Bank of Kentucky Financial (BKYF) 10-Q 2009 Q3 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 September 30, 2009

¨ 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: 001-34214

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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ¨    No  ¨

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

Large accelerated filer	¨	Accelerated filer	x
Non-accelerated filer	¨  (do not check if a smaller reporting company)	Smaller reporting company	¨

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 October 19, 2009, 5,616,707 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	18
	Item 3 – Quantitative and Qualitative Disclosures About Market Risk	30
	Item 4 – Controls and Procedures	30
Part II    OTHER INFORMATION
	Item 1 – Legal Proceedings	31
	Item 1A – Risk Factors	31
	Item 2 – Unregistered Sales of Equity Securities and Use of Proceeds	31
	Item 3 – Defaults Upon Senior Securities	31
	Item 4 – Submission of Matters to a Vote of Security Holders	31
	Item 5 – Other Information	31
	Item 6 – Exhibits	31

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THE BANK OF KENTUCKY FINANCIAL CORPORATION

PART I FINANCIAL INFORMATION

Item 1. Financial Statements

THE BANK OF KENTUCKY FINANCIAL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

(Dollars in thousands - unaudited)

	September 30 2009		December 31 2008
Assets
Cash and cash equivalents	$	56,418	$	38,656
Interest bearing deposits with banks		100		100
Available-for-sale securities		117,861		85,487
Held-to-maturity securities		35,871		33,725
Loans held for sale		2,926		2,625
Total loans		1,110,202		1,026,557
Less: Allowances for loan losses		13,778		9,910
Net loans		1,096,424		1,016,647
Premises and equipment, net		18,793		18,824
FHLB stock, at cost		4,959		4,959
Goodwill		15,209		15,209
Acquisition intangibles, net		1,716		2,552
Cash surrender value of life insurance		24,003		21,316
Accrued interest receivable and other assets		17,389		15,282
Total assets	$	1,391,669	$	1,255,382
Liabilities & Shareholders’ Equity
Liabilities
Deposits	$	1,150,764	$	1,071,153
Short-term borrowings		46,220		28,153
Notes payable		44,785		44,798
Accrued interest payable and other liabilities		11,030		9,830
Total liabilities		1,252,799		1,153,934
Shareholders’ Equity
Common stock, no par value, 15,000,000 shares authorized, 5,616,707 (2009) and 5,606,607 (2008) shares issued and outstanding		3,098		3,098
Additional paid-in capital		4,307		2,708
Preferred Stock, no par value, $34,000 liquidation value, authorized and issued 34,000 shares		33,142		—
Retained earnings		96,612		94,608
Accumulated other comprehensive income		1,711		1,034
Total shareholders’ equity		138,870		101,448
Total liabilities and shareholders’ equity	$	1,391,669	$	1,255,382

See accompanying notes

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THE BANK OF KENTUCKY FINANCIAL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2009 AND 2008

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

	Three Months Ended September 30					Nine Months Ended September 30
	2009			2008		2009			2008
INTEREST INCOME
Loans, including related fees	$	14,553		$	15,749	$	42,737		$	48,320
Securities and other		1,234			1,114		3,691			4,094
Total interest income		15,787			16,863		46,428			52,414
INTEREST EXPENSE
Deposits		4,019			5,607		12,586			19,863
Borrowings		351			712		1,211			2,283
Total interest expense		4,370			6,319		13,797			22,146
Net interest income		11,417			10,544		32,631			30,268
Provision for loan losses		4,000			775		8,325			3,175
Net interest income after provision for loan losses		7,417			9,769		24,306			27,093
NON-INTEREST INCOME
Service charges and fees		2,444			2,452		6,748			6,649
Gain on securities		0			0		263			0
Gain on loans sold		223			116		1,227			717
Other		909			1,339		3,662			3,752
Total non-interest income		3,576			3,907		11,900			11,118
NON-INTEREST EXPENSE
Salaries and benefits		4,006			4,224		12,053			12,499
Occupancy and equipment		1,158			1,191		3,564			3,586
Data processing		392			336		1,171			1,035
Advertising		276			263		744			594
Other		3,166			2,720		9,899			8,152
Total non-interest expense		8,998			8,734		27,431			25,866
INCOME BEFORE INCOME TAXES		1,995			4,942		8,775			12,345
Less: income taxes		450			1,523		2,343			3,795
NET INCOME	$	1,545		$	3,419	$	6,432		$	8,550
Preferred stock dividend and discount accretion		(506	)		—		(1,283	)		—
Net Income available to common shareholders		1,039			3,419		5,149			8,550
COMPREHENSIVE INCOME	$	2,296		$	3,633	$	7,109		$	8,593
Earnings per share, basic	$	.19		$	.61	$	.92		$	1.52
Earnings per share, diluted	$	.18		$	.61	$	.91		$	1.52

See accompanying notes

4

THE BANK OF KENTUCKY FINANCIAL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

FOR THE NINE MONTHS ENDED SEPTEMBER 30

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

	2009			2008
Balance as of January 1	$	101,448		$	93,485
Comprehensive Income:
Net Income		6,432			8,550
Change in net unrealized gain (loss), net of tax		677			43
Total Comprehensive Income		7,109			8,593
Cash dividends paid on common stock		(3,144	)		(3,038	)
Exercise of stock options (10,100 and 2,700 shares), including tax benefit		193			44
Stock-based compensation expense		391			501
Preferred stock issued		32,931			—
Common stock warrant issued		1,015			—
Paid and accrued dividends on preferred stock		(1,073	)		—
Stock repurchase and retirement (0 and 80,300 shares)		—			(1,866	)
Balance as of September 30	$	138,870		$	97,719
Dividends per share	$	0.56		$	0.54

See accompanying notes

5

THE BANK OF KENTUCKY FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE NINE MONTHS ENDED SEPTEMBER 30

(Dollars in thousands - unaudited)

	2009			2008
Cash Flows from Operating Activities
Net income	$	6,432		$	8,550
Adjustments to reconcile net income to net cash From operating activities		10,216			7,324
Net cash from operating activities		16,648			15,874
Cash flows from Investing Activities
Proceeds from paydowns and maturities of held-to-maturity securities		1,820			4,897
Proceeds from paydowns and maturities of available-for-sale securities		57,755			177,869
Purchases of held-to-maturity securities		(3,972	)		(13,894	)
Purchases of available-for-sale securities		(104,038	)		(98,301	)
Purchases of company owned life insurance		(2,000	)		—
Net change in loans		(41,211	)		(53,519	)
Purchase of loans		(49,060	)		—
Proceeds from the sale of other real estate		1,400			1,792
Proceeds from sale of securities		13,852			—
Property and equipment expenditures		(1,233	)		(2,616	)
Net cash from investing activities		(126,687	)		16,228
Cash Flows from Financing Activities
Net change in deposits		79,611			(69,586	)
Net change in short-term borrowings		18,067			45,665
Proceeds from exercise of stock options		193			44
Cash dividends paid		(4,003	)		(3,038	)
Stock repurchase and retirement		—			(1,866	)
Proceeds from note payable		—			20,000
Proceeds from issuance of preferred stock and warrants, net		33,946			—
Payments on note payable		(13	)		(17,538	)
Net cash from financing activities		127,801			(26,319	)
Net change in cash and cash equivalents		17,762			5,783
Cash and cash equivalents at beginning of period		38,656			38,876
Cash and cash equivalents at end of period	$	56,418		$	44,659

See accompanying notes

6

THE BANK OF KENTUCKY FINANCIAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2009

(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 Rule 10-01 of Regulation S-X 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. These financial statements and notes should be read in conjunction with the Company’s audited consolidated financial statements and notes thereto as set forth in the Company’s Annual Report on Form 10-K for the year ended December 31, 2008.

