UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K (Mark One) X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES - ----- EXCHANGE ACT OF 1934 [FEE REQUIRED] For the fiscal year ended December 31, 1997 OR _____ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED] For the transition period from to Commission file number 0-20908 PREMIER FINANCIAL BANCORP, INC. (Exact name of registrant as specified in its charter) KENTUCKY 61-1206757 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 120 N. HAMILTON STREET GEORGETOWN, KENTUCKY 40324 (Address of principal executive offices) (Zip Code) Registrants' telephone number: (502) 863-7500 Securities registered pursuant to Section 12 (b) of the Act: NONE Securities registered pursuant to Section 12 (g) of the Act: COMMON STOCK (Title of Class) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to filing requirements for the past 90 days. Yes X No --- ---- Indicate by check mark if the disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this 10-K or any amendment to this Form 10-K. [ ] The aggregate market value of voting stock held by non-affiliates of the Registrant as of March 24, 1998 was $107,497,472. The number of shares outstanding of the Registrant's Common Stock as of March 24, 1998 was 4,985,390. DOCUMENTS INCORPORATED BY REFERENCE Portions of the following documents are incorporated by reference into the Form 10-K part indicated: Document Form 10-K -------- --------- (1) Proxy statement for the 1998 annual meeting of Part III shareholders PART I ITEM 1. DESCRIPTION OF BUSINESS THE COMPANY Premier is a multi-bank holding company that, as of March 24, 1998, operated fourteen banking offices in Kentucky and three banking offices in Ohio through its seven bank subsidiaries (the "Affiliate Banks"), the seventh of which was acquired on March 20, 1998. At December 31, 1997, Premier had total consolidated assets of $425.4 million, total consolidated deposits of $324.6 million and total consolidated shareholders' equity of $47.8 million. Premier began an acquisition program in 1993 and has acquired five commercial banks and two branches of another commercial bank since that time. Premier also owns nonbank subsidiaries that provide consumer lending and data processing services. Premier continues to explore opportunities to acquire banks, savings associations, branches of either and nonbank companies as permitted by the Bank Holding Company Act of 1956, as amended (the "BHC Act"). Premier regularly reviews, analyzes and engages in discussions regarding possible additional acquisitions. It is not presently known whether, or on what terms, such discussions will result in further acquisitions, if any. Premier generally does not announce an acquisition until after the execution of a definitive agreement. Premier is a legal entity separate and distinct from its Affiliate Banks and nonbank subsidiaries. Accordingly, the right of Premier, and thus the right of Premier's creditors and shareholders, to participate in any distribution of the assets or earnings of any of the Affiliate Banks or nonbank subsidiaries is necessarily subject to the prior claims of creditors of such subsidiaries, except to the extent that claims of Premier, in its capacity as a creditor, may be recognized. The principal sources of Premier's revenues are dividends and fees from its Affiliate Banks and nonbank subsidiaries. See "REGULATORY MATTERS -- Dividend Restrictions" for discussion of the restrictions on the Affiliate Banks' ability to pay dividends to Premier. Premier was incorporated as a Kentucky corporation in 1991 and has functioned as a bank holding company since its formation. Premier's principal executive offices are located at 120 N. Hamilton Street, Georgetown, Kentucky 40324, and its telephone number is (502) 863-7500. BUSINESS GENERAL Through the Banks and its data processing subsidiary, the Company focuses on providing quality, community banking services to individuals and small-to medium sized businesses primarily in non-urban areas. By seeking to provide such banking services in non-urban areas, the Company believes that it can minimize the competitive effect of larger financial institutions that typically are focused on large metropolitan areas. Through its experiences in acquiring its Banks, the Company has successfully developed and implemented a strategy of joining together community banks that retain their commitment to local orientation and direction, while having the benefit of the Company's capital for growth and staff assistance to promote safety, soundness and regulatory compliance. Each Bank is managed on a decentralized basis that offers customers direct access to the Bank's president and other officers in an environment conducive to friendly, informed and courteous service. This decentralized approach also enables each Bank to offer local and timely decision-making, and flexible and reasonable operating procedures and credit policies limited only by a framework of centralized risk controls provided by the Company to promote prudent banking practices. Each Bank maintains its community orientation by, among other things, having selected members of its community as members of its board of directors, who assist in the introduction of prospective customers to the Bank and in the development or modification of products and services to meet customer needs. As a result of the development of personal banking relationships with its customers and the convenience and service offered by the Banks, the Banks' lending and investing activities are funded primarily by core deposits. When appropriate and economically advantageous, the Company centralizes certain of the Banks' back office, support and investment functions in order to achieve consistency and cost efficiency in the delivery of products and services. The Company centrally provides services such as data processing, operations support, accounting, loan review and compliance and internal auditing to the Banks to enhance their ability to compete effectively. The Company also provides overall direction in the areas of credit policy and administration, strategic planning, marketing, investment portfolio management and other financial and administrative services. Each Bank participates in product development by advising management of new products and service needed by their customers and desirable changes to existing products and services. Each of the Banks provides a wide range of retail and commercial banking services, including commercial, real estate, agricultural and consumer lending; depository and funds transfer services; collections; safe deposit boxes; cash management services; and other services tailored for both individuals and businesses. The Georgetown Bank, the Eminence Bank, and the Vanceburg Bank also offer limited trust services and act as executor, administrator, trustee and in various other fiduciary capacities. Through Premier Data Services, Inc., the Company's data processing subsidiary, the Company currently provides centralized data processing services to three of the Banks as well as two non-affiliated banks. The Banks' residential mortgage lending activities consist primarily of loans for purchasing personal residences, or loans for commercial or consumer purposes secured by residential mortgages. Consumer lending activities consist of traditional forms of financing for automobile and personal loans. The Banks' range of deposit services include checking accounts, NOW accounts, savings accounts, money market accounts, club accounts, individual retirement accounts, certificates of deposit and overdraft protection. Deposits of the Banks are insured by the Bank Insurance Fund administered by the FDIC. County Finance, Inc., a subsidiary of the Vanceburg Bank, is a consumer loan company that provides secured and unsecured loans to customers who would generally not qualify, due to credit experience or other factors, for loans at that Bank. The Company anticipates expanding the business of this consumer loan company, both in markets served by the Company's other Banks as well as potentially in other as yet unidentified market in Kentucky where business prospects appear favorable. COMPETITION The Banks encounter strong competition both in making loans and attracting deposits. The deregulation of the banking industry and the widespread enactment of state laws that permit multi-bank holding companies as well as the availability of nationwide interstate banking has created a highly competitive environment for financial services providers. In one or more aspects of its business, each Bank competes with other commercial banks, savings and loan associations, credit unions, finance companies, mutual funds, insurance companies, brokerage and investment banking companies and other financial intermediaries operating in its market and elsewhere, many of whom has substantially greater financial and managerial resources. With respect to the Georgetown Bank and the Germantown Bank, primary competitors include large bank holding companies having substantially greater resources that offer certain services that these two Banks do not currently provide. Each Bank seeks to minimize the competitive effect of larger financial institutions through a community banking approach that emphasizes direct customer access to the Bank's president and other officers in an environment conducive to friendly, informed and courteous service. Management believes that each Bank is well positioned to compete successfully in its respective primary market area, although no assurances can be given. Competition among financial institutions is based upon interest rates offered on deposit accounts, interest rates charged on loans and other credit and service charges, the quality and scope of the services rendered, the convenience of the banking facilities and, in the case of loans to commercial borrowers, relative lending limits. Management believes that the commitment of its Banks to personal service, innovation and involvement in their respective communities and primary market areas, as well as their commitment to quality community banking service, are factors that contribute to their competitiveness. REGULATORY MATTERS The following discussion sets forth certain elements of the regulatory framework applicable to bank holding companies and their subsidiaries and provides certain specific information relevant to Premier. This regulatory framework is intended primarily for the protection of depositors and the federal deposit insurance funds and not for the protection of the holders of securities, including Premier Common Shares. To the extent that the following information describes statutory or regulatory provisions, it is qualified in its entirety by reference to those provisions. A change in the statutes, regulations or regulatory policies applicable to Premier or its subsidiaries may have a material effect on the business of Premier. GENERAL - As a bank holding company, Premier is subject to regulation under the Bank Holding Company Act ("BHC Act"), and to inspection, examination and supervision by the Board of Governors of the Federal Reserve System ("Federal Reserve"). Under the BHC Act, bank holding companies generally may not acquire ownership or control of more than 5% of the voting shares or substantially all the assets of any company, including a bank, without the Federal Reserve's prior approval. Similarly, bank holding companies generally may not acquire ownership or control of a savings association without the prior approval of the Federal Reserve. Further, branching by the Affiliate Banks is subject to the jurisdiction, and requires the approval, of each Affiliate Bank's primary federal banking regulator and, if the Affiliate Bank is a state-chartered bank, the appropriate state banking regulator. In addition, bank holding companies generally may engage, directly or indirectly, only in banking and such other activities as are determined by the Federal Reserve to be closely related to banking. Under the BHC Act, the Federal Reserve has the authority to require a bank holding company to terminate any activity or relinquish control of the nonbank subsidiary (other than a nonbank subsidiary of a bank) upon the Federal Reserve's determination that such activity or control constitutes a risk to the financial soundness and stability of any bank subsidiary of the bank holding company. Premier and the Affiliate Banks are subject to the Federal Reserve Act, which limits borrowings by Premier and its nonbank subsidiaries from the Affiliate Banks and also limits various other transactions between Premier and its nonbank subsidiaries with the Affiliate Banks. The five Affiliate Banks chartered in Kentucky are supervised, regulated and examined by the Kentucky Department of Financial Institutions, and the two Affiliate Banks chartered in Ohio are supervised, regulated and examined by the Ohio Division of Financial Institutions. In addition, those Affiliate Banks that are state banks and members of the Federal Reserve System are supervised and regulated by the Federal Reserve, and those state banks that are not members of the Federal Reserve System are supervised and regulated by the Federal Deposit Insurance Corporation ("FDIC"). Each banking regulator has the authority to issue cease-and-desist orders if it determines that the activities of a bank regularly represent an unsafe and unsound banking practice or a violation of law. Both federal and state law extensively regulates various aspects of the banking business, such as, for example, reserve and capital requirements, truth-in-lending and truth-in-savings disclosure, equal credit opportunity, fair credit reporting, trading in securities and other aspects of banking operations. Premier, the Affiliate Banks and Premier's nonbank subsidiaries are also affected by the fiscal and monetary policies of the federal government and the Federal Reserve and by various other governmental laws, regulations and requirements. Further, the earnings of Premier and Affiliate Banks are affected by general economic conditions and prevailing interest rates. Legislation and administrative actions affecting the banking industry are frequently considered by the United States Congress, state legislatures and various regulatory agencies. It is not possible to predict with certainty whether such legislation or administrative actions will be enacted or the extent to which the banking industry, in general, or Premier and the Affiliate Banks, in particular, would be affected. LIABILITY FOR BANK SUBSIDIARIES - The Federal Reserve has a policy to the effect that a bank holding company is expected to act as a source of financial and managerial strength to each of its subsidiary banks and to maintain resources adequate to support each such subsidiary bank. This support may be required at times when Premier may not have the resources to provide it. In the event of a bank holding company's bankruptcy, any commitment by the bank holding company to a federal bank regulatory agency to maintain the capital of a subsidiary bank would be assumed by the bankruptcy trustee and entitled to priority of payment. Any depository institution insured by the FDIC may be held liable for any loss incurred, or reasonably expected to be incurred, by the FDIC in connection with (i) the default of a commonly controlled FDIC-insured depository institution, or (ii) any assistance provided by the FDIC to a commonly controlled FDIC-insured depository institution in danger of default. "Default" is defined generally as the appointment of a conservator or receiver and "in danger of default" is defined generally as the existence of certain conditions indicating that a "default" is likely to occur in the absence of regulatory assistance. In the event that such a default occurred with respect to a bank, any loans to the bank from its parent holding company will be subordinate in right of payment to payment of the bank's depositors and certain of its other obligations. CAPITAL REQUIREMENTS - Premier is subject to capital ratios, requirements and guidelines imposed by the Federal Reserve, which are substantially similar to the ratios, requirements and guidelines imposed by the Federal Reserve and the FDIC on the banks within their respective jurisdictions. These capital requirements establish higher capital standards for banks and bank holding companies that assume greater credit risks. For this purpose, a bank's or holding company's assets and certain specified off-balance sheet commitments are assigned to four risk categories, each weighted differently based on the level of credit risk that is ascribed to such assets or commitments. A bank's or holding company's capital is divided into two tiers: "Tier I" capital, which includes common shareholders' equity, noncumulative perpetual preferred stock and related surplus (excluding auction rate issues), minority interests in equity accounts of consolidated subsidiaries, less goodwill, certain identifiable intangible assets and certain other assets; and "Tier 2" capital, which includes, among other items, perpetual preferred stock not meeting the Tier I definition, mandatory convertible securities, subordinated debt and allowances for loan and lease losses, subject to certain limitations, less certain required deductions. Bank holding companies currently are required to maintain Tier I and total capital (the sum of Tier 1 and Tier 2 capital) equal to at least 4% and 8% of total risk-weighted assets, respectively. At December 31, 1997, Premier met both requirements, with Tier I and total capital equal to 19.82% and 25.43% of its total risk-weighted assets, respectively. In addition to the risk-based capital guidelines, the Federal Reserve requires bank holding companies to maintain a minimum "leverage ratio" (Tier I capital to adjusted total assets) of 3%, if the holding company has the highest regulatory ratings for risk-based capital purposes and, accordingly, is required to maintain a minimum "leverage ratio" of 3%. All other bank holding companies are required to maintain a leverage ratio of 3% plus at least 100 to 200 basis points. At December 31, 1997, Premier's leverage ratio was 13.52%. The foregoing capital requirements are minimum requirements. The Federal Reserve may set capital requirements higher than the minimums described above for holding companies whose circumstances warrant it. For example, holding companies experiencing or anticipating significant growth may be expected to maintain capital ratios, including tangible capital positions, well above the minimum levels. The Federal Reserve has not, however, imposed any such special capital requirements on Premier. Additionally, the Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA"), among other things, identifies five capital categories for insured depository institutions (well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized) and requires the respective federal regulatory agencies to implement systems for "prompt corrective action" for insured depository institutions that do not meet minimum capital requirements within such categories. FDICIA imposes progressively more restrictive constraints on operations, management and capital distributions, depending on the category in which an institution is classified. Failure to meet the capital guidelines could also subject a banking institution to capital raising requirements. An "undercapitalized" bank must develop a capital restoration plan and its parent holding company must guarantee the bank's compliance with the plan. The liability of the parent holding company under any such guarantee is limited to the lesser of 5% of the Bank's assets at the time it became "undercapitalized" or the amount needed to comply with the plan. Furthermore, in the event of the bankruptcy of the parent holding company, such guarantee would take priority over the parent's general unsecured