)
Net cash from investing activities		(5,032	)		9,119

Cash Flows from Financing Activities

Net change in deposits		(17,349	)		(3,509	)
Net change in short-term borrowings		(16,555	)		1,577
Proceeds from exercise of stock options		546			735
Cash dividends paid		(1,394	)		(1,379	)
Payments on note payable		(63	)		(62	)
Net cash from financing activities		(34,815	)		(2,638	)

Net change in cash and cash equivalents		(34,233	)		10,481
Cash and cash equivalents at beginning of period		185,376			78,621
Cash and cash equivalents at end of period	$	151,143		$	89,102

See accompanying notes.

THE BANK OF KENTUCKY FINANCIAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2015

(unaudited)

Note 1 - Basis of Presentation:

The condensed consolidated financial statements include the accounts of The Bank of Kentucky Financial Corporation (“BKFC” or the “Company”) and its wholly owned subsidiary, The Bank of Kentucky, Inc. (the “Bank”). All significant intercompany accounts and transactions have been eliminated.

Note 2 - General:

These financial statements were prepared in accordance with the instructions for Form 10-Q and Rule 10-01 of Regulation S-X and, therefore, do not include all of the disclosures necessary for a complete presentation of financial position, results of operations and cash flows in conformity with U.S. generally accepted accounting principles. Except for required accounting changes, these financial statements have been prepared on a basis consistent with the annual financial statements and include, in the opinion of management, all adjustments, consisting of only normal recurring adjustments, necessary for a fair presentation of the results of operations and financial position at the end of and for the periods presented. These financial statements and notes should be read in conjunction with the Company’s audited consolidated financial statements and notes thereto as set forth in the Company’s Annual Report on Form 10-K for the year ended December 31, 2014.

The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the financial statements and the disclosures provided, and future results could differ.

Note 3 - Earnings per Share:

Earnings per share are computed based upon the weighted average number of shares of common stock outstanding during the three months period. Diluted earnings per share show the potential dilutive effect of additional common shares issuable under the Company’s stock compensation plan and warrants. The following table presents the numbers of shares used to compute basic and diluted earnings per share for the indicated periods:

	Three Months Ended March 31,
	2015		2014

Weighted average shares outstanding		7,736,040		7,640,872
Dilutive effects of assumed exercises of stock options		34,645		46,234
Shares used to compute diluted earnings per share		7,770,685		7,687,106

Note 4 – Stock-Based Compensation:

Stock-based compensation in the form of options to buy stock and restricted stock units (“RSUs”) are granted to directors, officers and employees under the Company’s incentive stock plan (the “Plan”), which provides for the issuance of up to 1,000,000 shares.

Stock Options

The specific terms of each option agreement are determined by the Compensation Committee at the date of the grant. For current options outstanding, options granted to directors vest immediately and options granted to employees generally vest evenly over a five-year period.

The Company recorded stock option expense of $2,000 (net of taxes) in the three months ended March 31, 2015, and $5,000 (net of taxes) in the three months ended March 31, 2014.

Restricted Stock Units (RSUs)

The specific terms of each RSU award are determined by the Compensation Committee at the date of the grant. Compensation expense is recognized over the vesting period of the awards based on the fair value of the stock at issue date. The fair value of the stock was determined using the total number of RSUs granted multiplied by the grant date fair market value of a share of company stock. Certain service based RSUs vest after one year and performance based RSUs vest after three years based on achievement of certain targets.

A summary of changes in the Company’s non-vested shares for the three months ended March 31, 2015 follows:

			Weighted-Average
			Grant-Date
Nonvested Shares	Shares		Fair Value

Non-vested at January 1, 2015		10,820	$	36.93
Granted		-		-
Vested		-		-
Forfeited		479		37.98

Non-vested at March 31, 2015		10,341	$	36.88

The Company recorded RSU expense of $53,000 for the three months ended March 31, 2015. As of March 31, 2015, there was $176,000 of total unrecognized compensation cost related to non-vested shares granted under the Plan. The cost is expected to be recognized over a period of thirty-three months.

Note 5 – Cash and Cash Equivalents:

Cash and cash equivalents include cash on hand, amounts due from banks, federal funds sold and investments in money market mutual funds. The Company reports net cash flows for customer loan and deposit transactions, interest-bearing balances with banks and short-term borrowings with maturities of 90 days or less.

Note 6 – Reclassification:

Certain prior period amounts have been reclassified to conform to the current period presentation. Such reclassifications have no effect on previously reported net income or shareholders’ equity.

Note 7–Securities:

The fair value of available-for-sale securities and the related gains and losses recognized in accumulated other comprehensive income (loss) was as follows (in thousands):

			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
Available-for-Sale	Cost		Gains		Losses			Value
March 31, 2015
U.S. government, federal agencies and government sponsored enterprises	$	88,258	$	644	$	(378	)	$	88,524
U.S. government agency mortgage-backed		196,818		4,834		(87	)		201,565
Corporate		850		-		-			850

	$	285,926	$	5,478	$	(465	)	$	290,939

			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Losses			Value
December 31, 2014
U.S. Government, federal agencies and Government sponsored enterprises	$	90,439	$	319	$	(1,074	)	$	89,684
U.S. government agency mortgage-backed		206,786		4,174		(356	)		210,604
Corporate		850		-		-			850

	$	298,075	$	4,493	$	(1,430	)	$	301,138

The carrying amount, unrecognized gains and losses, and fair value of securities held-to-maturity were as follows (in thousands):

			Gross		Gross
	Amortized		Unrecognized		Unrecognized			Fair
Held-to-Maturity	Cost		Gains		Losses			Value
March 31, 2015
Municipal and other obligations	$	70,893	$	1,043	$	(591	)	$	71,345

December 31, 2014
Municipal and other obligations	$	73,629	$	1,084	$	(779	)	$	73,934

The amortized cost and fair value of debt securities at March 31, 2015 by contractual maturity were as follows (in thousands), with securities not due at a single maturity date, primarily mortgage-backed securities, shown separately.

	Available-for-Sale				Held-to-Maturity
	Amortized		Fair		Amortized		Fair
	Cost		Value		Cost		Value

Due in one year or less	$	2,049	$	2,051	$	5,909	$	5,945
Due after one year through five years		77,058		77,189		31,954		32,505
Due after five years through ten years		6,159		6,176		28,190		28,055
Due after ten years		3,842		3,958		4,840		4,840
U.S. government agency mortgage-backed		196,818		201,565		-		-

	$	285,926	$	290,939	$	70,893	$	71,345

No securities were sold in the first three months of 2015 or in the first three months of 2014.

Management evaluates securities for other-than-temporary impairment (“OTTI”) at least on a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. Investment securities classified as available-for-sale or held-to-maturity are evaluated for OTTI under ASC 320, Accounting for Certain Investments in Debt and Equity Securities.

In determining OTTI, management considers many factors, including: (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, (3) whether the market decline was affected by macroeconomic conditions and (4) whether the entity has the intent to sell the debt security or more likely than not will be required to sell the debt security before its anticipated recovery. The assessment of whether an other-than temporary decline exists involves a high degree of subjectivity and judgment and is based on the information available to management at a point in time.

When OTTI occurs, the amount of the OTTI recognized in earnings depends on whether an entity intends to sell the security or more likely than not will be required to sell the security before recovery of its amortized cost basis less any current-period credit loss. If an entity intends to sell or more likely than not will be required to sell the security before recovery of its amortized cost basis less any current-period credit loss, the OTTI shall be recognized in earnings equal to the entire difference between the investment’s amortized cost basis and its fair value at the balance sheet date. Otherwise, the OTTI shall be separated into the amount representing the credit loss and the amount related to all other factors. The amount of the total OTTI related to the credit loss is determined based on the present value of cash flows expected to be collected and is recognized in earnings. The amount of the total OTTI related to other factors shall be recognized in other comprehensive income, net of applicable taxes. The previous amortized cost basis less the OTTI recognized in earnings shall become the new amortized cost basis of the investment.

As of March 31, 2015 and December 31, 2014, the Bank’s security portfolio consisted of 211 securities, 44 of which were in an unrealized loss position of $1,056 and 217 securities, 56 of which were in an unrealized loss position; totaling $2,209 respectively. There was no OTTI of securities at March 31, 2015. Unrealized losses have not been recognized into income because the issuers’ bonds are of high credit quality (U.S. government agencies and government sponsored enterprises and “A” rated or better Kentucky municipalities), management does not have the intent to sell these securities and it is likely that it will not be required to sell the securities before their anticipated recovery. At March 31, 2015, 100% of the mortgage-backed securities held by the Bank were issued by U.S. government sponsored entities and agencies, primarily Fannie Mae and Freddie Mac, institutions which the government has affirmed its commitment to support

At March 31, 2015 and December 31, 2014, securities with a carrying value of $319,206 and $363,344 were pledged to secure public deposits and repurchase agreements.

