Cautionary Statement Regarding Forward-Looking Statements

Certain statements contained in this Annual Report on Form 10-K that are not statements of historical fact constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act. In addition, statements in our future filings with the Securities and Exchange Commission, in press releases or in oral and written statements made by or with our approval that are not statements of historical fact, also constitute forward-looking statements. Examples of forward-looking statements include, but are not limited to: (i) projections of revenue, income or loss, earnings or loss per share, the payment or nonpayment of dividends, capital structure and other financial items, (ii) statements of plans and objectives of ours or our management or board of directors, including those relating to products or services, (iii) statements of future economic performance and (iv) statements “anticipates”, “expects”, “intends”, “plans”, “targets”, and 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, which may cause actual results to differ materially from our estimates in such statements. In addition to the matters described under “Item 1A Risk Factors,” factors that could cause actual results to differ from those discussed in the forward-looking statements include, but are not limited to: (i) the strength of the U.S. economy in general and the strength of the local economies in the markets in which we operate; (ii) the effects of and changes in trade, monetary and fiscal policies and laws, including interest rate policies of the Federal Reserve Board; (iii) inflation, prevailing interest rates, market and monetary fluctuations; (iv) the timely development of and acceptance of new products and services and perceived overall value of these products and services by users; (v) changes in consumer spending, borrowing, and savings habits; (vi) technological changes; (vii) acquisitions; (viii) our ability to increase our market share and control expenses; (ix) the effect of changes in laws and regulations (including laws and regulations concerning taxes, banking, and securities) with which we must comply; (x) the effect of changes in accounting policies and practices, as may be adopted by the regulatory agencies as well as the Financial Accounting Standards Board, (xi) changes in our organization, compensation, and benefits plans; (xii) the costs and effects of litigation and of unexpected or adverse outcomes in such litigation; and (xiii) our success at managing these and other risks.

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

PART I

Item 1. Business

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

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

Institutions (“KOFI”). Our deposits are insured by the Savings Association Insurance Fund (“SAIF”) and administered by the FDIC.

On January 8, 2003, we converted to a Kentucky chartered commercial bank from a federally chartered savings bank. In connection with the conversion, we changed to a fiscal year ending on December 31. This report covers the year ended December 31, 2005.

General Business Overview

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

Our full complement of lending services includes:

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

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

· specialized financing programs to support community development;

· mortgages for multi-family real estate;

· commercial real estate loans;

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

· real estate development;

· construction lending; and

· agricultural lending.

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

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

· various savings accounts, including those for minors;

· money market accounts;

· tax qualified deposit accounts such as Individual Retirement Accounts; and

· a broad array of certificate of deposit products.

We also support our customers by providing services such as:

· functioning as a federal tax depository;

· providing access to merchant bankcard services;

· supplying various forms of electronic funds transfer;

· providing debit cards and credit cards; and

· providing telephone and Internet banking.

Through our personal investment financial counseling services, we offer a wide variety of mutual funds, equity investments, and fixed and variable annuities.

We invest in the wholesale capital markets through the management of our security portfolio and use various forms of wholesale funding. The security portfolio contains a variety of instruments, including callable debentures, taxable and non-taxable debentures, fixed and adjustable rate mortgage backed securities, and collateralized mortgage obligations.

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

Market Area Served

We conduct operations in 14 full-service banking centers in six contiguous counties in Central Kentucky along the Interstate 65 corridor. Our markets range from the major metropolitan area of Louisville in Jefferson County, Kentucky approximately 40 miles north of our headquarters in Elizabethtown, Kentucky to Hart County, Kentucky, approximately 30 miles south of Elizabethtown. Our markets are supported by a diversified industry base and have a regional population of over 1 million. Louisville is the 16th largest city in the United States. Our core markets have experienced a compound annual growth rate of 5% in deposits for the past four years. Management anticipates a similar growth rate of our markets for the next few years and believes it is well positioned to benefit from this continued growth.

The counties we operate in include Hardin, Nelson, Hart, Bullitt, Meade and Jefferson. Excluding Jefferson County, we control in the aggregate over 22% of the deposit market share with the next largest competitor controlling just 8% of the market. Over the past four years, these counties have demonstrated an average growth rate in deposits of 5%. According to the most recent census data, our core markets have experienced a population increase of 4%, a 26% increase in the median home price, and a growth in median family income of 22% over the past four census reporting years.

We expanded our presence into the Louisville market, primarily through our commercial lending operations. At December 31, 2005, over 21% of our total loan portfolio resides in this market. In an effort to better serve these customers and to enhance our retail branch network in this market, we opened two new full-service state of the art retail facilities in the second quarter of 2004. These facilities represent our state of the art prototype branch with a retail-focused design. This design features an internet café with access to online banking and bill payment services. Large plasma screens in the lobby provide customers with current news and information about bank products and services as well as upcoming community events. The facilities are staffed to offer a full range of financial services to the growing retail and commercial customer base. We have a combined $30 million in deposits in these two new facilities, representing a 71% increase in deposits in this market during 2005. Our current deposit market share in Louisville remains under 1% of the current $13.7 billion deposit base. Based on our service-focused operating strategy, we believe we can increase our presence in Louisville, where six large out-of-state holding companies hold the largest deposit market shares.

General and Operating Strategies

Our operating strategy is to serve the needs and cater to the economic strengths of the local communities in which we operate and strive to provide a high level of personal and professional customer service. We offer a variety of financial services to our retail and commercial banking customers.

Our growth strategy is focused on a combination of acquisitions and expansion in our existing markets through internal growth as well as establishing new branches.

Branch Expansion. Management continues to consider markets for branch expansion. Because of the economic growth in our markets over the past several years, we may consider further branch expansion in our current or surrounding market areas. However, we do not rule out branch expansion in other areas experiencing economic growth.

While no new banking centers were opened in Louisville during 2005, we continued to identify future branch sites. Negotiations continue on several locations, contingent upon successful rezoning efforts. Our expectation is to complete rezoning and begin construction on at least one facility in the first quarter of 2006 with an anticipated opening date in early 2007.

During 2005, we completed a major renovation of our Mt. Washington location in Bullitt County. We have also started construction on a new full service-banking center in Elizabethtown with plans of opening in early 2006. We are also considering other possible locations within our core market area. Our goal is to protect and grow our 22% market share as our core market is becoming increasingly competitive. .

Acquisitions. Management believes that the consolidation in the banking industries, along with the easing of restrictions on bank branching, as well as increased regulatory burdens, concerns about technology and marketing, are likely to lead owners of community banks and agencies within the Bank’s market areas to explore the possibility of sale or combination with a broader-based financial service companies such as ourselves.

In addition, branching opportunities have arisen from time to time as a result of divestiture of branches by large national and regional bank holding companies of certain overlapping branches resulting from consolidations. As a result, branch locations become available for purchase from time to time.

Management’s strategy in assimilating acquisitions is to emphasize revenue growth as well as to continuously review the operations of the acquired entities and streamline operations where feasible. Management does not believe that implementing wholesale administrative cost reductions in acquired institutions, particularly reducing customer focused personnel, is beneficial to our long-term growth, because significant administrative changes in community banks can have an adverse impact on customer satisfaction in the acquired institution’s community. However, management has determined that certain human resource, and accounting functions can be consolidated immediately upon acquisition to achieve higher productivity levels without compromising customer service. Increases in revenue growth are emphasized by offering customers a broader product line consistent with full service banking.

Management is very selective when evaluating a potential acquisition based upon factors such as the operating strategy, market, financial condition, and the culture of the acquisition candidate. The last acquisition we made was in July 1998 with the acquisition of three bank branches.

Internal Growth. Management believes that its largest source of internal growth is through our ongoing solicitation program conducted by branch managers and lending officers, followed by referrals from customers. The primary reason for referrals is positive customer feedback regarding our customer service and response time.

Our goal in continuing our expansion is to maintain a profitable, customer-focused financial institution. We believe that our existing structure, management, data and operational systems are sufficient to achieve further internal growth in asset size, revenues and capital without proportionate increases in operating costs. This growth should also allow us to increase the lending limits, thereby enabling us to increase our ability to serve the needs of existing and new customers. Our operating strategy has always been to provide high quality community banking services to our customers and increase market share through active solicitation of new business, repeat business and referrals from customers, and continuation of selected promotional strategies.

We believe that our banking customers seek a banking relationship with a service-oriented community banking organization. Our operational systems have been designed to facilitate personalized service. Management believes our banking locations have an atmosphere that encourages personalized services and decision-making, while we are of sufficient financial size to offer broad product lines to meet customers’ needs. We also believe that economic expansion in our market areas will continue to contribute to internal growth. Through our primary emphasis on customer service and our management’s banking experience, we intend to continue internal growth by attracting customers and primarily focusing on the following:

· Products Offered—We offer personal and corporate banking services, mortgage origination, mortgage servicing, personal investment, and financial counseling services as well as internet and telephone banking. We offer a full range of commercial banking services, checking accounts, ATM’s, checking accounts with interest, savings accounts, money market accounts, certificates of deposit, NOW accounts, Individual Retirement Accounts, brokerage and residential mortgage services, branch banking, and debit and credit cards. We also offer installment loans, including auto, recreational vehicle, and other secured and unsecured loans sourced directly by our branches. See “Lending Activities” below for a discussion of products we provide to commercial accounts.

· Operational Efficiencies—We seek to maximize operational and support efficiencies consistent with maintaining high quality customer service. Where feasible, we share a common information system designed to enhance customer service and improve efficiencies by providing system-wide voice and data communication connections. We have consolidated loan processing, bank balancing, financial reporting, investment management, information systems, payroll and benefit management, loan review, and audits.

· Marketing Activities—We focus on a proactive solicitation program for new business, as well as identifying and developing products and services that satisfy customer needs. We actively sponsor community events within our branch areas. We believe that active community involvement contributes to our long-term success.

Lending Activities

Commercial Real Estate & Construction Lending. The largest portion of our lending activity is the origination of commercial loans that are primarily secured by real estate, including construction loans. These loans are generated primarily in our market area. In recent years, we have put greater emphasis on small business lending, originating loans for small and medium-sized businesses from our various locations. We make commercial loans to a variety of industries. Substantially all of the commercial real estate loans we originate have adjustable interest rates with maturities of 25 years or less or are loans with fixed interest rates and maturities of five years or less. At December 31, 2005, we had $353.6 million outstanding in commercial real estate loans. The security for commercial real estate loans includes retail businesses, warehouses, churches, apartment buildings and motels. In addition, the payment experience of loans secured by income producing properties typically depends on the success of the related real estate project and thus may be more vulnerable to adverse conditions in the real estate market or in the economy generally.

Loans secured by multi-family residential property, consisting of properties with more than four separate dwelling units, amounted to $18.5 million of the loan portfolio at December 31, 2005. These loans are included in the $353.6 million outstanding in commercial real estate loans discussed above. We generally do not lend above 75% of the appraised values of multi-family residences on first mortgage loans. The mortgage loans we currently offer on multi-family dwellings are generally one or five year ARMs with maturities of 25 years or less.

Construction loans involve additional risks because loan funds are advanced upon the security of the project under construction, which is of uncertain value before the completion of construction. The uncertainties inherent in estimating construction costs, delays arising from labor problems, material shortages, and other unpredictable contingencies, make it relatively difficult to evaluate accurately the total loan funds required to complete a project, and related loan-to-value ratios. The analysis of prospective construction loan projects requires significantly different expertise from that required for permanent residential mortgage lending. At December 31, 2005 we had $13.6 million outstanding in construction loans.

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

Commercial Business Lending. The commercial business loan portfolio has grown in recent years as a result of our focus on small business lending. We make secured and unsecured loans for commercial, corporate, business, and agricultural purposes, including issuing letters of credit and engaging in inventory financing and commercial leasing activities. Commercial loans generally are made to small-to-medium size businesses located within our defined market area. Commercial loans generally carry a higher yield and are made for a shorter term than real estate loans. Commercial loans, however, involve a higher degree of risk than residential real estate loans due to potentially greater volatility in the value of the assigned collateral, the need for more technical analysis of the borrower’s financial position, the potentially greater impact that changing economic conditions may have on the borrower’s ability to retire debt, and the additional expertise required for commercial lending personnel. Commercial business loans outstanding at December 31, 2005 totaled $36.0 million.

Residential Real Estate. Residential mortgage loans are secured primarily by single-family homes. The majority of our mortgage loan portfolio is secured by real estate in Hardin, Nelson, Hart, Meade, and Bullitt counties. Fixed rate residential real estate loans we originate have terms ranging from ten to thirty years. Interest rates are competitively priced within the primary geographic lending market, and vary according to the term for which they are fixed. At December 31, 2005 we had $142.7 million in residential mortgage loans outstanding.

We generally emphasize the origination of adjustable-rate mortgage loans (“ARMs”) when possible. We offer six ARM products with an annual adjustment, which is tied to a national index with a maximum adjustment of 2% annually, and a lifetime maximum adjustment cap of 6%. As of December 31, 2005, approximately 43.7% of our residential real estate loans were adjustable rate loans with adjustment periods ranging from one to five years and balloon loans of seven years or less. The origination of these ARMs can be more difficult in a low interest rate environment where there is a significant demand for fixed rate mortgages. We limit the maximum loan-to-value ratio on one-to-four-family residential first mortgages to 90% of the appraised value and generally limit the loan-to-value ratio on second mortgages on one-to-four-family dwellings to 90%.

Consumer Lending. Consumer loans include loans on automobiles, boats, recreational vehicles and other consumer goods, as well as loans secured by savings accounts, home improvement loans, and unsecured lines of credit. As of December 31, 2005, consumer loans outstanding were $97.8 million. These loans involve a higher risk of default than loans secured by one-to-four-family residential loans. We believe, however, that the shorter term and the normally higher interest rates available on various types of consumer loans help maintain a profitable spread between the average loan yield and cost of funds. Home equity lines of credit as of December 31, 2005, totaled $41.1 million.

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

The indirect consumer loan portfolio is comprised of new and used automobile, motorcycle and all terrain vehicle loans originated on our behalf by a select group of auto dealers within the service area. Indirect consumer loans are considered to have greater risk of loan losses than direct consumer loans due to, among other things: borrowers may have no existing relationship with us; borrowers may not be residents of the lending area; less detailed financial statement information may be collected at application; collateral values can be more difficult to determine; and the condition of vehicles securing the loan can deteriorate rapidly. To address the additional risks associated with indirect consumer lending, the Executive Loan Committee continually evaluates data regarding the dealers enrolled in the program, including monitoring turn down and delinquency rates. All applications are approved by specific lending officers, selected based on experience in this field, who obtain credit bureau reports on each application to assist in the decision. Aggressive collection procedures encourage more timely recovery of late payments. At December 31, 2005, total loans under the indirect consumer loan program totaled $31.6 million.

Subsidiary Activities

First Service Corporation of Elizabethtown (“First Service”) acts as a broker for the purpose of selling investment services to our customers in the area of tax-deferred annuities, government securities, mutual funds, and stocks and bonds. First Service employs four full-time employees to perform these services. This investment function operates under licenses held by First Service. The net income of First Service was $11,000 for the year ended December 31, 2005.

First Heartland Mortgage Company of Elizabethtown (“First Heartland”), through which our secondary market lending department originates qualified VA, KHC, RHC and conventional secondary market loans on the behalf of the investors provides necessary liquidity to us and needed loan products to our customers. We do not service these loans after the sale. During 2005, First Heartland originated $45.4 million in loans on the behalf of investors. The net income of First Heartland Mortgage was $119,000 for the year ended December 31, 2005.

First Federal Office Park, LLC, holds commercial lots adjacent to our home office on Ring Road in Elizabethtown, that are available for sale. During the year ended December 31, 2005 lot sales resulted in a $143,000 gain. We are holding three lots for sale in this subsidiary, of the initial nine lots held for sale.

We provide title insurance coverage for mortgage borrowers through two subsidiaries: First Heartland Title, LLC, and First Federal Title Services, LLC. First Heartland Title is a joint venture with a local title insurance company and First Federal Title Services is a joint venture with a title insurance company in Louisville. We hold a 48% interest in First Heartland Title and a 49% interest in First Federal Title Services. The subsidiaries generated $157,000 in net income for the year ended December 31, 2005, of which our portion was $75,360.

Competition

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

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

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

The following table sets forth our market share and rank in terms of deposits in each Kentucky county where we have offices. We have two offices in Jefferson County, which is Louisville, Kentucky. The Louisville metropolitan area has a population of more than one million.

County	Number of Offices		FFKY Market Share %		FFKY Rank
Hardin		4		21.0		1
Nelson		2		8.0		5
Hart		1		17.0		3
Bullitt		2		27.0		1
Meade		3		56.0		1
Jefferson		2		<1.0		N/M

Employees

As of December 31, 2005, we had 262 employees, of which 247 were full-time and 15 part-time. None of our employees are subject to a collective bargaining agreement, and we believe that we enjoy good relations with our personnel.

