Bank of Kentucky Financial (BKYF) 10-Q 2003 Q2 Quarterly report

U.S. SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For Quarterly Period ended June 30, 2003

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                        to                        

Commission File Number: 0-25960

THE BANK OF KENTUCKY FINANCIAL CORPORATION

(Exact name of registrant as specified in its charter)

Kentucky (State or other jurisdiction of incorporation or organization) 61-1256535 (I.R.S. Employer Identification Number)

111 Lookout Farm Drive, Crestview Hills, Kentucky 41017

(Address of principal executive offices) (Zip Code)

Registrant’s telephone number: (859) 371-2340

Indicate by checkmark whether the registrant (1) 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.  Yes  x  No  ¨

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes  ¨  No  x

As of July 18, 2003, 5,977,149 shares of the Registrant’s Common Stock, no par value, were issued and outstanding.

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The Bank of Kentucky Financial Corporation

INDEX

		PAGE
Part I           FINANCIAL INFORMATION
	Item 1 –Financial Statements	3
	Item 2 –Management’s Discussion and Analysis of Financial Condition and Results of Operations	9
	Item 3 –Quantitative and Qualitative Disclosures About Market Risk	18
	Item 4 –Controls and Procedures	18
Part II         OTHER INFORMATION
	Item 1 –Legal Proceedings	19
	Item 2 –Changes in Securities and Use of Proceeds	19
	Item 3 –Defaults Upon Senior Securities	19
	Item 4 –Submission of Matters to a Vote of Security Holders	19
	Item 5 –Other Information	19
	Item 6 –Exhibits and Reports on Form 8-K	19

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THE BANK OF KENTUCKY FINANCIAL CORPORATION

PART I FINANCIAL INFORMATION

Item 1. Financial Statements

THE BANK OF KENTUCKY FINANCIAL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

(Dollars in thousands—unaudited)

	June 30 2003		December 31 2002
Assets
Cash and cash equivalents	$	78,387	$	73,318
Interest bearing deposits with banks		1,925		2,015
Available-for-sale securities		27,731		33,770
Held-to-maturity securities		17,624		15,694
Loans held for sale		8,341		10,799
Total loans		612,199		606,815
Less: Allowances for loan losses		6,539		6,408
Net loans		605,660		600,407
Premises and equipment, net		16,025		16,242
FHLB stock, at cost		3,834		3,759
Goodwill		9,397		9,329
Acquisition intangibles, net		4,549		4,871
Cash surrender value of life insurance		8,895		1,374
Accrued interest receivable and other assets		7,138		7,502
Total assets	$	789,506	$	779,080
Liabilities & Shareholders’ Equity
Liabilities
Deposits	$	678,526	$	667,346
Short-term borrowings		6,065		5,880
Notes payable		37,462		42,599
Accrued interest payable and other liabilities		4,468		4,832
Total liabilities		726,521		720,657
Shareholders’ Equity
Common stock, no par value, 15,000,000 authorized, 5,977,149 (2003) and 5,953,849 (2002) shares issued		3,098		3,098
Additional paid-in capital		10,767		10,379
Retained earnings		48,850		44,582
Accumulated other comprehensive income		270		364
Total shareholders’ equity		62,985		58,423
Total liabilities and shareholders’ equity	$	789,506	$	779,080

See accompanying notes

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THE BANK OF KENTUCKY FINANCIAL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

FOR THE THREE AND SIX MONTH PERIODS ENDED JUNE 30, 2003 AND 2002

(Dollars in thousands, except per share data—unaudited)

	Three Months Ended June 30						Six Months Ended June 30
	2003			2002			2003			2002
INTEREST INCOME
Loans, including related fees	$	9,282		$	7,564		$	18,812		$	14,929
Securities and other		565			661			1,218			1,361
Total interest income		9,847			8,225			20,030			16,290
INTEREST EXPENSE
Deposits		2,948			2,726			6,167			5,442
Borrowings		389			170			814			328
Total interest expense		3,337			2,896			6,981			5,770
Net interest income		6,510			5,329			13,049			10,520
Provision for loan losses		(175	)		(348	)		(325	)		(520	)
Net interest income after provision for loan losses		6,335			4,981			12,724			10,000
NON-INTEREST INCOME
Service charges and fees		967			626			1,763			1,177
Gain/(loss) on securities		0			87			0			113
Gain on loans sold		1,018			128			1,649			299
Other		629			307			1,112			610
Total non-interest income		2,614			1,148			4,524			2,199
NON-INTEREST EXPENSE
Salaries and benefits		2,380			1,514			4,644			3,014
Occupancy and equipment		829			527			1,723			1,020
Data processing		296			243			646			471
Advertising		132			82			247			179
Other		1,495			874			2,809			1,655
Total non-interest expense		5,132			3,240			10,069			6,339
INCOME BEFORE INCOME TAXES		3,817			2,889			7,179			5,860
Less: income taxes		1,298			946			2,434			1,913
NET INCOME	$	2,519		$	1,943		$	4,745		$	3,947
COMPREHENSIVE INCOME	$	2,537		$	2,235		$	4,651		$	4,111
Earnings per share	$	.42		$	.33		$	.80		$	.66
Earnings per share, assuming dilution	$	.42		$	.32		$	.79		$	.66
Dividends per share	$	.00		$	.00		$	.08		$	.06

