Bank of Kentucky Financial (BKYF) 10-Q 2006 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, 2006

¨ 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) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act (Check one):

Large accelerated filer  ¨    Accelerated filer  x    Non-accelerated filer  ¨

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

As of July 18, 2006, 5,833,679 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	10
Item 3 –Quantitative and Qualitative Disclosures About Market Risk	21
Item 4 –Controls and Procedures	21
Part II         OTHER INFORMATION
Item 1 –Legal Proceedings	22
Item 1A –Risk Factors	22
Item 2 –Unregistered Sales of Equity Securities and Use of Proceeds	22
Item 3 –Defaults Upon Senior Securities	22
Item 4 –Submission of Matters to a Vote of Security Holders	23
Item 5 –Other Information	23
Item 6 –Exhibits	23

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 2006			December 31 2005
Assets
Cash and cash equivalents	$	31,792		$	71,344
Interest bearing deposits with banks		100			100
Available-for-sale securities		59,170			79,552
Held-to-maturity securities		13,631			14,823
Loans held for sale		3,410			1,609
Total loans		787,807			731,059
Less: Allowances for loan losses		7,650			7,581
Net loans		780,157			723,478
Premises and equipment, net		17,626			17,479
FHLB stock, at cost		4,406			4,283
Goodwill		9,867			9,867
Acquisition intangibles, net		2,612			2,935
Cash surrender value of life insurance		19,414			19,078
Accrued interest receivable and other assets		14,959			12,790
Total assets	$	957,144		$	957,338
Liabilities & Shareholders’ Equity
Liabilities
Deposits	$	808,068		$	831,110
Short-term borrowings		30,506			4,225
Notes payable		27,979			34,291
Accrued interest payable and other liabilities		7,696			7,265
Total liabilities		874,249			876,891
Shareholders’ Equity
Common stock, no par value, 15,000,000 shares authorized, 5,833,679 (2006) and 5,884,079 (2005) shares issued and outstanding		3,098			3,098
Additional paid-in capital		6,957			7,888
Retained earnings		73,561			69,969
Accumulated other comprehensive loss		(721	)		(508	)
Total shareholders’ equity		82,895			80,447
Total liabilities and shareholders’ equity	$	957,144		$	957,338

See accompanying notes

3

THE BANK OF KENTUCKY FINANCIAL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2006 AND 2005

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

	Three Months Ended June 30					Six Months Ended June 30
	2006			2005		2006			2005
INTEREST INCOME
Loans, including related fees	$	14,344		$	11,739	$	27,549		$	22,635
Securities and other		1,053			550		2,317			1,090
Total interest income		15,397			12,289		29,866			23,725
INTEREST EXPENSE
Deposits		6,268			3,489		12,071			6,535
Borrowings		586			563		1,093			1,042
Total interest expense		6,854			4,052		13,164			7,577
Net interest income		8,543			8,237		16,702			16,148
Provision for loan losses		400			475		800			825
Net interest income after provision for loan losses		8,143			7,762		15,902			15,323
NON-INTEREST INCOME
Service charges and fees		1,229			1,092		2,358			1,883
Gain/(loss) on securities		0			0		0			0
Gain on loans sold		220			276		459			451
Other		1,125			972		2,205			1,927
Total non-interest income		2,574			2,340		5,022			4,261
NON-INTEREST EXPENSE
Salaries and benefits		3,718			3,007		7,335			5,764
Occupancy and equipment		1,018			987		1,997			1,928
Data processing		329			367		683			691
Advertising		172			186		303			269
Other		2,057			1,663		3,874			3,257
Total non-interest expense		7,294			6,210		14,192			11,909
INCOME BEFORE INCOME TAXES		3,423			3,892		6,732			7,675
Less: income taxes		1,043			1,277		2,086			2,515
NET INCOME	$	2,380		$	2,615	$	4,646		$	5,160
Other comprehensive income (loss)		(125	)		206		(213	)		(137	)
COMPREHENSIVE INCOME	$	2,255		$	2,821	$	4,433		$	5,023
Earnings per share, basic	$	.41		$	.44	$	.79		$	.87
Earnings per share, diluted	$	.41		$	.44	$	.79		$	.87

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, except per share data -unaudited)

