Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act)

The aggregate market value of the registrant’s outstanding voting stock held by non-affiliates on June 30, 20102012 (the last business day of the registrant’s most recently completed second fiscal quarter) was $33.5$44.8 million based on the closing price per share of the registrant’s common stock reported on the NASDAQ.

As of March 7, 20111, 2013 there were 7,411,6767,469,813 shares of common stock outstanding.

Documents incorporated by reference:

An index of exhibits filed with this Form 10-K can be found on page 123.138.

Farmers Capital Bank Corporation (the “Registrant”, “Company”, “we”, “us”,“Registrant,” “Company,” “we,” “us,” or “Parent Company”) is a bank holding company with four wholly-owned bank subsidiaries.  The Registrant was originally formed as a bank holding company under the Bank Holding Company Act of 1956, as amended, on October 28, 1982 under the laws of the Commonwealth of Kentucky.Kentucky (“Commonwealth”).  During 2000, the Federal Reserve Board (“Federal Reserve” or “FRB”) granted the Company financial holding company status. The Company withdrew its financial holding company election subsequent to the sale of KHL Holdings, LLC (“KHL Holdings”) during the third quarter of 2009. The Company’s subsidiaries provide a wide range of banking and bank-related services to customers throughout Central and Northern Kentucky.  The Company’s four bank subsidiaries owned by the Company include Farmers Bank & Capital Trust Company ("Farmers Bank"), Frankfort, Kentucky; United Bank & Trust Company ("United Bank"), Versailles, Kentucky; First Citizens Bank (“First Citizens”), Elizabethtown, Kentucky; and Citizens Bank of Northern Kentucky, Inc. (“Citizens Northern”), Newport, Kentucky. The Lawrenceburg Bank and Trust Company ("Lawrenceburg Bank"), Lawrenceburg, Kentucky, which previously was a separate bank subsidiary of the Parent Company, was merged into Farmers Bank during the second quarter of 2010.

The Company also owns FCB Services, Inc., ("FCB Services"), a nonbank data processing subsidiary located in Frankfort, Kentucky; FFKT Insurance Services, Inc., (“FFKT Insurance”), a captive property and casualty insurance company in Frankfort, Kentucky; EKT Properties, Inc., established during 2008 to manage and liquidate certain real estate properties repossessed by the Company; and Farmers Capital Bank Trust I (“Trust I”), Farmers Capital Bank Trust II (“Trust II”), and Farmers Capital Bank Trust III (“Trust III”), which are unconsolidated trusts established to complete the private offering of trust preferred securities. In the case of Trust I and Trust II, the proceeds of the offerings were used to finance the cash portion of the acquisition in 2005 of Citizens Bancorp Inc. (“Citizens Bancorp”), the former parent company of Citizens Northern. For Trust III, the proceeds of the offering were used to finance the cost of acquiring Company shares under a share repurchase program during 2007.

Kentucky General Holdings, LLC, (“Kentucky General”), in Frankfort, Kentucky, was a nonbank subsidiary of the Parent Company until it was dissolved during the third quarter of 2010. During 2009 Kentucky General sold its entire interest in KHL Holdings, the parent company of Kentucky Home Life Insurance Company (“KHL Insurance”).

The Company provides a broad range of financial services at its 36 locations in 23 communities throughout Central and Northern Kentucky to individual, business, agriculture, government, and educational customers. Its primary deposit products are checking, savings, and term certificate accounts.  Its primary lending products are residential mortgage, commercial lending, and consumer installment loans. Substantially all loans and leases are secured by specific items of collateral including business assets, consumer assets, and commercial and residential real estate. Commercial loans and leases are expected to be repaid from cash flow from operations of businesses. Farmers Bank has served as the general depository for the Commonwealth of Kentucky for over 70 years and also provides investment and other services to the Commonwealth. Other services provided by the Company include, but are not limited to, cash management services, issuing letters of credit, safe deposit box rental, and providing funds transfer services.  Other financial instruments, which potentially represent concentrations of credit risk, include deposit accounts in other financial institutions and federal funds sold.

While the chief decision-makers monitor the revenue streams of the various products and services, operations are managed and financial performance is evaluated on a Company-wide basis.   Operating segments are aggregated into one as operating results for all segments are similar. Accordingly, all of the financial service operations are considered by management to be aggregated in one reportable segment.  As of December 31, 2010,2012, the Company had $1.9$1.8 billion in consolidated assets.

Subsidiaries of Farmers Capital Bank Corporation at December 31, 20102012 are indicated in the table that follows. Percentages reflect the ownership interest held by the parent company of each of the subsidiaries. Tier 2 subsidiaries are direct subsidiaries of Farmers Capital Bank Corporation. Tier 3 subsidiaries are direct subsidiaries of the Tier 2 subsidiary listed immediately above them. Tier 4 subsidiaries are direct subsidiaries of the Tier 3 subsidiary listed immediately above them. Tier 5 subsidiaries are direct subsidiaries of the Tier 4 subsidiary listed immediately above them.

Farmers Bank, originally organized in 1850, is a state chartered bank engaged in a wide range of commercial and personal banking activities, which include accepting savings, time and demand deposits; making secured and unsecured loans to corporations, individuals and others; providing cash management services to corporate and individual customers; issuing letters of credit; renting safe deposit boxes; and providing funds transfer services.  The bank's lending activities include making commercial, construction, mortgage, and personal loans and lines of credit.  The bank serves as an agent in providing credit card loans.  It acts as trustee of personal trusts, as executor of estates, as trustee for employee benefit trusts and as registrar, transfer agent and paying agent for bond issues.

Farmers Bank is the largest bank operating in Franklin County based on total bank deposits in the county.  It conducts business at its principal office and four branches in Frankfort, the capital of Kentucky, as well as two branches in Anderson County, Kentucky, and one branch each in Mercer County, Kentucky and Boyle County, Kentucky.  The market served by Farmers Bank is diverse, and includes government, commerce, finance, industry, medicine, education, and agriculture.  The bank serves many individuals and corporations throughout Central Kentucky.  On December 31, 2010,2012, it had total consolidated assets of $750$699 million, including loans net of unearned income of $422$338 million.  On the same date, total deposits were $570$559 million and shareholders' equity totaled $67.2$73.4 million.

On October 23, 2009, the Company announced that it was in the preliminary stages of merging Lawrenceburg Bank into Farmers Bank.  The Company applied for regulatory approval for the merger in the first quarter of 2010 and the merger was effective during the second quarter of 2010.

Farmers Bank had teneight active direct subsidiaries during 2010:at year-end 2012:  Farmers Bank Realty Co. ("Farmers Realty"), Leasing One Corporation ("Leasing One"), Farmers Capital Insurance Corporation (“Farmers Insurance”), EG Properties, Inc. (“EG Properties”), FA Properties, Inc. (“FA Properties”), FORE Realty, LLC (“FORE Realty”), LORE Realty, LLC (“LORE Realty”), St. Clair Properties, LLC (“St. Clair Properties”), Austin Park Apartments, LTD (“Austin Park”), and Frankfort Apartments II, LTD (“Frankfort Apartments”).

Farmers Realty was incorporated in 1978 for the purpose of owning certain real estate used by the Company and Farmers Bank in the ordinary course of business.  Farmers Realty had total assets of $3.8$3.7 million on December 31, 2010.2012.

Farmers Insurance was organized in 1988 to engage in insurance activities permitted to the Company under federal and state law.  Farmers Bank capitalized this corporation in December 1998.   Farmers Insurance acts as an agent for Stewart Title Guaranty Company.  At year-end 20102012, it had total assets of $241$565 thousand.  Farmers Insurance holds a 50% interest in Farmers Fidelity Insurance Company,Agency, LLP (“Farmers Fidelity”).  The Creech & Stafford Insurance Agency, Inc., an otherwise unrelated party to the Company, also holds a 50% interest in Farmers Fidelity. Farmers Fidelity is a direct writer of property and casualty coverage, both individual and commercial.

In November 2002, Farmers Bank incorporated EG Properties.  EG Properties is involved in real estate management and liquidation for certain properties repossessed by Farmers Bank.  ItEG Properties holds a 93.4% interest in WCO, LLC

(“WCO”), which was formed during 2012 to hold certain real estate that has been repossessed by Farmers Bank and United Bank. EG Properties had total assets of $6.2$19.5 million at December 31, 2010.year-end 2012.

In July 2008, Farmers Bank incorporated FA Properties which, ownsprior to its dissolution during the fourth quarter of 2011, owned automobiles that arewere used by the Company and Farmers Bank in the ordinary course of business. It had total assets of $380 thousand at year-end 2010. FORE Realty and LORE Realty were organized in December 2009 and February 2010, respectively, for the purpose of managing and liquidating certain other properties repossessed by Farmers Bank. At year-end 20102012, FORE Realty had total assets of $67$600 thousand; LORE Realty was dissolved effective January 1, 2011.

Farmers Bank is a limited partner in Austin Park and Frankfort Apartments, two low income housing tax credit partnerships located in Frankfort, Kentucky.  These investments provide for federal income tax credits to the Company.  Farmers Bank’s aggregate investment in these partnerships was $417 thousand at year-end 2010. In December 2009, Farmers Bank became a limited partner in St. Clair Properties. The objective of St. Clair Properties is to restore and preserve certain qualifying historic structures in Frankfort for which the Company receives federal and state tax credits. Farmers Bank’s investment in St. Clair Properties was less than $10 thousandcumulative share of losses from the three partnerships at year-end 2010.2012 has exceeded the amount invested by an aggregate amount of $54 thousand.

On June 28, 1985, the Company acquired Lawrenceburg Bank, a state chartered bank originally organized in 1885 in Anderson County. As mentioned above, Lawrenceburg Bank was merged into Farmers Bank during the second quarter of 2010. Based on deposits at its Anderson County locations, Farmers Bank has the largest market presence in Anderson County.

On February 15, 1985, the Company acquired United Bank, a state chartered bank originally organized in 1880.  It is engaged in a general banking business providing full service banking to individuals, businesses and governmental customers.  On November 1, 2008, the Company merged Farmers Bank & Trust Company (“Farmers Georgetown”) and Citizens Bank of Jessamine County (“Citizens Jessamine”) into United Bank. Each of these three banks was previously a wholly-owned subsidiary of the Company. United Bank conducts business in its principal office and two branches in Woodford County, Kentucky, four branches in Scott County, Kentucky, threetwo branches in Fayette County, Kentucky, and four branches in Jessamine County, Kentucky.  Based on total bank deposits in Woodford County, United Bank is the second largest bank operating in Woodford County withCounty. On December 31, 2012, United Bank had total consolidated assets of $614$540 million, including loans net of unearned income of $296 million. On the same date, total deposits were $405 million and total deposits of $448 million at December 31, 2010.

United Bank had one direct subsidiary during 2010,2012, EGT Properties, Inc. (“EGT Properties”). EGT Properties was created in March 2008 and is involved in real estate management and liquidation for certain repossessed properties of United Bank.  In addition, EGT Properties holds an 83% interest in NUBT Properties, LLC (“NUBT”), the parent company of Flowing Creek Realty, LLC (“Flowing Creek”). Flowing Creek holds certain real estate that has been repossessed by United Bank and Citizens Northern along with parties unrelated to the Company. NUBT holds a 67% interest in Flowing Creek and unrelated financial institutions hold the remaining 33% interest. EGT Properties had total assets of $22.0$31.0 million at year-end 2010.

