Bank of Kentucky Financial (BKYF) 10-Q 2005 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, 2005

¨ 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	61-1256535
(State or other jurisdiction of incorporation or organization)	(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  x    No  ¨

As of July 15, 2005, 5,904,579 shares of the registrant’s Common Stock, no par value, were issued and outstanding.

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	20
	Item 4 –Controls and Procedures	20
Part II	OTHER INFORMATION
	Item 1 –Legal Proceedings	21
	Item 2 –Unregistered Sales of Equity Securities and Use of Proceeds	21
	Item 3 –Defaults Upon Senior Securities	22
	Item 4 –Submission of Matters to a Vote of Security Holders	22
	Item 5 –Other Information	22
	Item 6 –Exhibits and Reports on Form 8-K	22

2

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 2005			December 31 2004
Assets
Cash and cash equivalents	$	31,045		$	47,406
Interest bearing deposits with banks		100			0
Available-for-sale securities		44,076			52,204
Held-to-maturity securities		15,292			12,062
Loans held for sale		1,743			1,391
Total loans		733,579			719,157
Less: Allowances for loan losses		7,364			7,214
Net loans		726,215			711,943
Premises and equipment, net		17,567			16,465
FHLB stock, at cost		4,171			4,075
Goodwill		9,867			9,867
Acquisition intangibles, net		3,258			3,581
Cash surrender value of life insurance		12,357			12,106
Accrued interest receivable and other assets		7,150			7,029
Total assets	$	872,841		$	878,129
Liabilities & Shareholders’ Equity
Liabilities
Deposits	$	740,192		$	752,800
Short-term borrowings		12,242			9,161
Notes payable		37,433			37,573
Accrued interest payable and other liabilities		5,744			4,931
Total liabilities		795,611			804,465
Shareholders’ Equity
Common stock, no par value, 15,000,000 shares authorized, 5,909,679 (2005) and 5,927,979 (2004) shares issued		3,098			3,098
Additional paid-in capital		8,421			9,050
Retained earnings		65,946			61,614
Accumulated other comprehensive loss		(235	)		(98	)
Total shareholders’ equity		77,230			73,664
Total liabilities and shareholders’ equity	$	872,841		$	878,129

See accompanying notes

3

THE BANK OF KENTUCKY FINANCIAL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

FOR THE THREE AND SIX MONTH PERIODS ENDED JUNE 30, 2005 AND 2004

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

	Three Months Ended June 30						Six Months Ended June 30
	2005			2004			2005			2004
INTEREST INCOME
Loans, including related fees	$	11,739		$	9,645		$	22,635		$	19,024
Securities and other		550			396			1,090			794
Total interest income		12,289			10,041			23,725			19,818
INTEREST EXPENSE
Deposits		3,489			2,289			6,535			4,609
Borrowings		563			418			1,042			811
Total interest expense		4,052			2,707			7,577			5,420
Net interest income		8,237			7,334			16,148			14,398
Provision for loan losses		(475	)		(350	)		(825	)		(675	)
Net interest income after provision for loan losses		7,762			6,984			15,323			13,723
NON-INTEREST INCOME
Service charges and fees		1,092			946			1,883			1,792
Gain/(loss) on securities		0			0			0			10
Gain on loans sold		276			480			451			803
Other		972			781			1,927			1,510
Total non-interest income		2,340			2,207			4,261			4,115
NON-INTEREST EXPENSE
Salaries and benefits		3,007			2,593			5,764			5,130
Occupancy and equipment		987			794			1,928			1,629
Data processing		367			316			691			644
Advertising		186			187			269			259
Other		1,663			1,412			3,257			2,854
Total non-interest expense		6,210			5,302			11,909			10,516
INCOME BEFORE INCOME TAXES		3,892			3,889			7,675			7,322
Less: income taxes		1,277			1,287			2,515			2,409
NET INCOME	$	2,615		$	2,602		$	5,160		$	4,913
Other comprehensive income (loss)		206			(366	)		(137	)		(368	)
COMPREHENSIVE INCOME	$	2,821		$	2,236		$	5,023		$	4,545
Earnings per share, basic	$	.44		$	.44		$	.87		$	.82
Earnings per share, diluted	$	.44		$	.43		$	.87		$	.81

See accompanying notes

4

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)