creditors. In addition, FDICIA requires the various regulatory agencies to prescribe certain non-capital standards for safety and executive compensation and permits regulatory action against a financial institution that does not meet such standards. DIVIDEND RESTRICTIONS - Premier is dependent to a large extent on dividends from its Affiliate Banks for its revenues. Various federal and state regulatory provisions limit the amount of dividends the Affiliate Bank can pay to Premier without regulatory approval. At December 31, 1997, $7.7 million of the total shareholders' equity of the Affiliate Banks was available for payment of dividends to Premier without approval by the applicable regulatory authority. In addition, federal bank regulatory authorities have authority to prohibit Premier's Affiliate Banks from engaging in an unsafe or unsound practice in conducting their business. The payment of dividends, depending upon the financial condition of the bank in question, could be deemed to constitute such an unsafe or unsound practice. The ability of the Affiliate Banks to pay dividends in the future is presently, and could be further, influenced by bank regulatory policies and capital guidelines as well as each Affiliate Bank's earnings and financial condition. INTERSTATE BANKING - Under the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the "Riegle-Neal Act"), subject to certain concentration limits, (i) bank holding companies, such a Premier, are permitted to acquire banks and bank holding companies located in any state of the United States, subject to certain restrictions, and (ii) banks are permitted to acquire branch offices outside their home state by merging with out-of-state banks, purchasing branches in other states or establishing de novo branch offices in other states; provided that, in the case of any such purchase or opening of individual branches, the host state has adopted legislation "opting in" to the relevant provisions of the Riegle-Neal Act; and provided further, that, in the case of a merger with a bank located in another state, the host state has not adopted legislation "opting out" of the relevant provisions of the Riegle-Neal Act. NUMBER OF EMPLOYEES The Company and its subsidiaries collectively had approximately 193.5 full-time equivalent employees as of March 24, 1998. Its executive offices are located at 120 N. Hamilton Street, Georgetown, Kentucky, telephone number (502) 863-7500 (facsimile number (502) 863-7503). ITEM 2. PROPERTIES The Company owns the banking office of the Georgetown Bank at 120 North Hamilton Street, Georgetown, Kentucky, at which the Company's executive offices are located. In addition, the Company owns a building at 115 North Hamilton Street, Georgetown, Kentucky which is being remodeled for future offices, a branch banking office of the Georgetown Bank located at 103 Finley Drive, Georgetown, Kentucky and property at 812 South Broadway, Georgetown Kentucky where the Georgetown Bank has a temporary branch facility. In Sharpsburg, Kentucky, the Company owns the main banking office of the Sharpsburg bank at 648 Main Street and a building at 652 Main Street which is being remodeled for future offices. The Company also owns property located at 237 Frankfort Street, Brooksville, Kentucky, which was purchased as a possible future branch site for the Germantown Bank. Except as noted, each of the Banks owns the real property and improvements on where their banking activities are conducted. The Vanceburg Bank, in addition to its main office at 400 Second Street, Vanceburg, Kentucky has five branch offices in Lewis County, Kentucky, including one leased facility. The Germantown Bank, with its main office on Highway 10, Germantown, Kentucky, has no other offices in Bracken County, Kentucky. The Georgetown Bank, in addition to its main office has two branches in Scott County, Kentucky. The Sharpsburg Bank has, in addition to its main office, one branch located in Bath County, Kentucky. The Eminence Bank has its main office on Main Street, Eminence, Kentucky, and two branches in Henry County, Kentucky. The Sabina Bank has its main office at 135 North Howard Street, Sabina, Ohio, and two branches, one each located in Hardin and Auglaize Counties, Ohio. ITEM 3. LEGAL PROCEEDINGS The Banks are respectively parties to legal actions that are ordinary routine litigation incidental to a commercial banking business. In management's opinion, the outcome of these matters, individually or in the aggregate, will not have a material adverse impact on the results of operations or financial position of the Company. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS There were no matters submitted to a vote of security holders, through solicitation of proxies or otherwise during the fourth quarter of the fiscal year covered by this report. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS Prior to the Company's public offering in May, 1996, there had been no established public trading market for the common shares of the Company, with trading in common shares being limited and infrequent. During the 120 days prior to the offering, the Company was aware of certain trading transactions involving common shares at a sales price of $12.50 per share. Sales of common shares may have occurred in private transactions at prices that are not known to the Company. Further, these sale prices may not have been representative of prices that might have been realized in trading transactions in common shares following the offering. The Company's common stock is listed on the NASDAQ under the symbol PFBI. At March 24, 1998, the Company had approximately 608 record holders of its common shares. The following table sets forth on a quarterly basis cash dividends paid and the range of high and low sales prices on a per share basis during the quarters indicated. Cash dividends paid per share shown below have been adjusted retroactively to reflect prior stock splits effected in the form of share dividends. CASH SALES PRICE DIVIDENDS PAID HIGH LOW -------------- ----- ------ 1995: First Quarter $ 0.10 $ * $ * Second Quarter 0.10 * * Third Quarter 0.125 * * Fourth Quarter 0.125 * * ------ $ 0.45 ====== 1996: First Quarter $0.125 $ * $ * Second Quarter 0.125 14.25 13.50 Third Quarter 0.125 14.00 12.25 Fourth Quarter 0.125 14.12 12.00 ------ $0.50 ====== CASH SALES PRICE DIVIDENDS PAID HIGH LOW -------------- ----- ------ 1997: First Quarter $ 0.125 $15.62 $13.50 Second Quarter 0.125 18.75 14.25 Third Quarter 0.15 21.25 17.00 Fourth Quarter 0.15 27.50 20.12 ------ $ 0.55 ====== 1998: First Quarter **$0.15 $25.75 $21.56 * No established public trading market. ** Dividend declared March 10, 1998 to shareholders of record as of March 20, 1998, payable March 31, 1998. The Company has paid consecutive quarterly cash dividends since its organization. The Company's annual cash dividend has increased 7 consecutive years, from $0.12 per share in 1991 to $0.55 per share in 1997. While the Company currently expects to declare comparable cash dividends in the future, there can be no assurance that it will do so. The determination whether to pay cash dividends and the amount of such dividends is at the discretion of the Company's Board of Directors. The payment of dividends by the Company depends largely upon the ability of the Banks to declare and pay dividends to the Company because the principal source of the Company's revenue will be dividends paid by the Banks. At December 31, 1997, approximately $7.7 million was available for payment as dividends from the Banks to the Company without the need for approval from the FDIC or the state banking regulators. In considering the payment of dividends, the Board of Directors will take into account the Company's financial condition, results of operations, tax considerations, costs of expansion, industry standards, economic conditions and need for funds, as well as governmental policies and regulations applicable to the Company and the Banks. ITEM 6. SELECTED FINANCIAL DATA The following table presents consolidated selected financial data for the Company, it does not purport to be complete and is qualified in its entirety by more detailed financial information and the audited consolidated financial statements contained elsewhere in this annual report. The consolidated selected financial data presented below has been retroactively adjusted to reflect all prior stock splits effected in the form of share dividends and has been restated to give the effect of acquisitions accounted for as a pooling of interests. AT OR FOR THE YEAR ENDED DECEMBER 31, -------------------------------------------------------------------------------- 1997 1996 1995 1994 1993 -------- -------- ------- ------- ------- EARNINGS Net interest income $ 16,100 $ 12,426 $ 7,697 $ 7,319 $ 6,974 Provision for loan losses 1,232 760 196 335 389 Non-interest income 4,367 1,721 1,018 870 936 Non-interest expense 11,022 8,075 5,943 5,464 5,304 Income taxes 2,605 1,588 146 567 582 Net income $ 5,608 $ 3,724 $ 2,430 $ 1,823 $ 1,635 FINANCIAL POSITION Total assets $ 425,436 $ 329,127 $ 192,273 $ 154,653 $ 151,975 Loans, net of unearned income 283,390 242,625 137,550 106,431 97,521 Allowance for loan losses 3,144 2,854 1,997 1,172 1,192 Goodwill and other intangibles 7,262 5,490 248 8 16 Securities 69,211 52,660 33,919 30,619 35,582 Deposits 324,554 267,208 168,170 136,613 137,538 Other borrowings 20,897 14,977 1,502 0 0 Debt 28,750 0 5,000 1,500 0 Stockholders equity 47,797 44,625 15,603 13,617 12,767 SHARE DATA Net income - basic $ 1.20 $ 0.99 $ 1.02 $ 0.77 $ 0.69 Net income - diluted 1.19 0.99 1.02 0.77 0.69 Book value 10.20 9.52 6.54 5.77 5.42 Cash dividend 0.55 0.50 0.45 0.36 0.28 RATIOS Return on average assets 1.37% 1.42% 1.48% 1.19% 1.06% Return on average equity 12.17% 11.39% 16.49% 13.70% 13.02% Dividend payout 44.38% 53.22% 41.01% 33.60% 36.24% Stockholders' equity to total assets at period-end 11.23% 13.56% 8.12% 8.80% 8.40% Average stockholders' equity to average total assets 11.22% 12.48% 8.90% 8.69% 8.14% CAPITAL RATIOS Equity to assets 11.23% 13.56% 8.12% 8.80% 8.40% Leverage ratio 13.52% 12.11% 8.13% 8.84% 8.39% ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This discussion presents Management's analysis of the primary factors affecting Premier Financial Bancorp, Inc.'s (the "Company" or "Premier") performance and financial condition. It should be read in conjunction with the accompanying audited consolidated financial statements beginning on page 36 of this report. Unless otherwise noted, all amounts and per share data have been restated to give the effect of acquisitions accounted for as a pooling of interests. All dollar amounts (except per share data) are presented in thousands unless otherwise noted. FORWARD-LOOKING STATEMENTS Management's discussion and analysis contains forward-looking statements that are provided to assist in the understanding of anticipated future financial performance. However, such performance involves risks and uncertainties, and there are certain important factors that may cause actual results to differ materially from those anticipated. These important factors include, but are not limited to, economic conditions (both generally and more specifically in the markets in which Premier operates), competition for Premier's customers from other providers of financial services, government legislation and regulation (which changes from time to time), changes in interest rates, Premier's ability to originate quality loans and attract and retain deposits, the impact of Premier's rapid growth, Premier's ability to control costs, and new accounting pronouncements, all of which are difficult to predict and many of which are beyond the control of Premier. OVERVIEW In 1997, Premier continued to pursue its strategic plan to build a network of independently managed community banks into a strongly capitalized, risk controlled bank holding company with high quality earnings and shareholder liquidity. Premier continued to post record results in three key financial areas: earnings, total assets and shareholders' equity. For 1997, net income rose 50.6% to $5,608 from $3,723, as restated, in 1996; total assets increased to $425,436 from the $292,565 reported in 1996, and shareholders' equity increased to $47,797 from the $39,863 reported in 1996. During 1997, a number of larger financial institutions announced plans to divest of branches. In order to take advantage of these potential opportunities and to provide additional capital for other expansion opportunities, Premier issued $28.75 million of capital securities of subsidiary trust (capital securities) in June. A portion of these funds were used in December in connection with the purchase of two branches with $23.3 million in deposits and the balance will be used to complete the acquisition of three branches with total deposits of $148 million expected to be completed in June 1998. In the third and fourth quarters of 1997, Premier invested the proceeds of the capital securities in temporary investments realizing gross investment gains of $2.2 million which were added to earnings. At year end 1997, Premier had Tier I capital totaling $56.5 million which will provide sufficient capital to complete the proposed acquisitions as well as additional acquisitions which may become available. Highlights of Premier's 1997 performance and financial condition include: - Return on Average Assets of 1.37% - Return on Average Equity of 12.17% - Net Interest Margin 4.32% - Efficiency Ratio 57.3% - Allowance for Loan Losses to Non-Performing Loans 167% ACQUISITIONS Premier's acquisition philosophy is to seek community bank candidates in primarily non-urban areas that can become a part of Premier on a non-dilutive basis within a two year timeframe. In evaluating acquisition opportunities, Premier conducts a due diligence review to determine both risks and earnings potential. Desirable candidates have an established base of community involvement, strong local directors, a history of earnings and readily identifiable asset risks. Acquisition transactions are structured to make a fair return on investment while meeting the needs of the shareholders of banks joining Premier. In 1997, Premier completed one acquisition and also acquired the deposits and banking facilities of two branches. On November, 13, 1997, Premier acquired The Sabina Bank, Sabina, Ohio, in a share exchange accounted for as a pooling of interests. On December 11, 1997, two branch offices of the Fifth Third Bank of Western Ohio located in Waynesfield and Ada, Ohio, were acquired for cash and accounted for as a purchase. Also in 1997, Premier announced its intention to acquire Ohio River Bank, Ironton, Ohio, in the first quarter of 1998, in a business combination anticipated to be accounted for as a pooling of interests and also announced its planned purchase of three branch offices of Banc One Corporation located in Madison, Phillippi and Van, West Virginia, expected to be completed in the second quarter of 1998. In 1996, Premier completed one acquisition. On July 1, 1996, Farmers Deposit Bancorp of Eminence, Kentucky, and its wholly owned subsidiary, Farmers Deposit Bank, were acquired in a cash transaction that was accounted for as a purchase. In 1995, Premier completed two acquisitions. On March 24, 1995, the Company acquired Georgetown Bancorp, Inc. and its wholly owned subsidiary, Georgetown Bank & Trust, Georgetown, Kentucky, in a business combination accounted for as a pooling of interests. On October 31, 1995, Premier acquired all of the outstanding shares of Citizens Bank of Sharpsburg, Kentucky, for cash. This combination was accounted for as a purchase. The significant financial data relative to these acquisitions is set forth in Note 2 to the financial statements. CAPITAL SECURITIES OF SUBSIDIARY TRUST On June 9, 1997, Premier completed its public offering of $28.75 million of mandatorily redeemable capital securities of a subsidiary trust (capital securities). These securities qualify as Tier I capital up to an amount not to exceed 25% of Tier I capital and the portion that exceeds the 25% limitation qualifies as Tier 2 capital. The issuance of these securities and resultant increase in capital has allowed the Company to pursue larger financial institutions as potential acquisitions and to bid for branches offered for sale by other financial institutions. RESULTS OF OPERATIONS Earnings Summary Premier recorded net income for 1997 of $5,608, versus $3,723 and $2,431, respectively, in 1996 and 1995. Basic earnings per common share were $1.20 in 1997 compared to $.99 in 1996 and $1.02 in 1995. Net income increased $1,885 or 50.6% in 1997 compared to 1996. The primary factors contributing to the higher earnings in 1997 were a 29.6% increase in net interest income from $12,426 in 1996 to $16,100 in 1997 and an increase in the gain on the sale of investment securities of $2,202. Offsetting these increases was an increase in the provision for loan losses from $760 in 1996 to $1,232 in 1997, an increase in noninterest expense of $2,947 from $8,075 in 1996 to $11,022 in 1997 and an increase of $1,016 in income taxes from $1,589 in 1996 to $2,605 in 1997. Fully diluted earnings per share increased 20.2% in 1997 compared to 1996 despite the increase in the weighted average number of shares from 3.8 million in 1996 to 4.7 million in 1997. Net income of $3,723 in 1996 represented a 53.2% increase over the 1995 amount of $2,431. Net interest income increased 61.4% to $12,426 in 1996 versus $7,697 in 1995. Offsetting this increase was a $564 increase in the provision for loan losses and a $1,443 increase in income taxes from $146 in 1995 to $1,589 in 1996. In 1995, income taxes were substantially reduced as a result of the elimination of a $504 valuation allowance related to the deferred tax assets at Georgetown Bancorp, Inc. Per share earnings in 1996 of $0.99 were down $0.03 or 2.9% from the $1.02 recorded in 1995. The reduced level of per share earnings was primarily attributable to the increase in outstanding shares of 2,300,000 as a result of the Company's initial public offering in May of 1996. NET INTEREST INCOME Premier's primary source of revenue is its net interest income, which is the difference between the interest received on its earning assets and the interest paid on the funds acquired to support those assets. Loans made to businesses and individuals are the primary interest earning assets, followed by investment securities and federal funds sold in the inter-bank market. Deposits are the primary interest bearing liabilities used to support the interest earning assets. The level of net interest income is affected by both the balances and mix of interest earning assets and interest bearing liabilities, the changes in their corresponding yields and costs, by the volume of interest earning assets funded by noninterest bearing deposits, and the level of capital. Premier's long term objective is to manage this income to provide the largest possible amount of income while balancing interest rate, credit and liquidity risks. Nontaxable income from loans and investment securities is presented on a tax-equivalent basis whereby income exempt from tax has been adjusted upward by an amount equivalent to the prevailing federal income taxes that would have been paid if the income had been fully taxable. The discussion of factors influencing net interest income that follows is based on taxable equivalent data. In each of the three years, this adjustment is based on an assumed federal income tax rate of 34%. SUMMARY OF NET INTEREST INCOME. (Dollars in thousands on a taxable equivalent basis) 1997 1996 1995 --------- --------- --------- Interest income.................. $ 33,995 $ 22,401 $ 13,990 Tax equivalent adjustment........ 516 420 279 --------- --------- --------- Interest income.............. 34,511 22,821 14,269 Interest expense................. 