See accompanying notes

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THE BANK OF KENTUCKY FINANCIAL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

FOR THE SIX MONTHS ENDED JUNE 30

(Dollars in thousands—unaudited)

	2003			2002
Balance January 1	$	58,423		$	51,521
Comprehensive Income:
Net Income		4,745			3,947
Change in net unrealized gain/(loss)		(94	)		164
Total Comprehensive Income		4,651			4,111
Cash dividends paid		(477	)		(358	)
Exercise of stock options		466			154
Stock repurchase and retirement		(78	)		(931	)
Balance June 30	$	62,985		$	54,497

See accompanying notes

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THE BANK OF KENTUCKY FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE SIX MONTHS ENDED JUNE 30

(Dollars in thousands—unaudited)

	2003			2002
Cash Flows from Operating Activities
Net income	$	4,745		$	3,947
Adjustments to reconcile net income to net cash from operating activities		3,784			(124	)
Net cash from operating activities		8,529			3,823
Cash flows from Investing Activities
Net change in interest-bearing deposits with banks		90			(100	)
Proceeds from paydowns and maturities of held-to-maturity securities		3,270			3,805
Proceeds from paydowns and maturities of available-for-sale securities		34,938			9,213
Purchases of held-to-maturity securities		(5,204	)		(3,562	)
Purchases of available-for-sale securities		(29,099	)		(7,214	)
Net change in loans		(5,895	)		(31,273	)
Property and equipment expenditures		(412	)		(93	)
Purchase of bank owned life insurance		(7,501	)		0
Other		(68	)		0
Net cash from investing activities		(9,881	)		(29,224	)
Cash Flows from Financing Activities
Net change in deposits		11,398			26,716
Net change in short-term borrowings		185			(1,679	)
Proceeds from exercise of stock options		410			154
Cash dividends paid		(477	)		(358	)
Stock repurchase and retirement		(78	)		(931	)
Payments on note payable		(5,017	)		(15	)
Net cash from financing activities		6,421			23,887
Net change in cash and cash equivalents		5,069			(1,514	)
Cash and cash equivalents at beginning of period		73,318			26,706
Cash and cash equivalents at end of period	$	78,387		$	25,192

See accompanying notes

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THE BANK OF KENTUCKY FINANCIAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2003

Note 1—Basis of Presentation:

The condensed consolidated financial statements include the accounts of The Bank of Kentucky Financial Corporation (BKFC or the company) and its wholly owned subsidiaries, The Bank of Kentucky, Inc. (the Bank) and The Bank of Kentucky Capital Trust I. All significant intercompany accounts and transactions have been eliminated.

Note 2—General:

These financial statements were prepared in accordance with the instructions for Form 10-Q and, therefore, do not include all of the disclosures necessary for a complete presentation of financial position, results of operations and cash flows in conformity with generally accepted accounting principles. Except for required accounting changes, these financial statements have been prepared on a basis consistent with the annual financial statements and include, in the opinion of management, all adjustments, consisting of only normal recurring adjustments, necessary for a fair presentation of the results of operations and financial position at the end of and for the periods presented.

Note 3—Earnings per Share:

Earnings per share are computed based upon the weighted average number of shares outstanding during the respective three and six month periods. Diluted earnings per share are computed assuming that average stock options outstanding are exercised and the proceeds, including the relevant tax benefit, are used entirely to reacquire shares at the average price for the period. The following table presents the numbers of shares used to compute basic and diluted earnings per share for the indicated periods:

	Three Months Ended June 30		Six Months Ended June 30
	2003	2002	2003	2002
Weighted Average Shares Outstanding	5,971,987	5,964,226	5,964,588	5,969,198
Shares used to compute diluted Earnings per share	6,047,029	5,993,620	6,036,497	5,996,811

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Note 4—Stock Compensation:

Employee compensation expense under stock options is reported using the intrinsic value method. No stock-based compensation cost is reflected in net income, as all options granted had an exercise price equal to or greater than the market price of the underlying common stock at date of grant. The following table illustrates the effect on net income and earnings per share if expense was measured using the fair value recognition provisions of FASB Statement No. 123,Accounting for Stock-Based Compensation,as of June 30.

