Overview

This section presents an analysis of the consolidated financial condition of the Company and its wholly-owned subsidiaries, the Banks, at December 31, 2008 and 2007, and the consolidated results of operations for each of the years in the three year period ended December 31, 2008. The information contained in this section should be read in conjunction with the consolidated financial statements, notes to consolidated financial statements and other financial data presented elsewhere in this annual report on Form 10-K.

The Company conducts its primary business through the Banks, which are community-oriented financial institutions offering a variety of financial services to its local communities. The Banks are engaged primarily in the business of attracting deposits from the general public and using such funds for the origination of: 1) commercial business and real estate loans and 2) secured consumer loans such as home equity lines of credit, automobile loans, and recreational vehicle loans. Additionally, YCB originates and sells into the secondary market mortgage loans for the purchase of single-family homes in Floyd and Clark counties, Indiana, and Jefferson and Nelson counties, Kentucky, including surrounding communities. The Banks invest excess liquidity balances in mortgage-backed, U.S. agency, state and municipal and corporate securities.

The operating results of the Company depend primarily upon the Banks' net interest income, which is the difference between interest earned on interest-earning assets and interest incurred on interest-bearing liabilities. Interest-earning assets principally consist of loans, taxable and tax-exempt securities, and FHLB stock. Interest-bearing liabilities principally include deposits, retail repurchase agreements, federal funds purchased, and advances from the FHLB Indianapolis and Cincinnati. The net income of the Banks is also affected by 1) provision for loan losses, 2) non-interest income (including mortgage banking income, net gains on sales of securities, deposit account service charges and commission-based income on non-deposit investment products), 3) non-interest expenses (including compensation and benefits, occupancy, equipment, data processing expenses, marketing and advertising, and other expenses, such as audit, postage, printing, and telephone expenses), and
4) income tax expense.

Forward Looking Information

Statements contained within this report that are not statements of historical fact constitute forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934. When used in this discussion the words "anticipate," "project," "expect," "believe," and similar expressions are intended to identify forward-looking statements. The Company cautions that these forward-looking statements are subject to numerous assumptions, risks and uncertainties, all of which may change over time. Actual results could differ materially from forward-looking statements.

In addition to factors disclosed by the Company elsewhere in this annual report on Form 10-K, the following factors, among others, could cause actual results to differ materially from such forward-looking statements: 1) adverse changes in economic conditions affecting the banking industry in general and, more specifically, the market areas in which the Company and its subsidiary Banks operate, 2) adverse changes in the legislative and regulatory environment affecting the Company and its subsidiary Banks, 3) increased competition from other financial and non-financial institutions, 4) the impact of technological advances on the banking industry, and 5) other risks detailed at times in the Company's filings with the Securities and Exchange Commission. The Company does not assume an obligation to update or revise any forward-looking statements subsequent to the date on which they are made.

Application of Critical Accounting Policies

The Company's consolidated financial statements are prepared in accordance with U.S. generally accepted accounting principles and follow general practices within the financial services industry. The most significant accounting policies followed by the Company are presented in Note 1 to the Consolidated Financial Statements. These policies, along with the disclosures presented in the other financial statement notes and in this financial review, provide information on how significant assets and liabilities are valued in the financial statements and how those values are determined. Based on the valuation techniques used and the sensitivity of financial statement amounts to the methods, assumptions, and estimates underlying those amounts, management has identified the determination of the allowance for loan losses, valuation of goodwill and other intangible assets, fair value of investment securities and deferred tax assets to be the accounting areas that require the most subjective or complex judgments, and as such could be most subject to revision as new information becomes available.

Allowance for Loan Losses

The allowance for loan losses represents management's estimate of probable credit losses inherent in the loan portfolio. Determining the amount of the allowance for loan losses is considered a critical accounting estimate because it requires significant judgment and the use of estimates related to the amount and timing of expected future cash flows on impaired loans, estimated fair value of collateral securing the loans, estimated losses on loans based on historical loss experience, and consideration of current economic trends and conditions, all of which may be susceptible to significant change. The loan portfolio also represents the largest asset type on the consolidated balance sheet. Note 1 to the Consolidated Financial Statements describes the methodology used to determine the allowance for loan losses, and a discussion of the factors driving changes in the amount of the allowance for loan losses is included under "Asset Quality" below.

