form10-q033108.htm

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q

QUARTERLY REPORT
Pursuant to Section 13 OR 15(d) of
The Securities Exchange Act of 1934

For the quarterly period ended March 31, 2008


     
 
Farmers Capital Bank Corporation
  
 
(Exact name of registrant as specified in its charter)
  


 
Kentucky
  
0-14412
  
61-1017851
  
 
(State or other jurisdiction
  
(Commission
  
(IRS Employer
  
 
of incorporation)
  
File Number)
  
Identification No.)
  


 
P.O. Box 309  Frankfort, KY
  
40602
  
 
(Address of principal executive offices)
  
(Zip Code)
  

Registrant’s telephone number, including area code – (502)-227-1668


 
Not Applicable
  
 
(Former name or former address, if changed since last report.)
  


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

Yes   x      No  ¨

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

Large accelerated filer  ¨                                                                                                                                  Accelerated filer  x

Non-accelerated filer  ¨ (Do not check if a smaller reporting company)                                                              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

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

Common stock, par value $0.125 per share
7,350,162 shares outstanding at May 7, 2008
 
 
1
 


TABLE OF CONTENTS


PART I – FINANCIAL INFORMATION
  
   
 
3
4
5
6
7
8
   
12
   
23
   
23
   
PART II - OTHER INFORMATION
  
   
23
   
23
   
24
   
25



 
2
 

PART I – FINANCIAL INFORMATION
Item 1. Financial Statements
Unaudited Consolidated Balance Sheets
   
March 31,
    
December 31,
  
(In thousands, except share data)
  
2008
    
2007
  
Assets
            
Cash and cash equivalents:
            
Cash and due from banks
   $ 89,761     $ 44,896  
Interest bearing deposits in other banks
     2,102       2,290  
Federal funds sold and securities purchased under agreements to resell
     68,019       31,954  
Total cash and cash equivalents
     159,882       79,140  
Investment securities:
                
Available for sale, amortized cost of $549,024 (2008) and $542,259 (2007)
     556,325       542,633  
Held to maturity, fair value of $3,187 (2008) and $3,863 (2007)
     3,304       3,844  
Total investment securities
     559,629       546,477  
Loans, net of unearned income
     1,290,376       1,291,985  
Allowance for loan losses
     (14,555 )     (14,216 )
Loans, net
     1,275,821       1,277,769  
Premises and equipment, net
     39,961       38,663  
Company-owned life insurance
     34,472       34,171  
Goodwill
     52,408       52,408  
Other intangibles, net
     8,892       9,543  
Other assets
     27,312       30,076  
Total assets
   $ 2,158,377     $ 2,068,247  
Liabilities
                
Deposits:
                
Noninterest bearing
   $ 218,540     $  192,432  
Interest bearing
     1,322,572       1,281,665  
Total deposits
     1,541,112       1,474,097  
Federal funds purchased and other short-term borrowings
     86,016       80,755  
Securities sold under agreements to repurchase and other long-term borrowings
     276,147       267,339  
Subordinated notes payable to unconsolidated trusts
     48,970       48,970  
Dividends payable
     2,434       2,436  
Other liabilities
     29,550       26,159  
Total liabilities
     1,984,229       1,899,756  
Shareholders’ Equity
                
Preferred stock, no par value; 1,000,000 shares authorized; none issued
                
Common stock, par value $.125 per share; 9,608,000 shares authorized; 7,350,162 and 7,384,865 shares issued and outstanding at March 31, 2008 and December 31, 2007, respectively
     919       923  
Capital surplus
     48,007       48,176  
Retained earnings
     123,744       122,498  
Accumulated other comprehensive income (loss)
     1,478       (3,106 )
Total shareholders’ equity
     174,148       168,491  
Total liabilities and shareholders’ equity
   $ 2,158,377     $ 2,068,247  
See accompanying notes to unaudited consolidated financial statements.

 
3
 

Unaudited Consolidated Statements of Income
   
Three Months Ended
  
   
March 31,
  
(In thousands, except per share data)
  
2008
    
2007
  
Interest Income
            
Interest and fees on loans
   $ 22,776     $ 22,537  
Interest on investment securities:
                
Taxable
     5,867       2,624  
Nontaxable
     824       857  
Interest on deposits in other banks
     14       14  
Interest of federal funds sold and securities purchased under agreements to resell
     554       1,370  
Total interest income
     30,035       27,402  
Interest Expense
                
Interest on deposits
     10,952       10,951  
Interest on federal funds purchased and other short-term borrowings
     706       1,247  
Interest on securities sold under agreements to repurchase and other long-term
   borrowings
     2,826       661  
Interest on subordinated notes payable to unconsolidated trusts
     796       448  
Total interest expense
     15,280       13,307  
Net interest income
     14,755       14,095  
Provision for loan losses
     1,102       (496 )
Net interest income after provision for loan losses
     13,653       14,591  
Noninterest Income
                
Service charges and fees on deposits
     2,378       2,493  
Allotment processing fees
     1,165       957  
Other service charges, commissions, and fees
     1,107       984  
Data processing income
     280       277  
Trust income
     517       488  
Securities gains, net
     366          
Gains on sale of mortgage loans, net
     125       117  
Income from company-owned life insurance
     301       347  
Other
     148       4  
Total noninterest income
     6,387       5,667  
Noninterest Expense
                
Salaries and employee benefits
     7,551       7,510  
Occupancy expenses, net
     1,136       1,066  
Equipment expenses
     714       781  
Data processing and communication expenses
     1,311       1,166  
Bank franchise tax
     419       514  
Correspondent bank fees
     215       159  
Amortization of intangibles
     651       818  
Other
     2,383       2,324  
Total noninterest expense
     14,380       14,338  
Income before income taxes
     5,660       5,920  
Income tax expense
     1,284       1,310  
Net income
   $ 4,376     $ 4,610  
Net Income Per Common Share
                
Basic and diluted
   $  .59     $ .58  
Weighted Average Shares Outstanding
                
Basic
     7,374       7,893  
Diluted
     7,374       7,908  
See accompanying notes to unaudited consolidated financial statements.

 
4
 


Unaudited Consolidated Statements of Comprehensive Income
   
Three Months Ended
  
   
March 31,
  
(In thousands)
  
2008
    
2007
  
Net Income
   $ 4,376     $ 4,610  
Other comprehensive income:
                
Unrealized net holding gain on available for sale securities arising during the period, net of tax of $2,485 and $227, respectively
     4,615       421  
Reclassification adjustment for prior period unrealized loss previously reported in other comprehensive income recognized during the current period, net of tax of $60
     (112 )        
Change in unfunded portion of postretirement benefit obligation, net of tax of $44 and $35
     81       65  
Other comprehensive income
     4,584       486  
Comprehensive Income
   $ 8,960     $ 5,096  
See accompanying notes to unaudited consolidated financial statements.