Regulation

General Regulatory Matters. On January 8, 2003, we converted from a federally chartered savings bank to a Kentucky chartered commercial bank. Before the conversion, we were subject to the regulation of the Office of Thrift Supervision. As a Kentucky chartered commercial bank, we are now subject to supervision and regulation, which involves regular bank examinations, by both the FDIC and the KOFI. Our deposits are insured by the FDIC. Kentucky’s banking statutes contain a “super-parity” provision that permits a well-rated Kentucky banking corporation to engage in any banking activity in which a national bank operating in any state, a state bank, thrift or savings bank operating in any other state, or a federal chartered thrift or federal savings association meeting the qualified thrift lender test and operating in any state could engage, provided it first obtains a legal opinion specifying the statutory or regulatory provisions that permit the activity.

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

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

Federal law also prohibits a person or group of persons from acquiring “control” of a bank holding company without notifying the Federal Reserve Board in advance, and then only if the Federal Reserve Board does not object to the proposed transaction. The Federal Reserve Board has established a rebuttable presumptive standard that the acquisition of 10% or more of the voting stock of a bank holding company with a class of securities registered under the Securities Exchange Act of 1934 would constitute an acquisition of control of the bank holding company. In addition, any company is required to obtain the approval of the Federal Reserve Board before acquiring 25% (5% in the case of an acquirer that is a bank holding company) or more of any class of a bank holding company’s voting securities, or otherwise obtaining control or a “controlling influence” over a bank holding company.

The Gramm-Leach-Bliley Act. The Gramm-Leach-Bliley Act of 1999 (the “GLB Act”), signed into law on November 12, 1999, amended a number of Federal banking laws that affect the Corporation and First Federal. The provisions of the GLB Act believed to be of most significance to us are discussed below. In particular, the GLB Act permits a bank holding company to elect to become a financial holding company, which permits the holding company to conduct activities that are “financial in nature.” To become and maintain its status as a financial holding company, the bank holding company and all of its affiliated depository institutions must be well-capitalized, well managed, and have at least a satisfactory Community Reinvestment Act rating. We have not filed an election to become a financial holding company.

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

transactions, on terms and under circumstances that in good faith would be available to nonaffiliated companies.

Under Federal Reserve policy, a bank holding company is expected to act as a source of financial strength to, and to commit resources to support, its bank subsidiaries. This support may be required at times when, absent such a policy, the bank holding company may not be inclined to provide it. In addition, any capital loans by the bank holding company to its bank subsidiaries are subordinate in right of payment to deposits and to certain other indebtedness of the bank subsidiary. In the event of a bank holding company’s bankruptcy, any commitment by the bank holding company to a federal bank regulatory agency to maintain the capital of subsidiary banks will be assumed by the bankruptcy trustee and entitled to a priority of payment.

Capital Requirements. The Federal Reserve Board and the FDIC have issued substantially similar risk-based and leverage capital guidelines applicable to the banking organizations they supervise. Under the risk-based capital requirements, we are generally required to maintain a minimum ratio of total capital to risk-weighted assets (including certain off-balance sheet activities, such as standby letters of credit) of 8%. At least half of the total capital must be composed of common equity, retained earnings and qualifying perpetual preferred stock and certain hybrid capital instruments, less certain intangibles (“Tier 1 capital”). The remainder may consist of certain subordinated debt, certain hybrid capital instruments, qualifying preferred stock and a limited amount of the loan loss allowance (“Tier 2 capital” which, together with Tier 1 capital, composes “total capital”). To be considered well-capitalized under the risk-based capital guidelines, an institution must maintain a total risk-weighted capital ratio of at least 10% and a Tier 1 risk-weighted ratio of 6% or greater. For further information, see Item 7—Management Discussion and Analysis of Financial Condition and Results of Operations—Capital.

The Federal Deposit Insurance Corporation Act of 1991 (“FDICIA”), among other things, identifies five capital categories for insured depository institutions: well-capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized. The Corporation and First Federal are classified as “well-capitalized.” FDICIA also requires the bank regulatory agencies to implement systems for “prompt corrective action” for institutions that fail to meet minimum capital requirements within these five categories, with progressively more severe restrictions on operations, management and capital distributions according to the category in which an institution is placed. Failure to meet capital requirements can also cause an institution to be directed to raise additional capital. FDICIA also mandates that the agencies adopt safety and soundness standards relating generally to operations and management, asset quality and executive compensation, and authorizes administrative action against an institution that fails to meet such standards.

In addition, the Federal Reserve Board and the FDIC have each adopted risk-based capital standards that explicitly identify concentrations of credit risk and the risk arising from non-traditional activities, as well as an institution’s ability to manage these risks, as important factors to be taken into account by each agency in assessing an institution’s overall capital adequacy. The capital guidelines also provide that an institution’s exposure to a decline in the economic value of its capital due to changes in interest rates be considered by the agency as a factor in evaluating a banking organization’s capital adequacy. The agencies also jointly adopted a regulation, effective January 1, 2002, amending their regulatory capital standards to change the treatment of certain recourse obligations, direct credit subsidies, residual interest and other positions in securitized transactions that expose banking organizations to credit risk. The regulation amends the agencies’ regulatory capital standards to align more closely the risk-based capital treatment of recourse obligations and direct credit subsidies, to vary the capital requirements for positions in securitized transactions (and certain other credit exposures) according to their relative risk, and to require capital commensurate with the risks associated with residual interests.

In addition to the “prompt corrective action” directives, failure to meet capital guidelines can subject a banking organization to a variety of other enforcement remedies, including additional substantial restrictions on its operations and activities, termination of deposit insurance by the FDIC, and under some conditions the appointment of a conservator or receiver.

Deposit Insurance. Our deposits are insured by the FDIC up to the statutory maximum limit of $100,000 per depositor through the Savings Association Insurance Fund. For this protection, we must pay semiannual assessments to the FDIC. The assessment rate for an insured depository institution depends on the assessment risk classification assigned to the institution by the FDIC, which will be determined by the institution’s capital level and supervisory evaluations.

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

Under Kentucky law, dividends by Kentucky banks may be paid only from current or retained net profits. Before any dividend may be declared for any period (other than with respect to preferred stock), a bank must increase its capital surplus by at least 10% of the net profits of the bank for the period until the bank’s capital surplus equals the amount of its stated capital attributable to its common stock. Moreover, the KOFI Commissioner must approve the declaration of dividends if the total dividends to be declared by a bank for any calendar year would exceed the bank’s total net profits for such year combined with its retained net profits for the preceding two years, less any required transfers to surplus or a fund for the retirement of preferred stock or debt. We are also subject to the Kentucky Business Corporation Act, which generally prohibits dividends to the extent they result in the insolvency of the corporation from a balance sheet perspective or if becoming unable to pay debts as they come due.

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

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

The Community Reinvestment Act (“CRA”) requires the FDIC to assess our record in meeting the credit needs of the communities we serve, including low- and moderate-income neighborhoods and persons. The FDIC’s assessment of our record is made available to the public. The assessment also is part

of the Federal Reserve Board’s consideration of applications to acquire, merge or consolidate with another banking institution or its holding company, to establish a new branch office or to relocate an office. The Federal Reserve Board will also assess the CRA record of the subsidiary banks of a bank holding company in connection with an application to acquire a bank or other bank holding company, and such records may be the basis for denying the application.

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

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

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

Available Information

We file annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports with the Securities and Exchange Commission. These reports are available at the SEC’s website at http://www.sec.gov. The reports are also available on our website at http://www.ffsbky.com. You may obtain electronic or paper copies of our reports free of charge by contacting Rebecca Bowling, Corporate Secretary-Treasurer, First Federal Savings Bank, 2323 Ring Road, Elizabethtown, Kentucky 42701 (telephone) 270-765-2131.

Item 1A. Risk Factors

We, like other financial companies, are subject to a number of risks, many of which are outside of management’s control, though we strive to manage those risks while optimizing returns. These risks include: (a) credit risk, which is the risk that loan and lease customers or other counterparties will be unable to perform their contractual obligations, (b) market risk, which is the risk that changes in market rates and prices will adversely affect our financial condition or results of operation, (c) liquidity risk, which is the risk that we will have insufficient cash or access to cash to meet our operating needs, and (d) operational risk, which is the risk of loss resulting from inadequate or failed internal processes, people, and systems, or from external events.

In addition to the other information included readers should consider that the following important factors, among others, could materially impact our business, future results of operations, and future cash flows.

(a) Credit Risk

We extend credit to a variety of customers based on internally set standards and the judgment of management. We manage the credit risk it takes through a program of underwriting standards that we follow, the review of certain credit decisions, and an on-going process of assessment of the quality of the credit we have already extended. If our credit standards and our on-going process of credit assessment do not function as intended, we could incur significant credit losses.

Our loans and deposits are focused in central Kentucky. Adverse economic conditions in that region, in particular, could harm our results from operations, cash flows, and financial condition. Adverse economic conditions and other factors, such as political or business development or natural hazards that may affect Kentucky, may reduce demand for credit or fee-based products and could negatively affect real estate and other collateral values, interest rate levels, and the availability of credit to refinance loans at or before maturity.

(b) Market Risk

Changes in interest rates could harm our financial condition or results of operations.

Our results of operations depend substantially on net interest income, the difference between interest earned on interest-earning assets (such as investments and loans) and interest paid on interest-bearing liabilities (such as deposits and borrowings). Interest rates are highly sensitive to many factors, including governmental monetary policies and domestic and international economic and political conditions. Factors beyond our control, such as inflation, recession, unemployment, and money supply may also affect interest rates. If our interest-earning assets mature or reprice more quickly than our interest-bearing liabilities in a given period, as a result of decreasing interest rates, our net interest income may decrease. Likewise, our net interest income may decrease if interest-bearing liabilities mature or reprice more quickly than interest-earning assets in a given period as a result of increasing interest rates.

Fixed-rate loans increase our exposure to interest rate risk in a rising rate environment because interest-bearing liabilities would be subject to repricing before assets become subject to repricing. Adjustable-rate loans decrease the risk associated with changes in interest rates but involve other risks, such as the inability of borrowers to make higher payments in an increasing interest rate environment. At the same time, for secured loans, the marketability of the underlying collateral may be adversely affected by higher interests rates. In a declining interest rate environment, there may be an increase in prepayments on loans as the borrowers refinance their loans at lower interest rates, which could reduce net interest income and harm our results of operations.

(c) Liquidity Risk

If we cannot borrow funds through access to the capital markets, we may not be able to meet the cash flow requirements of our depositors and borrowers, or meet the operating cash needs of the Corporation to fund corporate expansion or other activities.

Liquidity policies and limits are established by the board of directors, with operating limits set by the Asset Liability Committee (“ALCO”), based upon analyses of the ratio of loans to deposits, the percentage of assets funded with non-core or wholesale funding. ALCO regularly monitors the overall liquidity position of the Bank and holding company to ensure that various alternative strategies exist to cover unanticipated events that could affect liquidity. Liquidity is the ability to meet cash flow needs on a timely basis at a reasonable cost. If our liquidity policies and strategies don’t work as well as intended, then we may be unable to make loans and to repay deposit liabilities as they become due or are demanded by customers. The ALCO establishes board approved policies and monitors guidelines to diversify our wholesale funding sources to avoid concentrations in any one-market source. Wholesale funding sources include Federal funds purchased, securities sold under repurchase agreements, non-core brokered deposits, and medium and long-term debt, which includes Federal Home Loan Bank (FHLB) advances that are collateralized with mortgage-related assets.

We maintain a portfolio of securities that can be used as a secondary source of liquidity. There are other available sources of liquidity, including the sale or securitization of loans, the ability to acquire additional non-core brokered deposits, additional collateralized borrowings such as FHLB advances, the issuance of debt securities, and the issuance of preferred or common securities in public or private transactions. If we were unable to access any of these funding sources when needed, we might be unable to meet the needs of our customers, which could adversely impact our financial condition, our results of operations, cash flows, and our level of regulatory-qualifying capital. For further discussion, see the “Liquidity” section of Management’s Discussion and Analysis of Financial Condition and Results of Operations.

(d) Operational Risk

We have significant competition in both attracting and retaining deposits and in originating loans. Competition is intense in most of the markets we serve. We compete on price and service with other banks and financial companies such as savings and loans, credit unions, finance companies, mortgage banking companies, and brokerage firms. Competition could intensify in the future as a result of industry consolidation, the increasing availability of products and services from non-banks, greater technological developments in the industry, and banking reform. If our competition prices deposits or loans at rates significantly more favorable than ours, then we may have difficulty in both attracting and retaining deposits and loans.

Management maintains internal operational controls and we have invested in technology to help us process large volumes of transactions. However, there can be no assurance that we will be able to continue processing at the same or higher levels of transactions. If our systems of internal controls should fail to work as expected, if our systems were to be used in an unauthorized manner, or if employees were to subvert the system of internal controls, significant losses could occur.

We process large volumes of transactions on a daily basis and are exposed to numerous types of operation risk, which could cause us to incur substantial losses. Operational risk resulting from inadequate or failed internal processes, people, and systems includes the risk of fraud by employees or persons outside of our company, the execution of unauthorized transactions by employees, errors relating to transaction processing and systems, and breaches of the internal control system and compliance requirements. This risk of loss also includes potential legal actions that could arise as a result of the operational deficiency or as a result of noncompliance with applicable regulatory standards.

We establish and maintain systems of internal operational controls that provide management with timely and accurate information about our level of operational risk. While not foolproof, these systems have been designed to manage operational risk at appropriate, cost effective levels. We have also established procedures that are designed to ensure that policies relating to conduct, ethics, and business practices are followed. From time to time, we experience loss from operational risk, including the effects of operational errors, and these losses may be substantial.

While management continually monitors and improves our system of internal controls, data processing systems, and corporate wide processes and procedures, there can be no assurance that we will not suffer such losses in the future. New, or changes in existing tax, accounting, are regulatory laws, regulations, rules, standards, policies, and interpretations could significantly impact strategic initiatives, results of operations, cash flows, and financial condition.

The financial services industry is extensively regulated. Federal and state banking regulations are designed primarily to protect deposit insurance funds and consumers, not to benefit a financial company’s shareholders. These regulations may sometimes impose significant limitations on operations. The significant federal and state banking regulations that affect us are described in this report under the heading “Regulation”. These regulations, along with currently existing tax, accounting, and monetary laws, regulations, rules, standards, policies and interpretations control the methods by which financial institutions conduct business, implement strategic initiatives and tax compliance, and govern financial reporting and disclosures. These laws, regulations, rules, standards, policies, and interpretations are constantly evolving and may change significantly over time. Events that may not have a direct impact on us, such as the bankruptcy of U.S. companies, can cause legislators, regulators, and authoritative bodies, such as the Financial Accounting Standards Board, the Securities and Exchange Commission, the Public Company Accounting Oversight Board, and other various taxing authorities to respond by adopting and or proposing substantive revisions to laws, regulations, rules, standards, policies, and interpretations. The nature, extent, and timing of the adoption of significant new laws and regulations, or changes in or repeal of existing laws and regulations may have a material impact on our business and results of operations. Changes in regulation may cause us to devote substantial additional financial resources and management time to compliance, which may negatively affect our operating results.

Item 1B. Unresolved Staff Comments

Not applicable

PART II

Item 5. Market for the Registrant’s Common Equity and Related Stockholder Matters

(a) Market Information

Our Common Stock is traded on the NASDAQ National Market System (NASDAQ) under the symbol “FFKY”. The following table shows the high and low closing prices of our Common Stock and the dividends paid.

	Quarter Ended
2005:(1)	3/31		6/30		9/30		12/31
High	$	22.35	$	22.75	$	24.49	$	28.99
Low	21.36		20.95		22.72		25.90
Cash dividends	0.173		0.173		0.173		0.190
2004:(1)	3/31		6/30		9/30		12/31
High	$	24.77	$	24.09	$	24.00	$	23.55
Low	22.59		20.22		21.85		22.28
Cash dividends	0.163		0.163		0.173		0.173

(1) Adjusted to reflect the impact of the stock dividend declared September 22, 2005.

(b) Holders

At February 28, 2006 the number of shareholders was approximately 1,130.

(c) Dividends

It is currently the policy of our Board of Directors to continue to pay quarterly dividends, but any future dividends are subject to the Board’s discretion based on its consideration of the our operating results, financial condition, capital, income tax considerations, regulatory restrictions and other factors.

(d) Securities Authorized for Issuance Under Equity Compensation Plans

Number of securities

remaining available for

to be issued

Weighted-average

future issuance under

upon exercise of

exercise price of

equity compensation plans

outstanding options,

(excluding securities

Plan category

warrants and rights

reflected in column (1))

Equity compensation plans approved by security holders

130,977

20.26

35,640

Equity compensation plans not approved by security holders

—

Total

130,977

20.26

35,640

See Note 11 of the Notes to Consolidated Financial Statements for additional information required by this item.