	2006			2005
Balance January 1	$	80,447		$	73,664
Comprehensive Income:
Net Income		4,646			5,160
Change in net unrealized gain(loss), net of tax		(213	)		(137	)
Total Comprehensive Income		4,433			5,023
Cash dividends paid		(1,054	)		(829	)
Exercise of stock options (24,300 and 4,600 shares), including tax benefit		509			96
Stock-based compensation expense		490			—
Stock repurchase and retirement (74,700 and 28,000 shares)		(1,930	)		(724	)
Balance June 30	$	82,895		$	77,230
Dividends per share	$	0.18		$	0.14

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)

	2006			2005
Cash Flows from Operating Activities
Net income	$	4,646		$	5,160
Adjustments to reconcile net income to net cash From operating activities		(2,040	)		1,076
Net cash from operating activities		2,606			6,236
Cash flows from Investing Activities
Net change in interest-bearing deposits with banks		0			(100	)
Proceeds from paydowns and maturities of held-to-maturity securities		1,181			2,640
Proceeds from paydowns and maturities of available-for-sale securities		99,080			7,910
Purchases of held-to-maturity securities		0			(5,880	)
Purchases of available-for-sale securities		(78,467	)		0
Net change in loans		(61,340	)		(15,202	)
Proceeds from the sale of other real estate		3,511			821
Property and equipment expenditures		(866	)		(1,790	)
Net cash from investing activities		(36,901	)		(11,601	)
Cash Flows from Financing Activities
Net change in deposits		(23,042	)		(12,599	)
Net change in short-term borrowings		26,281			3,081
Proceeds from exercise of stock options		509			96
Cash dividends paid		(1,054	)		(829	)
Stock repurchase and retirement		(1,930	)		(725	)
Payments on note payable		(6,021	)		(20	)
Net cash from financing activities		(5,257	)		(10,996	)
Net change in cash and cash equivalents		(39,552	)		(16,361	)
Cash and cash equivalents at beginning of period		71,344			47,406
Cash and cash equivalents at end of period	$	31,792		$	31,045

See accompanying notes

6

THE BANK OF KENTUCKY FINANCIAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2006

(unaudited)

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.

To prepare financial statements in conformity with accounting principles generally accepted in the United States of America, management makes estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the financial statements and the disclosures provided, and future results could differ. The allowance for loan losses and the fair values of financial instruments, in particular, are subject to change.

Note 3 - Earnings per Share:

Earnings per share are computed based upon the weighted average number of shares outstanding during the 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. For the three months ended June 2006 and 2005, 315,828 and 300,258 options were not considered, as they were not dilutive, and for the six months ended June 2006 and 2005, 316,021 and 297,849 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
	2006	2005	2006	2005
Weighted average shares outstanding	5,840,915	5,911,373	5,853,945	5,917,338
Dilutive effects of assumed exercises of Stock Options	26,923	37,350	28,650	38,040
Shares used to compute diluted Earnings per share	5,867,838	5,948,723	5,882,595	5,955,378

7

Note 4 – Stock Compensation:

The Company recorded stock option expense of $250,000 ($214,000 net of taxes) and $490,000 ($418,000 net of taxes) in the three and six months ended June 30, 2006, in accordance with Statement of Financial Accounting Standards No. 123(R),Share-BasedPayment (“SFAS 123(R)”), adopted on January 1, 2006. In accordance with Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees”, no stock-based compensation cost was reflected in net income for the three and six months ended June 30, 2005, 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 as reported for the periods indicated and the effect if expense was treated in accordance with SFAS 123(R).

The adoption of SFAS 123(R) had the following effect on reported amounts compared with amounts that would have been reported using the intrinsic value method under previous accounting.

(Dollars in thousands, except per share data)

	For the Three Months Ended June 30, 2006							For the Six Months Ended June 30, 2006
	Using Previous Accounting		SFAS 123(R) Adjustment			As Reported		Using Previous Accounting		SFAS 123(R) Adjustment			As Reported
Income before income taxes	$	3,673	$	(250	)	$	3,423	$	7,222	$	(490	)	$	6,732
Income taxes		1,079		(36	)		1,043		2,158		(72	)		2,086
Net Income	$	2,594	$	(214	)	$	2,380	$	5,064	$	(418	)	$	4,646
Basic earnings per share	$	.44	$	(.03	)	$	.41	$	.87	$	(.08	)	$	.79
Diluted earnings per share		.44		(.03	)		.41		.86		(.07	)		.79

The following table illustrates the effect on the prior year comparable period net income and earnings per share if expense had been measured using the fair value recognition provisions of SFAS No 123(R).