	Three Months Ended June 30				Six Months Ended June 30
	2003		2002		2003		2002
Net income as reported	$	2,519	$	1,943	$	4,745	$	3,947
Deduct Stock-based compensation expense determined under fair value based method		383		69		469		138
Pro forma net income		2,136		1,874		4,276		3,809
Basic earnings per share as reported		.42		.33		.80		.66
Pro forma basic earnings per share		.36		.31		.72		.64
Diluted earnings per share as reported		.42		.32		.79		.66
Pro forma diluted earnings per share		.36		.31		.71		.64

Note 5—Cash and Cash Equivalents:

Cash and cash equivalents include cash on hand, amounts due from banks, federal funds sold, and investments in money market mutual funds. The Company reports net cash flows for customer loan and deposit transactions, and interest-bearing balances with banks and short-term borrowings with maturities of 90 days or less.

Note 6—Reclassification:

Certain prior period amounts have been reclassified to conform to the current period presentation.Such reclassifications have no effect on previously reported net income or shareholders’ equity.

Note 7—Newly Issued But Not Yet Effective Accounting Standards:

In May 2003, the Financial Accounting Standards board issued Statement No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” This statement requires that an issuer classify a financial instrument that is within its scope as a liability. This statement was effective for financial instruments entered into or modified after May 31, 2003 and otherwise was effective beginning July 1,

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2003. The Company adopted Statement 150 effective July 1, 2003, and the adoption did not have a material effect on the Company’s financial condition or results of operations.

In January 2003, the Financial Accounting Standards Board issued Interpretation No. 46, “Consolidation of Variable Interest Entities, and Interpretation of ARB No. 51”. This interpretation provides new guidance for the consolidation of variable interest entities (VIEs) and requires such entities to be consolidated by their primary beneficiaries if the entities do not effectively disperse risk among parties involved. The interpretation also adds disclosure requirements for investors that are involved with unconsolidated VIEs. The consolidation requirements apply immediately to VIEs created after January 31, 2003 and are effective for the first fiscal year or interim period beginning after June 15, 2003 for VIEs acquired before February 1, 2003. The adoption of this interpretation is not expected to have a significant impact on the Company’s financial condition or results of operations.

In April 2003, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities.” This Statement is effective for contracts entered into or modified after June 30, 2003, except for hedging activities designated after June 30, 2003 and Statement 133, “Accounting for Derivative Instruments and Hedging Activities,” Implementation Issues that have been effective for fiscal quarters that began prior to June 15, 2003. Statement 149 amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities under Statement 133. Adoption of Statement No. 149 did not have any impact on the Company’s financial condition or results of operations.

Item 2. Management’s Discussion and Analysis of Financial Condition and the Results of Operations

This Form 10-Q contains forward-looking statements. Statements that are not historical or current facts, including statements about beliefs and expectations, are forward-looking statements. These forward-looking statements cover, among other things, anticipated future revenue and expenses and the future prospects of either The Bank of Kentucky Financial Corporation (BKFC or the Company) or The Bank of Kentucky, Inc. (the Bank) or The Bank of Kentucky Capital Trust I or all three. Forward-looking statements involve inherent risks and uncertainties, and important factors could cause actual results to differ materially from those anticipated, including the following, in addition to those contained in BKFC’s reports on file with the Commission: (i) general economic or industry conditions could be less favorable than expected, resulting in a deterioration in credit quality, a change in the allowance for credit losses, or a reduced demand for credit or fee-based products and services; (ii) changes in the domestic interest rate environment could reduce net interest income and could increase credit losses; (iii) the conditions of the securities markets could change, adversely affecting revenues from capital markets businesses, the value or credit quality of the Company’s assets, or the availability and terms of funding necessary to meet the Company’s liquidity needs; (iv) changes in the extensive laws, regulations and policies governing financial services companies could alter BKFC’s and the Bank’s business environment or affect operations; (v) the potential need to adapt to industry changes in information technology systems, on which the Bank is highly dependent, could present operational issues or require significant capital spending; (vi) competitive pressures could intensify and affect the Bank’s profitability, including as a result of continued industry consolidation, the increased availability of financial services from non-banks, technological developments or bank regulatory reform; and (vii) acquisitions may not produce revenue enhancements or cost savings at levels or

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within timeframes originally anticipated, or may result in unforeseen integration difficulties. Forward-looking statements speak only as of the date they are made, and BFKC undertakes no obligation to update them in light of new information or future events

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The Company’s financial statements and accompanying notes have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reported periods.

Management continually evaluates the Company’s accounting policies and estimates it uses to prepare the consolidated financial statements. In general, management’s estimates are based on historical experience, on information from regulators and third party professionals and on various assumptions that are believed to be reasonable under the facts and circumstances. Actual results could differ from those estimates made by management.

