Overview

Community Trust Bancorp, Inc. ("CTBI") is a bank holding company headquartered in Pikeville, Kentucky. At March 31, 2009, CTBI owned one commercial bank and one trust company. Through its subsidiaries, CTBI has seventy-seven banking locations in eastern, northeastern, central, and south central Kentucky and southern West Virginia, and five trust offices across Kentucky. At March 31, 2009, CTBI had total consolidated assets of $3.0 billion and total consolidated deposits, including repurchase agreements, of $2.5 billion, making it the largest depository of Kentucky based deposits of any bank holding company headquartered in the Commonwealth of Kentucky. Total shareholders' equity at March 31, 2009 was $313.0 million.

Critical Accounting Policies and Estimates

The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires the appropriate application of certain accounting policies, many of which require us to make estimates and assumptions about future events and their impact on amounts reported in our consolidated financial statements and related notes. Since future events and their impact cannot be determined with certainty, the actual results will inevitably differ from our estimates. Such differences could be material to the consolidated financial statements.

We believe the application of our accounting policies and the estimates required therein are reasonable. These accounting policies and estimates are constantly reevaluated, and adjustments are made when facts and circumstances dictate a change. Historically, we have found our application of accounting policies to be appropriate, and actual results have not differed materially from those determined using necessary estimates.

See note 1 to the condensed consolidated financial statements for further information regarding our accounting policies. We have identified the following critical accounting policies:

Cash and Cash Equivalents - Cash and cash equivalents include cash on hand, amounts due from banks, interest bearing deposits in other financial institutions, and federal funds sold. Generally, federal funds are sold for one-day periods.

Investments - Management determines the classification of securities at purchase. We classify securities into held-to-maturity, trading, or available-for-sale categories. Held-to-maturity securities are those which we have the positive intent and ability to hold to maturity and are reported at amortized cost. In accordance with Statement of Financial Accounting Standards ("SFAS") No. 115, Accounting for Certain Investments in Debt and Equity Securities, investments in debt securities that are not classified as held-to-maturity and equity securities that have readily determinable fair values shall be classified in one of the following categories and measured at fair value in the statement of financial position:

a. Trading securities. Securities that are bought and held principally for the purpose of selling them in the near term (thus held for only a short period of time) shall be classified as trading securities. Trading generally reflects active and frequent buying and selling, and trading securities are generally used with the objective of generating profits on short-term differences in price.

b. Available-for-sale securities. Investments not classified as trading securities (nor as held-to-maturity securities) shall be classified as available-for-sale securities. We do not have any securities that are classified as trading securities. Available-for-sale securities are reported at fair value, with unrealized gains and losses included as a separate component of shareholders' equity, net of tax. If declines in fair value are not temporary, the carrying value of the securities is written down to fair value as a realized loss.

Gains or losses on disposition of securities are computed by specific identification for all securities except for shares in mutual funds, which are computed by average cost. Interest and dividend income, adjusted by amortization of purchase premium or discount, is included in earnings.

Available-for-Sale Securities - Available-for-sale securities are valued using the following valuation techniques:

Securities Available-for-Sale - Level 2 Inputs. For these securities, CTBI obtains fair value measurements from an independent pricing service. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond's terms and conditions, among other things.

Securities Available-for-Sale - Level 3 Inputs. The securities owned by CTBI that were measured using Level 3 criteria are auction rate securities issued by FNMA. These securities were valued using an independent third party. For these securities, the valuation methods used were (1) a discounted cash flow model valuation, where the expected cash flows of the securities are discounted to the present using a yield that incorporates compensation for illiquidity and (2) a market comparables method, where the securities are valued based on indications, from the secondary market, of what discounts buyers demand when purchasing similar securities. Using these methods, the auction rate securities are classified as Level 3.

Loans - Loans with the ability and the intent to be held until maturity and/or payoff are reported at the carrying value of unpaid principal reduced by unearned interest and an allowance for loan and lease losses. Income is recorded on the level yield basis. Interest accrual is discontinued when management believes, after considering economic and business conditions, collateral value, and collection efforts, that the borrower's financial condition is such that collection of interest is doubtful. Any loan greater than 90 days past due must be well secured and in the process of collection to continue accruing interest. Cash payments received on nonaccrual loans generally are applied against principal, and interest income is only recorded once principal recovery is reasonably assured. Loans are not reclassified as accruing until principal and interest payments are brought current and future payments appear reasonably certain.