 
5
 

Unaudited Consolidated Statements of Cash Flows
Three months ended March 31, (In thousands)
  
2008
    
2007
  
Cash Flows from Operating Activities
            
Net income
   $ 4,376     $ 4,610  
Adjustments to reconcile net income to net cash provided by operating activities:
                
Depreciation and amortization
     1,630       1,789  
Net discount accretion of available for sale investment securities
     (244 )     (337 )
Provision for loan losses
     1,102       (496 )
Noncash compensation expense
     14       17  
Mortgage loans originated for sale
     (5,965 )     (6,007 )
Proceeds from sale of mortgage loans
     5,368       4,384  
Deferred income tax expense
     1,704       2,466  
Gain on sale of available for sale investment securities, net
     (366 )        
Gain on sale of mortgage loans, net
     (125 )     (117 )
Loss on sale of premises and equipment, net
             105  
Decrease in accrued interest receivable
     628       278  
Income from company-owned life insurance
     (301 )     (334 )
(Increase) decrease in other assets
     (1,955 )      1,230  
(Decrease) increase in accrued interest payable
     (155 )      12  
Increase (decrease) in other liabilities
     3,568       (6,806 )
Net cash provided by operating activities
     9,279       794  
Cash Flows from Investing Activities
                
Proceeds from maturities and calls of investment securities:
                
Available for sale
     85,807       98,529  
Held to maturity
     540       476  
Proceeds from sale of available for sale investment securities
     14,385       667  
Purchase of available for sale investment securities
     (106,347 )     (103,464 )
Loans originated for investment, net of principal collected
     1,568       (23,186 )
Purchase of PNC Military Allotment operations, net of cash acquired
             (1,876 )
Purchase price refinements of previous acquisitions
             (27 )
Additions to mortgage servicing rights, net
     (24 )     (15 )
Purchase of premises and equipment
     (2,231 )     (2,285 )
Proceeds from sale of equipment
             198  
Net cash used in investing activities
     (6,302 )     (30,983 )
Cash Flows from Financing Activities
                
Net increase in deposits
     67,015       5,065  
Net increase in federal funds purchased and other short-term borrowings
     5,261       76,604  
Proceeds from other long-term debt
     10,000       5,000  
Repayments of long-term debt
     (1,192 )     (5,198 )
Dividends paid
     (2,436 )     (3,473 )
Purchase of common stock
     (949 )     (572 )
Shares issued under Employee Stock Purchase Plan
     66       68  
Stock options exercised
             103  
Net cash provided by financing activities
     77,765       77,597  
Net increase in cash and cash equivalents
     80,742       47,408  
Cash and cash equivalents at beginning of year
     79,140       156,828  
Cash and cash equivalents at end of period
   $ 159,882     $ 204,236  
Supplemental Disclosures
                
Cash paid during the period for:
                
Interest
   $ 15,435     $ 13,590  
Income taxes
             3,700  
Transfers from loans to repossessed assets
     718       136  
Cash dividend declared and unpaid
     2,434       2,606  
See accompanying notes to unaudited consolidated financial statements.

 
6
 



Unaudited Consolidated Statements of Changes in Shareholders’ Equity

(In thousands, except per share data)
                
Accumulated
        
                     
Other
    
Total
  
Three months ended
  
Common Stock
    
Capital
    
Retained
    
Comprehensive
    
Shareholders’
  
March 31, 2008 and 2007
  
Shares
    
Amount
    
Surplus
    
Earnings
    
Income (Loss)
    
Equity
  
Balance at January 1, 2008
     7,385     $ 923     $ 48,176     $ 122,498     $ (3,106 )   $ 168,491  
Net income
                             4,376               4,376  
Other comprehensive income
                                     4,584       4,584  
Cash dividends declared, $.33 per share
                             (2,434 )             (2,434 )
Purchase of common stock
     (38 )     (5 )     (248 )     (696 )             (949 )
Shares issued pursuant to Employee Stock Purchase Plan
     3       1       65                       66  
Stock-based compensation
                     14                       14  
Balance at March 31, 2008
     7,350     $ 919     $ 48,007     $ 123,744     $ 1,478     $ 174,148  
                                                 
                                                 
                                                 
Balance at January 1, 2007
     7,895     $ 988     $ 53,201     $ 128,652     $ (5,778 )   $ 177,063  
Net income
                             4,610               4,610  
Other comprehensive income
                                     486       486  
Cash dividends declared, $.33 per share
                             (2,607 )             (2,607 )
Purchase of common stock
     (18 )     (2 )     (112 )     (458 )             (572 )
Stock options exercised
     4               104                       104  
Shares issued pursuant to Employee Stock Purchase Plan
     3               68                       68  
Stock-based compensation
                     17                       17  
Balance at March 31, 2007
     7,884     $ 986     $ 53,278     $ 130,197     $ (5,292 )   $ 179,169  
See accompanying notes to unaudited consolidated financial statements.

 
7
 

Notes to Unaudited Consolidated Financial Statements

1.
Basis of Presentation and Nature of Operations

The consolidated financial statements include the accounts of Farmers Capital Bank Corporation (the "Company"), a financial holding company, and its bank and nonbank subsidiaries. Bank subsidiaries and their significant nonbank subsidiaries include Farmers Bank & Capital Trust Co. (“Farmers Bank”) in Frankfort, KY and its wholly-owned subsidiaries Leasing One Corporation (“Leasing One”) and Farmers Capital Insurance Corporation. Leasing One is a commercial leasing company in Frankfort, KY and Farmers Insurance is an insurance agency in Frankfort, KY; Farmers Bank and Trust Company in Georgetown, KY; First Citizens Bank in Elizabethtown, KY; United Bank & Trust Co. in Versailles, KY; The Lawrenceburg Bank and Trust Company in Harrodsburg, KY; Citizens Bank of Northern Kentucky, Inc. in Newport, KY; and Citizens Bank of Jessamine County in Nicholasville, KY. The Company has three active nonbank subsidiaries, FCB Services, Inc. (“FCB Services”), Kentucky General Holdings, LLC (“Kentucky General”), and FFKT Insurance Services, Inc. (“FFKT Insurance”). FCB Services is a data processing subsidiary located in Frankfort, KY, which provides services to the Company’s banks as well as other unaffiliated entities. Kentucky General holds a 50% voting interest in KHL Holdings, LLC, which is the parent company of Kentucky Home Life Insurance Company. FFKT Insurance is a captive property and casualty insurance company insuring primarily deductible exposures and uncovered liability related to properties of the Company. All significant intercompany transactions and balances are eliminated in consolidation.

The Company provides financial services at its 36 locations in 23 communities throughout Central and Northern Kentucky to individual, business, agriculture, government, and educational customers. Its primary deposit products are checking, savings, and term certificate accounts.  Its primary lending products are residential mortgage, commercial lending and leasing, and installment loans. Substantially all loans and leases are secured by specific items of collateral including business assets, consumer assets, and commercial and residential real estate. Commercial loans and leases are expected to be repaid from cash flow from operations of businesses. Farmers Bank has served as the general depository for the Commonwealth of Kentucky for over 70 years and also provides investment and other services to the Commonwealth. Other services include, but are not limited to, cash management services, issuing letters of credit, safe deposit box rental, and providing funds transfer services.  Other financial instruments, which potentially represent concentrations of credit risk, include deposit accounts in other financial institutions and federal funds sold.

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  Estimates used in the preparation of the financial statements are based on various factors including the current interest rate environment and the general strength of the local economy.  Changes in the overall interest rate environment can significantly affect the Company’s net interest income and the value of its recorded assets and liabilities.  Actual results could differ from those estimates used in the preparation of the financial statements.

The financial information presented as of any date other than December 31 has been prepared from the books and records without audit.  The accompanying condensed consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X and do not include all of the information and the footnotes required by accounting principles generally accepted in the United States of America for complete statements.  In the opinion of management, all adjustments, consisting of normal recurring adjustments, necessary for a fair presentation of such financial statements, have been included.  The results of operations for the interim periods are not necessarily indicative of the results to be expected for the full year.

For further information, refer to the consolidated financial statements and footnotes thereto included in the Company's Annual Report on Form 10-K for the year ended December 31, 2007.

 
8
 


2.
Reclassifications

Certain reclassifications have been made to the consolidated financial statements of prior periods to conform to the current period presentation.  These reclassifications do not affect net income or total shareholders’ equity as previously reported.

3.
Recently Issued But Not Yet Effective Accounting Standards

In December 2007, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 141 (revised 2007), “Business Combinations” and SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements”. In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities”.