The Company believes its critical accounting policies and estimates include the valuation of the allowance for loan losses. Based on management’s calculations, an allowance of $6.5 million or 1.07% of total loans was an adequate estimate of losses within the loan portfolio as of June 30, 2003. This estimate resulted in a provision for loan losses on the income statement of $325 thousand for the six months ended June 30, 2003. If the mix and amount of future write-off percentages differ significantly from those assumptions used by management in making its determination, the allowance for loan losses and provision for loan losses on the income statement could be materially affected.

FINANCIAL CONDITION

Total assets at June 30, 2003 were $789,506,000 compared to $779,080,000 at December 31, 2002, an increase of $10,426,000 (1.34%). Deposits increased $11,180,000 (1.68%) to $678,526,000 at June 30, 2003 compared to $667,346,000 at December 31, 2002 while Notes payable decreased $5,137,000 (12%) to $37,462,000 at June 30,2003 from $42,599,000 December 31, 2002, as a result of a $5,000,000 Federal Home Loan Bank advance payoff. Loans outstanding increased $5,384,000 (.89%) from $606,815,000 at December 31, 2002 to $612,199,000 at June 30, 2003.

Cash surrender value of life insurance increased from $1,374,000 at the end of 2002 to $8,895,000 at June 30, 2003 as a result of an investment of $7,501,000 in Bank owned life insurance (BOLI) policies. Related to that investment the Company is in the process of changing certain employee benefit plans that will be put in place in the second half of 2003. Management anticipates that the annual cost of the changes in employee benefit plans will be in the range of $125,000 to $150,000, and that the anticipated incremental earnings of the insurance policies, compared to the prior investments, will offset this cost.

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The growth in the loan portfolio and the investment in the insurance policies were funded with traditional growth in the deposit base and earnings.

Currently the Bank has $78,387,000, or 10% of assets, in cash and cash equivalents, which is greater than its traditional position. While this liquidity position offers the Bank flexibility, it is higher than desired from a profitability standpoint. The Bank continues to look for good quality loans in the market area, but will not lower credit standards to gain a higher yield from these funds.

RESULTS OF OPERATIONS

GENERAL

Net income year to date increased from $3,947,000 in 2002 to $4,745,000 in 2003, an increase of $798,000 (20%). Net income for the quarter ended June 30,2003 was $2,519,000 ($.42 per share) compared to $1,943,000 ($.33 per share) during the same period of 2002, an increase of $576,000 (30%). The 2003 results reflect the purchase of certain assets and the assumption of certain liabilities of the Peoples Bank of Northern Kentucky (PBNK) on November 22, 2002. Driven by the exceptionally high level of gains on the sale of mortgage loans, as a result of the refinance business with the current low rate environment, the largest percentage increase in revenue was seen in non-interest income, which was up $2,325,000 or 106% to $4,524,000 for the six month ended June 30, and was up $1,466,000 or 128% for the second quarter of 2003 compared to the same period of 2002.

NET INTEREST INCOME

Net interest income increased $1,181,000 (22%) in the second quarter of 2003 over the same period in 2002, while the year to date total increased $2,529,000 (24%) from $10,520,000 in 2002 to $13,049,000 in 2003. The large increase in the net interest income was the result of the growth in earning assets and interest bearing liabilities associated with both the PBNK transaction and the growth experienced in 2002, and was offset with a drop in the net interest margin to 3.71% in the second quarter of 2003 from 4.41% for the same period in 2002. The decline in the net interest margin was the result of the historically low current interest rate environment and the balance sheet changes associated with the PBNK transaction. Although the Bank currently has more interest bearing transaction accounts that can be repriced immediately than assets that are immediately repriceable, lower interest rates would not have a positive impact on earnings. The rates on these interest bearing transactions accounts can’t drop appreciably lower than their current levels, and the value of net free funds (earning assets funded by non interest bearing liabilities) drops as rates fall. In any rate environment the net interest margin would benefit from an increase in loan demand and a drop in the current level of liquidity. The net effect of the balance sheet changes from the PBNK transaction was an increase in liquidity that

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led to a higher percentage of short-term investments to earning assets compared to a year ago, and a higher level of non-earning assets in the form of fixed assets and goodwill. As a result of these changes, the average interest-earning assets to interest-bearing liabilities ratio has decreased from 119.41% on average balances through six months ended June 30, 2002 to 111.92% for the same period in 2003.