Loan origination and commitment fees and certain direct loan origination costs are deferred and the net amount amortized over the estimated life of the related loans, leases, or commitments as a yield adjustment.

Allowance for Loan and Lease Losses - We maintain an allowance for loan and lease losses ("ALLL") at a level that is appropriate to cover estimated credit losses on individually evaluated loans determined to be impaired, as well as estimated credit losses inherent in the remainder of the loan and lease portfolio. Since arriving at an appropriate ALLL involves a high degree of management judgment, we use an ongoing quarterly analysis to develop a range of estimated losses. In accordance with accounting principles generally accepted in the United States, we use our best estimate within the range of potential credit loss to determine the appropriate ALLL. Credit losses are charged and recoveries are credited to the ALLL.

We utilize an internal risk grading system for commercial credits. Those larger commercial credits that exhibit probable or observed credit weaknesses are subject to individual review. The borrower's cash flow, adequacy of collateral coverage, and other options available to CTBI, including legal remedies, are evaluated. The review of individual loans includes those loans that are impaired as SFAS 114, Accounting by Creditors for Impairment of a Loan. We evaluate the collectibility of both principal and interest when assessing the need for loss provision. Historical loss rates are applied to other commercial loans not subject to specific allocations. The ALLL allocation for this pool of commercial loans is established based on the historical average, maximum, minimum, and median loss ratios.

Homogenous loans, such as consumer installment, residential mortgages, and home equity lines are not individually risk graded. The associated ALLL for these loans is measured under SFAS 5, Accounting for Contingencies. The ALLL allocation for these pools of loans is established based on the average, maximum, minimum, and median loss ratios over the previous eight quarters.

Historical loss rates for commercial and retail loans are adjusted for significant factors that, in management's judgment, reflect the impact of any current conditions on loss recognition. Factors that we consider include delinquency trends, current economic conditions and trends, strength of supervision and administration of the loan portfolio, levels of underperforming loans, level of recoveries to prior year's charge offs, trend in loan losses, industry concentrations and their relative strengths, amount of unsecured loans and underwriting exceptions. These factors are reviewed quarterly and a weighted range developed with a "most likely" scenario determined. The total of each of these weighted factors is then applied against the applicable portion of the portfolio and the ALLL is adjusted accordingly.

Loans Held for Sale - Mortgage loans originated and intended for sale in the secondary market are carried at the lower of cost or estimated market value in the aggregate. Net unrealized losses, if any, are recognized in a valuation allowance by charges to income.

Premises and Equipment - Premises and equipment are stated at cost less accumulated depreciation and amortization. Capital leases are included in premises and equipment at the capitalized amount less accumulated amortization. Premises and equipment are evaluated for impairment on a quarterly basis.

Depreciation and amortization are computed primarily using the straight-line method. Estimated useful lives range up to 40 years for buildings, 2 to 10 years for furniture, fixtures, and equipment, and up to the lease term for leasehold improvements. Capitalized leased assets are amortized on a straight-line basis over the lives of the respective leases.

Other Real Estate - Real estate acquired by foreclosure is carried at the lower of the investment in the property or its fair value. Other real estate owned by CTBI included in other assets at March 31, 2009 and December 31, 2008 was $15.2 million and $10.4 million, respectively.

Goodwill and Core Deposit Intangible - We evaluate total goodwill and core deposit intangible for impairment, based upon SFAS 142, Goodwill and Other Intangible Assets and SFAS 147, Acquisitions of Certain Financial Institutions, using fair value techniques including multiples of price/equity. Goodwill and core deposit intangible are evaluated for impairment on an annual basis or as other events may warrant.

Amortization of core deposit intangible is estimated at approximately $0.6 million annually for year one, approximately $0.4 million in year two, and approximately $0.1 million in years three and four.

Income Taxes - Income tax expense is based on the taxes due on the consolidated tax return plus deferred taxes based on the expected future tax consequences of temporary differences between carrying amounts and tax bases of assets and liabilities, using enacted tax rates.

Earnings Per Share ("EPS") - Basic EPS is calculated by dividing net income available to common shareholders by the weighted average number of common shares outstanding, excluding restricted shares.

Diluted EPS adjusts the number of weighted average shares of common stock outstanding by the dilutive effect of stock options, including restricted shares, as prescribed in SFAS 123R.