8

	For the Three Months Ended June 30, 2005							For the Six Months Ended June 30, 2005
	As Reported		SFAS 123(R) Adjustment			If Under SFAS 123(R)		As Reported		SFAS 123(R) Adjustment			If Under SFAS 123(R)
Income before income taxes	$	3,892	$	(201	)	$	3,691	$	7,675	$	(397	)	$	7,278
Income taxes		1,277		(31	)		1,246		2,515		(57	)		2,458
Net Income	$	2,615	$	(170	)	$	2,445	$	5,160	$	(340	)	$	4,820
Basic earnings per share	$	.44	$	(.03	)	$	.41	$	.87	$	(.06	)	$	.81
Diluted earnings per share		.44		(.03	)		.41		.87		(.06	)		.81

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 June 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109” (FIN 48), which prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. Management does not expect the adoption of this standard to have a material impact on the Company’s financial statements.

9

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, in addition to those described in Item 1A of BKFC’s annual report on Form 10-K or other BKFC reports on file with the Commission, the following: (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.

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 $7,650,000 or .97% of total loans was an appropriate estimate of losses within the loan portfolio as of June 30, 2006. This estimate resulted in a provision for loan losses on the income statement of $800,000 for the six months ended June 30, 2006. 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.

10

OVERVIEW

Highlighting second quarter results was growth in loans and revenue. Total loans grew $41,596,000 in the second quarter or 22% on an annualized basis, and revenues increased $540,000 or 5% from the second quarter of 2005, which was offset by an increase in non-interest expense of $1,084,000, or 17% in the same time period. The revenue increase was the result of increases in net interest income of $306,000 or 4% and non-interest income of $234,000 or 10% in the second quarter of 2006, as compared to the same period in 2005. The largest increases in non-interest expense were salaries and employee benefits expense which increased $711,000 or 24%, and included compensation cost for expensing stock options. The Company recorded stock option expense of $250,000 in the second quarter of 2006 in accordance with Statement of Financial Accounting Standards No. 123(R),Share-BasedPayment (“FAS 123(R)”), adopted on January 1, 2006. For comparison purposes, applying the new standards of FAS 123(R) to the second quarter of 2005 would have resulted in recording stock option compensation expense of $201,000, $170,000 after taxes. When the second quarter of 2005 is adjusted for the additional option expense, the diluted earnings per share would equal the $.41 recorded in the second quarter of 2006.

FINANCIAL CONDITION

Total assets at June 30, 2006 were $957,144,000 as compared to $957,338,000 at December 31, 2005, a decrease of $194,000 (less than 1%). Loans outstanding increased $56,748,000 (8%) from $731,059,000 at December 31, 2005 to $787,807,000 at June 30, 2006, while available-for-sale securities, cash and due balances and federal funds sold decreased $20,382,000 (26%), $11,990,000 (29%) and $27,562,000 (90%) respectively, for the same time period. As Table 1 illustrates, the growth in the loan portfolio in the second quarter of 2006 came from increases in commercial loans of $15,947,000 (12%) and nonresidential real estate loans of $38,567,000 (13%). Management believes the growth in the commercial and nonresidential real estate reflects the current strength in the demand for commercial and nonresidential real estate loans. The decrease in available-for-sale securities was the result of short-term investments maturing. These securities had been pledged as collateral for public fund deposits, which have decreased approximately $44,000,000 since December 31, 2005. Federal funds sold balances were reduced by the growth in loans and the decrease in deposits from December 31, 2005.