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make 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.

Subsequent events have been updated through November 6, 2009, the date these financial statements were issued.

Note 3 – Earnings per Share:

Earnings per share are computed based upon the weighted average number of common shares outstanding during the three and nine 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 September 2009 and 2008, 120,168 and 595,350 options were not considered, as they were not dilutive, and for the nine months ended September 2009 and 2008, 521,647 and 547,005 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 September 30		Nine Months Ended September 30
	2009	2008	2009	2008
Weighted average shares outstanding	5,615,475	5,606,607	5,613,230	5,626,046
Dilutive effects of assumed exercises of stock options and warrant	88,305	373	44,813	6,051
Shares used to compute diluted Earnings per share	5,703,780	5,606,980	5,658,043	5,632,097

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Note 4 – Stock-Based Compensation:

Options to buy stock are granted to directors, officers and employees under the Company’s stock option and incentive plan (the “Plan”) which provides for the issuance of up to 1,200,000 shares. The specific terms of each option agreement are determined by the Compensation Committee at the date of the grant. For current options outstanding, options granted to directors vest immediately and options granted to employees generally vest evenly over a five-year period.

The Company recorded stock option expense of $109,000 ($109,000, net of taxes) and $391,000 ($368,000, net of taxes) for the three and nine months ended September 30, 2009, with 2008 stock option expense of $141,000 ($141,000 net of taxes) and $501,000 ($474,000 net of taxes) in the three and nine months ended September 30, 2008.

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 – New Accounting Pronouncements:

Effective July 1, 2009, the Financial Accounting Standards Board (“FASB”) issued new guidance relating to FASB ASC 105-10: Generally Accepted Accounting Principles (“ASC 105-10”). The FASB Codification (the “Codification”) is the single source of authoritative nongovernmental generally accepted accounting principles (“GAAP”) in the United States. Rules and interpretive releases of the Securities and Exchange Commission (the “SEC”) are also sources of authoritative GAAP for companies that are subject to the reporting requirements of the Securities and Exchange Act of 1934, as amended (the “Exchange Act”). On the effective

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date of ASC 105-10, the Codification will supersede all then-existing non-SEC accounting and reporting standards. All other non-grandfathered non-SEC accounting literature not included in the Codification will become non-authoritative. ASC 105-10 is effective for financial statements that cover interim and annual periods ending after September 15, 2009. The adoption of this guidance by the Company did not have a material effect on the results of operations or financial condition. Technical references to GAAP are now provided in these financial statements under this new FASB ASC structure.

In December 2007, the FASB issued guidance impacting ASC 805,Business Combinations, which establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interests in an acquire, including the recognition and measurement of goodwill acquired in a business combination. It is effective for fiscal years beginning on or after December 15, 2008. The impact of adoption of this standard is disclosed in Note 11 to these Financial Statements.

In April 2009, the FASB issued guidance impacting ASC 320-10,Recognition and Presentation of Other-Than-Temporary Impairments,which amends existing guidance for determining whether impairment is other-than-temporary for debt securities. The additional guidance requires an entity to assess whether it intends to sell, or it is more likely than not that it will be required to sell a security in an unrealized loss position before recovery of its amortized cost basis. If either of these criteria is met, the entire difference between amortized cost and fair value is recognized in earnings. For securities that do not meet the aforementioned criteria, the amount of impairment recognized in earnings is limited to the amount related to credit losses, while impairment related to other factors is recognized in other comprehensive income. Additionally, the guidance expands and increases the frequency of existing disclosures about other-than-temporary impairments for debt and equity securities. This guidance is effective for interim and annual reporting periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009. The Company adopted this guidance in the second quarter, and the adoption did not to have a material effect on the results of operations or financial position. The adoption of this guidance is reflected in Note 8 to these Financial Statements, and the adoption of this guidance did not have a material effect on the results of operations or financial condition.

In April 2009, the FASB issued guidance impacting ASC 820-10,Determining Fair Value When the Volume and Level of Activity for the Asset and Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly. This additional guidance emphasizes that even if there has been a significant decrease in the volume and level of activity, the objective of a fair value measurement remains the same. Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants. The guidance provides a number of factors to consider when evaluating whether there has been a significant decrease in the volume and level of activity for an asset or liability in relation to normal market activity. In addition, when transactions or quoted prices are not considered orderly, adjustments to those prices based on the weight of available information may be needed to determine the appropriate fair value. The guidance also requires increased disclosures. This guidance is effective for interim and annual reporting periods ending after June 15, 2009, and shall be applied prospectively. Early adoption is permitted for periods ending after March 15, 2009. The Company adopted this guidance during the second quarter of 2009, and the adoption of the guidance has not had a material effect on the Company’s results of operations or financial position.

9

In April 2009, the FASB issued guidance impacting ASC 825-10,Interim Disclosures about Fair Value of Financial Instruments. This additional guidance amends FASB Statement No. 107,Disclosures about Fair Value of Financial Instruments, to require disclosures about fair value of financial instruments for interim reporting periods of publicly traded companies that were previously only required in annual financial statements. This guidance is effective for interim reporting periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009. The Company adopted this guidance during the second quarter of 2009, however, the adoption of the guidance has not had a material effect on the Company’s results of operations or financial position. The adoption of this guidance is reflected in Note 9 to these financial statements.

Note 8 – Securities:

The fair value of available for sale securities and the related gains and losses recognized in accumulated other comprehensive income (loss) was as follows (in thousands):

Available-for-Sale	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
September 30, 2009
U.S. Government, federal agencies and Government sponsored enterprises	$	56,723	$	415	$	—		$	57,138
U.S. Government agency mortgage-backed		57,301		2,177		—			59,478
Corporate		1,245		—		—			1,245
	$	115,269	$	2,592	$	—		$	117,861
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
December 31, 2008
U.S. Government, federal agencies and Government sponsored enterprises	$	40,045	$	381	$	—		$	40,426
U.S. Government agency mortgage-backed		42,631		1,191		(6	)		43,816
Corporate		1,245		—		—			1,245
	$	83,921	$	1,572	$	(6	)	$	85,487

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The carrying amount, unrecognized gains and losses, and fair value of securities held to maturity were as follows:

Held-to-Maturity	Carrying Amount		Gross Unrecognized Gains		Gross Unrecognized Losses			Fair Value
2009
Municipal and other obligations	$	35,871	$	694	$	—		$	36,565
2008
Municipal and other obligations	$	33,725	$	45	$	(354	)	$	33,416

The fair value of debt securities and carrying amount, if different, at September 30, 2009 by contractual maturity were as follows. Securities not due at a single maturity date, primarily mortgage backed securities, are shown separately.