Item 6. Selected Consolidated Financial and Other Data

	At December 31,								At June 30,
	2005		2004		2003		2002		2002		2001
Financial Condition Data:
Total assets	$	766,513	$	737,646	$	676,335	$	670,728	$	679,395	$	606,726
Net loans outstanding(1)	635,740		599,428		550,153		528,535		520,261		517,145
Interest bearing deposits	—		—		—		—		64,000		—
Investments	61,555		56,843		34,938		18,575		23,693		22,934
Deposits	591,106		586,386		529,162		521,121		529,882		468,825
Borrowings	107,875		88,904		88,283		87,683		87,778		77,298
Stockholders’ equity	64,741		59,801		56,321		59,647		58,615		54,592
Number of:
Real estate loans outstanding	10,130		9,358		8,028		7,156		7,577		7,618
Deposit accounts	50,790		48,637		48,443		49,210		49,726		49,615
Offices	14		14		13		13		13		13
Full time equivalent employees	254		246		237		219		209		192

	Year Ended									Six Months Ended				Year Ended
	December 31,									December 31,				June 30,
	2005			2004			2003			2002				2002			2001
Operations Data:
Interest income	$	45,368		$	39,143		$	39,339			$	21,556		$	44,100		$	45,392
Interest expense	17,862			14,792			16,365				9,394			21,426			27,429
Net interest income	27,506			24,351			22,974				12,162			22,674			17,963
Provision for loan losses	1,258			1,656			1,656				1,161			1,604			1,086
Non-interest income	8,067			8,104			7,981				3,177			5,398			5,145
Non-interest expense	20,759			19,274			17,292				7,597			15,281			13,570
Income tax expense	4,412			3,735			4,004				2,199			3,729			2,803
Net income	9,144			7,790			8,003				4,382			7,458			5,649
Earnings per share:(2)
Basic	$	2.29		$	1.94		$	1.93			$	0.99		$	1.65		$	1.25
Diluted	2.27			1.93			1.91				0.98			1.64			1.24
Book value per share(2)	16.25			14.91			13.82				13.53			12.99			12.01
Dividends paid per share(2)	0.71			0.67			0.64				0.30			0.59			0.59
Dividend payout ratio	31		%	35		%	33		%		30		%	36		%	48		%
Return on average assets	1.22		%	1.12		%	1.18		%		1.31		%	1.19		%	0.95		%
Average equity to average assets	8.33		%	8.28		%	8.26		%		8.77		%	9.10		%	8.97		%
Return on average equity	14.60		%	13.47		%	14.32		%		14.89		%	13.08		%	10.62		%
Efficiency ratio	58		%	59		%	56		%		50		%	54		%	59		%

(1) Includes loans held for sale.

(2) Amounts adjusted to reflect a 10% stock dividend declared April 16, 2003 and a 10% stock dividend declared September 20, 2005.

Item 7. Management Discussion and Analysis of Financial Condition and Results of Operations

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

OVERVIEW

We conduct operations in 14 full-service banking centers in six contiguous counties in Kentucky along the Interstate 65 corridor. Our market presence ranges from the major metropolitan market of Louisville in Jefferson County, Kentucky approximately 40 miles north of our headquarters in Elizabethtown, Kentucky to Hart County, Kentucky, approximately 30 miles south of Elizabethtown. Our core markets have experienced a compound annual growth rate of 5% in deposits for the past four years. We anticipate a similar growth rate of our markets for the next few years and believe we are well positioned to benefit from this continued growth.

Our emphasis over the past several years has been focused on the enhancement and expansion of our retail and commercial banking network in our core markets as well as establishing our presence in the Metro Louisville market. Our five county core markets, where we have a combined 22% market share, has become increasingly competitive with several new bank branches entering our markets in the past few years. In order to protect and grow our market share, we enhanced several of our new facilities and anticipate several new facilities over the next few years. In addition to the enhancement and expansion in our core markets, we began establishing our presence in the Metro Louisville market. The Metro Louisville market of Jefferson County is contiguous to our five county core markets. Approximately 75% of the deposit base in the Metro Louisville market is controlled by six out-of-state banks. While the market is very competitive, we believe this creates an opportunity for smaller community banks with a much more empowered staff of associates. We believe our investment in these initiatives along with our continued commitment to world class customer service will enhance our existing market share and effectively support our development in the Metro Louisville market.

The enhancement of our retail branch network continues to produce positive results for 2005. Total deposits have grown at a 6% compound annual growth rate over the past four years. Total deposits were $591.1 million at December 31, 2005, an increase of $4.7 million from December 31, 2004. We achieved this growth despite a $36.9 million decrease in public funds deposits as one of our county school district customers constructed three new schools during the year. For 2005, total retail and commercial deposits grew $41.6 million

The development of the retail branch network into the Metro Louisville market has also generated positive results. We have a combined $30.0 million in deposits in our two new full-service facilities in the Metro Louisville market representing a 71% increase in deposits for the year. We opened these new facilities in the second quarter of 2004 to support our growing commercial customer base in this market. Twenty-one percent of the loans in our portfolio are located in our Metro Louisville market.

We also have been significantly investing in our branch network outside of the Louisville metropolitan market, where we have a commanding 22% deposit market share. We have renovated several of our existing branches and have under construction a new full-service banking center in Hardin County opening in early 2006. The design of the new and enhanced facilities represents our state of the art prototype branch with a retail-focused design, complimenting our commitment to providing world class customer service.

While we anticipate these facilities will significantly enhance the value of our franchise in the near future, the additional expense in operating these new facilities will continue to place pressure on earnings.

We estimate new branch facilities will reach break even in approximately 18 to 24 months. We are optimistic that the growth in deposits and loans generated as a result of our expansion strategy will minimize this period and the long-term benefits will ultimately outweigh the initial investment costs.

Our emphasis on commercial lending generated a 6% compound annual growth rate in the total loan portfolio and a 30% compound annual growth rate in commercial loans over the past four years. Commercial loans were $403.2 million at December 31, 2005, an increase of $57.6 million, or 17%, from December 31, 2004.

The growth in our commercial loan portfolio, coupled with the rising interest rate environment, has increased interest income. Net interest margin increased to 3.93% for the year ended December 31, 2005, compared to 3.76% a year ago. This has resulted in a $3.2 million increase in net interest income to $27.5 million for 2005, compared to 2004. The increasing interest rate environment improved net interest margin due to the growth in the adjustable rate commercial loans coupled with the decrease in residential fixed rate loans in the loan portfolio.

Net interest margin has been favorably impacted since the Federal Open Market Committee began increasing short-term interest rates in June 2004. We believe the Federal Open Market Committee will stop increasing short term interest rates during 2006 and will likely decrease short term interest rates in late 2006 or into 2007. Our net interest margin and the level of net interest income will be negatively affected with a decrease in short-term interest rates over the next several quarters. We continually monitor the effects rate changes will have on our level of net interest income and management works to structure the maturity and pricing of loans and deposits to mitigate large swings in net interest income. During 2005, we made efforts to increase the level of short-term deposits with a money market promotion as well as offering more attractive rates on short-term certificates of deposit relative to long term maturities. In addition, 78% of the newly originated or renewed loans during 2005 were fixed rates loans with the interest rate fixed from three to five years. These efforts, in addition to other initiatives to structure funding and future liquidity needs will help decrease the negative impact flat or decreasing short-term interest rates may have on the level of net interest income. More detailed information on the effects of changing interest rates on our level of interest income can be found in the “Asset/Liability Management and Market Risk” section of Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Our asset quality remains favorable. Net charge-offs as a percent of total loans was 0.06% for the year ended December 31, 2005, compared to 0.12% for the same period a year ago. The allowance for loan losses as a percent of total loans, increased to 1.15% at December 31, 2005 compared to 1.07% at December 31, 2004. The percentage of non-performing loans to total loans increased to 0.97% at December 31, 2005, compared to 0.87% at December 31, 2004.

Provision for loan loss expense decreased $398,000 to $1.3 million for the year ended December 31, 2005, compared to $1.7 million a year ago. The decrease in the provision for the year was related to a decrease in net charge offs of $365,000 to $370,000 for the year ended December 31, 2005 compared to $735,000 the prior year.

Non-interest income decreased $37,000 to $8.1 million, while non-interest expense increased $1.5 million to $20.8 million for 2005, compared to 2004. The primary contributing factors to this increase were the additional operating and employee compensation expenses related to the recent expansion efforts. Twenty-four retail staff positions were added for the expansion into the Louisville metropolitan market, coupled with expanded facilities in Hardin County and Bullitt County, Kentucky. Additional increases in staff have taken place during 2004 and 2005 to continue the transformation towards a stronger retail sales culture and to provide expanded products and services to our retail and commercial customers. Non-interest expense levels are often measured using an efficiency ratio (non-interest expense divided by the sum of net interest income and non-interest income). Our efficiency ratio was 58% for the year ended December 31, 2005 and 59% for the year ended December 31, 2004.

APPLICATION OF CRITICAL ACCOUNTING POLICIES

Our accounting and reporting policies comply with U.S. generally accepted accounting principles and conform to general practices within the banking industry. The accounting policy relating to the allowance for loan losses is critical to the understanding of our results of operations since the application of this policy requires significant management assumptions and estimates that could result in materially different amounts to be reported if conditions or underlying circumstances were to change.

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

The allowance consists of specific and general components. The specific component relates to loans that are individually classified as impaired or loans otherwise classified as substandard or doubtful. The general component covers non-classified loans and is based on historical loss experience adjusted for current factors. The methodology for allocating the allowance for loan and lease losses takes into account our strategic plan to increase our emphasis on commercial and consumer lending. We increase the amount of the allowance allocated to commercial loans and consumer loans in response to the growth of the commercial and consumer loan portfolios and management’s recognition of the higher risks and loan losses in these lending areas. Allowance estimates are developed with actual loss experience adjusted for current economic conditions. Allowance estimates are considered a prudent measurement of the risk in the loan portfolio and are applied to individual loans based on loan type.

Based on our calculation, an allowance of $7.4 million or 1.15% of total loans was our estimate of probable losses within the loan portfolio as of December 31, 2005. This estimate resulted in a provision for loan losses on the income statement of $1.3 million during 2005. If the mix and amount of future charge off percentages differ significantly from those assumptions used by management in making its determination, the allowance for loan losses and provision for loan losses on the income statement could be materially affected.

RESULTS OF OPERATIONS

Net income for the period ended December 31, 2005 was $9.1 million or $2.27 per share diluted compared to $7.8 million or $1.93 per share diluted for the same period in 2004. The increase was primarily the result of an increase in net interest income of $3.2 million and a decrease in provision for loan loss expense of $398,000. Our book value per common share increased from $14.91 at December 31, 2004 to $16.25 at December 31, 2005. Net income for 2005 generated a return on average assets of 1.22% and a return on average equity of 14.60%. These compare with a return on average assets of 1.12% and a return on average equity of 13.47% for the 2004 period.

Net income for the period ended December 31, 2004 was $7.8 million or $1.93 per share diluted compared to $8.0 million or $1.91 per share diluted for the same period in 2003. The increase in diluted earnings per share was due to a stock repurchase of 60,000 shares of our own common stock, which decreased capital by $1.6 million. The decrease in earnings was primarily the result of an increase in non-interest expense of $2.0 million for the 2004 period compared to 2003, the direct result of our expansion efforts. Our book value per common share increased from $13.82 at December 31, 2003 to $14.91 at December 31, 2004. Net income for 2004 generated a return on average assets of 1.12% and a return on

average equity of 13.47%. These compare with a return on average assets of 1.18% and a return on average equity of 14.32% for the 2003 period.

We reported net income of $8.0 million during the year ended December 31, 2003 compared with $8.1 million for the 2002 period. Diluted earnings per share increased 6% from $1.80 during 2002 to $1.91 for 2003. Earnings remained relatively constant for the comparative periods. Favorable increases in non-interest income generated from the gain on sale of mortgage loans, service charges on deposit accounts, and two lots held for sale were offset by a decline in net interest income as well as an increase in non-interest expense. Our book value per common share increased from $13.53 at December 31, 2002 to $13.82 at December 31, 2003. Net income for 2003 generated return on average assets of 1.18% and return on average equity of 14.32%. These compare with return on average assets of 1.24% and return on average equity of 13.87% for the 2002 period.

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

Net interest margin as a percent of average earning assets increased by 17 basis points to 3.93% for the year ended December 31, 2005 compared to 3.76% for the 2004 period. The increasing interest rate environment in conjunction with an increase in average earning assets improved net interest margin for the periods presented. Average interest earning assets increased $52.1 million for the 2005 period compared to 2004. The yield on earning assets averaged 6.48% for the 2005 period compared to an average yield on earning assets of 6.04% for the same period in 2004. The prime-lending rate increased 325 basis points from the time the Federal Open Market Committee began increasing short-term interest rates in June 2004 through the end of 2005.

Our cost of funds averaged 2.77% for the 2005 period compared to an average cost of funds of 2.45% for the same period in 2004. Deposit costs have accelerated due to the re-pricing of certificate of deposit maturities rolling off at lower rates into current higher interest rates in addition to our higher rates paid on our money market products. Going forward, our cost of funds is expected to increase as the general market deposit rates have become increasingly competitive with the recent upward trend in interest rates.

Net interest margin has been favorably impacted since the Federal Open Market Committee began increasing short-term interest rates in June 2004. We believe the Federal Open Market Committee will stop increasing short term interest rates during 2006, and will likely decrease short term interest rates in late 2006 or into 2007. Our net interest margin and the level of net interest income will be negatively affected with a decrease in short-term interest rates. We continually monitor the effects rate changes will have on our level of net interest income and management works to structure the maturity and pricing of loans and deposits to mitigate large swings in net interest income. During 2005, we made efforts to increase the level of short-term deposits with a money market promotion as well as offering more attractive rates on short-term certificates of deposit. In addition, 78% of the newly originated or renewed loans during 2005 were fixed rates loans with the interest rate fixed from three to five years. These efforts, in addition to other initiatives to structure funding and future liquidity needs will help decrease the negative impact flat or decreasing short-term interest rates may have on the level of net interest income. More detailed information on the effects of changing interest rates on our level of interest income can be found in the “Asset/Liability Management and Market Risk” section of Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Comparative information regarding net interest income follows:

										2005/2004				2003/2004
	2005			2004			2003			Change				Change
	(Dollars in thousands)
Net interest income, tax equivalent basis	$	45,431		$	39,165		$	39,361			16.0	%			-0.5	%
Net interest spread	3.71		%	3.58		%	3.37		%		13		bp		21		bp
Net interest margin	3.93		%	3.76		%	3.61		%		17		bp		15		bp
Average Earnings Assets	$	700,849		$	648,703		$	636,624			8.0	%			1.9	%
Prime rate a year end	7.25		%	5.25		%	4.00		%		200		bp		125		bp
Average prime rate	6.19		%	4.34		%	4.12		%		185		bp		22		bp

bp = basis point = 1/100th of a percent

Prime rate is included above to provide a general indication of the interest rate environment in which we operate. A large portion of our variable rate loans were indexed to the prime rate and re-price as the prime rate changes, unless they reach a contractual floor or ceiling.

AVERAGE BALANCE SHEETS

The following table provides information relating to the Bank’s average balance sheet and reflects the average yield on assets and average cost of liabilities for the periods indicated. Dividing income or expense by the average monthly balance of assets or liabilities, respectively, derives such yields and costs for the periods presented.

	Year Ended December 31,
	2005								2004								2003
						Average								Average								Average
	Average Balance			Interest		Yield/ Cost			Average Balance			Interest		Yield/ Cost			Average Balance			Interest		Yield/ Cost
	(Dollars in thousands)
ASSETS
Interest earning assets:
U.S. Treasury and agencies	$	48,063		$	1,319		2.74	%	$	26,761		$	728		2.72	%	$	12,766		$	367		2.87	%
Mortgage-backed securities	12,714			516			4.06	%	9,343			352			3.77	%	6,976			269			3.86	%
Equity securities	2,063			93			4.51	%	3,215			124			3.86	%	2,073			79			3.81	%
State and political subdivision securities(1)	2,971			186			6.26	%	1,058			67			6.33	%	1,083			67			6.19	%
Corporate bonds	3,547			181			5.10	%	2,000			66			3.30	%	2,000			64			3.20	%
Loans(2)(3)(4)	613,185			42,481			6.93	%	583,020			37,364			6.41	%	531,750			37,413			7.04	%
FHLB stock	6,967			349			5.01	%	6,671			275			4.12	%	6,421			257			4.00	%
Interest bearing deposits	11,339			306			2.70	%	16,635			189			1.14	%	73,555			845			1.15	%
Total interest earning assets	700,849			45,431			6.48	%	648,703			39,165			6.04	%	636,624			39,361			6.18	%
Less: Allowance for loan losses	(6,794		)						(5,890		)						(5,006		)
Non-interest earning assets	57,632								55,760								45,075
Total assets	$	751,687							$	698,573							$	676,693
LIABILITIES AND STOCKHOLDERS’ EQUITY
Interest bearing liabilities:
Savings accounts	$	90,941		$	1,678		1.85	%	$	84,089		$	783		0.93	%	$	77,905		$	799		1.03	%
NOW and money market accounts	147,731			2,093			1.42	%	135,265			1,156			0.85	%	115,785			959			0.83	%
Certificates of deposit and other time deposits	312,807			9,428			3.01	%	291,486			8,539			2.93	%	301,730			10,366			3.44	%
Federal funds purchased	3,655			148			4.05	%	3,424			47			1.37	%	—			—			—
FHLB Advances	78,629			3,803			4.84	%	78,543			3,738			4.76	%	77,726			3,738			4.81	%
Subordinated debentures	10,000			712			7.12	%	10,000			529			5.29	%	10,000			503			5.03	%
Total interest bearing liabilities	643,763			17,862			2.77	%	602,807			14,792			2.45	%	583,146			16,365			2.81	%
Non-interest bearing liabilities:
Non-interest bearing deposits	41,505								34,925								34,075
Other liabilities	3,780								3,014								3,594
Total liabilities	689,048								640,746								620,815
Stockholders’ equity	62,639								57,827								55,878
Total liabilities and stockholders’ equity	$	751,687							$	698,573							$	676,693
Net interest income				$	27,569							$	24,373							$	22,996
Net interest spread							3.71	%							3.58	%							3.37	%
Net interest margin							3.93	%							3.76	%							3.61	%
Ratio of average interest earning assets to average interest bearing liabilities							108.87	%							107.61	%							109.17	%

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

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

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

(4) Includes loans held for sale.