Loans that exhibit probable or observed credit weaknesses are subject to individual review. Where appropriate, amounts of allowances are allocated to individual loans based on management's estimate of the borrower's ability to repay the loan given the availability of collateral, other sources of cash flow and legal options available to the Company. Included in the review of individual loans are those that are impaired as provided in SFAS No. 114, "Accounting by Creditors for Impairment of a Loan." The Company evaluates the collectability of both principal and interest when assessing the need for a loss accrual. Historical loss rates are applied to other loans not subject to allowance allocations. These historical loss rates may be adjusted for significant factors that, in management's judgment, reflect the impact of any current conditions on loss recognition. Factors which management considers in the analysis include the effects of the national and local economies, trends in the nature and volume of loans (delinquencies, charge-offs and nonaccrual loans), changes in mix, asset quality trends, risk management and loan administration, changes in internal lending policies and credit standards, and examination results from bank regulatory agencies and the Company's internal credit examiners.

The Company has not substantively changed any aspect to its overall approach in the determination of the allowance for loan losses. There have been no material changes in assumptions or estimation techniques as compared to prior periods that impacted the determination of the current period allowance.

Based on the procedures discussed above, management is of the opinion that the allowance of $9.5 million was adequate to address probable incurred credit losses associated with the loan portfolio at December 31, 2008.

Goodwill and Other Intangible Assets

The Company has a recorded balance of $15.3 million of goodwill and $2.5 million of other intangible assets at December 31, 2008 in association with its acquisition of SCSB in 2006. The Company is required to perform an assessment of goodwill and other intangible assets to determine potential impairment at least annually. Also, management, on an on-going basis, informally reviews and analyzes certain transactions or events that may indicate potential impairment of goodwill and other intangible assets throughout the year. The analysis and determination of potential impairment and the identification of relevant factors and events indicating potential impairment require a high degree of judgment from management. The Company performed a formal assessment of goodwill and other intangible assets in the 4th quarter of the 2008 utilizing the Company's results of operations through September 30, 2008 which indicated that goodwill and intangible assets were not impaired. Due to the continued decline in the Company's stock price during the 4th quarter of 2008 and the 1st quarter of 2009 and the results of operations for the 4th quarter of 2008 the Company performed another formal impairment assessment in the 1st quarter of 2009. The second assessment utilized the Company's results of operations through December 31, 2008. For purposes of assessing impairment, the Company contracted a third party consulting firm to assess the fair value of the Company, as the market capitalization of the Company was below the book value of equity for most of 2008. The impairment analyses utilized several different approaches and significant assumptions to establish the fair value of the Company including: the long and short term earnings potential of the Company, recent mergers and acquisitions in the Company's geographical region, asset valuations, and potential overhead reduction available to an acquirer. In evaluating these factors, the third party consultants relied on management's representations in providing relevant estimates and the budgeted 2009 earnings. The consultants also considered the thinly traded volume of the Company's stock in determining the fair value. Based on the result of the assessment, the Company determined that goodwill was not impaired as of December 31, 2008. No other events were identified in 2008 which caused us to believe that goodwill or intangible assets were impaired.

Fair Value of Investment Securities

The Company had six trust preferred securities in its investment portfolio as of December 31, 2008 with a combined book value of $5.7 million and a fair value of $3.3 million as of the same date. During 2008, the market for these types of securities effectively froze as market participants were unwilling to conduct transactions unless forced to do so. As a result, the fair value of these securities deteriorated significantly during 2008. Given the market conditions, management changed the valuation source for these types of securities which are provided by a third party to the Company. The fair value of these securities is an estimate which is more difficult to determine due to the current market volatility and illiquidity. The new valuation utilizes discounted cash flow models to value the securities utilizing significant unobservable inputs as defined by FSP SFAS 157-3. In management's estimate, the new valuation method provided a more relevant and accurate representation of the fair value of these securities as of December 31, 2008. Management evaluated the trust preferred securities for other-than-temporary impairment under FSP EITF 99-20-1 and determined that unrealized losses on these securities should not be recorded in 2008 earnings.