Deposits decreased $23,042,000 (3%) to $808,068,000 at June 30, 2006, compared to $831,110,000 at December 31, 2005, while short-term borrowings increased $26,281,000 (622%) to $30,506,000 at June 30, 2006 from $4,225,000 at December 31, 2005. The decrease in deposits was affected by the seasonal fluctuation in public fund deposits, which represent the collateralized balances of local municipalities, school boards and other county government agencies. Public fund deposits were down approximately $44,000,000 from December 31, 2005 to June 30, 2006. Deposits other than public fund deposits increased approximately $21,000,000 since December 31, 2005, with the largest increase from Money Market accounts which have increased $46,299,000 in 2006. The Bank’s Money Market Index account, which is indexed to short term interest rates, has seen the majority of the growth as depositors have moved and invested funds into this attractive yielding account. The sharp increase in short-term borrowing was used to fund the strong loan growth in the first half of 2006. Notes payable as of June 30, 2006 decreased by $6,312,000, as compared to the same period in 2005, as a result of $6,000,000 in Federal Home Loan Bank advances being called in the first six months of 2006.

11

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, 2006				December 31, 2005
	Amount		%		Amount		%
	(Dollars in thousands)
Type of Loan:
Nonresidential real estate loans	$	333,893	42.3	%	$	295,326	40.4	%
One- to four-family residential real estate loans		184,316	23.4			183,644	25.1
Commercial loans		152,640	19.3			136,693	18.7
Consumer loans		19,834	2.5			20,046	2.7
Construction and land development loans		91,905	11.7			89,847	12.3
Municipal obligations		5,954	0.8			6,171	0.8
Total loans	$	788,542	100.0	%	$	731,727	100.0	%
Less:
Deferred loan fees		735				668
Allowance for loan losses		7,650				7,581
Net loans	$	780,157			$	723,478

RESULTS OF OPERATIONS

GENERAL

Net income year to date decreased from $5,160,000 ($.87 diluted earnings per share) in 2005 to $4,646,000 ($.79 diluted earnings per share) in 2006, a decrease of $514,000 (10%). Net income for the quarter ended June 30, 2006 was $2,380,000 ($.41 diluted earnings per share) as compared to $2,615,000 ($.44 diluted earnings per share) during the same period of 2005, a decrease of $235,000 (9%). The primary reason for the decrease in earnings from 2005 was a $2,283,000 (19%) increase in non-interest expense as described below, which was offset by a $1,315,000 (6%) increase in revenues. The increase in revenue included a $554,000 (3%) increase in net interest income and $761,000 (18%) increase in non-interest income. The increase in non-interest expense was due in part to additional compensation costs for added staffing at the Bank’s cash management operations center, which opened in February of 2005, and the additional $490,000 in expense for stock options. The operations center was opened to handle lockbox item volume and expanded cash management product offerings, such as the service of consolidating returned checks. Contributing to the increase in non-interest income was service charges and fees (up $475,000, 25%), which included increased revenue from cash management products.

NET INTEREST INCOME

Net interest income increased $306,000 (4%) in the second quarter of 2006 as compared to the same period in 2005, while the year to date total increased $554,000 (3%) from $16,148,000 in 2005 to $16,702,000 in 2006. The increase was driven by the growth in the balance sheet and an increase in the effect of net free funds (non-interest bearing liabilities funding earning assets). As illustrated in

12

Table 3, net interest income was positively impacted by the volume additions, which includes the effect of net free funds, to the balance sheet by $679,000, and was offset by the rate variance, which had a $381,000 negative impact on net interest income. Contributing to the unfavorable rate variance was the flattening yield curve. The flatness of the yield curve has impacted interest on the Bank’s liabilities to a greater extent than interest income on assets as more immediately repriceable deposits and CD’s have repriced than have short-term assets. Also, long-term assets have repriced at relatively lower rates.

As illustrated in Table 2, growing demand deposit balances, coupled with rising rates, increased the impact of net free funds to the net interest margin by 49%, going from 37 basis points in the second quarter of 2005 to 55 basis points in same period of 2006. The balance sheet growth in the second quarter of 2006 was driven by the growth in deposits since June 2005, which funded the increase in average earning assets of $74 million from the second quarter of 2005, while the mix of these added earning assets reduced the extent of the favorable volume variance. Of the additional $74 million average earning assets added since the second quarter of 2005, $39 million consisted of higher yielding loans and $35 million consisted of lower yielding overnight investments and securities. This mix is in contrast to the current total portfolio mix, with average earning assets consisting of 88% loans and 12% lower yielding overnight investments and securities. The net interest margin of 3.98% for the second quarter of 2006 was 21 basis points lower than the 4.19% net interest margin for the second quarter of 2005. The lower yielding mix of earning assets added since the second quarter of 2005 and a flat yield curve contributed to the lower net interest margin. Also contributing to the drop in the net interest margin was higher average balances of non-performing assets in the second quarter of 2006, as compared to the same period in 2005. However, as of June 30, 2006, nonperforming loan balances were $811,000 lower as compared to June 30, 2005.