	Available-for-Sale		Held-to-Maturity
	Fair Value		Carrying Value		Fair Value
Due in one year or less	$	17,142	$	2,807	$	2,841
Due after one year through five years		37,976		19,893		20,103
Due after five years through ten years		—		13,171		13,621
Due after ten years		3,265		—		—
U.S. Government agency Mortgage-backed		59,478		—		—
	$	117,861	$	35,871	$	36,565

Gains from sales of securities available for sale were $263,000 for the first nine months of 2009, with no losses. There were no sales of available for sale securities in 2008.

Management evaluates securities for other-than-temporary impairment (“OTTI”) at least on a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. Investment securities classified as available for sale or held-to-maturity are evaluated for OTTI under ASC 320,Accounting for Certain Investments in Debt and Equity Securities.

In determining OTTI, management considers many factors, including: (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, (3) whether the market decline was affected by macroeconomic conditions, and (4) whether the entity has the intent to sell the debt security or more likely than not will be required to sell the debt security before its anticipated recovery. The assessment of whether an other-than temporary decline exists involves a high degree of subjectivity and judgment and is based on the information available to management at a point in time.

When OTTI occurs, the amount of the OTTI recognized in earnings depends on whether an entity intends to sell the security or more likely than not will be required to sell the security before recovery of its amortized cost basis less any current-period credit loss. If an entity intends to sell or more likely than not will be required to sell the security before recovery of its amortized cost basis less any

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current-period credit loss, the OTTI shall be recognized in earnings equal to the entire difference between the investment’s amortized cost basis and its fair value at the balance sheet date. If an entity does not intend to sell the security and it is not more likely than not that the entity will be required to sell the security before recovery of its amortized cost basis less any current-period loss, the OTTI shall be separated into the amount representing the credit loss and the amount related to all other factors. The amount of the total OTTI related to the credit loss is determined based on the present value of cash flows expected to be collected is recognized earnings. The amount of the total OTTI related to other factors shall be recognized in other comprehensive income, net of applicable taxes. The previous amortized cost basis less the OTTI recognized in earnings shall become the new amortized cost basis of the investment.

As of September 30, 2009, the Bank’s security portfolio consisted of 117 securities, one of which was in an unrealized loss position, this loss position was less than one hundred dollars. There were no other-than-temporary-impairment of securities at September 30, 2009. Unrealized losses have not been recognized into income because the issuers’ bonds are of high credit quality (U.S. government agencies and government sponsored enterprises and “A” rated or better Kentucky municipalities), management does not have the intent to sell these securities and its likely that it will not be required to sell the securities before their anticipated recovery.

Mortgage-backed Securities

At September 30, 2009, 100% of the mortgage-backed securities held by the Bank were issued by U.S. government-sponsored entities and agencies, primarily Fannie Mae and Freddie Mac, institutions which the government has affirmed its commitment to support. Because a decline in market value would be attributable to changes in interest rates and illiquidity, and not credit quality, and because the Company does not have the intent to sell these mortgage-backed securities and it is likely that it will not be required to sell the securities before their anticipated recovery, the Company would not consider these securities to be other-than temporarily impaired, if there were unrealized losses at September 30, 2009.

At September 30, 2009 and December 31, 2008, securities with a carrying value of $124,721 and $101,407 were pledged to secure public deposits and repurchase agreements.

12

Securities with unrealized losses at September 30, 2009 and December 31, 2008, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, were as follows:

	Less than 12 Months					12 Months or More					Total
Description of Securities	Fair Value		Unrealized Loss			Fair Value		Unrealized Loss			Fair Value		Unrealized Loss
September 30, 2009
U.S. Government, federal agencies and government sponsored enterprises	$	—	$	—		$	—	$	—		$	—	$	—
U.S. Gov’t agency Mortgage-backed		—		—			—		—			—		—
Municipal & other obligations		—		—			—		—			—		—
Total temporarily impaired	$	—	$	—		$	—	$	—		$	—	$	—
December 31, 2008
U.S. Gov’t agency Mortgage-backed	$	458	$	(6	)	$	—	$	—		$	458	$	(6	)
Municipal & other obligations		9,440		(309	)		3,371		(45	)		12,811		(354	)
Total temporarily impaired	$	9,898	$	(315	)	$	3,371	$	(45	)	$	13,269	$	(360	)

Note 9 – Fair Value:

Statement 157 establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:

Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.

Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

Level 3: Significant unobservable inputs that reflect a reporting entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

The fair values of securities available for sale are determined by matrix pricing, which is a mathematical technique widely used to in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities (Level 2 inputs). One corporate security is valued using Level 3 inputs as there is no readily observable market activity. Management determines the value of this security based on expected cash flows, the credit quality of the security, and current market interest rates. Based on the credit and interest rate characteristics of this security, fair value approximates amortized cost

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The fair value of impaired loans with specific allocations of the allowance for loan losses is generally based on recent real estate appraisals. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are typically significant and result in a Level 3 classification of the inputs for determining fair value.

Assets and Liabilities Measured on a Recurring Basis

Assets and liabilities measured at fair value on a recurring basis are summarized below (in thousands):

			Fair Value Measurements at September 30, 2009 Using
	Total September 30, 2009		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
Available for sale securities:
U.S. Government, federal agencies and Government sponsored enterprises	$	57,138	$	—	$	57,138	$	—
U.S. Government agency mortgage-backed		59,478		—		59,478		—
Corporate		1,245		—		—		1,245
Total		117,861		—		116,616		1,245
			Fair Value Measurements at December 31, 2008 Using
	Total December 31, 2008		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
Available for sale securities:
U.S. Government, federal agencies and Government sponsored enterprises	$	40,426	$	—	$	40,426	$	—
U.S. Government agency mortgage-backed		43,816		—		43,816		—
Corporate		1,245		—		—		1,245
Total		85,487		—		84,242		1,245

There were no gains or losses for assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the quarter ended September 30, 2009 or the year ended December 31, 2008.

There were no changes in unrealized gains and losses recorded in earnings for the quarter ended September 30, 2009 for Level 3 assets and liabilities that are still held at September 30, 2009.

14

Assets and Liabilities Measured on a Non-Recurring Basis

Assets and liabilities measured at fair value on a non-recurring basis are summarized below (in thousands):

			Fair Value Measurements at September 30, 2009 Using
	Total September 30, 2009		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
Impaired loans	$	25,955	$	—	$	15,498	$	10,457
			Fair Value Measurements at December 31, 2008 Using
	Total December 31, 2008		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
Impaired loans	$	10,524	$	—	$	4,064	$	6,460

Impaired loans, which are measured for impairment using the fair value of the collateral for collateral dependent loans, had a carrying amount of $32,521, with a valuation allowance of $6,566, resulting in an additional provision for loan losses of $1,530 for the third quarter of 2009 and $3,133 for first nine months of 2009.

