REGULATORY MATTERS

9 Months Ended

Sep. 30, 2012

Regulatory Matters [Abstract]

Regulatory Capital Requirements under Banking Regulations [Text Block]

2. REGULATORY MATTERS

In its 2012 Consent Order with the FDIC and KDFI, the Bank agreed to achieve and maintain a Tier 1 capital ratio of 9.0% and a total risk-based capital ratio of 12.0% by June 30, 2012. At September 30, 2012, we were not in compliance with the Tier 1 and total risk-based capital requirements. We notified the bank regulatory agencies that the increased capital levels would not be achieved and anticipate that the FDIC and KDFI will reevaluate our progress toward achieving the higher capital ratios at December 31, 2012.

The 2012 Consent Order requires that if the Bank should be unable to reach the required capital levels by June 30, 2012, and the Bank receives written directions from the FDIC and KDFI to do so, then the Bank would develop, adopt and implement within 30 days a written plan to sell or merge itself into another federally insured financial institution. The 2012 Consent Order requires the Bank to continue to adhere to the plans implemented in response to the 2011 Consent Order, and includes the substantive provisions of the 2011 Consent Order. A copy of the March 9, 2012 Consent Order is included as Exhibit 10.8 to our 2011 Annual Report on Form 10-K filed March 30, 2012.

While the Bank still has not met the required capital ratios at September 30, 2012, we have not received any written communications from the FDIC or KDFI directing the Bank to develop, adopt and implement a written plan to sell or merge the Bank into another federally insured financial institution.

The Bank’s Consent Orders with the FDIC and KDFI require us to obtain the consent of the Regional Director of the FDIC and the Commissioner of the KDFI to declare and pay cash dividends to the Corporation. The Bank is also no longer allowed to accept, renew or rollover brokered deposits, including deposits through the Certificate of Deposit Account Registry Service (CDARs) without first obtaining a written waiver from our regulators.

On April 20, 2011, the Corporation entered into a formal agreement with the Federal Reserve Bank of St. Louis, which requires the Corporation to obtain regulatory approval before declaring any dividends. We also may not redeem shares or obtain additional borrowings without prior approval.

Bank regulatory agencies can exercise discretion when an institution does not meet the terms of a consent order. The agencies may initiate changes in management, issue mandatory directives, impose monetary penalties or refrain from formal sanctions, depending on individual circumstances. Any action taken by bank regulatory agencies could damage our reputation and have a material adverse effect on our business.

In response to the 2011 Consent Order, we engaged an investment banking firm with expertise in the financial services sector to assist with a review of all of our strategic alternatives as we work to achieve the higher regulatory capital ratios.

One of these strategic alternatives involved the sale of eight branches located outside of our core market. Effective after the close of business on July 6, 2012, we have successfully executed the sale of four banking centers located in Corydon, Elizabeth, Lanesville and Georgetown, Indiana to First Savings Bank, F.S.B. We received a 3.65% premium on the $102.3 million of consumer and commercial deposits at closing. They assumed a total of approximately $115.4 million in non-brokered deposits, which included $13.1 million of government, corporate, other financial institution and municipal deposits for which we received zero premium or discount. We also sold approximately $30.4 million in performing loans at a discount of 0.80%. The consummated transaction resulted in a gain of $3.1 million.

We entered into a Branch Purchase Agreement with First Security Bank of Owensboro, Inc., the banking subsidiary of First Security, Inc. (“First Security”), headquartered in Owensboro, Kentucky on May 15, 2012. The Agreement provides for the sale of our four banking centers in Louisville, Kentucky to First Security. Under the terms of the Agreement, First Security will assume approximately $188.2 million of deposit liabilities. First Security will pay a deposit premium of approximately $2.9 million comprised of a premium of 2.00% on approximately $152.1 million of deposits and a premium ranging from 0% to 1.00% on approximately $36.1 million of other deposits. First Security will also assume performing loans related to the four branches at a 1.00% discount. The loans being assumed totaled approximately $46.9 million at September 30, 2012. The sale is subject to First Security raising additional capital, regulatory approval and other customary closing conditions. The Agreement provides that it may be terminated by either party after October 31, 2012, unless a closing occurs before that date or the Agreement is extended by the parties. On October 31, 2012, it was agreed by both parties to extend the termination date of the Branch Purchase Agreement to November 14, 2012.