SFAS No. 141(R) establishes principals and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, liabilities assumed, and any noncontrolling interest in an acquiree. The statement also provides guidance for recognizing and measuring goodwill or gain from a bargain purchase in a business combination and determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. SFAS No. 141(R) is to be applied prospectively for fiscal years beginning after December 15, 2008. The Company does not expect this statement to have a material impact on the Company’s consolidated results of operations or financial position upon adoption.

SFAS No. 160 amends Accounting Research Bulletin (“ARB”) No. 51, “Consolidated Financial Statements” to establish accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. The statement also amends certain of ARB No. 51’s consolidation procedures for consistency with the requirements of SFAS No. 141(R). This statement is effective for the fiscal years beginning after December 15, 2008 and is to be applied prospectively as of the beginning of the fiscal year in which the statement is initially adopted, except for presentation and disclosure requirements which are to be applied retrospectively for all periods presented. The Company does not expect this statement to have a material impact on the Company’s consolidated results of operations or financial position upon adoption.

SFAS No. 161 amends and expands the disclosure requirements of SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” to provide enhanced disclosures about 1) how and why an entity uses derivative instruments; 2) how derivative instruments and related hedged items are accounted for under SFAS No. 133 and related interpretations; and 3) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. This statement is effective for fiscal years and interim periods beginning after November 15, 2008, with early adoption encouraged. The Company does not expect this statement to have a material impact on the Company’s consolidated results of operations or financial position upon adoption.

4.
Adoption of New Accounting Standards

Effective January 1, 2008 the Company adopted SFAS No. 157, “Fair Value Measurements” and SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities”. Please refer to Note 6 for additional information related to the impact of adopting these Statements.

Effective January 1, 2008, the Company adopted FASB Emerging Issues Task Force (“EITF”) 06-4, “Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements”. This EITF Issue addresses accounting for separate agreements which split life insurance policy benefits between an employer and employee. The Issue requires the employer to recognize a liability for future benefits payable to the employee under these agreements. The effects of applying this issue must be recognized through either a change in accounting principle through an adjustment to equity or through the retrospective application to all prior periods. The Company currently does not have split life insurance policies. The adoption of this EITF Issue did not have an impact on the Company’s consolidated financial position or results of operations.

 
9
 


5.
Net Income per Common Share

Basic net income per common share is determined by dividing net income by the weighted average total number of shares of common stock outstanding.  Diluted net income per common share is determined by dividing net income by the total weighted average number of shares of common stock outstanding, plus the total weighted average number of shares that would be issued upon exercise of dilutive stock options assuming proceeds are used to repurchase shares pursuant to the treasury stock method.  Net income per common share computations was as follows at March 31, 2008 and 2007.

   
Three Months Ended
March 31,
  
(In thousands, except per share data)
  
2008
    
2007
  
             
Net income, basic and diluted
   $ 4,376     $ 4,610  
                 
Average shares outstanding
     7,374       7,893  
Effect of dilutive stock options
             15  
Average diluted shares outstanding
     7,374       7,908  
                 
Net income per share, basic and diluted
   $ .59     $ .58  

6.           Fair Value Measurements

Effective January 1, 2008 the Company adopted SFAS No. 157 and SFAS No. 159. SFAS No. 157 defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. SFAS No. 157 applies whenever other standards require or permit assets or liabilities to be measured at fair value, but does not require any new fair value measurements. The Company applied SFAS No. 157 prospectively as of the beginning of the year. SFAS No. 159 permits entities to choose to measure certain financial assets and liabilities at fair value. The Company has not elected the fair value option for any financial assets or liabilities.

In February  2008,  the  FASB issued Staff Position ("FSP") 157-2, “Effective Date  of FASB Statement No. 157”.  This FSP delays the effective date of SFAS No. 157  for all nonfinancial assets and nonfinancial liabilities, except those that  are  recognized  or  disclosed at fair value on a recurring basis (at least  annually)  to  fiscal  years  beginning after November 15, 2008, and interim periods within those fiscal years.

SFAS No. 157 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. SFAS No. 157 also 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 for identical assets or liabilities in active markets that the entity has the ability to access at 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 the asset or liability.

 
10
 


Following is a description of the valuation method used for instruments measured at fair value on a recurring basis. For this disclosure, the Company only has available for sale investment securities that meet the requirement.

Available for sale investment securities
Valued primarily by independent third party pricing services under the market valuation approach that include, but not limited to, the following inputs:

 
·
U.S. Treasury securities are priced using dealer quotes from active market makers and real-time trading systems.
 
·
Marketable equity securities are priced utilizing real-time data feeds from active market exchanges for identical securities.
 
·
Government-sponsored agency debt securities, obligations of states and political subdivisions, corporate bonds, and other similar investment securities are priced with available market information through processes using benchmark yields, matrix pricing, prepayment speeds, cash flows, live trading data, and market spreads sourced from new issues, dealer quotes, and trade prices, among others sources.
 
·
Investments in the Federal Reserve Bank, Federal Home Loan Bank, and other similar stock totaling $9.6 million at March 31, 2008 is carried at cost and not included in the table below, as they are outside the scope of SFAS No. 157.

Available for sale investment securities are the Company’s only balance sheet item that meets the disclosure requirements for instruments measured at fair value on a recurring basis. Disclosures are as follows in the table below.

         
Fair Value Measurements at March 31, 2008 Using
  
(In thousands)
 
 
 
Description
  
Fair Value
March 31, 2008
    
Quoted Prices in Active Markets for Identical Assets
(Level 1)
    
Significant Other Observable Inputs
(Level 2)
    
Significant Unobservable Inputs
(Level 3)
  
                         
Available for sale investment securities
   $ 546,705     $ 11,115     $ 535,590     $ 0  
                                 

The Company may be required to measure and disclose certain other assets and liabilities at fair value on a nonrecurring basis to comply with GAAP, primarily to adjust assets to fair value under the application of lower of cost or fair value accounting. Disclosures may also include financial assets and liabilities acquired in a business combination, which are initially measured at fair value and evaluated periodically for impairment.

For disclosures about assets and liabilities measured at fair value on a nonrecurring basis, the Company’s only current disclosure obligation consists of impaired loans. Loans are considered impaired when full payment under the contractual terms is not expected. In general, impaired loans are also on nonaccrual status. Impaired loans are measured at the present value of expected future cash flows discounted at the loan’s effective interest rate, at the loan’s observable market price, or at the fair value of the collateral if the loan is collateral dependent. If the value of an impaired loan is less than the unpaid balance, the difference is credited to the allowance for loan losses with a corresponding charge to provision for loan losses. Loan losses are charged against the allowance for loan losses when management believes the uncollectibility of a loan is confirmed.

Impaired loans measured at fair value, net of related allowance, were $25.2 million at March 31, 2008. Impaired loans were measured at fair value based on independent third-party appraisals of the underlying collateral and are considered level 3 inputs.