Values for collateral dependent loans are generally based on appraisals obtained from licensed real estate appraisers and in certain circumstances consideration of offers obtained to purchase properties prior to foreclosure or other factors management deems relevant to arrive at a representative fair value. Appraisals for commercial real estate generally use three methods to derive value: cost, sales or market comparison and income approach. The cost method bases value on the cost to replace the current property. Values using the market comparison approach evaluates the sales price of similar properties in the same market area. The income approach considers net operating income generated by the property and an investor’s required return. The final fair value is based on a reconciliation of these three approaches. The loans classified as level 2 had current and viable appraisals, while loans classified as level 3 had older appraisal and required the use of other unobservable inputs.

15

The carrying amounts and estimated fair values of financial instruments, at September 30, 2009 and December 31, 2008 are as follows (in thousands):

	September 30,						December 31,
	2 0 0 9						2 0 0 8
	Carrying Value			Fair Value			Carrying Value			Fair Value
Financial assets
Cash and cash equivalents	$	56,418		$	56,418		$	38,656		$	38,656
Interest-bearing deposits with banks		100			100			100			100
Available-for-sale securities		117,861			117,861			85,487			85,487
Held-to-maturity securities		35,871			36,565			33,725			33,416
Loans held for sale		2,926			2,926			2,625			2,625
Loans (net)		1,096,424			1,077,693			1,016,647			991,013
Federal Home Loan Bank stock		4,959			N/A			4,959			N/A
Accrued interest receivable		4,348			4,348			4,317			4,317
Financial liabilities
Deposits	$	(1,150,764	)	$	(1,154,264	)	$	(1,071,153	)	$	(1,071,915	)
Short-term borrowings		(46,220	)		(46,220	)		(28,153	)		(28,153	)
Notes payable		(44,785	)		(35,856	)		(44,798	)		(36,777	)
Accrued interest payable		(4,338	)		(4,338	)		(4,757	)		(4,757	)
Standby letters of credit		(245	)		(245	)		(185	)		(185	)

The estimated fair value approximates carrying amount for all items except those described below. Estimated fair value for both securities available for sale and held to maturity is as previously described for securities available for sale. It is not practicable to determine the fair value of FHLB stock due to restrictions placed on its transferability. Estimated fair value of loans held for sale is based on market quotes. Estimated fair value for loans is based on the rates charged at year-end for new loans with similar maturities, applied until the loan is assumed to reprice or be paid. Estimated fair value for time deposits is based on the rates paid at period end, for new deposits, applied until maturity. Estimated fair value of debt is based on current rates for similar financing. Estimated fair value for commitments to make loans and unused lines of credit are considered nominal.

Note 10 – Preferred Stock:

On February 13, 2009, the Company entered into a Letter Agreement (the “Purchase Agreement”) with the United States Department of Treasury (the “Treasury Department”) under the Troubled Asset Relief Program (TARP) Capital Purchase Program the (“CPP”), pursuant to which the Company issued 34,000 shares of Series A Non-Cumulative Perpetual Preferred Stock (the “Series A Preferred Stock”) for a total price of $34 million. The Series A Preferred Stock is to pay cumulative dividends at an annual dividend rate of 5% for the first five years and thereafter at annual dividend rate of 9%. No cash dividends can be paid to common stockholders unless all dividends on the Series A Preferred Stock have been declared and paid in full (or an amount sufficient for the payment of the dividends on the Series A Preferred Stock has been set aside for the payment of such dividends). Pursuant to the American Recovery and Reinvestment Act of 2009 (the “ARRA”), the Company may redeem the Series A Preferred Stock at any time, subject to the approval of its primary federal regulator.

As part of its purchase of the Series A Preferred Stock, the Treasury Department received a warrant (the “Warrant”) to purchase 274,784 shares of the Company’s common stock at an initial per share exercise price of $18.56. The Warrant provides for the adjustment of the exercise price and the number of shares of common stock issuable upon exercise pursuant to customary anti-dilution provisions. The Warrant expires ten years from the issuance date.

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Both the Series A Preferred Stock and the Warrant are accounted for as components of Tier 1 capital. The net proceeds received from the Treasury Department were allocated between the Series A Preferred Stock and Warrant based on relative fair value. The Series A Preferred Stock will be accreted to liquidation value over the expected life of the shares, with accretion charged to retained earnings.

Note 11 – Pending Acquisition:

On September 2, 2009, the Company and Integra Bank Corporation, headquartered in Evansville, Indiana announced that the Bank had agreed to purchase three banking offices of Integra Bank Corporation’s wholly-owned bank subsidiary, Integra Bank N.A. (“Integra Bank”), located in Crittenden, Dry Ridge and Warsaw, Kentucky. In addition, the Bank also agreed as part of the branch purchase to acquire certain deposit liabilities and assets of Integra Bank’s banking offices located in Union and Florence, Kentucky. In a separate transaction, the Bank agreed to purchase a portfolio of commercial loans originated by Integra Bank’s Covington, Kentucky, loan production office.

In the branch purchase transaction, the Bank will assume approximately $85 million (as of August 31, 2009) of deposit liabilities related to the five branches and buy certain branch-related assets, including at least $35 million (as of July 31, 2009) in selected loans. Integra Bank intends to close the Union and Florence banking offices following the completion of this transaction and seek a buyer for the real estate. Integra Bank’s customers at such banking offices will be served by existing, nearby branch offices of the Bank.

In the commercial loan purchase transaction, which occurred in September 2009, the Bank purchased approximately $50 million in selected commercial loans originated by Integra Bank’s Covington, Kentucky loan production office. It is anticipated that additional commercial loans related to Integra Bank’s Covington, Kentucky loan production office will be purchased at the closing of the branch purchase transaction.

Upon closing of the branch purchase, the Bank will pay a 6.50% deposit premium for the deposit liabilities, while the loans will be acquired at a 1% discount. All other assets will be sold at their book values. The transactions are subject to customary conditions, including regulatory approval for the branch sale. The parties expect the branch purchase transaction to close during the fourth quarter of 2009.

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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 $13,788,000 or 1.24% of total loans was an appropriate estimate of losses within the loan portfolio as of September 30, 2009. This estimate resulted in a provision for loan losses on the income statement of $8,325,000 for the nine months ended September 30, 2009. 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.