On June 30, 1986, the Company acquired Farmers Georgetown, a state chartered bank originally organized in 1850 located in Scott County, Kentucky. On November 1, 2008, the Company merged Farmers Georgetown into United Bank. Based on deposits at its Scott County locations, United Bank has the largest market presence in Scott County.

On October 1, 2006, the Company acquired Citizens National Bancshares (“Citizens Bancshares”), the former one-bank holding company of Citizens Jessamine. Citizens Bancshares was subsequently merged into the Company, leaving Citizens Jessamine as a direct subsidiary of the Company. Citizens Jessamine, organized in 1996 as a national charter bank located in Jessamine County, Kentucky, was merged into United Bank on November 1, 2008.  Based on deposits at its Jessamine County locations, United Bank has the second largest market presence in Jessamine County.

On March 31, 1986, the Company acquired First Citizens, a state chartered bank originally organized in 1964.  It is engaged in a general banking business providing full service banking to individuals, businesses and governmental customers. It conducts business at its main office and three branches in Hardin County, Kentucky along with two branch offices in Bullitt County, Kentucky. During 2003 First Citizens incorporated EHHBJ Properties, Inc.  This company was involved in real estate managementLLC (“HBJ Properties”) during 2012 to hold, manage, and liquidation forliquidate certain properties repossessed by First Citizens prior to it being dissolved in January, 2007.Citizens. HBJ Properties had total assets of $4.4 million at year-end 2012.

On October 8, 2004, First Citizens acquired Financial National Electronic Transfer, Inc. (“FiNET”), a data processing company that specializes in the processing of federal benefit payments and military allotments, headquartered in Radcliff, Kentucky.  Effective January 1, 2005 FiNET was merged into First Citizens. These services are now operated using the name of FirstNet.

On November 2, 2006, First Citizens announced the signing of a definitive agreement to acquire the military allotment operation of PNC Bank, National Association based in Elizabethtown, Kentucky. The operation specializes in the processing of data associated with military allotments and federal benefit payments. The transaction was completed on January 12, 2007 and merged into First Citizens and its FirstNet operations.

Based on total bank deposits in Hardin County, First Citizens ranks thirdfourth in size compared to all banks operating in Hardin County.  TotalOn December 31, 2012, First Citizens had total consolidated assets were $296of $310 million, andincluding loans net of unearned income of $203 million. On the same date, total deposits were $250$268 million at December 31, 2010.and shareholders’ equity was $30.1 million.

On December 6, 2005, the Company acquired Citizens Bancorp in Newport, Kentucky.  Citizens Bancorp was subsequently merged into Citizens Acquisition, a former bank holding company subsidiary of the Company. During January 2007, Citizens Acquisition was merged into the Company, leaving Citizens Northern as a direct subsidiary of the Company. Citizens Northern is a state chartered bank organized in 1993 and is engaged in a general banking business providing full service banking to individuals, businesses, and governmental customers.  It conducts business in its principal office in Newport and four branches in Campbell County, Kentucky, one branch in Boone County, Kentucky and two branches in Kenton County, Kentucky. Based on total bank deposits in Campbell County, Citizens Northern ranks thirdfourth in size compared to all banks operating in Campbell County.  At year-end 2010 it2012, Citizens Northern had total consolidated assets andof $251 million, including loans net of unearned income of $168 million. On the same date, total deposits of $250were $251 million and $201 million, respectively. Citizens Financial Services, formerly an investment brokerage subsidiary of Citizens Acquisition,shareholders’ equity was dissolved during 2006.$24.6 million.

In March 2008, Citizens Northern incorporated ENKY Properties, Inc. (“ENKY”). ENKY was established to manage and liquidate certain real estate properties repossessed by Citizens Northern. In addition, ENKY also holds a 17% interest in NUBT, the parent company of Flowing Creek. Flowing Creek holds real estate that has been repossessed by Citizens Northern and United Bank along with parties unrelated to the Company. NUBT holds a 67% interest in Flowing Creek and unrelated financial institutions hold the remaining 33% interest. ENKY had total assets of $1.1$5.0 million at year-end 2010.

FCB Services, organized in 1992, provides data processing services and support for the Company and its subsidiaries.  It is located in Frankfort, Kentucky. It also performs data processing services for nonaffiliated entities.  FCB Services had total assets of $3.2$4.2 million at December 31, 2010.2012.

Kentucky General was incorporated in November 2004. Kentucky General2004 and previously held a 50% voting interest in KHL Holdings prior to its sale during the third quarter of 2009.  KHL Holdings owned a 100% interest in KHL Insurance that it acquired in 2005. KHL Insurance writeswas a writer of credit life and health insurance in Kentucky. Kentucky General was dissolved during 2010.

EKT was created in September 2008 to manage and liquidate certain real estate properties repossessed by the Company’s subsidiary banks. On December 31, 2010,2012, EKT had total assets of $4.1$3.2 million.

Kentucky General Life Insurance Company was incorporated during 2000 to engage in insurance activities permitted by federal and state law.  This corporation has remained inactive since its inception and was dissolved during 2010.

Trust I, Trust II, and Trust III are each separate Delaware statutory business trusts sponsored by the Company.  The Company completed two private offerings of trust preferred securities during 2005 through Trust I and Trust II totaling $25.0 million. During 2007, the Company completed a private offering of trust preferred securities totaling $22.5 million. The Company owns all of the common securities of each of the Trusts. The Company does not consolidate the Trusts into its financial statements consistent with applicable accounting standards.

FFKT Insurance was incorporated during 2005. It is a captive property and casualty insurance company insuring primarily deductible exposures and uncovered liability related to properties of the Company. ItFFKT Insurance had total assets of $3.3$2.9 million at December 31, 2010.2012.

A significant part of the Company’s operating activities include originating loans, approximately 87%89% of which are secured by real estate at December 31, 2010.2012.  Real estate lending primarily includes loans secured by owner and non-owner occupied one-to-four family residential properties as well as commercial real estate mortgage loans to developers and owners of other commercial real estate.  Real estate lending primarily includes both variable and adjustable rate products.  Loan rates on variable rate loans generally adjust upward or downward immediately based on changes in the loan’s index, normally prime rate as published inby the Wall Street Journal.  Rates on adjustable rate loans move upward or downward after an initial fixed term of normally one, three, or five years. Rate adjustments on adjustable rate loans are made annually after the initial fixed term expires and are indexed mainly to shorter-term Treasury indexes.  Generally, variable and adjustable rate loans contain provisions that cap the amount of interest rate increases over the life of the loan of up to 600 basis points and lifetime floorsrate decreases of up to 100 basis points.points over the life of the loan. Over the past year, it has been increasingly common for the Company to set the floor equal to the initial rate without further downward adjustments. In addition to the lifetime caps and floors on rate adjustments, loans secured by residential real estate typically contain provisions that limit annual increases at a maximum of 100 basis points. There is typically no annual limit applied to loans secured by commercial real estate.

The Company also makes fixed rate commercial real estate loans to a lesser extent with repayment termsperiods generally not exceeding 12 months.ranging from three to five years.  The Company’s subsidiary banks make first and second residential mortgage loans secured by real estate not to exceed 90% loan to value without seeking third party guarantees.  Commercial real estate loans are made primarily to small and mid-sized businesses, secured by real estate not exceeding 80% loan to value.  Other commercial loans are asset based loans secured by equipment and lines of credit secured by receivables and include lending across a diverse range of business types.

Commercial lending and real estate construction lending, including commercial leasing, generally includes a higher degree of credit risk than other loans, such as residential mortgage loans.  Commercial loans, like other loans, are evaluated at the time of approval to determine the adequacy of repayment sources and collateral requirements.  Collateral requirements vary to some degree among borrowers and depend on the borrower’s financial strength, the terms and amount of the loan, and collateral available to secure the loan.  Credit risk results from the decreased ability or willingness to pay by a borrower.  Credit risk also results when a liquidation of collateral occurs and there is a shortfall in collateral value as compared to a loan’s outstanding balance.  For construction loans, inaccurate initial estimates of a project’s costs andor the property’s completed value could weaken the Company’s position and lead to the property having a value that is insufficient to satisfy full payment of the amount of funds advanced for the property.  Secured and unsecured direct consumer loanslending generally areis made for automobiles, boats, and other motor vehicles.  The Company does not presently engage in indirect consumer lending. Credit card lending is limited to one affiliate and is considered nominal risk exposure due to extremely low volume. In most cases loans are restricted to the subsidiaries' general market area.

The Company has a company-wide lending policy in place that is amended and approved from time to time as needed to reflect current economic conditions, law and regulatory changes, and product offerings in its markets.  The policy has established minimum standards that each of its bank subsidiaries must adopt. Additionally, the policy is subject to amendment based on positive and negative trends observed within the lending portfolio as a whole.  As an example, the loan to value limits and amortization terms contained within the policy were reduced during 2009 due to the declining

economy and the attendantrelated real estate market decline.  While new appraisals now reflect that decline, appraisal reviews and downward adjustments are a

 

The Company’s subsidiary banks may amend their lending policy so long as the amendment is no less stringent than the company-wide lending policy. These amendments are done within the control structure and oversight of the parent company.  The Company’s board of directors voted in favor ofapproved a recommendation from management during 2009 to create the position of Chief Credit Officer.  This position oversees all lending at affiliate institutions where the size and risk of individual credits are deemed significant to the Company.  The Chief Credit Officer also monitors trends in asset quality, portfolio composition, concentrations of credit, reports of examinations, internal audit reports, work-out strategies for large credits, and other responsibilities as matters evolve.

The lending policy lists the products and credit services offered by each of the Company’s subsidiary banks.   Each product and service has an established written procedure to adhere to when transacting business with a customer.   The lending policy also establishes pre-determined lending authorities for loan officers commensurate with their abilities and experience.  Further, the policy establishes committees to review and approve or deny credit requests at various lending amounts.  This includes subcommittees of the bank boards of directors and, at certain lending levels, the entire bank board.

Generally, for loans in excess of $1$2.5 million, the bank subsidiaries bank’s full board of directors will be presented with the loan request. This only occurs when the potential credit has first been recommended by the loan officer and chief credit officer of the subsidiary bank, and then by the directors’ loan committee.committee and the Chief Credit Officer.  When loan requests are within policy guidelines and the amount requested is within their lending authority, lenders are permitted to approve and close the transaction.  A review of the loan file and documentation takes place within 30 days to ensure policy and procedures are being followed.  Approval authorities are under regular review for adjustment by affiliate management and the parent company.Parent Company.  Loan requests outside of standard policy may be made on a case by case basis when justified, documented, and approved by either the board of directors of the subsidiary bank.bank, committee, or other authorized person as determined by the size of the transaction. Procedures are in place that requires ongoing monitoring subsequent to loan approval. For example, updated financial statements are required periodically for certain types of credits and risk ratings are re-evaluated at least annually for credit relationships in excess of $500 thousand, which includes analyzing updated cash flows and loan to value ratios.

Underwriting criteria for all types of loans are prescribed within the lending policy.

Commercial real estate lending made up 42% of the loan portfolio at year-end 2012. Commercial real estate lending underwriting criteria is documented in the lending policy.policy and includes loans secured by office buildings, retail stores, warehouses, hotels, and other commercial properties. Underwriting criteria and procedures for commercial real estate loans include:

RealThe Company’s real estate construction lending has declined over the last several years due to recent economic conditions. Where the Company’s markets continue to demonstrate demand, construction lending is continuingcontinues with close monitoring of the borrower and the local economy. At year-end 2010,2012, real estate construction lending comprised approximately 13%10% of the total loan portfolio.