17,894 9,975 6,294 --------- --------- --------- Net interest income.......... $ 16,617 $ 12,846 $ 7,975 ========= ========= ========= The table below shows, for the three year period ended December 31, 1997, the average distribution of assets, liabilities and the interest earned or paid on those items, together with the level of shareholders' equity, as well as Premier's net interest spread and net interest margin on interest earning assets (net interest income divided by average earning assets). In 1997, tax equivalent net interest income increased to $16,617 from $12,846 in 1996, an increase of $3,771 or 29.4%. This increase was due to an increase of $141,028 or 57.8% in average earning assets and an increase of $130,897 or 65.7% in average interest bearing liabilities. The yield on earning assets in 1997 of 8.96% was 39 basis points lower than the 9.35% earned in 1996 while the cost of interest bearing liabilities increased 41 basis points from 5.01% in 1996 to 5.42% in 1997. Consequently, Premier's net interest spread decreased from 4.34% in 1996 to 3.54% in 1997 and the net interest margin decreased from 5.26% in 1996 to 4.32% in 1997. The decrease in net interest spread and net interest margin is primarily attributable to the issuance of $28.75 million of mandatorily redeemable capital securities (capital securities) at an interest rate of 9.75% and the Company's implementation of an arbitrage investment strategy as described below. In an effort to minimize the adverse impact on net income until a permanent investment can be made of the funds from the issuance of the capital securities, the Company initiated an investment strategy at the end of the second quarter of 1997 of selling approximately $110 million of short-term (60 days) repurchase agreements and investing the proceeds in 2 to 5 year U.S. Treasury and agency securities with a weighted average interest rate of approximately 1% higher than the weighted average rate paid on the repurchase agreements. The Company's policy is to unwind its position whenever the spread between the weighted average interest rate of the repurchase agreements and the weighted average rate on the underlying securities falls below 50 basis points. During the third quarter of 1997 and again during the fourth quarter of 1997, the spread fell below 50 basis points, the Company unwound its positions and recognized net gains of $2.2 million on the sale of the underlying securities in the arbitrage portfolio. Although the Company's investment strategy to minimize the adverse impact on net income has been successful, the Company's net interest spread and net interest margin have been significantly reduced by its implementation. Excluding the effects of the capital securities and the Company's investment strategy, net interest spread would have been 4.28% in 1997 compared to 4.34% in 1996 and net interest margin would have been 5.20% in 1997 versus the 5.26% achieved in 1996. The net interest spread declined 12 basis points from 4.46% in 1995 to 4.34% in 1996, while the net interest margin, which measure net interest income as a percent of average earning assets, increased from 5.24% in 1995 to 5.26% in 1996. The increase in net interest margin is attributable to the higher levels of noninterest bearing deposits and capital supporting interest earning assets which rose from 22.5% in 1995 to 24.6% in 1996. The following table presents average balances and interest rates for the three year period ended December 31, 1997. AVERAGE CONSOLIDATED BALANCE SHEETS AND NET INTEREST ANALYSIS (Dollars in thousands.) 1997 1996 1995 ------------------------- ---------------------------- --------------------------- AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE BALANCE INTEREST RATE BALANCE INTEREST RATE BALANCE INTEREST RATE ------------------------- ---------------------------- --------------------------- ASSETS: Interest earning assets U.S. Treasury and federal agency securities $ 85,670 $ 5,288 6.17% $ 30,559 $ 1,772 5.80% $ 21,038 $ 1,186 5.64% States and municipal obligations(1) 18,027 1,455 8.07 12,783 1,017 7.96 8,088 667 8.25 Other securities (1) 5,155 507 9.84 3,716 395 10.63 2,556 280 10.95 -------- ------- ----- --------- ------- ----- -------- ------- ----- Total investment securities $108,852 $ 7,250 6.66 $ 47,058 $ 3,184 6.77 $ 31,682 $ 2,133 6.73 Federal funds sold 16,694 937 5.61 7,662 415 5.42 5,222 292 5.59 Interest-bearing deposits with banks 0 0 0 376 19 5.05 436 34 7.80 Loans, net of unearned income (3) (4) Commercial 111,448 11,260 10.10 88,161 8,923 10.12 59,650 6,138 10.29 Real estate mortgage 110,519 10,778 9.75 72,026 7,135 9.91 33,918 3,436 10.13 Installment 37,545 4,286 11.42 28,747 3,145 10.94 21,428 2,236 10.43 -------- ------- ----- --------- ------- ----- -------- ------- ----- Total loans $259,512 $26,324 10.14 $ 188,934 19,203 10.16 $114,996 $11,810 10.27 Total interest-earning assets $385,058 $34,511 8.96% $ 244,030 $22,821 9.35% $152,336 $14,269 9.37% Allowance for loan losses (2,975) (2,427) (1,299) Cash and due from banks 8,961 7,431 5,744 Premises and equipment 5,451 3,526 2,341 Other assets 14,200 8,921 4,800 -------- ---------- -------- Total assets $410,695 $ 261,481 $163,922 LIABILITIES: Interest bearing deposits: NOW and money market $ 45,135 $ 1,521 3.37% $ 32,532 $ 1,073 3.30% $ 19,828 $ 510 2.57 Savings 29,499 869 2.95 23,598 682 2.89 19,302 547 2.83 Certificates of deposit and other time deposits 175,302 10,342 5.90 133,356 7,630 5.72 84,486 4,877 5.77 -------- ------- ----- --------- ------- ----- -------- ------- ---- Total interest- bearing deposits $249,936 $12,732 5.09 $ 189,486 $ 9,385 4.95 $123,616 $ 5,934 4.80 Other borrowings 49,358 2,721 5.51 3,983 214 5.37 994 63 6.34 FHLB advances 14,301 810 5.66 3,660 208 5.68 713 44 6.17 Debt 16,460 1,631 9.91 2,029 168 8.28 2,891 253 8.75 -------- ------- ----- --------- ------- ----- -------- ------- ---- Total interest-bearing liabilities $330,055 $17,894 5.42% $ 199,158 $ 9,975 5.01% $128,214 $ 6,294 4.91% Non-interest bearing demand deposits 31,263 27,250 19,617 Other liabilities 3,279 2,373 1,372 -------- --------- -------- Total liabilities $364,597 $ 228,781 $149,203 SHAREHOLDERS' EQUITY: 46,098 32,700 14,719 -------- --------- -------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $410,695 $ 261,481 $163,922 NET INTEREST INCOME (1) 16,617 12,846 7,975 NET INTEREST SPREAD (1) 3.54% 4.34% 4.46% NET INTEREST MARGIN (1) 4.32% 5.26% 5.24% (1) Taxable - equivalent yields are calculated assuming a 34% federal income tax rate. (2) Yields are calculated on historical cost except for yields on marketable equity securities which are calculated using fair value. (3) Includes loan fees, immaterial in amount, in both interest income and the calculation of yield on loans. (4) Includes loans on nonaccrual status. The accompanying analysis of changes in net interest income in the following table shows the relationship of the volume and rate portions of these changes in 1997 and 1996. ANALYSIS OF CHANGES IN NET INTEREST INCOME (Dollars in thousands on a taxable equivalent basis) 1997 VS. 1996 1996 VS. 1995 INCREASE (DECREASE) DUE INCREASE (DECREASE) DUE TO CHANGE IN TO CHANGE IN ---------------------------- ---------------------------- VOLUME RATE NET CHANGE VOLUME RATE NET CHANGE Interest Income: Loans $ 7,166 $ (45) $ 7,121 $ 7,520 $ (127) $ 7,393 Investment securities 4,144 (78) 4,066 1,038 14 1,052 Federal funds sold 506 16 522 133 (10) 123 Deposits with banks (19) (19) (4) (12) (16) -------- ------ -------- ------- ------ ------- Total interest income $ 11,797 $ (107) $ 11,690 $ 8,687 $ (135) $ 8,552 Interest Expense: Deposits - NOW and money market $ 424 $ 24 $ 448 $ 390 $ 173 $ 563 Savings 173 14 187 124 11 135 Certificates of deposit 2,467 245 2,712 2,796 (43) 2,753 Other borrowings 2,501 6 2,507 159 (8) 151 FHLB borrowings 603 (1) 602 168 (4) 164 Debt 1,424 39 1,463 (72) (13) (85) -------- ------ -------- ------- ------ ------- Total interest expense $ 7,592 $ 327 $ 7,919 $ 3,565 $ 116 $ 3,681 Net interest income $ 4,205 $ (434) $ 3,771 $ 5,122 $ (251) $ 4,871 PROVISION AND ALLOWANCE FOR POSSIBLE LOAN LOSSES The company maintains its allowance for possible loan losses (allowance) at a level that is considered sufficient to absorb potential losses in the loan portfolio. The allowance is increased by the provision for possible loan losses as well as recoveries of previously charged-off loans, and is decreased by loan charge-offs. The provision is the necessary charge to expense to provide for current loan losses and to maintain the allowance at an adequate level commensurate with management's evaluation of the risks inherent in the loan portfolio. Various factors are taken into consideration when the Company determines the amount of the provision and the adequacy of the allowance. Some of the factors include: - Past due and nonperforming assets; - Specific internal analyses of loans requiring special attention; - The current level of regulatory classified and criticized assets and the associated risk factors with each; - Examinations and reviews by the Company's independent accountants and internal loan review personnel; and - Examinations of the loan portfolio by federal and state regulatory agencies. The data collected from these sources is evaluated with regard to current national and local economic trends, prior loss history, underlying collateral values, credit concentrations, and industry risks. An estimate of potential future loss on specific loans is developed in conjunction with an overall risk evaluation of the total loan portfolio. The following table is a summary of the Company's loan loss experience for each of the past five years. SUMMARY OF LOAN LOSS EXPERIENCE (Dollars in Thousands) YEARS ENDED DECEMBER 31, --------------------------------------------------------- 1997 1996 1995 1994 1993 -------- -------- -------- -------- ------- Balance at beginning of year $ 2,854 $ 1,996 $ 1,172 $ 1,192 $ 1,349 Balance of allowance for loan losses of acquired subsidiaries at acquisition date 0 812 803 0 0 Amounts charged off: Commercial 532 250 74 312 372 Real estate mortgage 139 68 19 5 47 Consumer 513 619 180 200 279 -------- -------- -------- -------- ------- Total loans charged off $ 1,184 $ 937 $ 273 $ 517 $ 698 Recoveries on amounts previously charged off: Commercial 48 89 32 94 76 Real estate mortgage 0 4 2 5 64 Consumer 194 130 64 63 12 -------- -------- -------- -------- ------- Total recoveries 242 223 98 $ 162 $ 152 Net charge-offs 942 714 175 355 546 Provision for loan losses 1,232 760 196 335 389 -------- -------- -------- -------- ------- Balance at end of year $ 3,144 $ 2,854 $ 1,996 $ 1,172 $ 1,192 Total loans, net of unearned income: Average 259,512 188,934 114,996 102,515 99,464 At December 31 283,390 242,625 137,550 106,431 97,521 As a percentage of average loans: Net charge-offs .36% .38% .15% .35% .55% Provision for possible loan losses .47% .40% .17% .33% .39% Allowance as a percentage of year-end net loans 1.11% 1.18% 1.45% 1.10% 1.22% Allowance as a multiple of net charge-offs 3 4 11 3 2 The provision for possible loan losses for 1997 was $1,232 compared to $760 in 1996, an increase of $472. This increase resulted from loan growth, the inclusion of Farmers Deposit Bancorp for a full year, and provisions made for possible loan losses for certain indirect consumer loans at the consumer finance subsidiary operated by Citizens Deposit Bank. In 1997, net charge-offs were $942 compared to $714 in 1996, an increase of $228. This increase was primarily attributable to the charge-off of loans acquired in the acquisition of Farmers Deposit Bancorp. At December 31, 1997, Premier's allowance for possible loan losses was 1.11% of period-end loans compared to 1.18% at December 31, 1996. Net charge-offs to average loans were .36% for the year 1997 compared to .38% for the year 1996. At December 31, 1997, Premier's allowance for possible loan losses totaled $3,144, representing an increase of $290 over the amount reported at December 31, 1996. The allowance for possible loan losses was 167% of nonperforming loans on December 31, 1997, compared to 155% at December 31, 1996. At year end 1997, nonperforming loans represented .50% of total outstanding loans, down from .56% on December 31, 1996. The provision for possible loan losses for 1996 was $760, an increase of $564 over the $196 in 1995. Net charge-offs in 1996 were $714, versus $175 charged-off in 1995. The following table sets forth an allocation for the allowance for possible loan losses by category of loan and a percentage distribution of the allowance allocation. In making the allocation, consideration was given to such factors as management's evaluation of risk in each category, current economic conditions and charge-off experience. An allocation for the allowance for possible loan losses is an estimate of the portion of the allowance that will be used to cover future charge-offs in each major loan category, but it does not preclude any portion of the allowance allocated to one type of loan being used to absorb losses of another loan type. ALLOCATION OF ALLOWANCE FOR LOAN LOSSES (Dollars in thousands) At December 31, --------------------------------------------------------------------------------------------------------- 1997 1996 1995 1994 1993 Amount % Amount % Amount % Amount % Amount % ---------------- ---------------- -------------- --------------- -------------- Commercial $1,186 37.7% $1,038 36.4% $ 675 33.8% $ 560 47.8% $ 566 47.5% Real estate 550 17.5 1,097 38.4 575 28.8 175 14.9 159 13.3 mortgage Consumer 852 27.1 626 21.9 573 28.7 292 24.9 304 25.5 Unallocated 556 17.7 93 3.3 173 8.7 145 12.4 163 13.7 ------ ---- ------ ------ ------ ----- ------ ------ ------ ---- Total $3,144 100.0% $2,854 100.0% $1,996 100.0% $1,172 100.0% $1,192 100.0% NONINTEREST INCOME AND EXPENSES Noninterest income is a significant component of the Company's total income. The Company continues to develop and enhance existing products and to create new products in order to augment fee income as trends in the financial services industry and the economic environment continue to put pressure on the Company's ability to increase its net interest income. Noninterest income includes deposit service charges, fees from data processing and trust services, fees and commissions from many other corporate and retail products and gains and losses from the sale of investment securities. The discussion that follows considers the impact for comparative purposes of the acquisition of Farmers Deposit Bancorp (Farmers Deposit) on July 1, 1996. Since the acquisition was accounted for as a purchase, only amounts from that date through December 31, 1996 are included in the consolidated financial statements for 1996, whereas the 1997 consolidated financial statements include Farmers Deposit for the full year. Total fees and other income increased $444 or 25.8% in 1997 to $2,163 from $1,719 in 1996. Excluding Farmers Deposit, fees and other income increased $164 or 11.3%. All categories increased in 1997, with service charges on deposit accounts increasing 15.4%, insurance commissions increasing 32.4% and all other income increasing 46.5%. Total fees and other income in 1996 increased $695 or 67.9% over 1995. Excluding Farmers Deposit, the increase would have been $427 for a 41.7% increase. In 1996, service charges on deposit accounts increased 54.0%, insurance commissions increased 88.4% and other income increased 94.8% over the amounts recorded in 1995. Investment securities gains in 1997 were $2,204 versus $1 in 1996 and losses in 1995 of $6. The significant increase in 1997 was due to the unwinding of an arbitrage investment portfolio established to maximize the utilization of the proceeds received from the issuance of capital securities. Noninterest expenses increased $2,947 or 36.5% in 1997, from $8,075 in 1996 to $11,022 in 1997, and increased $2,132 or 35.9% in 1996 from $5,943 in 1995. Excluding Farmers Deposit, noninterest expense increased 25.6% in 1997 and 16.3% in 1996. Salaries and employee benefits, the largest component of noninterest expense, increased 27.8% in 1997 and 43.6% in 1996. Excluding Farmers Deposit, the increases were 16.7% in 1997 and 19.4% in 1996. The increases include salary increases and reflect increases in the number of full time equivalent employees from 111 at December 31, 1995 to 150 at December 31, 1996 and 161 at December 31, 1997, due to acquisitions and expansion of the Company's business activity. Occupancy and equipment expense for 1997 of $1,421 was $224 or 18.7% higher than the $1,197 for 1996. Excluding Farmers Deposit, the increase was $122 or 11.2%. The increase in 1996 was $208 or 21.0% from $989 in 1995. The increase in 1996 and 1997 are primarily attributable to the expansion in the number of banking locations from 9 at December 31, 1995 up to 16 at December 31, 1997. Other noninterest expense, which is the second largest category, increased $540 or 30.6% in 1997 and $384 or 27.9% in 1996. Excluding Farmers Deposit, the increase in 1997 would have been 36.0% and the increase in 1996 would have been 2.7%. The Company incurred expenses relating to the acquisition of The Sabina Bank of $467 in 1997. No acquisition expenses were incurred in 1996, while acquisition expenses of $110 were incurred in 1995. Expenses related to acquisitions are charged to expense for acquisitions accounted for as pooling of interests while expense related to acquisitions accounted for as purchases are capitalized as a component of the purchase price and ultimately increase the amount of goodwill included with the purchase. Goodwill amortization increased in 1997 primarily due to the inclusion of Farmers Deposit for the full year versus half the year in 1996. The Company continually seeks to develop fees and other income for services provided while holding operating expenses to the minimum amount required to provide quality service. In 1997, total net noninterest expenses (excluding investment securities gains and acquisition expenses) as a percent of average total assets were reduced to 2.04% from 2.43% in 1996 and 2.93% in 1995. The following table is a summary of non-interest income and expense for the three year period indicated. NON-INTEREST INCOME AND EXPENSE (Dollars in thousands) INCREASE INCREASE (DECREASE) (DECREASE) 1997 VS. 1996 VS. 1997 1996 1996 1996 1995 1995 ------- ------ ------ ------ ------ ------ Non-Interest Income: Service charges on deposit accounts $ 1,155 $1,001 $ 154 $1,001 $ 650 $ 351 Insurance income 409 309 100 309 164 145 Other 599 409 190 409 210 199 ------- ------ ------ ------ ------ ------ Total fees and other income $ 2,163 $1,719 $ 444 $1,719 $1,024 $ 695 Investment securities gains (losses) 2,204 1 2,203 2 (6) 8 ------- ------ ------ ------ ------- ------ Total non-interest income $ 4,367 $1,720 $2,647 $1,721 $1,018 $ 703 Non-Interest Expense: Salaries and employee benefits 5,587 4,372 1,215 4,372 3,044 1,328 Occupancy and equipment expense 1,421 1,197 224 1,197 989 208 Professional fees 472 259 213 259 209 50 Taxes, other than payroll, property and income 387 288 99 288 210 78 Acquisition related expenses 467 0 467 0 110 (110) Amortization of intangibles 386 197 189 197 3 194 Other expenses 2,302 1,762 540 1,762 1,378 384 ------- ------ ------ ------ ------ ------ Total non-interest expenses $11,022 $8,075 $2,947 $8,075 $5,943 $2,132 Net non-interest expenses as a percent of average assets 1.62% 2.43% 2.43% 3.00% Net non-interest expenses as a percent of average assets (excluding investment securities gains and losses and acquisition related expenses) 2.04% 2.43% 2.43% 2.93% INCOME TAXES Premier's provision for income taxes was $2,605 in 1997, which represented 31.7% of pre-tax income versus $1,589 or 29.9% of pre-tax income in 1996. The increase is primarily due to the lower percentage of tax-exempt income in relation to total pre-tax income and the increase in nondeductible amortization