Tables 1 & 2 set forth certain information relating to the Bank’s average balance sheet information and reflects the average yield on interest-earning assets, on a tax equivalent basis, and the average cost of interest-bearing liabilities for the periods indicated. Such yields and costs are derived by dividing income or expense by the average monthly balance of interest-earning assets or interest-bearing liabilities, respectively, for the years presented. Average balances are daily averages for the Bank and include nonaccruing loans in the loan portfolio, net of the allowance for loan losses.

Table 1- Average Balance Sheet Rates for Three Months Ended June 30, 2003 and 2002 (presented on a tax equivalent basis in thousands)

	Three Months ended June 30, 2003							Three Months ended June 30, 2002
	Average outstanding balance			Interest earned/ paid		Yield/ rate		Average outstanding balance			Interest earned/ paid		Yield/ rate
								(Dollars in thousands)
Interest-earning assets:
Loans receivable (1)(2)	$	614,323		$	9,302	6.07	%	$	436,414		$	7,572	6.96	%
Securities (2)		80,120			544	2.72			50,152			678	5.42
Other interest-earning assets		18,271			80	1.76			4,826			48	3.99
Total interest-earning assets		712,714			9,926	5.59			491,392			8,298	6.77
Non-interest-earning assets		67,601							29,415
Total assets	$	780,315						$	520,807
Interest-bearing liabilities:
Transaction accounts		321,804			872	1.09			208,664			927	1.78
Time deposits		269,161			2,076	3.09			180,406			1,799	4.00
Borrowings		43,906			389	3.55			22,622			170	3.01
Total interest-bearing liabilities		634,871			3,337	2.11			411,692			2,896	2.82
Non-interest-bearing liabilities		83,495							55,564
Total liabilities		718,366							467,256
Shareholders’ equity		61,949							53,551
Total liabilities and shareholders’ equity	$	780,315						$	520,807
Net interest income				$	6,589						$	5,402
Interest rate spread						3.48	%						3.95	%
Net interest margin (net interest income as a percent of average interest-earning assets)						3.71	%						4.41	%
Average interest-earning assets to interest-bearing liabilities		112.26	%						119.36	%

(1) Includes non-accrual loans.

(2) Income presented on a tax equivalent basis using a 35% and 34% tax rate for 2003 and 2002 respectively. The tax equivalent adjustment was $79,000 and $73,000, in 2003 and 2002 respectively.

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Table 2- Average Balance Sheet Rates for Six Months Ended June 30, 2003 and 2002 (presented on a tax equivalent basis in thousands)

	Six Months ended June 30, 2003							Six Months ended June 30, 2002
	Average outstanding balance			Interest earned/ paid		Yield/ rate		Average outstanding balance			Interest earned/ paid		Yield/ rate
								(Dollars in thousands)
Interest-earning assets:
Loans receivable (1)(2)	$	612,686		$	18,851	6.20	%	$	424,377		$	14,945	7.10	%
Securities (2)		73,238			1,155	3.18			51,216			1,398	5.51
Other interest-earning assets		21,627			181	1.69			5,089			96	3.79
Total interest-earning assets		707,551			20,187	5.75			480,682			16,439	6.90
Non-interest-earning assets		67,672							28,616
Total assets	$	775,223						$	509,298
Interest-bearing liabilities:
Transaction accounts		316,547			1,902	1.21			204,457			1,715	1.69
Time deposits		269,644			4,265	3.19			175,967			3,727	4.27
Borrowings		45,977			814	3.57			22,111			328	2.99
Total interest-bearing liabilities		632,168			6,981	2.23			402,535			5,770	2.89
Non-interest-bearing liabilities		82,053							54,127
Total liabilities		714,221							456,662
Shareholders’ equity		61,002							52,636
Total liabilities and shareholders’ equity	$	775,223						$	509,298
Net interest income				$	13,206						$	10,669
Interest rate spread						3.52	%						4.01	%
Net interest margin (net interest income as a percent of average interest-earning assets)						3.76	%						4.48	%
Average interest-earning assets to interest-bearing liabilities		111.92	%						119.41	%

(1) Includes non-accrual loans.

(2) Income presented on a tax equivalent basis using a 35% and 34% tax rate for 2003 and 2002 respectively. The tax equivalent adjustment was $157,000 and $149,000, in 2003 and 2002 respectively.

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Table 3 below describes the extent to which changes in interest rates and changes in volume of interest-earning assets and interest-bearing liabilities have affected the Bank’s interest income and expense during the periods indicated. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (i) changes in volume (change in volume multiplied by prior year rate), (ii) changes in rate (change in rate multiplied by prior year volume) and (iii) total changes in rate and volume. The combined effects of changes in both volume and rate, which cannot be separately identified, have been allocated proportionately to the change due to volume and the change due to rate.

