Critical Accounting Policies

The consolidated condensed financial statements as of September 30, 2008 and December 31, 2007, and for the three and nine month periods ended September 30, 2008 and September 30, 2007 included herein have been prepared by the Company, without an audit, pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in interim financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations. These financial statements should be read in conjunction with the financial statements and notes thereon included in the Company's 2007 Annual Report to Stockholders on Form 10-K.

Certain of the Company's accounting policies are important to the portrayal of the Company's financial condition, since they require management to make difficult, complex or subjective judgments, some of which may relate to matters that are inherently uncertain. Estimates associated with these policies are susceptible to material changes as a result of changes in facts and circumstances. Facts and circumstances, which could affect these material judgments, include, but without limitation, changes in interest rates, in the performance of the economy or in the financial condition of borrowers. Management believes that its critical accounting policies include determining the allowance for loan losses and determining the fair value of securities and other financial instruments and assessing other than temporary impairments of securities.

Comparison of Financial Condition at September 30, 2008 and December 31, 2007

Total assets increased by $35.0 million, from $808.4 million at December 31, 2007 to $843.4 million at September 30, 2008. Securities available for sale increased from $142.3 million at December 31, 2007 to $144.2 million at September 30, 2008. Federal funds sold increased from $3.8 million at December 31, 2007 to $9.3 million at September 30, 2008. The Company's holdings of Federal Home Loan Bank (FHLB) stock, at cost, increased from $3.8 million at December 31, 2007 to $4.1 million at September 30, 2008. Total FHLB borrowings decreased $10.5 million, from $101.9 million at December 31, 2007 to $91.4 million at September 30, 2008. Total repurchase balances decreased from $37.2 million at December 31, 2007 to $32.6 million at September 30, 2008.

At September 30, 2008 and December 31, 2007, investments classified as "held to maturity" were carried at an amortized cost and had an estimated fair value of $499,000 and $14.1 million, respectively. At September 30, 2008 and December 31, 2007, securities classified as "available for sale" had an amortized book value of $147.3 million and $142.8 million, respectively.

The loan portfolio increased $45.2 million during the nine month period ended September 30, 2008. Net loans totaled $621.5 million and $576.3 million at September 30, 2008 and December 31, 2007, respectively. For the nine month periods ended September 30, 2008 and September 30, 2007 and the twelve months ended December 31, 2007, the average tax equivalent yield on loans was 7.09%, 7.76% and 7.70% respectively. Set forth below is selected data relating to the composition of the loan portfolio by type of loan at September 30, 2008, December 31, 2007 and September 30, 2007.

At September 30, 2008, September 30, 2007 and December 31, 2007, there were no concentrations of loans exceeding 10% of total loans other than as disclosed below:

                                    9/30/2008    9/30/2008      12/31/2007    12/31/2007     9/30/2007    9/30/2007
                                      Amount      Percent         Amount       Percent         Amount      Percent
                                                                (Dollars in Thousands)
Real estate loans:
One-to-four family (closed end)
first mortgages                     $  180,960       28.86 %   $    183,901        31.66 %   $  184,050       32.72 %
Second mortgages (closed end)            8,769        1.40 %          6,771         1.17 %        6,715        1.19 %
Home equity lines of credit             34,268        5.47 %         32,216         5.55 %       31,387        5.58 %
Multi-family                            34,780        5.55 %         24,538         4.22 %       23,710        4.22 %
Commercial real estate                 218,745       34.88 %        183,168        31.53 %      176,845       31.44 %
Construction                            60,475        9.65 %         50,230         8.65 %       45,394        8.07 %

Total mortgage loans                   537,997       85.81 %        480,824        82.78 %      468,101       83.22 %

Loans secured by deposits                3,192        0.51 %          4,419         0.76 %        3,730        0.66 %
Other consumer loans                    20,431        3.26 %         21,331         3.67 %       21,507        3.82 %
Commercial loans                        65,315       10.42 %         74,276        12.79 %       69,148       12.30 %

Total other loans                       88,938       14.19 %        100,026        17.22 %       94,385       16.78 %

Total loans, gross                     626,935      100.00 %        580,850       100.00 %      562,486      100.00 %