expense. Income tax expense for 1995 was $146 or 5.7% of pre-tax income. The lower income tax for 1995 was attributable primarily to the elimination of the valuation allowance of $504 for deferred tax assets at Georgetown Bank & Trust. FINANCIAL CONDITION LENDING ACTIVITIES Loans are the Company's primary use of financial resources and represent the largest component of earning assets. The Company's loans are made predominantly within the Banks' market areas and the portfolio is diversified. Credit risk is inherent in each financial institution's loan and investment portfolio. In an effort to minimize credit risk, the Company utilizes a credit administration network, including specific lending authorities for each loan officer, a system of loan committees to review and approve loans, and a loan review and credit quality rating system. This network assists in the evaluation of the quality of new loans and in the identification of problem or potential problem credits and provides information to aid management in determining the adequacy of the allowance for possible loan losses. Total loans, net of unearned income, averaged $259,512 in 1997 compared with $188,934 in 1996. At year end 1997, loans net of unearned income totaled $283,390 compared to $242,625 at December 31, 1996, an increase of $40,765 or 16.8%. The following table presents a summary of the Company's loan portfolio by category for each of the last five years. Other than the categories noted, there is no concentration of loans in any industry greater than 5% in the portfolio. The Company has no foreign loans or highly leveraged transactions in its loan portfolio. LOAN PORTFOLIO COMPOSITION LOANS OUTSTANDING (Dollars in thousands) December 31 ------------------------------------------------------------------------------------------------- 1997 % 1996 % 1995 % 1994 % 1993 % -------- ------ -------- ------ -------- ------ -------- ------ -------- ------ Commercial, secured by real estate $ 66,893 23.41% $ 60,018 24.52% $ 39,568 28.57% $ 30,643 28.55% $ 29,274 29.46% Commercial, other 45,024 15.75 35,393 14.46 19,702 14.23 18,850 17.56 16,587 16.69 Real estate construction 7,857 2.75 4,138 1.69 2,377 1.72 1,822 1.70 881 .89 Real estate mortgage 93,789 32.82 87,335 35.69 41,096 29.67 30,067 28.01 27,557 27.73 Agricultural 13,208 4.62 11,731 4.79 6,924 5.00 3,271 3.05 3,226 3.25 Consumer 58,523 20.47 44,753 18.29 28,397 20.50 22,397 20.87 21,581 21.72 Other 504 .18 1,363 .56 435 0.31 279 0.26 254 .26 -------- ------ -------- ------ -------- ------ -------- ------ -------- ------ Total loans $285,798 100.00% $244,731 100.00% $138,499 100.00% $107,329 100.00% $ 99,360 100.00% -------- ------ -------- ------ -------- ------ -------- ------ -------- ------ Less unearned income (2,408) (2,106) (949) (898) (1,839) Total loans net of unearned income $283,390 $242,625 $137,550 $106,431 $ 97,521 Commercial loans generally are made to small-to-medium size businesses located within a Bank's defined market area and typically are secured by business assets and guarantees of the principal owners. Collateral for real estate mortgage loans include residential properties and the loans generally do not exceed 80% of the value of the real property securing the loan, based on recent independent appraisals. The Company's real estate mortgage loan portfolio primarily consists of adjustable rate residential mortgage loans. The origination of these mortgage loans can be more difficult in a low interest rate environment where there is a significant demand for fixed rate mortgages. Consumer loans generally are made to individuals living in a Bank's defined market area who are known to the Bank's staff. Consumer loans are made for terms of up to seven years on a secured or unsecured basis. While consumer loans generally provide the Company with increased interest income, consumer loans may involve a greater risk of default. Loss experience in all categories has remained low over the past five years, with net charge offs being .36% of loans in 1997 and .38% in 1996. With respect to consumer loans in particular, net charge offs for the year ended December 31, 1997 were $319, or .55% of total consumer loans outstanding at December 31, 1997, and $489 in 1996, or 1.09% of total consumer loans outstanding at December 31, 1996. The following table sets forth the maturity distribution and interest sensitivity of selected loan categories at December 31, 1997. Maturities are based upon contractual terms. The Company's policy is to specifically review and approve any loan renewed; no loans are automatically rolled over. LOAN MATURITIES AND INTEREST SENSITIVITY DECEMBER 31, 1997 (Dollars in thousands) One Year One Through Over Total or Less Five Years Five Years Loans Commercial, secured by real estate $ 10,670 $ 12,595 $ 43,628 $ 66,893 Commercial, other 23,535 12,596 8,893 45,024 Real estate construction 6,856 301 700 7,857 Agricultural 7,024 3,595 2,589 13,208 -------- -------- -------- -------- Total $ 48,085 $ 29,087 $ 55,810 $132,982 Fixed rate loans $ 29,997 $ 21,446 $ 29,384 $ 80,827 Floating rate loans 18,088 7,641 26,426 52,155 -------- -------- -------- -------- Total $ 48,085 $ 29,087 $ 55,810 $132,982 NONPERFORMING ASSETS Nonperforming assets consist of loans on which interest is no longer accrued, certain restructured loans where interest rate or other terms have been renegotiated, accruing loans past due 90 days or more and real estate acquired through foreclosure. All loans considered impaired under SFAS 114 are included in nonperforming loans. The Company discontinues the accrual of interest on loans that become 90 days past due as to principal or interest unless they are adequately secured and in the process of collection. A loan remains in a nonaccrual status until doubts concerning the collectibility no longer exist. A loan is classified as a restructured loan when the interest rate is materially reduced or the term is extended beyond the original maturity date because of the inability of the borrower to service the loan under the original terms. Other real estate is recorded at the lower of cost or fair value less estimated costs to sell. A summary of the components of nonperforming assets, including several ratios using period-end data, is shown below: NONPERFORMING ASSETS (Dollars in Thousands) DECEMBER 31 ---------------------------------------------------- 1997 1996 1995 1994 1993 Nonaccrual loans $ 562 $ 768 $ 693 $ 203 $ 1,028 Accruing loans which are contractually past due 90 days or more 490 588 480 261 543 Restructured loans 356 0 0 0 0 ------- ------- ------- ----- ------- Total nonperforming and restructured loans $ 1,408 $ 1,356 $ 1,173 $ 464 $ 1,571 Other real estate acquired through foreclosures 836 485 132 427 110 ------- ------- ------- ----- ------- Total nonperforming and restructured loans and other real estate $ 2,244 $ 1,841 $ 1,305 $ 891 $ 1,681 Nonperforming and restructured loans as a percentage of net loans .50% .56% .85% .44% 1.61% Nonperforming and restructured loans and other real estate as a percentage of total assets .53% .56% .44% .58% 1.11% Nonaccrual loans decreased from $768 at December 31, 1996 to $562 at December 31, 1997. Total nonperforming assets increased from $1,841 at December 31, 1996 to $2,244 at December 31, 1997, however the percentage of nonperforming loans to total loans decreased from .56% to .50% The Company continues to follow its long-standing policy of not engaging in international lending and not concentrating lending activity in any one industry. Although loans may be classified as nonperforming, many continue to pay interest irregularly or at less than original contractual rates. A summary of actual income recognized on nonperforming loans versus their full contractual yields for each of the past five years is presented below. INTEREST INCOME ON NON-ACCRUAL AND RESTRUCTURED LOANS YEAR ENDED DECEMBER 31 (Dollars in thousands) 1997 1996 1995 1994 1993 Contractual interest 77 73 32 15 49 Interest recognized 61 2 22 0 6 INVESTMENT ACTIVITIES The securities portfolio consists of debt and equity securities which provide the Company with a relatively stable source of income. Additionally, the investment portfolio provides a balance to interest rate and credit risks in other categories of the balance sheet. The securities portfolio is also used as a secondary source of liquidity by the Company. The Company has classified all municipal securities and certain U. S. Treasury and Agency securities as held to maturity based on management's positive intent and ability to hold such securities to maturity. These municipal securities provide tax-free income and are within management's guidelines with respect to credit risk and market risk. The municipal securities have been issued principally by Kentucky municipalities. The U. S. Treasury and Agency securities are held as a source of stable, long-term income which can be used as collateral to secure municipal deposits and repurchase agreements. All other investment securities are classified as available for sale. The securities portfolio does not contain significant holdings in mortgage-backed securities, collateralized mortgage obligations or other mortgage-related derivative products and/or structured notes. Securities, exclusive of the arbitrage portfolio, as a percentage of average interest-earning assets decreased to 15.1% in 1997 versus 19.3% in 1996 and 20.8% in 1995.. These decreases in securities reflect management's emphasis on originating higher yielding loans and placing a lesser reliance on the securities portfolio for sources of income. At December 31, 1997 and 1996, the Company had an investment in noncumulative perpetual preferred stock of First Guaranty Bank, Hammond, Louisiana. The market value of this investment approximated its book value which totaled $2 million at December 31, 1997 and 1996. The dividend rate on the preferred stock is 2% in excess of the prime rate as in effect from time to time. The following tables present the carrying values and maturity distribution of investment securities. CARRYING VALUE OF SECURITIES (Dollars in thousands) DECEMBER 31 1997 1996 1995 U.S. Treasury and Federal agencies: Available for sale $ 35,967 $ 22,720 $ 19,163 Held to maturity 5,588 8,387 2,300 State and municipal obligations: Available for sale 3,564 4,464 2,864 Held to maturity 14,625 12,190 6,347 Equity securities: Available for sale 2,795 2,788 2,819 Held to maturity 0 0 0 Other securities: Available for sale 3,600 0 0 Held to maturity 149 416 18 Total securities: Available for sale 45,926 29,972 24,846 Held to maturity 20,362 20,993 8,665 -------- -------- -------- Total $ 66,288 $ 50,965 $ 33,511 MATURITY DISTRIBUTION OF SECURITIES December 31, 1997 (Dollars in thousands) ONE FIVE YEAR THROUGH THROUGH OVER OR FIVE TEN TEN OTHER MARKET LESS YEARS YEARS YEARS SECURITIES TOTAL VALUE U.S. Treasury and Federal agencies: Available for sale $20,869 $ 9,315 $ 4,403 $1,380 $ 0 $35,967 $35,967 Held to maturity 2,300 2,986 301 0 0 5,587 5,603 State and municipal obligations: Available for sale 414 2,160 613 377 0 3,564 3,564 Held to maturity 732 5,321 5,657 2,916 0 14,626 15,110 Other securities: Available for sale 0 0 0 0 6,395 6,395 6,395 Held to maturity 0 0 0 0 149 149 149 Total securities: Available for sale 21,283 11,475 5,016 1,757 6,395 45,926 45,926 Held to maturity 3,032 8,307 5,958 2,916 149 20,362 20,862 ------- ------- ------- ------ ------ ------- ------- Total $24,315 $19,782 $10,974 $4,673 $6,544 $66,288 $66,788 ======= ======= ======= ====== ====== ======= ======= Percent of total 36.68% 29.84% 16.56% 7.05% 9.87% 100.00% 100.75% Weighted average yield* 4.85% 4.61% 5.11% 4.55% 8.52% 5.17% *The weighted average yields are calculated on historical cost on a non tax-equivalent basis. DEPOSIT ACTIVITIES Managing the mix and repricing of deposit liabilities is an important aspect of the Company's ability to maximize its net interest margin. The strategies used to manage interest-bearing deposit liabilities are designed to adjust as the interest rate environment changes. In this regard, management of the Company regularly assesses its funding needs, deposit pricing, and interest rate outlooks. Total deposits averaged $281,199 in 1997, a 29.7% increase over 1996. Total deposits averaged $216,736 in 1996, an increase of $73,503 or 51.37% over 1995. Noninterest bearing deposits averaged 12.5% of total deposits in 1997, compared to 14.4% in 1996 and 15.9% in 1995. At December 31, 1997, deposits totaled $324,554, compared to $267,208 at December 31, 1996, an increase of $57,346, or 21.5%. Of this increase, approximately $23,300 is attributable to the acquisition of two branches during 1997. Exclusive of the acquisition, deposits increased $34,046 from December 31, 1996 to December 31, 1997, representing a 12.7% increase. The table below provides information on the maturities of time deposits of $100,000 or more at December 31, 1997. MATURITY OF TIME DEPOSITS OF $100,000 OR MORE December 31, 1997 ----------------- (in thousands) Maturing 3 months or less $ 9,200 Maturing over 3 months through 6 months 8,459 Maturing over 6 months through 12 months 12,510 Maturing over 12 months 16,936 -------- Total $ 47,105 ======== The following table sets forth the average amount of and average rate paid on selected deposit categories during the past three full years. 1997 1996 1995 CATEGORY AMOUNT RATE (%) AMOUNT RATE (%) AMOUNT RATE (%) (Dollars in thousands) Demand $ 31,263 0% $ 27,250 0% $ 19,617 0% NOW and money market accounts 45,135 3.37% 32,532 3.30% 19,828 2.57% Savings 29,499 2.95% 23,598 2.89% 19,302 2.83% Certificates of deposit and other time 175,302 5.90% 133,356 5.72% 84,486 5.57% -------- ----- -------- ----- -------- ----- Total $281,199 4.53% $216,736 4.33% $143,233 4.14% CAPITAL Stockholders' equity increased $3,172 in 1997 to $47.8 million or 11.2% of total assets at December 31, 1997. This compares to $44.6 million, or 13.6% of total assets at December 31, 1996. The primary source of growth in stockholders' equity in 1997 was the retention of net earnings of $3,119. The primary sources of growth in 1996 were the issuance of common stock in the Company's initial public offering of $27.1 million and retention of net earnings of $1,741. The consolidated statements of changes in stockholders' equity details the changes in equity for the last three years. The fair value adjustment of the Company's available for sale securities portfolio, which is recorded as a component of stockholders' equity, may change significantly as market conditions change. At December 31, 1997 and 1996, the adjustment resulted in a reduction of stockholders' equity of $65 and $118, respectively. Further volatility in stockholders' equity may occur in the future as market conditions change. The Company's principal source of funds for dividend payments to stockholders is dividends received from the subsidiary Banks. Banking regulations limit the amount of dividends that may be paid without prior approval of regulatory agencies. Under these regulations, the amount of dividends that may be paid without prior approval of regulatory agencies in any calendar year is limited to the current year's net profits, as defined, combined with the retained net profits of the preceding two years, subject to regulatory capital requirement limitations. During 1998, the Banks could, without prior approval, declare dividends to the Company of approximately $7,656 plus any 1998 net profits retained to the date of the dividend declaration. The various regulatory agencies having supervisory authority over financial institutions have adopted risk-based capital guidelines which define the adequacy of the capital levels of regulated institutions. These risk-based capital guidelines require minimum levels of capital based upon the risk rating of assets and certain off-balance-sheet items. Assets and off-balance-sheet items are assigned regulatory-risk weights ranging from 0% to 100% depending on their level of credit risk. The guidelines classify capital in two tiers, Tier I and Tier 2, the sum of which is total capital. Tier I capital is essentially common equity, less intangible assets. Tier 2 capital is essentially qualifying long-term debt and a portion of the allowance for possible loan losses. During 1997, the Company completed its public offering of $28.75 million of mandatorily redeemable capital securities of a subsidiary trust. These securities qualify as Tier I capital up to an amount not to exceed 25% of Tier I capital and the portion that exceeds the 25% limitation qualifies as Tier 2 capital. Consequently, the Company's capital ratios as of December 31, 1997 increased significantly over the ratios at December 31, 1996 as noted in the following table: SELECTED CAPITAL INFORMATION (Dollars in thousands) DECEMBER 31 1997 1996 CHANGE Stockholders' Equity $ 47,797 $ 44,625 $ 3,172 Qualifying capital securities of subsidiary trust 15,931 0 15,931 Disallowed amounts of goodwill and other intangibles (7,262) (5,490) (1,772) Unrealized loss on securities available for sale (5) 6 (11) -------- -------- ------- Tier I capital $ 56,461 $ 39,141 $17,320 DECEMBER 31 1997 1996 CHANGE Tier II capital adjustments: Qualifying capital securities of subsidiary trust 12,819 0 12,819 Allowance for loan losses 3,144 2,854 290 -------- -------- -------- Total capital $ 72,424 $ 41,995 $ 30,429 Total risk-weighted assets $284,846 $238,210 Ratios Tier I capital to risk-weighted assets 19.82% 16.43% Total capital to risk-weighted assets 25.43% 17.63% Leverage at year-end 13.52% 12.10% The Company believes that its capital, together with existing credit facilities and its ability to obtain future credit facilities, provides funds sufficient to support the Company's current operations. LIQUIDITY Liquidity for a financial institution can be expressed in terms of maintaining sufficient cash flows to meet both existing and unplanned obligations in a cost effective manner. Adequate liquidity allows the Company to meet the demands of both the borrower and the depositor on a timely basis, as well as pursuing other business opportunities as they arise. Thus, liquidity management embodies both an asset and liability aspect. Liquidity is maintained through the Company's ability to convert assets into cash, manage the maturities of liabilities and generate funds through the attraction of local deposits. As part of its liquidity management, the Company maintains funding relationships with the Federal Home Loan Bank and other financial institutions, including a $20 million revolving line of credit available for both general corporate purposes and future acquisitions. The Company prefers to manage its liquidity requirements generally through the matching of maturities of assets and liabilities. The consolidated statements of cash flows for the periods presented in the financial statements provide an indication of the Company's sources and uses of cash as well as an indication of the ability of the Company to maintain an adequate level of liquidity. Liquidity risk is the possibility that the Company may not be able to meet its cash requirements. Management of liquidity risk includes maintenance of adequate cash and sources of cash to fund operations and meet the needs of borrowers, depositors and creditors. Liquidity must be maintained at a level which is adequate but not excessive. Excess liquidity has a negative impact on earnings resulting from the lower yields on short-term assets. In addition to cash, cash equivalents and Federal funds sold, the securities portfolio provides an important source of liquidity. The total of securities maturing within one year along with cash, due from banks and Federal funds sold totaled $76.7 million as of December 31, 1997. Additionally, securities available-for-sale with maturities greater than one year and equity securities totaled $24.7 million at December 31, 1997. These securities represent a secondary source available to meet liquidity needs on a continuing basis. To maintain a desired level of liquidity, the Company has several sources of funds available. One is the cash flow generated daily from the Banks' various loan portfolios in the form of principal and interest payments. Another source is its deposit base. The Company maintains a relatively stable base of customer deposits which has historically exhibited steady growth. This growth, when combined with other sources, is expected to be adequate to meet its demand for funds. Due to the nature of the markets served by the Company's subsidiary banks, management believes that the majority of certificates of deposit of $100,000 or more are no more volatile than its core deposits. During a period of relatively stable interest rates, these balances as a percentage of total deposits have remained relatively the same for 1997 and 1996. Certificates of deposits and other time deposits of $100,000 or more represented approximately 14.5% and 15.0% of total deposits at December 31, 1997 and 1996, respectively. A number of techniques are used to measure the liquidity position, including the utilization of several ratios that are presented below. These ratios are calculated based on annual averages for each year. LIQUIDITY RATIOS 1997 1996 1995 Total loans/total deposits..................... 