	2005			2004
Balance January 1	$	73,664		$	66,689
Comprehensive Income:
Net Income		5,160			4,913
Change in net unrealized gain/(loss)		(137	)		(368	)
Total Comprehensive Income		5,023			4,545
Cash dividends paid		(829	)		(658	)
Exercise of stock options (4,600 and 23,775 shares), including tax benefit		96			578
Stock repurchase and retirement (28,000 and 49,200 shares)		(724	)		(1,467	)
Balance June 30	$	77,230		$	69,687
Dividends per share	$	0.14		$	0.11

See accompanying notes

5

THE BANK OF KENTUCKY FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE SIX MONTHS ENDED JUNE 30

(Dollars in thousands - unaudited)

	2005			2004
Cash Flows from Operating Activities
Net income	$	5,160		$	4,913
Adjustments to reconcile net income to net cash
From operating activities		1,897			(833	)
Net cash from operating activities		7,057			4,080
Cash flows from Investing Activities
Net change in interest-bearing deposits with banks		(100	)		1,935
Proceeds from paydowns and maturities of held-to-maturity securities		2,640			2,220
Proceeds from paydowns and maturities of available-for-sale securities		7,910			23,337
Proceeds from sales of available-for-sale securities		0			3,016
Purchases of held-to-maturity securities		(5,880	)		(865	)
Purchases of available-for-sale securities		0			(19,080	)
Net change in loans		(15,202	)		(30,793	)
Property and equipment expenditures		(1,790	)		(409	)
Net cash from investing activities		(12,422	)		(20,639	)
Cash Flows from Financing Activities
Net change in deposits		(12,599	)		(1,727	)
Net change in short-term borrowings		3,081			16,179
Proceeds from exercise of stock options		96			494
Cash dividends paid		(829	)		(658	)
Stock repurchase and retirement		(725	)		(1,467	)
Payments on note payable		(20	)		(18	)
Net cash from financing activities		(10,996	)		12,803
Net change in cash and cash equivalents		(16,361	)		(3,756	)
Cash and cash equivalents at beginning of period		47,406			47,321
Cash and cash equivalents at end of period	$	31,045		$	43,565

See accompanying notes

6

THE BANK OF KENTUCKY FINANCIAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2005

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 subsidiary, The Bank of Kentucky, Inc. (the “Bank”). 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 three month period. 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. For the three months ended June 2005 and 2004, 300,258 and 145,862 options were not considered, as they were not dilutive, and for the six months ended June 2005 and 2004, 297,849 and 127,883 options were not considered, as they were not dilutive. 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
	2005	2004	2005	2004
Weighted average shares outstanding	5,911,373	5,964,199	5,917,338	5,971,146
Dilutive effects of assumed exercises of Stock Options	37,350	59,937	38,040	62,070
Shares used to compute diluted
Earnings per share	5,948,723	6,024,136	5,955,378	6,033,216

7

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 for the periods indicated if expense was measured using the fair value recognition provisions of FASB Statement No. 123,Accounting for Stock-Based Compensation.

(Dollars in thousands, except per share data)

	Three Months Ended June 30				Six Months Ended June 30
	2005		2004		2005		2004
Net income as reported	$	2,615	$	2,602	$	5,160	$	4,913
Stock-based compensation expense determined under fair value based method		170		195		340		354
Pro forma net income		2,445		2,407		4,820		4,559
Basic earnings per share as reported		.44		.44		.87		.82
Pro forma basic earnings per share		.41		.40		.81		.76
Diluted earnings per share as reported		.44		.43		.87		.81
Pro forma diluted earnings per share		.41		.40		.81		.76

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.

8

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

Statement of Financial Accounting Standards 123, Revised, requires all public companies to record compensation cost for stock options provided to employees in return for employee service. The cost is measured at the fair value of the options when granted, and this cost is expensed over the employee service period, which is normally the vesting period of the options. This will apply to awards granted or modified after the first fiscal year beginning after June 15, 2005. Compensation cost will also be recorded for prior option grants that vest after the date of adoption. The effect on results of operations will depend on the level of future option grants and the calculation of the fair value of the options granted at such future date, as well as the vesting periods provided, and so cannot currently be predicted. Existing options that will vest after adoption date are expected to result in additional compensation expense of approximately $441,000, $400,000 and $285,000 during 2006, 2007 and 2008. There will be no significant effect on financial position as total equity will not change.

Item 2. Management’s Discussion and Analysis of Financial Condition and 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 both. 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 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.

9

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 $7.4 million or 1.00% of total loans was an appropriate estimate of losses within the loan portfolio as of June 30, 2005. This estimate resulted in a provision for loan losses on the income statement of $825,000 for the six months ended June 30, 2005. If the mix and amount of future losses 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.