Deferred loan origination cost,
net of income                              299                          244                         431
Less allowance for loan losses           5,749                        4,842                       4,840

Total net loans                     $  621,485                 $    576,252                  $  558,077

The allowance for loan losses totaled $5.7 million at September 30, 2008, $4.8 million at December 31, 2007 and $4.8 million at September 30, 2007. The ratio of the allowance for loan losses to loans was 0.92% at September 30, 2008, 0.83% at December 31, 2007 and 0.86% at September 30, 2007. Also at September 30, 2008, non-performing loans, defined as loans past due ninety days or more, were $8.4 million, or 1.34% of total loans, compared to $593,000, or 0.10% of total loans, at December 31, 2007 and $755,000, or 0.13% at September 30, 2007. Non-performing assets, which include other real estate owned and other assets owned, were $8.8 million or 1.04% of total assets at September 30, 2008, compared to $1.1 million, or 0.14% of assets, at September 30, 2007 and $940,000, or 0.12% of assets at December 31, 2007.

The increase in non-performing loans is the result of a bankruptcy filing of one large residential developer. The relationship has an aggregate balance of approximately $7.3 million and is secured with numerous properties including both developed and undeveloped land, fully completed single family and duplex residences, office buildings and other various pieces of collateral. Management anticipates the liquidation of these properties will take six to twelve months and that the Company's losses will be minimal.

The Company does not originate loans it considers sub-prime and is not aware of any exposure to the additional credit concerns associated with sub-prime lending in either the Company's loan or investment portfolios. The Company's loan portfolio includes construction and land development loan balances of approximately $60.5 million, or 9.7% of total loans. Management reports to the Company's Board of Directors on the status of the Company's specific construction and development loans as well as the market trends in those markets in which the Company actively participates.

The Company's annualized net charge off ratios for the nine-month periods ended September 30, 2008 and September 30, 2007 and the year ended December 31, 2007 were 0.17%, 0.09% and 0.11%, respectively. The ratios of allowance for loan losses to non-performing loans at September 30, 2008, September 30, 2007 and December 31, 2007 were 68.4%, 641.1% and 816.5%, respectively.

The increase in the charge off ratio at September 30, 2008 was largely the result of two loans charged off during the first quarter of the year. The following table sets forth an analysis of the Bank's allowance for loan losses for the periods indicated:

                                          Nine Month                 Nine Month
                                         Period ended               Period Ended                Year Ended
                                           9/30/2008                  9/30/2007                 12/31/2007
                                                               (Dollars in Thousands)
Beginning balance
Allowance for loan loss                  $       4,842        $                   4,470        $      4,470
Loans charged off:
Commercial loans                                  (241 )                            (44 )              (110 )
Consumer loans and overdrafts                     (486 )                           (477 )              (625 )
Residential loans                                 (254 )                            (74 )              (186 )

Total charge offs                                 (981 )                           (595 )              (921 )

Recoveries                                         206                              263                 317

Net charge offs                                   (775 )                           (332 )              (604 )

Provision for loan loss expense                  1,682                              702                 976

End of period balance                    $       5,749        $                   4,840        $      4,842

Ratio of net charge offs to average
outstanding loans during the period               0.17 %                           0.09 %              0.11 %

The determination of the allowance for loan losses is based on management's analysis, performed on a quarterly basis. Various factors are considered, including the market value of the underlying collateral, growth and composition of the loan portfolio, the relationship of the allowance for loan losses to outstanding loans, historical loss experience, delinquency trends and prevailing economic conditions. Although management believes its allowance for loan losses is adequate, there can be no assurance that additional allowances will not be required or that losses on loans will not be incurred.

A loan is considered to be impaired when management determines that it is probable that the Company will be unable to collect all principal and interest payments due in accordance with the contractual terms of the loan agreement. The value of individually impaired loans is measured based on the present value of expected payments using the fair value of the collateral if the loan is collateral dependent. At September 30, 2008 and December 31, 2007, the Company's impaired loans totaled $14.9 million and $2.1 million, respectively. At September 30, 2008 and December 31, 2007, the Company's reserve for impaired loans totaled approximately $775,000 and $488,000, respectively.