RATE/VOLUME ANALYSIS

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

	Year Ended											Year Ended
	December 31,											December 31,
	2005 vs. 2004											2004 vs. 2003
	Increase (decrease)											Increase (decrease)
	Due to change in											Due to change in
								Net											Net
	Rate			Volume				Change				Rate			Volume				Change
	(Dollars in thousands)
Interest income:
U.S. Treasury and agencies	$	6			$	585			$	591		$	(22	)		$	383		$	361
Mortgage-backed securities	29				135				164			(6		)		89			83
Equity securities	19				(50		)		(31		)	1				44			45
State and political subdivision securities	(1		)		120				119			2				(2		)	—
Corporate bonds	115				—				115			2				—			2
Loans	3,123				1,994				5,117			(3,489		)		3,440			(49		)
FHLB stock	61				13				74			8				10			18
Interest bearing deposits	193				(76		)		117			(9		)		(647		)	(656		)
Total interest earning assets	3,545				2,721				6,266			(3,513		)		3,317			(196		)
Interest expense:
Savings accounts	826				69				895			(77		)		61			(16		)
NOW and money market accounts	822				115				937			31				166			197
Certificates of deposit and other time deposits	251				638				889			(1,485		)		(342		)	(1,827		)
Federal funds purchased	101				—				101			—				47			47
FHLB advances	61				4				65			(39		)		39			—
Subordinated debentures	183				—				183			26				—			26
Total interest bearing liabilities	2,244				826				3,070			(1,544		)		(29		)	(1,573		)
Net change in net interest income	$	1,301			$	1,895			$	3,196		$	(1,969	)		$	3,346		$	1,377

Non-Interest Income and Non-Interest Expense

The following tables provide a comparison of the components of non-interest income and expenses for the years ended December 31, 2005, 2004 and 2003. The tables show the dollar and percentage change from 2004 to 2005 and from 2003 to 2004. Below each table is a discussion of significant changes and trends.

							2005/2004						2003/2004
	2005		2004		2003		Change				%		Change				%
	(Dollars in thousands)
Non-interest income
Customer sevice fees on deposit accounts	$	5,167	$	4,913	$	4,556		$	254		5.2	%		$	357		7.8	%
Gain on sale of mortgage loans	868		862		1,564			6			0.7	%		(702		)	-44.9	%
Gain on sale of investments	381		202		—			179			88.6	%		202			100.0	%
Gain on sale of real estate held for development	143		526		437			(383		)	-72.8	%		89			20.4	%
Brokerage commissions	313		404		353			(91		)	-22.5	%		51			14.4	%
Other income	1,195		1,197		1,071			(2		)	-0.2	%		126			11.8	%
	$	8,067	$	8,104	$	7,981		$	(37	)	-0.5	%		$	123		1.5	%

Growth in customer service fees on deposit accounts, our largest component of non-interest income, is primarily due to growth in customer deposits, overdraft fee income on retail checking accounts and the sale of fee based products for both 2005 and 2004. We continue to increase our customer base through cross-selling opportunities and marketing initiatives and promotions. We undertook a renewed emphasis on growing our checking account base during 2005 to better enhance our profitability and franchise value and will continue this emphasis going forward. This initiative initially began in late 2004 with the introduction of 10 new checking account products and/or significant enhancements to existing products. We also introduced two new checking account products in 2005 geared toward customers on check systems who would not normally qualify for a standard checking account. We expect the increase in checking accounts we experienced in 2005 to continue going forward. This will positively impact our level of customer service fees on deposit accounts.

Through our mortgage banking subsidiary, First Heartland Mortgage Company, we originate qualified VA, KHC, RHC and conventional secondary market loans and sell them into the secondary market with servicing rights released. For 2005, gain on sale of mortgage loans remained steady compared to 2004. However, due to a decline in refinancing activity of 1-4 family loans, gain on sale of mortgage loans decreased for the 2004 period compared to 2003. We expect the gain on sale of mortgage loans to remain consistent with the levels reached in 2005 and 2004.

We invest in various types of liquid assets, including United States Treasury obligations, securities of various federal agencies, obligations of states and political subdivisions, corporate bonds, mutual funds, stocks and others. During the first quarter of 2005 we recorded a gain on sale of investments of $381,000. For 2004, gain on sale of investments includes various other sales of equity investments. Gains on investment securities are infrequent in nature and are not a consistent recurring source of income.

Through our subsidiary, First Federal Office Park, we hold commercial lots adjacent to our home office on Ring Road in Elizabethtown, that are available for sale. During 2005 we recorded $143,000 in gains from a lot sale compared to $526,000 in gains from the sale of three properties held for development during 2004. Two properties were sold in 2003 for a recorded gain of $437,000. Currently, we are holding three lots for sale in this subsidiary, of the initial nine lots held for sale.

During the fourth quarter of 2004 we made the decision to outsource our trust operations and implemented this plan during 2005. Included in other income for the 2005, 2004, and 2003 periods is income from trust operations of $93,000, $128,000, and $125,000 respectively. This source of non-interest income will largely be eliminated going forward with our decision to outsource our trust operations.

							2005/2004					2003/2004
	2005		2004		2003		Change			%		Change		%
	(Dollars in thousands)
Non-interest expenses
Employee compensation and benefits	$	11,126	$	10,295	$	9,446	$	831		8.1	%	$	849	9.0	%
Office occupancy expense and equipment	2,065		1,833		1,534		232			12.7	%	299		19.5	%
Marketing and advertising	778		726		568		52			7.2	%	158		27.8	%
Outside services and data processing	2,393		2,134		1,826		259			12.1	%	308		16.9	%
Bank franchise tax	788		822		623		(34		)	-4.1	%	199		31.9	%
Other expense	3,609		3,464		3,295		145			4.2	%	169		5.1	%
	$	20,759	$	19,274	$	17,292	$	1,485		7.7	%	$	1,982	11.5	%

Employee compensation and benefits is the largest component of non-interest expense. Twenty-four retail staff positions were added for the expansion into the Louisville metropolitan market, coupled with expanded facilities in Hardin County and Bullitt County, Kentucky. Additional increases in staff have taken place during 2005, 2004 and 2003 to continue the transformation towards a stronger retail sales culture and to provide expanded products and services to our retail and commercial customers. We look for a continued increase in employee compensation and benefits expense in line with recent trends, as we progress with our retail expansion and market protection efforts.

Office occupancy expense and equipment, marketing and advertising, and outside services and data processing increased due to additional operating expenses related to our expansion efforts for 2005, 2004 and 2003. The two full service branch openings in 2004 contributed to higher operating costs including additional postage for promotions and direct mailings for marketing, along with increased communications and supplies expense. We look for a continuation of these trends as we continue our retail expansion and market protection efforts.

Bank franchise tax expense increased $199,000 in 2004 from 2003 due to a higher tax expense accrual resulting from the conversion from a federally chartered thrift to a Kentucky state-chartered commercial bank. The state tax expense for a bank charter is calculated based upon different rules.

We anticipate the increased level of non-interest expense to continue into 2006 with continued retail expansion and market share protection efforts. We started construction on a new full service-banking center in Elizabethtown, KY with plans of opening in early 2006. We will begin construction on a third facility in Jefferson County to begin in the first quarter of 2006 with the anticipation of opening in early 2007. We are also considering other possible locations within the core market area to protect and grow our 22% market share. Despite the increase in non-interest expense for 2005, our efficiency ratio was 58% compared to 59% for the 2004 period.

ANALYSIS OF FINANCIAL CONDITION

Total assets at December 31, 2005 increased to $766.5 million compared to $737.6 million at December 31, 2004, an increase of $28.9 million. The increase was primarily driven by an increase in investment securities of $4.7 million and an increase in net loans of $36.3 million. The growth in investment securities and loans was principally funded with cash and cash equivalents, which decreased by $15.5 million, deposits, which increased by $4.7 million, and federal funds purchased, which increased by $19.5 million.

Total assets at December 31, 2004 increased to $737.6 million compared to $676.3 million at December 31, 2003, an increase of $61.3 million. The increase was primarily related to an increase in investment securities of $21.9 million and an increase in net loans receivable of $49.3 million. The growth in investment securities and loans was principally funded with cash and cash equivalents, which decreased by $12.1 million, and deposits, which increased by $57.2 million.

Loans

Net loans increased $36.3 million or 6% to $635.7 million at December 31, 2005 compared to $599.4 million at December 31, 2004. Our commercial, commercial real estate and real estate construction portfolios increased $57.6 million, a 17% increase in these loans to $403.2 million at December 31, 2005. For the 2005 period, these loans comprised 63% of the total loan portfolio compared to 57% of the loan portfolio at December 31, 2004, and 49% of the loan portfolio at December 31, 2003. Offsetting this growth was a $16.8 million, or 11% decrease in the residential mortgage loan portfolio to $142.7 million at December 31, 2005, compared to $159.6 million at December 31, 2004. Consumer and home equity loans also decreased for the 2005 period by $3.9 million to $66.2 million at December 31, 2005. For 2006, the growth in commercial loans is expected to continue in line with recent trends.

Residential mortgage loans decreased by $31.4 million during the 2004 period as declining market interest rates caused an increase in 1-4 family refinancing activity into fixed-rate, secondary market loan products. Our emphasis on commercial lending continued to produce positive results generating a $73.4 million, or 27% increase in commercial loans to $345.6 million at December 31, 2004, compared to $272.2 million at December 31, 2003. Our consumer, home equity and indirect consumer loan portfolios increased $7.9 million to $100.9 million at December 31, 2004.

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

	December 31,																June 30,
	2005				2004				2003				2002				2002				2001
	Amount		%		Amount		%		Amount		%		Amount		%		Amount		%		Amount		%
	(Dollars in thousands)
Type of Loan:
Real Estate:
Residential	$	142,359	22.14	%	$	158,966	26.23	%	$	190,088	34.21	%	$	262,990	49.34	%	$	291,668	55.66	%	$	320,860	61.70	%
Construction	13,579		2.11		10,850		1.79		9,952		1.79		12,857		2.41		10,805		2.06		9,205		1.77
Commercial	353,637		54.99		302,567		49.94		230,964		41.56		133,328		25.01		111,502		21.28		84,378		16.22
Consumer and home equity	66,207		10.29		70,141		11.58		64,759		11.65		67,398		12.64		67,882		12.95		66,492		12.79
Indirect consumer	31,577		4.91		30,798		5.08		28,279		5.09		20,594		3.86		19,640		3.75		21,822		4.20
Commercial, other	35,161		5.47		31,376		5.18		30,658		5.52		32,268		6.05		20,988		4.01		16,662		3.20
Loans held for sale	597		0.09		1,219		0.20		1,021		0.18		3,676		0.69		1,511		0.29		632		0.12
Total loans	$	643,117	100.00	%	$	605,917	100.00	%	$	555,721	100.00	%	$	533,111	100.00	%	$	523,996	100.00	%	$	520,051	100.00	%

Loan Maturity Schedule. The following table sets forth information at December 31, 2005, regarding the dollar amount of loans, net of deferred loan fees, maturing in the loan portfolio based on their contractual terms to maturity.

				Due after
	Due during			1 through			Due after 5
	the year ended			5 years after			years after
	December 31,			December 31,			December 31,			Total
	2006			2005			2005			Loans
	(Dollars in thousands)
Residential mortgage		$	4,933		$	24,394		$	113,032	$	142,359
Real estate construction		13,579			—			—		13,579
Real estate commercial		119,455			199,142			35,040		353,637
Consumer, home equity and indirect consumer		8,586			50,533			38,665		97,784
Commercial, other		12,305			20,085			2,771		35,161
Loans held for sale		597			—			—		597
Total		$	159,455		$	294,154		$	189,508	$	643,117

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

				Floating or
	Fixed Rates			Adjustable Rates			Total
	(Dollars in thousands)
Residential mortgage		$	77,350		$	60,076	$	137,426
Real estate commercial		67,918			166,264		234,182
Consumer, home equity
and indirect consumer		46,758			42,440		89,198
Commercial, other		14,883			7,973		22,856
Total		$	206,909		$	276,753	$	483,662

Allowance and Provision for Loan Losses

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

The Allowance for Loan Loss Review Committee evaluates the allowance for loan losses quarterly to maintain a level sufficient to absorb probable incurred credit losses existing in the loan portfolio. Periodic provisions to the allowance are made as needed. The allowance is determined based on the application of loss estimates to graded loans by categories. The amount of the provision for loan losses necessary to maintain an adequate allowance is also based upon an analysis of such factors as changes in lending policies and procedures; underwriting standards; collection; charge-off and recovery history; changes in national and local economic business conditions and developments; changes in the characteristics of the portfolio; ability and depth of lending management and staff; changes in the trend of the volume and severity of past due, non-accrual and classified loans; troubled debt restructuring and other loan modifications; and results of regulatory examinations.

The methodology for allocating the allowance for loan and lease losses takes into account our strategic plan to increase our emphasis on commercial and consumer lending. We increase the amount of the allowance allocated to commercial loans and consumer loans in response to the growth of the commercial and consumer loan portfolios and management’s recognition of the higher risks and loan losses in these lending areas. The indirect consumer loan program is comprised of new and used automobile, motorcycle and all terrain vehicle loans originated on our behalf by a select group of auto

dealers within the our service area. The indirect loan program involves a greater degree of risk and is evaluated quarterly and monitored by the Board of Directors. In light of the greater charge-offs from indirect consumer loans compared to direct consumer loans, proportionally more of the allowance for consumer loans is allocated for indirect loans than direct loans. As the indirect loan program has evolved, dealer analysis and underwriting standards have been refined to improve the loan loss experience of the program. Estimating the allowance is a continuous process. In this regard, the Allowance for Loan Loss Review Committee continues to monitor the performance of indirect consumer loans as well as our other loan products and updates estimates as the evidence warrants.

The following table sets forth an analysis of loan loss experience for the periods indicated.

										Six Months Ended
	Year Ended December 31,									December 31,				Year Ended June 30,
	2005			2004			2003			2002				2002			2001
	(Dollars in thousands)
Balance at beginning of period	$	6,489		$	5,568		$	4,576			$	3,735		$	2,906		$	2,252
Loans charged-off:
Real estate mortgage	15			41			60				5			25			2
Consumer	584			702			721				419			635			482
Commercial	67			206			76				—			256			15
Total charge-offs	666			949			857				424			916			499
Recoveries:
Real estate mortgage	4			—			—				—			6			4
Consumer	290			214			190				74			97			63
Commercial	2			—			3				30			38			—
Total recoveries	296			214			193				104			141			67
Net loans charged-off	370			735			664				320			775			432
Provision for loan losses	1,258			1,656			1,656				1,161			1,604			1,086
Balance at end of period	$	7,377		$	6,489		$	5,568			$	4,576		$	3,735		$	2,906
Allowance for loan losses to total loans (excluding loans held for sale)	1.15		%	1.07		%	1.00		%		0.86		%	0.71		%	0.56		%
Net charge-offs to average loans outstanding	0.06		%	0.13		%	0.12		%		0.12		%	0.15		%	0.09		%
Allowance for loan losses to total non-performing loans	118		%	124		%	105		%		100		%	100		%	88		%

The provision for loan losses decreased $398,000, or 24% to $1.3 million for the year ended December 31, 2005, compared to the 2004 period. The decrease in the provision for the year was related to a decrease in net charge offs of $365,000 to $370,000 for the year ended December 31, 2005 compared to $735,000 the prior year due to lower commercial and indirect consumer loan charge-offs. The total allowance for loan losses increased $888,000 to $7.4 million from December 31, 2004 to December 31, 2005. The increase in the allowance was related to a $37.8 million increase in net loans at 2005 compared to 2004, in conjunction with a $2.8 million increase in classified loans for the 2005 period compared to the 2004 period.