Segments - Management analyzes the operation of CTBI assuming one operating segment, community banking services. CTBI, through its operating subsidiaries, offers a wide range of consumer and commercial community banking services. These services include: (i) residential and commercial real estate loans; (ii) checking accounts; (iii) regular and term savings accounts and savings certificates; (iv) full service securities brokerage services; (v) consumer loans; (vi) debit cards; (vii) annuity and life insurance products; (viii) Individual Retirement Accounts and Keogh plans; (ix) commercial loans; (x) trust services; and (xi) commercial demand deposit accounts.

Bank Owned Life Insurance - CTBI's bank owned life insurance policies are carried at their cash surrender value. We recognize tax-free income from the periodic increases in cash surrender value of these policies and from death benefits.

Mortgage Servicing Rights - Mortgage servicing rights ("MSRs") are carried at fair market value with the implementation of SFAS 156 in January 2007. MSRs are valued using Level 3 inputs as defined in SFAS 157. The fair value is determined quarterly based on an independent third-party valuation using a discounted cash flow analysis and calculated using a computer pricing model. The computer valuation is based on key economic assumptions including the prepayment speeds of the underlying loans, the weighted-average life of the loan, the discount rate, the weighted-average coupon, and the weighted-average default rate, as applicable. Along with the gains received from the sale of loans, fees are received for servicing loans. These fees include late fees, which are recorded in interest income, and ancillary fees and monthly servicing fees, which are recorded in noninterest income. Costs of servicing loans are charged to expense as incurred. Changes in fair market value of the MSRs are reported in mortgage banking income.

Stock Options - At March 31, 2009 and December 31, 2008, CTBI had a share-based employee compensation plan, which is described more fully in note 13 to the consolidated financial statements for the year ended December 31, 2008, included in CTBI's Annual Report on Form 10-K. CTBI accounts for this plan under the recognition and measurement principles of SFAS 123R, Share-Based Payment.

Reclassifications - Certain reclassifications considered to be immaterial have been made in the prior year condensed consolidated financial statements to conform to current year classifications. These reclassifications had no effect on net income.

Dividends

The following schedule shows the quarterly cash dividends paid for the past six
quarters:

   Pay Date        Record Date        Amount Per Share
 April 1, 2009    March 15, 2009     $             0.30
January 1, 2009 December 15, 2008    $             0.30
October 1, 2008 September 15, 2008   $             0.29

Statement of Income Review

CTBI reported earnings for the quarter ended March 31, 2009 of $7.4 million or $0.49 per basic share compared to $6.5 million or $0.43 per basic share earned during the quarter ended December 31, 2008 and $8.5 million or $0.57 per basic share earned during the first quarter of 2008. The increase from prior quarter resulted from a $1.6 million decrease in provision for loan losses as the loan portfolio and net charge-offs declined, $0.5 million in securities gains from repositioning of the investment portfolio, and a $1.7 million increase in gains on sales of loans resulting from increased refinancing by consumers of residential real estate. The decrease from prior year first quarter was primarily the result of a $1.8 million decrease in net interest income as interest rates remain at historically low levels.

Earnings Summary
(in thousands except per share data)             1Q 2009       4Q 2008       1Q 2008
Net income                                     $   7,363     $   6,485     $   8,545
Earnings per share                             $    0.49     $    0.43     $    0.57
Earnings per share (diluted)                   $    0.48     $    0.43     $    0.57

Return on average assets                            1.00 %        0.87 %        1.18 %
Return on average equity                            9.52 %        8.44 %       11.20 %
Efficiency ratio                                   64.06 %       61.45 %       56.39 %
Tangible common equity/tangible assets ratio        8.34 %        8.37 %        8.46 %

Dividends declared per share                   $    0.30     $    0.30     $    0.29
Book value per share                           $   20.74     $   20.46     $   20.48

Weighted average shares                           15,076        15,065        15,000
Weighted average shares (diluted)                 15,193        15,221        15,116

First Quarter 2009 Highlights

††† CTBI continues to maintain a significantly higher level of capital than required by regulatory authorities to be designated as well-capitalized. On March 31, 2009, our Tangible Common Equity/Tangible Assets Ratio remained significantly higher than our peer institutions at 8.34%, our Tier 1 Leverage Ratio of 10.38% was 538 basis points higher than the 5.00% required, our Tier 1 Risk-Based Capital Ratio of 13.08% was 708 basis points higher than the required 6.00%, and our Total Risk-Based Capital Ratio of 14.33% was 433 basis points higher than the 10.00% regulatory requirement for this designation.