OVERVIEW

Highlighting the second quarter, and first six months results, was the increase in net interest income from the same periods in 2004. Net interest income increased $903,000 or 12% in the second quarter of 2005, as compared to the same period in 2004 This increase was both the result of an increase in earning assets and a favorable rate variance. The rate variance was the result of rising interest rates, which had a positive impact on net interest income. The rate variance and the Bank’s interest rate sensitivity is explained in detail in “Results of Operations – Net Interest Income”. The growth in net interest income in the second quarter was offset by a $204,000 (43%) reduction in gains on loans sold and a $908,000 (17%) increase in non-interest expense. The reduction in gains on loans sold was caused by the rising interest rates and the corresponding slowdown in the mortgage loan refinancing market. The increase in non-interest expense was due in part to the opening of the Bank’s cash management operations center in February.

FINANCIAL CONDITION

Total assets at June 30, 2005 were $872,841,000 compared to $878,129,000 at December 31, 2004, a decrease of $5,288,000 (.6%). Loans outstanding increased $14,422,000 (2%) from $719,157,000 at December 31, 2004 to $733,579,000 at June 30, 2005, while available-for-sale securities decreased $8,128,000 (16%) and cash and due balances decreased $16,361,000 (35%) for the same time period. As Table 1 illustrates, the majority of the loan growth came from the commercial loan portfolio, which increased $11,182,000 (9%) from December 31, 2004. The decrease in available-for-sale securities was the result of run-off in short-term investments purchased with excess liquidity in the third quarter of 2004, while the decrease in cash and due balances reflected the reduction in the cash required to be held with the Federal Reserve Bank. The Bank’s reserve

10

requirement decreased as a result of the completion of the process the Bank undertook to reclassify a portion of it’s transaction deposits (primarily demand deposits and interest bearing checking accounts) to savings deposits. Deposits decreased $12,608,000 (2%) to $740,192,000 at June 30, 2005, compared to $752,800,000 at December 31, 2004. The decrease in deposits reflects the seasonal fluctuation in public fund deposits, which represent the collateralized balances of local municipalities, school boards and other county government agencies. Public funds deposits were down approximately $30,000,000 from December 31, 2004 to June 30, 2005. This seasonal fluctuation is the result of the timing of tax receipts at the local municipalities, the majority of which are received in the fourth quarter of the year.

Table 1 The following table sets forth the composition of the Bank’s loan portfolio by type of loan at the dates indicated:

	June 30, 2005				December 31, 2004
	Amount		%		Amount		%
	(Dollars in thousands)
Type of Loan:
Nonresidential real estate loans	$	289,722	39.5	%	$	290,684	40.3	%
One- to four-family residential real estate loans		188,920	25.7			188,140	26.1
Commercial loans		141,942	19.3			130,760	18.2
Consumer loans		22,234	3.0			20,606	2.9
Construction and land development loans		85,231	11.6			84,690	11.8
Municipal obligations		6,269	0.9			5,074	0.7
Total loans	$	734,318	100.0	%	$	719,954	100.0	%
Less:
Deferred loan fees		739				797
Allowance for loan losses		7,364				7,214
Net loans	$	726,215			$	711,943

RESULTS OF OPERATIONS

GENERAL

Net income year to date increased from $4,913,000 ($.81 diluted earnings per share) in 2004 to $5,160,000 ($.87 diluted earnings per share) in 2005, an increase of $247,000 (5%). Net income for the quarter ended June 30, 2005 was $2,615,000 ($.44 diluted earnings per share) as compared to $2,602,000 ($.43 diluted earnings per share) during the same period of 2004, an increase of $13,000 (.5%). The primary reason for the earnings gain from 2004 was a $1,750,000 (12%) increase in net interest income as described below. The increase in net interest income was offset by $352,000 (44%) reduction in gains on loans sold and a $1,393,000 (13%) increase in non-interest expense. The reduction in gains on loans sold was caused by the rising interest rates and the corresponding slowdown in the mortgage loan refinancing market. The increase in non-interest expense was due in part to the opening of the Bank’s cash management operations center in February. The provision for loan losses was $150,000 (22%) higher for the six month ended June 30, 2005, and $125,000 (36%) higher for the second quarter, than 2004. The increase in the provision was the result of higher charge-offs, nonperforming loans, and the Bank’s continued process of evaluating inherent risk in the loan portfolio.