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OVERVIEW

The Company reported a decrease in diluted net income per share of 40% for the first nine months of 2009, and a decrease of 70% for the third quarter, as compared to the same periods in 2008. Highlighting third quarter 2009 results was an increase in total operating revenue of 1,065,000 (7%), an increase in loans of $110,809,000 (11%) and an increase in deposits of 158,272,000 (16%), as compared to the third quarter of 2008. Offsetting these increases was an additional $3,225,000 provision for loan losses and a $523,000 increase in losses on the sale of other real estate owned (OREO) as compared to the third quarter of 2008. Contributing to the revenue increase was the result of increases in net interest income of $873,000, or 8% in the third quarter of 2009, as compared to the same period in 2008. Contributing to the increase in the provision for loan losses were higher levels of charge-offs and non-performing loans in the third quarter of 2009 as compared to the same period in 2008, and management’s continuing concerns over the effect of the declining housing market, falling real estate values and the overall deteriorating economic conditions will have on the Company’s loan portfolio. The losses on the sale of OREO property included a loss of $462,000 on one property.

The third quarter and the first nine months of 2009 results also reflect the sale of 34,000 shares of the Company’s Fixed Rate Cumulative Perpetual Preferred Stock, Series A (the “Series A Preferred Stock”) and the issuance of a warrant (the “Warrant”) to the United States Department of the Treasury (the “Treasury Department”) as part of the Troubled Asset Relief Program (TARP) Capital Purchase Program (the “CPP”) for a total price of $34 million. The effect of the Treasury Department’s investment on the Company’s earnings per common share includes the accrual for the payment of dividends on the Series A Preferred Stock and related amortization expense of $506,000 and $1,283,000 for the third quarter and nine month period ended September 30, 2009, respectively. No comparable dividends and amortization were applicable during the comparable 2008 periods.

In the third quarter of 2009, the Bank announced plans to purchase three banking offices of Integra Bank Corporation’s wholly-owned bank subsidiary, Integra Bank N.A. (“Integra Bank”), located in Crittenden, Dry Ridge and Warsaw, Kentucky and a portfolio of selected commercial loans originated by Integra Bank’s Covington, Kentucky, loan production office. This transaction is expected to add $85,000,000 in deposits and at least $85,000,000 million in loans. As of September 30, 2009, the Bank has purchased $50,000,000 million of the loans from Integra Bank. The remainder of the transaction is expected to close in the fourth quarter of 2009.

FINANCIAL CONDITION

Total assets at September 30, 2009 were $1,391,669,000 as compared to $1,255,382,000 at December 31, 2008, an increase of $136,287,000 (11%). Loans outstanding increased $83,645,000 (8%) from $1,026,557,000 at December 31, 2008 to $1,110,202,000 at September 30, 2009, while available-for-sale securities increased $32,374,000 (38%) for the same time period. As Table 1 illustrates, the growth in the loan portfolio in 2009 came from increases in commercial loans of $45,626,000 (26%) and nonresidential real estate loans of $28,279,000 (7%). Contributing to the increase in loans was the $50,0000,000 loans purchase from Integra, the majority of which were commercial loans. The increase in available-for-sale securities was due in part to the addition of short term investments purchased with the proceeds resulting from the sale of Series A Preferred Stock to the Treasury Department in connection with the CPP.

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Deposits increased $79,611,000 (7%) to $1,150,764,000 at September 30, 2009, compared to $1,071,153,000 at December 31, 2008, while short-term borrowings increased $18,067,000 (64%) to $46,220,000 at September 30, 2009 from $28,153,000 at December 31, 2008. As Table 1 illustrates, the growth in deposits for the first nine months of 2009 came from increases in savings deposits of $12,714,000 (42%) and certificates of deposits of $45,496,000 (14%). The increase in short term borrowings included fed funds purchased of $24,306,000 on September 30, 2009, which were used to fund a portion of the loans purchased from Integra.

Table 1 The following table sets forth the composition of the Bank’s loans and deposits at the dates indicated:

	September 30, 2009				December 31, 2008
	Amount		%		Amount		%
	(Dollars in thousands)
Type of Loan:
Nonresidential real estate loans	$	457,138	41.1	%	$	428,859	41.7	%
One- to four-family residential real estate loans		243,303	21.9			239,729	23.3
Commercial loans		220,814	19.9			175,188	17.1
Consumer loans		18,057	1.6			17,693	1.7
Construction and land development loans		153,131	13.8			150,754	14.7
Municipal obligations		18,960	1.7			14,983	1.5
Total loans	$	1,111,403	100.0	%	$	1,027,206	100.0	%
Less:
Deferred loan fees		1,201				649
Allowance for loan losses		13,778				9,910
Net loans	$	1,096,424			$	1,016,647
Type of Deposit:
Non interest bearing deposits	$	175,877	15.3	%	$	157,082	14.7	%
Interest bearing transaction deposits		249,984	21.7			266,704	24.9
Money market deposits		253,119	22.0			220,704	20.6
Savings deposits		43,244	3.8			35,355	3.3
Certificates of deposits		365,073	31.7			334,312	31.2
Individual Retirement accounts		63,467	5.5			56,996	5.3
Total Deposits	$	1,150,764	100.0	%	$	1,071,153	100.0	%

RESULTS OF OPERATIONS

GENERAL

Net income available to common stockholders year to date decreased from $8,550,000 ($1.52 diluted earnings per share) in 2008 to $5,149,000 ($.91 diluted earnings per share) in 2009, a decrease of $3,401,000 (40%). Net income available to common stockholders for the quarter ended September 30, 2009 was $1,039,000 ($.18 diluted earnings per share) as compared to $3,419,000 ($.61 diluted earnings per share) during the same period of 2008, a decrease of $2,380,000 (70%). The year to date and third quarter figures

20

included $1,283,000 and $506,000 respectively in accrued preferred stock dividends and amortization. No comparable dividends and amortization were applicable for the 2008 periods. Other factors contributing to the decrease in earnings during the first nine months of 2009 were a $5,150,000 (162%) increase in provision expense, and increase of Federal Deposit Insurance Corporation (“FDIC”) expense of $1,284,000, which were partially offset by a $3,138,000 (8%) increase in revenue. The increase in FDIC insurance included a $600,000 special assessment that was accrued in the second quarter of 2009 and paid in the third quarter of 2009. Contributing to the increase in the provision for loan losses was higher levels of net charge-offs and non-performing loans in the third quarter of 2009 versus the same period in 2008 and management’s concerns over the declining housing market, falling real estate values and the overall deteriorating economic conditions. Contributing to the increase in revenue was a $2,363,000 (8%) increase in net interest income and an increase of sold loan income of $510,000 (71%).

NET INTEREST INCOME

Net interest income increased $873,000 (8%) in the third quarter of 2009 as compared to the same period in 2008, while the year to date total increased $2,363,000 (8%) from $30,268,000 in 2008 to $32,631,000 in 2009. As illustrated in Table 4, relatively all of the growth in net interest income was the result of growth in the balance sheet. The table shows the net interest income on a fully tax equivalent basis was positively impacted by the volume additions to the balance sheet by $1,095,000. Contributing to the favorable volume variance, as illustrated in Table 2, was average earning assets increasing $148,317,000 or 14% from the third quarter of 2008 to the third quarter of 2009, while average interest bearing liabilities only increased $103,895,000 or 11% to $1,035,521,000 from the third quarter of 2008 to the third quarter of 2009.