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, 2006 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.

Net interest income estimates are summarized below.

	Net Interest Income Change
Increase 200 bp	.46	%
Increase 100 bp	.30
Decrease 100 bp	(.50	)
Decrease 200 bp	(1.73	)

13

Tables 2 and 3 sets 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 periods 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, 2006 and 2005 (presented on a tax equivalent basis in thousands)

		Three Months ended June 30, 2006							Three Months ended June 30, 2005
		Average outstanding balance			Interest earned/ paid		Yield/ rate		Average outstanding balance			Interest earned/ paid		Yield/ rate
Interest-earning assets:
Loans receivable (1)(2)		$	768,004		$	14,372	7.51	%	$	729,139		$	11,766	6.47	%
Securities (2)			87,884			921	4.20			60,963			544	3.58
Other interest-earning assets			14,279			186	5.22			6,464			69	4.28
Total interest-earning assets			870,167			15,479	7.13			796,566			12,379	6.23
Non-interest-earning assets			84,133							74,959
Total assets		$	954,300						$	871,525
Interest-bearing liabilities:
Transaction accounts			391,405			3,022	3.10			349,784			1,423	1.63
Time deposits			312,776			3,246	4.16			271,826			2,066	3.05
Borrowings			38,257			586	6.14			53,431			563	4.23
Total interest-bearing liabilities			742,438			6,854	3.70			675,041			4,052	2.41
Non-interest-bearing liabilities			130,489							120,126
Total liabilities			872,927							795,167
Shareholders’ equity	��		81,373							76,358
Total liabilities and shareholders’ equity		$	954,300						$	871,525
Net interest income					$	8,625						$	8,327
Interest rate spread							3.43	%						3.82	%
Net interest margin (net interest income as a percent of average interest-earning assets)							3.98	%						4.19	%
Effect of Net Free Funds (earning assets funded by non interest bearing liabilities)							.55	%						.37	%
Average interest-earning assets to interest-bearing liabilities			117.20	%						118.00	%

(1) Includes non-accrual loans.

(2) Income presented on a tax equivalent basis using a 35% tax rate. The tax equivalent adjustment was $82,000 and $90,000, in 2006 and 2005 respectively.

14

Table 3- Average Balance Sheet Rates for Six Months Ended June 30, 2006 and 2005 (presented on a tax equivalent basis in thousands)

	Six Months ended June 30,2006							Six Months ended June 30, 2005
	Average outstanding balance			Interest earned/ paid		Yield/ rate		Average outstanding balance			Interest earned/ paid		Yield/ rate
Interest-earning assets:
Loans receivable (1)(2)	$	753,316		$	27,605	7.39	%	$	722,097		$	22,687	6.34	%
Securities (2)		94,489			1,927	4.11			61,017			1,071	3.54
Other interest-earning assets		20,470			496	4.89			7,124			135	3.82
Total interest-earning assets		868,275			30,028	6.97			790,238			23,893	6.10
Non-interest-earning assets		84,823							81,249
Total assets	$	953,098						$	871,487
Interest-bearing liabilities:
Transaction accounts		391,965			5,786	2.98			362,428			2,709	1.51
Time deposits		313,590			6,285	4.04			267,407			3,826	2.89
Borrowings		38,254			1,093	5.76			50,796			1,042	4.14
Total interest-bearing liabilities		743,809			13,164	3.57			680,631			7,577	2.24
Non-interest-bearing liabilities		128,193							115,349
Total liabilities		872,002							795,980
Shareholders’ equity		81,096							75,507
Total liabilities and shareholders’ equity	$	953,098						$	871,487
Net interest income				$	16,864						$	16,316
Interest rate spread						3.40	%						3.86	%
Net interest margin (net interest income as a percent of average interest-earning assets)						3.92	%						4.16	%
Effect of Net Free Funds (earning assets funded by non interest bearing liabilities)						.52	%						.30	%
Average interest-earning assets to interest-bearing liabilities		116.73	%						116.10	%

(1) Includes non-accrual loans.