Commercial, financial, and agriculture lending underwriting criteria is documented in the lending policy.policy and includes loans to small and medium sized businesses secured by business assets, loans to financial institutions, and loans to farmers and for the production of agriculture. At year-end 2012, these loans made up approximately 9% of the total loan portfolio Underwriting criteria and procedures for such loans are detailed below.

For commercial loans secured by business assets, the following loan to value ratios and debt coverage are required by policy:

Loans to financial institutions are generally secured by the capital stock of the financial institution with a loan to value ratio not to exceed 60% and repayment terms not exceeding 10 years. Capital stock values of non-public companies are determined by common metrics such as a multiple of tangible book value or by obtaining third party estimates. Financial covenants are also obtained that require the borrower to maintain certain levels of asset quality, capital adequacy, liquidity, profitability, and regulatory compliance. At year-end 2010,2012, loans to financial institutions were $16.4$12.9 million. The Company has not experienced any loan losses related to financial institutions.

Agricultural lending, such as for tobacco or corn, is limited to 75% of expected sales proceeds while lending for cattle and farm equipment is capped at 80% loan to value.

Interest only loans are limited to construction lending and properties recently completed and undergoing an occupancy stabilization period.  These loans are short-term in nature, usually with maturities of less than one year.

Installment lending is a relatively small component of the Company’s portfolio mix, reflecting 2.4%less than 2% of outstanding loans at year-end 2010.2012. These loans predominantly are direct loans to established bank customers and primarily include the financing of automobiles, boats, and other consumer goods. The character, capacity, collateral, and conditions are evaluated using policy restraints. Installment loans are made for terms of up to 5 years.

Installment lending underwriting criteria and procedures for such financing include:

Lease financing is also a relatively small component of the Company’s portfolio, representing 1.3%less than 1% of outstanding loans at year-end 2010.2012.  Lease receivables are generally obtained through indirect sources such as equipment brokers and dealers.  The board of directors of the Company’s Leasing One subsidiary has reduced the staff and curtailed new lending in this environmentleasing transactions for the present time.foreseeable future.  Servicing existing leases and terming out residuals are the extent of its ongoing activity at the present time.

Lease financing underwriting criteria is documented by policy. Underwriting criteria and procedures for such financing include:

The Company and its subsidiary banks have a policy of not underwriting, originating, selling or holding hybrid loans.  The Company does not currently hold hybrid loans.  Hybrid loans include payment option adjustable rate mortgages (ARM’s), negative amortization loans, and stated income/stated asset loans.

The valuevalues of real estate in the Company’s markets hasare beginning to stabilize, but overall levels have generally declined as a result ofduring the economic downturn beginningwhich accelerated in 2008. Net loan charge-offs have been negatively impacted in recent years by slower sales and excess inventory related to loans secured by real estate developments.estate. The slower sales and excess inventory has decreased the cash flow and financial prospects of many borrowers, particularly those in the real estate development and related industries, and reduced the estimated fair value of the collateral securing these loans.

The Company uses independent third party state-certifiedstate certified or licensed appraisers. These appraisers take into account local market conditions when preparing their estimate of a properties fair value. However, management of the Company will often include refinements in the appraised value for estimated costs to sell as required under relevant accounting standards.

The Company considers appraisals it receives on one property as a means to extrapolate the estimated value for other collateral of similar characteristics if that property may not otherwise have a need for an appraisal. Should a borrower’s financial condition continue to deteriorate, an updated appraisal on that specific collateral will be obtained.

Appraisals obtained for construction and development lending purposes are performed by state licensed or state-certifiedstate certified appraisers who are credentialed and on the Company’s approved list.  Plans and specifications are provided to the appraiser by bank personnel not directly involved in the credit approval process.  The appraisals conform to the standards of appraisal practices established by the Appraisal Standards Board in effect at the time of the appraisal. This includes net present value accounting for construction and development loans on an “as completed” and “as is” basis.

Appraisal reviews are conducted internally by bank personnel familiar with the local market and who are not directly involved in the credit approval process.process and externally by state licensed and certified appraisers.  Bank personnel do not increase the valuation from the appraisal but may, in some instances, make a reduction. Upon completion, a follow up site visit by the appraiser is completed to verify the property was improved perin accordance with the original plans and specifications and recertify, if appropriate, the original estimate of “as completed” market value.  There are two circumstancesCircumstances where management may make adjustments to appraisals:appraisals include the following:

Loan to value ratios are typically well under 100% at inception, which gives the Company a cushion as collateral values fall.  However, when updated appraisals reveal collateral exposure (i.e. the value of the collateral for a nonperforming loan is less than originally estimated and no longer supports the outstanding loan balance)amount), negotiations ensue with the borrower aimed at providing additional collateral support for the credit.  This may be in many forms as determined by the financial holdings of the borrower.  If not available, third party support for the credit is pursued (e.g., guarantors or equity investors).  If negotiations fail to provide additional adequate collateral support, reserves are allocated to the loan or the loan is written down to the fair value of the collateral less the estimated costs to sell.

When a construction loan or development loan is downgraded, a new appraisal is ordered contemporaneously with the downgrade.  The appraisers are instructed to give a fair value based upon both an “as is” basis and an “as completed” basis.  The twofold purpose is to facilitate management’s decision making process in determining the cost benefits of completing a project vs.compared with marketing the project as is.

The carrying value of a downgraded loan or non performingnonperforming asset wherein the underlying collateral is an incomplete project is based on a freshan updated appraisal at the “as is” value.  The current appraisal is a compilation of the most recent sales available and therefore includes the risk premium established by the market conditions.  When the comparable sales are not deemed to be reliable or the adjustments are not satisfactory, management will make appropriate adjustments to the fair value which includes a risk premium (discount) deducted using the discounted cash flow framework.  The reserve or write down is expended upon completion of the appraisal and other relevant information assessment.

Interest reserves represent funds loaned to a borrower for the payment of interest during the development phase on certain construction and development loans. Interest reserves were a common industry practice when banks were more actively lending in their markets and the

sources and uses of funds for the project, and is intended to match the project’s debt service requirements with its expected cash flows. In all construction lending projects, we monitorthe Company monitors the project to determine if it is being completed as planned and if sales/stabilization projections are being met.

 

SinceAs a result of the overall decline in the real estate market has diminished over time,during the last several years, the Company has been less active in construction and development lending and the use of the interest reserves. For present and future construction and development loan requests, borrowers must show sufficient cash reserves and significant excess cash flow from all sources in addition to other underwriting criteria measures.  The projects viability is a major consideration as well, along with the probability of its stabilization and/or sale.

The Company and its subsidiaries are subject to comprehensive supervision and regulation that affect virtually all aspects of their operations. These laws and regulations are primarily intended to protectfor the protection of depositors, borrowers, and borrowersfederal deposit insurance funds, and, to a lesser extent, stockholders.for the protection of stockholders and creditors. Changes in applicable laws, regulations, or in the policies of banking and other government regulators may have a material adverse effect on our current or future business. The following summarizes certain of the more important aspects of the relevant statutory and regulatory provisions.

The Company is a bank holding company, registered with and regulated by the Federal Reserve Board (“FRB”).Reserve. All four of its subsidiary banks are Kentucky state-chartered banks. Two of the Company’s subsidiary banks are members of their regional Federal Reserve Bank. The Company and its subsidiary banks are subject to supervision, regulation and examination by the Federal Reserve, Federal Deposit Insurance Corporation (“FDIC”) and the Kentucky Department of Financial Institutions (“KDFI”). The regulatory authorities routinely examine the Company and its subsidiary banks to monitor their compliance with laws and regulations, financial condition, adequacy of capital and reserves, quality and documentation of loans, payment of dividends, adequacy of systems and controls, credit underwriting and asset liability management, and the establishment of branches. The Company and its subsidiary banks are required to file regular reports with the FRB, the FDIC and the KDFI, as applicable.

The FRB, the FDIC, and the KDFI require the Company and its subsidiary banks to meet certain ratios of capital to assets in order to conduct their activities. To be well-capitalized, the institutions must generally maintain a Total Risk-based Capital ratio of 10% or greater, a Tier 1 Risk-based Capital ratio of 6% or greater, and a Tier 1 Leverage ratio of 5% or more. For the purposes of these tests, Tier 1 Capital consists of common equity and related surplus, retained earnings, and a limited amount of qualifying preferred stock, less goodwill (net of certain deferred tax liabilities) and certain core deposit intangibles. Tier 2 Capital consists of non-qualifying preferred stock, certain types of debt and a limited amount of other items. Total Capital is the sum of Tier 1 and Tier 2 Capital.

In measuring the adequacy of capital, assets are generally weighted for risk. Certain assets, such as cash and U.S. government securities, have a zero risk weighting. Others, such as commercial and consumer loans, have a 100% risk weighting. Risk weightings are also assigned for off-balance sheet items such as loan commitments. The various items are multiplied by the appropriate risk-weighting to determine risk-adjusted assets for the capital calculations. For the leverage ratio mentioned above, average quarterly assets (as defined) are used and are not risk-weighted.

If the institution fails to remain well-capitalized, it will be subject to a series of restrictions that increase as the capital condition worsens. For instance, federal law generally prohibits a depository institution from making any capital distribution, including the payment of a dividend or paying any management fee to its holding company, if the depository institution would be undercapitalized as a result. Undercapitalized depository institutions may not accept brokered deposits absent a waiver from the FDIC, are subject to growth limitations, and are required to submit a capital restoration plan for approval, which must be guaranteed by the institution’s parent holding company. Significantly undercapitalized depository institutions may be subject to a number of requirements and restrictions, including orders to sell sufficient voting stock to become adequately capitalized, requirements to reduce total assets, and cessation of receipt of deposits

from correspondent banks. Critically undercapitalized institutions are subject to the appointment of a receiver or conservator.

In December 2010, the Basel Committee on Banking Supervision issued final rules related to global regulatory standards on bank capital adequacy and liquidity (commonly referred to as “Basel III”) previously agreed on by the Group of Governors and Heads of Supervision (the oversight body of the Basel Committee).  The new rules present details of the Basel III framework, which includes increased capital requirements and limits the types of instruments that can be included in Tier 1 capital. U.S. federal banking agencies issued proposed rules during 2012 seeking to implement Basel III standards effective January 1, 2013. Due to the nature and volume of comments received on the proposed rules, the federal banking agencies announced that the proposed rules would not become effective on the date proposed. There has been no indication of an alternative effective date by the agencies. As such, the dates and phase-in periods of the Basel III framework discussed below will change. Final rules could change significantly from the proposed rules.

Basel III includes the following provisions: (i) that the minimum ratio of common equity to risk weightedrisk-weighted assets be increased to 4.5% from the current level of 2%, to be fully phased in by January 1, 2015, and (ii) that the minimum requirement for the Tier 1 Risk-based capital

Basel III also includes a “capital conservation buffer” requiring banking organizations to maintain an additional 2.5% of Tier 1 common equity to total risk weightedrisk-weighted assets in addition to the minimum requirement. This requirement willwas initially set to be phased in between January 1, 2016 and January 1, 2019. The capital conservation buffer is designed to absorb losses in periods of financial and economic distress and, while banks are allowed to draw on the buffer during periods of stress, if a bank’s regulatory capital ratios approach the minimum requirement, the bank will be subject to more stringent constraints on dividends and bonuses. In addition, Basel III includes a countercyclical buffer of up to 2.5%, which could be imposed by countries to address economies that appear to be building excessive system-wide risks due to rapid growth.