††† CTBI's basic earnings per share increased 14.0% from prior quarter as we continue to successfully operate within challenging economic conditions. Our prior quarter earnings were impacted by the other than temporary impairment charge of $1.1 million based upon the market value of Freddie Mac and Fannie Mae trust preferred pass-through auction rate securities, as well as a $1.1 million decline in the fair value of mortgage servicing rights. Basic earnings per share decreased 14.0% from prior year first quarter primarily due to the decline in net interest income.

††† Pressure continued on our net interest margin due to the current interest rate environment and economic conditions. Our net interest margin for the quarter ended March 31, 2009 decreased 8 basis points from prior quarter and 39 basis points from prior year. Net interest income decreased $0.7 million and $1.8 million from prior quarter and prior year as average earning assets increased by $37.9 million and $105.2 million, respectively.

††† Noninterest income for the first quarter 2009, excluding gains and losses on securities, increased 22.4% over prior quarter and 16.4% over prior year first quarter. The quarter over quarter increase included a $1.7 million increase in gains on sales of loans and a positive $0.8 million variance in the fair value of mortgage servicing rights.

††† During the quarter, CTBI did a small repositioning of our investment portfolio. Gains on sales of securities for the 1st quarter 2009 were $519 thousand, and the reinvestment of the proceeds allowed us to increase the yield in the portfolio while only slightly increasing the overall duration of the portfolio.

††† Noninterest expense increased 7.9% from prior quarter and 12.1% from prior year first quarter primarily due to increases in legal, other real estate owned, insurance, and repossession expenses from increased collection activity, as well as increased personnel expense.

††† Nonperforming loans remained relatively flat from December 31, 2008 to March 31, 2009 at $52.2 million. Nonperforming assets (nonperforming loans plus OREO) increased $4.7 million from prior quarter-end, December 31, 2008, and $17.3 million from prior year quarter-end, March 31, 2008.

††† Our loan portfolio decreased an annualized 2.3% during the quarter with a $13.0 million decline, primarily in the residential loan portfolio due to the high level of refinancing activity from portfolio adjustable rate loans to secondary market long-term fixed rate loans. Loan growth from prior year was $83.8 million or 3.7%.

††† Our investment portfolio decreased $2.2 million for the quarter and $40.2 million year over year.

††† Our tangible common equity/tangible assets ratio remains strong at 8.34%.

CTBI had basic weighted average shares outstanding of 15.1 million and 15.0 million, respectively, for the three months ended March 31, 2009 and 2008. The following table sets forth on an annualized basis the return on average assets and return on average shareholders' equity for the three months ended March 31, 2009 and 2008:

                                           Three Months Ended
                                                March 31
                                           2009           2008
Return on average shareholders' equity        9.52 %       11.20 %
Return on average assets                      1.00 %        1.18 %

Net Interest Income

Our quarterly net interest margin declined 8 basis points from prior quarter and 39 basis points from prior year first quarter as repricing of deposits in our asset sensitive balance sheet is slower than the repricing of loans. Net interest income for the quarter decreased 2.7% from prior quarter and 7.0% from prior year first quarter, although average earning assets increased 1.4% and 3.9%, respectively, for the same periods. The yield on average earnings assets decreased 25 basis points from prior quarter and 123 basis points from prior year in comparison to the 20 basis point and 101 basis point decreases in the cost of interest bearing funds during the same periods.

The following table summarizes the annualized net interest spread and net interest margin for the three months ended March 31, 2009 and 2008.