Table 3-Volume/Rate Analysis (in thousands)

	Three months ended June 30, 2003 Compared to Three months ended June 30, 2002								Six months ended June 30, 2003 Compared to Six months ended June 30, 2002
	Increase (Decrease) Due to								Increase (Decrease) Due to
	Volume		Rate			Total			Volume		Rate			Total
Interest income attributable to:
Loans receivable	$	2,795	$	(1,065	)	$	1,730		$	6,029	$	(2,124	)	$	3,905
Securities		296		(430	)		(134	)		477		(720	)		(243	)
Other interest-earning assets(1)		72		(40	)		32			165		(80	)		85
Total interest-earning assets		3,163		(1,535	)		1,628			6,671		(2,924	)		3,747
Interest expense attributable to:
Transactions accounts		390		(445	)		(55	)		771		(584	)		187
Time deposits		750		(473	)		277			1,658		(1,120	)		538
Borrowings		185		35			219			416		71			486
Total interest-bearing liabilities		1,324		(883	)		441			2,844		(1,633	)		1,211
Increase (decrease) in net interest income	$	1,839	$	(652	)	$	1,187		$	3,827	$	(1,291	)	$	2,536

(1) Includes federal funds sold and interest-bearing deposits in other financial institutions.

PROVISION FOR LOAN LOSSES

The provision for loan losses was $325,000 for the six months ended June 30, 2003, a decrease of $195,000 compared to the $520,000 provision recorded during the same period in 2002. For the second quarter of 2003 the provision for loan losses was $175,000, a decrease of $173,000 compared to the $348,000 provision for the second quarter of 2002. During the six-month period of 2003, total loans increased by $5,384,000, from $606,815,000 at December 31, 2002 to $612,199,000 at June 30, 2003, for the same period of 2002 total loans increased $36,696,000. Non-performing loans declined slightly, to $4,116,000 or .67% of total loans outstanding at June 30, 2003, compared to $4,173,000 or .68% at December 31, 2002. Net charge-offs, year to date 2003 were $194,000 or .06% on an annualized bases to average loans, compared to the $75,000 and .04% for the first six months of 2002. These charge-offs ratios are well below industry average and the .06% for 2003 is below the Bank’s charge-off ratio of .10% for

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the entire year of 2002. The allowance for loan losses was 158% of non-performing loans on June 30, 2003 compared to 154% at the end of 2002 and 162% at June 30, 2002. The decreases in non-performing loans accompanied with the stable charge-off levels and the stable allowance to non-performing loan ratio led to the decline in the provision from 2002. Management continues to monitor the loan portfolio closely and believes the provision for loan losses is directionally consistent with the change in credit quality, and the allowance is sufficient to absorb probable incurred losses in the loan portfolio.

The following table sets forth an analysis of the Bank’s allowance for losses for the periods indicated:

Table 4-Summary of Loan Loss Experience and Allowance for Loan Loss Analysis (in thousands)

	Three Months ended June 30, 2003						Six Months ended June 30, 2002
	2003			2002			2003			2002
Balance of allowance at beginning of period	$	6,446		$	4,368		$	6,408		$	4,244
Recoveries of loans previously charged off:
Commercial loans		1			5			3			7
Consumer loans		15			1			17			5
Mortgage loans		0			0			0			0
Total recoveries		16			6			20			12
Loans charged off:
Commercial loans		46			0			46			7
Consumer loans		62			12			120			47
Mortgage loans		(10	)		21			48			33
Total charge-offs		98			33			214			87
Net charge-offs		(82	)		(27	)		(194	)		(75	)
Provision for loan losses		175			348			325			520
Merger adjustment		0			0			0			0
Balance of allowance at end of period	$	6,539		$	4,689		$	6,539		$	4,689
Net charge-offs to average loans outstanding for period		.05	%		.02	%		.06	%		.04	%
Allowance at end of period to loans at end of period		1.07	%		1.05	%		1.07	%		1.05	%
Allowance to nonperforming loans at end of period		158.87	%		162.47	%		158.87	%		162.47	%