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

FORWARD-LOOKING STATEMENTS

This report contains forward-looking statements under the Private Securities Litigation Reform Act of 1995 that involve risks and uncertainties.  In general, forward-looking statements relate to a discussion of future financial results or projections, future economic performance, future operational plans and objectives, and statements regarding the underlying assumptions of such statements.  Although the Company believes that the assumptions underlying the forward-looking statements contained herein are reasonable, any of the assumptions could be inaccurate, and therefore, there can be no assurance that the forward-looking statements included herein will prove to be accurate. Factors that could cause actual results to differ from the results discussed in the forward-looking statements include, but are not limited to: economic conditions (both generally and more specifically in the markets in which the Company and its subsidiaries operate) and lower interest margins; competition for the Company’s customers from other providers of financial services; deposit outflows or reduced demand for financial services and loan products; government legislation, regulation, and changes in monetary and fiscal policies (which changes from time to time and over which the Company has no control); changes in interest rates; changes in prepayment speeds of loans or investment securities; inflation; material unforeseen changes in the liquidity, results of operations, or financial condition of the Company’s customers; changes in the level of non-performing assets and charge-offs; changes in the number of common shares outstanding; the capability of the Company to successfully enter into a definitive agreement for and close anticipated transactions; the possibility that acquired entities may not perform as well as expected; unexpected claims or litigation against the Company; technological or operational difficulties; the impact of new accounting pronouncements and changes in policies and practices that may be adopted by regulatory agencies; acts of war or terrorism; and other risks or uncertainties detailed in the Company’s filings with the Securities and Exchange Commission, all of which are difficult to predict and many of which are beyond the control of the Company.  The Company expressly disclaims any intent or obligation to update any forward-looking statements after the date hereof to conform such statements to actual results or to changes in the Company’s opinions or expectations.


RESULTS OF OPERATIONS

First Quarter 2008 vs. First Quarter 2007

The Company reported net income per share of $.59 for the three months ended March 31, 2008, an increase of $.01 or 1.7% compared to $.58 for the same three-month period a year earlier. Net income was $4.4 million for the current three months, a decrease of $234 thousand or 5.1% compared to $4.6 million reported for the three months ended March 31, 2007. Although net income decreased in the three-month comparison, per share net income increased as a result of the fewer number of shares currently outstanding. The Company purchased 559 thousand of its outstanding shares through a modified Dutch auction tender offer in the third quarter of 2007.

The change in net income for the current three months was influenced primarily by three factors – a positive impact from net interest income and noninterest income offset by a negative impact from the provision for loan losses. Net interest income for the current period was $14.8 million, an increase of $660 thousand or 4.7% compared to $14.1 million for the same period a year earlier. The increase in net interest income was the result of the $200 million balance sheet leverage transaction entered into during the fourth quarter of 2007 which netted $910 thousand in the first three months of 2008. Total interest income increased $2.6 million or 9.6% while total interest expense increased $2.0 million or 14.8%.

The provision for loan losses totaled $1.1 million for the first quarter of 2008, an increase of $1.6 million compared to the same period last year that included a negative provision recognized in the first quarter of 2007. Net charge-offs remain in line with industry averages (peer group banks $1 billion to $3 billion in total assets) even though nonperforming loans are increasing. Net charge-offs were $763 thousand, or .06% of total loans, compared to $219 thousand or .02% a year ago. Nonperforming loans have increased $8.8 million from year-end 2007 and total $29.9 million at March 31, 2008. The increase in nonperforming loans was driven by continuing weaknesses and credit deterioration in real estate development lending in the first quarter. The allowance for loan losses as a percent of net loans was 1.13%, up from 1.10% at year-end 2007.

 
12
 



Noninterest income was $6.4 million during the current three-month period, an increase of $720 thousand or 12.7% compared to $5.7 million a year earlier. The increase in noninterest income was driven by higher allotment processing fees and investment securities gains. The $208 thousand increase in allotment processing fees was impacted mainly by the acquisition of the Military Allotment operation of PNC Bank, National Association during the first quarter of 2007. Securities gains were $366 thousand for the current quarter with none a year ago. Included in securities gains for the current quarter is $207 thousand attributed to the mandatory redemption of part of the Visa, Inc. Class B common stock received in connection with the Visa initial public offering (“IPO”) during the first quarter of 2008.

Total noninterest expenses were $14.4 million, up less than 1% compared to the same period a year ago. The effective income tax rate was 22.7% for the current three months compared to 22.1% a year earlier.

The return on average assets (“ROA”) was .82% for the current quarter, a decrease of 19 basis points compared to 1.01% reported for the same period in 2007.  The decrease in ROA was led by a 38 basis point decline in net interest margin to 3.29% from 3.67%. The provision for loan losses reduced ROA 21 basis points in the current period while a negative provision added 11 basis points to ROA in the prior year. The impact of noninterest expenses and income taxes improved ROA by 46 basis points and five basis points, respectively, in the comparison. Noninterest expenses and income taxes were relatively flat in the comparison while average assets rose $292 million or 15.8%.

Return on average equity (“ROE”) was 10.28% for the first quarter of 2008 compared to 10.50% in the same period of 2007.  The lower ROE was driven by the Company’s $200 million balance sheet leverage transaction that occurred during the fourth quarter of 2007, leading to a lower net interest margin. The higher provision for loan losses in the comparison also was a significant factor contributing to the lower ROE.

 
13
 


Net Interest Income

Net interest income was $14.8 million for the first three months of 2008, an increase of $660 thousand or 4.7% from $14.1 million a year earlier. The increase in net interest income is attributed to the Company’s $200 million balance sheet leverage transaction during the fourth quarter of 2007. This transaction added $910 thousand to net interest income in the current quarter and year-to-year comparison.

Total interest income was $30.0 million in the first quarter of 2008, an increase of $2.6 million or 9.6% fueled by an additional $3.2 million from investment securities, related mainly to the leverage transaction. Interest and fees on loans were relatively flat, up $239 thousand or 1.1% from a year ago as the impact of lower rates earned nearly equaled the impact of volume increases. Interest on short-term investments declined $816 thousand due to both a lower average rate earned and lower average outstanding balances. Lower rates earned on short-term investments are indicative of a lower overall interest rate environment in the current period compared to a year earlier.

Total interest expense was $15.3 million in the current quarter. This represents an increase of $2.0 million or 14.8% compared to $13.3 million a year ago. The increase in interest expense is attributed to the Company’s leverage transaction that occurred during the fourth quarter of 2007. The transaction added $2.1 million of additional interest expense. Total other interest expense decreased $192 thousand or 1.5%, led by $541 thousand or 43.4% lower interest on short-term borrowing that was mainly driven by lower average rates paid as overall short-term borrowing rates have fallen.  Interest expense on subordinated debt increased $348 thousand or 78% due to an additional $23.2 million borrowed during the third quarter of 2007 to fund the Company’s share buy-back program. Interest expense on deposits was unchanged at $11.0 million. Higher average outstanding interest bearing deposit balances of $69.6 million or 5.6%, led by an increase in time deposits of $56.6 million or 7.8%, were offset by a lower average rate paid of 22 basis points on interest bearing deposits to 3.4% from 3.6%.

The net interest margin on a taxable equivalent basis decreased 38 basis points to 3.29% during the first quarter of 2008 compared to 3.67% in the same quarter of 2007.  The lower net interest margin is attributed to a 23 basis point decrease in the spread between rates earned on earning assets and the rates paid on interest bearing liabilities to 2.99% in the current quarter from 3.22% in the comparable quarter of 2007. The decrease in net interest margin was impacted mainly by an overall lower interest rate environment. Higher nonaccrual loans also negatively impacted net interest margin since interest earned, but not collected, is reversed when the loan is classified as nonaccrual. The impact of noninterest bearing sources of funds reduced net interest margin an additional 15 basis points. The impact of noninterest bearing sources of funds on net interest margin typically decreases as the cost of funds decline. The Company expects continued margin compression in the near term as many earning assets, particularly loans, and funding sources reprice downward to reflect the overall lower market interest rate environment.

 
14
 


The following tables present an analysis of net interest income for the quarterly periods ended March 31. The tables represent major components of interest earning assets and interest bearing liabilities on a tax equivalent basis.  To compare the tax-exempt asset yields to taxable yields, amounts are adjusted to pretax equivalents based on the marginal corporate Federal tax rate of 35%.