Deferred Tax Assets

The Company has a net deferred tax asset of approximately $1.5 million. The Company evaluates this asset on a quarterly basis. To the extent the Company believes it is more likely than not that it will not be utilized, the Company will establish a valuation allowance to reduce its carrying amount to the amount it expects to be realized. At December 31, 2008, a valuation allowance of $806,000 has been established against the outstanding deferred tax asset. Note 12 to the Consolidated Financial Statements describes the net deferred tax asset. The deferred tax asset will be utilized as the Company is profitable or as the Company carries back tax losses to periods in which it paid income taxes. The estimate of the realizable amount of this asset is a critical accounting policy.

Highlights

The Company's net income decreased to $821,000 for the year ended December 31, 2008 from $3.5 million for 2007, or 76.6%. The decrease in net income was due to a significant increase in the Company's provision for loan losses of $5.6 million to $6.9 million for 2008 compared to $1.3 million in 2007 as the Company's loan portfolio experienced a significant increase in past due loans, further weakening of collateral securing certain commercial credits, and continued weakness in the Company's local market for commercial construction and development loans. Net income for 2008 was also negatively impacted by an increase in non-interest expense of $750,000, or 3.4%. The increases in provision for loan losses and non-interest expense were partially offset by an increase in non-interest income from 2007 of $2.0 million and a decrease in provision for income taxes of $1.6 million. The Company's book value per share decreased to $19.31 per share at December 31, 2008 from $19.77 at December 31, 2007.

The following table summarizes selected financial information regarding the Company's financial performance:

Table 1 - Summary


                                                             For the Year Ended December 31,
(Dollars in thousands, except per share amounts)         2008              2007             2006
Net income                                            $       821       $     3,503      $    4,111
Basic earnings per share                                     0.25              1.05            1.36
Diluted earnings per share                                   0.25              1.04            1.35
Return on average assets                                     0.10 %            0.43 %          0.55 %
Return on average equity                                     1.29              5.39            7.73

The Company's total assets increased to $877.4 million at December 31, 2008 from $823.6 million at December 31, 2007 primarily due to an increase in interest-bearing deposits in other financial institutions of $31.8 million, an increase in securities available for sale of $22.2 million, and an increase in cash and due from financial institutions of $5.2 million, offset by a decrease in net loans of $6.6 million. Total deposits increased by $29.8 million to $603.2 million at December 31, 2008 with $12.6 million of the increase attributable to non-interest bearing deposits. Other borrowings and FHLB advances increased by $6.2 million and $20.6 million, respectively, to $79.0 million and $111.9 million as of December 31, 2008. Total shareholders' equity decreased by $1.9 million to $62.6 million at December 31, 2008 as the Company declared and paid dividends that were in excess of net income by $1.5 million in 2008.

Results of Operations

Net Interest Income

The Company's principal revenue source 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 the 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 changes in market interest rates.

In 2008, net interest income increased by $73,000 to $23.5 million for the year ended December 31, 2008 from $23.4 million for the equivalent period in 2007 while the net interest margin on a taxable equivalent basis decreased to 3.09% for 2008 compared to 3.16% for 2007. The decrease in net interest margin was the result of the Federal Open Market Committee's dramatic reduction in the federal funds rate throughout 2008. As a result, the Company's yield on interest bearing assets decreased by 109 basis points to 5.87% for 2008 compared to 6.96% in 2007, with most of the decrease attributable to a decrease in the yield on the Company's loan portfolio. The cost on interest bearing liabilities also decreased in 2008 from 4.29% for the year ended December 31, 2007 to 3.15% for the same period in 2008. Most of the decrease in the cost of interest-bearing deposits was due to decreases in the cost of savings and other deposit accounts of 130 basis points, other borrowings of 245 basis points, and subordinated debentures of 223 basis points.