The provision for loan losses remained constant at $1.7 million for the year ended December 31, 2004, compared to the 2003 period. The total allowance for loan losses increased $921,000 to $6.5 million or 1.07% of total loans for December 31, 2004 compared to 1.00% of total loans for December 31, 2003. The increased allowance was primarily due to increases in commercial loans during the 2004 period. Net loan

charge-offs increased $71,000 to $735,000 during 2004 compared to $664,000 during 2003, due to an increase in commercial loan net charge-offs.

The provision for loan losses decreased 17% to $1.7 million for the fiscal year ended December 30, 2003 compared to $2.0 million for the 2002 period. The higher provision expense for 2002 was due to a change in loan types. The total allowance for loan losses increased $992,000 to $5.6 million from December 31, 2002 to December 31, 2003. We increased the allowance for loan losses due to the continued strong growth in commercial real estate lending and changes in the product mix within the loan portfolios. Net loan charge-offs decreased $49,000 to $664,000 during 2003 compared to $713,000 during 2002. The decrease in charge-offs is primarily related to a decrease in charge-offs of indirect consumer loans during the 2003 period.

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

	December 31,
	2005						2004						2003						2002
	Amount of Allowance			Percent of Total loans			Amount of Allowance			Percent of Total loans			Amount of Allowance			Percent of Total loans			Amount of Allowance			Percent of Total loans
	(Dollars in thousands)
Residential mortgage		$	373		22	%		$	413		26	%		$	456		34	%		$	608		49	%
Consumer		1,372			15			1,345			17			1,235			17			1,096			17
Commercial		5,632			63			4,731			57			3,877			49			2,872			34
Total		$	7,377		100	%		$	6,489		100	%		$	5,568		100	%		$	4,576		100	%

	June 30,
	2002						2001
	Amount of Allowance			Percent of Total loans			Amount of Allowance			Percent of Total loans
	(Dollars in thousands)
Residential mortgage		$	645		56	%		$	884		62	%
Consumer		1,023			17			953			17
Commercial		2,067			27			1,069			21
Total		$	3,735		100	%		$	2,906		100	%

Federal regulations require insured institutions to classify their own assets on a regular basis. The regulations provide for three categories of classified loans—substandard, doubtful and loss. Assets classified as substandard or doubtful require the institution to establish general allowances for loan losses. If an asset or portion thereof is classified as loss, the insured institution must either establish specified allowances for loan losses in the amount of 100% of the portion of the asset classified loss, or charge off such amount. At December 31, 2005, on the basis of management’s review of the loan portfolio, we had $9.8 million of assets classified substandard, $933,000 classified as doubtful, and $21,000 of assets classified as loss. At December 31, 2004, on the basis of management’s review of the loan portfolio, we had $6.9 million assets classified substandard, $1.0 million classified as doubtful, and $35,000 of assets classified as loss. The $2.9 million increase in substandard assets for December 31, 2005 was primarily the result of two credit relationships. These credit relationships were a $1.5 million commercial real estate relationship and a $763,000 commercial relationship. Both relationships were classified as substandard in September of 2005.

Loans are classified according to estimated loss as follows: Substandard-2.5% to 35%; Doubtful-5% to 75%; and Loss-100%. We additionally provide an allowance estimate for probable incurred losses in non-classified loans ranging from .20% to 6.00%. Although we may allocate a portion of the allowance to specific loans or loan categories, the entire allowance is available for active charge-offs. Allowance estimates are developed with actual loss experience adjusted for current economic conditions. Allowance estimates are considered a prudent measurement of the risk in the loan portfolio and are applied to individual loans based on loan type.

Non-Performing Assets

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

Loans are reviewed on a regular basis and normal collection procedures are implemented when a borrower fails to make a required payment on a loan. If the delinquency on a mortgage loan exceeds 90 days and is not cured through normal collection procedures or an acceptable arrangement is not worked out with the borrower, we institute measures to remedy the default, including commencing a foreclosure action. Consumer loans generally are charged off when a loan is deemed uncollectible by management and any available collateral has been disposed of. Commercial business and real estate loan delinquencies are handled on an individual basis by management with the advice of legal counsel.

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

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

The following table sets forth information with respect to non-performing assets as of the periods indicated.

	December 31,												June 30,
	2005			2004			2003			2002			2002			2001
	(Dollar in thousands)
Restructured	$	3,104		$	3,218		$	3,037		$	3,325		$	3,350		$	—
Past due 90 days still on accrual	—			—			—			—			—			—
Loans on non-accrual status	3,128			2,022			2,281			1,259			386			3,309
Total non-performing loans	6,232			5,240			5,318			4,584			3,736			3,309
Real estate acquired through foreclosure	1,022			681			387			510			660			296
Other repossessed assets	119			40			62			119			119			70
Total non-performing assets	$	7,373		$	5,961		$	5,767		$	5,213		$	4,515		$	3,675
Interest income that would have been earned on non-performing loans	$	432		$	336		$	374		$	177		$	300		$	276
Interest income recognized on non-performing loans	219			197			227			126			201			—
Ratios:
Non-performing loans to total loans (excluding loans held for sale)	0.97		%	0.87		%	0.96		%	0.87		%	0.72		%	0.64		%
Non-performing assets to total loans (excluding loans held for sale)	1.15		%	0.99		%	1.04		%	0.98		%	0.86		%	0.71		%

Included in non-performing assets for the 2005 period is $3.1 million in restructured commercial and residential mortgage loans. The restructured loans primarily consist of three credit relationships aggregating $2.9 million, including a $2.2 million commercial relationship, a $210,000 commercial relationship and a $452,000 residential mortgage relationship. The terms of these loans have been renegotiated to reduce the rate of interest and extend the term thus reducing the amount of cash flow required from the borrower to service the loans. The terms of the restructured loans are currently being met.

Non-accrual loans increased $1.1 million from December 31, 2004. Included in this increase was a $1.5 million commercial real estate relationship, which became non-accrual in September of 2005. The relationship is collateralized by real estate with a value of $1.9 million. Management has proceeded with foreclosure action and does not anticipate a loss resulting from the credit.

Investment Securities

Interest on securities provides us our largest source of interest income after interest on loans, constituting 6.4% of the total interest income for the year ended December 31, 2005. The securities portfolio serves as a source of liquidity and earnings and contributes to the management of interest rate risk. We have the authority to invest in various types of liquid assets, including short-term United States Treasury obligations and securities of various federal agencies, obligations of states and political subdivisions, corporate bonds, certificates of deposit at insured savings and loans and banks, bankers’ acceptances, and federal funds. We may also invest a portion of our assets in certain commercial paper and corporate debt securities. We are also authorized to invest in mutual funds and stocks whose assets conform to the investments that we are authorized to make directly. The available-for-sale and held-to-maturity investment portfolios increased by $4.7 million or 8% during the 2005 period due to investments in U.S. agencies, mortgage-backed securities, state and municipal obligations and a corporate bond. We purchased the short-term U.S. agency and mortgage-backed securities as a source of liquidity for funding future loan growth. The corporate bond re-prices quarterly with three-month LIBOR and was purchased

to enhance our earnings. The state and municipal obligations have an average life of 10 years. We purchased these securities to enhance earnings and manage interest rate risk by placing longer-dated assets on the balance sheet. See Note 2 of the Notes to Consolidated Financial Statements for further information concerning the investment portfolio.

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

	December 31,
	2005			2004			2003
	(Dollars in thousands)
Securities available-for-sale:
U.S. Treasury and agencies		$	6,437		$	15,929		$	—
Mortgage-backed		11,302			1,879			—
Equity		1,991			3,079			2,939
State and municipal		5,558			1,041			1,070
Corporate		3,036			—			—
Total		$	28,324		$	21,928		$	4,009
Securities held-to-maturity:
U.S. Treasury and agencies		$	26,095		$	26,095		$	19,999
Mortgage-backed		5,136			6,820			8,930
Corporate		2,000			2,000			2,000
Total		$	33,231		$	34,915		$	30,929

The following table sets forth the scheduled maturities, amortized cost, fair value and weighted average yields for our securities at December 31, 2005.

	Amortized Cost			Fair Value			Weighted Average Yield*
	(Dollars in thousands)
Securities available-for-sale:
Due in one year or less		$	3,215		$	3,194		2.50	%
Due after one year through five years		3,584			3,579			4.06
Due after five years through ten years		6,192			6,057			4.31
Due after ten years		13,892			13,503			4.48
Equity		1,353			1,991			4.51
Total		$	28,236		$	28,324		4.17
Securities held-to-maturity:
Due in one year or less		$	8,000		$	7,892		2.44	%
Due after one year through five years		22,937			22,231			3.47
Due after ten years		2,294			2,311			5.62
Total		$	33,231		$	32,434		3.37

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

Deposits

We attract both short-term and long-term deposits from the general public by offering a wide range of deposit accounts and interest rates. In recent years we have been required by market conditions to rely increasingly on short-term certificate accounts and other deposit alternatives that are more responsive to market interest rates. We use forecasts based on interest rate risk simulations to assist management in

monitoring our use of certificates of deposit and other deposit products as funding sources and the impact of their use on interest income and net interest margin in various rate environments.

We rely primarily on customer service and long-standing relationships with customers to attract and retain deposits. Market interest rates and rates on deposit products offered by competing financial institutions can significantly affect our ability to attract and retain deposits. In conjunction with our initiatives to expand and enhance our retail branch network we have undertaken a renewed emphasis on growing our customer checking account base to better enhance profitability and franchise value, as well as lower our dependence on certificate of deposit funding. A heightened level of advertising and promotions coupled with associate incentive plans designed to encourage the sale of checking account were successful in attracting deposits during 2005. We plan to continue these efforts during 2006 and anticipate continued progress.

The combination of our long-standing relationships in addition to promotions of money market and checking account products enabled us to increase total deposits by $4.7 million at December 31, 2005, compared to the 2004 period. We were able to achieve this increase despite the decrease of $36.9 million in public funds deposits during the year. Total retail and commercial deposits increased $41.6 million during the year, offsetting the decrease in public funds. Checking balances grew $4.5 million, or 6% at December 31, 2005, compared to December 31, 2004. Money market and savings deposits grew $25.5 million, or 18% for December 31, 2005, compared to the 2004 period and certificates of deposit grew $11.6 million, or 4% for December 31, 2005, compared to December 31, 2004. The decrease in public funds was the result of one of our county school district customers using the deposits to construct three new schools during the year. The deposit growth in our Louisville Metropolitan market was across all deposit categories. Checking deposit balances increased 31%, savings and money market balances increased 139%, and certificate of deposit balances increased 59%.

To evaluate our funding needs in light of deposit trends resulting from these changing conditions, management and Board committees evaluate simulated performance reports that forecast changes in margins. We continue to offer attractive certificate rates for various terms to allow us to retain deposit customers and reduce interest rate risk during the current rate environment, while protecting the margin as interest rates increase and the economy recovers.

We offer statement and passbook savings accounts, NOW accounts, money market accounts and fixed and variable rate certificates with varying maturities. We also offer tax-deferred individual retirement accounts. The flow of deposits is influenced significantly by general economic conditions, changes in interest rates and competition. As of December 31, 2005, approximately 48% of our deposits consisted of various savings and demand deposit accounts from which customers can withdraw funds at any time without penalty. Interest rates paid, maturity terms, service fees and withdrawal penalties are established by management on a periodic basis.

We also offer certificates of deposit with a variety of terms and interest rates. These certificates have minimum deposit requirements as well. The variety of deposit accounts allows us to compete more effectively in obtaining funds and to respond with more flexibility to the flow of funds away from depository institutions into direct investment vehicles such as government and corporate securities. However, our ability to attract and maintain deposits and its cost of funds has been, and will continue to be, significantly affected by market conditions.

As of December 31, 2005, the holders of our certificates of deposits in amounts of $100,000 or more were $101.6 million in non-brokered deposits, most of who reside within our service areas. Certificates of deposits in amounts of $100,000 or more obtained from deposit brokers were $490,000 for the 2005 period. Brokered deposits consist of certificates of deposit placed by deposit brokers for a fee and can be utilized to support our asset growth.

The following table breaks down our deposits.

	December 31,
	2005			2004			2003
	(Dollars in thousands)
Non-interest bearing		$	39,145		$	38,441		$	28,632
NOW demand		76,848			73,801			67,504
Savings		99,879			78,499			86,419
Money market		66,175			85,418			51,773
Certificates of deposit		309,059			310,227			294,834
Total		$	591,106		$	586,386		$	529,162

The following table shows at December 31, 2005 the amount of our certificates of deposit of $100,000 or more by time remaining until maturity.

Maturity Period	Certificates of Deposit
	(In Thousands)
Three months or less		$	9,339
Three through six months		20,570
Six through twelve months		29,074
Over twelve months		42,634
Total		$	101,617

Borrowings

Deposits are the primary source of funds for our lending and investment activities and for our general business purposes. We can also use advances (borrowings) from the FHLB of Cincinnati to supplement our supply of lendable funds, meet deposit withdrawal requirements and extend the term of its liabilities. Advances from the FHLB are secured by our stock in the FHLB, certain commercial real estate loans and substantially all of our first mortgage loans. At December 31, 2005 we had $78.4 million in advances outstanding from the FHLB and the capacity to increase our borrowings an additional $30 million. We also had $19.5 million in federal funds purchased from the FHLB at December 31, 2005.

The FHLB of Cincinnati functions as a central reserve bank providing credit for savings banks and other member financial institutions. As a member, we are required to own capital stock in the FHLB and are authorized to apply for advances on the security of such stock and certain of our home mortgages and other assets (principally, securities which are obligations of, or guaranteed by, the United States) provided that we meet certain standards related to creditworthiness. For further information, see Note 6 of the Notes to Consolidated Financial Statements in this Annual Report.

The following table sets forth information about our FHLB advances and federal funds purchased as of and for the periods ended.

	December 31,
	2005				2004				2003
	(Dollars in thousands)
Average balance outstanding		$	82,284			$	78,543			$	77,726
Maximum amount outstanding at any month-end during the period		97,875				78,974				78,283
Year end balance		97,875				78,904				78,283
Weighted average interest rate:
At end of year		4.76		%		4.87		%		4.88		%
During the year		4.80		%		4.76		%		4.81		%

LIQUIDITY

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

Funds are available from a number of sources, including the sale of securities in the available-for-sale portion of the investment portfolio, principal pay-downs on loans and mortgage-backed securities, proceeds realized from loans held for sale, brokered deposits and other wholesale funding. At December 31, 2005, we had brokered deposits totaling $490,000. We also secured federal funds borrowing lines from two of our correspondent banks totaling $15 million each. Our banking centers also provide access to retail deposit markets. If large certificate depositors shift to our competitors or other markets in response to interest rate changes, we have the ability to replenish those deposits through alternative funding sources. Traditionally, we have also utilized borrowings from the FHLB to supplement our funding requirements. At December 31, 2005, we had an unused approved line of credit in the amount of $118.6 million and sufficient collateral available to borrow, approximately, an additional $30 million in advances from the FHLB. We believe our sources of liquidity are adequate to meet expected cash needs for the foreseeable future.

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

The primary source of funding for the Corporation has been dividends and returns of investment from the Bank. As discussed in Note 9 to the consolidated financial statements, banking regulations limit the amount of dividends that may be paid. Accordingly, consolidated cash flows as presented in the consolidated statements of cash flows may not represent cash immediately available to the Corporation. During 2005, the Bank declared and paid dividends to the Corporation of $4.0 million.

CAPITAL

Stockholders’ equity increased $4.9 million for the period ended December 31, 2005 compared to December 31, 2004. The increase in capital was primarily attributable to net income during the period. This increase was offset by cash dividends declared, the purchase of 29,000 shares of our own common stock, and a decrease in accumulated other comprehensive income, a result of temporary unrealized losses recorded on securities. Average stockholders’ equity to average assets ratio increased to 8.33% for the year ended December 31, 2005 compared to 8.28% for 2004.

In March 2002, a trust formed by First Financial Service Corporation completed the private placement of 10,000 shares of cumulative trust preferred securities with a liquidation preference of $1,000 per security. The proceeds of the offering were loaned to us in exchange for floating rate junior subordinated deferrable interest debentures. Distributions on the securities are payable quarterly at a rate per annum equal to the 3-month LIBOR plus 3.60%. We issued these securities to enhance our regulatory capital position as the securities are considered as Tier I capital under current regulatory guidelines.

Kentucky banking laws limit the amount of dividends that may be paid to First Financial Service Corporation by First Federal Savings Bank without prior approval of the KOFI. Under these laws, the amount of dividends that may be paid in any calendar year is limited to current year’s net income, as defined in the laws, combined with the retained net income of the preceding two years, less any dividends declared during those periods. At December 31, 2005, without prior regulatory approval, we had approximately $8.9 million of retained earnings that the Bank could pay as dividends to the Company if authorized by our board of directors.