Distribution of Assets, Liabilities and Shareholders’ Equity:  Interest Rates and Interest Differential
Quarter Ended March 31,
  
2008
    
2007
  
 
(In thousands)
  
Average
Balance
    
Interest
    
Average
Rate
    
Average
Balance
    
Interest
    
Average
Rate
  
Earning Assets
                                    
Investment securities
                                    
Taxable
   $ 427,138     $ 5,867       5.52 %   $ 222,203     $ 2,624       4.79 %
Nontaxable1
     89,147       1,180       5.32       89,940       1,227       5.53  
Time deposits with banks, federal funds sold and securities purchased under agreements to resell
     73,468       568       3.11       112,403       1,384       4.99  
Loans1,2,3
     1,295,913       23,078       7.16       1,199,064       22,753       7.70  
Total earning assets
     1,885,666     $ 30,693       6.55 %     1,623,610     $ 27,988       6.99 %
Allowance for loan losses
     (14,125 )                     (11,983 )                
Total earning assets, net of
allowance for loan losses
     1,871,541                       1,611,627                  
Nonearning Assets
                                                
Cash and due from banks
     80,178                       78,028                  
Premises and equipment, net
     39,254                       38,497                  
Other assets
     145,680                       116,199                  
Total assets
   $ 2,136,653                     $ 1,844,351                  
Interest Bearing Liabilities
                                                
Deposits
                                                
Interest bearing demand
   $ 267,433     $ 672       1.01 %   $ 267,487     $ 1,033       1.57 %
Savings
     259,272       1,032       1.60       246,212       1,402       2.31  
Time
     783,225       9,248       4.75       726,591       8,516       4.75  
Federal funds purchased and other short-term borrowings
     89,870       706       3.16       105,677       1,247       4.79  
Securities sold under agreements to repurchase and other long-term borrowings
       325,136         3,622         4.48         86,421         1,109         5.20  
Total interest bearing liabilities
     1,724,936     $ 15,280       3.56 %     1,432,388     $ 13,307       3.77 %
Noninterest Bearing Liabilities
                                                
Commonwealth of Kentucky deposits
     36,389                       36,537                  
Other demand deposits
     174,223                       175,527                  
Other liabilities
     29,871                       21,783                  
Total liabilities
     1,965,419                       1,666,235                  
Shareholders’ equity
     171,234                       178,116                  
Total liabilities and shareholders’ equity
   $ 2,136,653                     $ 1,844,351                  
Net interest income
             15,413                       14,681          
TE basis adjustment
             (658 )                     (586 )        
Net interest income
           $ 14,755                     $ 14,095          
Net interest spread
                     2.99 %                     3.22 %
Impact of noninterest bearing sources of funds
                     .30                       .45  
Net interest margin
                     3.29 %                     3.67 %

1Income and yield stated at a fully tax equivalent basis using the marginal corporate Federal tax rate of 35%.
2Loan balances include principal balances on nonaccrual loans.
3Loan fees included in interest income amounted to $472 thousand and $562 thousand in 2008 and 2007, respectively.


 
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Analysis of Changes in Net Interest Income (tax equivalent basis)
(In thousands)
  
Variance
    
Variance Attributed to
  
Quarter Ended March 31,
     2008/2007 1  
Volume
    
Rate
  
Interest Income
                    
Taxable investment securities
   $ 3,243     $ 2,783     $ 460  
Nontaxable investment securities2
     (47 )       (9 )       (38 )  
Time deposits with banks, federal funds sold and securities purchased under agreements to resell
     (816 )       (391 )       (425 )  
Loans2
     325       7,105       (6,780 )  
Total interest income
     2,705       9,488       (6,783 )  
Interest Expense
                        
Interest bearing demand deposits
     (361 )       -       (361 )  
Savings deposits
     (370 )       461       (831 )  
Time deposits
     732       732       -  
Federal funds purchased and other short-term borrowings
     (541 )       (165 )       (376 )  
Securities sold under agreements to repurchase and other long-term borrowings
    2,513       3,578       (1,065 )  
Total interest expense
     1,973       4,606       (2,633 )  
Net interest income
   $ 732     $ 4,882     $ (4,150 )  
Percentage change
     100.0 %     666.9 %     (566.9 )%

 1
The changes that are not solely due to rate or volume are allocated on a percentage basis using the absolute values of rate and volume variances as a basis for allocation.
 2Income stated at fully tax equivalent basis using the marginal corporate Federal tax rate of 35%.

Provision and Allowance for Loan Losses

The provision for loan losses represents charges (or credits) to earnings that maintain an allowance for loan losses at an adequate level based on credit losses specifically identified in the loan portfolio, as well as management’s best estimate of probable loan losses in the remainder of the portfolio at the balance sheet date.

The provision for loan losses for the quarter ended March 31, 2008 was $1.1 million, representing a $1.6 million increase compared to the same quarter of 2007. The Company recorded a negative provision for loan losses a year ago of $496 thousand. Although non-performing loans have increased $8.8 million or 42.0% to $29.9 million from $21.1 million at year-end 2007, net charge-offs remain in line with industry averages (peer group banks $1 billion to $3 billion in total assets). Net charge-offs were $763 thousand, or .06% of net loans at March 31, 2008. Net charge-offs a year ago were $219 thousand or .02% of net loans. On an annualized basis, net charge-offs were .24% of average loans for the first quarter of 2008.

The allowance for loan losses was $14.6 million or 1.13% of net loans at March 31, 2008, an increase of $339 thousand or 2.4% compared to $14.2 million or 1.10% of net loans at year-end 2007. A year ago, the allowance was $11.3 million or .92% of net loans outstanding. As a percentage of nonperforming loans, the allowance for loan losses was 48.7%, 67.5%, and 346.9% at March 31, 2008, December 31, 2007, and March 31, 2007, respectively.

Noninterest Income

Noninterest income was $6.4 million for the first quarter of 2008, an increase of $720 thousand or 12.7% compared to the same period a year ago. Gains on the sale of investment securities of $366 thousand were the primary reason for the higher noninterest income along with an increase in allotment processing fees of $208 thousand or 21.7%.

Securities gains include $207 thousand attributed to the mandatory redemption of part of the Visa, Inc. common stock received during the first quarter of 2008 and the remaining securities gains of $159 thousand are attributed to normal asset and liability management. As a result of its membership in the Visa USA network, the Company received 12,508 shares of Class B common stock from the Visa IPO completed in March, of which 4,836 shares

 
16
 

were redeemed for a gain of $207 thousand. The Company continues to own 7,672 shares of Class B common stock that are convertible into Class A shares. The Class B shares owned include significant ownership and transfer restrictions, including a provision whereby conversion or redemption of the shares may be prohibited until up to three years or longer after the IPO. As of March 28, 2008 the conversion rate from Class B shares into Class A shares was .71429. At the end of the first quarter of 2008, if the Company’s Class B shares could be converted into Class A shares, they would have a market value of $342 thousand. The Company will not recognize a gain, if any,  on the Visa Class B stock it currently holds until the shares are redeemed at a time in the future that is currently not known.
 
Allotment processing fees were up $208 thousand or 21.7% due mainly to the timing of the acquisition of the Military Allotment operations of PNC Bank during the first quarter a year ago. Service charges and fees on deposit accounts dropped $115 thousand or 4.6% and was driven by lower dormant account fees of $333 thousand at one of the Company’s subsidiary banks. The decrease in dormant account fees is related to a change in the subsidiary banks’ dormant account policy during 2007, which for some accounts lengthened the period of transaction inactivity required to consider it dormant. The policy changed the dormant period of certain deposit accounts to 12 months from six months. This resulted in a decrease in dormant accounts and the related fee income. Other service charges, commissions, and fees were up $123 thousand or 12.5% due to higher volume related interchange and safekeeping fees. Income from bank owned life insurance decreased $46 thousand or 13.3% due mainly to the expiration of certain trailing commissions earned. The Company earned $49 thousand in commissions during the first quarter of 2007; none during the first quarter of 2008. Other noninterest income was $148 thousand, up $144 thousand in the quarterly comparison. The first quarter of the prior year included losses on the sale of premises and equipment of $105 thousand; there were none in the current period.

