Forward-Looking Statements

This discussion contains forward-looking statements under the Private Securities Litigation Reform Act of 1995 that involve risks and uncertainties. These statements are not historical facts, but rather statements based on our current expectations regarding our business strategies and their intended results and our future performance. Forward-looking statements are preceded by terms such as "expects," "believes," "anticipates," "intends" and similar expressions.

Although we believe that the assumptions underlying the forward-looking statements contained herein are reasonable, any of the assumptions could be inaccurate, and therefore, there can be no assurance that the forward-looking statements included herein will prove to be accurate. Factors that could cause actual results to differ from the results discussed in the forward-looking statements include, but are not limited to: economic conditions (both generally and more specifically in the markets, including the tobacco market and the thoroughbred horse industry, in which we and our bank operate); competition for our subsidiary's customers from other providers of financial and mortgage services; government legislation, regulation and monetary policy (which changes from time to time and over which we have no control); changes in interest rates (both generally and more specifically mortgage interest rates); material unforeseen changes in the liquidity, results of operations, or financial condition of our subsidiary's customers; adequacy of the allowance for losses on loans and the level of future provisions for losses on loans; and other risks detailed in our filings with the Securities and Exchange Commission, all of which are difficult to predict and many of which are beyond our control.

You are cautioned not to place undue reliance on any forward-looking statements made by us or on our behalf. We undertake no obligation to republish revised forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.

Summary

The Company recorded net income of $3.4 million, or $1.25 basic earnings and diluted earnings per share for the first six months ending June 30, 2012 compared to $2.7 million or $0.98 basic earnings and diluted earnings per share for the six month period ending June 30, 2011. The first six months earnings reflects an increase of 26.6% compared to the same time period in 2011, due primarily to an increase in the gain on sold mortgage loans of $565 thousand, an increase in net interest income of $433 thousand and a decrease of $450 thousand in the provision for loan losses. These positive changes to net income during 2012 were partially offset by an increase of $277 thousand in employee salaries and benefits and an increase of $226 thousand in repossession expenses. The earnings for the three months ending June 30, 2012 were $1.8 million, or $0.65 basic and diluted earnings per share compared to $1.4 million or $0.52 basic and diluted earnings per share for the three month period ending June 30, 2011. The earnings for the three month period in 2012 reflect a 25.1% increase compared to the same time period in 2011.

Return on average assets was 1.00% for the six months ended June 30, 2012 and 0.82% for the six month period ended June 30, 2011. Return on average assets was 1.05% for the three months ended June 30, 2012 and 0.87% for the three months ended June 30, 2011. Return on average equity was 9.6% for the six month period ended June 30, 2012 and 8.6% for the same period in 2011. Return on average equity was 10.0% for the three months ended June 30, 2012 and 8.9% for the same time period in 2011. Gross Loans increased $9.5 million from $411.9 million on December 31, 2011 to $421.4 million on June 30, 2012. The overall increase is attributed mostly to an increase of $8.6 million in non-farm and non-residential real estate loans, an increase of $6.4 million in 1-4 family residential real estate loans and an increase of $3.6 million in commercial loans. Decreases in the loan portfolio from December 31, 2011 to June 30, 2012 included a decrease of $4.1 million in agricultural loans, a decrease of $3.1 million in real estate construction loans and a decrease of $1.6 million in multi-family residential real estate loans.

Total deposits increased from $542.9 million on December 31, 2011 to $543.1 million on June 30, 2012, an increase of $200 thousand. Non-interest bearing demand deposit accounts increased $6.7 million from December 31, 2011 to June 30, 2012. This increase is not all attributable to additional deposits being placed with the bank as part of the increase is from deposit accounts changing from time deposits to non-interest bearing demand deposit accounts. Time deposits $100 thousand and over decreased $4.7 million and other interest bearing deposit accounts decreased $1.8 million.

Net Interest Income

Net interest income is the difference between interest income earned on interest-earning assets and the interest expense paid on interest-bearing liabilities.