To constrain the build-up of excess leverage in the banking system, Basel III introduces a new non-risk-based leverage ratio. A minimum Tier 1 Leverage ratio of 3% willwas initially to be tested during a parallel run period between January 1, 2013 and January 1, 2017. Based on the results of the parallel run period,2017 with any final adjustments would be carried out in the first half of 2017.2017 based on the results of the parallel run.

As discussed above, regulatory agencies in the U.S. have yet to adopt final rules for implementing Basel III. Further regulations and guidelines issued by banking regulators may significantly differ from current proposals. The impact from Basel III is not expected toregulatory agencies’ current proposal, if adopted, could have a material negative impact on the Company’s level of capital. In addition to the overall higher levels of required capital, sincethe proposed rules would phase out the inclusion of trust preferred securities from the Company’s regulatory capital base. Unrealized holding gains and losses related to available for sale securities would be included as a component of capital under the current levels areproposal, which could lead to high degree of volatility in excessregulatory capital calculations. Other significant requirements included in the proposal relate to higher risk-weighting of the requirements.assets, particularly of loans, which would result in lower capital ratios.

Basel III also includes two separate standards for supervising liquidity risks which include: (i) a “liquidity coverage ratio” designed to ensure that banks have a sufficient amount of high-quality liquid assets to survive a significant liquidity stress scenario over a 30-day period, (ii) a “net stable funding ratio” designed to promote more medium and long-term funding of the assets and activities of banks over a one-year time horizon. After an observation period beginning in 2011, theThe liquidity coverage ratio willwas initially set to become effective on January 1, 2015. The revised net stable funding ratio willwas to become effective January 1, 2018.

In general, other companies seeking to acquire control of a bank holding company such as the Company would require the approval of the FRB under the Bank Holding Company Act. In addition, individuals or groups of individuals seeking to acquire control of a bank holding company such as the Company would need to file a prior notice with the FRB (which the FRB may disapprove under certain circumstances) under the Change in Bank Control Act. Control is conclusively presumed to exist if an individual or company acquires 25% or more of any class of voting securities of the bank holding company. Control may exist under the Change in Bank Control Act if the individual or company acquires 10% or more of any class of voting securities of the bank holding company and no shareholder holds a larger percentage of the subject class of voting securities.

In February 2009, the FDIC adopted a long-term DIF restoration plan as well as an additional emergency assessment for 2009. The restoration plan increased base assessment rates for banks in all risk categories with the goal of raising the DIF reserve ratio from its then-current .40% to its statutorily mandated minimum of 1.15% within eight years (as amended). Beginning April 1, 2009, the FDIC established a bank’s initial base assessment rate ranging between 12 and 45 basis points, depending on the banks risk category. The initial base assessment rate iswas then adjusted higher or lower to obtain the total base assessment rate. Adjustments to the initial base assessment rate arewere based on a bank’s

The FDIC adopted an emergency special assessment in 2009 which superseded its interim rule that would have imposed a 20 basis point assessment with an option for an additional 10 basis point assessment. Under the final rule adopted, the FDIC imposed a special assessment of 5 basis points on a bank’s total assets minus Tier 1 capital as of June 30, 2009 and collected September 30, 2009. The Company paid $1.1 million related to the 2009 special assessment. The final rule also authorized the FDIC to impose up to two additional 5 basis points assessments if needed while capping each assessment at 10 basis points of the banks assessment base.

The Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”) requiresrequired changes to a number of components of the FDIC insurance assessment with an implementation date ofthat was effective April 1, 2011. The Dodd-Frank Act requiresrequired the FDIC to adopt a new DIF restoration plan to ensure that the reserve ratio increases to 1.35% from 1.15% of insured deposits by 2020. Under the new restoration plan, the FDIC will foregodropped the uniform three-basis point increase in initial assessment rates that was scheduled to take place on January 1, 2011. The FDIC has proposed2011 and adopted new regulations that would redefineredefined the assessment base as average consolidated assets less average tangible equity.  The proposed regulations would useequity during the current assessment rate schedule with modificationsperiod.  Since the new assessment base

resulted in a larger overall base when compared to the unsecured debtdomestic deposits base methodology, overall assessments rates have been lowered and brokered deposit adjustments, and eliminate the secured liability adjustment.adjustment has been eliminated from the rate calculation in an attempt to make the new assessments revenue neutral. The new regulations retain the risk category system for depository institutions with less than $10 billion in assets. Under this system, each institution is assigned to one of four risk categories based upon the institution’s capital and supervisory evaluation. At least semi-annually, the FDIC will update its loss and income projections for the DIF and, if needed, increase or decrease assessment rates. In establishing assessments, the FDIC is required to offset the effect of the higher reserve ratio against insured depository institutions with total consolidated assets of less than $10 billion.

In addition to deposit insurance assessments, all FDIC-insured institutions are required to pay assessments to the FDIC to fund interest payments on bonds issued by the Financing Corporation (“FICO”), a mixed-ownership government corporation established by the Competitive Equality Banking Act of 1987 possessing assessment powers in addition to the FDIC. The FDIC acts as a collection agent for FICO, whose sole purpose was to function as a financing vehicle for the now defunct Federal Savings & Loan Insurance Corporation. FICO assessment rates are determined quarterly and will continue until the FICO bonds mature in 2017.

During the fourth quarter of 2010, the FDIC issued a final rule implementing provisions of the Dodd-Frank Act that provide for temporary unlimited coverage for noninterest-bearing transaction accounts. The separate coverage for noninterest-bearing transaction accounts, which became effective on December 31, 2010 and terminatesexpired on December 31, 2012.

The Company and its subsidiary banks are subject to a myriad ofnumerous other statutes and regulations affecting their activities. Some of the more important are:

 

Under the DGP, as amended, eligible participating entities were permitted to issue senior unsecured debt guaranteed by the FDIC through October 31, 2009. The guarantee by the FDIC would expire on the earlier of the maturity date of the debt or December 31, 2012. During October 2009, the FDIC adopted final rules to phase out the DGP. The DGP expired October 31, 2009; however, the FDIC established a six month emergency guarantee facility effective upon the expiration of the DGP. Subject to its prior approval, the FDIC will provide guarantees of senior debt issued after October 31, 2009 through April 30, 2010 with the guarantee expiring on the earlier of the maturity date of the debt or December 31, 2012. The Company chose to opt out of the DGP.

Under the TAGP, which was terminated at year-end 2012, the FDIC guaranteesguaranteed 100% of certain noninterest bearing transaction accounts up to any amount to participating FDIC insured institutions. The unlimited coverage, set to initially expire on December 31, 2009, was extended by the FDIC in August 2009 with an expiration date of June 30, 2010. In April 2010, the FDIC further extended the TAGP to December 31, 2010 and adopted rules that allowed extending the program an additional twelve months without further rulemaking. However, amendments related to the enactment of the Dodd-Frank Act now provideprovided full deposit insurance coverage for noninterest bearing deposit transaction accounts beginning December 31, 2010 for an additional two year period.period, which ended December 31, 2012. No opt-out option isoptions were permitted and there iswas no separate assessment applicable to the covered accounts.

The Company opted to participate in the TAGP, including the extension period. All participating institutions initially paid an additional 10 basis point quarterly-assessed fee on certain noninterest bearing transaction accounts that exceed the existing $250 thousand deposit insurance limit. The Company incurred the additional 10 basis point annual fee through the program’s original expiration date of December 31, 2009 of the program.2009. For coverage after December 31, 2009, the program included an increase in the annualized assessment based on an institutions risk category. Institutions in risk category one and two were subject to a 15 basis point and 20 basis point fee assessment, respectively. Institutions in risk category three and four were subject to a 25 basis point fee assessment.

Many aspects of the Dodd-Frank Act are subject to further rulemaking andwhich will take effect over several years, making it difficult to anticipate the overall financial impact on the Company, its customers or the financial industry more generally. Provisions in the legislation that affect deposit insurance assessments and payment of interest on commercial demand deposits could increase the costs associated with deposits as well as place limitations on certain revenues those deposits may generate.

The Company’s subsidiary banks are subject to capital-based regulatory requirements.  The Company has historically managed its banks’ capital levels with the goal of meeting the criteria established by its regulators for each bank subsidiaries to be “well-capitalized.” Historically, to be well-capitalized, a depository institution needed to have a Tier 1 leverage capitalLeverage ratio of at least 5% and a Total risk-based capitalRisk-based Capital ratio of 10%.  As of December 31, 2010,2012, each of the Company’s four subsidiary banks satisfied these capital ratios.

regulatory agencies have granted approval of all subsequent quarterly Company requests to make interest payments on its trust preferred securities and dividends on its preferred stock, the Company has not (based on the assessment by Company management of both the Company’s capital position and the earnings of its subsidiaries) sought regulatory approval for the payment of common stock dividends since the fourth quarter of 2009.  Moreover, the Company will not pay any such dividends on its common stock in any subsequent quarter until the regulator’s assessment of the earnings of the Company’s subsidiaries, and the Company’s assessment of its capital position, both yield the conclusion that the payment of a Company common stock dividend is warranted. 

Other components in the regulatory order for the parent company include requesting and receiving regulatory approval for the payment of new salaries/bonuses or other compensation to insiders; assisting its subsidiary banks in addressing weaknesses identified in their reports of examinations; providing periodic reports detailing how it will meet its debt service obligations; and providing progress reports with its compliance with the regulatory Memorandum.

Other parts of the regulatory order include the development and documentation of plans for reducing problem loans, providing progress reports on compliance with the Memorandum, developing and implementing a written profit plan and strategic plans, and evaluating policies and procedures for monitoring construction loans and use of interest reserves. It also restricts the bank from extending additional credit to borrowers with credits classified as substandard, doubtful or special mention in the report of examination.

Other components in the regulatory order include stricter oversight and reporting to its regulators in terms of complying with the Consent Order. It also includes an increase in the level of reporting by management to its board of directors of its financial results, budgeting, and liquidity analysis, as well as restricting the bank from extending additional credit to borrowers with credits classified as substandard, doubtful or special mention in the report of examination. There is also a requirement to obtain written consent prior to declaring or paying a dividend and to develop a written contingency plan if the bank is unable to meet the capital levels established in the Consent Order.

2010.  At December 31, 2010,2012, Citizens Northern had a Tier 1 Leverage ratio of 8.04%9.36% and a Total Risk-based Capital ratio of 12.68%14.22%.

Other parts of the regulatory order include the development and documentation of plans for reducing problem loans, providing progress reports on compliance with the Memorandum, and for the development and implementation of a written profit plan and strategic plans. It also restricts the bank from extending additional credit to borrowers with credits classified as substandard, doubtful or special mention in the report of examination.

Regulators continue to monitor the Company’s progress and compliance with the regulatory agreements through periodic on-site examinations, regular communications, and quarterly data analysis. At the Parent Company and at each of its bank subsidiaries, the Company believes it is adequately addressing all issues of the regulatory agreements to which it is subject. However, only the respective regulatory agencies can determine if compliance with the applicable regulatory agreements have been met. The Company believes that it and its subsidiary banks are in compliance with the requirements identified in the regulatory agreements as of December 31, 2010, with the exception that the level of substandard loans at Farmers Bank exceed the target amount by $1.3 million. Regulators continue to monitor the Company’s progress and compliance with the agreements through periodic on-site examinations, regular communications, and quarterly data analysis. The results of these examinations and communications show satisfactory progress toward meeting the requirements included in the regulatory agreements.2012.

The Parent Company maintains cash available to fund a certain amount of additional injections of capital to its bank subsidiaries as determined by management or if required by its regulators. If needed, further amounts in excess of available cash may be funded by future public or private sales of securities, although the Parent Company is currently under no directive by its regulators to raise any additional capital.