Noninterest Expense

Total noninterest expenses were $14.4 million for the first quarter of 2008, relatively unchanged from the first quarter of 2007. Salaries and employee benefits, the largest component of noninterest expenses, was relatively flat; increasing $41 thousand or .5% to $7.6 million. Salary and related payroll taxes were up $151 thousand, which was nearly offset by lower benefit costs of $106 thousand. The average number of full time equivalent employees dropped to 575 from 581 in the comparison.

Intangible amortization expense decreased $167 thousand or 20.4% in the quarterly comparison which helped to offset relatively minor increases in other expense line items. Amortization of intangible assets, which relate to customer lists and core deposits from prior acquisitions, is decreasing as a result of actuarially determined schedules that allocate a higher amount of amortization in the earlier periods following an acquisition.

Income Taxes

Income tax expense for the first quarter of 2008 was $1.3 million, unchanged from the same period a year earlier. The effective federal income tax rate increased 56 basis points to 22.7% from 22.1% in the comparison. The Company’s effective tax rate can change between periods mainly due to changes in the mix of taxable and tax-exempt sources of income.


 
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FINANCIAL CONDITION

Total assets were $2.2 billion at March 31, 2008, an increase of $90.1 million or 4.4% from the prior year-end.  The most significant changes in the Company’s assets from year-end were as follows: an $80.7 million or 102% increase in cash and cash equivalents; an increase in investment securities of $13.2 million or 2.4%. Net loans outstanding were relatively unchanged in the comparison.

Total liabilities increased $84.5 million or 4.4% at March 31, 2008 compared to December 31, 2007. Higher deposit balances make up $67.0 million of the increase in liabilities; other borrowings account for $14.1 million of the increase in liabilities. Shareholders’ equity was up $5.7 million or 3.4% to $174 million at March 31, 2008.

The increase in current end of period cash and cash equivalents compared to year-end 2007 was driven by an additional $25.4 million in deposits from the Commonwealth of Kentucky (“Commonwealth”). The Company has used other sources of funds for the current quarter primarily to invest in shorter-term federal funds and other investment securities. The decrease in the loan portfolio from year-end 2007 is representative of a more cautious lending strategy. This is a result of continuing signs of a weaker economic outlook and tighter loan underwriting standards.

Management of the Company considers it noteworthy to understand the relationship between the Company’s principal subsidiary, Farmers Bank & Capital Trust Co. (“Farmers Bank”), and the Commonwealth.  Farmers Bank provides various services to state agencies of the Commonwealth.  As the depository for the Commonwealth, checks are drawn on Farmers Bank by these agencies, which include paychecks and state income tax refunds.  Farmers Bank also processes vouchers of the WIC (Women, Infants and Children) program for the Cabinet for Human Resources. The Bank’s investment department provides services to the Teacher’s Retirement systems. As the depository for the Commonwealth, significant fluctuations in deposits are likely to occur on a daily basis.  Therefore, reviewing average balances is important to understanding the financial condition of the Company.

On an average basis, total assets were $2.1 billion for the first three months of 2008, an increase of $251 million or 13.3% from year-end 2007. The increase in average assets is attributed mainly to higher earning asset balances. Average investment securities were up $174 million, boosted by the $200 million balance sheet leverage transaction that occurred during the fourth quarter of 2007. Average loans were up $45.5 million or 3.6% compared to their average year-end balance. Deposits averaged $1.5 billion at the end of the first quarter of 2008, an increase of $53.9 million from year-end. Average deposits from the Commonwealth declined $730 thousand or 2.0% in the comparison. Average earning assets were 88.3% of total average assets at March 31, 2008, an increase of 11 basis points compared to 88.1% at year-end 2007.

Temporary Investments

Temporary investments consist of interest bearing deposits in other banks and federal funds sold and securities purchased under agreements to resell. The Company uses these funds in the management of liquidity and interest rate sensitivity. At March 31, 2008, temporary investments were $70.1 million, an increase of $35.9 million compared to $34.2 million at year-end 2007. Temporary investments averaged $73.5 million during the first three months of 2008, an increase of $3.4 million or 4.9% from year-end 2007. The increase is a result of the Company’s overall net funding position. Temporary investments are reallocated as loan demand and other investment alternatives present the opportunity.

Investment Securities

The investment securities portfolio is comprised primarily of U.S. government-sponsored agency securities, mortgage-backed securities, and tax-exempt securities of states and political subdivisions. During the first quarter of 2008, the Company purchased $14.5 million principal amount of fixed rate preferred stocks made up of a combination of a U.S. government-sponsored agency and other large national financial services organizations. The Company also holds $12.5 million principal amount of trust preferred capital securities in which approximately half is represented by a floating rate instrument of a global financial services firm and the remaining is a fixed coupon rate instrument of a national financial services firm. The Company does not have direct exposure to the subprime

 
18
 

mortgage market. The Company does not originate subprime mortgages nor has it invested in bonds that are secured by such mortgages.

Total investment securities were up $13.2 million at March 31, 2008 compared to year-end 2007. The increase is mainly due to an increase in the unrealized gain on available for sale investment securities of $6.9 million and the purchase of $106 million in new securities, which offset sold, matured, and called securities of $100 million

Total investment securities averaged $516 million for the first quarter of 2008, an increase of $174 million or 51.0% from year-end 2007. The increase in average investment securities is mainly due to the GNMA mortgage-backed bonds that were purchased in the balance sheet leverage transaction during the fourth quarter of 2007.

The Company had a net unrealized gain on available for sale investment securities of $7.3 million at March 31, 2008 compared to $374 thousand at year-end 2007.  The $6.9 million increase in the current quarter is attributed to a net increase in the market value on available for sale investment securities, primarily influenced by the volume of fixed rate GNMA bonds purchased in the Company’s balance sheet leverage transaction. The unrealized gain on the GNMA bonds purchased in the leverage transaction was $5.1 million at March 31, 2008 compared to $112 thousand at December 31, 2007. This represents an unrealized gain of 2.5% over the amortized costs of the GNMA bonds at March 31, 2008.

The increase in market value of available for sale investment securities is due primarily to the impact of changing economic conditions, including a decrease in Treasury yields. Treasury yields have fallen between 154 and 198 basis points in the one to three-month maturity categories. The 10 and 20 year Treasury yields have declined 59 basis points and 20 basis points, respectively. Market values of fixed rate investments are inversely related to changes in market interest rates. Unrealized losses within the Company’s investment securities portfolio have not been included in income since they are considered interest rate related and identified as temporary. The securities’ fair values are expected to recover as they approach their maturity dates and the Company has the intent and ability to hold to recovery.

Loans

Loans, net of unearned income, totaled $1.3 billion at March 31, 2008, relatively unchanged from year-end 2007.  The composition of the loan portfolio is summarized in the table below.