Each of the federal bank regulatory agencies has established minimum leverage capital requirements for banking organizations. Banking organizations must maintain a minimum ratio of Tier 1 capital to adjusted average quarterly assets equal to 3% to 5% subject to federal bank regulatory evaluation of an organization’s overall safety and soundness. We intend to maintain a capital position that meets or exceeds the “well capitalized” requirements as defined for banks by the FDIC. The following table shows the ratios of Tier 1 capital and total capital to risk-adjusted assets and the leverage ratios for the Corporation and the Bank as of December 31, 2005.

Capital Adequacy Ratios as of
December 31, 2005

	Regulatory			Well-Capitalized
Risk-Based Capital Ratios	Minimums			Minimums			The Corporation			The Bank
Tier 1 capital(1)		4.0	%		6.0	%		10.4	%		10.0	%
Total risk-based capital(2)		8.0	%		10.0	%		11.5	%		11.1	%
Tier 1 leverage ratio(3)		4.0	%		5.0	%		8.8	%		8.5	%

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

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

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

OFF BALANCE SHEET ARRANGEMENTS

We have no off balance sheet arrangements other than as disclosed in Note 16 to the consolidated financial statements.

AGGREGATE CONTRACTUAL OBLIGATIONS

						Greater than			Greater than
				Less than		one year to			3 years to			More than
	December 31, 2005	Total		one year		3 years			5 years			5 years
		(Dollars in thousands)
Aggregate Contractual Obligations:
Time deposits		$	309,059	$	171,555		$	113,930		$	23,071		$	503
FHLB borrowings		78,375		146			281			262			77,686
Federal funds purchased		19,500		19,500			—			—			—
Subordinated debentures		10,000		—			—			—			10,000
Lease commitments		1,900		345			577			566			412

FHLB borrowings represent the amounts that are due to the FHLB of Cincinnati. These amounts have fixed maturity dates. Some of these borrowings, although fixed, are subject to conversion provisions at the option of the FHLB. The FHLB has the right to convert these advances to variable rates or we can prepay the advance at no penalty. There is a substantial penalty if we prepay the advance before the FHLB exercises its right. We do not believe these advances will be converted in the near term.

The subordinated debentures, which mature March 26, 2032, are redeemable prior to the maturity date at our option on or after March 26, 2007 at their principal amount plus accrued interest. The subordinated debentures are also redeemable in whole or in part from time to time, upon the occurrence of specific events defined within the trust indenture. The interest rate on our subordinated debentures adjusts quarterly at three-month LIBOR plus 3.60%. These debt instruments are currently being issued as spreads to three-month LIBOR which are more favorable than our 3.60% spread. If this pricing continues through March 26, 2007, we will likely exercise our option to redeem these subordinated debentures on or after March 26, 2007. We have the option to defer distributions on the subordinated debentures from time to time for a period not to exceed 20 consecutive quarters.

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

IMPACT OF INFLATION & CHANGING PRICES

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

We have an asset and liability structure that is essentially monetary in nature. As a result, interest rates have a more significant impact on our performance than the effects of general levels of inflation. Periods of high inflation are often accompanied by relatively higher interest rates, and periods of low inflation are accompanied by relatively lower interest rates. As market interest rates rise or fall in relation to the rates earned on our loans and investments, the value of these assets decreases or increases respectively.

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

ASSET/LIABILITY MANAGEMENT AND MARKET RISK

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

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

Our interest sensitivity profile was asset sensitive at both December 31, 2005 and December 31, 2004. Given a sustained 100 basis point decrease in rates, our base net interest income would decrease by an estimated 2.03% at December 31, 2005 compared to a decrease of 2.38% at December 31, 2004. Given a 100 basis point increase in interest rates our base net interest income would increase by an estimated 1.92% at December 31, 2005 compared to an increase of 2.19% at December 31, 2004.

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

As demonstrated by the December 31, 2005 and December 31, 2004 sensitivity tables, we are in an asset sensitive position. This means that our earning assets, which consist of loans and investment securities, will change in price at a faster rate than our deposits and borrowings. Therefore, as short term interest rates increase, our net interest income will also increase. Likewise, as short term interest rates decrease, our net interest income will decrease.

The Federal Open Market Committee began increasing short-term interest rates in June 2004. We believe the Federal Open Market Committee will stop increasing short term interest rates during 2006 and will likely decrease short term interest rates in late 2006 or into 2007. Our net interest margin and the level of net interest income would be negatively affected with a decrease in short-term interest rates. We continually monitor the effects rate changes will have on our level of net interest income and management works to structure the maturity and pricing of loans and deposits to mitigate large swings in net interest income. During 2005, we made efforts to increase the level of short-term deposits with a money market promotion as well as offering more attractive rates on short-term certificates of deposit. In addition, 78% of the newly originated or renewed loans during 2005 were fixed rates loans with the interest rate fixed from three to five years. These efforts, in addition to other initiatives to structure funding and future liquidity needs will decrease our asset sensitivity. This will help decrease the negative impact flat or decreasing short-term interest rates may have on the level of net interest income.

Our sensitivity to interest rate changes is presented based on data as of December 31, 2005 and December 31, 2004.

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

	December 31, 2004
	Decrease in Rates										Increase in Rates
	200				100						100				200
	Basis Points				Basis Points				Base		Basis Points				Basis Points
	(Dollars in thousands)
Projected interest income
Loans		$	38,503			$	39,834		$	40,943		$	41,960			$	42,995
Investments		1,963				2,332			2,517			2,667				2,820
Total interest income		40,466				42,166			43,460			44,627				45,815
Projected interest expense
Deposits		10,215				10,805			11,395			11,914				12,433
Borrowed funds		4,262				4,307			4,352			4,393				4,434
Total interest expense		14,477				15,112			15,747			16,307				16,867
Net interest income		$	25,989			$	27,054		$	27,713		$	28,320			$	28,948
Change from base		$	(1,724	)		$	(659	)				$	607			$	1,235
% Change from base		(6.22		)%		(2.38		)%				2.19		%		4.46		%

FIRST FINANCIAL SERVICE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

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

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

On January 8, 2003, the First Federal Savings Bank converted from a federal savings bank, regulated by the Office of Thrift Supervision (OTS), to a commercial bank chartered under Kentucky banking laws regulated by the Federal Deposit Insurance Corporation (FDIC) and the Kentucky Department of Financial Institutions (KDFI). At the same time, the First Financial Service Corporation became a bank holding company regulated by the Federal Reserve and changed its fiscal year from June 30 to December 31.

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

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

First Service Corporation acts as a broker for the purpose of selling investment services to our customers in the area of tax-deferred annuities, government securities and stocks and bonds. First Heartland Mortgage Company, through the secondary mortgage lending department, originates qualified government and conventional secondary market loans on the behalf of the investors. First Federal Office Park, LLC holds commercial lots adjacent to our home office on Ring Road in Elizabethtown, which are available for sale.

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

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

FIRST FINANCIAL SERVICE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Securities—We classify investments into held-to-maturity and available-for-sale. Debt securities in which management has a positive intent and ability to hold are classified as held-to-maturity and are carried at cost adjusted for the amortization of premiums and discounts using the interest method over the terms of the securities. Debt and equity securities, which do not fall into this category, nor held for the purpose of selling in the near term, are classified as available-for-sale. Unrealized holding gains and losses, net of tax, on available-for-sale securities are reported as a component of other comprehensive income.

Interest income includes amortization of purchase premium or discount. Premiums and discounts on securities are amortized on the level-yield method. Gains and losses on sales are recorded on the trade date and determined using the specific identification method.

Declines in the fair value of securities below their cost that are other than temporary are reflected as realized losses. In estimating other-than-temporary losses, management considers: (1) the length of time and extent that fair value has been less than cost, (2) the financial condition and near term prospects of the issuer, and (3) our ability and intent to hold the security for a period sufficient to allow for any anticipated recovery in fair value.

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

Interest income on loans is accrued on the unpaid principal balance except for those loans in nonaccrual status. The accrual of interest is discontinued when a loan becomes 90 or more days delinquent. When interest accrual is discontinued, interest income is subsequently recognized only to the extent cash payments are received. Interest accruals resume when the loan becomes less than 90 days delinquent.

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

Loans are considered impaired when, based on current information and events, it is probable that full principal or interest payments are not anticipated in accordance with the contractual loan terms. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Impaired loans are carried at the present value of expected future cash flows discounted at the loan’s effective

FIRST FINANCIAL SERVICE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

interest rate or at the fair value of the collateral if the loan is collateral dependent. Commercial and commercial real estate loans are individually evaluated for impairment. Large groups of smaller balance homogeneous loans, such as consumer and residential real estate loans, are collectively evaluated for impairment and are separately identified for impairment disclosures. A portion of the allowance for loan losses is allocated to impaired loans if the value of such loans is less than the unpaid balance. If these allocations cause the allowance for loan losses to require an increase, such increase is reported in the provision for loan losses.

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

Loan commitments related to the origination of mortgage loans held for sale are accounted for as derivative instruments. Our commitments are for fixed rate mortgage loans, generally lasting 60 to 90 days and are at market rates when initiated. Considered derivatives, we had commitments to originate $1.2 million and $3.3 million in loans at December 31, 2005 and 2004, which we intend to sell after the loans are closed.

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

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

Cash Surrender Value of Life Insurance—We have purchased life insurance policies on certain key executives. The life insurance is recorded at its cash surrender value, or the amount that can be realized.

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

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

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

FIRST FINANCIAL SERVICE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

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

Stock Dividends—We declared a 10% stock dividend on April 16, 2003 to our shareholders of record as of April 28, 2003, payable on May 14, 2003. In addition, we declared another 10% stock dividend on September 20, 2005 to our shareholders of record as of October 7, 2005, payable on October 21, 2005. The payment of these dividends is in addition to the regular quarterly cash dividends. Per share amounts have been restated for the impact of the stock dividends.

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

Stock Option Plans—Employee compensation expense under stock option plans is reported using the intrinsic value method. No stock-based compensation cost is reflected in net income, as all options granted had an exercise price equal to the market price of the underlying common stock at date of grant. The following table illustrates the effect on net income and earnings per share if expense was measured using the fair value recognition provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation.

	Year Ended December 31,
	2005			2004			2003
	(Dollars in thousands except per share data)
Net income:
As reported	$	9,144		$	7,790		$	8,003
Deduct: Stock-based compensation expense determined under fair value based method	(89		)	(190		)	(108		)
Pro-forma	$	9,055		$	7,600		$	7,895
Earnings per share:
Basic As Reported	$	2.29		$	1.94		$	1.93
Pro-forma	2.26			1.89			1.90
Diluted As Reported	$	2.27		$	1.93		$	1.91
Pro-forma	2.25			1.88			1.88

FIRST FINANCIAL SERVICE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

The weighted-average assumptions for options granted during the year ended December 31, 2004 and the resulting estimated weighted average fair value per share used in computing the pro forma disclosures is presented below. There were no options granted for the years ended December 31, 2005 and 2003.

	December 31,
	2004
Assumptions:
Risk-free interest rate		4.13		%
Expected dividend yield		2.84		%
Expected life (years)		10
Expected common stock market price volatility		26		%
Estimated fair value per share		$	7.03

Income Taxes—Deferred income tax assets and liabilities are determined using the liability method. Under this method, the net deferred tax asset or liability is determined based on the tax effects of the differences between the book and tax basis of the various balance sheet assets and liabilities.

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

Earnings Per Common Share—Basic earnings per common share is net income divided by the weighted average number of common shares outstanding during the period. Diluted earnings per common share include the dilutive effect of additional potential common shares issuable under stock options.

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

Comprehensive Income—Comprehensive income consists of net income and other comprehensive income. Other comprehensive income includes unrealized gains and losses on securities available-for-sale, which are also recognized as a separate component of equity, net of tax.

Derivatives—The Corporation only uses derivative instruments as described in “Mortgage Banking Activities.”

Effect of Newly Issued But Not Yet Effective Accounting Standards—In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standard (“SFAS”) No. 123 (Revised 2004) (“SFAS No. 123R”), “Share-Based Payment.” SFAS No. 123R is a revision of FASB Statement 123, “Accounting for Stock-Based Compensation” and supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees,” and its related implementation guidance. SFAS No. 123R requires all public companies to record compensation cost for stock options provided to employees in return for employee service. The cost is measured at the fair value of the options when granted, and this cost is expensed over the employee service period, which is normally the vesting period of the options. This will apply to awards granted or modified for the year beginning January 1, 2006. Compensation cost will also be recorded for prior option grants that vest after the date of adoption. The effect on results of operations will depend on the level of future option grants and the calculation of the fair value of the options granted at such future date, as well as the vesting periods provided, and so they cannot currently be predicted. Existing options that will vest after adoption date are expected to result in additional

FIRST FINANCIAL SERVICE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

compensation expense of approximately $62,000 in 2006, $56,000 in 2007, $56,000 in 2008 and $42,000 in 2009. There will be no significant effect on financial position as total equity will not change.

In May 2005, the FASB issued Statement of Financial Accounting Standards No. 154 (“SFAS No. 154”), “Accounting Changes and Error Corrections.” This statement replaces Accounting Principles Board Opinion No. 20 “Accounting Changes”, and FASB Statement No. 3, “Reporting Accounting Changes in Interim Financial Statements” and changes the requirements for the accounting for and reporting of a change in accounting principle. SFAS No. 154 shall be effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005.

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

Reclassifications—Some items in the prior year financial statements were re-classified to conform to the current presentation.

FIRST FINANCIAL SERVICE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

2. SECURITIES

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

	Amortized Cost			Gross Unrealized Gains			Gross Unrealized Losses				Fair Value
	(Dollars in thousands)
Securities available-for-sale:
December 31, 2005:
U.S. Treasury and agencies		$	6,486		$	—		$	(49	)		$	6,437
Mortgage-backed		11,558			—			(256		)		11,302
Equity		1,353			638			—				1,991
State and municipal		5,803			14			(259		)		5,558
Corporate		3,036			—			—				3,036
Total		$	28,236		$	652		$	(564	)		$	28,324
December 31, 2004:
U.S. Treasury and agencies		$	15,985		$	—		$	(56	)		$	15,929
Mortgage-backed		1,901			—			(22		)		1,879
Equity		1,898			1,181			—				3,079
State and municipal		999			42			—				1,041
Total		$	20,783		$	1,223		$	(78	)		$	21,928

	Amortized Cost			Gross Unrecognized Gains			Gross Unrecognized Losses				Fair Value
	(Dollars in thousands)
Securities held-to-maturity:
December 31, 2005:
U.S. Treasury and agencies		$	26,095		$	—		$	(607	)		$	25,488
Mortgage-backed		5,136			2			(207		)		4,931
Corporate		2,000			15			—				2,015
Total		$	33,231		$	17		$	(814	)		$	32,434
December 31, 2004:
U.S. Treasury and agencies		$	26,095		$	3		$	(244	)		$	25,854
Mortgage-backed		6,820			7			(124		)		6,703
Corporate		2,000			—			—				2,000
Total		$	34,915		$	10		$	(368	)		$	34,557

FIRST FINANCIAL SERVICE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

2. SECURITIES (Continued)

The amortized cost and fair value of securities at December 31, 2005, by contractual maturity, are shown below. Securities not due at a single maturity date, primarily mortgage-backed and equity securities, are shown separately.

	Available for Sale					Held-to-Maturity
	Amortized			Fair		Amortized			Fair
	Cost			Value		Cost			Value
	(Dollars in thousands)
Due in one year or less		$	3,215	$	3,194		$	8,000	$	7,892
Due after one year through five years		3,584		3,579			18,095		17,596
Due after five years through ten years		611		602			—		—
Due after ten years		7,915		7,656			2,000		2,015
Mortgage-backed		11,558		11,302			5,136		4,931
Equity		1,353		1,991			—		—
		$	28,236	$	28,324		$	33,231	$	32,434

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

	Year Ended December 31,
	2005		2004		2003
	(Dollars in thousands)
Proceeds from sales	$	1,431	$	745		—
Gross realized gains	381		202			—

The tax expense related to these realized gains was $130,000 and $69,000, respectively.

Investment securities having an amortized cost of $36.7 million and fair value of $35.8 million and $34.5 million amortized cost and $36.1 fair value at December 31, 2005 and 2004 were pledged to secure public deposits.