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NON-INTEREST INCOME

Total non-interest income increased $2,325,000 (106%) for the first six months of 2003 from $2,199,000 at June 30, 2002 to $4,524,000 at June 30, 2003. For the second quarter of 2003 non-interest income was up $1,466,000 (128%) to $2,614,000 compared to $1,148,000 for the same period in 2002. The 2003 figures reflect the effects of the PBNK transaction, which added eight banking offices, sixty-two employees, $140 million in loans and $162 million in deposits. The largest increase in non-interest income, for both the quarter and the six months ending June 30, 2003, was in gains on the sale of mortgage loans, which increased $890,000 (695%) for the quarter and $1,350,000 (452%) for the six month ending June 30, 2003 compared to the same periods in 2002. The increase was due to strong refinancing activity as a result of the current low interest rate environment. The Bank originates fixed rate first mortgage loans and sells them, service released, into the secondary market. For the six months ended June 30, 2003, 1,173 loans with principal balances of $151 million were sold compared to 190 loans with a principal balance of $29 million during the same period in 2002. Loans held for sale at June 30, 2003 decreased to $8,341,000 from $10,799,000 at December 31, 2002. These loans have been approved by the secondary market buyer and closed by the Bank. The Bank is awaiting settlement but is not exposed to significant interest rate or pricing risk during the period between closing the loan and settlement. The level of the current refinancing business is dependent on rates, and with rates rising on fixed rate mortgage loans subsequent to the end of the second quarter, refinancing applications have slowed appreciably. Service charges and fees on deposit accounts increased by $586,000 (50%) from $1,177,000 in the first half of 2002 to $1,763,000 for the same period in 2003, reflecting the significant increase in volume associated with the added deposits. The Bank had no gains or losses from the sale of investment securities in 2003 versus a realized gain of $113,000 on the sale of securities in the first six months of 2002.

NON-INTEREST EXPENSE

Non-interest expense increased to $10,069,000 in the first half of 2003 and to $5,132,000 for the second quarter of 2003 from $6,339,000 and $3,240,000 in the same periods of 2002, an increase of $3,730,000 (59%) and $1,892,000 (58%) respectively. The 2003 figures reflect the effects of the PBNK transaction, which added eight banking offices, sixty-two employees, $140 million in loans and $162 million in deposits. The added staff was the largest added expense and drove the salaries and benefits increase of $1,630,000 (54%) in the first half of 2003 to $4,644,000 compared to $3,014,000 for the same period in 2002. Occupancy and equipment expense increased $703,000 (69%) from $1,020,000 in the first half of 2002 to $1,723,000 in 2003 as a result of the added banking offices, and high amount of snow removal expense in 2003. Non-interest expense includes $323,000 in the amortization of intangible assets associated with the PBNK transaction in 2003 versus $0 in 2002.

INCOME TAX EXPENSE

Income tax expense increased due to higher income before taxes and a higher effective tax rate of 33.90% compared to 32.65% for the first six months of 2003 and 2002 respectively. The higher effective tax rate was due to a higher tax bracket associated with higher earnings.

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LIQUIDITY AND CAPITAL RESOURCES

The Bank achieves liquidity by maintaining an appropriate balance between its sources and uses of funds to assure that sufficient funds are available to meet loan demands and deposit fluctuations. The Bank has the ability to draw funds from the Federal Home Loan Bank and two of its correspondent banks to meet liquidity demands. With 10%, or $78,387,000, of assets in cash and cash equivalents and these other sources of funds, management is satisfied that the Company’s liquidity is sufficient at June 30, 2003. While this liquidity position offers the Bank flexibility, it is higher than desired from a profitability standpoint, and the Bank continues to look for good quality loans in the market area but will not lower credit standards to gain a higher yield from these funds.

The Company’s total shareholders’ equity increased $4,562,000, from $58,423,000 at December 31, 2002 to $62,985,000 at June 30, 2003. In the first half of 2003, the Company paid a cash dividend of $.08 per share totaling $477,000.

On October 8, 2001, the Company’s Board of Directors approved the repurchase and retirement of 100,000 common shares of the Company in the over-the-counter market. As of the date of this report, this authorization has expired with 99,130 shares repurchased. Any repurchases are funded, as needed, by dividends from the Bank. On June 27, 2003, the Company’s Board of Directors approved the repurchase and retirement of 200,000 common shares of the Company in the over-the-counter market, this plan ends on December 31, 2004. As of the date of this report, none of the 200,000 shares authorized for repurchase have been repurchased. Any repurchases will be funded, as needed, by dividends from the Bank.

The Company’s liquidity depends primarily on the dividends paid to it as the sole shareholder of the Bank. The Company needs liquidity to meet the financial obligations of the Trust Preferred securities, for the payment of dividends to shareholders and for general operating expenses. The FRB and the FDIC have issued policy statements, which provide that insured banks and bank holding companies should generally only pay dividends out of current operating earnings. The FDIC prohibits the payment of any dividend by a bank that would constitute an unsafe or unsound practice. Compliance with the minimum capital requirements limits the amounts that the Company and the Bank can pay as dividends. At June 30, 2003, the Bank had capital in excess of the FDIC’s most restrictive minimum capital requirements in an amount over $3 million from which dividends could be paid, subject to the FDIC’s general safety and soundness review.

For purposes of determining a bank’s deposit insurance assessment, the FDIC has issued regulations that define a “well capitalized” bank as one with a leverage ratio of 5% or more and a total risk-based ratio of 10% or more. At June 30, 2003, the Bank’s leverage and total risk-based ratios were 8.52% and 10.54% respectively, which exceed the well-capitalized thresholds.