   
March 31, 2008
    
December 31, 2007
  
(Dollars in thousands)
  
Amount
    
%
    
Amount
    
%
  
                         
Commercial, financial, and agriculture
   $ 153,149       11.9 %   $ 154,015       11.9 %
Real estate - construction
     245,580       19.0       254,788       19.7  
Real estate mortgage - residential
     411,650       31.9       405,992       31.5  
Real estate mortgage farmland and other commercial enterprises
     402,711       31.2       394,900       30.6  
Installment
     49,287       3.8       52,028       4.0  
Lease financing
     27,999       2.2       30,262       2.3  
Total
   $ 1,290,376       100.0 %   $ 1,291,985       100.0 %

On average, loans represented 68.7% of earning assets during the current three-month period, a decrease of 649 basis points compared to 75.2% for year-end 2007. Average loans represent a lower percentage of earning assets as a result of the 2007 balance sheet leverage transaction, which was the primary driver of increased investment securities and earning assets. As loan demand fluctuates, the available funds are reallocated between loans and temporary investments or investment securities, which typically involve a decrease in credit risk and lower yields.

The Company does not have direct exposure to the subprime mortgage market. The Company does not originate subprime mortgages nor has it invested in bonds that are secured by such mortgages.

 
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Nonperforming Loans

Nonperforming loans consist of nonaccrual loans and loans past due ninety days or more on which interest is still accruing.  Nonperforming loans increased during the current quarter as overall economic conditions continue to stress certain segments of the Company’s lending portfolio, particularly real estate development. Nonperforming loans were as follows at March 31, 2008 and December 31, 2007.

(In thousands)
  
March 31,
2008
    
December 31,
2007
    
Change
    
%
  
Nonaccrual
   $ 24,041     $ 18,073     $ 5,968       33.0 %
Past due 90 days or more and still accruing
     5,851       2,977       2,874       96.5  
Total nonperforming loans
   $ 29,892     $ 21,050     $ 8,842       42.0 %


The $24.0 million balance of nonaccrual loans outstanding at March 31, 2008 is comprised mainly of eight credits totaling $20.9 million, of which $19.6 million is secured by real estate.

The increase in nonaccrual loans at March 31, 2008 compared to the prior year-end is primarily limited to four credits totaling $6.6 million. Real estate development lending, which began to show signs of deterioration in certain parts of our banking market late in 2007, accounts for $3.4 million of the increase. The Company is working diligently to reduce and minimize the impact of holding nonperforming loans. Subsequent to March 31, 2008, the Company transferred to other real estate owned $4.1 million of real estate collateral related to a previously reported nonaccrual credit at March 31, 2008. In addition, a $2.0 million outstanding nonaccrual credit at March 31, 2008 has since been paid.

A $2.9 million increase in loans past due 90 days or more and still accruing interest is mainly the result of two large credits totaling $2.5 million added during the current quarter. The larger of these two credits, totaling $1.8 million, is well secured with real estate and other collateral. Subsequent to March 31, 2008 this credit is no longer past due and all payments are current. The smaller of the two credits, totaling $667 thousand, is secured by residential real estate. While the creditor continues to be hampered by slow-moving housing sales, it has become current on its principal and interest obligations subsequent to March 31, 2008.

Other Real Estate

Other real estate owned (“OREO”) includes real estate properties acquired by the Company through foreclosure. At March 31, 2008 OREO was $7.4 million, up $1.4 million or 22.7% from year-end 2007. The increase in OREO is driven by $1.3 million in properties acquired that previously secured outstanding loans to three individual credits.

Deposits

A summary of the Company’s deposits are as follows for the periods indicated.

   
End of Period
    
Average
  
(In thousands)
  
March 31,
2008
    
December 31,
 2007
    
Difference
    
March 31,
 2008
    
December 31,
 2007
    
Difference
  
Noninterest Bearing
                                    
Commonwealth
   $ 40,720     $ 15,367     $ 25,353     $ 36,389     $ 37,119     $ (730 )
Other
     177,820       177,065       755       174,223       177,304       (3,081 )
Total
   $ 218,540     $ 192,432     $ 26,108     $ 210,612     $ 214,423     $ (3,811 )
                                                 
Interest Bearing
                                                
Demand
   $ 273,589     $ 261,642     $ 11,947     $ 267,433     $ 258,992     $ 8,441  
Savings
     263,484       250,002       13,482       259,272       244,299       14,973  
Time
     785,499       770,021       15,478       783,225       748,939       34,286  
Total
   $ 1,322,572     $ 1,281,665     $ 40,907     $ 1,309,930     $ 1,252,230     $ 57,700  
                                                 
Total Deposits
   $ 1,541,112     $ 1,474,097     $ 67,015     $ 1,520,542     $ 1,466,653     $ 53,889  


 
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Deposit balances of the Commonwealth can fluctuate significantly from day to day. The Company believes average balances are important when analyzing its deposit balances. Both end of period and average savings account deposit balances were boosted by promotional efforts beginning in the fourth quarter of 2007.

Borrowed Funds

Total borrowed funds were $411 million at March 31, 2008, an increase of $14.1 million or 3.5% from $397 million at year-end 2007. Long-term borrowings increased $8.8 million resulting from additional FHLB borrowings of $10.0 million during the current quarter partially offset by repayments of $1.2 million. Short-term borrowings increased $5.3 million or 6.5% due mainly to higher federal funds purchases and securities sold under agreements to repurchase balances. This source of short-term funding fluctuates as the overall net funding position of the Company changes.

LIQUIDITY

The Parent Company’s primary use of cash consists of dividend payments to its common shareholders, purchases of its common stock, corporate acquisitions, interest expense on borrowings, and other general operating purposes. Liquidity of the Parent Company depends primarily on the receipt of dividends from its subsidiary banks, cash balances maintained, and borrowings from nonaffiliated sources.  As of March 31, 2008 combined retained earnings of the subsidiary banks was $50.9 million, of which $8.7 million was available for the payment of dividends to the Parent Company without obtaining prior approval from bank regulatory agencies.  As a practical matter, payment of future dividends is also subject to the maintenance of other capital ratio requirements.

Management expects that in the aggregate, its subsidiary banks will continue to have the ability to pay dividends in order to provide funds to the Parent Company to meet its near-term liquidity needs. In addition, the Parent Company has a $15.0 million unsecured line of credit with an unrelated financial institution available for general corporate purposes. This line of credit matures in June 2008 and bears interest at the three-month LIBOR rate plus 125 basis points.

The Parent Company had cash balances of $8.8 million at March 31, 2008, a decrease of $6.1 million or 41.0% from $15.0 million at year-end 2007.  Significant cash flows during the current quarter for the Parent Company include the following: management fees received from subsidiaries of $714 thousand; payment of dividends to shareholders of $2.4 million; the purchase of $1.0 million of common shares in two unaffiliated banks; interest payment on borrowed funds of $801 thousand; and the repurchase of the Company’s stock in the amount of $949 thousand.

The Company's objective as it relates to liquidity is to ensure that its subsidiary banks have funds available to meet deposit withdrawals and credit demands without unduly penalizing profitability.  In order to maintain a proper level of liquidity, the subsidiary banks have several sources of funds available on a daily basis that can be used for liquidity purposes.  Those sources of funds include the subsidiary banks' core deposits, consisting of business and nonbusiness deposits, cash flow generated by repayment of principal and interest on loans and investment securities, FHLB and other borrowings, and federal funds purchased and securities sold under agreements to repurchase.  While maturities and scheduled amortization of loans and investment securities are generally a predictable source of funds, deposit outflows and mortgage prepayments are influenced significantly by general interest rates, economic conditions, and competition in the Company’s local markets.  As of March 31, 2008 the Company had approximately $197 million in additional borrowing capacity under various FHLB, federal funds, and other borrowing agreements.  However, there is no guarantee that these sources of funds will continue to be available to the Company, or that current borrowings can be refinanced upon maturity, although the Company is not aware of any events or uncertainties that are likely to cause a decrease in the Company’s liquidity from these sources.