Average interest earning assets increased to $770.6 million for the year ended December 31, 2008 from $748.1 million for the equivalent period in 2007 as most of the increase was attributable to increases in interest-bearing deposits in other financial institutions and loans. The effect of the increase in interest-bearing deposits in other financial institutions was to decrease the yield on average interest earning assets as those deposits primarily consisted of federal funds sold and other short-term deposits that had an average yield of 1.99% in 2008. The yield on the Company's loan portfolio decreased to 6.07% in 2008 from 7.35% in 2007, or 128 basis points. A large portion of the Company's loan portfolio is variable and tied to the prime rate which decreased throughout 2008 in conjunction with the decrease in the federal funds rate to a historically low level. Offsetting the decrease in loan and interest-bearing deposits in other financial institutions yields, was an increase in the yield on taxable securities to 5.07% in 2008 from 4.79% in 2007. Management attributes the increase in yield to maturities of lower yielding U.S. Government securities that were replaced with higher yielding mortgage backed securities.

Average interest bearing liabilities increased to $680.0 million for 2008 from $662.4 million for 2007 due to increases in the average balances of other borrowings and FHLB advances. The reduction in the cost of interest bearing liabilities was affected by the aforementioned decrease in the federal funds rate as management aggressively lowered rates on the Company's deposit offerings throughout 2008 in an effort to substantially match the decrease. As a result, the cost of savings and other was reduced to 1.30% in 2008 from 2.60% in 2007 and time deposits decreased to 3.94% in 2008 from 4.83% in 2007. As time deposits mature, management plans to price them accordingly and anticipates a further reduction in the cost over 2009. The cost of other borrowings decreased to 1.98% for 2008 from 4.43% in 2007, or 245 basis points due primarily to a reduction in rates of the Company's repurchase agreements which had carried a weighted average interest rate of 3.36% at December 31, 2007 compared to a weighted average rate of 0.42% at December 31, 2008.

Net interest income increased by $2.3 million, or 10.8%, to $23.4 million for the twelve months ended December 31, 2007 from $21.1 million for the same period in 2006 due primarily to the acquisition of SCSB on July 1, 2006. Net interest margin on a taxable equivalent basis increased by 12 bps to 3.16% for the year ended 2007 as compared to 3.04% for the same period in 2006. The increase in net interest margin was driven primarily by an increase in the yield on interest earning assets, which increased by 22 bps to 6.96% on a fully taxable equivalent basis for the year ended December 31, 2007 from 6.74% for the year ended December 31, 2006. Most of the increase in yield on interest earning assets was due to the increase in yield on the Company's loan portfolio. The cost on interest bearing liabilities increased by 17 bps to 4.29% for the twelve months ended 2007 from 4.12% for the same period in 2006 due to an increase in the average rate on time deposits.

Average interest earning assets increased by 6.5% from $702.2 million for 2006 to $748.1 million for 2007. The increase in interest earning assets was primarily due to an increase in average loans of $50.9 million as a result of the acquisition of SCSB on July 1, 2006 and an increase in the Company's loan portfolio during 2007 of $22.5 million. The yield on the Company's loan portfolio increased to 7.35% for the twelve months ended 2007 from 7.19% for the same period in 2006. Management attributes the increase in loan yield to a continued focus on enhancing the net interest margin through profitable growth in the Company's loan portfolio and an emphasis on increasing current and existing customer profitability through evaluation of the entire relationship, including deposits. The yield on average earning assets was also impacted by an increase in the yield on taxable securities of 29 bps from 4.50% for the year ended 2006 to 4.79% in 2007. The increase in the yield on taxable securities was due to maturities and sales of lower yielding U.S Government and federal agency securities during the year. Offsetting the increase in yield on interest earning assets was a decrease in the fully taxable equivalent yield of tax-exempt securities to 6.69% for the year ended December 31, 2007 from 7.51% for the year ended December 31, 2006. Management attributes the decrease to maturities of higher yielding tax-exempt securities replaced with lower yielding tax-exempt securities.