Net interest income was $12.5 million for the six months ended June 30, 2012 compared to $12.0 million for the six months ended June 30, 2011, an increase of 3.6%. The interest spread of 4.00% for the first six months of 2012 is slightly down from 4.02% reported for the same period in 2011, a decrease of 2 basis points. Rates have remained fairly low in the past year. For the first six months ending June 30, 2012, the cost of total deposits was 0.47% compared to 0.84% for the same time period in 2011. Increasing non-interest bearing deposit accounts and lower rates on certificates of deposit accounts have helped to lower the cost of deposits. Net interest income was $6.4 million for the three months ending June 30, 2012 compared to $6.2 million for the three months ending June 30, 2011, an increase of 2.3%. The interest spread was 4.06% for the three month period ending June 30, 2012 compared to 4.19% for the three month period in 2011, a decrease of 13 basis points.

For the first six months, the yield on assets decreased from 5.07% in 2011 to 4.68% in 2012. The yield on loans decreased 15 basis points in the first six months of 2012 compared to 2011 from 5.89% to 5.74%. The yield on securities decreased 69 basis points in the first six months of 2012 compared to 2011 from 3.48% in 2011 to 2.79% in 2012. The cost of liabilities decreased from 1.06% in 2011 to 0.67% in 2012. Year to date average loans increased $5.3 million, or 1.3% from June 30, 2011 to June 30, 2012. Loan interest income decreased $85 thousand for the first six months of 2012 compared to the first six months of 2011. Year to date average deposits increased from June 30, 2011 to June 30, 2012, up $20.1 million or 3.7%. The increase is largely attributed to an increase in public funds. Year to date average interest bearing deposits increased $6.3 million, or 1.5%, from June 30, 2011 to June 30, 2012. Deposit interest expense has decreased $925 thousand for the first six months of 2012 compared to the same period in 2011. Year to date average borrowings decreased $11.5 million, or 21.5% from June 30, 2011 to June 30, 2012. The decrease is mostly attributed to paying off Federal Home Loan Bank advances as they mature. Interest expense on borrowed funds has decreased $164 thousand for the first six months of 2012 compared to the same period in 2011.

The volume rate analysis for 2012 that follows indicates that $1.2 million of the decrease in interest income is attributable to a decrease in interest rates, while the change in volume contributed to an increase of $506 thousand in interest income. Even more affected by volume and rate changes was the liability side of the balance sheet. The average rate of the Company's total outstanding deposits and borrowing liabilities decreased from 1.06% in 2011 to 0.67% in 2012. Based on the volume rate analysis that follows, the lower level of interest rates contributed to a decrease of $852 thousand in interest expense, while the change in volume was responsible for a $237 thousand decrease in interest expense. As a result, the increase in net interest income for the first six months in 2012 is mostly attributed to increases in volume in the loan and security portfolios and reduced rates on deposits.

The accompanying analysis of changes in net interest income in the following table shows the relationships of the volume and rate portions of these changes in 2012. Changes in interest income and expenses due to both rate and volume are allocated on a pro rata basis.

Changes in Interest Income and Expense



                                                                  2012 vs. 2011
                                                       Increase (Decrease) Due to Change in
(in thousands)                                     Volume             Rate            Net Change

INTEREST INCOME
Loans                                           $        318     $         (404 )   $          (86 )
Investment Securities                                    175               (752 )             (577 )
Other                                                     13                 (6 )                7
Total Interest Income                                    506             (1,162 )             (656 )
INTEREST EXPENSE
Deposits
Demand                                                   174               (377 )             (203 )
Savings                                                   11                (14 )               (3 )
Negotiable Certificates of Deposit and Other
Time Deposits                                           (171 )             (548 )             (719 )
Securities sold under agreements to
repurchase and other borrowings                          (37 )               26                (11 )
Federal Home Loan
Bank advances                                           (214 )               61               (153 )
Total Interest Expense                                  (237 )             (852 )           (1,089 )
Net Interest Income                             $        743     $         (310 )   $          433