The increase in impaired loans is the result of a bankruptcy filing of one residential developer with an aggregate lending relationship of approximately $7.3 million. At September 30, 2008, the Company's specific reserve for this relationship was approximately $175,000. The Company is in the process of reviewing all appraisals and loan documentation associated with this relationship. The Company's preliminary analysis indicates that the value of the collateral is adequate to pay all interest and principal balances due. At this time, the Company anticipates that the current reserve level for this lending relationship is adequate.

The Company had $346,000 in real estate owned and $5,000 of other assets owned at September 30, 2008. At September 30, 2008, the Company had loans totaling $64.9 million classified as watch or special mention and loans totaling $14.9 million classified as impaired. Watch and special mention loans are not considered impaired but are reserved for based on potential weaknesses or higher levels of perceived risk due to the various factors, including unpredictable cash flows, a business operating in a challenging industry, or a new and significant relationship.

At September 30, 2008, deposits increased to $646.7 million from $598.8 million at December 31, 2007. The Company's balances of brokered deposits increased from $19.8 million at December 31, 2007 to $72.7 million at September 30, 2008. The increase in brokered deposits was the result of pricing abnormalities in the credit markets, making brokered deposits up to 0.50% lower as compared to for one year deposits. Recent developments in the credit markets have forced large regional banks to price time deposits in an increasingly aggressive manner. The new pricing practice of regional banks will result in an increase in the Company's cost of funds as the Company must increase its deposit rates in order to maintain adequate liquidity levels.

The average cost of deposits during the nine month periods ended September 30, 2008 and September 30, 2007 and the year ended December 31, 2007 was 3.30%, 3.77%, and 3.80%, respectively. Management continually evaluates the investment alternatives available to customers and adjusts the pricing on its deposit products to more actively manage its funding costs while remaining competitive in its market area.

Comparison of Operating Results for the Nine Months Ended September 30, 2008 and 2007

Net Income. Net income for the nine months ended September 30, 2008 was $3,902,000, compared to net income of $3,155,000 for the nine months ended September 30, 2007. The increase in the Company's net income for the nine month period ended September 30, 2008 was largely the result of changes in market interest rates. Lower short-term rates provided the Company the opportunity to reduce its cost of funds and sell selected securities with a net gain of approximately $700,000.

Net Interest Income. Net interest income for the nine months ended September 30, 2008 was $17.4 million, compared to $15.1 million for the nine months ended September 30, 2007. The increase in net interest income for the nine months ended September 30, 2008 as compared to September 30, 2007 was largely due to a $71.8 million increase in the average balance of loans outstanding. To a lesser extent, the improvement in net interest margin has benefited from the reduction in the Company's cost of funding interest earning assets, which has declined at a faster rate than the reduction of its net yield on interest earning assets.

Average Balances, Yields and Interest Expenses. The table below summarizes the overall effect of changes to both interest rates and changes in the average balances of interest earning assets and liabilities for the nine months ended September 30, 2008, and September 30, 2007. Yields on assets and cost of liabilities are derived by dividing income or expense by the average daily balances of interest earning assets and liabilities for the appropriate nine-month periods. Average balances for loans include loans classified as non-accrual, net of the allowance for loan losses.

The table adjusts tax-free investment income by $207 for September 30, 2008, and $156 for September 30, 2007, for a tax equivalent rate using a cost of funds rate of 3.70% for September 30, 2008 and 4.30% for September 30, 2007. The table adjusts tax-free loan income by $209 for September 30, 2008 and $201 for September 30, 2007 for a tax equivalent rate using the same cost of funds rate.