Securities with unrealized losses at year-end 2005 and 2004 not recognized in income are as follows:

December 31, 2005	Less than 12 Months						12 Months or More						Total
Description of Securities	Fair Value		Unrealized Loss				Fair Value		Unrealized Loss				Fair Value		Unrealized Loss
U. S. Treasury and agencies	$	6,377		$	(104	)	$	25,548		$	(552	)	$	31,925		$	(656	)
Mortgage-backed	10,239			(218		)	5,753			(245		)	15,992			(463		)
State and municipal	4,620			(259		)	—			—			4,620			(259		)
Total temporarily impaired	$	21,236		$	(581	)	$	31,301		$	(797	)	$	52,537		$	(1,378	)

December 31, 2004	Less than 12 Months						12 Months or More						Total
Description of Securities	Fair Value		Unrealized Loss				Fair Value		Unrealized Loss				Fair Value		Unrealized Loss
U. S. Treasury and agencies	$	41,783		$	(300	)	$	—		$	—		$	41,783		$	(300	)
Mortgage-backed	1,879			(22		)	6,703			(124		)	8,582			(146		)
Total temporarily impaired	$	43,662		$	(322	)	$	6,703		$	(124	)	$	50,365		$	(446	)

FIRST FINANCIAL SERVICE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

2. SECURITIES (Continued)

All unrealized losses are reviewed at least on a quarterly basis to determine whether the losses are other than temporary and more frequently when economic or market concerns warrant such evaluation. Consideration is given to the length of time and the extent to which the fair value has been less than cost, the financial condition and near-term prospects of the issuer, and our intent and ability to retain the investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. In analyzing an issuer’s financial condition, we may consider whether the securities are issued by the federal government or its agencies, whether downgrades by bond rating agencies have occurred, and the results of reviews of the issuer’s financial condition. The unrealized losses on our investments in U.S. Treasury and agencies, mortgage-backed securities and obligations of state and political subdivisions were caused by interest rate increases. Because the decline in market value is attributable to changes in interest rates and not credit quality, and because we have the ability and intent to hold these investments until recovery of fair value, which may be maturity, we do not consider these investments to be other-than-temporarily impaired at December 31, 2005 and 2004.

3. LOANS

Loans are summarized as follows:

	2005			2004
	(Dollars in thousands)
Commercial	$	36,004		$	32,228
Real estate commercial	353,637			302,567
Real estate construction	13,579			10,850
Residential mortgage	142,727			159,550
Consumer and home equity	66,208			70,143
Indirect consumer	31,577			30,798
Loans held for sale	597			1,219
	644,329			607,355
Less:
Net deferred loan origination fees	(1,212		)	(1,438		)
Allowance for loan losses	(7,377		)	(6,489		)
	(8,589		)	(7,927		)
Loans Receivable	$	635,740		$	599,428

We utilize eligible real estate loans to collateralize advances and letters of credit from the Federal Home Loan Bank. We had $369 and $342 million in residential mortgage loans and commercial real estate loans pledged under this arrangement at December 31, 2005 and 2004.

FIRST FINANCIAL SERVICE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

3. LOANS (Continued)

The allowance for loan loss is summarized as follows:

	As of and For the Years Ended December 31,
	2005			2004			2003
	(Dollars in thousands)
Balance, beginning of year	$	6,489		$	5,568		$	4,576
Provision for loan losses	1,258			1,656			1,656
Charge-offs	(666		)	(949		)	(857		)
Recoveries	296			214			193
Balance, end of year	$	7,377		$	6,489		$	5,568

Impaired loans are summarized below. There were no impaired loans for the periods presented without an allowance allocation.

	As of and For the Years Ended December 31,
	2005		2004		2003
	(Dollars in thousands)
Year-end impaired loans	$	6,232	$	5,240	$	5,318
Amount of allowance for loan loss allocated	1,445		928		911
Average impaired loans outstanding	5,647		4,783		4,804
Interest income recognized	219		197		227
Interest income received	219		197		227

We report non-performing loans as impaired. Our non-performing loans at year-end by source were as follows:

	December 31,
	2005		2004
	(Dollars in thousands)
Restructured	$	3,104	$	3,218
Loans past due over 90 days still on accrual	—		—
Non accrual loans	3,128		2,022
Total	$	6,232	$	5,240

FIRST FINANCIAL SERVICE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

4. PREMISES AND EQUIPMENT

Premises and equipment consist of the following:

	December 31,
	2005			2004
	(Dollars in thousands)
Land	$	3,675		$	2,902
Buildings	15,826			13,468
Furniture, fixtures and equipment	8,649			9,280
	28,150			25,650
Less accumulated depreciation	(9,016		)	(8,181		)
	$	19,134		$	17,469

Certain premises are leased under various operating leases. Rental expense was $274,000, $259,000 and $278,000, for the years ended December 31, 2005, 2004 and 2003, respectively. Future minimum commitments under these leases are:

	Year Ended December 31,
	(Dollars in thousands)
2006		$	345
2007		296
2008		281
2009		283
2010		283
Thereafter		412
		$	1,900

5. DEPOSITS

Time Deposits of $100,000 or more were $101.6 million and $104.9 million at December 31, 2005 and 2004, respectively. At December 31, 2005, scheduled maturities of time deposits are as follows:

	Amount
	(Dollars in thousands)
2006		$	171,555
2007		92,831
2008		21,099
2009		16,531
2010		6,540
Thereafter		503
		$	309,059

FIRST FINANCIAL SERVICE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

6. ADVANCES FROM FEDERAL HOME LOAN BANK

Under the collateral requirements of the Federal Home Loan Bank (FHLB) of Cincinnati we have available collateral to borrow an additional $30 million from the FHLB at December 31, 2005. During January 2001, we entered into $75 million in convertible fixed rate advances with a maturity of ten years. These advances are fixed for periods of two to three years. At the end of the fixed term and quarterly thereafter, the FHLB has the right to convert these advances to variable rate advances tied to the three-month LIBOR index or the Corporation can prepay the advance at no penalty. There is a substantial penalty if we prepay the advance before the FHLB exercises its right.

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

	December 31,
	2005					2004
	Weighted- Average Rate			Amount		Weighted- Average Rate			Amount
	(Dollars in Thousands)
Fixed rate advances:
Mortgage matched advances with interest rates from 5.30% to 7.80% due through 2009		6.35	%	$	42		6.45	%	$	80
Convertible fixed rate advances with interest rates from 4.86% to 5.05% due through 2011		4.92	%	75,000			4.92	%	75,000
Other fixed rate advances with interest rates from 4.19% to 5.72% due through 2019		4.93	%	3,333			4.86	%	3,824
Total borrowings				$	78,375				$	78,904

The aggregate minimum annual repayments of borrowings as of December 31, 2005 is as follows:

	(Dollars in thousands)
2006		$	146
2007		142
2008		139
2009		131
2010		131
Thereafter		77,686
		$	78,375

7. SUBORDINATED DEBENTURES

On March 26, 2002, a trust formed by the First Financial Service Corporation, First Federal Statutory Trust I (Trust), issued $10.0 million of Floating Rate Capital Securities (Trust Preferred Securities). The proceeds of the offering were loaned by the Trust to us in exchange for subordinated debentures with terms that are identical to the Trust Preferred Securities. Issuance costs of $302,000 paid from the proceeds are being amortized to maturity. The subordinated debentures and deferred issue costs are the sole assets of the Trust. Distributions on the Trust Preferred Securities are payable quarterly in arrears at the annual rate (adjusted quarterly) of three-month LIBOR plus 3.60% (7.56% as of the last adjustment), and are included in interest expense. The annual rate cannot exceed 11% prior to March 26, 2007.

FIRST FINANCIAL SERVICE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

7. SUBORDINATED DEBENTURES (Continued)

The subordinated debentures, which mature March 26, 2032, are redeemable prior to the maturity date at our option on or after March 26, 2007 at their principal amount plus accrued interest. The subordinated debentures are also redeemable in whole or in part from time to time, upon the occurrence of specific events defined within the trust debenture. We have the option to defer distributions on the subordinated debentures from time to time for a period not to exceed 20 consecutive quarters. The Trust Preferred Securities are subject to mandatory redemption, in whole or in part, upon repayment of the subordinated debentures.

The Subordinated Debentures are considered as Tier I capital for the Corporation under current regulatory guidelines.

8. INCOME TAXES

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

	Year Ended December 31,
	2005			2004			2003
	(Dollars in thousands)
Current		$	4,178		$	3,334		$	3,909
Deferred		234			401			95
Total income tax expense		$	4,412		$	3,735		$	4,004

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

	Year Ended December 31,
	2005			2004			2003
	(Dollars in thousands)
Federal statutory rate		34.0	%		34.0	%		34.0	%
Tax-exempt interest income		(0.3	)		(0.1	)		(0.2	)
Increase in cash surrender value of life insurance		(0.7	)		(0.9	)		(0.2	)
Dividends to ESOP		(0.3	)		(0.4	)		(0.4	)
Other		(0.2	)		(0.2	)		0.1
Effective rate		32.5	%		32.4	%		33.3	%

FIRST FINANCIAL SERVICE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

8. INCOME TAXES (Continued)

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

	December 31,
	2005			2004
	(Dollars in thousands)
Deferred tax assets:
Allowance for loan losses		$	2,508		$	2,206
Accrued liabilities and other		109			127
		2,617			2,333
Deferred tax liabilities:
Depreciation		$	1,509		$	1,360
Net unrealized gain on securities available-for-sale		30			389
Federal Home Loan Bank stock		1,304			1,185
Intangibles		704			503
Deferred gain on like-kind exchange		30			34
Other		419			367
		3,996			3,838
Net deferred tax liability		$	1,379		$	1,505

Federal income tax laws provided savings banks with additional bad debt deductions through 1987, totaling $9.3 million for us. Accounting standards do not require a deferred tax liability to be recorded on this amount, which would otherwise total $3.2 million at December 31, 2005 and 2004. If we were liquidated or otherwise ceased to be a bank or if tax laws were to change, the $3.2 million would be recorded as a liability with an offset to expense.

9. STOCKHOLDERS’ EQUITY

(a) Charter Conversion—On October 22, 2002, our Board of Directors adopted a plan to convert from a federal savings bank to a commercial bank chartered under Kentucky banking laws. The plan also provided that First Financial Service Corporation would become a bank holding company. Effective January 8, 2003, we became a Kentucky State Chartered Commercial Bank and First Financial Service Corporation became a bank holding company regulated by the Federal Reserve Board. Expenses of $16,300 were recognized during 2003 associated with the conversion.

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

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

FIRST FINANCIAL SERVICE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

9. STOCKHOLDERS’ EQUITY (Continued)

defined) to average assets (as defined). As of December 31, 2005, the Corporation and the Bank met all capital adequacy requirements to which they are subject.

The most recent notification from the FDIC categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, we must maintain minimum Total Risk Based, Tier I Risk Based and Tier I Leverage rations as set forth in the table. There are no conditions or events since that notification that management believes have changed our capital ratings.

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

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

	Actual					For Capital Adequacy Purposes					To Be Considered Well Capitalized Under Prompt Correction Action Provisions
	Amount		Ratio			Amount		Ratio			Amount	Ratio
	(Dollars in thousands)
As of December 31, 2004:
Total risk-based capital (to risk-weighted assets)
Consolidated	$	67,798		11.6	%	$	46,793		8.0	%	N/A		N/A
Bank	65,087			11.2		46,600			8.0		58,250		10.0
Tier I capital (to risk-weighted assets)
Consolidated	61,029			10.4		23,397			4.0		N/A		N/A
Bank	58,318			10.0		23,300			4.0		34,950		6.0
Tier I capital (to average assets)
Consolidated	61,029			8.5		28,860			4.0		N/A		N/A
Bank	58,318			8.1		28,762			4.0		35,953		5.0

FIRST FINANCIAL SERVICE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

9. STOCKHOLDERS’ EQUITY (Continued)

(c) Dividend Restrictions—Our principal source of funds for dividend payments is dividends received from the Bank. Banking regulations limit the amount of dividends that may be paid without prior approval of regulatory agencies. Under these regulations, the amount of dividends that may be paid in any calendar year is limited to the current year’s net profits, combined with the retained net profits of the preceding two years, subject to the capital requirements described above. During 2006, the Bank could, without prior approval, declare dividends of approximately $8.9 million plus any 2006 net profits retained to the date of the dividend declaration.

(d) Liquidation Account—In connection with our conversion from mutual to stock form of ownership during 1987, we established a “liquidation account”, currently in the amount of $621,737 for the purpose of granting to eligible deposit account holders a priority in the event of future liquidation. Only in such an event, an eligible account holder who continues to maintain a deposit account will be entitled to receive a distribution from the liquidation account. The total amount of the liquidation account decreases in an amount proportionately corresponding to decreases in the deposit account balances of the eligible account holders.

10. EARNINGS PER SHARE

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

	Year Ended December 31,
	2005			2004			2003
	(In thousands, except per share data)
Net income available to common shareholders		$	9,144		$	7,790		$	8,003
Basic EPS:
Weighted average common shares		3,998			4,025			4,158
Diluted EPS:
Weighted average common shares		3,998			4,025			4,158
Dilutive effect of stock options		27			18			38
Weighted average common and incremental shares		4,025			4,043			4,196
Earnings Per Share:
Basic		$	2.29		$	1.94		$	1.93
Diluted		$	2.27		$	1.93		$	1.91

Stock options for 10,000 shares of common stock were not included in the December 31, 2004 computation of diluted earnings per share because their impact was anti-dilutive. All of the outstanding stock options for the year ended December 31, 2005 and 2003 were included in the computation of diluted earnings per share.

FIRST FINANCIAL SERVICE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

11. EMPLOYEE BENEFIT PLANS

(a) Pension Plans—We are a participant in the Financial Institutions Retirement Fund, a multiple-employer defined benefit pension plan, covering employees hired before June 1, 2002. Because the plan was curtailed, employees hired on or after that date are not eligible for membership in the fund. Eligible employees are 100% vested at the completion of five years of participation in the plan. Our policy is to contribute annually the minimum funding amounts. Employer contributions and administrative expenses charged to operations for the years ended December 31, 2005, 2004 and 2003 totaled $210,000, $253,000, and $250,000, respectively. Accrued liabilities associated with the plan as of December 31, 2005 were $52,000. There were no accrued liabilities associated with the plan as of December 31, 2004.

(b) We have a contributory thrift plan as well as a 401 (k) plan, which covers substantially all of the employees. Under the terms of the thrift plan, voluntary employee after tax contributions are matched by up to 6% of the employee base pay and employees are 100% vested at the completion of three years of participation in the plan. Under the terms of the 401 (k) plan, voluntary employee pre tax contributions are matched by up to 6% of the employee base pay and employees are 100% vested at the completion of three years of participation in the plan. Though the employee may participate in one or both plans, the employer will match voluntary contributions on only one of the two plans. Employer contributions and administrative expenses charged to operations for these plans for the years ended December 31, 2005, 2004 and 2003 were $334,000, $302,000, and $270,000, respectively.

(c) Employee Stock Ownership Plan—We have a non-contributory employee stock ownership plan (ESOP) in which employees are eligible to participate upon completion of one year of service. Employees are vested in accordance with a schedule, which provides for 100% vesting upon completion of seven years of service.

Shares of our common stock are acquired in non-leveraged transactions. At the time of purchase, the shares are released and allocated to eligible employees determined by a formula specified in the plan agreement. Accordingly, the plan has no unallocated shares. The number of shares to be purchased and allocated is at the Board of Directors discretion.