As illustrated in Table 2, the net interest margin of 3.72% for the third quarter of 2009 was 14 basis points lower than the 3.86% net interest margin for the third quarter of 2008, while the net interest margin decreased, the net interest spread, the difference between the Bank’s yield on earning assets and the cost of interest bearing liabilities, decreased by only 1 basis point from the third quarter of 2008. The difference between the net interest margin and net interest spread is accounted for by the diminishing impact that net non interest bearing funding, net free funds, has on the margin as over all funding cost decrease. Table 3 shows that the net interest margin of 3.65% for the first nine months of 2009 was 4 basis points lower than the 3.69% the first nine months of 2008. On a linked quarter basis, the net interest margin increased 11 basis points from the 3.61% net interest margin in the second quarter of 2009. Contributing to the increase in the net interest margin from the second quarter of 2009 was the decreasing cost of interest bearing liabilities, which decreased 9 basis points in the third quarter.

The Company 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. By simulating the effects of movements in interest rates the model can estimate the Company’s interest rate exposure. The results of the model are used by management to approximate the results of rate changes and do not indicate actual expected results. As shown below, the September 30, 2009 simulation analysis indicates that the Company is in a slightly liability interest rate sensitive position with the net interest income less negatively impacted from declining rates than by rising rates. As a result of the current historically low rate environment the effects of a 100 or 200 basis point decrease in rates would be negative to the net interest income. This is the result of a significant portion of the interest bearing liabilities already having a cost below 1.00%.

Net interest income estimates are summarized below.

Net Interest Income Change
Increase 200 bp	(3.84	)%
Increase 100 bp	(1.87	)
Decrease 100 bp	(0.97	)

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Tables 2 and 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 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 September 30, 2009 and 2008 (presented on a tax equivalent basis in thousands)

	Three Months ended September 30, 2009							Three Months ended September 30, 2008
	Average outstanding balance			Interest earned/ paid		Yield/ rate		Average outstanding balance			Interest earned/ paid		Yield/ rate
Interest-earning assets:
Loans receivable (1)(2)	$	1,065,031			14,650	5.46	%	$	991,206			15,784	6.32	%
Securities (2)		161,026			1,327	3.27			99,185			1,145	4.58
Other interest-earning assets		20,516			73	1.41			7,865			81	4.14
Total interest-earning assets		1,246,573			16,050	5.11			1,098,256			17,010	6.14
Non-interest-earning assets		100,101							97,033
Total assets	$	1,346,674						$	1,195,289
Interest-bearing liabilities:
Transaction accounts		546,114			944	0.69			492,501			2,013	1.62
Time deposits		421,854			3,075	2.89			359,898			3,594	3.96
Borrowings		67,553			351	2.06			79,227			712	3.57
Total interest-bearing liabilities		1,035,521			4,370	1.67			931,626			6,319	2.69
Non-interest-bearing liabilities		172,547							167,045
Total liabilities		1,208,068							1,098,671
Shareholders’ equity		138,606							96,618
Total liabilities and shareholders’ equity	$	1,346,674						$	1,195,289
Net interest income				$	11,680						$	10,691
Interest rate spread						3.44	%						3.45	%
Net interest margin (net interest income as a percent of average interest-earning assets)						3.72	%						3.86	%
Effect of net free funds (earning assets funded by non interest bearing liabilities)						.28	%						.41	%
Average interest-earning assets to interest-bearing liabilities		120.38	%						117.89	%

(1) Includes non-accrual loans.

(2) Income presented on a tax equivalent basis using a 34.7% and 34.4% tax rate in 2009 and 2008, respectively. The tax equivalent adjustment was $263,000 and $147,000 in 2009 and 2008 respectively.

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Table 3- Average Balance Sheet Rates for Nine Months Ended September 30, 2009 and 2008 (presented on a tax equivalent basis in thousands)

	Nine Months ended September 30, 2009							Nine Months ended September 30, 2008
	Average outstanding balance			Interest earned/ paid		Yield/ rate		Average outstanding balance			Interest earned/ paid		Yield/ rate
Interest-earning assets:
Loans receivable (1)(2)	$	1,047,862		$	42,992	5.50	%	$	972,194		$	48,448	6.68	%
Securities (2)		148,111			3,972	3.60			111,063			3,656	4.41
Other interest-earning assets		30,457			213	0.94			31,004			721	3.11
Total interest-earning assets		1,226,430			47,177	5.14			1,114,261			52,825	6.33
Non-interest-earning assets		98,069							94,992
Total assets	$	1,324,499						$	1,209,253
Interest-bearing liabilities:
Transaction accounts		547,619			2,856	0.70			517,710			7,734	2.00
Time deposits		409,725			9,730	3.18			365,540			12,129	4.45
Borrowings		66,729			1,211	2.43			72,643			2,283	4.21
Total interest-bearing liabilities		1,024,073			13,797	1.81			955,893			22,146	3.11
Non-interest-bearing liabilities		168,680							158,455
Total liabilities		1,192,753							1,114,348
Shareholders’ equity		131,746							94,905
Total liabilities and shareholders’ equity	$	1,324,499						$	1,209,253
Net interest income				$	33,380						$	30,679
Interest rate spread						3.33	%						3.22	%
Net interest margin (net interest income as a percent of average interest-earning assets)						3.65	%						3.69	%
Effect of Net Free Funds (earning assets funded by non interest bearing liabilities)						.32	%						.47	%
Average interest-earning assets to interest-bearing liabilities		119.76	%						116.57	%

(1) Includes non-accrual loans.

(2) Income presented on a tax equivalent basis using a 34.7% and 34.4% tax rate in 2009 and 2008, respectively. The tax equivalent adjustment was $749,000 and $411,000, in 2009 and 2008 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.

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Table 4-Volume/Rate Analysis (in thousands)

	Three months ended September 30,2009 Compared to Three months ended September 30, 2008									Nine months ended September 30, 2009 Compared to Nine months ended September 30, 2008
	Increase (Decrease)									Increase (Decrease)
				Due to Rate									Due to Rate
	Volume						Total			Volume						Total
Interest income attributable to:
Loans receivable	$	1,110		$	(2,243	)	$	(1,133	)	$	3,586		$	(9,042	)	$	(5,456	)
Securities		569			(387	)		182			1,080			(764	)		316
Other interest-earning assets(1)		70			(79	)		(9	)		(13	)		(495	)		(508	)
Total interest-earning assets		1,749			(2,709	)		(960	)		4,653			(10,301	)		(5,648	)
Interest expense attributable to:
Transactions accounts		198			(1,267	)		(1,069	)		425			(5,303	)		(4,878	)
Time deposits		549			(1,068	)		(519	)		1,349			(3,748	)		(2,399	)
Borrowings		(93	)		(268	)		(361	)		(174	)		(898	)		(1,072	)
Total interest-bearing liabilities		654			(2,603	)		(1,949	)		1,600			(9,949	)		(8,349	)
Increase (decrease) in net interest income	$	1,095		$	(106	)	$	989		$	3,053		$	(352	)	$	2,701