Securities with unrealized losses at March 31, 2015 and December 31, 2014, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, were as follows (in thousands):

Available for Sale:	Less than 12 Months					12 Months or More					Total
	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
Description of Securities	Value		Loss			Value		Loss			Value		Loss
March 31, 2015
U.S. government, federal agencies and government sponsored enterprises	$	-	$	-		$	42,997	$	(378	)	$	42,997	$	(378	)
U.S government agency mortgage-backed		14,046		(56	)		13,164		(31	)		27,210		(87	)
Total temporarily impaired	$	14,046	$	(56	)	$	56,161	$	(409	)	$	70,207	$	(465	)

Held to Maturity:	Less than 12 Months					12 Months or More					Total
	Fair		Unrecognized			Fair		Unrecognized			Fair		Unrecognized
Description of Securities	Value		Loss			Value		Loss			Value		Loss
March 31, 2015
Municipal & other obligations	$	9,827	$	(89	)	$	16,544	$	(502	)	$	26,371	$	(591	)
Total temporarily impaired	$	9,827	$	(89	)	$	16,544	$	(502	)	$	26,371	$	(591	)

Available for Sale:	Less than 12 Months					12 Months or More					Total
	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
Description of Securities	Value		Loss			Value		Loss			Value		Loss
December 31, 2014
U.S. government, federal agencies and government sponsored enterprises	$	4,987	$	(13	)	$	53,188	$	(1,061	)	$	58,175	$	(1,074	)
U.S government agency mortgage-backed		14,982		(129	)		34,683		(227	)		49,665		(356	)
Total temporarily impaired	$	19,969	$	(142	)	$	87,871	$	(1,288	)	$	107,840	$	(1,430	)

Held to Maturity:	Less than 12 Months					12 Months or More					Total
	Fair		Unrecognized			Fair		Unrecognized			Fair		Unrecognized
Description of Securities	Value		Loss			Value		Loss			Value		Loss
December 31, 2014
Municipal & other obligations	$	6,719	$	(93	)	$	21,840	$	(686	)	$	28,559	$	(779	)
Total temporarily impaired	$	6,719	$	(93	)	$	21,840	$	(686	)	$	28,559	$	(779	)

Note 8 - Loans

Loan balances were as follows (in thousands):	March 31,			December 31,
	2015			2014

Commercial	$	251,077		$	233,522
Residential real estate		268,988			272,531
Nonresidential real estate		597,401			592,642
Construction		104,642			104,299
Consumer		14,270			15,080
Municipal obligations		41,661			42,347
Gross loans		1,278,039			1,260,421
Less: Deferred loan origination fees and discount		(1,397	)		(1,516	)
Allowance for loan losses		(13,217	)		(14,639	)

Net loans	$	1,263,425		$	1,244,266

The following tables present the activity in the allowance for loan losses for the three months ending March 31, 2015 and 2014, and the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based on impairment method as of March 31, 2015 (in thousands):

							Non
				Residential			Residential									Municipal
March 31, 2015	Commercial			Real estate			Real estate			Construction			Consumer			Obligations			Total
Allowance for loan losses
Beginning balance	$	3,297		$	3,052		$	6,855		$	998		$	312		$	125		$	14,639
Provision for loan losses		(172	)		(307	)		(117	)		475			137			(16	)		-
Loans charged off		(221	)		(238	)		(776	)		(125	)		(144	)		-			(1,504	)
Recoveries		26			18			-			-			38			-			82

Total ending allowance balance	$	2,930		$	2,525		$	5,962		$	1,348		$	343		$	109		$	13,217

Ending allowance balance attributable to loans
Individually evaluated for impairment	$	1,822		$	90		$	643		$	588		$	-		$	-		$	3,143
Collectively evaluated for impairment		1,108			2,435			5,319			760			343			109			10,074

Total ending allowance balance	$	2,930		$	2,525		$	5,962		$	1,348		$	343		$	109		$	13,217

Loans
Loans individually evaluated for impairment	$	4,536		$	3,547		$	5,071		$	1,066		$	-		$	-		$	14,220
Loans collectively evaluated for impairment		246,541			265,441			592,330			103,576			14,270			41,661			1,263,819

Total ending loans balance	$	251,077		$	268,988		$	597,401		$	104,642		$	14,270		$	41,661		$	1,278,039

							Non
				Residential			Residential								Municipal
March 31, 2014	Commercial			Real estate			Real estate			Construction		Consumer			Obligations			Total
Allowance for loan losses
Beginning balance	$	3,247		$	4,554		$	6,502		$	1,538	$	373		$	92		$	16,306
Provision for loan losses		274			404			170			3		51			(2	)		900
Loans charged off		(44	)		(714	)		(83	)		-		(122	)		-			(963	)
Recoveries		20			11			3			1		71			-			106

Total ending allowance balance	$	3,497		$	4,255		$	6,592		$	1,542	$	373		$	90		$	16,349

					Non
			Residential		Residential						Municipal
December 31, 2014	Commercial		Real estate		Real estate		Construction		Consumer		Obligations		Total
Ending allowance balance attributable to loans
Individually evaluated for impairment	$	2,025	$	227	$	1,569	$	214	$	-	$	-	$	4,035
Collectively evaluated for impairment		1,272		2,825		5,286		784		312		125		10,604

Total ending allowance balance	$	3,297	$	3,052	$	6,855	$	998	$	312	$	125	$	14,639

Loans
Loans individually evaluated for impairment	$	4,669	$	3,985	$	6,645	$	1,678	$	-	$	-	$	16,977
Loans collectively evaluated for impairment		228,853		268,546		585,997		102,621		15,080		42,347		1,243,444

Total ending loan balance	$	233,522	$	272,531	$	592,642	$	104,299	$	15,080	$	42,347	$	1,260,421

The following table presents individually impaired loans by class of loans as of and for the three months ended March 31, 2015 (in thousands):

	Unpaid				Allowance for		Average		Interest
	Principal		Recorded		Loan Losses		Recorded		Income		Interest
	Balance		Investment		Allocated		Investment		Recognized		Received

With no related allowance recorded
Commercial	$	26	$	26	$	-	$	363	$	-	$	-

Residential real estate
Home equity lines of credit		-		-		-		-		-		-
Multifamily properties		1,440		1,090		-		1,098		-		-
Other		1,155		1,086		-		1,170		-		-

Nonresidential real estate
Owner occupied properties		3,213		809		-		922		-		-
Non owner occupied properties		1,882		1,832		-		1,847		-		-

Construction		345		65		-		286		-		-
Consumer		-		-		-		-		-		-

With an allowance recorded
Commercial		5,108		4,510		1,822		4,240		40		40

Residential real estate
Home equity lines of credit		-		-		-		-		-		-
Multifamily properties		579		579		66		579		8		8
Other		792		792		24		920		6		6

Nonresidential real estate
Owner occupied properties		559		559		126		1,124		3		3
Non owner occupied properties		2,391		1,871		518		1,966		23		23
Construction		1,902		1,001		587		1,086		-		-
Consumer		-		-		-		-		-		-

Total	$	19,392	$	14,220	$	3,143	$	15,601	$	80	$	80

The following table presents individually impaired loans by class of loans as of and for the three months ended March 31, 2014 (in thousands):

	Unpaid				Allowance for		Average		Interest
	Principal		Recorded		Loan Losses		Recorded		Income		Interest
	Balance		Investment		Allocated		Investment		Recognized		Received

With no related allowance recorded
Commercial	$	1,102	$	1,102	$	-	$	1,103	$	-	$	-

Residential real estate
Home equity lines of credit		-		-		-		-		-		-
Multifamily properties		1,293		943		-		951		-		-
Other		1,975		1,848		-		1,771		-		-

Nonresidential real estate
Owner occupied properties		1,541		1,541		-		1,287		-		-
Non owner occupied properties		3,659		3,609		-		3,716		-		-

Construction		-		-		-		-		-		-
Consumer		-		-		-		-		-		-

With an allowance recorded
Commercial		6,995		6,995		1,880		5,004		79		78

Residential real estate
Home equity lines of credit		339		339		186		356		3		3
Multifamily properties		1,485		1,485		238		1,485		20		20
Other		3,145		2,862		394		3,266		10		10

Nonresidential real estate
Owner occupied properties		9,051		7,295		692		6,914		2		2
Non owner occupied properties		2,582		1,956		117		2,395		34		30
Construction		2,815		2,534		732		2,542		25		22
Consumer		-		-		-		-		-		-

Total	$	35,982	$	32,509	$	4,239	$	30,790	$	173	$	165

The following table presents loans individually evaluated for impairment by class of loans as of December 31, 2014 (in thousands):

	Unpaid				Allowance for
	Principal		Recorded		Loan Losses
	Balance		Investment		Allocated

With no related allowance recorded
Commercial	$	699	$	699	$	-

Residential real estate
Home equity lines of credit		-		-		-
Multifamily properties		1,455		1,105		-
Other		1,267		1,253		-

Nonresidential real estate
Owner occupied properties		1,034		1,034		-
Non owner occupied properties		1,912		1,862		-

Construction		787		507		-
Consumer		-		-		-

With an allowance recorded
Commercial		4,568		3,970		2,025

Residential real estate
Home equity lines of credit		-		-		-
Multifamily properties		579		579		113
Other		1,048		1,048		114

Nonresidential real estate
Owner occupied properties		3,318		1,689		1,040
Non owner occupied properties		2,705		2,060		529
Construction		1,947		1,171		214
Consumer		-		-		-

Total	$	21,319	$	16,977	$	4,035

The following table presents the aging of the recorded investment in past due loans by class of loans as of March 31, 2015 and December 31, 2014 (in thousands):

	Loans		Loans over
	30-90 days		90 days				Loans not
	past due		past due		Nonaccrual		past due		Total
March 31, 2015
Commercial	$	93	$	-	$	1,189	$	249,795	$	251,077
Residential real estate
Home equity lines of credit		265		-		563		97,720		98,548
Multifamily properties		-		-		206		53,553		53,759
Other residential real estate		2,251		-		2,148		112,282		116,681

Nonresidential real estate
Owner occupied properties		267		-		816		301,028		302,111
Non owner occupied properties		339		-		2,193		292,758		295,290
Construction		-		-		1,066		103,576		104,642

Consumer
Credit card balances		67		6		-		6,751		6,824
Other consumer		7		-		13		7,426		7,446

Municipal obligations		-		-		-		41,661		41,661

Total	$	3,289	$	6	$	8,194	$	1,266,550	$	1,278,039

	Loans		Loans over
	30-90 days		90 days				Loans not
	past due		past due		Nonaccrual		past due		Total
December 31, 2014
Commercial	$	224	$	-	$	687	$	232,611	$	233,522
Residential real estate
Home equity lines of credit		1,006		7		365		100,393		101,771
Multifamily properties		-		-		206		53,280		53,486
Other residential real estate		2,173		-		2,379		112,722		117,274
Nonresidential real estate
Owner occupied properties		275		-		2,045		300,150		302,470
Non owner occupied properties		271		-		2,413		287,488		290,172
Construction		-		-		1,678		102,621		104,299
Consumer
Credit card balances		70		28		-		6,862		6,960
Other consumer		9		-		9		8,102		8,120
Municipal obligations		-		-		-		42,347		42,347

Total	$	4,028	$	35	$	9,782	$	1,246,576	$	1,260,421

Troubled Debt Restructurings (dollars in thousands):

The Company allocated $1,153 and $1,661 of specific reserves to customers whose loan terms had been modified in troubled debt restructurings as of March 31, 2015 and March 31, 2014, respectively. Troubled debt restructurings totaled $8,670 and $20,529 as of March 31, 2015 and March 31, 2014, respectively. The Company had not committed to lend additional amounts as of March 31, 2015 and March 31, 2014 to customers with outstanding loans that were classified as troubled debt restructurings.