(2) Income presented on a tax equivalent basis using a 35% tax rate. The tax equivalent adjustment was $162,000 and $168,000, in 2006 and 2005 respectively.

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.

15

Table 4-Volume/Rate Analysis (in thousands)

	Three months ended June 30,2006 Compared to Three months ended June 30, 2005 Increase (Decrease) Due to								Six months ended June 30, 2006 Compared to Six months ended June 30, 2005 Increase (Decrease) Due to
	Volume			Rate			Total		Volume			Rate			Total
Interest income attributable to:
Loans receivable	$	654		$	1,952		$	2,606	$	1,023		$	3,894		$	4,918
Securities		271			106			377		667			189			856
Other interest-earning assets(1)		99			18			117		317			44			361
Total interest-earning assets		1,024			2,076			3,100		2,007			4,128			6,135
Interest expense attributable to:
Transactions accounts		188			1,411			1,599		240			2,837			3,077
Time deposits		345			835			1,180		747			1,713			2,459
Borrowings		(188	)		211			23		(299	)		350			51
Total interest-bearing liabilities		345			2,457			2,802		688			4,899			5,587
Increase (decrease) in net interest income	$	679		$	(381	)	$	298	$	1,319		$	(771	)	$	548

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

PROVISION FOR LOAN LOSSES

The provision for loan losses was $800,000 for the six months ended June 30, 2006, a decrease of $25,000 compared to the $825,000 provision recorded during the same period in 2005. For the second quarter of 2006 the provision for loan losses was $400,000, a decrease of $75,000 compared to the $475,000 provision for the second quarter of 2005. Non-performing loans decreased 33%, to $6,081,000 or .77% of total loans outstanding at June 30, 2006, compared to $9,045,000 or 1.24% at December 31, 2005. Non-performing loans also decreased 12% from the June 30, 2005 level of $6,892,000 or .94% of total loans outstanding. Management continues to monitor these relationships and has established appropriate reserves. Net charge-offs, year to date 2006, were $731,000 or .20% on an annualized basis to average loans, compared to the $675,000 and .19% for the first six months of 2005. The majority of the loans charged-off in the first half of 2006 had been reserved for in previous periods. The allowance for loan losses was 126% of non-performing loans on June 30, 2006 compared to 84% at the end of 2005 and 107% at June 30, 2005. The decrease in non-performing loans from December 31, 2005 included a $2,800,000 commercial loan that was foreclosed on by the Bank and classified as “other real estate owned”. The decrease in non-performing loans, and the Bank’s continued process of evaluating inherent risk in the loan portfolio led to the decrease in the provision by $75,000 (16%) from the second quarter of 2005. 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.

16

Non-performing assets, which include non-performing loans and other real estate owned, totaled $11,199,000 at June 30, 2006 and $14,108,000 at December 31, 2005. This represents 1.17% of total assets at June 30, 2006 compared to 1.47% at December 31, 2005. Total non-performing assets as of June 30, 2006 increased from the level at June 30, 2005 when total non-performing assets were $8,228,000 or .94% of total assets. The largest decreases to non-performing assets since the December 31, 2005 was the result of $3,511,000 in proceeds for the sale of certain real estate, which resulted in a total of $214,000 in losses on the sale of these properties.

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,
	2006			2005			2006			2005
Balance of allowance at beginning of period	$	7,389		$	7,320		$	7,581		$	7,214
Recoveries of loans previously charged off:
Commercial loans		8			1			16			16
Consumer loans		0			3			2			6
Mortgage loans		0			0			0			0
Total recoveries		8			4			18			22
Loans charged off:
Commercial loans		(117	)		(381	)		(690	)		(518	)
Consumer loans		(28	)		(54	)		(57	)		(92	)
Mortgage loans		(2	)		(0	)		(2	)		(87	)
Total charge-offs		(147	)		(435	)		(749	)		(697	)
Net charge-offs		(139	)		(431	)		(731	)		(675	)
Provision for loan losses		400			475			800			825
Balance of allowance at end of period	$	7,650		$	7,364		$	7,650		$	7,364
Net charge-offs to average loans outstanding for period		.07	%		.24	%		.20	%		.19	%
Allowance at end of period to loans at end of period		.97	%		1.00	%		.97	%		1.00	%
Allowance to nonperforming loans at end of period		125.80	%		106.85	%		125.80	%		106.85	%