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

PROVISION FOR LOAN LOSSES

The provision for loan losses was $8,325,000 for the nine months ended September 30, 2009, an increase of $5,150,000 (162%) compared to the $3,175,000 provision recorded during the same period in 2008. For the third quarter of 2009 the provision for loan losses was $4,000,000, an increase of $3,225,000 (416%) compared to the $775,000 provision for the third quarter of 2008. Contributing to this increase were higher levels of charge-offs, non-performing loans and higher specific reserves for impaired loans in the third quarter of 2009 versus the same period in 2008 and management’s continuing concerns over the effect of the declining housing market, falling real estate values and overall deteriorating economic conditions will have on the Company’s loan portfolio. While the Company does not have higher risk loans such as subprime loans or option adjustable rate mortgage products in its portfolio, the majority of the non performing loans are secured by real estate. The provision and allowance for loan losses reflect the depreciation in real estate values, for loans that are going into foreclosure, and for the appraisals on loans that are showing impairment. The provision and allowance also reflects the deterioration in the value of guarantor support and lower debt coverage ratio’s for all loan categories.

The allowance for loan losses was $13,778,000 (1.24% of loan outstanding) at September 30, 2009 versus $9,910,000 (.97% of loan outstanding) at December 31, 2008 and $9,464,000 (.95% of loan outstanding) at September 30, 2008. Removing the approximately $50,000,000 loans purchased from Integra in the third quarter of 2009 at a discount of just under 1%, the allowance to loan ratio would have increased to 1.30%. These purchased loans are performing loans, and current accounting practice does not allow the

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discount to be added to the Company’s allowance for loan losses. Contributing to the increase in the allowance to loan ratio on a sequential basis from 1.12% of loans outstanding at June 30, 2009 to 1.24% (1.30% excluding the purchased loans) at September 30, 2009 was higher specific reserves for impaired loans, which increased from $5,036,000 (.47% of loans outstanding) at June 30, 2009 to $6,566,000 (.59% of loans outstanding) at September 30, 2009.

Non-performing loans increased to $25,397,000 or 2.29% of total loans outstanding at September 30, 2009, compared to $10,136,000 or .99% at December 31, 2008, and also increased from the September 30, 2008 level of $11,645,000 or 1.17% of then total loans outstanding. The growth of non-performing loans in the third quarter included one commercial loan relationship for approximately $8,000,000, that while current on payments, showed significant stress resulting in the Bank’s concern as to whether this borrower will be able to continue making these payments. The majority of the non-performing loans are individual commercial loans, which are reviewed for impairment with specific reserves allocated to them. Net charge-offs, year to date 2009, were $4,457,000 or .57% on an annualized basis to average loans, compared to the $2,216,000 and .30% for the first nine months of 2008. The allowance for loan losses was 54% of non-performing loans on September 30, 2009 compared to 98% at the end of 2008 and 81% at September 30, 2008. Management’s evaluation of the inherent risk in the loan portfolio considers both historic losses and information about specific borrowers. Also, as a result of the current economic stress with its negative effect on debt coverage ratio’s, guarantor support and the depreciation in real estate values management has aggressively downgraded loans. Classified loans have increased from $86,848,000 at December 31, 2008 to $148,516,000 at September 30, 2009. While all of the classified loans do not show impairment and are not all non-performing loans, they do show significant stress on the borrower and require a higher level of attention from management. 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 aggregate amounts of the Bank’s classified assets at September 30, 2009 and December 31, 2008 were as follows:

	9/30/09		12/31/08
	(Dollars in thousands)
Special mention (risk rating 6)	$	60,069	$	47,149
Substandard (risk rating 7)		87,881		39,524
Doubtful (risk rating 8)		566		175
Loss (risk rating 9)		—		—
Total classified assets	$	148,516	$	86,848

Non-performing assets, which include non-performing loans and other real estate owned, totaled $26,412,000 at September 30, 2009 and $10,848,000 at December 31, 2008. This represents 1.91% of total assets at September 30, 2009 compared to .87% at December 31, 2008. Total non-performing assets as of September 30, 2009 increased from the level at September 30, 2008 when total non-performing assets were $15,318,000 or 1.26% of total assets.

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

	Three Months ended September 30,						Nine Months ended September 30,
	2009			2008			2009			2008
Balance of allowance at beginning of period	$	11,816		$	9,099		$	9,910		$	8,505
Adjustment related to business combination
Recoveries of loans previously charged off:
Commercial loans		124			16			153			204
Consumer loans		82			59			234			193
Mortgage loans		—			2			—			2
Total recoveries		206			77			387			399
Loans charged off:
Commercial loans		(1,860	)		(228	)		(3,664	)		(1,653	)
Consumer loans		(356	)		(221	)		(916	)		(854	)
Mortgage loans		(28	)		(38	)		(264	)		(108	)
Total charge-offs		(2,244	)		(487	)		(4,844	)		(2,615	)
Net charge-offs		(410	)		(410	)		(4,457	)		(2,216	)
Provision for loan losses		4,000			775			8,325			3,175
Balance of allowance at end of period	$	13,778		$	9,464		$	13,778		$	9,464
Net charge-offs to average loans outstanding for period		.76	%		.16	%		.57	%		.30	%
Allowance at end of period to loans at end of period		1.24	%		.95	%		1.24	%		.95	%
Allowance to nonperforming loans at end of period		54.25	%		81.27	%		54.25	%		81.27	%

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NON-INTEREST INCOME

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

	Three Months ended September 30,						Nine Months ended September 30,
Non-interest income:	2009			2008			2009			2008
Service charges and fees	$	2,444		$	2,452		$	6,748		$	6,649
Gain on sale of securities		0	��		0			263			0
Mortgage banking income		223			116			1,227			717
Trust fee income		288			284			789			859
Bankcard transaction revenue		579			502			1,621			1,435
Company owned life insurance earnings		227			196			686			603
Losses on other real estate owned		(594	)		(71	)		(542	)		(286	)
Other		409			428			1,108			1,141
Total non-interest income	$	3,576		$	3,907		$	11,900		$	11,118

As illustrated in Table 6, total non-interest income increased $782,000 (7%) for the first nine months of 2009 from $11,118,000 at September 30, 2008 to $11,900,000 at September 30, 2009. For the third quarter of 2009 non-interest income decreased $331,000 (8%) to $3,576,000 compared to $3,907,000 for the same period in 2008. Increases for the nine months ended September 30, 2009 included service charges and fees (up $99,000, 1%), mortgage banking income (up $510,000, 71%), and bankcard transaction revenue (up $186,000, 13%), which were partially offset by lower trust fee income (down $70,000, 8%) and losses on the sale other real estate owned (“OREO”) (up $256,000, 90%). The increase in mortgage banking income was the result of higher refinancing business as a result of lower mortgage loan rates. Contributing to the decrease in trust fee income was the recent economic downturn that has affected portfolio balances. The losses on the sale of OREO included a loss of $462,000 on one property in the third quarter of 2009.