Modifications involving a reduction of the stated interest rate of the loan were for periods up to three years. Modifications involving an extension of the maturity date were for periods ranging from eight to twelve months.

The following table presents loans by class modified as troubled debt restructurings that occurred during the three months ended March 31, 2015 and 2014 (dollars in thousands):

	2015						2014
		Number Of Loans	Pre- Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment			Number Of Loans	Pre- Modification Outstanding Recorded Investment		Post- Modification Outstanding Recorded Investment
Troubled Debt Restructurings:

Commercial		2	$	55	$	55		7	$	3,500	$	3,500

Residential real estate
Home equity lines of credit		-		-		-		-		-		-
Multifamily properties		-		-		-		-		-		-
Other residential real estate		-		-		-		-		-		-
Nonresidential real estate						-						-
Owner occupied properties		3		352		352		3		433		433
Non owner occupied properties		1		71		71		1		137		137
Construction		-		-		-		-		-		-
Consumer
Credit card balances		-		-		-		-		-		-
Other consumer		-		-		-		-		-		-
Municipal obligations				-		-				-		-
Total		6	$	478	$	478		11	$	4,070	$	4,070

The six restructured notes added during the first quarter of 2015 for $478 were added as performing troubled debt restructured loans. The eleven restructured notes added in the first quarter 2014 for a total of $4,070 were added as performing troubled debt restructured loans.

The troubled debt restructurings described above increased the allowance for loan losses by $57 and $756, which resulted in charge-offs of $0 and $0 during the first quarter ending March 31, 2015 and 2014 respectively.

There were no loans modified as troubled debt restructurings for which there was a payment default within twelve months following the modification during the first quarter ending March 31, 2015.

The following table presents loans by class modified as troubled debt restructurings for which there was a payment default within twelve months following the modification during the first quarter ending March 31, 2014.

(dollars in thousands)

Troubled Debt Restructurings

That Subsequently Defaulted:	Number of Loans	Recorded Investment

Commercial	2	$	163
Residential real estate
Home equity lines of credit	-		-
Multifamily properties	-		-
Other residential real estate	1		491
Nonresidential real estate
Owner occupied properties	-		-
Non owner occupied properties	-		-
Construction	3		584
Consumer
Credit card balances	-		-
Other consumer	-		-
Municipal obligations	-		-

Total	6	$	1,238

A loan is considered to be in payment default once it is 30 days contractually past due under the modified terms.

The troubled debt restructurings that subsequently defaulted described above increased the allowance for loan losses by $0 and $0, which resulted in charge-offs of $0 and $0 during the first quarter ending March 31, 2015 and 2014 respectively.

Credit Quality Indicators:

The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt, including: current financial information, historical payment experience, credit documentation, public information and current economic trends, among other factors. The Company analyzes loans individually by classifying the loans as to credit risk. This analysis includes loans with an outstanding balance greater than $100,000 and non-homogeneous loans, such as commercial and commercial real estate loans. This analysis is performed on a quarterly basis. Loans with balances below $100,000 and homogenous loans, such as residential real estate and consumer loans, are analyzed for credit quality based on aging status, which was previously presented. The Company uses the following definitions for risk ratings:

Special Mention. Loans classified as special mention 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 of the institution's 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.

Based on the most recent analysis performed, the risk category of loans by class of loans is as follows (in thousands):

			Special
	Pass		Mention		Substandard		Doubtful		Not Rated(1)		Total
March 31, 2015
Commercial	$	242,830	$	2,174	$	5,599	$	474	$	-	$	251,077
Residential real estate
Home equity lines of credit		12,150		240		2,019		-		84,139		98,548
Multifamily properties		52,974		-		785		-		-		53,759
Other residential real estate		38,117		2,721		5,204		-		70,639		116,681

Nonresidential real estate
Owner occupied properties		275,122		10,227		16,762		-		-		302,111
Non owner occupied properties		286,700		3,777		4,813		-		-		295,290
Construction		100,190		881		3,571		-		-		104,642

Consumer
Credit card balances		-		-		-		-		6,824		6,824
Other consumer		-		-		13		-		7,433		7,446
Municipal obligations		41,661		-		-		-		-		41,661

Total	$	1,049,744	$	20,020	$	38,766	$	474	$	169,035	$	1,278,039

(1)

Not rated loans represent the homogenous pools risk category.

			Special
	Pass		Mention		Substandard		Doubtful		Not Rated(1)		Total
December 31, 2014
Commercial	$	223,920	$	3,294	$	6,308	$	-	$	-	$	233,522
Residential real estate
Home equity lines of credit		12,105		167		2,070		-		87,429		101,771
Multifamily properties		52,701		-		785		-		-		53,486
Other residential real estate		35,151		2,749		5,982		-		73,392		117,274

Nonresidential real estate
Owner occupied properties		273,465		11,266		17,739		-		-		302,470
Non owner occupied properties		280,392		5,292		4,488		-		-		290,172
Construction		100,101		-		4,198		-		-		104,299

Consumer
Credit card balances		-		-		-		-		6,960		6,960
Other consumer		-		-		9		-		8,111		8,120
Municipal obligations		42,347		-		-		-		-		42,347

Total	$	1,020,182	$	22,768	$	41,579	$	-	$	175,892	$	1,260,421

(1)

Not rated loans represent the homogenous pools risk category.

Note 9 –Fair Value:

Accounting guidance establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:

Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.

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.

Investment Securities: The fair values of securities available-for-sale are determined by 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). One corporate security is valued using Level 3 inputs as there is no readily observable market activity. Management determines the value of this security based on expected cash flows, the credit quality of the security and current market interest rates.

Derivatives: The Bank’s derivative instruments consist of over-the-counter interest-rate swaps that trade in liquid markets. The fair value of the derivative instruments is primarily measured by obtaining pricing from broker-dealers recognized to be market participants. The pricing is derived from market observable inputs that can generally be verified and do not typically involve significant judgment by the Bank. This valuation method is classified as Level 2 in the fair value hierarchy.

Impaired Loans: At the time a loan is considered impaired, it is recorded at the lower of cost or fair value. Impaired loans carried at fair value generally receive specific allocations of the allowance for loan losses. For collateral dependent loans, fair value is commonly based on recent real estate appraisals. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value. Non-real estate collateral may be valued using an appraisal, net book value per the borrower’s financial statements or aging reports, adjusted or discounted based on management’s historical knowledge, changes in market conditions from the time of the valuation and management’s expertise and knowledge of the client and client’s business, resulting in a Level 3 fair value classification. Impaired loans are evaluated on a quarterly basis for additional impairment and adjusted accordingly.

Other Real Estate Owned: Assets acquired through or instead of loan foreclosure are initially recorded at fair value less costs to sell when acquired, establishing a new cost basis. These assets are subsequently accounted for at the lower of cost or fair value less estimated costs to sell. Fair value is commonly based on recent real estate appraisals. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value.

Loans Held For Sale: Loans held for sale are carried at the lower of cost or fair value, which is evaluated on a pool-level basis. The fair value of loans held for sale is determined using quoted prices for similar assets, adjusted for specific attributes of that loan or other observable market data, such as outstanding commitments from third party investors (Level 2).

Assets and Liabilities Measured on a Recurring Basis

Assets and liabilities measured at fair value on a recurring basis are summarized below (in thousands):

			Fair Value Measurements at
			March 31, 2015 Using:
					Significant
			Quoted Prices in		Other		Significant
	Total		Active Markets for		Observable		Unobservable
	March 31,		Identical Assets		Inputs		Inputs
	2015		(Level 1)		(Level 2)		(Level 3)
Assets
Investment securities available-for-sale
U.S. government sponsored entities and agencies	$	88,524	$	-	$	88,524	$	-
U.S. government agency mortgage backed		201,565		-		201,565		-
Corporate		850		-		-		850
Derivatives		3,215		-		3,215		-
Total	$	294,154	$	-	$	293,304	$	850

Liabilities
Derivatives	$	3,215	$	-	$	3,215	$	-
Total	$	3,215	$	-	$	3,215	$	-

			Fair Value Measurements at
			December 31, 2014 Using:
					Significant
			Quoted Prices in		Other		Significant
	Total		Active Markets for		Observable		Unobservable
	December 31,		Identical Assets		Inputs		Inputs
	2014		(Level 1)		(Level 2)		(Level 3)
Assets
Investment securities available-for-sale
U.S. government sponsored entities and agencies	$	89,684	$	-	$	89,684	$	-
U.S. government agency mortgage backed		210,604		-		210,604		-
Corporate		850		-		-		850
Derivatives		2,280		-		2,280		-

Total	$	303,418	$		$	302,563	$	850

Liabilities
Derivatives	$	2,280	$	-	$	2,280	$	-

Total	$	2,280	$	-	$	2,280	$	-

There were no transfers between Level 1 and Level 2 during 2015 or 2014.

There were no gains or losses for assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the quarter ended March 31, 2015.

There were no changes in unrealized gains and losses recorded in earnings for the quarter ended March 31, 2015 for Level 3 assets and liabilities that are still held at March 31, 2015.