For the longer term, the liquidity position is managed by balancing the maturity structure of the balance sheet.  This process allows for an orderly flow of funds over an extended period of time.  The Company’s Asset and Liability Management Committee, both at the bank subsidiary level and on a consolidated basis, meets regularly and monitors the composition of the balance sheet to ensure comprehensive management of interest rate risk and liquidity.

Liquid assets consist of cash, cash equivalents, and securities available for sale.  At March 31, 2008, consolidated liquid assets were $716 million, an increase of $94.4 million or 15.2% from year-end 2007.  The increase in liquid

 
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assets is mainly attributed to $80.7 million higher cash and equivalents. The increase in cash and equivalents is due in part to higher deposit activity of the Commonwealth and the overall funding position of the Company, which changes as loan demand, deposit levels, and other sources and uses of funds fluctuate.

Net cash provided by operating activities was $9.3 million in the first three months of 2008 compared to $794 thousand a year earlier. The increase in operating cash is mainly attributed to the impact of fluctuations in other liabilities in the comparable periods. Operating cash declines as current liabilities are paid; alternatively, an increase in current liabilities results in a source of cash. In the first three months of 2008, other liabilities increased $3.6 million. In the same period a year earlier, other liabilities decreased $6.8 million.

Net cash used in investing activities was $6.3 million in the first quarter of 2008, a $24.7 million decline compared to $31.0 million in the first quarter of 2007. The change in cash flows is related to lower net loan activity in the current three-month period compared to a year ago. Net cash provided by financing activities was relatively unchanged at $77.8 million in the comparison. Lower funding from federal funds purchased and other short-term borrowings of $71.3 million was partially offset by a net increase in deposits of $62.0 million. In addition, net cash provided by long-term borrowings increased $9.0 million in the three-month comparison.

Commitments to extend credit are considered in addressing the Company’s liquidity management.  The Company does not expect these commitments to significantly effect the liquidity position in future periods. The Company has not entered into any contracts for financial derivative instruments such as futures, swaps, options, or similar instruments.

CAPITAL RESOURCES

Shareholders’ equity was $174 million on March 31, 2008, an increase of $5.7 million or 3.4% from $168 million at December 31, 2007. The increase in shareholders’ equity is due mainly to a $4.6 million increase in accumulated other comprehensive income followed by $1.2 million higher retained earnings.

Accumulated other comprehensive income was higher mainly due to a net increase in the market value of available for sale investment securities of $4.5 million, net of tax. The GNMA bonds purchased in the balance sheet leverage transaction in 2007 is the primary driver of the increase. The increase in the market value of available for sale investment securities is due primarily to the impact of changing economic conditions, including a decline in Treasury yields at March 31, 2008 compared to December 31, 2007. The decline in yields was evident in all maturity ranges of the yield curve, with shorter-term rates experiencing the largest decreases. As overall yields have declined, the portfolio has increased in value.  Market values of fixed rate investments are inversely related to changes in market interest rates.

The increase in retained earnings is due to net income of $4.4 million, partially offset by $2.4 million or $.33 per share cash dividends declared and the purchase of 38 thousand shares of the Company’s outstanding shares.

Consistent with the objective of operating a sound financial organization, the Company’s goal is to maintain capital ratios well above the regulatory minimum requirements.  The Company's capital ratios as of March 31, 2008 and the regulatory minimums are as follows.

 
   
Farmers Capital
    
Regulatory
  
   
Bank Corporation
    
Minimum
  
Tier 1 risk based
     11.44 %     4.00 %
Total risk based
     12.49 %     8.00 %
Leverage
     7.64 %     4.00 %

As of March 31, 2008, all of the Company’s subsidiary banks were in excess of the well-capitalized regulatory ratio requirements as calculated under guidelines established by federal banking agencies. The Company is not aware of any recommendations by its regulatory authorities which, if implemented, would have a material effect on its capital resources, liquidity, or operations.

 
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Item 3.  Quantitative and Qualitative Disclosures About Market Risk

The Company uses a simulation model as a tool to monitor and evaluate interest rate risk exposure.  The model is designed to measure the sensitivity of net interest income and net income to changing interest rates over future time periods.  Forecasting net interest income and its sensitivity to changes in interest rates requires the Company to make assumptions about the volume and characteristics of many attributes, including assumptions relating to the replacement of maturing earning assets and liabilities.  Other assumptions include, but are not limited to, projected prepayments, projected new volume, and the predicted relationship between changes in market interest rates and changes in customer account balances.  These effects are combined with the Company’s estimate of the most likely rate environment to produce a forecast of net interest income and net income.  The forecasted results are then adjusted for the effect of a gradual increase and decrease in market interest rates on the Company’s net interest income and net income.  Because assumptions are inherently uncertain, the model cannot precisely estimate net interest income or net income or the effect of interest rate changes on net interest income and net income.  Actual results could differ significantly from simulated results.

At March 31, 2008, the model indicated that if rates were to gradually increase by 150 basis points during the remainder of the calendar year, then net interest income and net income would increase 3.1% and 7.5%, respectively for the year ending December 31, 2008.  The model indicated that if rates were to gradually decrease by 150 basis points over the same period, then net interest income and net income would decrease .5% and 1.5%, respectively.

Item 4.  Controls and Procedures

The Company’s Chief Executive Officer and Chief Financial Officer have reviewed and evaluated the effectiveness of the Company’s disclosure controls and procedures as of the end of the period covered by this report, and have concluded that the Company’s disclosure controls and procedures were adequate and effective to ensure that all material information required to be disclosed in this report has been made known to them in a timely fashion.

There were no significant changes in the Company’s internal controls or in other factors that could significantly affect these controls subsequent to the date of the Chief Executive Officer and Chief Financial Officers evaluation, nor were there any significant deficiencies or material weaknesses in the controls which required corrective action.

PART II - OTHER INFORMATION

Item 1.  Legal Proceedings

As of March 31, 2008, there were various pending legal actions and proceedings against the Company arising from the normal course of business and in which claims for damages are asserted.  Management, after discussion with legal counsel, believes that these actions are without merit and that the ultimate liability resulting from these legal actions and proceedings, if any, will not have a material effect upon the consolidated financial statements of the Company.

Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds
         
Period
Total Number of Shares Purchased
Average Price Paid per Share
Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs
Maximum Number of Shares that May Yet Be Purchased Under the Plans or Programs
January 1, 2008 to January 31, 2008
      
127,971
February 1, 2008 to February 29, 2008
10,000
$26.35
10,000
117,971
March 1, 2008 to March 31, 2008
28,000
  24.47
28,000
89,971
Total
38,000
$24.97
38,000
  

At various times, the Company’s Board of Directors has authorized the purchase shares of the Company’s outstanding common stock.  No stated expiration dates have been established under any of the previous authorizations.

 
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Item 6.  Exhibits

List of Exhibits
     
  3i.  
Amended and Restated Articles of Incorporation of Farmers Capital Bank Corporation (incorporated by reference to Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2006).
       
3ii.
  
Amended and Restated By-Laws of Farmers Capital Bank Corporation (incorporated by reference to Annual Report of Form 10-K for the fiscal year ended December 31, 1997.
       
3iia
  
Amendments to By-Laws of Farmers Capital Bank Corporation (incorporated by reference to Quarterly Report of Form 10-Q for the quarterly period ended March 31, 2003).
       
  31.1  
       
  31.2  
       
  32  
       



 
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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.





Date:
   May 5, 2008    /s/ G. Anthony Busseni
     
G. Anthony Busseni,
     
President and CEO
     
(Principal Executive Officer)
       
Date:
   May 8, 2008    /s/ Doug Carpenter
     
C. Douglas Carpenter,
     
Senior Vice President, Secretary, and CFO
     
(Principal Financial and Accounting Officer)


 
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