In 2007, average interest bearing liabilities increased by 5.0% to $662.4 million from $630.7 million in 2006. The increase in average interest bearing liabilities was primarily due to an increase in time deposits which increased to $273.1 million for the year ended December 31, 2007 from $249.0 million for the year ended December 31, 2006 with the average rate increasing to 4.83% from 4.36% over the same period. The increase in the average rate of time deposits was the result of management's efforts to maintain and increase the Company's deposit base in a competitive local market. The Company was able to decrease its cost on other borrowings to 4.43% for the twelve months ended in 2007 from 4.76% for the same period in 2006 by obtaining a $9.8 million structured repurchase agreement entered into in the fourth quarter of 2007 that had a yield of 2.79% at December 31, 2007. Also contributing to the reduction in the average rate of other borrowings was a decrease in the average rate paid on the Company's repurchase agreements from 4.84% for 2006 to 3.36% for 2007 and a decrease in the federal funds rate of 100 bps during 2007. The increase in the net interest margin on a fully taxable equivalent basis in 2007 was further enhanced by an increase in average non-interest bearing deposits of $18.7 million, or 30.1%, to $80.8 million for 2007 from $62.1 million for 2006 due to the acquisition of SCSB on July 1, 2006 and a focused effort to increase non-interest bearing deposits through employee incentives, increased deposit product offerings including remote deposit capture and lockbox, and cross-selling of current and prospective loan customers.

Table 2 provides detailed information as to average balances, interest income/expense, and rates by major balance sheet category for 2006 through 2008.

Table 2 - Average Balance Sheets and Rates for Years Ended 2008, 2007 and 2006

For analytical purposes, net interest margin and net interest spread are
adjusted to a taxable equivalent adjustment basis to recognize the income tax
savings on tax-exempt assets, such as state and municipal securities. A tax rate
of 34% was used in adjusting interest on tax-exempt assets to a fully taxable
equivalent ("FTE") basis.

                                                                            2008                                        2007                                        2006
                                                            Average                      Average        Average                      Average        Average                      Average
(Dollars in thousands)                                      Balance       Interest         Rate         Balance       Interest         Rate         Balance       Interest         Rate
ASSETS
Earning assets:
Interest-bearing deposits in other
financial institutions                                     $  12,122     $      241           1.99 %   $   4,279     $      144           3.37 %   $   4,365     $      132           3.02 %
   Taxable securities                                         94,667          4,798           5.07        98,342          4,711           4.79       105,287          4,738           4.50
   Tax-exempt securities                                      16,350          1,056           6.46        11,546            773           6.69         9,419            708           7.51
   Total loans and fees (1)(2)                               639,275         38,833           6.07       625,972         46,030           7.35       575,100         41,360           7.19
   FHLB and Federal Reserve stock                              8,141            338           4.15         7,928            381           4.81         8,028            397           4.95
 Total earning assets                                        770,555         45,266           5.87       748,067         52,039           6.96       702,199         47,335           6.74

Non-interest earning assets:
 Less: Allowance for loan losses                              (6,763 )                                    (5,684 )                                    (5,823 )
   Non-earning assets:
   Cash and due from banks                                    24,924                                      17,047                                      15,759
   Bank premises and equipment, net                           15,160                                      15,320                                      13,827
   Other assets                                               40,266                                      40,440                                      22,505
Total assets                                               $ 844,142                                   $ 815,190                                   $ 748,467

LIABILITIES AND SHAREHOLDERS' EQUITY
Interest bearing liabilities:
   Savings and other                                       $ 212,475     $    2,771           1.30 %   $ 214,683     $    5,582           2.60 %   $ 218,981     $    6,071           2.77 %
   Time deposits                                             272,847         10,758           3.94       273,078         13,201           4.83       249,036         10,862           4.36
   Other borrowings                                           70,691          1,403           1.98        63,713          2,824           4.43        64,153          3,054           4.76
   FHLB advances                                             106,969          5,605           5.24        93,889          5,492           5.85        86,024          5,066           5.89
   Subordinated debenture                                     17,000            916           5.39        17,000          1,296           7.62        12,479            942           7.55
Total interest bearing liabilities                           679,982         21,453           3.15       662,363         28,395           4.29       630,673         25,995           4.12

Non-interest bearing liabilities:
. . .