NON-INTEREST EXPENSE

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

	Three Months ended September 30,				Nine Months ended September 30,
Non-interest expense:	2009		2008		2009		2008
Salaries and benefits	$	4,006	$	4,224	$	12,053	$	12,499
Occupancy and equipment		1,158		1,191		3,564		3,586
Data processing		392		336		1,171		1,035
Advertising		276		263		744		594
Electronic banking		252		262		753		760
Outside servicing fees		355		369		1,108		1,015
State bank taxes		456		420		1,364		1,240
Other real estate owned		31		19		101		145
Amortization of intangible assets		258		296		837		981
FDIC insurance		429		195		1,855		571
Other		1,385		1,159		3,881		3,440
Total non-interest expense	$	8,998	$	8,734	$	27,431	$	25,866

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As illustrated in Table 7, non-interest expense increased to $27,431,000 in the first nine months of 2009 and to $8,998,000 for the third quarter of 2009 from $25,866,000 and $8,734,000 in the same periods of 2008, an increase of $1,565,000 (6%) and $264,000 (3%), respectively. The largest increase in non-interest expense resulted from a $1,284,000 (225%) increase in the FDIC assessment rates and the special assessment to all FDIC insured institutions for the first nine months of 2009, as compared to the same period in 2008. The increased FDIC assessments were imposed to increase the Deposit Insurance Fund’s reserve ratio, which has been impacted by an increased number of bank failures. The next largest increase in non-interest expense was advertising, which increased $150,000 (25%) for the first nine months of 2009 compared to the same period in 2008. The increase in advertising expense was the result of $230,000 in expense as a result of the naming rights for The Bank of Kentucky Center at Northern Kentucky University and The Bank of Kentucky Field at the Thomas More College.

INCOME TAX EXPENSE

During the first nine months of 2009, income tax expense decreased $1,452,000 (38%) from $3,795,000 in the first nine months of 2008 to $2,343,000 in the same period of 2009 as a result of lower earnings. For the third quarter of 2009 income tax expense decreased $1,073,000 (70%) to $450,000 compared to $1,523,000 for the same period in 2008 as a result of lower earnings. The effective tax rate decreased to 26.70% for the first nine months of 2009 compared to 30.74% for the same period in 2008. For the third quarter of 2009 the effective tax rate decreased to 22.56% compared to 30.82% for the same period of 2008. Contributing to the decrease in the effective tax rates was an increase in tax free income.

LIQUIDITY AND CAPITAL RESOURCES

The Company’s total shareholders’ equity increased $37,422,000 from $101,448,000 at December 31, 2008 to $138,870,000 at September 30, 2009, of which $34,000,000 was the result of the Treasury Department’s investment in the Company through the CPP. In the first nine months of 2009, the Company paid a cash dividend of $.56 per common share totaling $3,144,000.

The Company’s liquidity depends primarily on the dividends paid to it as the sole shareholder of the Bank and the Company’s cash on hand. The Company needs liquidity to meet its financial obligations under certain subordinated debentures issued by the Company in connection with the issuance of trust preferred securities issued by the Company’s unconsolidated subsidiary, for the payment of dividends to preferred and common stockholders, and for general operating expenses. The Board of Governors of the Federal Reserve System 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 September 30, 2009, the Bank had capital in excess of the FDIC’s most restrictive minimum capital requirements in an amount over $39,070,000 from which dividends could be paid, subject to the FDIC’s general safety and soundness review and state banking regulations.

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 capital ratio of 10% or more. At September 30, 2009, the Bank’s leverage and total risk-based capital ratios were 10.41% and 13.05% respectively, which exceed the well-capitalized thresholds.

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As of January 1, 2009, the Company did not have a stock repurchase program in place.

On February 13, 2009, the Company entered into a Letter Agreement (the “Purchase Agreement”) with the Treasury Department under the CPP, pursuant to which the Company agreed to issue 34,000 shares of Series A Preferred Stock for a total price of $34 million. The Series A Preferred Stock is to pay cumulative dividends at a rate of 5% per year for the first five years and thereafter at a rate of 9% per year. Pursuant to the American Recovery and Reinvestment Act of 2009 (the “ARRA”), the Company may redeem the Series A Preferred Stock at any time, subject to the approval of its primary federal regulator. As part of its purchase of the Series A Preferred Stock, the Treasury Department received the Warrant to purchase 274,784 shares of the Company’s common stock at an initial per share exercise price of $18.56. The Warrant provides for the adjustment of the exercise price and the number of shares of common stock issuable upon exercise pursuant to customary anti-dilution provisions, such as upon stock splits or distributions of securities or other assets to holders of the Company’s common stock, and upon certain issuances of the Company’s common stock at or below a specified price relative to the initial exercise price. The Warrant expires ten years from the issuance date. If, on or prior to December 31, 2009, the Company receives aggregate gross cash proceeds of not less than $34 million from “qualified equity offerings”, the number of shares of common stock issuable pursuant to the Treasury Department’s exercise of the Warrant will be reduced by one-half of the original number of shares, taking into account all adjustments, underlying the Warrant. Pursuant to the Purchase Agreement, the Treasury Department has agreed not to exercise voting power with respect to any shares of common stock issued upon exercise of the Warrant. Under the ARRA, the Warrant would be liquidated upon the redemption by the Company of the Series A Preferred Stock.

Both the Series A Preferred Stock and the Warrant are accounted for as components of Tier 1 capital.

Prior to February 13, 2012, unless the Company has redeemed the Series A Preferred Stock or the Treasury Department has transferred the Series A Preferred Stock to a third party, the consent of the Treasury Department will be required for the Company to (1) declare or pay any dividend or make any distribution on its common stock (other than regular semiannual cash dividends of not more than $0.28 per share of common stock) or (2) redeem, purchase or acquire any shares of its common stock or other equity or capital securities, other than in connection with benefit plans consistent with past practice and certain other circumstances specified in the Purchase Agreement.

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CONTRACTUAL OBLIGATIONS AND OFF-BALANCE SHEET ARRANGEMENTS

There have been no significant changes to the Bank’s contractual obligations or off-balance sheet arrangements since December 31, 2008. 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, 2008.

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

There has been no material change in market risk since December 31, 2008. For information regarding the Company’s market risk, refer to the Company’s Form 10-K for the year ending December 31, 2008. 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 Company’s disclosure controls and procedures as of September 30, 2009, and, based upon this evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that these disclosure 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 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.

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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, 2008.

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

The Company no longer maintains a share repurchase program and did not repurchase any shares during the third quarter of 2009.

Item 3. Defaults Upon Senior Securities

Not applicable

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

None

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

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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 thereunto duly authorized.

		The Bank of Kentucky Financial Corporation
Date:	November 6, 2009	/s/    ROBERT W. ZAPP
		Robert W. Zapp
		President
Date:	November 6, 2009	/s/    MARTIN J.GERRETY
		Martin J. Gerrety
		Treasurer and Assistant Secretary

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