17

NON-INTEREST INCOME

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

	Three Months ended June 30,				Six Months ended June 30,
	2006		2005		2006		2005
Non-interest income:
Service charges and fees	$	1,229	$	1,092	$	2,358	$	1,883
Gain on sale of securities		0		0		0		0
Gains on sale of real estate loans		220		276		459		451
Trust Fee Income		251		227		492		449
Bankcard transaction revenue		326		267		611		510
Company owned life insurance earnings		202		118		336		251
Other		346		360		766		717
Total non-interest income	$	2,574	$	2,340	$	5,022	$	4,261

As illustrated in Table 6, total non-interest income increased $761,000 (18%) for the first six months of 2006 from $4,261,000 at June 30, 2005 to $5,022,000 at June 30, 2006. For the second quarter of 2006 non-interest income increased $234,000 (10%) to $2,574,000 compared to $2,340,000 for the same period in 2005. Increases for the six months ended June 30, 2006 included service charges and fees (up $475,000, 25%), bankcard transaction revenue (up $101,000, 20%), and Company owned life insurance earnings (up $85,000, 34%). Other non-interest income included $202,000 in gains on the payoff of certain Federal Home Loan Bank advances, due to the reversal of the remaining purchase accounting adjustment on such advances, which was offset with $214,000 in losses from the sale of other real estate owned. The Federal Home Loan Bank long-term advances were callable advances that were part of the assets purchased in 2002, and were assumed at their fair value at the date of purchase. As rates have risen, the assumed advances fair value had fallen below the amortized liability as of the date they were called thus resulting in the gain.

Contributing to the growth in service charges and fees was revenue from cash management products and included increased lockbox revenue and fees from the Bank’s consolidated returns product. In 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 from the new lockbox customers and the consolidated returns was approximately $505,000 for the first six months ended June 30, 2006. The consolidating of returns 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 bankcard transaction revenue 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 increase in company owned life insurance earnings was the result of the additional $6,500,000 invested in company owned life insurance in December of 2005.

18

NON-INTEREST EXPENSE

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

	Three Months ended June 30,				Six Months ended June 30,
	2006		2005		2006		2005
Non-interest expense:
Salaries and benefits	$	3,718	$	3,007	$	7,335	$	5,764
Occupancy and equipment		1,018		987		1,997		1,928
Data processing		329		367		683		691
Advertising		172		186		303		269
State bank taxes		213		252		501		504
Amortization of intangible assets		162		162		323		323
Other		1,682		1,249		3,050		2,430
Total non-interest expense	$	7,294	$	6,210	$	14,192	$	11,909

As illustrated in Table 7, non-interest expense increased to $14,192,000 in the first half of 2006 and to $7,294,000 for the second quarter of 2006 from $11,909,000 and $6,210,000 in the same periods of 2005, an increase of $2,283,000 (19%) and $1,084,000 (17%) The largest increase in non-interest expense was in salaries and benefits, which increased $1,571,000 (27%) in the first six months of 2006 compared to the same period in 2005. The increase in salaries and benefits included the additional compensation cost for added staffing for the Bank’s cash management operations center which opened in February of 2005, and $490,000 in compensation cost for stock options. The Company recorded this stock option expense of $490,000 in the first six months of 2006 in accordance with Statement of Financial Accounting Standards No. 123(R),Share-BasedPayment (“FAS 123(R)”), adopted on January 1, 2006. For comparison purposes, applying the new standards of FAS 123(R) to the first six months of 2005 would have resulted in recording stock option compensation expense of $397,000. The operations center was opened to handle the increased lockbox item volume and expanded cash management product offerings, such as the service of consolidating returned checks. Other expenses in the first six months of 2006 included a $99,000 expense for the Bank’s investment in a low-income housing project. This before tax expense was offset with the reduction of Federal income tax expense resulting from recognition of a $124,000 low-income housing tax credit.