The table below presents a reconciliation of all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three months ended March 31 (in thousands):

Corporate Securities

	Three months ended		Three months ended
	March 31, 2015		March 31, 2014

Balance of recurring Level 3 assets at January 1	$	850	$	925
Total gains or losses for the period:
Included in earnings		-		-
Included in other comprehensive income		-		-
Purchases		-		-
Sales		-		-
Issuances		-		-
Settlements		-		-
Transfers into Level 3		-		-
Transfers out of Level 3		-		-

Balance of recurring Level 3 assets at March 31	$	850	$	925

The following table presents quantitative information about recurring Level 3 fair value measurements at March 31, 2015 (in thousands):

Valuation

Fair value

Technique(s)

Unobservable Input(s)

Value

Corporate

850

Discounted cash flow

Probability of default

The following table presents quantitative information about recurring Level 3 fair value measurements at December 31, 2014 (in thousands):

Valuation

Fair value

Technique(s)

Unobservable Input(s)

Value

Corporate

925

Discounted cash flow

Probability of default

The interest rate on this security is based on interest rates paid for securities with similar credit characteristics, but the probability of default is determined through a credit quality review rather than formal ratings or other observable inputs. The interest rate adjusts to reflect current market conditions of highly rated investments, if probability of default changed significantly, the interest rate would adjust accordingly and the fair value would be updated. Management reviews this interest rate and the security’s credit quality quarterly and a market value adjustment is made if necessary pursuant to this review.

Assets and Liabilities Measured on a Non-Recurring Basis

(Dollars in thousands)

Assets and liabilities measured at fair value on a non-recurring basis are summarized below:

			Fair Value Measurements at
			March 31, 2015 Using:
					Significant
			Quoted Prices in		Other		Significant
	Total		Active Markets for		Observable		Unobservable
	March 31,		Identical Assets		Inputs		Inputs
	2015		(Level 1)		(Level 2)		(Level 3)
Assets
Impaired loans
Commercial	$	669	$	-	$	-	$	669
Nonresidential real estate
Owner occupied properties		219		-		-		219
Non owner occupied properties		191		-		-		191
Construction		414		-		-		414
Other real estate owned
Non-Residential		1,438		-		-		1,438

Total	$	2,931	$	-	$	-	$	2,931

			Fair Value Measurements at
			December 31, 2014 Using:
					Significant
			Quoted Prices in		Other		Significant
	Total		Active Markets for		Observable		Unobservable
	December 31,		Identical Assets		Inputs		Inputs
	2014		(Level 1)		(Level 2)		(Level 3)
Assets
Impaired loans
Commercial	$	1,085	$	-	$	-	$	1,085
Nonresidential real estate
Owner occupied properties		337		-		-		337
Non owner occupied properties		366		-		-		366
Residential real estate
Other		124		-		-		124
Construction		957		-		-		957
Other real estate owned
Residential		36		-		-		36
Non-Residential		1,438		-		-		1,438

Total	$	4,343	$	-	$	-	$	4,343

Impaired loans, which are measured for impairment using the fair value of the collateral for collateral dependent loans, had a gross carrying amount of $2,641 with a valuation allowance of $1,148, resulting in an increase in provision for loan losses of $0 in the first quarter ending March 31, 2015. As of December 31, 2014, impaired loans had a gross carrying amount of $4,702, with a valuation allowance of $1,833, resulting in a decrease in provision for loan losses of $738.

Other real estate owned, measured at fair value less costs to sell, had a net carrying amount of $1,438, which is made up of the outstanding balance of $1,598, net of a valuation allowance of $160 at March 31, 2015, resulting in a write-down of $0, for the quarter ended March 31, 2015. At December 31, 2014, other real estate owned measured at fair value less costs to sell, had a net carrying amount of $1,474, which is made up of the outstanding balance of $1,701, net of a valuation allowance of $227, resulting in a write-down of $227 for the year ended December 31, 2014.

Values for collateral dependent loans and other real estate owned are generally based on appraisals obtained from licensed real estate appraisers and in certain circumstances consideration of offers obtained to purchase properties prior to foreclosure or other factors management deems relevant to arrive at a representative fair value. 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 cost to replace the current property. The market comparison approach evaluates the sales price of similar properties in the same market area. The income approach considers net operating income generated by the property and an investor’s required return. The final fair value is based on a reconciliation of these three approaches.

The following table presents quantitative information about recurring Level 3 fair value measurements at March 31, 2015 (in thousands):

	Fair Value		Valuation Technique(s)	Unobservable Input(s)	Discount Range (Avg discount)
Assets
Impaired Loans:
Commercial	$	669	Cost, sales, income approach	Adjustment for comparable properties, market conditions	35-90% (51%)
Nonresidential real estate
Owner occupied properties		219	Cost, sales, income approach	Adjustment for comparable properties, market conditions	10-40% (37%)

Non owner occupied properties		191	Cost, sales, income approach	Adjustment for comparable properties, market conditions	13% (13%)

Construction		414	Cost, sales, income approach	Adjustment for comparable properties, market conditions	35-90% (51%)

Other real estate owned Non-residential		1,438	Cost, sales, income approach	Adjustment for comparable properties, market conditions	7% (7%)

Total	$	2,931

The following table presents quantitative information about recurring Level 3 fair value measurements at December 31, 2014 (in thousands):

	Fair Value		Valuation Technique(s)	Unobservable Input(s)	Discount Range (Avg discount)
Assets
Impaired Loans:
Commercial	$	1,085	Cost, sales, income approach	Adjustment for comparable properties, market conditions	48-61% (54%)
Nonresidential real estate
Owner occupied properties		337	Cost, sales, income approach	Adjustment for comparable properties, market conditions	4-95% (19%)

Non owner occupied properties		366	Cost, sales, income approach	Adjustment for comparable properties, market conditions	7% (7%)

Residential real estate
Other		124	Cost, sales, income approach	Adjustment for comparable properties, market conditions	13-74% (25%)

Construction		957	Cost, sales, income approach	Adjustment for comparable properties, market conditions	3-56% (27%)

Other real estate owned Residential		36	Cost, sales, income approach	Adjustment for comparable properties, market conditions	11% (11%)
Non-residential		1,438			7% (7%)

Total	$	4,343

The carrying amounts and estimated fair values of financial instruments at March 31, 2015 and December 31, 2014 are as follows (in thousands):

				Fair Value Measurements at
				March 31, 2015 Using:
	Carrying Value			Level 1			Level 2			Level 3			Total
Financial assets
Cash and cash equivalents	$	151,143		$	151,143		$	-		$	-		$	151,143
Interest-bearing deposits with banks		252			252			-			-			252
Securities available-for-sale		290,939			-			290,089			850			290,939
Securities held-to-maturity		70,893			-			71,345			-			71,345
Federal Home Loan Bank stock		4,850			N/A			N/A			N/A			N/A
Loans held for sale		2,797			-			2,797			-			2,797
Loans, net		1,263,425			-			-			1,269,002			1,269,002
Accrued interest receivable		3,972			-			1,140			2,832			3,972
Derivative assets		3,215			-			3,215			-			3,215
Financial liabilities
Deposits	$	(1,598,530	)	$	(1,303,128	)	$	(296,823	)	$	-		$	(1,599,951	)
Short-term borrowings		(29,148	)		-			(29,148	)		-			(29,148	)
Notes payable		(50,262	)		-			(26,988	)		(18,358	)		(45,346	)
Accrued interest payable		(853	)		-			(840	)		(13	)		(853	)
Standby letters of credit		(201	)		-			-			(201	)		(201	)
Derivative liabilities		(3,215	)		-			(3,215	)		-			(3,215	)

				Fair Value Measurements at
				December 31, 2014 Using:
	Carrying Value			Level 1			Level 2			Level 3			Total
Financial assets
Cash and cash equivalents	$	185,376		$	185,376		$	-		$	-		$	185,376
Interest-bearing deposits with banks		252			252			-			-			252
Securities available-for-sale		301,138			-			300,288			850			301,138
Securities held-to-maturity		73,629			-			73,934			-			73,934
Federal Home Loan Bank stock		4,850			N/A			N/A			N/A			N/A
Loans held for sale		2,255			-			2,255			-			2,255
Loans, net		1,244,266			-			-			1,249,398			1,249,398
Accrued interest receivable		3,911			-			1,213			2,698			3,911
Derivative assets		2,280			-			2,280			-			2,280
Financial liabilities
Deposits	$	(1,615,879	)	$	(1,317,357	)	$	(299,586	)	$	-		$	(1,616,943	)
Short-term borrowings		(45,703	)		-			(45,703	)		-			(45,703	)
Notes payable		(50,325	)		-			(27,014	)		(18,112	)		(45,126	)
Accrued interest payable		(892	)		-			(878	)		(14	)		(892	)
Standby letters of credit		(307	)		-			-			(307	)		(307	)
Derivative liabilities		(2,280	)		-			(2,280	)		-			(2,280	)

The estimated fair value approximates carrying amounts for all items except those described below. The carrying amounts of cash and short-term instruments approximate fair values and are classified as either Level 1 or Level 2. Estimated fair value for both securities available-for-sale and held-to-maturity is as previously described for securities available-for-sale. It is not practicable to determine the fair value of Federal Home Loan Bank stock due to restrictions placed on its transferability. Fair values of loans, excluding loans held for sale, are estimated as set forth below:

The methods and assumptions, not previously presented, used to estimate fair values are described as follows:

Cash and Cash Equivalents: The carrying amounts of cash and cash equivalents approximate fair values and are classified as Level 1.

Interest-Bearing Deposits With Banks: The carrying amount of interest-bearing deposits equivalents approximate fair value and are classified a Level 1.

Federal Home Loan Bank Stock: It is not practicable to determine the fair value of Federal Home Loan Bank stock due to restrictions placed on its transferability.

Loans Held for Sale: The fair value of loans held for sale is estimated based upon binding contracts and quotes from third party investors resulting in a Level 2 classification.

Loans, Net: For variable rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values resulting in a Level 3 classification. Fair values for other loans are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality resulting in a Level 3 classification. Impaired loans are valued at the lower of cost or fair value as described previously. The methods utilized to estimate the fair value of loans do not necessarily represent an exit price.

Accrued Interest Receivable/Payable: The carrying amounts of accrued interest approximate fair value resulting in a Level 1, Level 2 or Level 3 classification consistent with the classification of the asset/liability with which they are associated.