The Company competes primarily on the basis of quality of services, interest rates and fees charged on loans, and the rates of interest paid on deposit funds. The business of the Company is not dependent upon any one customer or on a few customers, and the loss of any one or a few customers would not have a material adverse effect on the Company.

No material portion of the business of the Company is seasonal. No material portion of the business of the Company is subject to renegotiation of profits or termination of contracts or subcontracts at the election of the government, though certain contracts are subject to such renegotiation or termination.

The Company is not engaged in operations in foreign countries.

As of December 31, 2010,2012, the Company and its subsidiaries had 512518 full-time equivalent employees. Employees are provided withoffered a variety of employee benefits. A salary savings plan, group life insurance, hospitalization, dental, and major medical insurance along with postretirement health insurance benefits are available to eligible personnel.  Employees are not represented by a union. Management and employee relations are considered good.

The Company maintains a Stock Option Plan (“Plan”) that grants certain eligible employees the option to purchase a limited number of the Company’s common stock. The Plan specifies the conditions and terms that the grantee must meet in order to exercise the options. No options have been granted under the Plan since 2004.

In 2004, the Company’s Board of Directors adopted an Employee Stock Purchase Plan (“ESPP”). The ESPP was subsequently approved by the Company’s shareholders and became effective July 1, 2004. Under the ESPP, at the discretion of the Board of Directors, employees of the Company and its subsidiaries can purchase Company common stock at a discounted price and without payment of brokerage costs or other fees and in the process benefit from the favorable tax treatment afforded such plans pursuant to Section 423 of the Internal Revenue Code.

Investing in the Company’s common stock is subject to risks inherent to the Company’s business. The material risks and uncertainties that management believes affect the Company are described below. Before making an investment decision, you should carefully consider the risks and uncertainties described below together with all of the other information included or incorporated by reference in this report. The risks and uncertainties described below are not the only ones facing the Company. Additional risks and uncertainties that management is not aware of or focused on or that management currently deems immaterial may also impair the Company’s business operations. This report is qualified in its entirety by these risk factors.

 

If any of the following risks actually occur, the Company’s financial condition and results of operations could be materially and adversely affected. If this were to happen, the market price of the Company’s common stock could decline significantly, and shareholders could lose all or part of their investment.

The Company is subject to extensive regulation, supervision and examination by federal and state banking authorities. Any change in applicable regulations or laws could have a substantial adverse impact on the Company and its operations.  Additional legislation and regulations that could significantly affect the Company’s powers, authority and operations may be enacted or adopted in the future, which could have a material adverse effect on the Company’s results of operations and financial condition.  Further, in the performance of their supervisory duties and enforcement powers, the Company’s banking regulators have significant discretion and authority to prevent or remedy practices they deem as unsafe or unsound or violations of law.

Under federal and state laws and regulations pertaining to the safety and soundness of insured depository institutions, the KDFI (for state-chartered banks), the Board of Governors of the Federal Reserve (the “Federal Reserve”) (for bank holding companies), and separately the FDIC as the insurer of bank deposits, have the authority to compel or restrict certain actions on the Company’s part if they determine that the Company has insufficient capital or areis otherwise operating in a manner that may be deemed to be inconsistent with safe and sound banking practices. Under this authority, bank regulators can require the Company to enter into informal or formal enforcement orders, including board resolutions, memoranda of understanding, written agreements and consent or cease and desist orders, pursuant to which the Company would be required to take identified corrective actions to address cited concerns and to refrain from taking certain actions.

If the Company is unable to comply with the terms of its current regulatory orders, or is unable to comply with the terms of any future regulatory orders to which it may become subject, then weit could become subject to additional, heightened supervisory actions and orders, possibly including cease and desist orders, prompt corrective actions and/or other regulatory enforcement actions. If the Company’s regulators were to take such additional supervisory actions, then we could, among other things, become subject to significant restrictions on our ability to develop any new business, as well as restrictions on our existing business, and we could be required to raise additional capital, dispose of certain assets and liabilities within a prescribed period of time, or both. If one or more of the Company’s banks were unable to comply with regulatory requirements, such banks could ultimately face failure.  The terms of any such supervisory action could have a material negative effect on our business, operating flexibility, financial condition and the value of our common stock.

AsThe Company’s level of December 31, 2010, nonperforming loans (which include restructured loans of $37.0 million) totaled $91.0 million or 7.6% of the Company’s loan portfolio. Nonperforming assets (which include foreclosed real estate) were $122 million or 6.3% of total assets at year-end 2010.  In addition, loans past due 30-89 days and still accruing were $6.7 million as of December 31, 2010.performing restructured loans), although improving, remain high. Nonperforming assets adversely affect the Company’s net income in various ways.  If economic conditions do not improve or actually worsen in our markets, the Company could continue to incur additional losses relating to an increase in nonperforming assets.  The Company does not record interest income on nonaccrual loans or other real estate owned, thereby adversely affecting interest income.  When the Company takes collateral in foreclosures and similar proceedings, it is required to mark the related loanproperty to theits fair value of the collateral less estimated selling costs, which decreases earnings.  Thesenet income.

Nonperforming loans and other real estate owned also increase our risk profile and the amount of capital the Company’s regulators believe is appropriate in light of such risks.  While the Company seeks to reduce its problem loans through workouts, restructurings and otherwise, decreases in the value of these assets, the underlying collateral or our borrowers’ performance or financial conditions have adversely affected, and may continue to adversely affect, the Company’s results of operations and financial condition.  Moreover, the resolution of nonperforming assets requires significant time commitments from management of our banks, which can be detrimental to the performance of their other responsibilities. There can be no assurance that the Company will not experience further increases in nonperforming loans in the future.

Real estate development loans have dominated the Company’s increase in impaired loans.  Substantially all of the Company’s $54.0 million nonaccrual loans outstanding at December 31, 2010 are secured by real estate.  Development lending has historically been considered to be higher credit risk than that of other types of lending, such as for single-family residential lending.properties. At year-end 2012, 23% of the outstanding balance of real estate development loans was classified as impaired. Such loans typically involve larger loan balances to a single borrower or related borrowers. SuchThese loans can be affected by adverse conditions in real estate markets or the economy in general because commercial real estate borrowers’ ability to repay their loans depends on successful development and, in most cases, sale of theirthe underlying property. These loans also involve greater risk because they generally are not fully amortized over the loan period, but have a balloon payment due at maturity of the loan. A borrower’s ability to make a balloon payment typically will depend on being able to either refinance the loan or timely sell the underlying property. In the current economic environment, the ability of borrowers to refinance or sell newly developed property or vacant land has greatly diminished.  If the real estate markets were to worsen or not improve, the Company would likely experience increased credit losses and require additional provisions to our allowance for loan losses, which would adversely impact the Company’s earnings and financial condition.

Unlike many other community banks, theThe Company relies more heavily on its investment securities portfolio as a source of interest income than many other community banks because it has a comparatively small loan portfolio.  If the Company is not able to successfully manage the interest rate spread on the investment

During 2012, the Company sold and realized net gains on investment securities.  The Company may not have the same level of net gains (and may have net realized losses) in future periods on the sale of investment securities, which would reduce earnings.  Moreover, due to the current interest rate environment, proceeds from recent sales may be reinvested in investment securities with lower yields which may reduce earnings from investment securities.

The Company continually monitors its investment securities portfolio for deteriorating values and for other-than-temporary impairments.impairment.  Any material other-than-temporary impairmentsimpairment charges would likewise have an adverse affecteffect on the Company’s results of operations and could lead to additional losses.

The national economy and the financial services sector in particular continue to face unique challenges.challenges stemming from the economic recession occurring between 2007 and 2009. The Company cannot accurately predict the severity or duration of the current economic downturn,slowdown, which has adversely impacted its performance and the markets it serves.  Any further deterioration in the economies of the nation as a whole or in the Company’s local markets would have an adverse effect, which could be material, on the Company’s financial condition, results of operations and prospects, and could also cause the market price of the Company’s stock to decline.  While it is impossible to predict how long these conditions may exist, the economic downturnslowdown could continue to present risks for some time for our industry and the Company.

The Company’s results of operations are affected by the monetary and fiscal policies of the federal government, the policies of the Company’s regulators, and the prevailing interest rates in the United States and the Company’s markets.  In addition, it is increasingly common for the Company’s competitors, who may be aggressively seeking to attract deposits as a result of increased liquidity concerns arising from changing economic or other conditions, to pay rates on deposits that are much higher than normal market rates.  A significant component of the Company’s earnings is the net interest income of its subsidiary banks, which is the difference between the income from interest earning assets, such as loans, and the expense ofon interest bearing liabilities, such as deposits.  A change in market interest rates could adversely affect the Company’s earnings if market interest rates change such that the interest it pays on deposits and borrowings increases faster than the interest it collects on loans and investments; or, alternatively, if interest rates earned on earning assets decline faster than those rates paid on interest paying liabilities.  Consequently, as with most financial institutions, the Company is sensitive to interest rate fluctuations.

Under the Federal Deposit Insurance Act, as amended by the Dodd-Frank Act, the FDIC must establish and implement a plan to restore the deposit insurance fund’s designated reserve ratio to 1.35% of insured deposits by 2020. The Dodd-Frank Act removed the previously established upper limit reserve ratio of 1.15%. The FDIC must continue to assess and consider the appropriate level of the reserve ratio annually by considering each of the following: risk of loss to the insurance fund; economic conditions affecting the banking industry; the prevention of sharp swings in the assessment rates; and any other factors the FDIC deems important. In December 2010, the FDIC announced that it had established the long-term reserve ratio at 2.0%.

In the wake of a rapid depletion of the FDIC’s Deposit Insurance Fund resulting from a high number of bank failures, the FDIC required that all (with limited exceptions) insured institutions pay in the fourth quarter of 2009 its following estimated three years’ quarterly deposit assessments in advance.  This resulted in an aggregate payment by the Company’s bank subsidiaries totaling $8.2 million in the fourth quarter of 2009.  The three years’ advance payment was recorded as a

prepaid asset that is being expensed in approximately equal amounts over the prepayment period and, thus, only impactimpacts earnings in the normal course. However,At December 31, 2012, the advance payment reducedprepaid FDIC insurance assessment included on the liquid assetsCompany’s balance sheet was $2.6 million.

Federal prohibitions against financial institutions paying interest on demand deposit accounts of business customers were repealed as part of the Dodd-Frank Act. As a result, beginning on July 21, 2011, financial institutions cancould offer to pay interest on commercial demand deposits to compete for customers. The Company cannot predict the interest rates other institutions may offer. The Company’sexpects that its interest expense is expected towould increase and its net interest margin is expected to decrease should it begin to pay interest on commercial demand deposits to attract additional customers or to keep current customers. This could result in a material adverse impact on the Company’s financial condition and results of operations. As of December 31, 2012, the Company does not offer interest bearing demand deposits to its business customers.

The Company is required by federal and state regulatory authorities to maintain levels of capital to support its operations.  Furthermore, in the wake of recent regularly scheduled examinations of three of its subsidiaries, the Company’s regulators have required these three banks to raise their capital to levels significantly above the well-capitalized benchmark.  The Company’s ability to raise additional capital, if needed, will depend on conditions in the capital markets at that time and on the Company’s future financial condition and performance.  Accordingly, the Company cannot make assurances with respect to its ability to raise additional capital on favorable terms, or at all.  If the Company cannot raise additional capital when needed, its ability to further expand its operations through internal growth and acquisitions could be materially impaired and its financial condition and liquidity could be materially and adversely affected. The Parent Company is currently under no directive by its regulators to raise any additional capital.