INCOME TAX EXPENSE

During the first six months of 2006, income tax expense decreased $429,000 (17%) from $2,515,000 in the first six months of 2005 to $2,086,000 in the same period of 2006 as a result of the low-income housing tax credit, higher tax-free income and lower earnings. The effective tax rate decreased to 30.99% for the first six months of 2006 compared to 32.77% for the same period in 2005. Contributing to the decrease in the effective tax rate was the low-income housing tax credit, higher tax-free income and lower earnings.

19

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 $2,448,000, from $80,447,000 at December 31, 2005 to $82,895,000 at June 30, 2006. In the first six months of 2006, the Company paid a cash dividend of $.18 per share totaling $1,054,000.

On December 16, 2005, the Company’s Board of Directors approved a new share repurchase program. The repurchase program began January 1, 2006 and will expire on December 31, 2006. The repurchase program authorized the repurchase of up to 200,000 shares of the Company’s outstanding common shares in the over-the-counter market from time to time. Any repurchases will be funded, as needed, by dividends from the Bank, or from the Company’s revolving line of credit.

The Company’s liquidity depends primarily on the dividends paid to it as the sole shareholder of the Bank and the Company’s line of credit. 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 Board of Governors of the Federal Reserve System and the Federal Deposit Insurance Corporation (“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, 2006, the Bank had capital in excess of the FDIC’s most restrictive minimum capital requirements in an amount over $1,800,000 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, 2006, the Bank’s leverage and total risk-based ratios were 9.24% and 10.20% respectively, which exceed the well-capitalized thresholds.

CONTRACTUAL OBLIGATIONS AND OFF-BALANCE SHEET ARRANGEMENTS

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 agreement and expiring twenty years after the opening of the Arena. In 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.

20

There have been no other significant changes to the Bank’s contractual obligations or off-balance sheet arrangements since December 31, 2005. 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, 2005.

NEWLY ISSUED BUT NOT YET EFFECTIVE ACCOUNTING STANDARDS:

In June 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109” (FIN 48), which prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. Management does not expect the adoption of this standard to have a material impact on the Company’s financial statements.

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

There has been no material change in market risk since December 31, 2005. For information regarding the Company’s market risk, refer to the Company’s Form 10-K for the year ending December 31, 2005. 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 design and operation of the disclosure controls and procedures as of June 30, 2006, 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.

21

Changes in Internal Control Over Financial Reporting

There was no change in the Company’s internal control over financial reporting that occurred in the last fiscal quarter that has materially affected, or is reasonably likely to materially affect the Company’s internal control over financial reporting.

The Bank of Kentucky Financial Corporation

PART II OTHER INFORMATION

Item 1. Legal Proceedings

From time to time, the Company and the Bank are involved in litigation incidental to the conduct of 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 1A. Risk Factors

There have been no material changes in the Company’s risk factors from those previously disclosed in the Company’s Form 10-K for the year ended December 31, 2005.

Item 2. Unregistered Sales 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, 2006:

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, 2006	0	$	0	59,000	141,000
May 1-31, 2006	3,700	$	25.47	62,700	137,300
June 1-30, 2006	12,000	$	26.00	74,700	125,300

(1) The Company currently maintains a share repurchase program that was approved by the Company’s board of directors in December of 2005. This repurchase program, which began on January 1, 2006 and will expire on December 31, 2006, 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, 74,700 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.

Item 3. Defaults Upon Senior Securities

Not applicable

22

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

The Annual Meeting of Stockholders of the Company was held on April 21, 2006. 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 2009:

	For	Against/Withheld	Abstentions
Harry J. Humpert	4,829,600	18,405	—
Herbert H. Works	4,827,186	20,819	—
John P. Williams Jr.	4,782,219	65,786	—
Robert W. Zapp	4,784,669	63,336	—

(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
4,799,766	35,256	12,983

Item 5. Other Information

None

Item 6. Exhibits

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

23

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 thereunto duly authorized.

	The Bank of Kentucky Financial Corporation
Date: August 4, 2006	/s/ Robert W. Zapp
	Robert W. Zapp
	President
Date: August 4, 2006	/s/ Martin J.Gerrety
	Martin J. Gerrety
	Treasurer and Assistant Secretary

24