Deposits: The fair values disclosed for demand deposits (e.g., interest and non-interest checking, passbook savings and certain types of money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amount) resulting in a Level 1 classification. The carrying amounts of variable rate, fixed-term money market accounts and certificates of deposit approximate their fair values at the reporting date resulting in a Level 2 classification. Fair values for fixed rate certificates of deposit are estimated using a discounted cash flows calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits resulting in a Level 2 classification.

Short-Term Borrowings: The carrying amounts of short-term borrowings, generally maturing within ninety days, approximate their fair values resulting in a Level 2 classification.

Notes Payable: The carrying amounts of borrowings under repurchase agreements approximate their fair values resulting in a Level 2 classification. The fair values of the Company’s long-term borrowings are estimated using discounted cash flow analyses based on the current borrowing rates for similar types of borrowing arrangements resulting in a Level 2 classification. The fair values of the Company’s subordinated debentures are estimated using discounted cash flow analyses based on the current borrowing rates for similar types of borrowing arrangements resulting in a Level 3 classification.

Standby Letters of Credit and Off-Balance Sheet Instruments: Fair values for off-balance sheet, credit-related financial instruments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing, which results in a level 3 classification. The fair value of commitments is not material. Estimated fair value of standby letters of credit are based on their current unearned fee balance. Estimated fair value for commitments to make loans and unused lines of credit are considered nominal.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The objective of this section is to help shareholders and potential investors understand our views on our results of operations and financial condition. You should read this discussion in conjunction with the consolidated financial statements and notes to the consolidated financial statements that appear elsewhere in this quarterly report on form 10-Q (this “Quarterly Report”). References to the “Company,” “BKFC,” “we,” “us,” and “our” in this section refer to the Bank of Kentucky Financial Corporation and its subsidiaries, including The Bank of Kentucky, Inc. (the “Bank”), unless otherwise specified or unless the context otherwise requires.

FORWARD-LOOKING STATEMENTS

Certain statements contained in this quarterly report which are not statements of historical fact constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Examples of forward-looking statements include, but are not limited to, projections of revenues, income or loss, earnings or loss per share, the payment or non-payment of dividends, capital structure and other financial items; statements of plans and objectives of us or our management or Board of Directors; and statements of future economic performance and statements of assumptions underlying such statements. Words such as “believes,” “anticipates,” “intends” and other similar expressions are intended to identify forward-looking statements but are not the exclusive means of identifying such statements.

Forward-looking statements involve risks and uncertainties that may cause actual results to differ materially from those in such statements. Factors that could cause actual results to differ from those discussed in the forward-looking statements include, but are not limited to, the following:

indications of an improving economy may prove to be premature;

general economic or industry conditions could be less favorable than expected, resulting in a deterioration in credit quality, a change in the allowance for credit losses, or a reduced demand for credit or fee-based products and services;

changes or volatility in interest rates may adversely impact the value of securities, loans, deposits and other financial instruments and the interest rate sensitivity of our balance sheet as well as our liquidity;

our ability to determine accurate values of certain assets and liabilities;

the impact of turmoil in the financial markets and the effectiveness of governmental actions taken in response, and the effect of such governmental actions on us, our competitors and counterparties, financial markets generally and availability of credit specifically;

changes in the extensive laws, regulations and policies governing financial services companies, including the Dodd-Frank Act and any regulations promulgated thereunder;

the potential need to adapt to industry changes in information technology systems, on which the Bank is highly dependent, could present operational issues or require significant capital spending;

competitive pressures could intensify and affect the Bank’s profitability, including as a result of continued industry consolidation, the increased availability of financial services from non-banks, technological developments or bank regulatory reform;

the effect of the announcement and pendency of our merger with BB&T Corporation (“BB&T”) on our relationships with customers, vendors or employees;

the possibility that the merger does not close when expected or at all; and

the merger may not produce revenue enhancements or cost savings at levels or within timeframes originally anticipated, or may result in unforeseen integration difficulties.

Any forward-looking statements made by us or on our behalf speak only as of the date they are made, and we do not undertake any obligation to update any forward-looking statement to reflect the impact of subsequent events or circumstances. Before making an investment decision, you should carefully consider all risks and uncertainties disclosed in our other public documents on file with the Securities and Exchange Commission (“SEC”), including those described in Item 1A of our Annual Report on Form 10-K, for the year ended December 31, 2014.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

BKFC has prepared all of the consolidated financial information in this quarterly report in accordance with U.S. Generally Accepted Accounting Principles (“GAAP”). In preparing the consolidated financial statements in accordance with GAAP, BKFC makes estimates and assumptions that affect the reported amount of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expenses during the reporting period. There can be no assurances that actual results will not differ from those estimates.

We have identified the accounting policy related to the allowance for loan losses as critical to the understanding of BKFC’s results of operations, since the application of this policy requires significant management assumptions and estimates that could result in reporting materially different amounts if conditions or underlying circumstances were to change.

The Bank maintains an allowance to absorb probable, incurred loan losses inherent in the loan portfolio. The Bank’s policy is to maintain an allowance for loan losses at an adequate level based upon ongoing quarterly assessments and evaluations of the collectability and historical loss experience of loans. Loan losses are charged and recoveries are credited to the allowance for loan losses. Provisions for loan losses are based on the Bank’s review of its historical loan loss experience and such factors that, in management’s judgment, deserve consideration under existing economic conditions in estimating probable loan losses. The Bank’s strategy for credit risk management includes a combination of well-defined credit policies, uniform underwriting criteria, and ongoing risk monitoring and review processes for all commercial and consumer credit exposures. The credit risk management strategy also includes assessments of compliance with commercial and consumer policies, risk ratings and other important credit information. The strategy also emphasizes regular credit examinations and management reviews of loans exhibiting deterioration in credit quality. The Bank strives to identify potential problem loans early and promptly undertake the appropriate actions necessary to mitigate or eliminate the increasing risk identified in these loans.

The allowance for loan losses consists of two components, the specific reserve, pursuant to ASC 310, Accounting by Creditors for Impairment of a Loan, and the general reserve, pursuant to ASC 450-10, Accounting for Contingencies. A loan is considered impaired when, based upon current information and events, it is probable that the Bank will be unable to collect all amounts due according to the contractual terms of the loan. The specific reserve component is an estimate of loss based upon an impairment review of loans which meet certain criteria that are considered impaired. An insignificant delay or insignificant shortfall in amount of payments is not considered an impairment. In addition, a loan is not impaired during a period of delay in payment if the creditor expects to collect all amounts due including interest accrued at the contractual interest rate for the period of delay. Thus, a demand loan or loan that has been extended beyond its original maturity date is not impaired if the creditor expects to collect all amounts due including interest accrued at the contractual interest rate during the period the loan is outstanding.

The general reserve includes an estimate of commercial and consumer loans with similar characteristics. Depending on the set of facts with respect to a particular loan, the Bank utilizes one of the following methods for determining the proper impairment of a loan:

the present value of expected future cash flows of a loan;

the market price of the loan based upon readily available information for that type of loan; and

the fair value of collateral.

The allowance established for impaired loans is generally based, for all collateral-dependent loans, on the fair value of the collateral, less the estimated cost to liquidate. For non-collateral dependent loans (such as accruing troubled debt restructurings), the allowance is based on the present value of expected future cash flows discounted by the loan’s effective interest rate. A small portion of the Bank’s loans which are impaired under the ASC 310 process carry no specific reserve allocation. These loans were reviewed for impairment and are considered adequately collateralized with respect to their respective outstanding principal loan balances. The majority of these loans are loans which have had their respective impairment (or specific reserve) amounts charged off, or are loans related to other impaired loans which continue to have a specific reserve allocation. It is the Bank’s practice to maintain these impaired loans, as analyzed and provided for in the ASC 310 component of the allowance for loan losses, to avoid double counting of any estimated losses that may have been included in the ASC 450-10 component of the allowance for loan losses.

Generally, the Bank orders a new or updated appraisal on real estate properties which are subject to an impairment review. Upon completion of the impairment review, loan reserves are increased as warranted. Charge-offs, if necessary, are generally recognized in a period after the reserves were established. Adjustments to new or updated appraisal values are not typically done, but in those cases when an adjustment is necessary, it is documented with supporting information and typically results in an adjustment to decrease the property’s value because of additional information obtained concerning the property after the appraisal or an update has been received by the Bank. If a new or updated appraisal is not available at the time of a loan’s impairment review, the Bank typically applies a discount to the value of an old appraisal to reflect the property’s current estimated value if there is believed to be deterioration in either (i) the physical or economic aspects of the subject property or (ii) any market conditions. Updated valuations on one to four family residential properties with small to moderate values are generally accomplished by obtaining an evaluation or appraisal. Generally, an “as is” value is utilized in most of the Bank’s real estate based impairment analyses. However, under certain limited circumstances, an “as stabilized” valuation may be utilized, provided that the “as stabilized” value is tied to a well-justified action plan to bring the real estate project to a stabilized occupancy under a reasonable period of time.

If a partially charged-off loan has been restructured in a manner that is reasonably assured of repayment and performance according to prudently modified terms, and has sustained historical payment performance for a reasonable period of time prior to and/or after the restructuring, it may be returned to accrual status and is classified as a TDR loan. However, if the above conditions cannot be reasonably met, the loan remains on non-accrual status.

In addition, the Bank evaluates the collectability of both principal and interest when assessing the need for loans to be placed on non-accrual status. Non-accrual status denotes loans in which, in the opinion of management, the collection of accrued interest is unlikely. A loan is generally placed on non-accrual status if: (i) it becomes 90 days or more past due or (ii) for which payment in full of both principal and interest cannot be reasonably expected. Payments received on a non-accrual loan are applied to principal, until qualifying for return to accrual status.

The general component of the allowance covers non-impaired loans and is based on historical loss experience adjusted for current factors. For loans that are risk rated, the historical loss experience is determined based on the actual loss history experienced by the Company over the most recent four years. These loss ratios are calculated from a migration analysis of the charge offs over this period, but excludes the ratios from the most recent six months period as they are not appropriately seasoned. The loss ratios for loans designated as belonging to homogeneous pools, including smaller balance consumer loans, are calculated for a five year period and a one year period, with the higher of the two loss ratio’s currently used in the allowance calculation. These actual loss experiences are 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; trends in volume and terms of loans; 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. These factors are consistent within each of the portfolio segments, which have been identified as: commercial, residential real estate, nonresidential real estate, construction, consumer and municipal obligations.