Non-Interest Income

Non-interest income increased $877 thousand for the six months ended June 30, 2012, compared to the same period in 2011, to $5.0 million. The increase was due primarily to an increase of $565 thousand in gains recognized on sold mortgage loans, an increase of $108 thousand in debit card interchange income and an increase of $91 thousand in other non-interest income. Increases to non-interest income for the first six months of 2012 compared to the first six months of 2011 also included an increase of $47 thousand in recognized gains on sold securities, an increase of $49 thousand in brokerage income and an increase of $27 thousand in service charges. Non-interest income increased $208 thousand for the three months ended June 30, 2012 compared to the three months ended June 30, 2011. The increase was mostly the result of an increase of $235 thousand in gains recognized on the sale of mortgage loans, an increase of $55 thousand in debit card interchange income and an increase of $74 thousand in other non-interest income. Increases to non-interest income for the three month period ending June 30, 2012 compared to the three months ending June 30, 2011 also includes a decrease of $110 thousand in gains recognized on sold securities, a decrease of $46 thousand in loan service fee income and a decrease of $40 thousand in service charges.

The gain on the sale of mortgage loans increased from $283 thousand in the first six months of 2011 to $848 thousand during the first six months of 2012, an increase of $565 thousand. For the three months ending June 30, 2012 compared to the same time period in 2011, the gain on the sale of mortgage loans increased $235 thousand. The volume of loans originated to sell during the first six months of 2012 increased $19.3 million compared to the same time period in 2011. The volume of mortgage loan originations and sales is generally inverse to rate changes. A change in the mortgage loan rate environment can have a significant impact on the related gain on sale of mortgage loans. Loan service fee income, net of amortization expense, was $83 thousand for the six months ending June 30, 2012 compared to $86 thousand for the six months ending June 30, 2011, a decrease of $3 thousand. For the three month period ending June 30, 2012, loan service fee income, net of amortization expense, was a loss of $4 thousand compared to positive income of $42 thousand for the same time period one year ago. During the first six months of 2012, the carrying value of the mortgage servicing right was written up a net amount of $40 thousand, as the fair value of this asset recovered. Of this, a positive adjustment of $63 thousand was recorded in the first quarter of 2012 and a write-down of $23 thousand was recorded during the second quarter of 2012. For the six months ending June 30, 2011, the carrying value of the mortgage servicing right had a positive valuation adjustment in the amount of $41 thousand with a $ 20 thousand positive adjustment recorded during the first quarter of 2011 and a $21 thousand positive adjustment recorded during the second quarter of 2011.

Non-Interest Expense

Total non-interest expenses increased $732 thousand for the six month period ended June 30, 2012 compared to the same period in 2011. For the three month period ended June 30, 2012 compared to the three months ending June 30, 2011, total non-interest expense decreased $46 thousand.

For the comparable six month periods, salaries and benefits increased $277 thousand, an increase of 4.7%. The increase is attributed largely to additional employees being hired throughout 2011 and 2012 and normal pay increases at the beginning of 2012. The number of full time equivalent employees at June 30, 2012 was 197 compared to 188 one year ago and 184 at December 31, 2010. Salaries and employee benefits decreased $88 thousand for the three month period ending June 30, 2012 compared to the same time period in 2011.

Occupancy expenses decreased $25 thousand to $1.5 million for the first six months of 2012 compared to the same time period in 2011. Occupancy expenses increased $21 thousand for the three month period ended June 30, 2012 compared to the same time period in 2011.

Legal and professional fees increased $5 thousand for the first six months ended June 30, 2012 compared to the same time period in 2011. Legal and professional fees decreased $25 thousand for the three month period ending June 30, 2012 compared to the same time period in 2011. Repossession expenses increased $226 thousand for the first six months ending June 30, 2012 compared to the same time period in 2011 and decreased $24 thousand for the three months period ending June 30, 2012 compared to the same period one year ago. Repossession expenses are reported net of income earned on the repossessed properties. Repossession expenses were higher during the first six months of 2012 when compared to the same time period in 2011 due to maintaining additional other real estate owned properties in 2012. In addition, the rents earned on other real estate properties, including new property added, decreased $106 thousand to $169 thousand for the six months ending June 30, 2012 compared to the same period last year. FDIC insurance expense decreased $167 thousand for the six months ending June 30, 2012 and $79 thousand for the three months ending June 30, 2012, compared to the same time period in 2011. The decrease is mostly attributed to a change in the calculation the FDIC uses to assess insurance premiums.