11

NET INTEREST INCOME

Net interest income increased $903,000 (12%) in the second quarter of 2005 as compared to the same period in 2004, while the year to date total increased $1,750,000 (12%) from $14,398,000 in 2004 to $16,148,000 in 2005. The increase in the net interest income was the result of the growth in earning assets and a favorable rate variance. As illustrated in Table 4, net interest income, from the second quarter of 2004 to second quarter of 2005, was positively impacted by volume additions to the balance sheet of $651,000 and by a net favorable rate variance of $275,000. Contributing to the positive volume variance was the growth in earning assets and the positive effect of decreasing the Bank’s reserve requirement at the Federal Reserve Bank. The main contributor to the growth in earning assets was loans, which were up $42 million or 6% at the end of the first quarter of 2005 from the same period a year earlier. As allowed by the Federal Reserve Bank, in the first quarter of 2005, the Bank completed a process to reclassify a portion of its transaction deposits (primarily demand deposits and interest bearing checking accounts) to savings deposits. The effect of this process was a reduction in the amount of cash (approximately $21,000,000) that the Bank was required to hold with the Federal Reserve Bank. The cash balances reduced at The Federal Reserve Bank as a result of the lower reserve requirement were used to reduce short-term borrowing, which decreased $19,000,000 from March 31, 2005, and to fund the increase in loans. The lower cash reserve requirement contributed to the increase in the effect of net free funds from .19% in the second quarter of 2004 to .37% in the second quarter of 2005 that can be seen in Table 2. The lower reserve requirement also contributed to the Bank’s percentage of average interest-earning assets to interest-bearing liabilities improving to 118.00% in the second quarter of 2005 from 113.65% in 2004, which is also illustrated in Table 2. The Bank is in an asset sensitive position, which means that a higher dollar volume of interest earning assets can, or will, reprice in the next year, as compared to the dollar volume of interest bearing liabilities. As a result rising interest rates have led to a positive rate variance, as more assets have repriced than liabilities. The favorable volume and rate variance produced a net interest margin of 4.19% for the second quarter of 2005, which was 17 basis points higher than the 4.02% net interest margin for the second quarter of 2004.

The Bank uses an earnings simulation model to estimate and evaluate the impact of changing interest rates on earnings. The model projects the effect of instantaneous movements in interest rates of both 100 and 200 basis points. As shown below, the June 30, 2005 simulation analysis indicates that the Bank is in an asset sensitive position, and that an increase in interest rates would have a positive effect on net interest income, and a decrease in rates would have a negative effect on net interest income. An asset sensitive position means that a higher dollar volume of interest earning assets can, or will, reprice in the next year, as compared to the dollar volume of interest bearing liabilities. As shown below, lower rates would have a more dramatic effect on earnings than rising rates. This is due to interest bearing transaction accounts whose rates can not drop appreciably lower than their current levels.

Net interest income estimates are summarized below.

	Net Interest Income Change
Increase 200 bp	7.86	%
Increase 100 bp	4.11
Decrease 100 bp	(4.17	)
Decrease 200 bp	(10.49	)

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Tables 2 & 3 set forth certain information relating to the Bank’s average balance sheet information and reflect 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 2- Average Balance Sheet Rates for Three Months Ended June 30, 2005 and 2004 (presented on a tax equivalent basis in thousands)

	Three Months ended June 30, 2005							Three Months ended June 30, 2004
	Average outstanding balance			Interest earned/ paid		Yield/ rate		Average outstanding balance			Interest earned/ paid		Yield/ rate
Interest-earning assets:
Loans receivable (1)(2)	$	729,139		$	11,766	6.47	%	$	684,316		$	9,662	5.68	%
Securities (2)		60,963			544	3.58			49,110			401	3.28
Other interest-earning assets		6,464			69	4.28			6,198			45	2.92
Total interest-earning assets		796,566			12,379	6.23			739,624			10,108	5.50
Non-interest-earning assets		74,959							82,693
Total assets	$	871,525						$	822,317
Interest-bearing liabilities:
Transaction accounts		349,784			1,423	1.63			340,577			654	.77
Time deposits		271,826			2,066	3.05			256,984			1,635	2.56
Borrowings		53,431			563	4.23			53,210			418	3.16
Total interest-bearing liabilities		675,041			4,052	2.41			650,771			2,707	1.67
Non-interest-bearing liabilities		120,126							102,086
Total liabilities		795,167							752,857
Shareholders’ equity		76,358							69,460
Total liabilities and shareholders’ equity	$	871,525						$	822,317
Net interest income				$	8,327						$	7,401
Interest rate spread						3.82	%						3.83	%
Net interest margin (net interest income as a percent of average interest-earning assets)						4.19	%						4.02	%
Effect of Net Free Funds (earning assets funded by non interest bearing liabilities)						.37	%						.19	%
Average interest-earning assets to interest-bearing liabilities		118.00	%						113.65	%

(1) Includes non-accrual loans.