                                     Three Months Ended
                                          March 31
                                     2009           2008
Yield on interest earning assets        5.53 %        6.76 %
Cost of interest bearing funds          2.44 %        3.45 %
Net interest spread                     3.09 %        3.31 %

Net interest margin                     3.61 %        4.00 %

Provision for Loan Losses

The analysis of the changes in the allowance for loan losses and selected ratios
is set forth below:

                                                                       Three Months Ended
                                                                            March 31
(in thousands)                                                        2009            2008
Allowance balance at January 1                                     $    30,821     $    28,054
Additions to allowance charged against operations                        1,981           2,369
Recoveries credited to allowance                                           856             586
Losses charged against allowance                                        (3,059 )        (2,410 )
Allowance balance at March 31                                      $    30,599     $    28,599

Allowance for loan losses to period-end loans                             1.31 %          1.27 %
Average loans, net of unearned income                              $ 2,352,178     $ 2,239,608
Provision for loan losses to average loans, annualized                    0.34 %          0.43 %
Loan charge-offs net of recoveries, to average loans, annualized          0.38 %          0.33 %

Net loan charge-offs for the quarter of $2.2 million, or 0.38% of average loans annualized, was a decrease from prior quarter's 0.45% of average loans annualized but an increase from the 0.33% for prior year first quarter. Although net loan charge-offs increased $0.4 million quarter over quarter, provision for loan losses decreased $0.4 million due to the $13.0 million decline in loans outstanding during the first quarter 2009 compared to the $24.0 million growth in loans during the first quarter 2008. Allocations to loan loss reserve were $2.0 million for the quarter ended March 31, 2009 compared to $3.6 million for the quarter ended December 31, 2008 and $2.4 million for the quarter ended March 31, 2008. Our loan loss reserve as a percentage of total loans outstanding at March 31, 2009 remained at 1.31% from December 31, 2008, but increased from the 1.27% at March 31, 2008. The adequacy of our loan loss reserve is analyzed quarterly and adjusted as necessary with a focus on maintaining appropriate reserves for potential losses.

Noninterest Income

Noninterest income for the first quarter 2009, excluding gains and losses on securities, increased 22.4% over prior quarter and 16.4% over prior year first quarter. The increases in noninterest income quarter over quarter and year over year resulted primarily from increased gains on sales of residential real estate loans and positive variances in the fair value of mortgage servicing rights. Gains on sales of securities for the 1st quarter 2009 were $0.5 million, while 4th quarter 2008 was impacted by an other than temporary impairment charge of $1.1 million based upon the market value of Freddie Mac and Fannie Mae trust preferred pass-through auction rate securities.

Noninterest Expense

Noninterest expense for the quarter increased 7.9% from prior quarter and 12.1% from prior year first quarter. Personnel expense increased $0.6 million over prior quarter and prior year, and legal, other real estate owned, insurance and repossession expenses increased approximately $1.1 million compared to the same period 2008 and $0.6 million from prior quarter due to increased collection activity.

The FDIC announced a special assessment of up to 20 basis points to be collected on September 30, 2009. The FDIC may also impose an emergency special assessment after June 30, 2009 of up to 10 basis points if the FDIC deems that an additional special assessment in necessary to maintain public confidence in federal deposit insurance. Based on the FDIC insurance premium schedule for 2009, we anticipate our premiums, exclusive of the special assessment of up to 20 basis points, to be $2.2 million for 2009 compared to $0.3 million for 2008. The special assessment at the maximum 20 basis points based on our deposit base at December 31, 2008 would be $4.6 million.

Balance Sheet Review

CTBI's total assets at $3.0 billion increased 2.3% from prior quarter and 4.1% from prior year. Loans outstanding at March 31, 2009 were $2.3 billion reflecting an annualized 2.3% decline during the quarter and a 3.7% growth from March 31, 2008. Loans held for sale increased $2.5 million during the quarter as a result of the increase in refinancing as interest rates have decreased. CTBI's investment portfolio decreased an annualized 3.0% from prior quarter and 12.1% from prior year. Federal funds sold and deposits in other banks increased $76.3 million quarter over quarter and $67.5 million year over year. Deposits, including repurchase agreements, at $2.5 billion increased an annualized 7.0% from prior quarter and 3.2% from prior year.

Shareholders' equity at March 31, 2009 was $312.6 million compared to $308.2 million at December 31, 2008 and $306.8 at March 31, 2008. CTBI's annualized dividend yield to shareholders as of March 31, 2009 was 4.49%.

Loans

Loan growth occurred in the commercial and consumer loan portfolios but decreased in the residential loan portfolio during the first three months of 2009. The commercial loan portfolio increased $18.1 million, the consumer portfolio increased $3.9 million, and residential real estate loans decreased $35.0 million.

The following tables summarize CTBI's nonperforming loans as of March 31, 2009 and December 31, 2008.

                                         As a % of Loan                               As a % of Loan      Accruing Loans       As a % of Loan
. . .