Income Taxes

The effective tax rate for the six months ended June 30, 2012 was 18.2% compared to 14.2% in 2011. The effective tax rate for the three months ended June 30, 2012 was 19.4% compared to 14.3% for the three months ended June 30, 2011. These rates are less than the statutory rate as a result of the tax-free securities and loans and tax credits generated by certain investments held by the Company. The rates for 2012 are higher due to the higher level of income for 2012. Tax-exempt interest income decreased $20 thousand for the first six months of 2012 compared to the first six months of 2011.

As part of normal business, Kentucky Bank typically makes tax free loans to select municipalities in our market and invests in selected tax free securities, primarily in the Commonwealth of Kentucky. In making these investments, the Company considers the overall impact to managing our net interest margin, credit worthiness of the underlying issuer and the favorable impact on our tax position. For the six months ended June 30, 2012, the Company averaged $81.2 million in tax free securities and $17.6 million in tax free loans. As of June 30, 2012, the weighted average remaining maturity for the tax free securities is 140 months, while the weighted average remaining maturity for the tax free loans is 151 months.

Liquidity and Funding

Liquidity is the ability to meet current and future financial obligations. The Company's primary sources of funds consist of deposit inflows, loan repayments, maturities and sales of investment securities and FHLB borrowings.

Liquidity risk is the possibility that we may not be able to meet our cash requirements. Management of liquidity risk includes maintenance of adequate cash and sources of cash to fund operations and to meet the needs of borrowers, depositors and creditors. Excess liquidity has a negative impact on earnings as a result of the lower yields on short-term assets.

Cash and cash equivalents were $15.3 million as of June 30, 2012 compared to $17.7 million at December 31, 2011. The decrease in cash and cash equivalents is attributed to a decrease of $1.9 million in cash and due from banks and a decrease of $418 thousand in federal funds sold. In addition to cash and cash equivalents, the securities portfolio provides an important source of liquidity. Securities available for sale totaled $185.0 million at June 30, 2012 compared to $180.4 million at December 31, 2011. The available for sale securities are available to meet liquidity needs on a continuing basis. However, we expect our customers' deposits to be adequate to meet our funding demands.

Generally, we rely upon net cash inflows from financing activities, supplemented by net cash inflows from operating activities, to provide cash used in our investing activities. As is typical of many financial institutions, significant financing activities include deposit gathering and the use of short-term borrowings, such as federal funds purchased and securities sold under repurchase agreements along with long-term debt. Our primary investing activities include purchasing investment securities and loan originations.

For the first six months of 2012, deposits increased $207 thousand. The Company's investment portfolio increased $4.5 million and the Company's loan portfolio increased $9.5 million. The borrowed funds the Company have with the Federal Home Loan Bank increased $3.0 million. The Company paid down FHLB advances by $25.0 million during the first six months of 2012 but replaced some of those maturing advances with new short-term borrowings. Federal Funds purchased increased $2.7 million from $0 at December 31, 2011 to $2.7 million at June 30, 2012.

The Company has a promissory note payable that matures July 29, 2012, and has principal due at maturity and interest payable quarterly at prime, and is secured by 100% of the common stock of the bank. The loan agreement contains certain covenants and performance terms. The Bank was not in compliance with the non-performing asset covenant at June 30, 2012. However, a debt covenant waiver was obtained from the lending institution. The loan is in the process of being renewed on similar terms for an additional 1 year term.

Management is aware of the challenge of funding sustained loan growth. Therefore, in addition to deposits, other sources of funds, such as Federal Home Loan Bank (FHLB) advances, may be used. We rely on FHLB advances for both liquidity and asset/liability management purposes. These advances are used primarily to fund long-term fixed rate residential mortgage loans. As of June 30, 2012, we have sufficient collateral to borrow an additional $58 million from the Federal Home Loan Bank. In addition, as of June 30, 2012, $21 million is available in overnight borrowing through various correspondent banks and the Company has access to $232 million in brokered deposits. In light of this, management believes there is sufficient liquidity to meet all reasonable borrower, depositor and creditor needs in the present economic environment.

Capital Requirements

The Company and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possible additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of the Company's and the Bank's assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Company and Bank capital amounts and classifications are also subject to qualitative judgments by regulators about components, risk weightings, and other factors.

Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (set forth in the following table) of Total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital to average assets (as defined). Management believes, as of June 30, 2012 and December 31, 2011, that the Company and the Bank meet all capital adequacy requirements to which they are subject.

The most recent notification from the Federal Deposit Insurance Corporation categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Bank must maintain minimum Total risk-based, Tier I risk-based and Tier I leverage ratios as set forth in the following table. There are no conditions or events since that notification that management believes have changed the institution's category.

The Company's and the Bank's actual amounts and ratios are presented in the table below:

                                                                                  To Be Well
                                                                                 Capitalized
                                                                                 Under Prompt
                                                        For Capital               Corrective
                                   Actual            Adequacy Purposes        Action Provisions
                               Amount    Ratio       Amount       Ratio        Amount       Ratio
                                                     (Dollars in Thousands)
June 30, 2012
Consolidated

Total Capital (to
Risk-Weighted Assets)         $ 66,246     14.3 %  $    37,002         8 %  $        N/A       N/A
Tier I Capital (to
Risk-Weighted Assets)           60,446     13.1         18,501         4             N/A       N/A
Tier I Capital (to Average
Assets)                         60,446      9.1         26,643         4             N/A       N/A

Bank Only
Total Capital (to
Risk-Weighted Assets)         $ 66,633     14.4 %  $    36,983         8 %  $     46,629        10 %
Tier I Capital (to
Risk-Weighted Assets)           60,836     13.2         18,492         4          27,737         6
Tier I Capital (to Average
Assets)                         60,836      9.1         26,633         4          33,291         5

December 31, 2011
Consolidated
Total Capital (to
Risk-Weighted Assets)         $ 64,279     14.0 %  $    36,718         8 %           N/A       N/A
Tier I Capital (to
Risk-Weighted Assets)           58,525     12.8         18,359         4             N/A       N/A
Tier I Capital (to Average
Assets)                         58,525      9.2         25,405         4             N/A       N/A

Bank Only
Total Capital (to
Risk-Weighted Assets)         $ 65,229     14.2 %  $    36,705         8 %  $     45,882        10 %
Tier I Capital (to
Risk-Weighted Assets)           59,476     13.0         18,353         4          27,529         6
Tier I Capital (to Average
Assets)                         59,476      9.4         25,405         4          31,756         5

Non-Performing Assets

As of June 30, 2012, our non-performing assets totaled $23.6 million or 3.56% of assets compared to $15.8 million or 2.40% of assets at December 31, 2011 (See table below.) The Company experienced an increase of $623 thousand in non-accrual loans from December 31, 2011 to June 30, 2012. As of June 30, 2012, non-accrual loans include $3.0 million in loans secured by real estate construction, $389 thousand in loans secured by farmland, $1.5 million in loans secured by 1-4 family residential properties, $1.5 million in loans secured by non-farm & non-residential real estate and $155 thousand in loans secured by multi-family residential real estate. Real estate loans composed 99.0% of the non-performing loans as of June 30, 2012 and 99.3% as of December 31, 2011. Forgone interest income on non-accrual loans totaled $180 thousand for the first six months of 2012 compared to forgone interest of $276 thousand for the same time period in 2011. Accruing loans that are contractually 90 days or more past due as of June 30, 2012 totaled $471 thousand compared to $398 thousand at December 31, 2011, an increase of $73 thousand. The total nonperforming and restructured loans increased $7.5 million from December 31, 2011 to June 30, 2012, resulting in an increase in the ratio of nonperforming loans to loans of 173 basis points to 3.56%. In addition, the amount the Company has booked as "Other Real Estate" has increased $348 thousand from December 31, 2011 to June 30, 2012. As of June 30, 2012, the amount recorded as "Other Real Estate" totaled $8.6 million compared to $8.3 million at December 31, 2011. The overall increase to total "Other Real Estate" properties is largely attributed to one property which was recorded into other real estate during 2012 and has a carrying value of $478 thousand. The property is classified as non-farm and non-residential. The allowance as a percentage of non-performing and restructured loans and Other Real Estate Owned decreased from 37% at December 31, 2011 to 24% at June 30, 2012.

. . .