A tightening of the credit and liquidity markets and the Company’s inability to obtain adequate funding to replace deposits may negatively affect its earnings and capital levels.  In addition to deposit growth, maturity of investment securities and loan payments from borrowers, the Company relies from time to time on advances from the Federal Home Loan Bank and other wholesale funding sources to fund loans and replace deposits.  In the event of a further downturn in the economy, these additional funding sources could be negatively affected which could limit the funds available to the Company.  The Company’s liquidity position could be significantly constrained if it were unable to access funds from the Federal Home Loan Bank or other wholesale funding sources.

The Company’s financial condition and outlook is highly dependent upon perceptions of its business practices and reputation. Its ability to attract and retain customers and employees could be adversely affected to the extent its reputation is damaged. Negative public opinion could result from its actual or alleged conduct in any number of activities, including regulatory actions taken against the Company, lending practices, corporate governance, regulatory compliance, mergers of its subsidiaries, or sharing or inadequate protection of customer information.  Damage to the Company’s reputation could give rise to loss of customers and legal risks, which could have an adverse impact on its financial condition.

The Company conducts most of its operations in Central and Northern Kentucky. The banking and financial services businesses in these areas are highly competitive and increased competition in its primary market areas may adversely impact the level of its loans and deposits. Ultimately, the Company may not be able to compete successfully against current and future competitors. These competitors include national banks, regional banks and other community banks. The Company also faces competition from many other types of financial institutions, including savings and loan associations, finance companies, brokerage firms, insurance companies, credit unions, mortgage banks and other financial intermediaries. In particular, the Company’s competitors include major financial companies whose greater resources may afford them a marketplace advantage by enabling them to maintain numerous locations and mount extensive promotional and advertising campaigns. Areas of competition include interest rates for loans and deposits, efforts to obtain loan and deposit customers and a range in quality of products and services provided, including new technology-driven products and services. If the Company is unable to attract and retain banking customers, it may be unable to continueincrease its loan growthloans and level of deposits.

The Financial Accounting Standards Board and the SEC frequently change the financial accounting and reporting standards that govern the preparation of the Company’s financial statements. In addition, from time to time, federal and state taxing authorities will change the tax laws, regulations, and their related interpretations. These changes and their effects can be difficult to predict and can materially and adversely impact how the Company records and reports its financial condition and results of operations.

In December 2010, the Basel Committee on Banking Supervision issued final rules related to global regulatory standards on bank capital adequacy and liquidity. The new rules present details of the Basel III framework, which includes increased capital requirements and limits the types of instruments that can be included in Tier 1 capital. U.S. federal banking agencies issued proposed rules during 2012 seeking to implement Basel III standards effective January 1, 2013. Due to the nature and volume of comments received on the proposed rules, the federal banking agencies announced that the proposed rules would not become effective on the date proposed. There has been no indication of an alternative effective date by the agencies. As such, the dates and phase-in periods of the Basel III framework discussed below will change. Final rules could change significantly from the proposed rules.

Basel III includes the following provisions: (i) that the minimum ratio of common equity to risk weightedrisk-weighted assets be increased to 4.5% from the current level of 2%, to be fully phased in by January 1, 2015, and (ii) that the minimum requirement for the Tier 1 Risk-based capital ratio will be increased from 4% to 6%, to be fully phased in by January 1, 2015. The new minimums willwere initially set to be phasesphased in starting January 1, 2013.

Basel III also includes a “capital conservation buffer” requiring banking organizations to maintain an additional 2.5% of Tier 1 common equity to total risk weightedrisk-weighted assets in addition to the minimum requirement. This requirement willwas initially set to be phased in between January 1, 2016 and January 1, 2019. The capital conservation buffer is designed to absorb losses in periods of financial and economic distress and, while banks are allowed to draw on the buffer during periods of stress, if a bank’s regulatory capital ratios approach the minimum requirement, the bank will be subject to more stringent constraints on dividends and bonuses. In addition, Basel III includes a countercyclical buffer of up to 2.5%, which could be imposed by countries to address economies that appear to be building excessive system-wide risks due to rapid growth.

To constrain the build-up of excess leverage in the banking system, Basel III introduces a new non-risk-based leverage ratio. A minimum Tier 1 Leverage ratio of 3% willwas initially set to be tested during a parallel run period between January 1, 2013 and January 1, 2017. Based on the results of the parallel run period,2017 with any final adjustments would be carried out in the first half of 2017.2017 based on the results of the parallel run.

Basel III also includes two separate standards for supervising liquidity risks which include: (i) a “liquidity coverage ratio” designed to ensure that banks have a sufficient amount of high-quality liquid assets to survive a significant liquidity stress scenario over a 30-day period, (ii) a “net stable funding ratio” designed to promote more medium and long-term funding of the assets and activities of banks over a one-year time horizon. After an observation period beginning in 2011, theThe liquidity coverage ratio willwas initially set to become effective on January 1, 2015. The revised net stable funding ratio willwas to become effective January 1, 2018.

The Company cannot predict at this time the precise content of capital and liquidity guidelines or regulations that may be adopted by regulatory agencies having authority over us and our subsidiaries, or the impact that any changes in regulation would have on the Company. However, we expect that thesubsidiaries. The new standards, however, will generally require the Company orand our banking subsidiaries to maintain more capital with(with common equity as a more predominant component, orcomponent) and manage the configuration of our assets and liabilities in order to comply with new liquidity requirements, which could significantly impact our return on equity, financial condition, operations, capital position, and ability to pursue business opportunities.

The Company is not restricted from issuing additional common stock or preferred stock, including any securities that are convertible into or exchangeable for, or that represent the right to receive, common stock or preferred stock or any substantially similar securities. The market price of the Company’s common stock could decline as a result of sales by the Company of a large number of shares of common stock or preferred stock or similar securities in the market or from the perception that such sales could occur.

The Company’s board of directors is authorized generally to cause it to issue additional common stock, as well as series ofand preferred stock without any action on the part of the Company’s shareholders, except as may be required under the listing requirements of the NASDAQ Stock Market. In addition, the board has the power, without shareholder approval, to set the terms of any series of preferred stock that may be issued, including voting rights, dividend rights, preferences and other terms.  This could include preferences over the common stock with respect to dividends or upon liquidation.  If the Company issues preferred stock in the future that has a preference over the common stock with respect to the payment of dividends or upon liquidation, or if the Company issues preferred stock with voting rights that dilute the voting power of the common stock, the rights of holders of the common stock or the market price of the common stock could be adversely affected. The Parent Company is currently under no directive by its regulators to raise any additional capital.

Holders of the Company’s common stock are entitled to receive dividends only when, as, and if its board of directors declares them and as permitted by its regulators.  Although the Company has (up through 2009) historically declared quarterly cash dividends on its common stock, it is not required to do so.  The Company’s board of directors reduced its quarterly common stock dividend in January 2009 from $.33 per share to $.25 per share and again in October 2009 to $.10 per share. The Company also agreed to not make interest payments on its trust preferred securities or dividends on its common or preferred stock without prior approval from the FRB St. Louis and KDFI.  Representatives of the FRB St. Louis and KDFI have indicated that any such approval for the payment of dividends will be predicated on a demonstration of adequate, normalized earnings on the part of the Company’s subsidiaries sufficient to support quarterly payments on the Company’s trust preferred securities and quarterly dividends on the Company’s common and preferred stock.  However, there can be no assurance the Company’s regulators will provide such approvals in the future.

In addition, the Company’s payment of dividends is subject to certain restrictions as a result of its issuance of Series A preferred stock to the Treasury on January 9, 2009 under the TARP CPP.  The dividendsDividends declared and discount accretion on the Company’s Series A preferred stock reduce the net income available to common stockholders and reduce earnings per common share.  Moreover, under the terms of the Company’s articles of incorporation, it is unable to declare dividend payments on shares of its common stock if it is in arrears on the dividends on the Series A preferred stock.  Further, until January 9, 2012, the Company must have the Treasury’s approval before it may increase dividends on its common stock above the amount of the last quarterly cash dividend per share we declared prior to October 14, 2008, which was $.33 per share.  This restriction no longer applies if all the Series A preferred stock has been redeemed by the Company or transferred by the Treasury.

If the Company is in arrears on interest payments on its trust preferred securities, it may not pay dividends on its common stock until such interest obligations are brought current.

The Company’s common stock is listed for trading on the NASDAQ Global Select Stock Market.  As of December 31, 20102012, the 50-day average trading volume of the Company’s common stock on NASDAQ was 7,14315,907 shares or .10%.21% of the total common shares outstanding of 7,411,676.7,469,813.  An efficient public trading market is dependent upon the existence in

Subject to consultation with banking regulators, the Company intends to repurchase the Series A preferred stock and potentially the warrant, it issued to the Treasury when it believes the credit metrics in its loan portfolio have improved for the long-term and the overall economy has rebounded. However, there can be no assurance when the Series A preferred stock and warrant held by the Treasury can be repurchased, if at all. Until such time as the Series A preferred stock areis repurchased, the Company will remain subject to the terms and conditions of those instruments,the instrument, which, among other things, limit the Company’s ability to repurchase or redeem common stock or increase the dividends on its common stock over $.33 per share prior to 2012. Further, the Company’s continued participation in the CPP subjects it to increased regulatory and legislative oversight, including with respect to executive compensation. These new and any future oversight and legal requirements and implementing standards under the CPP may have unforeseen or unintended adverse effects on the financial services industry as a whole, and particularly on CPP participants such as the Company.stock.

The Series A preferred stock that the Company issued to the Treasury is senior to the Company’s shares of common stock, and holders of the Series A preferred stock have certain rights and preferences that are senior to holders of the Company’s common stock. The restrictions on the Company’s ability to declare and pay dividends to common stockholders are discussed above. In addition, the Company and its subsidiaries may not purchase, redeem or otherwise acquire for consideration any shares of the Company’s common stock unless the Company has paid in full all accrued dividends on the Series A preferred stock for all prior dividend periods, other than in certain circumstances. Furthermore, the Series A preferred stock is entitled to a liquidation preference over shares of the Company’s common stock in the event of liquidation, dissolution or winding up.

Shares of the Company’s common stock represent equity interests in our holding company and do not constitute indebtedness. Accordingly, the shares of the Company’s common stock rank junior to all of its indebtedness and to other non-equity claims on Farmers Capital Bank

The Company’s right to participate in any distribution of assets of any of its subsidiaries upon the subsidiary’s liquidation or otherwise, and thus the ability of the Company’s common stock to benefit indirectly from such distribution, will be subject to the prior claims of creditors of that subsidiary.  As a result, holders of the Company’s common stock will be

If the Company is unable to redeem its Series A preferred stock prior to February 15, 2014, the cost of this capital to us will increase from approximately $1.5 million annually (5.0% per annum of the Series A preferred stock liquidation value) to $2.7 million annually (9.0% per annum of the Series A preferred stock liquidation value).  This increase in the annual dividend rate on the Series A preferred stock would have a material negative effect on the earnings the Company can retain for growth and to pay dividends on its common stock.