                                    Average      Income and       Average       Average      Income and       Average
                                    Balance       Expense          Rates        Balance       Expense          Rates
                                   9/30/2008     9/30/2008       9/30/2008     9/30/2007     9/30/2007       9/30/2007
Loans                              $  593,088   $     31,532          7.09 %   $  521,333   $     30,331          7.76 %
Investments AFS taxable               133,479          4,919          4.91 %      142,356          5,010          4.69 %
Investment AFS tax free                17,311            684          5.27 %       14,931            530          4.73 %
Investment held to maturity             4,428            150          4.52 %       18,020            593          4.39 %
Federal funds                           6,522            118          2.41 %        9,076            347          5.10 %

Total interest earning assets         754,828         37,403          6.61 %      705,716         36,811          6.95 %

Other assets                           64,567                                      65,414

Total assets                       $  819,395                                  $  771,130

Interest bearing deposits          $  563,255         15,331          3.63 %   $  533,924         16,484          4.12 %
FHLB borrowings                        93,775          3,018          4.29 %       93,478          3,259          4.65 %
Repurchase agreements                  34,661            856          3.29 %       26,715            979          4.89 %
Subordinated debentures                10,310            405          5.24 %       10,310            587          7.59 %

Total interest bearing
liabilities                           702,001         19,610          3.72 %      664,427         21,309          4.28 %

Non-interest bearing deposits          55,369                                      49,769
Other liabilities                       5,110                                       5,022
Shareholders equity                    56,915                                      51,912

Total liabilities and
shareholder equity                 $  819,395                                  $  771,130

Net change in interest bearing
assets and liabilities                          $     17,793          2.89 %                $     15,502          2.67 %

Net yield on interest earning
assets                                                  3.14 %                                      2.93 %

Interest Income. Interest income increased by approximately $500,000 from $36.5 million to $37.0 million, during the nine months ended September 30, 2008 compared to the same period in 2007. The modest increase in total interest income is the result of strong loan growth, offsetting a 375 basis point decline in the prime rate. The average balance of loans receivable increased $71.8 million to $593.1 million at September 30, 2008 from $521.3 million at September 30, 2007. The ratio of average interest-earning assets to average interest-bearing liabilities increased from 106.21% for the nine months ended September 30, 2007 to 107.53% for the nine months ended September 30, 2008.

Interest Expense. Interest expense decreased approximately $1.7 million for the nine months ended September 30, 2008 as compared to the same period in 2007. The decrease was primarily attributable to lower short term interest rate which was offset by a higher average balance of interest bearing deposits, and an increase in repurchase agreements as compared to September 30, 2007. The average cost of average interest-bearing deposits declined from 4.12% at September 30, 2007 to 3.63% at September 30, 2008.

Over the same period, the average balance of interest bearing deposits increased $29.4 million, from $533.9 million at September 30, 2007 to $563.3 million at September 30, 2008 and the average balance of funds borrowed from the FHLB increased approximately $300,000, from $93.5 million at September 30, 2007 to $93.8 million at September 30, 2008. The average cost of average borrowed funds from the FHLB decreased from 4.65% at September 30, 2007 to 4.29% at September 30, 2008.

The average cost of all deposits declined from 3.77% at September 30, 2007 to 3.30% at September 30, 2008. The average balance of repurchase agreements increased from $26.7 million at September 30, 2007 to $34.7 million at September 30, 2008. The average cost of repurchase agreements declined from 4.89% at September 30, 2007 to 3.29% at September 30, 2008.

Provision for Loan Losses. The allowance for loan losses is established through a provision for loan losses based on management's evaluation of the risk inherent in its loan portfolio and the general economy. Such evaluation considers numerous factors including, general economic conditions, loan portfolio composition, prior loss experience, the estimated fair value of the underlying collateral and other factors that warrant recognition in providing for an adequate loan loss allowance. The Company determined that an additional $1.7 million of provision for loan loss was required for the nine months ended September 30, 2008 compared to a $702,000 provision for loan loss expense for the nine months ended September 30, 2007. The increase in the Company's provision expense was largely the result in an increase in total loans outstanding.

Non-Interest Income. Non-interest income increased approximately $1.1 million in the nine months ended September 30, 2008 as compared to the same period in 2007. For the nine months ended September 30, 2008, gains on the sale of loans were $112,000 as compared to $82,000 in the same period in 2007. For the nine months ended September 30, 2008, income from financial services was $840,000, compared to $879,000 for the same period in 2007. The Company realized gains on the sale of investments totaling $718,000 for the nine months ended September 30, 2008. These gains were the result of the sale of agency bonds. In addition, two agency bonds classified as held to maturity with unearned discounts were called at par, contributing approximately $27,000 to the above mentioned gains. The proceeds from both sales and calls of agency bonds were reinvested in both loans and mortgage-back securities. For the nine months ended September 30, 2008, income from bank owned life insurance declined by $44,000 as one insurance company reduced the rate of interest paid on its policies.