(2) Income presented on a tax equivalent basis using a 35% tax rate. The tax equivalent adjustment was $90,000 and $67,000, in 2005 and 2004 respectively.

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Table 3- Average Balance Sheet Rates for Six Months Ended June 30, 2005 and 2004 (presented on a tax equivalent basis in thousands)

	Six Months ended June 30,2005							Six Months ended June 30, 2004
	Average outstanding balance			Interest earned/ paid		Yield/ rate		Average outstanding balance			Interest earned/ paid		Yield/ rate
Interest-earning assets:
Loans receivable (1)(2)	$	722,097		$	22,687	6.34	%	$	675,601		$	19,058	5.67	%
Securities (2)		61,017			1,071	3.54			50,666			805	3.20
Other interest-earning assets		7,124			135	3.82			5,870			89	3.05
Total interest-earning assets		790,238			23,893	6.10			732,137			19,952	5.48
Non-interest-earning assets		81,249							82,617
Total assets	$	871,487						$	814,754
Interest-bearing liabilities:
Transaction accounts		362,428			2,709	1.51			341,383			1,310	.77
Time deposits		267,407			3,826	2.89			254,744			3,299	2.60
Borrowings		50,796			1,042	4.14			50,027			811	3.26
Total interest-bearing liabilities		680,631			7,577	2.24			646,154			5,420	1.69
Non-interest-bearing liabilities		115,349							99,858
Total liabilities		795,980							746,012
Shareholders’ equity		75,507							68,742
Total liabilities and shareholders’ equity	$	871,487						$	814,754
Net interest income				$	16,316						$	14,532
Interest rate spread						3.86	%						3.79	%
Net interest margin (net interest income as a percent of average interest-earning assets)						4.16	%						3.99	%
Effect of Net Free Funds (earning assets funded by non interest bearing liabilities)						.30	%						.20	%
Average interest-earning assets to interest-bearing liabilities		116.10	%						113.31	%

(1) Includes non-accrual loans.

(2) Income presented on a tax equivalent basis using a 35% tax rate. The tax equivalent adjustment was $168,000 and $134,000, in 2005 and 2004 respectively.

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Table 4 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 4-Volume/Rate Analysis (in thousands)

	Three months ended June 30, 2005 Compared to Three months ended June 30, 2004						Six months ended June 30, 2005 Compared to Six months ended June 30, 2004
	Increase (Decrease) Due to						Increase (Decrease) Due to
	Volume		Rate		Total		Volume		Rate		Total
Interest income attributable to:
Loans receivable	$	665	$	1,439	$	2,104	$	1,376	$	2,252	$	3,628
Securities		103		40		143		177		89		266
Other interest-earning assets(1)		2		22		24		22		25		46
Total interest-earning assets		770		1,501		2,271		1,575		2,366		3,940
Interest expense attributable to:
Transactions accounts		18		751		769		86		1,313		1,399
Time deposits		99		332		431		170		357		527
Borrowings		2		143		145		13		218		231
Total interest-bearing liabilities		119		1,226		1,345		269		1,888		2,157
Increase (decrease) in net interest income	$	651	$	275	$	926	$	1,306	$	478	$	1,783

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

PROVISION FOR LOAN LOSSES

The provision for loan losses was $825,000 for the six months ended June 30, 2005, an increase of $150,000 compared to the $675,000 provision recorded during the same period in 2004. For the second quarter of 2005 the provision for loan losses was $475,000, an increase of $125,000 compared to the $350,000 provision for the second quarter of 2004. Non-performing loans increased, to $6,892,000 or .94% of total loans outstanding at June 30, 2005, compared to $5,145,000 or .72% at December 31, 2004, and increased from the June 30, 2004 level of