Although the Company remains well-capitalized, it continues to operate in a very challenging and uncertain economic environment. Financial institutions, including the Company, arecontinue to being adversely effected by difficult economic conditions that have impacted not only local markets, but on a national and global scale. Substantial deterioration in real estate and other financial markets in recent years have and may continue to adversely impact the Company’s financial performance. Continuing declinesDeclines in real estate values and home sales volumes, along with job losseshigh levels of unemployment and other economic stresses can decrease the value of collateral securing loans extended to borrowers, particularly that of real estate loans. Lower values of real estate securing loans may make it more difficult for the Company to recover amounts it is owed in the event of default by a borrower.

The current economic conditions may result in a higher degree of financial stress on the Company’s borrowers and their customers which could impair the Company’s ability to collect payments on loans, potentially increasing loan delinquencies, nonperforming assets, foreclosures, and higher losses. Current market forces have and may in the future cause the value of investment securities or other assets held by the Company to deteriorate, resulting in impairment charges, higher losses, and lower regulatory capital levels.

The capital and credit markets experienced heavy volatility and disruptions during the recent economic downturn, with unprecedented levels of volatility and disruptions that took place beginning within the last few months of 2008. In many cases, this has led to downward pressure on stock prices and credit availability for certain issuers without regard to those issuers’ underlying financial strength. If market disruptions and volatility continue or worsen, there can be no assurance that the Company will notmay experience a material adverse effect on its results of operations and liquidity position or on its ability to access additional capital.

Commercial banks and other financial institutions, including the Company, are affected by economic and political conditions, both domestic and international, and by governmental monetary policies. Conditions such as inflation, value of the dollar, recession, high unemployment rates, high interest rates, prolonged periods of low interest rates, short money supply, scarce natural resources, international disorders,turmoil, terrorism and other factors beyond the Company’s control may adversely affect profitability. In addition, almost all of the Company’s primary business area is located in Central and Northern Kentucky. A significant downturnSignificant downturns in this regional economyeconomic region may result in, among other things, deterioration in the Company’s credit quality or a reduced demand for credit and may harm the financial stability of the Company’s customers. Due to the Company’s regional market area, these negative conditions may have a more noticeable effect on the Company than would be experienced by an institution with a larger, more diverse market area.

Due to the fact that the outstanding principal balances can be larger for commercial loans than other types of loans, such loans present a greater risk to the Company than other types of loans when non-payment by a borrower occurs.

In addition, consumerConsumer loans typically have shorter terms and lower balances with higher yields compared to real estate mortgage loans, but generally carry higher risks of frequency of default than real estate mortgage and commercial loans. Consumer loan collections are dependent on the borrower’s continuing financial stability, and thus are more likely to be affected by adverse personal circumstances. Furthermore, the application of various federal and state laws, including bankruptcy and insolvency laws, may limit the amount that can be recovered on these loans.

The Company relies on key personnel to manage and operate its business, including major revenue generating functions such as its loan and deposit portfolios. The loss of key staff may adversely affect the Company’s ability to maintain and manage these portfolios effectively, which could negatively affect our revenues. In addition, loss of key personnel could result in increased recruiting and hiring expenses, which could cause a decrease in our net income.

The Company’s management regularly reviews and updates its internal controls, disclosure controls and procedures, and corporate governance policies and procedures. Any system of controls, however well-designed and operated, can provide only reasonable, not absolute, assurances that the objectives of the system of controls are met. Any failure or circumvention of the Company’s controls and procedures or failure to comply with regulations related to controls and procedures could have a material and adverse effect on the Company’s business, results of operations, and financial condition.

On July 21, 2010, the Dodd-Frank Act was signed into law by President Obama. The goals of the new legislation include restoring public confidence in the financial system that resulted from the recent financial and credit crises, preventing another financial crisis, and allowing regulators to identify failings in the system before another crisis can occur.  As part of the reform, the Dodd-Frank Act createscreated the Financial Stability Oversight Council, with oversight authority for monitoring and regulating systemic risk, and the Bureau of Consumer Financial Protection, which will havehas broad regulatory and enforcement powers over consumer financial products and services.  The Dodd-Frank Act also changes the responsibilities of the current federal banking regulators, imposes additional corporate governance and disclosure requirements in areas such as executive compensation and proxy access, and limits or prohibits proprietary trading and hedge fund and private equity activities of banks. It also impacts areas such as deposit insurance, mortgage lending, capital requirements, securitizations, and insurance.

The scope of the Dodd-Frank Act impacts many aspects of the financial services industry and requires the development and adoption of manynumerous implementing regulations, over the next several months and years; consequently,many of which have yet to be proposed. Consequently, the effects of the Dodd-Frank Act on the financial services industry and the Company will depend, in large part, upon the extent to which regulators exercise the authority granted to them and the approaches taken to implement the regulations.  The Company has beguncontinues to assess the potential impact of the Dodd-Frank Act on its business and operations and believes that compliance with these new laws and regulations will likely result in additional costs, but at this early stage, the probable impact cannot be predictedmeasured with a high degree of certainty. Compliance with the new laws and regulations could adversely impact the Company’s results of operations, financial condition or liquidity, any of which may impact the market price of the Company’s common stock. The Company believes that the Dodd-Frank Act will most likely impact it in the areas of corporate governance, deposit insurance assessments, capital requirements, and restrictions on fees charges to consumers.

None.

 

Unless otherwise indicated, the properties listed below are owned by the Company and its subsidiaries as of December 31, 2010.2012.

201 W. Main Street, Frankfort, KY

The Company considers its properties to be suitable and adequate based on its present needs.

As of December 31, 2010,2012, there were various pending legal actions and proceedings against the Company arising from the normal course of business and in which claims for damages are asserted.  Management,It is the opinion of management, after discussion with legal counsel, believes that these actions are without merit and that the disposition or ultimate liability resulting from theseresolution of such claims and legal actions and proceedings, if any, will not have a material adverse effect upon the consolidated financial statements of the Company.

At various times, the Company’s Board of Directors has authorized the purchase of shares of the Company’s outstanding common stock.  No stated expiration dates have been established under any of the previous authorizations. There were no shares of common stock repurchased by the Company during the quarter ended December 31, 2010.2012. The maximum number of shares that may still be purchased under previously announced repurchase plans is 84,971.

On January 9, 2009, the Company received a $30.0 million equity investment by issuingissued 30 thousand shares of Series A, no par value cumulative perpetual preferred stock to the Treasury for $30.0 million pursuant to a Letter Agreement and Securities Purchase Agreement that was previously disclosed by the Company. In addition, theAgreement. The Company also issued a warrant to the Treasury allowing it to purchase 224 thousand shares of the Company’s common stock at an exercise price of $20.09. The warrant can be exercised immediately and has a term of 10 years. The Series A preferred stock and warrant were issued in a private placement exempt from registration pursuant to Section 4(2) of the Securities Act of 1933, as amended.

The following graph sets forth a comparison of the five-year cumulative total returns among the shares of Company Common Stock, the NASDAQ Composite Index ("broad market index") and Southeastern Banks underUnder 1 Billion Market-Capitalization ("peer group index"). Cumulative shareholder return is computed by dividing the sum of the cumulative amount of dividends for the measurement period and the difference between the share price at the end and the beginning of the measurement period by the share price at the beginning of the measurement period.

The broad market index includes over 3,000 domestic and international based common shares listed on The NASDAQ Stock Market. The peer group index consists of 4440 banking companies in the Southeastern United States. The Company is included among the 44 companies includedthose in the peer group index.

Direct correspondence to:

A valuation allowance to offset credit losses specifically identified in the loan portfolio, as well as management’s best estimate of probable incurred losses in the remainder of the portfolio at the balance sheet date.  Management estimates the allowance balance required using past loan loss experience, an assessment of the financial condition of individual borrowers, a determination of the value and adequacy of underlying collateral, the condition of the local economy, an analysis of the levels and trends of the loan portfolio, and a review of delinquent and classified loans. Actual losses could differ significantly from the amounts estimated by management.

Each basis point is equal to one hundredth of one percent.  Basis points are calculated by multiplying percentage points times 100. For example:  3.7 percentage points equals 370 basis points.

Net income (loss) divided by average shareholders’ equity. Measures the relative profitability of the shareholders' investment in the Company.

Income from tax-exempt loans and investment securities havehas been increased by an amount equivalent to the taxes that would have been paid if this income were taxable at statutory rates. In order to provide comparisons of yields and margins for all earning assets, the interest income earned on tax-exempt assets is increased to make them fully equivalent to other taxable interest income investments.

The following pages present management’s discussion and analysis of the consolidated financial condition and results of operations of Farmers Capital Bank Corporation (the “Company” or “Parent Company”), a bank holding company, and its bank and nonbank subsidiaries. Bank subsidiaries include Farmers Bank & Capital Trust Company (“Farmers Bank”) in Frankfort, KY, United Bank & Trust Company (“United Bank”) in Versailles, KY, First Citizens Bank (“First Citizens”) in Elizabethtown, KY, and its significant wholly-ownedCitizens Bank of Northern Kentucky, Inc. (“Citizens Northern”) in Newport, KY.

At year-end 2012, Farmers Bank had three primary subsidiaries, which include EG Properties, Inc., Leasing One Corporation (“Leasing One”), and Farmers Capital Insurance Corporation (“Farmers Insurance”). EG Properties, Inc. is involved in real estate management and liquidation for certain repossessed properties of Farmers Bank. Leasing One is a commercial leasing company in Frankfort, KY and Farmers Insurance is an insurance agency in Frankfort, KY. The Lawrenceburg Bank and Trust Company, which previously was a separate bank subsidiary of the Parent Company, was merged into Farmers Bank on May 8, 2010; First Citizens Bank in Elizabethtown, KY; United Bank & Trust Company (“United Bank”) in Versailles, KY which, during 2008, was the surviving company after the merger with two sister companies of Farmers Bank and Trust Company (“Farmers Georgetown”) and Citizens Bank of Jessamine County; United Bank had one direct subsidiary at year-end 2010,2012, EGT Properties, Inc. EGT Properties, Inc. is involved in real estate management and liquidation for certain repossessed properties of United Bank; andBank. First Citizens Bank of Northern Kentucky, Inc. in Newport, KY (“Citizens Northern”); Citizens Northern had one subsidiary at year-end 2010,2012, HBJ Properties, LLC. HBJ Properties, LLC is involved in real estate management and liquidation for certain repossessed properties of First Citizens. Citizens Northern had one direct subsidiary at year-end 2012, ENKY Properties, Inc. ENKY Properties, Inc., which is involved in real estate management and liquidation for certain repossessed properties of Citizens Northern.

The Company has three active nonbank subsidiaries, FCB Services, Inc. (“FCB Services”), FFKT Insurance Services, Inc. (“FFKT Insurance”), and EKT Properties, Inc. (“EKT”). FCB Services is a data processing subsidiary located in Frankfort, KY that provides services to the Company’s banks as well as unaffiliated entities. FFKT Insurance is a captive property and casualty insurance company insuring primarily deductible exposures and uncovered liability related to properties of the Company. EKT was created in 2008formed to manage and liquidate certain real estate properties repossessed by the Company. In addition, the Company has three subsidiaries organized as Delaware statutory trusts that are not consolidated into its financial statements. These trusts were formed for the purpose of issuing trust preferred securities. All significant intercompany transactions and balances are eliminated in consolidation.

This report contains forward-looking statements with the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”) and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), under the Private Securities Litigation Reform Act of 1995 that involve risks and uncertainties.  Statements in this report that are not statements of historical fact are forward-looking statements. In general, forward-looking statements relate to a discussion of future financial results or projections, future economic performance, future operational plans and objectives, and statements regarding the underlying assumptions of such statements.  Although the Company believes 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.