92.29% 87.17% 80.29% Total loans/total deposits less float.......... 93.28% 88.81% 81.41% Net short-term borrowings/total assets......... 13.67% 2.82% .87% This analysis shows that the Company's loan to deposit ratios increased in 1997 and 1996 compared to the prior year due to an increase in loan demand that exceeded the increase in deposit activity. Information regarding short-term borrowings for the past three years is presented in the following table. SHORT-TERM BORROWINGS (Dollars in thousands) 1997 1996 1995 Federal funds purchased and repurchase agreements: Balance at year end $ 5,634 $ 5,599 $ 747 Weighted average rate at year end 5.38% 5.05% 3.25% Average balance during the year $ 49,227 $ 3,702 $ 721 Weighted average rate during the year 5.51% 5.10% 4.91% Maximum month-end balance $120,257 $ 6,696 $1,547 Other short-term borrowings: Balance at year end $ 4,082 $ 7,055 $ 755 Weighted average rate at year end 6.17% 5.57% 6.05% Average balance during the year $ 6,914 $ 3,660 $ 713 Weighted average rate during the year 6.04% 5.68% 6.17% Maximum month-end balance $ 9,396 $ 8,555 $ 755 Total short-term borrowings: Balance at year end $ 9,716 $12,654 $1,502 Weighted average rate at year end 5.71% 5.34% 4.88% Average balance during the year $ 56,141 $ 7,362 $1,434 Weighted average rate during the year 5.57% 5.39% 5.54% Maximum month-end balance $129,653 $ 15,251 $2,302 Substantially all federal funds purchased and repurchase agreements mature in one business day. Other short-term borrowings principally represent Federal Home Loan Bank (FHLB) advances to Georgetown Bank (with varying maturity dates), which are funding residential mortgage and commercial loans. INTEREST RATE SENSITIVITY The interest spread and liability funding discussed above are directly related to changes in asset and liability mixes, volumes, maturities and repricing opportunities of interest-earning assets and interest-bearing liabilities. Interest-sensitive assets and liabilities are those which are subject to being repriced in the near term, including both floating or adjustable rate instruments and instruments approaching maturity. The interest sensitivity gap is the difference between total interest-sensitive assets and total interest-sensitive liabilities. Interest rates on the Company's various asset and liability categories do not respond uniformly to changing market conditions. Interest rate risk is the degree to which interest rate fluctuations in the marketplace can affect net interest income. The need for interest sensitivity gap management is most critical in times of a significant change in overall interest rates. Management generally seeks to limit the exposure of the Company to interest rate fluctuations by maintaining a relatively balanced mix of rate sensitive assets and liabilities on a one-year time horizon. This mix is altered periodically depending upon management's assessment of current business conditions and the interest rate outlook. One tool which is used to monitor interest rate risk is the interest sensitivity analysis as shown in the table below. This analysis reflects the repricing characteristics of assets and liabilities over various time periods. The gap indicates the level of assets and liabilities that are subject to repricing over a given time period. As shown by the interest rate sensitivity analysis as of December 31, 1997, the cumulative amount of the Company's interest earning assets repricing during the first year is higher than the total amount of its interest bearing liabilities repricing during this period. This position, which is normally termed a positive interest sensitivity gap, generally allows for enhanced net interest income during periods of rising interest rates. This positive gap is within the Company's internal policy guidelines and is not expected to impact significantly the Company's net interest income during a period of declining interest rates. The following table provides an analysis of the Company's interest rate sensitivity at December 31, 1997. INTEREST RATE SENSITIVITY ANALYSIS (Dollars in Thousands) 0 - 90 91 DAYS - 1 - 5 OVER 5 DAYS 1 YEAR YEARS YEARS TOTAL Assets Loans, net of unearned income $ 73,646 $ 75,375 $ 75,742 $58,627 $283,390 Investment securities 10,393 19,852 22,732 16,234 69,211 Federal funds sold 40,771 0 0 0 40,771 -------- -------- -------- ------- -------- Total earning assets $124,810 $ 95,227 $ 98,474 $74,861 $393,372 Sources of Funds NOW, money market and savings $ 22,438 $ 22,713 $ 28,841 $ 1,291 $ 75,283 Time deposits 43,186 95,267 72,989 127 211,569 Other 9,716 0 11,086 95 20,897 -------- -------- -------- ------- -------- Total interest bearing liabilities $ 75,340 $117,980 $112,916 $ 1,513 $307,719 Interest Sensitivity Gap For the period $ 49,470 $(22,753) $(14,442) $73,348 $ 85,623 Cumulative 49,470 26,717 12,275 85,623 Cumulative as a percent of earning assets 12.58% 6.79% 3.12% 21.77% MARKET RISK MANAGEMENT Market risk is the risk of gain or loss from changes in the fair value of financial instruments due to changes in interest rates, exchange rates and equity prices. Premier's market risk is composed almost exclusively with interest rate risk. This exposure is managed primarily through the strategy of selecting the types and terms of interest earning assets and interest bearing liabilities which generate favorable earnings, while limiting the potential negative effects of changes in market interest rates. Since Premier's primary source of interest bearing liabilities is customer deposits, the ability to manage the types and terms of such deposits may be somewhat limited by customer preferences in the market areas in which it operates. Borrowings, which include Federal Home Loan Bank advances, short-term borrowings and long-term borrowings, are generally structured with specific terms which in management's judgment, when aggregated with the terms for outstanding deposits and matched with interest earning assets, mitigate our exposure to interest rate risk. The Company's Asset/Liability Committee (ALCO) is responsible for reviewing the interest rate sensitivity of the Company and establishing policies to monitor and limit exposure to interest rate risk. Interest rate risk is monitored through the use of three complementary measures: static gap analysis, earnings simulation modeling and net present value estimation. While each of the interest rate risk measurements has limitations, taken together they represent a reasonably comprehensive view of the magnitude of interest rate risk in the Company, the distribution of risk along the yield curve, the level of risk through time, and the amount of exposure to changes in certain interest rate relationships. STATIC GAP ANALYSIS Premier uses interest rate sensitivity gap analysis to monitor the relationship between the maturity and repricing of its interest earning assets and interest bearing liabilities, while maintaining an acceptable interest spread rate spread. Gap is defined as the difference between the amount of interest earnings assets maturing or repricing within a specific time period and the amount of interest bearing liabilities maturing or repricing within that time period. A gap is considered positive when the amount of interest rate sensitive assets exceeds the amount of interest rate sensitive liabilities, and is considered negative when the amount of interest rate sensitive liabilities exceeds the amount of interest rate sensitive assets. Generally, during a period of rising interest rates, a negative gap would adversely affect net interest income, while a positive gap would result in an increase in net interest income. Conversely, during a period of falling interest rates, a negative gap would result in an increase in net interest income, while a positive gap would negatively affect net interest income. It is management's goal to maintain a reasonable balance between exposure to interest rate fluctuations and earnings. EARNINGS SIMULATION MODELING The earnings simulation model forecasts net interest income under different scenarios that incorporate changes in the level of interest rates and their relationships with each other. The most recent earnings simulation model projects net interest income would decrease by approximately 3.5% of stable rate net interest income if rates fall by two percentage points over the next year. It projects an increase of 3.4% if the rates rise by two percentage points. Management believes this reflects a slight asset sensitive rate risk position for the one year horizon. Within the same time frame, but assuming an additional one percentage point move in rates, the model forecasts that net interest income would fall below that earned in a stable rate environment by 5.3% in a falling rate scenario and increase by 5.1% in a rising rate scenario. This simulation model includes assumptions about how the balance sheet is likely to evolve through time. Loan prepayments are developed from industry median estimates for prepayment speeds. Noncontractual deposit pricing and sensitivity are assumed to follow historical patterns. NET PRESENT VALUE The Net Present Value (NPV) of the balance sheet, at a point in time, is defined as the discounted present value of asset cash flows minus the discounted value of liability cash flows. The resulting percentage change in NPV is an indication of the longer term repricing risk imbedded in the balance sheet. At year end, a 200 basis point increase in rates is estimated to reduce NPV by 8.0%. Additionally, NPV is projected to decrease by 7.0% if rates fall by 200 basis points. The calculations of present value have certain shortcomings. The discount rates utilized are based on estimated market interest rate levels for similar loans and securities nationwide. The unique characteristics of Premier's loans and securities may not necessarily parallel those assumed in this calculation, and therefore, would likely result in different discount rates, prepayment experiences and present values. The discount rates utilized for deposits and borrowings are based upon available alternative types and sources of funds which are not necessarily indicative of the present value of deposits and FHLB advances since such deposits and advances are unique to, and have certain price and customer relationship advantages for, depository institutions. A higher or lower interest rate environment will most likely result in different investment and borrowing strategies by Premier designed to further mitigate the effect on the value of, and the net earnings generated from, the Company's net assets from any change in interest rates. Summary information about each of the three interest rate risk measures is presented below: Year-End Year-End ALCO 1997 1996 Guidelines Static 1-Year Cumulative Gap 6.8% 3.1% +10% - 1-Year Net Interest Income Simulation Project -200 bp change vs. Stable Rate -3.5 -4.4 +10% - +200 bp change vs. Stable Rate 3.4 4.4 +10% - 1-Year Net Interest Income Simulation Project -300 bp change vs. Stable Rate -5.3 -6.7 +10% - +300 bp change vs. Stable Rate 5.1 6.6 +10% - Static Net Present Value Change -200 bp Shock vs. Stable Rate -7.0 -1.7 +10% - +200 bp Shock vs. Stable Rate -8.0 3.0 +10% - INTEREST RATE RISK MANAGEMENT Premier's strategy of investing primarily in loans and securities permits it to limit its exposure to interest rate risk, together with credit risk, while at the same time achieving a positive interest rate spread from the difference between the income earned on interest earning assets and the cost of interest bearing liabilities. Managing this exposure involves significant assumptions about the relationship of various interest rate indices of certain financial instruments. Prepayments on loans generally increase when long-term interest rates fall or are at historically low levels relative to short-term interest rates making fixed rate loans more desirable. Investment securities, other than those with early call provisions, generally do not have significant imbedded options and repay pursuant to specific terms until maturity. While savings and checking deposits generally may be withdrawn upon the customer's request without prior notice, a continuing relationship with customers resulting in future deposits and withdrawals is generally predictable resulting in a dependable and uninterruptible source of funds. Time deposits generally have early withdrawal penalties which discourage customer withdrawal, while term Federal Home Loan Bank advances have prepayment penalties, which discourage prepayment prior to maturity. Certain shortcomings are inherent in the method of analysis presented in the foregoing table. For example, although certain assets and liabilities may have similar maturities or periods to repricing, they may react in different degrees to changes in market interest rates. Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market rates. Additionally, certain assets, such as adjustable rate mortgage loans, have features that restrict changes in interest rates on a short-term basis and over the life of the loan. Further, in the event of a change in interest rates, prepayment and early withdrawal levels could deviate significantly from those assumed in calculating the table. Finally, the ability of many borrowers to service their debt may decrease in the event of a significant interest rate increase. The previous table does not necessarily indicate the impact of general interest rate movements on Premier's net interest income because the repricing of certain categories of assets and liabilities are subject to competitive and other pressures beyond our control. As a result, certain assets and liabilities indicated as maturing or otherwise repricing within a stated period may in fact mature or reprice at different times and at different volumes. Management expects interest rates to be relatively stable during 1998 and believes that the current modest level of asset sensitivity is appropriate. TRADE RISK MANAGEMENT Premier does not maintain a trading account which would primarily provide investment products and risk management services to its customers as well as to take propriety risk positions. DERIVATIVE INSTRUMENTS A derivative financial instrument includes futures, forwards, interest rate swaps, options and other financial instruments with similar characteristics. Premier currently does not enter into futures, forwards, swaps or options. However, the Company is party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to make loans and standby letters of credit, which involve to varying degrees elements of credit risk and interest rate in excess of amounts recognized on the balance sheets. Commitments to make loans are agreements to lend to a customer as long as there is no violation of any contract condition. Commitments generally have fixed expiration dates and may require collateral if deemed necessary. Standby letters of credit are conditional commitments issued by Premier to guarantee the performance of a customer to a third party up to a stipulated amount and with specific terms and conditions. Commitments to make loans and standby letters of credit are not recorded as an asset or liability by the Company until the instrument is exercised. OTHER Year 2000 - Premier initiated the process of preparing its computer systems and applications for the year 2000 during 1997. This process involves assessing, then modifying or replacing certain hardware and software maintained by the Company as well as communicating with external service providers to ensure that they are taking the appropriate action to remedy their Year 2000 issues. Management intends to have substantially all of the system and application changes completed by the end of 1998 and anticipates the estimated cumulative costs of compliance will not be material to the Company's financial statements. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The Company's Financial Statements and related Independent Auditors' Report are presented in the following pages. The financial statements filed in this Item 8 are as follows: Independent Auditors' Report Financial Statements: Balance Sheets - December 31, 1997 and 1996 Statements of Income - Years Ended December 31, 1997, 1996 and 1995 Statements of Changes in Stockholders' Equity - Years ended December 31, 1997, 1996 and 1995 Statements of Cash Flows - Years ended December 31, 1997, 1996 and 1995 Notes to Financial Statements ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE There have been no changes in or disagreements with accountants on accounting or financial disclosure matters. PREMIER FINANCIAL BANCORP, INC. CONTENTS Pages INDEPENDENT AUDITORS' REPORT.............................................1 FINANCIAL STATEMENTS: Consolidated Balance Sheets............................................2 Consolidated Statements of Income......................................3 Consolidated Statements of Stockholders' Equity........................4 Consolidated Statements of Cash Flows..................................5 - 6 Notes to Consolidated Financial Statements.............................7 - 30 INDEPENDENT AUDITORS' REPORT Board of Directors Premier Financial Bancorp, Inc. Georgetown, Kentucky We have audited the accompanying consolidated balance sheets of Premier Financial Bancorp, Inc. as of December 31, 1997 and 1996, and the related consolidated statements of income, changes in stockholders' equity and cash flows for each of the three years in the period ended December 31, 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Premier Financial Bancorp, Inc. as of December 31, 1997 and 1996 and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1997 in conformity with generally accepted accounting principles. /s/ Eskew & Gresham, PSC February 3, 1998 PREMIER FINANCIAL BANCORP, INC. CONSOLIDATED BALANCE SHEETS December 31 1997 1996 ASSETS Cash and due from banks $ 11,609,886 $ 9,303,925 Federal funds sold 40,771,000 10,935,000 Investment securities: Available for sale 45,925,758 29,971,958 Held to maturity 20,361,807 20,993,089 Loans $285,798,438 $244,731,159 Unearned income (2,408,652) (2,106,364) Allowance for loan losses (3,144,142) (2,853,725) ------------ ------------ Net loans $280,245,644 $239,771,070 Federal Home Loan Bank and Federal Reserve stock 2,923,250 1,695,350 Premises and equipment, net 6,894,894 4,519,815 Real estate and other property acquired through foreclosure 836,201 485,003 Interest receivable 5,237,264 4,322,289 Income taxes refundable 70,974 22,319 Deferred income taxes 170,027 393,231 Goodwill and other intangibles 7,261,591 5,490,210 Other assets 3,127,721 1,162,461 ------------ ------------ TOTAL ASSETS $425,436,017 $329,065,720 LIABILITIES AND STOCKHOLDERS' EQUITY Deposits: Non-interest bearing $ 37,702,480 $ 32,464,664 Time deposits, $100,000 and over 47,105,404 40,150,498 Other interest bearing 239,746,157 194,592,712 ------------ ------------ Total deposits $324,554,041 $267,207,874 Securities sold under agreements to repurchase 5,634,132 5,599,420 Federal Home Loan Bank advances 15,263,339 9,377,456 Interest payable 1,657,599 1,394,550 Other liabilities 1,779,936 861,340 ------------ ------------ Total liabilities $348,889,047 $284,440,640 Mandatorily redeemable capital securities of subsidiary trust $ 28,750,000 $ 0 Stockholders' Equity: Preferred stock, no par value; 1,000,000 shares authorized; none issued or outstanding $ 0 $ 0 Common stock, no par value; 10,000,000 shares authorized; 4,685,390 shares issued and outstanding 982,308 982,308 Surplus 33,824,798 33,824,798 Retained earnings 13,054,826 9,935,858 Net unrealized losses on securities available for sale (64,962) (117,884) ------------ ------------ Total stockholders' equity $ 47,796,970 $ 44,625,080 TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $425,436,017 $329,065,720 See notes to consolidated financial statements. Page 2 PREMIER FINANCIAL BANCORP, INC. CONSOLIDATED BALANCE SHEETS Year Ended December 31 1997 1996 1995 INTEREST INCOME: Loans, including fees $26,324,299 $19,192,986 $11,809,666 Investment securities - Taxable 5,411,453 1,942,904 1,302,417 Tax-exempt 1,157,751 815,821 547,496 Federal funds sold 936,570 424,546 292,588 Other interest income 164,689 24,711 38,136 ----------- ----------- ----------- Total interest income $33,994,762 $22,400,968 $13,990,303 INTEREST EXPENSE: Deposits $12,731,585 $ 9,357,130 $ 5,933,460 Other borrowings 3,531,542 450,433 106,808 Debt 1,631,467 167,413 252,999 ----------- ----------- ---------- Total interest expense $17,894,594 $ 9,974,976 $ 6,293,267 Net interest income $16,100,168 $12,425,992 $ 7,697,036 Provision for loan losses 1,232,208 759,831 195,950 ----------- ----------- ----------- Net interest income after provision for loan losses $14,867,960 $11,666,161 $ 7,501,086 NON-INTEREST INCOME: Service charges $ 1,154,979 $ 1,001,179 $ 649,473 Insurance commissions 409,407 308,690 164,338 Investment securities gains (losses) 2,203,545 1,459 (6,026) Other 598,659 409,447 210,347 ----------- ----------- ---------- $ 4,366,590 $ 1,720,775 $ 1,018,132 NON-INTEREST EXPENSES: Salaries and employee benefits $ 5,586,124 $ 4,371,715 $ 3,043,367 Occupancy and equipment expenses 1,421,139 1,196,731 989,052 Professional fees 471,857 258,758 209,298 Taxes, other than payroll, property and income 387,255 288,132 209,901 Acquisition related expenses 467,035 0 110,296 Amortization of intangibles 386,134 197,357 2,553 Other expenses 2,302,157 1,762,416 1,378,317 ----------- ----------- ----------- $11,021,701 $ 8,075,109 $ 5,942,784 Income before income taxes $ 8,212,849 $ 5,311,827 $ 2,576,434 Provision for income taxes 2,604,939 1,588,610 145,732 ----------- ----------- ----------- NET INCOME $ 5,607,910 $ 3,723,217 $ 2,430,702 Earnings per share $ 1.20 $ .99 $ 1.02 Earnings per share assuming dilution $ 1.19 $ .99 $ 1.02 See notes to consolidated financial statements. Page 3 PREMIER FINANCIAL BANCORP, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 Net Unrealized Gain (Loss) on Securities Common Retained Available Stock Surplus Earnings For Sale Total Balances, January 1, 1995 $758,127 $ 6,857,637 $ 6,760,575 $ (470,286) $13,906,053 Issuance of 1,000 shares of Georgetown Bancorp, Inc. common stock 10,272 114,728 125,000 Net change in unrealized losses on securities available for sale 399,019 399,019 5-for-4 common stock split 190,909 (190,909) Net income 2,430,702 2,430,702 Dividends paid - Company ($.45 per share) (859,091) (859,091) Dividends paid - Sabina prior to pooling (137,500) (137,500) -------- ----------- ----------- ---------- ----------- Balances, December 31, 1995 $959,308 $ 6,781,456 $ 8,194,686 $ (71,267) $15,864,183 Issuance of 2,300,000 shares of Company common stock 23,000 27,043,342 27,066,342 Net change in unrealized losses on securities available for sale (46,617) (46,617) Net income 3,723,217 3,723,217 Dividends paid - Company ($.50 per share) (1,817,045) (1,817,045) Dividends paid - Sabina prior to pooling (165,000) (165,000) -------- ----------- ----------- ---------- ----------- Balances, December 31, 1996 $982,308 $33,824,798 $ 9,935,858 $ (117,884) $44,625,080 Net change in unrealized losses on securities available for sale 52,922 52,922 Net income 5,607,910 5,607,910 Dividends paid - Company ($.55 per share) (2,406,442) (2,406,442) Dividends paid - Sabina prior to pooling (82,500) (82,500) -------- ----------- ----------- ---------- ----------- BALANCES, DECEMBER 31, 1997 $982,308 $33,824,798 $13,054,826 $ (64,962) $47,796,970 See notes to consolidated financial statements. Page 4 PREMIER FINANCIAL BANCORP, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS Year Ended December 31 1997 1996 1995 CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 5,607,910 $ 3,723,217 $ 2,430,702 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation 485,602 321,173 273,772 Amortization, net 373,180 363,043 181,927 Provision for loan losses 1,232,208 759,831 195,950 Deferred income taxes 256,664 (10,929) (248,964) FHLB stock dividends (155,000) (46,000) (4,800) Investment securities losses (gains), net (2,203,545) (1,459) 6,026 Changes in: Interest receivable (914,975) (385,317) (102,508) Other assets (2,015,799) 658,194 (376,229) Interest payable 263,049 (200,003) 330,117 Other liabilities 918,596 390,745 50,854 Income taxes refundable (48,655) 221,530 (281,667) ------------- ------------ ------------ Net cash provided by operating activities $ 3,799,235 $ 5,794,025 $ 2,455,180 CASH FLOWS FROM INVESTING ACTIVITIES: Proceeds from maturity of deposits held in other banks $ 0 $ 0 $ 523,609 Purchases of securities available for sale (307,051,391) (15,463,076) (15,679,289) Proceeds from sales of securities available for sale 277,135,191 2,499,125 7,553,462 Proceeds from maturities and calls of securities available for sale 16,169,544 13,388,575 9,050,000 Purchases of investment securities held to maturity (4,254,989) (2,741,799) (1,673,728) Proceeds from maturities and calls of securities held to maturity 4,878,764 2,241,255 1,212,544 Proceeds from sales of investment securities held to maturity 0 0 1,000,000 Purchases of FHLB stock (1,072,900) (753,300) (315,800) Net change in federal funds sold (29,836,000) (2,145,000) (1,495,000) Proceeds from sale of real estate acquired through foreclosure 290,925 131,701 340,812 Net change in loans (42,348,905) (23,239,040) (16,345,596) Purchases of premises and equipment (2,256,831) (1,062,587) (1,376,591) Proceeds from sale of premises and equipment 31,575 20,085 437,132 Net cash received (paid) related to acquisitions 20,613,412 (10,576,808) (999,742) ------------- ------------ ------------ Net cash used in investing activities $ (67,701,605) $(37,700,869) $(17,768,187) See notes to consolidated financial statements. Page 5 PREMIER FINANCIAL BANCORP, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED) Year Ended December 31 1997 1996 1995 CASH FLOWS FROM FINANCING ACTIVITIES: Net change in deposits $ 34,026,678 $12,246,554 $13,283,731 Advances from Federal Home Loan Bank 17,727,000 6,800,000 0 Repayment of Federal Home Loan Bank advances (11,841,117) (2,067,206) 0 Debt proceeds 0 0 3,500,000 Repayment of debt 0 (6,850,000) 0 Net change in agreements to repurchase securities 34,712 (1,797,697) (52,882) Proceeds from issuance of capital securities of subsidiary trust 28,750,000 0 0 Proceeds from issuance of common stock 0 27,066,342 125,000 Dividends paid (2,488,942) (1,982,045) (996,591) ------------ ----------- ----------- Net cash provided by financing activities $ 66,208,331 $33,415,948 $15,859,258 Net increase in cash and cash equivalents $ 2,305,961 $ 1,509,104 $ 546,251 Cash and cash equivalents at beginning of year 9,303,925 7,794,821 7,248,570 ------------ ----------- ----------- CASH AND CASH EQUIVALENTS AT END OF YEAR $ 11,609,886 $ 9,303,925 $ 7,794,821 SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid during the year for - Interest $ 17,631,545 $10,174,979 $ 5,963,150 Income taxes 2,462,000 1,062,063 719,974 SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING ACTIVITIES: Non-cash transfer from securities held to maturity to securities available for sale $ 0 $ 0 $ 500,000 Change in unrealized loss on securities available for sale 52,922 (46,617) 399,019 Loans transferred to real estate acquired through foreclosure 730,371 80,849 16,000 See notes to consolidated financial statements. Page 6 PREMIER FINANCIAL BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES A. Basis of Presentation - The consolidated financial statements include the accounts of Premier Financial Bancorp, Inc. (the Company) and its wholly-owned subsidiaries, Georgetown Bank & Trust Co., Georgetown, Kentucky; Citizens Deposit Bank & Trust, Vanceburg, Kentucky; Bank of Germantown, Germantown, Kentucky; Citizens Bank, Sharpsburg, Kentucky; Farmers Deposit Bank, Eminence, Kentucky; and The Sabina Bank, Sabina, Ohio (the Banks). In addition, the Company has a data processing service subsidiary, Premier Data Services, Inc., Vanceburg, Kentucky. All material intercompany transactions and balances have been eliminated. Prior period consolidated financial statements have been restated to include the accounts of significant acquisitions accounted for using the pooling of interests method of accounting. Business combinations accounted for as purchases are included in the consolidated financial statements from the respective dates of acquisition. Assets and liabilities of financial institutions accounted for as purchases are adjusted to their fair values as of their dates of acquisition. Certain 1995 and 1996 amounts have been reclassified to conform with the 1997 financial reporting presentation. B. Nature of Operations - The Banks operate under state bank charters and provide full banking services, including trust services. As state banks, the Banks are subject to regulation by their respective state banking regulators and the Federal Deposit Insurance Corporation (FDIC). The Company is also subject to regulation by the Federal Reserve Bank. C. Estimates in the Financial Statements - The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. D. Cash and Cash Equivalents - For purposes of reporting cash flows, cash and cash equivalents include cash on hand and amounts due from banks. E. Investment Securities - The Company classifies its investment securities portfolio into three categories: trading, securities available for sale and securities held to maturity. Fair value adjustments are made to the securities based on their classification with the exception of the held to maturity category. The Company has no investments classified as trading. Investment securities available for sale are carried at fair value. Adjustments from amortized cost to fair value are recorded in stockholders' equity, net of related income tax, under net unrealized gains (losses) on securities available for sale. The adjustment is computed on the difference between fair value and cost adjusted for amortization of premiums and accretion of discounts which are recorded as adjustments to interest income using the constant yield method. Page 7 PREMIER FINANCIAL BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 (CONTINUED) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Investment securities for which the Banks have the positive intent and ability to hold to maturity are stated at cost, adjusted for amortization of premiums and accretion of discounts which, are recorded as adjustments to interest income using the constant yield method. Gains or losses on dispositions are based on the net proceeds and adjusted carrying amount of the securities sold using the specific identification method. F. Loans - Loans are stated at the amount of unpaid principal, reduced by unearned income and an allowance for loan losses. Interest income on loans is recognized on the accrual basis except for those loans in a nonaccrual of income status. The accrual of interest on impaired loans is discontinued when management believes, after consideration of economic and business conditions and collection efforts, that the borrowers' financial condition is such that collection of interest is doubtful. When interest accrual is discontinued, interest income is subsequently recognized only to the extent cash payments are received. The allowance for loan losses is established through a provision for loan losses charged to expense. The allowance is an amount that management believes will be adequate to absorb losses on existing loans that may become uncollectible based on evaluations of the collectibility of loans and prior loan loss experience. The evaluations take into consideration such factors as changes in the nature and volume of the loan portfolio, overall portfolio quality, review of specific problem loans, and current economic conditions that may affect the borrowers' ability to pay. Loans are charged against the allowance for loan losses when management believes that the collection of principal is unlikely. The allowance for loan losses on impaired loans is determined using the present value of estimated future cash flows of the loan, discounted at the loan's effective interest rate or the fair value of the underlying collateral. A loan is considered to be impaired when it is probable that all principal and interest amounts will not be collected according to the loan contract. The entire change in present value of expected cash flows is reported as provision for loan losses in the same manner in which impairment initially was recognized or as a reduction in the amount of provision for loan losses that otherwise would be reported. Certain loan origination fees and direct origination costs are capitalized and recognized as an adjustment of the yield on the related loan. G. Premises and Equipment - Premises and equipment are stated at cost less accumulated depreciation. Depreciation is recorded principally by the straight-line method over the estimated useful lives of the premises and equipment. Page 8 PREMIER FINANCIAL BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 (CONTINUED) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) H. Real Estate Acquired Through Foreclosure - Real estate acquired through foreclosure is carried at the lower of the recorded investment in the property or its fair value. The value of the underlying loan is written down to the fair value of the real estate to be acquired by a charge to the allowance for loan losses, if necessary. Any subsequent write-downs are charged to operating expenses. Certain parcels of real estate are being leased to third parties to offset holding period costs. Operating expenses of such properties, net of related income, and gains and losses on their disposition are included in other expenses. I. Goodwill and Other Intangibles - The unamortized costs in excess of the fair value of acquired net tangible assets are included in goodwill and other intangibles. Identifiable intangibles, except for premiums on purchased deposits which are amortized on a straight-line method over 10 years, are amortized over the estimated periods benefited. The remaining costs (goodwill) are amortized on a straight-line basis over 15 years. J. Income Taxes - The Company uses the liability method for computing deferred income taxes. Under the liability method, deferred income taxes are based on the change during the year in the deferred tax liability or asset established for the expected future tax consequences of differences in the financial reporting and tax bases of assets and liabilities. The differences relate principally to premises and equipment, unrealized gains and losses on investment securities available for sale, net operating loss carryforwards, changes in tax methods of accounting, FHLB stock, and the allowance for loan losses. K. Per Share Information - In the fourth quarter of 1997, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 128, "Earnings Per Share", under which basic and diluted earnings per share are computed. Prior amounts have been restated to be comparable. Basic earnings per share is based on net income divided by the weighted average number of shares outstanding during the period. Diluted earnings per share shows the dilutive effect of additional common shares issuable under stock options. L. Effect of New Accounting Standards - The Financial Accounting Standards Board has issued SFAS No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities", which provides accounting and reporting guidance regarding various financial instruments and related transactions. The Statement was effective for transactions occurring after December 31, 1996 and was adopted by the Company, as required, on January 1, 1997. The effect of adopting the new guidance was not material to the Company's consolidated financial statements. Page 9 PREMIER FINANCIAL BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 (CONTINUED) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) In June 1997, the Financial Accounting Standards Board issued SFAS No. 130, "Reporting Comprehensive Income". The Statement establishes standards for reporting the components of comprehensive income and requires that all items that are required to be recognized under accounting standards as components of comprehensive income be included in a financial statement that is displayed with the same prominence as other financial statements. Comprehensive income includes net income as well as certain items that are reported directly within a separate component of stockholders' equity and bypass net income. The provisions of this Statement are effective beginning with 1998 interim reporting. These disclosure requirements will have no impact on financial position or results of operations. M. Marketing Expense - The Company charges all marketing expenses to operations when incurred. No amounts have been established for any future benefits relative to these expenditures. 