Management utilizes a detailed approach to setting the environmental adjustments to the historical loss. Factors that management considers as part of this approach in setting the environmental adjustments include economic trends, loan policies, lender experience, loan growth, delinquency trend, non-performing asset trends, classified loan trends and credit concentrations.

Reserves on individual loans and historical loss rates are reviewed quarterly and adjusted as necessary based on changing borrower and/or collateral conditions, as well as actual collection and charge-off experience.

Charge-offs are recognized when it becomes evident that a loan or a portion of a loan is deemed uncollectible regardless of its delinquent status. The Bank generally charges off that portion of a loan that is determined to be unsupported by an obligor’s continued ability to repay the loan from income and/or assets, both pledged and unpledged as collateral.

OVERVIEW

Economic Overview

The year ended December 31, 2014 saw slow growth both nationally and in the geographic markets where we operate. The United States’ gross domestic product (GDP) rebounded strongly from a difficult first quarter in 2014. For the full year 2014, the economy experienced year-over-year growth of 2.4%. While the economy continues to show improvement, the rate of growth remains below a historical normalized rate of 3%.

The first quarter ended March 31, 2015 saw the pace of growth slow both nationally and in the geographic markets where we operate, as adverse winter weather conditions impacted economic output. Current first quarter gross domestic product (GDP) estimates range from slight growth, less than 1.50% to negative for the first quarter.

2015 First Quarter Performance Overview

On September 5, 2014, BKFC entered into a merger agreement with BB&T, pursuant to which the Company will merge into BB&T, with BB&T as the surviving entity. As a result, the first quarter of 2015 results included approximately $1,965,000 in merger related expenses. The effect of this added overhead was a 11% decrease in net income in 2015 compared with 2014.

The results of the first quarter of 2015 also reflect the effects of overall improving credit metrics, and lower non-merger related expenses, which were offset by lower levels of net interest income and non-interest income. Non-performing loans decreased from $15,543,000 at March 31, 2014 to $8,200,000 at March 31, 2015 and the allowance for loan losses allocated to impaired loans decreased from $4,239,000 at March 31, 2014 to $3,143,000 at March 31, 2015. These improving credit quality metrics led the Bank to provide $0 in the provision for loans losses in the first quarter of 2015 compared to $900,000 in the same period in 2014. A decrease in salary and benefit expenses, as a result of fewer employees, and lower FDIC insurance expense contributed to the decrease in non-merger related expenses. The decrease in net interest income was the result of a negative rate variance, caused by falling asset yields, while the decrease in non-interest income was the result of lower service charges.

Pending Merger

On September 8, 2014, BKFC and BB&T announced the signing of a definitive agreement under which BB&T will acquire BKFC in a cash and stock merger for total consideration valued at approximately $363 million. Under the terms of the agreement, which was approved by the shareholders of BKFC and the Board of Directors of each company, shareholders of BKFC will receive 1.0126 shares of BB&T common stock and $9.40 of cash for each share of BKFC common stock. Based on BB&T’s 14-day average closing price of $37.13 as of September 4, 2014, shareholders of BKFC will receive $47.00 for each share of BKFC common stock. The merger is subject to customary closing conditions, including receipt of regulatory approvals, and is expected to close in the second quarter of 2015.

The following sections provide more detail on subjects presented in the overview.

FINANCIAL CONDITION

Total assets at March 31, 2015 were $1,902,337,000 compared with $1,931,656,000 at December 31, 2014, a decrease of $29,319,000. Loans outstanding increased $17,618,000 from $1,260,421,000 at December 31, 2014 to $1,278,039,000 at March 31, 2015. Available-for-sale securities decreased $10,199,000 (3%) from $301,138,000 at December 31, 2014 to $290,939,000 at March 31, 2015.

As Table 1 illustrates, the increase in the loan portfolio in 2015 was the result of increases in commercial loans of $17,555,000 (8%) and commercial real estate loans of $4,759,000 (1%). Management expects a steady, although slow, increase in loan demand in 2015, mirroring the current economic conditions as discussed above. The Bank intends to continue to make loans that meet its longstanding prudent lending standards.

Deposits decreased $17,349,000 to $1,598,530,000 at March 31, 2015, compared to $1,615,879,000 at December 31, 2014. The largest decrease in deposits came from interest bearing transaction deposits which decreased $11,078,000 (2%), which was partially offset with a $8,157,000 (5%) increase in savings deposits.

Table 1 Composition of the Bank’s loans and deposits at the dates indicated:

	March 31,2015					December 31, 2014
	Amount		%			Amount		%
	(Dollars in thousands)
Type of Loan:
Commercial real estate loans	$	597,401		46.7	%	$	592,642		47.0	%
One- to four-family residential real estate loans		268,988		21.1			272,531		21.6
Commercial loans		251,077		19.6			233,522		18.5
Consumer loans		14,270		1.1			15,080		1.2

Construction and land development loans		104,642		8.2			104,299		8.3
Municipal obligations		41,661		3.3			42,347		3.4
Total loans	$	1,278,039		100.0	%	$	1,260,421		100.0	%
Less:
Deferred loan fees		1,397					1,516
Allowance for loan losses		13,217					14,639
Net loans	$	1,263,425				$	1,244,266

Type of Deposit:
Non-interest bearing deposits		363,819		22.8	%		370,869		22.9	%
Interest bearing transaction deposits		594,609		37.2			605,687		37.5
Money market deposits		182,947		11.4			187,207		11.6
Savings deposits		161,752		10.1			153,595		9.5
Certificates of deposits		242,644		15.2			245,612		15.2
Individual retirement accounts		52,759		3.3			52,909		3.3
Total deposits	$	1,598,530		100.0	%	$	1,615,879		100.0	%

RESULTS OF OPERATIONS

GENERAL

Net income for the quarter ended March 31, 2015 was $4,112,000 ($.53 diluted earnings per share) as compared to $4,618,000 ($.60 diluted earnings per share) during the same period of 2014, a decrease of $506,000 (11%). As discussed in the first quarter performance overview, the primary reason for the decrease in net income from the first quarter of 2014 compared with the first quarter of 2015 was $1,965,000 in merger related expenses. The merger related expenses were the result of the previously discussed merger agreement with BB&T. Other factors effecting the first quarter results was a $900,000 (100%) decrease in the provision for loan losses, a $1,048,000 (9%) decrease in non-merger related expenses, which were offset by a $422,000 (3%) decrease in net interest income and a $210,000 (4%) decrease in non-interest income.

NET INTEREST INCOME

Net interest income decreased $422,000 in the first quarter of 2015 as compared to the same period in 2014. As illustrated in Table 2 below, the net interest margin of 3.22% for the first quarter of 2015 was 17 basis points less than the 3.39% net interest margin for the first quarter of 2014. The cost of interest-bearing liabilities increased three basis points from .33% for the first quarter of 2014 to .36% in the first quarter of 2015, while the yield on earning assets decreased 15 basis points from 3.65% for the first quarter of 2014 to 3.50% for the first quarter of 2015.

The decrease in net interest income was the result of lower yields on earning assets, while the decrease in asset yields coupled with a lower yielding mix of earning assets in the first quarter of 2015 as compared to the first quarter of 2014 led to the decrease in the net interest margin. As illustrated in Table 2, average interest earning assets increased $37,810,000 or 2% from the first quarter of 2014 to the first quarter of 2015. The mix of earning assets contributed to the decrease in the net interest margin as average loan balances only increased $8,206,000 or 1% which had a yield of 4.19%, while other interest-earning assets with a yield of .43% increased $72,621,000 or 243% from the first quarter of 2014. Table 3 shows that the net interest income on a fully tax equivalent basis was negatively impacted by the volume mix of the balance sheet by $55,000, and was also negatively impacted by a rate variance of $356,000. As the negative rate variance in the first quarter of 2015 shows, if rates were to continue to fall in 2015, the effect on the Company is expected to be negative, as shown and explained below.

The Company uses an earnings simulation model to estimate and evaluate the impact of changing interest rates on earnings. The model projects the effect of instantaneous movements in interest rates of both 100 and 200 basis points. By simulating the effects of movements in interest rates, the model can estimate the Company’s interest rate exposure. The results of the model are used by management to approximate the results of rate changes and do not indicate actual expected results. As shown below, the March 31, 2015 simulation analysis indicates that the Company is in a slightly liability interest rate sensitive position, with the net interest income negatively impacted by rising rates. As a result of the current historically low rate environment, the effects of a 100 basis point decrease in rates would also be negative to the net interest income. This is the result of a significant portion of the interest-bearing liabilities already having a cost below 1.00%.

Net interest income estimates are summarized below.

	Net Interest Income Change
Increase 300 bp		2.80	%
Increase 200 bp		2.09
Increase 100 bp		.93
Decrease 100 bp		(3.54	)

Tables 2 sets forth certain information relating to the Bank’s average balance sheet information and reflects the average yield on interest-earning assets, on a tax equivalent basis, and the average cost of interest-bearing liabilities for the periods indicated. Such yields and costs are derived by dividing income or expense by the average daily balance of interest-earning assets or interest-bearing liabilities, respectively, for the periods presented. Average balances are daily averages for the Bank and include non-accruing loans in the loan portfolio, net of the allowance for loan losses.