Non-Interest Expenses. There was a $1.3 million increase in total non-interest expenses in the nine months ended September 30, 2008 compared the same period in 2007. For the nine months ended September 30, 2008, compensation expense increased to $8.7 million compared to $7.9 million for the nine months ended September 30, 2007 largely due to the opening of two new retail offices during the period. The increase in advertising expenses and postage expenses are related to the Company's direct marketing campaign focus on demand deposit growth. The increase in data processing and occupancy expenses are related the addition of two retail offices.

Income Taxes. The effective tax rate for the nine months ended September 30, 2008 was 29.7%, compared to 29.1% for the same period in 2007. The increase in the effective tax rate is due to large amount of gains on the sale of securities and increased income from taxable sources, all of which are taxed at 34%. The Company does not pay Kentucky income taxes but does pay a 6% tax on all Tennessee income.

Comparison of Operating Results for the Three Months Ended September 30, 2008 and 2007

Net Income. Net income for the three months ended September 30, 2008 was $1,149,000, compared to net income of $1,025,000 for the three months ended September 30, 2007. The increase in the Company's net income for the three month period ended September 30, 2008 was largely the result of an increase in interest earning assets and changes in market interest rates. Partially offsetting the Company's improved net income levels was a $581,000 increase in the Company's provision for loan loss expense resulting from an increase in total loans outstanding. Non-interest expenses increased by $379,000 as the Company opened two new retail banking locations in the last twelve months and entered into marketing agreements to greatly expand its ATM network.

Net Interest Income. Net interest income for the three months ended September 30, 2008 was $6.0 million, compared to $5.0 million for the three months ended September 30, 2007. The increase in net interest income for the three months ended September 30, 2008 as compared to September 30, 2007 was largely due to a $66.9 million increase in the average balance of loans outstanding and, to a lesser extent, lower short-term interest rates. For the three months ended September 30, 2008 and September 30, 2007, the tax equivalent yield on total interest earning assets declined to 6.47% from 7.02%. For the three month periods ended September 30, 2008 and September 30, 2007, the Company's cost of interest bearing liabilities was 3.56% and 4.38%, respectively.

Average Balances, Yields and Interest Expenses. The table below summarizes the overall effect of changes to both interest rates and changes in the average balances of interest earning assets and liabilities for the three months ended September 30, 2008, and September 30, 2007. Yields on assets and cost of liabilities are derived by dividing income or expense by the average daily balances of interest earning assets and liabilities for the appropriate three-month periods. Average balances for loans include loans classified as non-accrual, net of the allowance for loan losses. The table adjusts tax-free investment income by $67 for September 30, 2008, and $54 for September 30, 2007, for a tax equivalent rate using a cost of funds rate of 3.50% for September 30, 2008 and 4.30% for September 30, 2007. The table adjusts tax-free loan income by $80 for September 30, 2008 and $80 for September 30, 2007 for a tax equivalent rate using the same cost of funds rate. The cost of funds rates used for the periods above correspond to the Company's actual cost of funds rates for those periods.

                              Average       Income &         Average        Average       Income &         Average
                              Balance        Expense          Rates         Balance        Expense          Rates
                             9/30/2008      9/30/2008       9/30/2008      9/30/2007      9/30/2007       9/30/2007
Loans                        $  608,925    $    10,425           6.85 %    $  542,025    $    10,477           7.73 %
Investments AFS taxable         134,440          1,726           5.14 %       131,406          1,575           4.79 %
Investment AFS tax free          16,872            220           5.22 %        15,147            183           4.83 %
Investment Held to
maturity                          1,926             24           4.98 %        17,891            197           4.40 %
Federal funds                     5,110             23           1.80 %         7,167             93           5.19 %

Total interest earning
assets                          767,273         12,418           6.47 %       713,636         12,525           7.02 %

Other assets                     63,929                                        66,996

Total assets                 $  831,202                                    $  780,632
. . .