2. BUSINESS COMBINATIONS CONSUMMATED ACQUISITIONS On November 13, 1997, the Company acquired The Sabina Bank, Sabina, Ohio (Sabina), in a business combination accounted for as a pooling of interests. All of the outstanding shares of Sabina were exchanged for 476,300 shares of the Company's common stock. The accompanying consolidated financial statements for 1997 are based on the assumption that the companies were combined for the full year, and financial statements of prior years have been restated to give the effect of the combination. Summarized results of operations of the separate companies for the period January 1, 1997 through the date of acquisition are as follows: Premier Financial The Sabina Bancorp, Inc. Bank (in thousands) Net interest income after provision for loan losses $ 11,205 $ 1,321 Other operating income 3,804 208 Other operating expenses 8,446 1,270 Net income $ 4,507 $ 215 Page 10 PREMIER FINANCIAL BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 (CONTINUED) 2. BUSINESS COMBINATIONS (CONTINUED) Following is a reconciliation of interest income, non-interest income and net income previously reported with restated amounts: Year Ended December 31 1996 1995 (in thousands) Interest income: As previously reported $ 19,674 $11,103 Acquired subsidiary 2,727 2,887 -------- ------- As restated $ 22,401 $13,990 Non-interest income: As previously reported $ 1,484 $ 825 Acquired subsidiary 237 193 -------- ------- As restated $ 1,721 $ 1,018 Net income: As previously reported $ 3,436 $ 2,156 Acquired subsidiary 287 275 -------- ------- As restated $ 3,723 $ 2,431 On December 11, 1997, Sabina completed its purchase and assumption of two branch offices of the Fifth Third Bank of Western, Ohio. Included in the purchase was approximately $23.3 million of deposits from the Ada and Waynesfield, Ohio branches. A premium of approximately $2.1 million was paid for the purchase of these deposits. On July 1, 1996, the Company acquired all of the outstanding shares of Farmers Deposit Bancorp, Eminence, Kentucky (Farmers Deposit), a one-bank holding company owning all of the shares of Farmers Deposit Bank, for cash. The total acquisition cost was $12,588,000, which exceeded the fair value of tangible net assets acquired by approximately $5,400,000. The combination was accounted for as a purchase and the results of operations of Farmers Deposit are included in the consolidated financial statements from July 1, 1996. The major categories of assets acquired and liabilities assumed from Farmers Deposit as of the acquisition date are as follows: (in thousands) Cash and due from banks $ 2,011 Investment securities 19,263 Net loans 81,988 Intangibles and other assets 9,035 Deposits 86,791 Other borrowings 10,540 Debt 1,850 Other liabilities 528 -------- Total acquisition cost $ 12,588 Page 11 PREMIER FINANCIAL BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 (CONTINUED) 2. BUSINESS COMBINATIONS (CONTINUED) On October 31, 1995, the Company acquired all of the outstanding shares of Citizens Bank of Sharpsburg, Kentucky, for cash. The total acquisition cost was $1,496,387, which exceeded the fair value of tangible net assets acquired by approximately $248,000. This combination was accounted for as a purchase and the results of operations of Citizens Bank are included in the consolidated financial statements from November 1, 1995. The major categories of assets acquired and liabilities assumed from Citizens Bank as of the acquisition date are as follows: (in thousands) Cash and due from banks $ 497 Investment securities 3,976 Net loans 14,316 Intangibles and other assets 1,365 Deposits 18,273 Other liabilities 385 ------- Total acquisition cost $ 1,496 On March 24, 1995, the Company acquired Georgetown Bancorp, Inc. and its wholly-owned subsidiary, Georgetown Bank & Trust, Georgetown, Kentucky, in a business combination accounted for as a pooling of interests. All of the outstanding shares of Georgetown Bancorp were exchanged for 409,090 shares, as adjusted for subsequent stock splits, of the Company's common stock. The accompanying consolidated financial statements for 1995 are based on the assumption that the companies were combined for the full year. PENDING ACQUISITIONS On October 31, 1997, the Company entered into an Agreement and Plan of Merger with Ohio River Bank (Ohio River), Ironton, Ohio, whereby the Company will exchange 300,000 common shares for all the issued and outstanding shares of Ohio River in a business combination anticipated to be accounted for as a pooling of interests. At December 31, 1997, Ohio River had total assets of $39.5 million and total stockholders' equity of $4.3 million. The share exchange is expected to be completed in the first quarter of 1998. On December 30, 1997, the Company entered into a purchase and assumption agreement to acquire three branch offices of Banc One Corporation located in Madison, Philippi and Van, West Virginia. Included in the purchase is approximately $148 million in deposits, $10 million in loans and $1.2 million in facilities. The net premium to be paid for these branches is approximately $14.3 million. The acquisition is expected to be completed in the second quarter of 1998. Page 12 PREMIER FINANCIAL BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 (CONTINUED) 3. RESTRICTIONS ON CASH AND DUE FROM BANKS Included in cash and due from banks are certain non-interest bearing deposits that are held at the Federal Reserve or maintained in vault cash in accordance with average balance requirements specified by the Federal Reserve Board of Governors. The average balance requirement was $725,000 and $999,000 at December 31, 1997 and 1996, respectively. 4. INVESTMENT SECURITIES Amortized cost and fair value of investment securities, by category, at December 31, 1997 are as follows: Amortized Unrealized Unrealized Fair Cost Gains Losses Value Available for sale: U. S. Treasury securities $ 10,070,978 $ 2,837 $ (11,486) $ 10,062,329 U. S. agency securities 25,965,520 29,205 (90,335) 25,904,390 Obligations of states and political subdivisions 3,457,927 109,529 (3,602) 3,563,854 Asset-backed securities 3,629,753 0 (29,225) 3,600,528 Preferred stock 2,000,000 0 0 2,000,000 Other securities 900,007 0 (105,350) 794,657 ------------ --------- --------- ------------ Total available for sale $ 46,024,185 $ 141,571 $(239,998) $ 45,925,758 Held to maturity: U. S. Treasury securities $ 1,249,985 $ 5,896 $ (849) $ 1,255,032 U. S. agency securities 4,337,802 15,928 (5,422) 4,348,308 Obligations of states and political subdivisions 14,625,016 499,959 (15,435) 15,109,540 Asset-backed securities 149,004 905 (420) 149,489 ------------ --------- --------- ------------ Total held to maturity $ 20,361,807 $ 522,688 $ (22,126) $ 20,862,369 Amortized cost and fair value of investment securities, by category, at December 31, 1996 are as follows: Amortized Unrealized Unrealized Fair Cost Gains Losses Value Available for sale: U. S. Treasury securities $ 5,991,476 $ 4,691 $ (8,566) $ 5,987,601 U. S. agency securities 16,880,922 40,445 (190,296) 16,731,071 Obligations of states and political subdivisions 4,330,371 136,779 (2,165) 4,464,985 Preferred stock 2,000,000 0 0 2,000,000 Other securities 900,007 0 (111,706) 788,301 ------------ --------- --------- ------------ Total available for sale $ 30,102,776 $ 181,915 $(312,733) $ 29,971,958 Page 13 PREMIER FINANCIAL BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 (CONTINUED) 4. INVESTMENT SECURITIES (CONTINUED) Amortized Unrealized Unrealized Fair Cost Gains Losses Value Held to maturity: U. S. Treasury securities $ 2,058,469 $ 5,787 $ (9,366) $ 2,054,890 U. S. agency securities 6,328,804 18,482 (26,209) 6,321,077 Obligations of states and political subdivisions 12,190,012 249,553 (59,327) 12,380,238 Asset-backed securities 415,804 3,933 (4,045) 415,692 ------------ --------- --------- ------------ Total held to maturity $ 20,993,089 $ 277,755 $ (98,947) $ 21,171,897 The amortized cost and fair value of investment securities at December 31, 1997, by category and contractual maturity are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Amortized Fair Cost Value Available for sale: Due in one year or less $ 21,336,870 $ 21,283,274 Due after one year through five years 11,447,265 11,475,189 Due after five years through ten years 4,971,058 5,015,370 Due after ten years 1,739,232 1,756,740 Other securities 6,529,760 6,395,185 ------------ ------------ Total available for sale $ 46,024,185 $ 45,925,758 Held to maturity: Due in one year or less $ 3,032,278 $ 3,038,537 Due after one year through five years 8,307,082 8,449,812 Due after five years through ten years 5,957,470 6,184,088 Due after ten years 2,915,973 3,040,443 Asset-backed securities 149,004 149,489 ------------ ------------ Total held to maturity $ 20,361,807 $ 20,862,369 Proceeds from sales of investment securities during 1997, 1996 and 1995 were $277,135,191, $2,499,125 and $8,553,462, respectively. Gross gains of $2,193,933, $70 and $25,650 and gross losses of $938, $611 and $31,676, respectively, were realized on those sales. Proceeds from maturities and calls of investment securities during 1997, 1996 and 1995 were $21,048,308, $15,629,830 and $10,262,544, respectively. Gross gains of $10,550, $2,000 and $0 were realized on those calls and maturities during 1997, 1996 and 1995, respectively. No losses were realized on calls and maturities during 1997, 1996 and 1995. Page 14 PREMIER FINANCIAL BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 (CONTINUED) 4. INVESTMENT SECURITIES (CONTINUED) Investment securities with an approximate carrying value of $29,616,908 and $28,136,619 at December 31, 1997 and 1996, respectively, were pledged to secure public deposits, trust funds, securities sold under agreements to repurchase and for other purposes as required or permitted by law. 5. LOANS Major classifications of loans are summarized as follows: December 31 1997 1996 (in thousands) Commercial, secured by real estate $ 66,893 $ 60,018 Commercial, other 45,024 35,393 Real estate construction 7,857 4,138 Real estate mortgage 93,789 87,335 Agricultural 13,208 11,731 Consumer and home equity 58,523 44,753 Other 504 1,363 --------- --------- $ 285,798 $ 244,731 Certain directors and executive officers of the Banks and companies in which they have beneficial ownership, were loan customers of the Banks during 1997 and 1996. Total loans to these persons at December 31, 1997 and 1996 amounted to $4,409,332 and $4,511,218, respectively. Such loans were made in the ordinary course of business at the Banks' normal credit terms and interest rates. An analysis of the 1997 activity with respect to all director and executive officer loans is as follows: Balance, December 31, 1996 $ 4,511,218 Additions, including loans now meeting disclosure requirements 1,880,220 Amounts collected, including loans no longer meeting disclosure requirements (1,982,106) ---------- Balance, December 31, 1997 $ 4,409,332 Changes in the allowance for loan losses were as follows: 1997 1996 1995 Balance, beginning of year $ 2,853,725 $ 1,997,042 $ 1,171,704 Allowance related to acquired subsidiaries 0 812,000 803,177 Loans charged off (1,184,093) (938,019) (272,393) Recoveries 242,302 222,871 98,604 Provision for loan losses 1,232,208 759,831 195,950 ----------- ----------- ----------- Balance, end of year $ 3,144,142 $ 2,853,725 $ 1,997,042 Page 15 PREMIER FINANCIAL BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 (CONTINUED) 5. LOANS (CONTINUED) The Company's recorded investment in impaired loans was approximately $1,049,308 and $910,305 at December 31, 1997 and 1996, respectively, as measured using the value of the underlying collateral. Of those amounts, $1,049,308 and $617,799 represent loans for which an allowance for loan losses, in the amount of $149,486 and $274,409, respectively, has been established. The average recorded investment of impaired loans was approximately $1,261,561 and $712,500 for the years ended December 31, 1997 and 1996, respectively. Interest income recognized on impaired loans totaled approximately $60,660 and $2,000 for the years ended December 31, 1997 and 1996, respectively, which represented actual cash payments received on impaired loans. 6. PREMISES AND EQUIPMENT Premises and equipment are summarized as follows: December 31 1997 1996 Land $ 1,221,962 $ 1,190,628 Buildings and leasehold improvements 4,667,550 3,193,754 Furniture and equipment 5,175,463 3,832,485 ------------ ------------ $ 11,064,975 $ 8,216,867 Less: accumulated depreciation (4,170,081) (3,697,052) ------------ ------------ $ 6,894,894 $ 4,519,815 Depreciation expense was $485,602, $321,173 and $273,772 in 1997, 1996 and 1995, respectively. 7. DEPOSITS At December 31, 1997, the scheduled maturities of time deposits are as follows: 1998 $ 138,452,753 1999 53,510,697 2000 12,240,618 2001 5,524,855 2002 and thereafter 1,839,200 ------------- $ 211,568,123 Certain directors and executive officers of the Banks and companies in which they have beneficial ownership are deposit customers of the Banks. The amount of these deposits was approximately $6,174,000 and $7,902,000 at December 31, 1997 and 1996, respectively. Page 16 PREMIER FINANCIAL BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 (CONTINUED) 8. SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE Securities sold under agreements to repurchase generally mature within one to ninety days from the transaction date. Information concerning securities sold under agreements to repurchase is summarized as follows: December 31 1997 1996 Year-end balance $ 5,634,132 $ 5,599,420 Average balance during the year 49,226,593 5,599,420 Average interest rate during the year 5.51% 5.14% Maximum month-end balance during the year $ 5,955,482 $ 6,495,743 U. S. Treasury and agency securities underlying the agreements are as follows: December 31 1997 1996 Carrying value $ 6,385,288 $ 6,221,104 Estimated fair value $ 6,397,694 $ 6,216,000 9. FEDERAL HOME LOAN BANK ADVANCES The Banks own stock of the Federal Home Loan Bank (FHLB) of Cincinnati, Ohio. This stock allows the Banks to borrow advances from the FHLB which the Banks use to fund loans. At December 31, 1997 and 1996, $15,263,339 and $9,377,456, respectively, represented the balance due on the above advances from the FHLB. All advances are paid either on a monthly basis or at maturity, over remaining terms of one to nineteen years, with interest rates ranging from 5.55% to 7.95%. Advances are secured by the FHLB stock and all single family first mortgage loans of the participating Banks. Scheduled principal payments due on advances during the five years subsequent to December 31, 1997 are as follows: 1998 -$10,568,765; 1999 - $2,575,264; 2000 - $529,331; 2001 - $564,048; 2002 and years thereafter - $1,025,931. 10. CAPITAL SECURITIES OF SUBSIDIARY TRUST Mandatorily Redeemable Capital Securities of Subsidiary Trust (Capital Securities) represent preferred beneficial interests in the assets of PFBI Capital Trust (Trust). The Trust holds certain 9.75% junior subordinated debentures due June 30, 2027 issued by the Company on June 9, 1997. Distributions on the Capital Securities will be payable at an annual rate of 9.75% of the stated liquidation amount of $25 per Capital Security, payable quarterly. Cash distributions on the Capital Securities are made to the extent interest on the debentures is received by the Trust. In the event of certain changes or amendments to regulatory requirements or federal tax rules, the Capital Securities are redeemable in whole. Otherwise, the Capital Securities are generally redeemable in whole or in part on or after June 30, 2002 at 100% of the liquidation amount. Page 17 PREMIER FINANCIAL BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 (CONTINUED) 11. LINE OF CREDIT In February 1997, the Company received approval for a two year, $20 million revolving line of credit from a financial institution. The line of credit is available for general corporate purposes, including acquisitions. The credit agreement contains certain covenants and performance terms. The common stock of the Banks is pledged to secure the revolving line of credit. As of December 31, 1997, there have been no borrowings under this line of credit. 12. INCOME TAXES The components of the provision for income taxes are as follows: 1997 1996 1995 Current $ 2,348,275 $ 1,599,539 $ 394,696 Deferred 256,664 (10,929) 255,211 Change in valuation allowance 0 0 (504,175) ----------- ----------- --------- $ 2,604,939 $ 1,588,610 $ 145,732 The Company's deferred tax assets and liabilities at December 31, 1997 and 1996 are shown below. No valuation allowance for the realization of deferred tax assets is considered necessary. 1997 1996 Deferred tax assets: Allowance for loan losses $ 419,567 $ 423,871 NOL carryforwards 198,573 330,426 Unrealized loss on investment securities 33,466 13,382 Other 39,900 33,093 ---------- ---------- Total deferred tax assets $ 691,506 $ 800,772 Deferred tax liabilities: Depreciation $ (285,374) $ (197,755) Change in accounting method (77,276) (93,874) Federal Home Loan Bank dividends (103,764) (45,520) Other (55,065) (70,392) ---------- ---------- Total deferred tax liabilities $ 521,479 $ (407,541) Net deferred tax asset $ 170,027 $ 393,231 At December 31, 1997, two of the subsidiary Banks had net operating loss carryforwards totaling approximately $584,000, which begin expiring in 2005. The utilization of these net operating loss carryforwards is subject to limitations imposed by Section 382 of the Internal Revenue Code. Page 18 PREMIER FINANCIAL BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 (CONTINUED) 12. INCOME TAXES (CONTINUED) An analysis of the differences between the effective tax rates and the statutory U.S. federal income tax rate is as follows: 1997 1996 1995 (in thousands) U. S. federal income tax rate $ 2,792 34.0% $ 1,806 34.0% $ 876 34.0% Changes from the statutory rate: Tax-exempt investment income (408) (5.0) (295) (5.6) (194) (7.5) Non-deductible interest expense related to carrying tax-exempt investments 50 0.6 34 0.6 21 0.8 Tax credits (70) (0.8) (70) (1.3) (69) (2.7) Change in valuation allowance 0 0.0 0 0.0 (504) (19.5) Goodwill amortization 131 1.6 67 1.3 1 0.0 Other 110 1.3 47 0.9 15 0.6 ------- ---- ------- ---- ----- ---- $ 2,605 31.7% $ 1,589 29.9% $ 146 5.7% Income taxes (benefits) applicable to investment securities gains (losses) were $749,205, $496 and $(2,049) for 1997, 1996 and 1995, respectively. 13. OPERATING LEASE COMMITMENTS The Company has entered into lease agreements for certain premises and equipment. Future minimum lease payments under the leases during the five years subsequent to December 31, 1997 are as follows: 1998 $ 157,602 1999 155,721 2000 151,456 2001 12,856 2002 and thereafter 10,178 Total rental expense incurred amounted to approximately $199,000, $156,000 and $19,000 in 1997, 1996 and 1995, respectively. Page 19 PREMIER FINANCIAL BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 (CONTINUED) 14. EMPLOYEE BENEFIT PLANS The Company has qualified profit sharing plans which cover substantially all employees. Profit sharing contributions are at the discretion of the Company's Board of Directors. Profit sharing contributions were $176,347, $202,500 and $132,744 in 1997, 1996 and 1995, respectively. The Company also maintains the Premier Financial Bancorp, Inc. 1996 Employee Stock Ownership Incentive Plan (the Plan), whereby certain employees of the Company are eligible to receive incentive stock options. The Plan is accounted for in accordance with Accounting Principles Board Opinion (APB) No. 25, "Accounting for Stock Issued to Employees", and related interpretations. Under the Plan, a maximum of 100,000 shares of the Company's common stock may be issued through the exercise of these incentive stock options. The option price is the fair market value of the Company's shares at the date of the grant. The options are exercisable ten years from the date of grant. At December 31, 1997, the Company had granted options to certain key employees to purchase 40,000 shares at an option price of $13.00 per share, of which 28,000 are currently eligible for exercise. Options outstanding at December 31, 1997, have a remaining contractual life of 8.5 years. Although the Company has elected to follow APB No. 25, SFAS No. 123, "Accounting for Stock Based Compensation" requires pro forma disclosure of net income and earnings per share as if the Company had accounted for its employee stock options under that Statement. The fair value of each option grant was estimated on the grant date using an option-pricing model. Under SFAS No. 123, compensation cost is recognized in the amount of the estimated fair value of the options and amortized to expense over the options' vesting period. The pro forma effect on 1997 and 1996 net income and earnings per share of this statement are as follows: 1997 1996 (in thousands) Net income As reported $ 5,608 $ 3,723 Pro forma $ 5,555 $ 3,698 Earnings per share As reported $ 1.20 $ 0.99 Pro forma $ 1.19 $ 0.98 Earnings per share assuming dilution As reported $ 1.19 $ 0.99 Pro forma $ 1.18 $ 0.98 Page 20 PREMIER FINANCIAL BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 (CONTINUED) 14. EMPLOYEE BENEFIT PLANS (CONTINUED) 1997 1996 (in thousands) Weighted averages Fair value of options granted $ 5.77 $ 2.70 Risk free interest rate 6.00% 6.50% Expected life 10 years 10 years Expected volatility 38.02% 13.97% Expected dividend $ 0.60 $ .50 15. RELATED PARTY TRANSACTIONS During the years ended December 31, 1997, 1996 and 1995, the Company paid approximately $211,000, $241,000 and $65,000, respectively, for printing and supplies from a company affiliated by common ownership. The Company also paid this affiliate approximately $339,000, $317,000 and $223,000 in 1997, 1996 and 1995, respectively, to permit the Company's employees to participate in its employee medical benefit plan. The Company has purchased and currently holds noncumulative perpetual preferred stock with a carrying value of $2,000,000 in a bank in Louisiana controlled by the Company's largest stockholder. The dividend rate on the preferred stock is 2% over the prevailing prime rate. 16. DIVIDEND LIMITATIONS The Company's principal source of funds for dividend payments is dividends received from the subsidiary Banks. Banking regulations limit the amount of dividends that may be paid without prior approval of regulatory agencies. Under these regulations, the amount of dividends that may be paid in any calendar year is limited to the current year's net profits, as defined, combined with the retained net profits of the preceding two years, subject to the capital requirements as defined below. During 1998, the Banks could, without prior approval, declare dividends of approximately $7,656,000 plus any 1998 net profits retained to the date of the dividend declaration. 