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

	Year Ended December 31,
	2005			2004			2003
ESOP shares (ending)		178,803			182,709			185,291
Shares released		2,923			2,148			2,048
Compensation expense		$	83,081		$	54,000		$	54,000

FIRST FINANCIAL SERVICE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

11. EMPLOYEE BENEFIT PLANS (Continued)

(d) Stock Option Plan—Under the 1998 Stock Option and Incentive Plan, we may grant either incentive or non-qualified stock options to key employees for an aggregate of 182,600 shares of our common stock at not less than fair market value at the date such options are granted. The option to purchase shares vest over periods of one to five years and expire ten years after the date of grant. At December 31, 2005 options available for future grant under the 1998 Stock Option Plan totaled 35,640. A summary of option transactions is as follows:

	Year Ended December 31,
	2005					2004				2003
	Number of Options		Weighted Average Exercise Price			Number of Options	Weighted Average Exercise Price			Number of Options		Weighted Average Exercise Price
Outstanding, beginning of period	135,817			$	20.16	75,867		$	17.60	119,790			$	16.13
Granted during period	—			—		59,950		$	23.41	—			—
Exercised during the period	(4,840	)		17.52		—		—		(43,923	)		13.33
Outstanding, end of period	130,977			$	20.26	135,817		$	20.16	75,867			$	17.60
Eligible for exercise at period end	78,177			$	18.13	71,148		$	17.86	54,329			$	18.12

The following table summarizes information about stock options outstanding at December 31, 2005:

		Options Outstanding								Options Exercisable
	Range of Exercise Prices	Number Outstanding		Weighted Average Remaining Contractual Life			Weighted Average Exercise Price			Number Exercisable		Weighted Average Exercise Price
$13.41 to $14.05			14,762		5.5	years		$	13.66		14,762		$	13.66
$18.49 to $18.70			55,055		3.6			18.61			55,055		18.61
$20.25			1,210		3.2			20.25			1,210		20.25
$23.31 to $23.85			59,950		8.8			23.41			7,150		23.31
			130,977		6.2			$	20.26		78,177		$	18.13

FIRST FINANCIAL SERVICE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

12. CASH FLOW ACTIVITIES

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

(a) Cash Paid for:

	Year Ended
	December 31,
	2005		2004		2003
	(Dollars in thousands)
Interest expense	$	17,886	$	14,795	$	16,453
Income taxes	$	4,625	$	3,532	$	4,203

(b) Supplemental disclosure of non-cash activities:

	Year Ended
	December 31,
	2005		2004		2003
	(Dollars in thousands)
Loans to facilitate sales of real estate owned and repossessed assets	$	1,561	$	1,124	$	1,123
Transfers from loans to real estate acquired through foreclosure and repossessed assets	$	1,981	$	1,396	$	944

13. CONDENSED FINANCIAL INFORMATION (PARENT COMPANY ONLY)

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

Condensed Balance Sheets

	December 31,
	2005		2004
	(Dollars in thousands)
Assets
Cash and interest bearing deposits	$	179	$	157
Investment in Bank	72,077		67,089
Securities available-for sale	1,431		2,447
Land	752		—
Other assets	328		270
	$	74,767	$	69,963
Liabilities and Stockholders’ Equity
Subordinated debentures	$	10,000	$	10,000
Other liabilities	26		162
Stockholders’ equity	64,741		59,801
	$	74,767	$	69,963

FIRST FINANCIAL SERVICE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

13. CONDENSED FINANCIAL INFORMATION (PARENT COMPANY ONLY) (Continued)

Condensed Statements of Income

	Year Ended
	December 31,
	2005		2004		2003
	(Dollars in thousands)
Dividend from Bank	$4,022		$4,500		$6,318
Interest income	80		114		88
Interest expense	(712	)	(529	)	(503	)
Gain on sale of investments	381		202		—
Other expenses	(223	)	(223	)	(253	)
Income before income tax benefit	3,548		4,064		5,650
Income tax benefit	222		220		286

Income before equity in undistributed net income of Bank	3,770		4,284		5,936
Equity in undistributed net income of Bank	5,374		3,506		2,067
Net income	$9,144		$7,790		$8,003

Condensed Statements of Cash Flows

	Year Ended
	December 31,
	2005			2004			2003
	(Dollars in thousands)
Operating Activities:
Net income	$	9,144		$	7,790		$	8,003
Adjustments to reconcile net income to cash provided by operating activities:
Equity in undistributed net income of Bank	(5,374		)	(3,506		)	(2,067		)
Gain on sale of investments available-for-sale	(381		)	(202		)	—
Changes in:
Other assets	101			10			18
Accounts payable and other liabilities	(136		)	(106		)	(265		)
Net cash from operating activities	3,354			3,986			5,689
Investing Activities:
Purchases of securities available-for-sale	(506		)	(640		)	(1,415		)
Sales of securities available-for-sale	1,431			745			—
Net purchases of premises and equipment	(752		)	—			—
Net change in receivable from Bank	—			165			433
Net cash from investing activities	173			270			(982		)
Financing Activities:
Proceeds from stock options exercised	85			—			559
Dividends paid	(2,830		)	(2,708		)	(2,660		)
Common stock repurchases	(760		)	(1,560		)	(9,628		)
Net cash from financing activities	(3,505		)	(4,268		)	(11,729		)
Net change in cash and interest bearing deposits	22			(12		)	(7,022		)
Cash and interest bearing deposits, beginning of year	157			169			7,191
Cash and interest bearing deposits, end of year	$	179		$	157		$	169

FIRST FINANCIAL SERVICE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

14. FAIR VALUES OF FINANCIAL INSTRUMENTS

The estimated fair value of financial instruments is as follows:

	December 31, 2005				December 31, 2004
	Carrying		Fair		Carrying		Fair
	Value		Value		Value		Value
	(Dollars in thousands)
Financial assets:
Cash and cash equivalents	$	20,451	$	20,451	$	35,910	$	35,910
Securities available-for-sale	28,324		28,324		21,928		21,928
Securities held-to-maturity	33,231		32,434		34,915		34,557
Loans held for sale	597		608		1,219		1,239
Loans, net	635,143		640,079		598,209		603,134
Federal Home Loan Bank stock	7,194		7,194		6,845		6,845
Accrued interest receivable	3,051		3,051		2,487		2,487
Financial liabilities:
Deposits	591,106		587,642		586,386		581,477
Federal funds purchased	19,500		19,500		—		—
Advances from Federal Home Loan Bank	78,375		78,703		78,904		82,409
Subordinated debentures	10,000		10,000		10,000		10,000
Accrued interest payable	389		389		413		413

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

Carrying amount is the estimated fair value for cash and cash equivalents, interest bearing deposits, Federal Home Loan Bank stock, accrued interest receivable and payable, demand deposits, short-term debt and variable rate loans or deposits that reprice frequently and fully. Security fair values are based on market prices or dealer quotes and if no such information is available, on the rate and term of the security and information about the issuer. The value of loans held for sale is based on the underlying sale commitments. For fixed rate loans or deposits and for variable rate loans or deposits with infrequent reprising or reprising limits, fair value is based on discounted cash flows using current market rates applied to the estimated life and credit risk. Fair values for impaired loans are estimated using discounted cash flow analysis or underlying collateral values. Fair values of advances from Federal Home Loan Bank are based on current rates for similar financing. The principal amount of the subordinated debentures is the estimated fair value. The fair value of off-balance-sheet items is based on the current fees or cost that would be charged to enter into or terminate such arrangements and is not material.

15. FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK

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

FIRST FINANCIAL SERVICE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

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

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

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

	December 31, 2005					December 31, 2004
	Fixed			Variable		Fixed			Variable
	Rate			Rate		Rate			Rate
	(Dollars in thousands)
Commitments to make loans		$	38	$	882		$	—	$	470
Unused lines of credit		—		118,598			—		89,109
Standby letters of credit		—		12,536			—		11,180
		$	38	$	132,016		$	—	$	100,759

Unused lines of credit at December 31, 2005 were at current rates ranging from 2.50% to 17.00% and primarily at the national prime rate of interest plus .5% to 5% for standby letters of credit.

At December 31, 2005 and 2004, we had $54.7 million, and $85.4 million in letters of credit from the Federal Home Loan Bank issued to collateralize public deposits. These letters of credit are secured by a blanket pledge of eligible one-to-four family residential mortgage loans. (For additional information see Note 3 on Loans and Note 6 on Advances from the Federal Home Loan Bank.)

16. RELATED PARTY TRANSACTIONS

Certain directors, executive officers and principal shareholders of the Company, including associates of such persons, are our loan and deposit customers. Related party deposits at December 31, 2005 and 2004 were $3.1 million and $2.8 million. A summary of the related party loan activity, for loans aggregating $60,000 or more to any one related party, is as follows:

	Year Ended
	December 31,
	2005			2004
	(Dollars in thousands)
Beginning of year	$	315		$	305
New loans	—			34
Repayments	(24		)	(24		)
End of year	$	291		$	315

FIRST FINANCIAL SERVICE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

17. SUMMARY OF QUARTERLY FINANCIAL DATA—(Unaudited)

Year Ended December 31, 2005:	March 31,			June 30,		September 30,			December 31,
	(Dollars in thousands except per share data)
Total interest income		$	10,630	$	11,027		$	11,593		$	12,118
Total interest expense		3,994		4,272			4,634			4,963
Net interest income		6,636		6,755			6,959			7,155
Provision for loan losses		275		41			440			502
Non-interest income		2,021		1,976			2,061			2,008
Non-interest expense		5,144		5,276			5,156			5,181
Net income		2,186		2,294			2,311			2,353
Earnings per share:
Basic		0.55		0.57			0.58			0.59
Diluted		0.55		0.57			0.57			0.58

Year Ended December 31, 2004:	March 31,			June 30,			September 30,			December 31,
	(Dollars in thousands except per share data)
Total interest income		$	9,550		$	9,440		$	9,784		$	10,369
Total interest expense		3,777			3,575			3,590			3,850
Net interest income		5,773			5,865			6,194			6,519
Provision for loan losses		389			259			824			184
Non-interest income		1,771			2,261			2,122			1,950
Non-interest expense		4,439			5,016			4,970			4,849
Net income		1,838			1,926			1,714			2,312
Earnings per share:
Basic		0.45			0.48			0.43			0.57
Diluted		0.45			0.48			0.43			0.56

Kentucky		61-1168311
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		Identification No.)
2323 Ring Road, Elizabethtown, Kentucky		42701
(Address of principal executive offices)		Zip Code

		Page
	Part I.
Item 1.	Business		2
Item 1A.	Risk Factors		14
Item 1B.	Unresolved Staff Comments		16
Item 2.	Properties		17
Item 3.	Legal Proceedings		17
Item 4.	Submission of Matters to a Vote of Security Holders		17
	Part II.
Item 5.	Market for Registrant’s Common Stock and Related Stockholder Matters		18
Item 6.	Selected Financial Data		19
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		20
Item 7A.	Quantitative and Qualitative Disclosures about Market Risk		41
Item 8.	Financial Statements and Supplementary Data		43
Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosures		76
Item 9A.	Controls and Procedures		76
Item 9B.	Other Information		76
	Part III.
Item 10.	Directors and Executive Officers of the Registrant		77
Item 11.	Executive Compensation		77
Item 12.	Security Ownership of Certain Beneficial Owners and Management		77
Item 13.	Certain Relationships and Related Transactions		77
Item 14.	Principal Accountant Fees and Services		77
	Part IV.
Item 15.	Exhibits and Financial Statement Schedules		78
	Signatures		79

			Approximate
	Owned or		Square
Banking Centers	Leased		Footage
ELIZABETHTOWN
2323 Ring Road		Owned		55,000
325 West Dixie Avenue		Owned		5,880
101 Wal-Mart Drive		Leased		984
RADCLIFF
475 West Lincoln Trail		Owned		2,728
BARDSTOWN
401 East John Rowan Blvd.		Leased		4,500
315 North Third Street		Owned		1,271
MUNFORDVILLE
925 Main Street		Owned		2,928
SHEPHERDSVILLE
395 N. Buckman Street		Owned		7,600
MT. WASHINGTON
279 Bardstown Road		Owned		6,310
BRANDENBURG
416 East Broadway		Leased		4,395
50 Old Mill Road		Leased		575
FLAHERTY
4055 Flaherty Road		Leased		1,216
LOUISVILLE
11810 Interchange Drive		Owned		4,675
3650 South Hurstbourne Parkway		Owned		4,428

Audited Consolidated Financial Statements:
Report on Management’s Assessment of Internal Control Over Financial Reporting		44
Report of Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting		45
Report of Independent Registered Public Accounting Firm on Financial Statements		47
Consolidated Balance Sheets		48
Consolidated Statements of Income		49
Consolidated Statements of Comprehensive Income		50
Consolidated Statements of Changes in Stockholders’ Equity		51
Consolidated Statements of Cash Flows		52
Notes to Consolidated Financial Statements		53-75

Date: March 15, 2006	By:	/s/ B. KEITH JOHNSON
		B. Keith Johnson
		President and Chief Executive Officer
Date: March 15, 2006	By:	/S/ GREGORY SCHREACKE
		Gregory Schreacke
		Chief Financial Officer Principal Accounting Officer

	Common Shares				Stock Amount				Additional Paid-in Capital				Retained Earnings			Accumulated Other Comprehensive Income, Net of Tax				Total
Balance, January 1, 2003		3,644				$	3,644			$	—		$	55,605			$	398		$	59,647
Net income													8,003							8,003
Stock dividend—10%		337				337				10,213			(10,550		)					—
Exercise of stock options, net of redemptions		34				34				525										559
Net change in unrealized gains (losses) on securities available-for-sale, net of tax																	400			400
Cash dividends declared ($.64 per share)													(2,660		)					(2,660		)
Stock repurchased		(310		)		(310		)		(1,012		)	(8,306		)		—			(9,628		)
Balance, December 31, 2003		3,705				3,705				9,726			42,092				798			56,321
Net income													7,790							7,790
Net change in unrealized gains (losses) on securities available-for-sale, net of tax																	(42		)	(42		)
Cash dividends declared ($.67 per share)													(2,708		)					(2,708		)
Stock repurchased		(60		)		(60		)		(1,500		)	—				—			(1,560		)
Balance, December 31, 2004		3,645				3,645				8,226			47,174				756			59,801
Net income													9,144							9,144
Stock dividend—10%		363				363				8,834			(9,197		)					—
Exercise of stock options		5				5				80										85
Net change in unrealized gains (losses) on securities available-for-sale, net of tax																	(699		)	(699		)
Cash dividends declared ($.71 per share)													(2,830		)					(2,830		)
Stock repurchased		(29		)		(29		)		(731		)	—				—			(760		)
Balance, December 31, 2005		$	3,984			$	3,984			$	16,409		$	44,291			$	57		$	64,741

(a)(1)		Report of Independent Registered Public Accounting Firm on Consolidated Financial Statements-Crowe Chizek and Company LLC
(b)		Consolidated Balance Sheets at December 31, 2005 and 2004.
(c)		Consolidated Statements of Income for the years ended December 31, 2005, 2004 and 2003.
(d)		Consolidated Statements of Comprehensive Income for the years ended December 31, 2005, 2004 and 2003.
(e)		Consolidated Statements of Changes in Stockholders’ Equity for the years ended December 31, 2005, 2004 and 2003.
(f)		Consolidated Statements of Cash Flows for the years ended December 31, 2005, 2004 and 2003.
(g)		Notes to Consolidated Financial Statements

3	(a), 4(a)	Articles of Incorporation *
3	(b), 4(b)	Amended and Restated Bylaws**
4	(c)	Rights Agreement between First Financial Service Corporation and Illinois Stock Tranfser Company dated April 15, 2003***
10	(a)	1998 Stock Option and Incentive Compensation Plan **
10	(b)	Form of Stock Option Agreement**
10	(c)	Executive Compensation **
21		Subsidiaries of the Registrant
23	(a)	Consent of Crowe Chizek and Company LLC, Independent Registered Public Accounting Firm
31	.1	Certification of Chief Executive Officer Pursuant to Section 302 of Sarbanes-Oxley Act
31	.2	Certification of Chief Financial Officer Pursuant to Section 302 of Sarbanes-Oxley Act
32		Certification of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350 (As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002)

	FIRST FINANCIAL SERVICE CORPORATION
Date: 3/15/06	By:	/s/ B. KEITH JOHNSON
		B. Keith Johnson
		President and Chief Executive Officer
		Duly Authorized Representative

By:	/s/ B. KEITH JOHNSON	By:	/s/ BOB BROWN
	B. Keith Johnson		Bob Brown
	Principal Executive Office & Director		Director
Date:	3/15/06	Date:	3/15/06
By:	/s/ WRENO M. HALL	By:	/s/ DIANE E. LOGSDON
	Wreno M. Hall		Diane E. Logsdon
	Director		Director
Date:	3/15/06	Date:	3/15/06
By:	/s/ J. ALTON RIDER	By:	/s/ JOHN L. NEWCOMB, JR.
	J. Alton Rider		John L. Newcomb, Jr.
	Director		Director
Date:	3/15/06	Date:	3/15/06
By:	/s/ WALTER D. HUDDLESTON	By:	/s/ MICHAEL THOMAS, DVM
	Walter D. Huddleston		Michael Thomas, DVM
	Director		Director
Date:	3/15/06	Date:	3/15/06
By:	/s/ STEPHEN MOUSER	By:	/s/ DONALD SCHEER
	Stephen Mouser		Donald Scheer
	Director		Director
Date:	3/15/06	Date:	3/15/06
By:	/s/ GAIL SCHOMP	By:	/s/ GREGORY SCHREACKE
	Gail Schomp		Gregory Schreacke
	Director		Chief Financial Officer Principal Accounting Officer
Date:	3/15/06	Date:	3/15/06

Exhibit No.		Description
3	(a), 4(a)	Articles of Incorporation *
3	(b), 4(b)	Amended and Restated Bylaws**
4	(c)	Rights Agreement between First Financial Service Corporation and Illinois Stock Tranfser Company dated April 15, 2003***
10	(a)	1998 Stock Option and Incentive Compensation Plan**
10	(b)	Form of Stock Option Agreement**
10	(c)	Executive Compensation**
21		Subsidiaries of the Registrant
23	(a)	Consent of Crowe Chizek and Company LLC, Independent Registered Public Accounting Firm
31	.1	Certification of Chief Executive Officer Pursuant to Section 302 of Sarbanes-Oxley Act
31	.2	Certification of Chief Financial Officer Pursuant to Section 302 of Sarbanes-Oxley Act
32		Certification of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350 (As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002)

	State of	Percentage
Subsidiaries	Incorporation	Owned

First Federal Savings Bank of Elizabethtown	Kentucky	100	%

First Service Corporation of Elizabethtown (a)	Kentucky	100	%

First Heartland Mortgage of Elizabethtown (a)	Kentucky	100	%

First Federal Office Park, LLC (a)	Kentucky	100	%