Table 2- Average Balance Sheet Rates for Three Months Ended March 31, 2015 and 2014 (presented on a tax equivalent basis in thousands)

	Three Months ended March 31, 2015								Three Months ended March 31, 2014
	Average outstanding balance			Interest earned/ paid		Yield/ rate			Average outstanding balance			Interest earned/ paid		Yield/ rate

Interest-earning assets:
Loans receivable (1)(2)	$	1,263,758		$	13,053		4.19	%	$	1,255,552		$	13,123		4.24	%
Securities (2)		369,030			1,827		2.01			412,047			2,074		2.04
Other interest-earning assets (3)		102,475			109		0.43			29,854			67		0.91

Total interest-earning assets		1,735,263			14,989		3.50			1,697,453			15,264		3.65

Non-interest-earning assets		172,343								158,850
Total assets	$	1,907,606							$	1,856,303

Interest-bearing liabilities:
Transaction accounts		964,108			397		0.17			947,221			386		0.17
Time deposits		295,831			563		0.77			298,020			438		0.60
Borrowings		78,271			236		1.22			73,529			236		1.30
Total interest-bearing liabilities		1,338,210			1,196		0.36			1,318,770			1,060		0.33

Non-interest-bearing liabilities		366,382								353,648

Total liabilities		1,704,592								1,672,418

Shareholders’ equity		203,014								183,885

Total liabilities and shareholders’ equity	$	1,907,606							$	1,856,303
Net interest income				$	13,793							$	14,204
Interest rate spread							3.14	%							3.32	%
Net interest margin (net interest income as a percent of average interest-earning assets)							3.22	%							3.39	%
Effect of net free funds (earning assets funded by non-interest bearing liabilities)							0.08	%							0.07	%
Average interest-earning assets to interest-bearing liabilities		129.67	%							128.71	%

(1)

Includes non-accrual loans.

(2)

Income presented on a tax equivalent basis using a 35.00% tax rate in 2015 and 2014, respectively. The tax equivalent adjustment was $346,000 and $335,000 in 2015 and 2014, respectively

(3)

Includes federal funds sold and interest-bearing deposits in other financial institutions.

Table 3 below illustrates the extent to which changes in interest rates and changes in volume of interest-earning assets and interest-bearing liabilities have affected the Bank’s interest income and expense during the periods indicated. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (i) changes in volume (change in volume multiplied by prior year rate), (ii) changes in rate (change in rate multiplied by prior year volume) and (iii) total changes in rate and volume. The combined effects of changes in both volume and rate, which cannot be separately identified, have been allocated proportionately to the change due to volume and the change due to rate.

Table 3-Volume/Rate Analysis (in thousands)

	Three months ended March 31, 2015 Compared to Three months ended March 31, 2014
	Increase (Decrease) Due to
	Volume			Rate			Total
Interest income attributable to:
Loans receivable	$	87		$	(157	)	$	(70	)
Securities		(217	)		(30	)		(247	)
Other interest-earning assets(1)		94			(52	)		42

Total interest-earning assets		(36	)		(239	)		(275	)

Interest expense attributable to:
Transactions accounts		7			4			11
Time deposits		(3	)		128			125
Borrowings		15			(15	)		-

Total interest-bearing liabilities		19			117			136

Increase (decrease) in net interest income	$	(55	)	$	(356	)	$	(411	)

(1)

Includes federal funds sold and interest-bearing deposits in other financial institutions.

PROVISION FOR LOAN LOSSES

While the economic conditions continue to be challenging, the provision for loan losses reflected the improving economy that was discussed above in the economic overview. While still above historical levels, the credit metrics showed significant improvement in 2015 compared with 2014.

Provision for loan losses decreased $900,000 in the first quarter of 2015 as compared to the same period in 2014. The decrease in the provision for loan losses in the first quarter of 2015 reflected significantly lower levels of non-performing loans, adversely classified loans and lower levels of specific reserves for impaired loans in the first quarter of 2015 versus the first quarter of 2014. As illustrated in Table 5 below, total non-accrual loans plus loans past due 90 days or more were $8,200,000 (.64% of loans outstanding) at March 31, 2015, compared to $9,817,000 (.78% of loans outstanding) at December 31, 2014, while adversely classified loans decreased $5,087,000 (8%) from $64,347,000 at December 31,2014 to $59,260,000 at March 31, 2015. Also, specific reserves for impaired loans decreased $892,000 (22%) from $4,035,000 at December 31, 2014 to $3,143,000 at March 31, 2015. For the first quarter of 2015, net charge-offs were $1,422,000 or .46% of average loan balances compared to 2014 figures of $857,000 or .27% of average loan balances. The majority of the loans charged off in the first quarter of 2015 were reserved for in previous periods. Management’s evaluation of the inherent risk in the loan portfolio considers both historical losses and information regarding specific borrowers. Management continues to monitor the non-performing relationships and has established appropriate reserves.

On a sequential quarterly basis, the provision for loan losses of $0 in the first quarter of 2015 was equal to the provision in the fourth quarter of 2014. Net charge-offs on a sequential basis increased slightly from $1,302,000 (.41% of loans) in the fourth quarter of 2014 to $1,422,000 (.46% of loans) in the first quarter of 2015.

The provision for loan losses by portfolio segment for the first quarter of 2015, included in Note 8 of the financial statements, included the effects of added reserves in the construction portfolio, compared with the fourth quarter of 2014 which were partially offset by the effects of lower levels of reserves in the residential real estate portfolio compared to the same period.

The aggregate amounts of the Bank’s classified assets at March 31, 2015 and December 31, 2014 were as follows:

	March 31, 2015		December 31, 2014
	(Dollars in thousands)
Special mention (risk rating 6)	$	20,020	$	22,768
Substandard (risk rating 7 & 8)		38,766		41,579
Doubtful (risk rating 9)		474		0

Total classified assets	$	59,260	$	64,347

Non-performing assets, which include non-performing loans, other real estate owned (“OREO”) and repossessed assets, totaled $14,972,000 at March 31, 2015 versus $16,487,000 at December 31, 2014. This represents .78% of total assets at March 31, 2015 compared to .85% at December 31, 2014. OREO balances increased $102,000 (2%) from $6,670,000 at December 31, 2014 to $6,772,000 at March 31, 2015. These properties are initially recorded at their fair value less estimated costs to sell with the difference between this value and the loan balance being recorded as a charge-off.

Troubled Debt Restructurings (TDRs). In certain circumstances, the Bank may modify the terms of a loan to maximize the collection of amounts due. In cases where the borrower is experiencing financial difficulties or is expected to experience difficulties in the near-term, concessionary modification is granted to minimize or eliminate the economic loss and to avoid foreclosure or repossession of the collateral. Modifications may include interest rate reductions, extension of the maturity date or a reduction in the principal balance. Restructured loans accrue interest as long as the borrower complies with the modified terms. Performing TDRs are loans that are paying pursuant to the agreed upon modified terms and are not more than 30 days past due. Non-performing TDRs are the remainder. Total performing TDRs, which are not considered non-performing loans by management, were $5,982,000 at March 31, 2015 as compared to $6,099,000 at December 31, 2014. Total nonperforming TDRs were $2,688,000 at March 31, 2015 as compared to $4,222,000 at December 31, 2014. In order to proactively manage and resolve problem loans, the Bank expects higher than normal levels of TDRs as it continues to work with relationships that show signs of stress. All TDRs are considered impaired loans and any specific reserves related to the TDRs are included in the allowance for loan losses on the balance sheet. Any additional specific reserves related to TDRs added or reduced in a period would be reflected in the provision for loan losses on the income statement for that period. Ordinarily, loans are identified as potential problem loans, through a higher risk weighting, before actually being restructured.

Allowance for Loan Losses (“ALL”). The decrease in the ALL was directionally consistent in 2015 with the improving credit metrics and the slow economic recovery. The ALL decreased 10%, from $14,639,000 at December 31, 2014 to $13,217,000 at March 31, 2015, which reflects a decrease in allowance for loan losses as a percentage of total loans from 1.16% at December 31, 2014, to 1.04% at March 31, 2015. The amount of the allowance allocated to impaired loans at March 31, 2015 was $3,143,000, which was down 22% from the $4,035,000 at year end 2014. The amount of the allowance allocated to specific pools of loans based on risk ratings decreased in 2015 as a result of lower historic loss rates and lower amounts of classified loans. The impairment process is described in the critical accounting policies section of this quarterly report. Management believes the current level of the ALL is sufficient to absorb probable incurred losses in the loan portfolio. Management continues to monitor the loan portfolio closely and believes the provision for loan losses is directionally consistent with the changes in the probable losses inherent in the loan portfolio from December 31, 2014 to March 31, 2015. The Bank does not originate or purchase sub-prime loans for its portfolio. Management will continue to monitor and evaluate the effects of the housing market conditions and any signs of further deterioration in credit quality on the Bank’s loan portfolio.

Monitoring loan quality and maintaining an adequate allowance is an ongoing process overseen by senior management and the loan review function. On at least a quarterly basis, a formal analysis of the adequacy of the ALL is prepared and reviewed by management and the Board of Directors. This analysis serves as a point in time assessment of the level of the ALL and serves as a basis for provisions for loan losses. The loan quality monitoring process includes assigning loan grades and the use of a watch list to identify loans of concern.

The following tables set forth an analysis of certain credit risk information for the periods indicated:

Table 4-Summary of Loan Loss Experience and Allowance for Loan Loss Analysis (in thousands)

	Three Months ended March 31,
	2015			2014
Balance of allowance at beginning of period	$	14,639		$	16,306
Recoveries of loans previously charged off:
Commercial loans		26			20
Consumer loans		38			71
Mortgage loans		18			15
Total recoveries		82			106
Loans charged off:
Commercial loans		221			44
Consumer loans		269			122
Mortgage loans		1,014			797
Total charge-offs		1,504			963
Net charge-offs		(1,422	)		(857	)
Provision for loan losses		-			900
Balance of allowance at end of period	$	13,217		$	16,349
Net charge-offs to average loans outstanding for period		0.46	%		0.27	%

Allowance at end of period to loans at end of period		1.04	%		1.30	%

Allowance to non-performing loans at end of period		161	%		105	%

Table 5 - Analysis of non-performing loans for the periods indicated (in thousands)

	March 31, 2015			December 31, 2014
Loans accounted for on a non-accrual basis:
Nonresidential real estate	$	3,009		$	4,458
Residential real estate		2,917			2,950
Construction		1,066			1,678
Commercial		1,189			687
Consumer and other		13			9
Total		8,194			9,782
Accruing loans which are contractually past due 90 days or more:
Nonresidential real estate	$	-		$	-
Residential real estate		-			7
Construction		-			-
Commercial		-			-
Consumer and other loans		6			28
Total		6			35
Total non-performing loans	$	8,200		$	9,817
Non-performing loans as a percentage of total loans		.64	%		.78	%

Other real estate owned	$	6,772		$	6,670

Trouble debt restructured (TDR) loans:
Performing troubled debt restructured (TDR) loans	$	5,982		$	6,099
Nonperforming trouble debt restructured (TDR) loans (included in nonaccrual loans)		2,688			4,222
Total troubled debt restructured loans	$	8,670		$	10,321

The amount of gross interest income that would have been recorded for nonaccrual loans in the first quarter of 2015 if loans had been current in accordance with their original terms was $99,000 and $173,000 in the first quarter of 2014.