The sale of our four Louisville banking centers, is projected to increase our Tier I capital ratio from 6.50% to over 8.00% and increase our total risk-based capital ratio from 11.88% to over 13.00% based on September 30, 2012 financial information.

Additionally, we continue reducing our non-interest costs where possible to offset the increased credit costs associated with other real estate and non-performing loans while taking into consideration the resources necessary to execute our strategies. We have suspended the annual employee stock ownership contribution, frozen most executive management compensation the past three years including 2012, frozen most officer compensation for the past year including 2012, eliminated board of director fees, reduced marketing expenses, community donation expenses, compensation expense through reductions in associates, and implemented various other cost savings initiatives. Expense reductions for 2011 were $1.1 million and were approximately $1.0 million for the 2012 nine month period. We are also in the process of evaluating the remaining terms on existing contracts in an effort to identify expenses that can be eliminated in the near future. These efforts will remain ongoing.

On February 10, and May 15, 2012, we announced several changes to our management and the board of directors. In addition, on September 19, 2012 we announced the election of Gregory Schreacke to the board of directors of both the Corporation and the Bank. His term will expire at the 2013 annual meeting of the Corporation’s shareholders. Mr. Schreacke has served as President of the Corporation and the Bank since January 2008. He assumed principal management responsibility for the Corporation and the Bank effective February 10, 2012. We also announced the retirement of Senator Walter Dee Huddleston as a director of the Corporation and the Bank. Senator Huddleston has served on the board of directors of the Bank since 1966, and the board of directors of the Corporation since its inception in 1987, serving as Chairman from 1997 through February 2012. Senator Huddleston has been appointed as a Director Emeritus of the Corporation and the Bank.

Our plans for 2012 include the following:

· Continuing to research and evaluate all available strategic options to meet and maintain the required regulatory capital levels and all of the other consent order issues for the Bank. Strategic alternatives include divesting of branch offices, as noted earlier we have already sold four banking centers in the Indiana market and have a Branch Purchase Agreement to sell four banking centers in the Louisville market. During 2012, we also sold commercial real estate loans totaling $10.7 million, at par, to First Capital Bank of Kentucky.

· Continuing to serve our community banking customers and operate the Corporation and the Bank in a safe and sound manner. We have worked diligently to maintain the strength of our retail and deposit franchise. The strength of this franchise contributes to earnings to help withstand our credit quality issues. In addition, the inherent value of the retail franchise will provide value to the Bank to accomplish the various capital initiatives. As of June 30, 2012 data, we rank in the top three in four of the five counties that we serve. This excludes the Indiana market where we no longer have a presence and the Louisville market in anticipation of the pending sale of those branch centers. We rank first in Hardin County and Meade County with market share of approximately 23% and 49%, respectively.

· Continuing to reduce our lending concentration in commercial real estate through natural roll off and loan diversification initiatives. The mortgage and consumer lending operations continue to maintain strong credit quality metrics throughout the economic downturn. The diversification of the loan portfolio includes an increased emphasis on retail lending, small business lending, and Small Business Administration (“SBA”) lending which should provide a boost to non-interest fee income. We have already allocated and reallocated resources that should contribute to the successful execution of all of these efforts.

· Enhancing our resources dedicated to special asset dispositions both on a permanent and temporary basis. This is a necessary step as we increase our ongoing efforts to speed up the disposal of our problem assets. This will significantly reduce the involvement of our commercial lenders in the special asset area allowing them to shift their focus to their existing loan customer base and to generate new business that will support our diversification efforts while stemming off some of the loan roll off. The new lenders that have been hired this year bring a significant amount of experience in real estate and commercial and industrial lending.

· Reducing our inventory of other real estate owned properties.  We have entered into a bulk sale contract to sell fourteen other real estate owned properties with a carrying value of $16.1 million scheduled to close during the fourth quarter of 2012, indicating a continued interest in our other real estate owned properties.  The net proceeds after sales expenses will be $15.0 million, resulting in a $1.1 million charge against these properties which was recorded in the quarter ended June 30, 2012.  We incurred higher than usual commission and closing costs due to the size of the transaction.  If sold on an individual basis, it is unlikely that we would have accepted a discount this large for these properties.  However, if this transaction goes through under these terms, it would represent a 52% decrease to our other real estate owned properties balance of $28.6 million as of September 30, 2012. As with all sales contracts, completing the sale is subject to both parties meeting all of the terms and conditions of the contracts. In the event that the terms and conditions are not met, by either of the parties, it is possible that the contracts on these sales will be terminated.