Newly Issued But Not Yet Effective Accounting Standards:

In May 2003, the Financial Accounting Standards board issued Statement No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” This statement requires that an issuer classify a financial instrument that is within its scope as a liability. This

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statement was effective for financial instruments entered into or modified after May 31, 2003 and otherwise was effective beginning July 1, 2003. The Company adopted Statement 150 effective July 1, 2003, and the adoption did not have a material effect on the Company’s financial condition or results of operations.

In January 2003, the Financial Accounting Standards Board issued Interpretation No. 46, “Consolidation of Variable Interest Entities, and Interpretation of ARB No. 51”. This interpretation provides new guidance for the consolidation of variable interest entities (VIEs) and requires such entities to be consolidated by their primary beneficiaries if the entities do not effectively disperse risk among parties involved. The interpretation also adds disclosure requirements for investors that are involved with unconsolidated VIEs. The consolidation requirements apply immediately to VIEs created after January 31, 2003 and are effective for the first fiscal year or interim period beginning after June 15, 2003 for VIEs acquired before February 1, 2003. The adoption of this interpretation is not expected to have a significant impact on the Company’s financial condition or results of operations.

In April 2003, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities.” This Statement is effective for contracts entered into or modified after June 30, 2003, except for hedging activities designated after June 30, 2003 and Statement 133, “Accounting for Derivative Instruments and Hedging Activities,” Implementation Issues that have been effective for fiscal quarters that began prior to June 15, 2003. Statement 149 amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities under Statement 133. Adoption of Statement No. 149 did not have any impact on the Company’s financial condition or results of operations.

Item  3. Quantitative and Qualitative Disclosures About Market Risk.

There has been no material change in market risk since the Company’s annual report on Form 10-K for the year ending December 31, 2002.

Item  4. Controls and Procedures.

Disclosure Controls and Procedures

Disclosure controls and procedures are the Company’s controls and other procedures that are designed to ensure that information required to be disclosed by the Company in the reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate to allow timely decisions regarding required disclosure.

Under the supervision, and with the participation of our management, including our chief executive officer and chief financial officer, we have evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of June 30, 2003, and, based upon this evaluation, our chief executive officer and chief financial officer have concluded that these controls and procedures are adequate to ensure that information requiring disclosure is communicated to management in a timely manner and reported within the timeframe specified by the SEC’s rules and forms.

Changes in Internal Control Over Financial Reporting

There were no changes in our internal controls over financial reporting that occurred in the last fiscal quarter that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting.

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The Bank of Kentucky Financial Corporation

PART II

Item  1. Legal Proceedings

From time to time, BKFC and the Bank are involved in litigation incidental to the conduct of the business, but neither BKFC nor the Bank is presently involved in any lawsuit or proceeding which, in the opinion of management, is likely to have a material adverse affect on BKFC.

Item  2. Changes in Securities and Use of Proceeds

Not applicable

Item  3. Defaults Upon Senior Securities

Not applicable

Item  4. Submission of Matters to a Vote of Security Holders

The Annual Meeting of Stockholders of the Company was held on April 25, 2003. The matters voted on at the meeting and the results of these votes are as follows.

(1) Election of four directors of BKFC for terms expiring in 2006:

	For	Against/Withheld	Abstentions
Harry J. Humpert	5,029,503	24,468	—
John P. William, Jr.	5,029,373	24,598	—
Herbert H. Works	5,029,603	24,368	—
Robert W. Zapp	4,980,220	73,751	—

(2) Ratification of the appointment of Crowe, Chizek and Company LLP as the auditors of BKFC for the current fiscal year:

For	Against/Withheld	Abstentions
5,042,309	938	10,724

Item  5. Other Information

None

Item  6. Exhibits and Reports on Form 8-K

(a) Exhibits

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Exhibit Number	Description
31.1	Rule 13a—14(a) Certification of Robert W. Zapp
31.2	Rule 13a—14(a) Certification of Martin J. Gerrety
32.1	Section 1350 Certification of Robert W. Zapp
32.2	Section 1350 Certification of Martin J. Gerrety

(b) Reports of Form 8-K.

BKFC filed an amended current report on Form 8-K on April 22, 2003, disclosing under Item 12, a press release announcing BKFC’s financial results for the first quarter of fiscal year 2003.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized.

		THE BANKOF KENTUCKY FINANCIAL CORPORATION
Date:	August 13, 2003	/s/    ROBERT W. ZAPP
		Robert W. Zapp
		President

Date:	August 13, 2003	/s/    MARTIN J.GERRETY
		Martin J. Gerrety
		Treasurer and Assistant Secretary

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