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$3,316,000 or .48%. Net charge-offs, year to date 2005, were $675,000 or .19% on an annualized basis to average loans, compared to the $350,000 and .10% for the first six months of 2004. These charge-off ratios are below industry average and the .19% for the six months ended June 30, 2005 is equal to the Bank’s charge-off ratio for 2004 of .19%. The allowance for loan losses was 107% of non-performing loans on June 30, 2005 compared to 140% at the end of 2004 and 206% at June 30, 2004. The increase in non-performing loans and the allowance to non-performing loan ratios were the result of one loan for $2,700,000, that is collateralized with commercial real estate, which was 90 days past due at June 30, 2005. Management continues to monitor this relationship and has established appropriate reserves. The increase in charge-offs, nonperforming loans, and the Bank’s continued process of evaluating inherent risk in the loan portfolio led to the provision to increase $125,000 (36%) over the second quarter of 2004 and $150,000 (22%) over the six months ended June 30, 2004. Management’s evaluation of the inherent risk in the loan portfolio considers both historic losses and information about specific borrowers. Management believes the provision for loan losses is directionally consistent with the Bank’s change in credit quality, and is sufficient to absorb probable incurred losses in the loan portfolio.

The following table sets forth an analysis of certain credit risk information for the periods indicated:

Table 5-Summary of Loan Loss Experience and Allowance for Loan Loss Analysis (in thousands)

	Three Months ended June 30,						Six Months ended June 30,
	2005			2004			2005			2004
Balance of allowance at beginning of period	$	7,320		$	7,017		$	7,214		$	6,855
Recoveries of loans previously charged off:
Commercial loans		1			1			16			5
Consumer loans		3			0			6			1
Mortgage loans		0			0			0			0
Total recoveries		4			1			22			6
Loans charged off:
Commercial loans		(381	)		(84	)		(518	)		(211	)
Consumer loans		(54	)		(98	)		(92	)		(139	)
Mortgage loans		(0	)		(6	)		(87	)		(6	)
Total charge-offs		(435	)		(188	)		(697	)		(356	)
Net charge-offs		(431	)		(187	)		(675	)		(350	)
Provision for loan losses		475			350			825			675
Balance of allowance at end of period	$	7,364		$	7,180		$	7,364		$	7,180
Net charge-offs to average loans outstanding for period		.24	%		.11	%		.19	%		.10	%
Allowance at end of period to loans at end of period		1.00	%		1.04	%		1.00	%		1.04	%
Allowance to nonperforming loans at end of period		106.85	%		205.61	%		106.85	%		205.61	%

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NON-INTEREST INCOME

Table 6-Major Components of non-interest income (in thousands)

	Three Months ended June 30,				Six Months ended June 30,
	2005		2004		2005		2004
Non-interest income:
Service charges and fees	$	1,092	$	946	$	1,883	$	1,792
Gain on sale of securities		0		0		0		10
Gains on sale of real estate loans		276		480		451		803
Trust Fee Income		227		188		449		360
Bankcard transaction revenue		267		208		510		354
Company owned life insurance earnings		118		119		251		248
Other		360		266		717		548
Total non-interest income	$	2,340	$	2,207	$	4,261	$	4,115

As illustrated in Table 6, total non-interest income increased $146,000 (4%) for the first six months of 2005 from $4,115,000 at June 30, 2004 to $4,261,000 at June 30, 2005. For the second quarter of 2005 non-interest income increased $133,000 (6%) to $2,340,000 compared to $2,207,000 for the same period in 2004. Increases for the six months ended June 30, 2005 in bankcard transaction revenue (up $156,000, 44%), standby letters of credit fees (up $170,000, 412%), trust fee income (up $89,000, 25%), and service charges and fees (up $91,000, 5%) were offset by lower gains on the sale of real estate loans (down $352,000, 44%).

The increase in bankcard transaction revenue was the result of both volume increases and rate increases. The increased volume reflects consumers continued acceptance of electronic forms of payments and the resulting growth in usage of the Bank’s debit and credit card products.

The decrease in gains on the sale of real estate loans was due to rising mortgage rates and a saturated refinancing market. The Bank originates fixed rate first mortgage loans and sells them, servicing released, into the secondary market. For the six months ended June 30, 2005, 236 loans with principal balances of $34 million were sold compared to 423 loans with a principal balance of $60 million during the same period in 2004. Loans held for sale at June 30, 2005 increased to $1,743,000 from $1,391,000 at December 31, 2004. 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. While the loans held for sale have increased from the end of 2004, the refinancing activity remains well behind the level experienced in the first half of 2004. With the saturation of the refinancing market and rising rates, the gains on loans sold activity is expected to stay well below the level experienced in the first half of 2004, which slowed significantly beginning in the third quarter of 2004.