The Company’s forward-looking statements are based on information available at the time such statements are made. The Company expressly disclaims any intent or obligation to update any forward-looking statements to reflect changes in underlying assumptions or factors, new information, future events, or other changes.

The Company’s audited consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America and follow general practices applicable to the banking industry. Application of these principles requires management to make estimates, assumptions, and judgments that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reported period. These estimates, assumptions, and judgments are based on information available as of the date of the financial statements; accordingly, as this information changes, the financial statements could reflect different estimates, assumptions, and judgments. Certain policies inherently have a greater reliance on the use of estimates, assumptions, and judgments and as such have a greater possibility of producing results that could be materially different than originally reported. Estimates, assumptions, and judgments are necessary when assets and liabilities are required to be recorded at fair value, when a decline in the value of an asset warrants an impairment write-down or valuation reserve to be established, or when an asset or liability needs to be recorded contingent upon a future event. Carrying assets and liabilities at fair value inherently results in more financial statement volatility from period to period. The fair values and the information used to record valuation adjustments for certain assets and liabilities are based either on quoted market prices or are provided by other third-party sources, when available. When third-party information is not available, valuation adjustments are estimated in good faith by management primarily through the use of internal cash flow modeling techniques.

The most significant accounting policies followed by the Company are presented in Note 1 of the Company’s 20102012 audited consolidated financial statements. These policies, along with the disclosures presented in the other financial statement notes and in this management’s discussion and analysis of financial condition and results of operations, 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 and fair value measurements and accounting for goodwill to be the accounting areas that requires the most subjective or complex judgments, and as such could be most subject to revision as new information becomes available.

The carrying value of certain financial assets and liabilities of the Company is impacted by the application of fair value measurements, either directly or indirectly.  Fair value is the price that would be received to sell an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. In certain cases, an asset or liability is measured and reported at fair value on a recurring basis, such as investment securities classified as available for sale.  In other cases,

The Company estimates the fair value of a financial instrument using a variety of valuation methods. Where financial instruments are actively traded and have quoted market prices, quoted market prices are used for fair value. The Company characterizes active markets as those where transaction volumes are sufficient to provide objective pricing information, with reasonably narrow bid/ask spreads, and where received quoted prices do not vary widely. When the financial instruments are not actively traded, other observable market inputs such as quoted prices of securities with similar characteristics may be used, if available, to determine fair value. Inactive markets are characterized by low transaction volumes, price quotations that vary substantially among market participants, or in which minimal information is released publicly.

When observable market prices do not exist, the Company estimates fair value primarily by using cash flow and other financial modeling methods. The valuation methods may also consider factors such as liquidity and concentration concerns. Other factors such as model assumptions, market dislocations, and unexpected correlations can affect estimates of fair value. Changes in these underlying factors, assumptions, or estimates in any of these areas could materially impact the amount of revenue or loss recorded.

 

Additional information regarding fair value measurements can be found in Notes 1 and 1918 of the Company’s 20102012 audited consolidated financial statements.  The following is a summary of the Company’s more significant assets that may be affected by fair value measurements, as well as a brief description of the current accounting practices and valuation methodologies employed by the Company:

Investment securities classified as available for sale are measured and reported at fair value on a recurring basis. Available for sale investment securities are valued primarily by independent third party pricing services under the market valuation approach that include, but are not limited to, the following inputs:

At December 31, 2010,2012, all of the Company’s available for sale investment securities were measured using observable market data.

 

Other real estate owned (“OREO”) includes properties acquired by the Company through, or in lieu of, actual loan foreclosures and is initially carried at fair value less estimated costs to sell. Fair value of OREOassets is generally based on third party appraisals of the property that includes comparable sales data comprised of significant unobservable inputs.data. If the carrying amount of the OREO exceeds fair value less estimated costs to sell, an impairment loss is recorded through expense. OREO is subsequently accounted for at the lower of carrying amount or fair value less estimated costs to sell. At December 31, 20102012, OREO was $30.5$52.6 million compared to $31.2$38.2 million at year-end 2009.2011.

Loans are considered impaired when full paymentit is probable that the Company will be unable to collect all amounts due under the contractual terms is not expected.of the loan agreement. Impaired loans are measured at the present value of expected future cash flows, discounted at the loan’s effective interest rate, at the loan’s observable market price, or at the fair value of the collateral based on recent appraisals if the loan is collateral dependent. If the value of an impaired loan is less than the unpaid

balance, the difference is credited to the allowance for loan losses with a corresponding charge to provision for loan losses. Loan losses are charged against the allowance for loan losses when management believes the uncollectibility of a loan is confirmed.

Appraisals used in connection with valuing collateral dependent loans may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Appraisers take absorption rates into consideration and adjustments are routinely made in the appraisal process to identify differences between the comparable sales and income data available. Such adjustments consist primarily of estimated costs to sell that are usually significant and typically include significant unobservable inputsnot included in certain appraisals or to update appraised collateral values as a result of market declines of similar properties for determining fair value.which a newer appraisal is available. These adjustments can be significant. Impaired loans were $130$63.9 million and $108$138 million at year-end 20102012 and 2009,2011, respectively.

The Company offers a variety of financial products and services at its 36 banking locations in 23 communities throughout Central and Northern Kentucky. The Company has four separately chartered commercial banks that operate under a community banking philosophy. This philosophy is focused primarily on understanding the banking needs and providing competitively priced products and a high level of personalized service to those in the local communities and surrounding areas in which the Company operates. The most significant products and services the Company offers include consumer and commercialbusiness lending, receiving deposits,checking, savings, and other deposit accounts, automated teller machines, electronic bill payments, and providing trust services and offeringamong other traditional banking products and services. The primary goals of the Company are to continually improve profitability and shareholder value, increase and maintain a strong capital position, provide excellent service to our customers through our community banking structure, and to provide a challenging and rewarding work environment for our employees.

The Company generates a significant amount of its revenue, cash flows, and net income from interest income and net interest income, respectively.  Interest income is generated by earnings on the Company’s earning assets, primarily loans and investment securities.  Net interest income is the excess of the interest income earned on earning assets over the interest expense paid on amounts borrowed to support those

Significant issues and into 2009 created unprecedented market volatility. During that time, certain capital markets ceased to function and credit markets were unavailable to many businesses and consumers. In response, the U.S. government took extraordinary steps to stabilize financial markets by enacting broad legislation and regulatory initiatives that included the largest stimulus plan in its history. Improvement in the U.S. financial markets and the overall economy occurred during 2010. However, certain key metrics, such as high unemployment and lower real estate values persist. This has had a significant negative effect onevents impacting the Company’s operations in the form of elevated nonperforming loans, allowance for loan losses,during 2012 and net loan charge-offs.

The Company reported net income of $6.9$12.1 million or $.68 per common share in 2010 compared to a net loss of $44.7 million or $6.32$1.37 per common share for 2009.2012 compared to $2.7 million or $.11 per common share for 2011. This represents an improvementincrease of $51.7$9.4 million or $7.00$1.26 per common share. The prior year net loss was mainly attributed to a one-time $46.5 million after tax non-cash goodwill charge representingSelected income statement amounts and related information is presented in the Company’s write off of its entire previously reported goodwill.table below.

The decrease in interest expenseincome for 20102012 exceeded the decrease forreduction in interest income asexpense due to the Company has been ablerepricing structure of the Company’s earning assets and rate paying liabilities. The very low interest rate environment that currently exists makes it increasingly difficult to more aggressively reduce its funding costs, particularly related toreprice already low interest on deposits.paying liabilities further downward. The short-term targeted federal funds rate which washas remained at 4.25% at the beginning of 2008, fell to near zero percent bysince the end of 2008 and has remained at that level for all of 2009 and 2010. New deposits and other borrowing arrangements as well as the repricing of existing deposits and borrowings at lower market interest rates, particularly for shorter-term instruments, contributed to the overall lower interest expense in the comparable periods.2008.

Net interest income is the most significant component of the Company’s operating earnings. Net interest income is the excess of the interest income earned on earning assets over the interest paid for funds to support those assets. The two most common metrics used to analyze net interest income are net interest spread and net interest margin.  Net interest spread represents the difference between the taxable-equivalenttaxable equivalent yields on earning assets and the rates paid on interest bearing liabilities.  Net interest margin represents the percentage of taxable equivalent net interest income to average earning assets.  Net interest margin will exceed net interest spread because of the existence of noninterest bearing sources of funds, principally demand deposits and shareholders’ equity, which are also available to fund earning assets.  Changes in net interest income and margin result from the interaction between the volume and composition of earning assets, their related yields, and the associated cost and composition of the interest bearing liabilities. Accordingly, portfolio size, composition, and the related yields earned and the average rates paid can have a significant impact on net interest spread and margin. The table following this discussion represents the major components of interest earning assets and interest bearing liabilities on a tax equivalent basis.  To compare the tax-exempt asset yields to taxable yields, amounts in the table are adjusted to pretax equivalents based on the marginal corporate Federal tax rate of 35%.

The Company continues to actively monitormonitors and proactively managemanages the rate sensitive components of both its assets and liabilities in a continuously changing and difficult market environment. This task has become increasingly more difficult following the extreme market disruptions and economic downturn that began in 2008. Competition in the Company’s market areas continues to be intense. Theintense, and the overall interest rate environment remains low by historical measures. The Federal Reserve has kept its short-term federal funds target rate at near zero percent since mid-December 2008 and has indicated that it expects to maintain that rate at an exceptionally low level for an extended period of time.while unemployment rates remain above 6.5%. Yields on Treasury securities of medium and longer-term maturity structures have decreased as ofare relatively unchanged or slightly lower at year-end 2010 compared to2012 than a year earlier. The two and 10-year notes decreased 5421 basis pointspoint and 54312 basis points, respectively in the comparison while the 30-year bond dropped 307increased 6 basis points.

Similar to the short-term federal funds target rate, the prime interest rate has not changed since December 2008. The Company uses the prime interest rate as part of its pricing model primarily on variable rate commercial real estate loans. The prime interest rate can have a significant impact on the Company’s interest income on loans that reprice based on changes to the prime interestthis rate. The Company’s variable interest rate loans contain provisions that limit the amount of increase or

decrease in the interest rate during the life of thea loan. This will limit the increase or decrease in interest income on loans that have interest rates tied to the prime interest rate. For 2010,2012, the average yield earned on loans was 5.7%5.5%, which is in excess ofexceeded the prime interest rate of 3.25% at year-end 2010.2012. Predicting the movement of future interest rates is uncertain.

During 2010,2012, the average rates for two of the most significant components of net interest income for the Company, loans and time deposits, both declined. As previously noted, theThe average rate earned on the Company’s loan portfolio declined 19for 2012 edged downward 7 basis points to 5.7% for 2010. The5.5% and the average rate paid on time deposits decreased 8746 basis points to 2.5%1.4% compared to 2011. The Company expects its net interest margin to trend upward in the annual comparison. Shouldnear term according to internal modeling using expectations about future market interest rates, onthe maturity structure of the Company’s earning assets and interest paying liabilities, reprice lower, the Company’s yield on earning assets could potentially decrease faster than its cost of funds. Should interest rates reprice higher,and other factors. In particular, the Company’s cost of funds may also increase andis expected to decrease in the near term primarily from the maturity of $50.0 million of 3.98% fixed rate borrowings combined with $23.2 million of 6.60% fixed rate borrowings that repriced downward to a floating interest rate of three-month LIBOR plus 132 basis points. Each of these events occurred during the fourth quarter of 2012. Future results, however, could continue to increase fasterbe significantly different than the yields on earning assets, resulting in a lower net interest margin.expectations.