Loans detailed on the credit quality table, as in note 8, and the non-performing loan table, as in table 5, are the indicators of potential problem loans and there are no other known problems beyond what is disclosed in these tables.

NON-INTEREST INCOME

Table 6-Major components of non-interest income (in thousands)

	Three Months ended March 31,
Non-interest income:	2015		2014

Service charges and fees	$	2,098	$	2,434
Mortgage banking income		248		165
Trust fee income		1,007		941
Bankcard transaction revenue		1,056		999
Company owned life insurance earnings		275		290
Gain/(loss) on other real estate owned		8		(81	)
Other		680		834

Total non-interest income	$	5,372	$	5,582

As illustrated in Table 6, total non-interest income decreased $210,000 (4%) for the first three months of 2015, from $5,582,000 at March 31, 2014 to $5,372,000 at March 31, 2015. Contributing to the decrease in non-interest income was a $336,000 (14%) decrease in service charges which was partially offset by a $83,000 (50%) increase in mortgage banking income. The decrease in service charges and fees was driven by lower non-sufficient fund charges.

NON-INTEREST EXPENSE

Table 7-Major components of non-interest expense (in thousands)

	Three Months ended March 31,
Non-interest expense:	2015		2014

Salaries and benefits	$	5,318	$	5,873
Occupancy and equipment		1,456		1,435
Data processing		555		535
Advertising		401		374
Electronic banking		378		386
Outside servicing fees		293		244
State bank taxes		612		642
Other real estate owned and loan collection		245		342
Amortization of intangible assets		104		133
Merger related expenses		1,965		-
FDIC insurance		245		554
Other		1,463		1,600

Total non-interest expense	$	13,035	$	12,118

As illustrated in Table 7 above, non-interest expense increased to $13,035,000 in the first three months of 2015 from $12,118,000 in the same period of 2014, an increase of $917,000 (8%). As discussed above, the merger related expenses were the result of the pending merger with BB&T. Offsetting the higher merger related expenses was lower salaries and benefits expense (down $555,000 or 9%) and lower FDIC insurance expense (down $309,000 or 56%). Contributing to the decrease in salaries and benefits was a decrease in full time equivalent employees as compared to the same period in 2014 as a result of attrition associated with the pending merger with BB&T. The decrease in FDIC insurance expense was the result of an insurance rate decrease for the Bank.

INCOME TAX EXPENSE

During the first quarter of 2015, income tax expense decreased $143,000 (8%) from $1,815,000 in the first quarter of 2014 to $1,672,000 in the same period of 2015 as a result of higher earnings in 2014. For the first quarter of 2015, the effective tax rate increased slightly to 28.91% compared to 28.21% for the same period of 2014.

LIQUIDITY AND CAPITAL RESOURCES

The Bank achieves liquidity by maintaining an appropriate balance between its sources and uses of funds to assure that sufficient funds are available to meet loan demands and deposit fluctuations. As indicated on the statement of cash flows, cash and cash equivalents have decreased $34,233,000, from $185,376,000 at December 31, 2014 to $151,143,000 at March 31, 2015.

The Company’s total shareholders’ equity increased $4,586,000 from $200,721,000 at December 31, 2014 to $205,307,000 at March 31, 2015. In the first three months of 2015, the Company paid a cash dividend of $.18 per share totaling $1,394,000 to common shareholders. The change in the shareholders’ equity in 2015 included a $1,267,000 increase in accumulated other comprehensive income, which was the result of the increase in the market value of the available-for-sale securities. The market value of these securities increased as a result of the decrease in long term interest rates since December 31, 2014. The after tax market value of these securities increased from an unrealized gain at December 31, 2014 of $1,991,000 to $3,258,000 at March 31, 2015.

The Company’s liquidity depends primarily on the dividends paid to it as the sole shareholder of the Bank and the Company’s cash on hand. The Company needs liquidity to meet its financial obligations under certain subordinated debentures issued by the Company in connection with the issuance of trust preferred securities issued by the Company’s unconsolidated subsidiary, for the other notes payable and for the payment of dividends to common shareholders and for general operating expenses. The Board of Governors of the Federal Reserve System and the FDIC have legal requirements, which provide that insured banks and bank holding companies should generally only pay dividends out of current operating earnings. The FDIC prohibits the payment of any dividend by a bank that would constitute an unsafe or unsound practice. Compliance with the minimum capital requirements limits the amounts that the Company and the Bank can pay as dividends. As detailed in Note 10, at March 31, 2015, the Bank had capital in excess of the FDIC’s most restrictive minimum capital requirements in an amount over $48,943,000 from which dividends could be paid, subject to the FDIC’s general safety and soundness review and state banking regulations.

Banks and bank holding companies 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 result in regulatory action. Management believes as of March 31, 2015, the Company and Bank met all capital adequacy requirements to which they are subject.

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. Management believes that, as of At March 31, 2015, the Bank met all capital adequacy requirements to which it is subject.

There have been no subsequent conditions or events that management believes have changed the institution's category.

The consolidated and Bank’s capital amounts and ratios, at March 31, 2015 are presented below:

											To Be Well
											Capitalized Under
						For Capital					Prompt Corrective
	Actual					Adequacy Purposes					Action Provisions
	Amount		Ratio			Amount		Ratio			Amount		Ratio

March 31 2015
Total Capital to risk weighted assets Consolidated	$	216,758		12.91	%	$	134,337		8.00	%		N/A		N/A
Bank		216,676		12.92	%		134,187		8.00	%	$	167,734		10.00	%

Tier 1 (Core) Capital to risk weighted assets Consolidated	$	195,541		11.64	%	$	100,752		6.00	%		N/A		N/A
Bank		195,459		11.65	%		100,640		6.00	%	$	134,187		8.00	%

Common Equity Tier 1 (Core) Capital to risk weighted assets Consolidated	$	177,541		10.57	%	$	75,565		4.50	%		N/A		N/A
Bank		195,459		11.65	%		75,480		4.50	%	$	109,027		6.50	%

Tier 1 (Core) Capital to average assets Consolidated	$	195,541		10.38	%	$	75,324		4.00	%		N/A		N/A
Bank		195,459		10.42	%		75,038		4.00	%	$	93,798		5.00	%

CONTRACTUAL OBLIGATIONS AND OFF-BALANCE SHEET ARRANGEMENTS

There have been no significant changes to the Bank’s contractual obligations or off-balance sheet arrangements since December 31, 2014. For additional information regarding the Bank’s contractual obligations and off-balance sheet arrangements, refer to the Company’s Form 10-K for the year ending December 31, 2014.

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

There has been no material change in market risk since December 31, 2014. For information regarding the Company’s market risk, refer to the Company’s Form 10-K for the year ending December 31, 2014. Market risk is discussed further under the heading “Net Interest Income” above.

Item 4. Controls and Procedures.

Disclosure Controls and Procedures

Disclosure controls and procedures are the Company’s controls and other procedures that are designed to ensure that information required to be disclosed by the Company in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be included in the reports filed or submitted under the Exchange Act is accumulated and communicated to Management, including the Company’s Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

Under the supervision, and with the participation of Management, including the Company’s Chief Executive Officer and Chief Financial Officer, the Company has evaluated the effectiveness of the design and operation of the disclosure controls and procedures as of March 31, 2015, and, based upon this evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that these controls and procedures were effective to ensure that information requiring disclosure is communicated to Management in a timely manner and reported within the timeframe specified by the SEC’s rules and forms.

Changes in Internal Control over Financial Reporting

There was no change in the Company’s internal control over financial reporting that occurred in the last fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

The Bank of Kentucky Financial Corporation

PART II OTHER INFORMATION

Item 1.

Legal Proceedings

From time to time, the Company and the Bank are involved in litigation incidental to the conduct of business, but neither the Company nor the Bank is presently involved in any lawsuit or proceeding which, in the opinion of management, is likely to have a material adverse effect on the Company.

Item 1A.

Risk Factors

There have been no material changes in the Company’s risk factors from those previously disclosed in the Company’s Form 10-K for the year ended December 31, 2014.

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

Not applicable

Item 3.

Defaults Upon Senior Securities

Not applicable

Item 4.

Mine Safety Disclosures

Not applicable

Item 5.

Other Information

None

Item 6.

Exhibits

Exhibit Number		Description
31.1		Rule 13a – 14(a) Certification of Robert W. Zapp
31.2		Rule 13a – 14(a) Certification of Martin J. Gerrety
32.1		Section 1350 Certification of Robert W. Zapp
32.2		Section 1350 Certification of Martin J. Gerrety
101.INS		XBRL Instance Document

101.SCH

XBRL Taxonomy Extension Schema Document

101.CAL

XBRL Taxonomy Extension Calculation Linkbase

101.LAB

XBRL Taxonomy Extension Label Linkbase

101.PRE

XBRL Taxonomy Extension Presentation Linkbase

101.DEF

XBRL Taxonomy Extension Definition Linkbase

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

		The Bank of Kentucky Financial Corporation

Date:	May 8, 2015		/s/ Robert W. Zapp
			Robert W. Zapp
			President and Chief Executive Officer
			(principal executive officer)

Date:	May 8, 2015		/s/ Martin J.Gerrety
			Martin J. Gerrety
			Treasurer and Assistant Secretary
			(principal financial officer)

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BANK OF KENTUCKY FINANCIAL CORP Reports