Service charges and fees increased $91,000 (5%) from $1,792,000 in the first six months of 2004 to $1,883,000 for the same period in 2005. Increased lockbox revenue and fees from the Bank’s consolidated returns product offset the effects that rising interest rates had on service charges and a

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drop in fees received for non sufficient fund checks. Rising interest rates contributed to the decrease in service charges and fees, as the earnings credit rate used to offset service charges increased. Service charges in the second quarter of 2005 included the earnings from several new large lockbox customers. The volume of lockbox items processed increased 400% in March of 2005 compared to February of 2005 as a result of these customers. In the first six months of 2005, the Bank began to provide a new cash management product by offering the service of consolidating returned checks for specific customers. The related fees are expected to grow significantly in the second half of 2005. This service helps national and regional retailers save money by routing the returned checks of their customers to one financial institution, versus through multiple local depository banks.

The increase in trust fee income was a result of continued new business development and equity market advances.

NON-INTEREST EXPENSE

Table 7-Major Components of non-interest expense (in thousands)

	Three Months ended June 30,				Six Months ended June 30,
	2005		2004		2005		2004
Non-interest expense:
Salaries and benefits	$	3,007	$	2,593	$	5,764	$	5,130
Occupancy and equipment		987		794		1,928		1,629
Data processing		367		316		691		644
Advertising		186		187		269		259
State bank taxes		252		222		504		444
Amortization of intangible assets		162		161		323		323
Other		1,249		1,029		2,430		2,087
Total non-interest expense	$	6,210	$	5,302	$	11,909	$	10,516

As illustrated in Table 7, non-interest expense increased to $11,909,000 in the first half of 2005 and to $6,210,000 for the second quarter of 2005 from $10,516,000 and $5,302,000 in the same periods of 2004, an increase of $1,393,000 (13%) and $908,000 (17%) The largest increase in non-interest expense was in salaries and benefits, which increased $634,000 (12%) in the first six months of 2005 compared to the same period in 2004. The increase in salaries and benefits was the result of annual merit increases, staff additions and rising employee benefit costs. Contributing to the staff additions was the opening of the Bank’s cash management operations center. This operations center was opened to handle the increased lockbox item volume and the expanded cash management product offerings, such as the service of consolidating returned checks. The opening of the operations center also contributed to the increase in occupancy and equipment, up $299,000 (18%) from the first six months of 2004.

INCOME TAX EXPENSE

During the first six months of 2005, income tax expense increased $106,000 (4%) from $2,409,000 in the first six months of 2004 to $2,515,000 in the same period of 2005 as a result of higher earnings. The effective tax rate remained relatively stable at 32.77% for the first six months of 2005 compared to 32.90% for the same period in 2004.

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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 four of its correspondent banks to meet liquidity demands.

The Company’s total shareholders’ equity increased $3,566,000, from $73,664,000 at December 31, 2004 to $77,230,000 at June 30, 2005. In the first six months of 2005, the Company paid a cash dividend of $.14 per share totaling $829,000.

On November 19, 2004, the Company’s Board of Directors authorized the extension of the share repurchase program it previously approved in June of 2003. This repurchase program, which will now expire on December 31, 2005, authorized the repurchase and retirement of 200,000 common shares of the Company in the over-the-counter market. As of the date of this report, 113,500 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 its trust preferred securities, for the payment of dividends to shareholders, for the stock repurchase plan and for general operating expenses. The FRB and the FDIC have legal requirements, 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, 2005, the Bank had capital in excess of the FDIC’s most restrictive minimum capital requirements in an amount over $4.7 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, 2005, the Bank’s leverage and total risk-based ratios were 9.31% and 10.57% respectively, which exceed the well-capitalized thresholds.

CONTRACTUAL OBLIGATIONS AND OFF-BALANCE SHEET ARRANGEMENTS

On February 16, 2005, the Bank entered into an agreement to lease space for its cash management operation center. The lease has a term of five years with an annual cost which escalates from $79,000 for the first year to $89,000 by the fifth year.

On March 3, 2005, the Bank entered into an agreement with Northern Kentucky University whereby the University will grant to the Bank the naming rights for the new Northern Kentucky University Arena to be constructed on the campus of the University for a term commencing immediately upon execution of the document and expiring twenty years after the opening of the Arena. In

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consideration therefore the Bank will pay the lesser of 10% of the total construction cost of the Arena or $6,000,000, such sum to be paid in seven equal annual installments beginning after substantial completion and opening of the Arena. The cost of the naming rights will be amortized over the life of the contract commencing on the opening of the Arena.

There have been no other significant changes to the Bank’s contractual obligations or off-balance sheet arrangements since December 31, 2004. For additional information regarding the Bank’s contractual obligations and off-balance sheet arrangements, refer to the Company’s Form 10-K for the year ending December 31, 2004.

NEWLY ISSUED BUT NOT YET EFFECTIVE ACCOUNTING STANDARDS:

Statement of Financial Accounting Standards 123, Revised, requires all public companies to record compensation cost for stock options provided to employees in return for employee service. The cost is measured at the fair value of the options when granted, and this cost is expensed over the employee service period, which is normally the vesting period of the options. This will apply to awards granted or modified after the first fiscal year beginning after June 15, 2005. Compensation cost will also be recorded for prior option grants that vest after the date of adoption. The effect on results of operations will depend on the level of future option grants and the calculation of the fair value of the options granted at such future date, as well as the vesting periods provided, and so cannot currently be predicted. Existing options that will vest after adoption date are expected to result in additional compensation expense of approximately $436,000, $395,000 and $281,000 during 2006, 2007 and 2008. There will be no significant effect on financial position as total equity will not change.

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

There has been no material change in market risk since December 31, 2004. For information regarding the Company’s market risk, refer to the Company’s Form 10-K for the year ending December 31, 2004. Market risk is discussed further under the heading “Net Interest Income” above.

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 included in the reports filed or submitted under the Exchange Act is accumulated and communicated to Management, including the Company’s Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

Under the supervision, and with the participation of Management, including the Company’s Chief Executive Officer and Chief Financial Officer, the Company has evaluated the effectiveness of the

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design and operation of the disclosure controls and procedures as of June 30, 2005, and, based upon this evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that these controls and procedures are effective 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 the Company’s internal controls over financial reporting that occurred in the last fiscal quarter that have materially affected, or are reasonably likely to materially affect the Company’s internal control over financial reporting.

The Bank of Kentucky Financial Corporation

PART II

Item 1. Legal Proceedings

From time to time, the Company and the Bank are involved in litigation incidental to the conduct of the business, but neither the Company 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 the Company.

Item 2. Unregistered Sale of Equity Securities and Use of Proceeds

The following table shows information relating to the repurchase of shares by the Company during the three months ended June 30, 2005:

Period	Total number of shares purchased	Average price paid per share		Total number of shares purchased as part of publicly announced plans (1)	Maximum number of shares that may be purchased under the plans or programs
April 1-30, 2005	0	$	0	106,000	94,000
May 1-31, 2005	0	$	0	106,000	94,000
June 1-30, 2005	7,500	$	25.75	113,500	86,500

(1) The Company currently maintains a share repurchase program that was approved by the Company’s board of directors in June of 2003, as thereby extended by the board of directors on November 19, 2004. This repurchase program, which will expire on December 31, 2005, authorizes the repurchase and retirement of 200,000 common shares of the Company in the over-the-counter market. As of the date of this report, 113,500 of the 200,000 shares authorized for repurchase have been repurchased. There were no share repurchase plans that expired during the quarter, and the Company did not terminate any plan prior to its expiration date.

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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 22, 2005. 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 2008:

	For	Against/Withheld	Abstentions
Charles M. Berger	4,873,539	12,344	—
David E. Meyer	4,869,889	15,994	—
John E. Miracle	4,872,176	13,707	—
Mary Sue Rudicill	4,872,738	13,145	—

(2) Ratification of the selection of Crowe Chizek and Company LLC as the independent registered public accounting firm of BKFC for the current fiscal year:

For	Against/Withheld	Abstentions
4,851,070	34,813	—

Item 5. Other Information

None

Item 6. Exhibits

(a) Exhibits

Exhibit Number	Description
3.2	Bylaws of the Bank of Kentucky Financial Corporation, as amended through July 15, 2005
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 a report on Form 8-K on April 22, 2005, disclosing under Item 2.02, a press release. The press release announced BKFC’s financial results for the first quarter of 2005.

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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 Bank of Kentucky Financial Corporation
Date: August 5, 2005	/s/ Robert W. Zapp
	Robert W. Zapp
	President
Date: August 5, 2005	/s/ Martin J.Gerrety
	Martin J. Gerrety
	Treasurer and Assistant Secretary

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