17. EARNINGS PER SHARE A reconciliation of the numerators and denominators of the earnings per common share and earnings per common share assuming dilution computations for 1997, 1996 and 1995 is presented below: Year Ended 1997 1996 1995 Earnings Per Share Net income available to common stockholders $ 5,607,910 $ 3,723,217 $ 2,430,702 Weighted average common shares outstanding 4,685,390 3,763,805 2,379,560 Earnings per share $ 1.20 $ .99 $ 1.02 Page 21 PREMIER FINANCIAL BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 (CONTINUED) 17. EARNINGS PER SHARE (CONTINUED) Year Ended 1997 1996 1995 Earnings Per Share Assuming Dilution Net income available to common stockholders $ 5,607,910 $ 3,723,217 $ 2,430,702 Weighted average common shares outstanding 4,685,390 3,763,805 2,379,560 Add dilutive effects of assumed exercise of stock options 13,074 214 0 ----------- ----------- ----------- Weighted average common and dilutive potential common shares outstanding 4,698,464 3,764,019 2,379,560 Earnings per share assuming dilution $ 1.19 $ .99 $ 1.02 18. STOCKHOLDERS' EQUITY On May 22, 1996, the Company completed its initial public offering by selling 2,000,000 common shares at an offering price of $13.00 per share and on June 19, 1996, the Company completed the sale of an additional 300,000 common shares (which represented the Underwriters' over-allotment option) at a price of $13.00 per share. Total proceeds to the Company, net of the underwriting discount and issuance costs, were $27,066,342. On March 15, 1996, the stockholders approved a 2-for-1 stock split effective March 29, 1996, in the form of a dividend of the Company's common stock to stockholders of record on February 22, 1996. Additionally, the stockholders approved an increase in the number of common shares authorized from 1,800,000 to 10,000,000, approved a change in the par value of the common shares from $1 to no par value and approved the authorization of 1,000,000 preferred shares, without par value. On September 12, 1995, the Board of Directors approved a 5-for-4 stock split effective September 30, 1995, in the form of a dividend of the Company's common stock to stockholders of record on September 15, 1995. All references in the accompanying financial statements to the number of average shares and per share data have been restated to reflect the stock splits. Page 22 PREMIER FINANCIAL BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 (CONTINUED) 19. DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value: Cash and Due From Banks - For these short-term instruments, the carrying amount is a reasonable estimate of fair value. Federal Funds Sold - For these short-term instruments, the carrying amount is a reasonable estimate of fair value. Investment Securities - For investment securities, fair values are based on quoted market prices or dealer quotes. Federal Home Loan Bank and Federal Reserve Stock - For FHLB and Federal Reserve stock, carrying value is a reasonable estimate of fair value. Loans - Fair value is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. Deposit Liabilities - The fair value of demand deposits, savings accounts, and certain money market deposits is the amount payable on demand at the reporting date. The fair value of fixed-maturity certificates of deposit is estimated by discounting future cash flows using the rates currently offered for deposits of similar remaining maturities. Securities Sold Under Agreements to Repurchase - For these short-term instruments, the carrying amount is a reasonable estimate of fair value. Federal Home Loan Bank Advances - Rates currently available to the Company for advances with similar terms and remaining maturities are used to estimate fair value of existing debt. Mandatorily Redeemable Capital Securities of Subsidiary Trust - The carrying value of these funds is a reasonable estimate of fair value. Commitments to Extend Credit and Standby Letters of Credit -Commitments to extend credit and standby letters of credit represent agreements to lend to a customer at the market rate when the loan is extended, thus the commitments and letters of credit are not considered to have a fair value. Page 23 PREMIER FINANCIAL BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 (CONTINUED) 19. DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED) The fair values of the Company's financial instruments at December 31, 1997 and 1996 are as follows: 1997 1996 Carrying Fair Carrying Fair Amount Value Amount Value Financial assets: Cash and due from banks $ 11,609,886 $ 11,610,000 $ 9,303,925 $ 9,304,000 Federal funds sold 40,771,000 40,771,000 10,935,000 10,935,000 Investment securities 66,287,565 66,788,000 50,965,047 51,144,000 Federal Home Loan Bank and Federal Reserve stock 2,923,250 2,923,000 1,695,350 1,695,000 Loans 283,389,786 282,655,000 242,624,795 242,656,000 Less: allowance for loan losses (3,144,142) (3,144,000) (2,853,725) (2,854,000) ------------- ------------- ------------- ------------- $ 401,837,345 $ 401,603,000 $ 312,670,392 $ 312,880,000 Financial liabilities: Deposits $ (324,554,041) $(326,330,000) $(267,207,874) $(268,988,000) Securities sold under agreements to repurchase (5,634,132) (5,634,000) (5,599,420) (5,600,000) Federal Home Loan Bank advances (15,263,339) (15,290,000) (9,377,456) (9,412,000) Mandatorily redeemable capital securities of subsidiary trust (28,750,000) (28,750,000) 0 0 ------------- ------------- ------------- ------------- $ (374,201,512) $(376,004,000) $(282,184,750) $(284,000,000) 20. FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK The Banks are parties to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of their customers. These financial instruments include standby letters of credit and commitments to extend credit in the form of unused lines of credit. The Banks use the same credit policies in making commitments and conditional obligations as they do for on-balance sheet instruments. Page 24 PREMIER FINANCIAL BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 (CONTINUED) 20. FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK (CONTINUED) At December 31, 1997 and 1996, the Banks had the following financial instruments whose approximate contract amounts represent credit risk: 1997 1996 Standby letters of credit $ 1,099,300 $ 1,081,875 Commitments to extend credit $ 17,692,415 $ 11,367,341 Standby letters of credit represent conditional commitments issued by the Banks to guarantee the performance of a third party. The credit risk involved in issuing these letters of credit is essentially the same as the risk involved in extending loans to customers. Collateral held varies but primarily includes real estate and certificates of deposit. Some letters of credit are unsecured. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The Banks evaluate each customer's creditworthiness on a case-by-case basis. Since some of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Collateral held varies but may include accounts receivable, inventory, property and equipment, and income producing properties. 21. CONCENTRATION OF CREDIT RISK The Banks grant residential, commercial and consumer related loans to customers primarily located in the counties and adjoining counties in Kentucky and Ohio in which the Banks operate. Although they have diverse loan portfolios, a substantial portion of their debtors' ability to perform is somewhat dependent on the economic conditions of the counties in which they operate. 22. LEGAL PROCEEDINGS Legal proceedings involving the Company and its subsidiaries periodically arise in the ordinary course of business, including claims by debtors and their related interests against the Company's subsidiaries following initial collection proceedings. These legal proceedings sometimes can involve claims for substantial damages. At December 31, 1997, management is unaware of any legal proceedings, of which the ultimate result would have a material adverse effect upon the consolidated financial statements of the Company. Page 25 PREMIER FINANCIAL BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 (CONTINUED) 23. REGULATORY MATTERS The Company and the subsidiary Banks are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Banks must meet specific guidelines that involve quantitative measures of their assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Company and Banks to maintain minimum amounts and ratios (set forth in the table below) of Total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital (as defined) to average assets (as defined). Management believes, as of December 31, 1997, the Company and the Banks meet all capital adequacy requirements to which they are subject. As of December 31, 1997, the most recent notification from the Federal Reserve Bank categorized the Company as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Company must maintain minimum Total risk-based, Tier I risk-based and Tier I leverage ratios as set forth in the following table. There are no conditions or events since that notification that management believes have changed the Company's category. The Company's and the two largest subsidiary Banks' capital amounts and ratios as of December 31, 1997 and 1996 are presented in the table below. To Be Well Capitalized Under Prompt For Capital Corrective Actual Adequacy Purposes Action Provisions 1997 Amount Ratio Amount Ratio Amount Ratio (amounts in thousands) Total Capital (to Risk-Weighted Assets): Consolidated $ 72,424 25.43% $ 22,788 8.0% $ 28,485 10.0% Farmers Deposit Bank 13,019 13.65 7,632 8.0 9,540 10.0 Citizens Deposit Bank 9,864 12.98 6,078 8.0 7,599 10.0 Tier I Capital (to Risk-Weighted Assets): Consolidated $ 56,461 19.82% $ 11,394 4.0% $ 16,428 6.0% Farmers Deposit Bank 12,009 12.59 3,816 4.0 5,223 6.0 Citizens Deposit Bank 9,036 11.89 3,039 4.0 4,559 6.0 Tier I Capital (to Average Assets): Consolidated $ 56,461 13.52% $ 17,091 4.0% $ 20,535 5.0% Farmers Deposit Bank 12,009 9.70 4,793 4.0 5,991 5.0 Citizens Deposit Bank 9,036 8.75 3,885 4.0 4,856 5.0 Page 26 PREMIER FINANCIAL BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 (CONTINUED) 23. REGULATORY MATTERS (CONTINUED) To Be Well Capitalized Under Prompt For Capital Corrective Actual Adequacy Purposes Action Provisions 1997 Amount Ratio Amount Ratio Amount Ratio (amounts in thousands) Total Capital (to Risk-Weighted Assets): Consolidated $ 41,995 17.63% $ 19,057 8.0% $ 23,821 10.0% Farmers Deposit Bank 10,878 13.20 7,012 8.0 8,765 10.0 Citizens Deposit Bank 8,085 11.75 5,505 8.0 6,882 10.0 Tier I Capital (to Risk-Weighted Assets): Consolidated $ 39,141 16.43% $ 9,528 4.0% $ 14,293 6.0% Farmers Deposit Bank 10,003 12.14 3,506 4.0 5,259 6.0 Citizens Deposit Bank 7,375 10.72 2,753 4.0 4,129 6.0 Tier I Capital (to Average Assets): Consolidated $ 39,141 12.10% $ 12,885 4.0% $ 16,106 5.0% Farmers Deposit Bank 10,003 8.95 4,685 4.0 5,857 5.0 Citizens Deposit Bank 7,375 8.73 3,379 4.0 4,223 5.0 Page 27 PREMIER FINANCIAL BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 (CONTINUED) 24. PARENT COMPANY FINANCIAL STATEMENTS Condensed Balance Sheets December 31 1997 1996 (in thousands) ASSETS Cash $ 1,584 $ 1,654 Interest bearing deposits in subsidiary banks 4,371 4,047 -------- -------- Total cash and cash equivalents $ 5,955 $ 5,701 Federal funds sold 16,340 0 Investment in subsidiaries 42,833 35,750 Investment securities available for sale 2,000 2,000 Loans 5,621 0 Premises and equipment 2,419 1,186 Other assets 1,546 114 -------- -------- TOTAL ASSETS $ 76,714 $ 44,751 LIABILITIES AND STOCKHOLDERS' EQUITY Deferred income taxes $ 12 $ 0 Other liabilities 155 126 -------- -------- Total liabilities $ 167 $ 126 Mandatorily redeemable capital securities of subsidiary trust $ 28,750 $ 0 Stockholders' Equity: Preferred stock, no par value; 1,000,000 shares authorized; none issued or outstanding $ 0 $ 0 Common stock, no par value; 10,000,000 shares authorized; 4,685,390 shares issued and outstanding 982 982 Surplus 33,825 33,825 Retained earnings 13,055 9,936 Net unrealized losses on securities available for sale (65) (118) -------- -------- Total stockholders' equity $ 47,797 $ 44,625 TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 76,714 $ 44,751 Page 28 PREMIER FINANCIAL BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 (CONTINUED) 24. PARENT COMPANY FINANCIAL STATEMENTS (CONTINUED) Condensed Statements of Income Year Ended December 31 1997 1996 1995 (in thousands) Income: Dividends from subsidiary banks $ 0 $ 597 $ 1,825 Interest and dividend income 4,049 361 166 Gain on sale of investment securities 2,183 0 0 Other income 16 73 11 ------ ------- ------- Total income $ 6,248 $ 1,031 $ 2,002 Expenses: Interest expense $ 4,037 $ 167 $ 253 Salaries and employee benefits 465 287 71 Other expenses 804 186 271 ------ ------- ------- Total expenses $ 5,306 $ 640 $ 595 Income before income taxes and equity in undistributed income of subsidiaries $ 942 $ 391 $ 1,407 Income tax expense (benefit) 326 (95) (178) ------- ------- ------- Income before equity in undistributed income of subsidiaries $ 616 $ 486 $ 1,585 Equity in undistributed income of subsidiaries 4,992 3,237 846 ------ ------- ------- NET INCOME $ 5,608 $ 3,723 $ 2,431 Page 29 PREMIER FINANCIAL BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 (CONTINUED) 24. PARENT COMPANY FINANCIAL STATEMENTS (CONTINUED) Condensed Statements of Cash Flows Year Ended December 31 1997 1996 1995 (in thousands) CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 5,608 $ 3,723 $ 2,431 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation 74 28 11 Investment securities gains (2,183) 0 0 Equity in undistributed income of subsidiaries (4,992) (3,237) (846) Change in other assets (1,453) 286 (259) Change in other liabilities 41 30 89 --------- -------- -------- Net cash (used in) provided by operating activities $ (2,905) $ 830 $ 1,426 CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of subsidiary banks $ 0 $(12,622) $ (1,496) Capital contributed to subsidiaries (2,100) (2,500) (1,401) Purchase of securities available for sale (273,500) 0 (500) Proceeds from sale of securities 275,683 0 0 Net change in federal funds sold (16,340) 0 0 Net change in loans (5,621) 0 0 Purchase of premises and equipment (1,307) (618) (608) --------- -------- -------- Net cash used in investing activities $ (23,185) $(15,740) $ (4,005) CASH FLOWS FROM FINANCING ACTIVITIES: Dividends paid $ (2,406) $ (1,817) $ (859) Proceeds from issuance of common stock 0 27,066 0 Proceeds from issuance of capital securities of subsidiary trust 28,750 0 0 Proceeds from debt 0 0 3,500 Repayment of debt 0 (5,000) 0 --------- -------- -------- Net cash provided by financing activities $ 26,344 $ 20,249 $ 2,641 Net increase in cash and cash equivalents $ 254 $ 5,339 $ 62 Cash and cash equivalents at beginning of year 5,701 362 300 --------- -------- -------- CASH AND CASH EQUIVALENTS AT END $ 5,955 $ 5,701 $ 362 OF YEAR Page 30 PART III ITEM 10, 11, 12 AND 13. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT; EXECUTIVE COMPENSATION; SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT; AND CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by these Items is omitted because the Corporation is filing a definitive proxy statement pursuant to Regulation 14A not later than 120 days after the end of the fiscal year covered by this report which includes the required information. The required information contained in the Corporation's proxy statement is incorporated herein by reference. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) The following documents are filed as part of this report: 1. Financial Statements: Independent Auditors' Report Balance Sheets - December 31, 1997 and 1996 Statements of Loss - Years Ended December 31, 1997, 1996 and 1995 Statements of Changes in Stockholders' Equity - Years Ended December 31, 1997, 1996 and 1995 Statements of Cash Flows - Years Ended December 31, 1997, 1996 and 1995 Notes to Financial Statements 2. Financial Statement Schedules: No financial statement schedules have been included as part of this report because they are either not required or the information is otherwise included. 3. List of Exhibits: The following is a list of exhibits required by Item 601 of Regulation S-K and by paragraph (c) of this Item 14. EXHIBIT NUMBER DESCRIPTION OF DOCUMENT 3.1 Form of Articles of Incorporation of registrant (included as Exhibit 3.1 to registrant's Registration Statement on Form S-1, Registration No. 333-1702, filed on February 28, 1996 with the Commission and incorporated herein by reference). 3.2 Form of Articles of Amendment to Articles of Incorporation effective March 15, 1996 re: amendment to Article IV (included as Exhibit 3.2 to registrant's Amendment No. 1 to Registration Statement on Form S-1, Registration No. 333-1702, filed on March 25, 1996 with the Commission and incorporated herein by reference). 3.3 Bylaws of registrant (included as Exhibit 3.2 to registrant's Registration Statement on Form S-1, Registration No. 333-1702, filed on February 28, 1996 with the Commission and incorporated herein by reference). 4.1 Form of Junior Subordinated Indenture dated as of June 6, 1997 between Registrant and Bankers Trust Company, as Trustee, with respect to 9.75% Junior Subordinated Deferrable Interest Debentures due June 30, 2027 (incorporated by reference to Exhibit 4.1 to the Registration Statement on Form S-1 of Registrant filed May 28, 1997 with the Commission (Registration No. 333-27943)). 4.2 Form of 9.75% Junior Subordinated Deferrable Interest Debenture Certificate (incorporated by reference to Exhibit 4.2 to the Registration Statement on Form S-1 of Registrant filed May 28, 1997 with the Commission (Registration No. 333-27943)). 4.3 Form of Amended and Restated Trust Agreement dated as of June 6, 1997 among Registrant, as Depositor, Bankers Trust Company, as Property Trustee, and Bankers Trust (Delaware), as Delaware Trustee (incorporated by reference to Exhibit 4.4 to the Registration Statement on Form S-1 of Registrant filed May 28, 1997 with the Commission (Registration No. 333-27943)). 4.4 Form of Guarantee Agreement dated as of June 6, 1997 between Registrant and Bankers Trust Company (incorporated by reference to Exhibit 4.6 to the Registration Statement on Form S-1 of Registrant filed May 28, 1997 with the Commission (Registration No. 333-27943)). 10.1 Amended and Restated Preferred Stock Purchase Agreement dated as of September 29, 1994 between First Guaranty Bank, Hammon, Louisiana, and registrant (included as Exhibit 10.3 to registrant's Registration Statement on Form S-1, Registration No. 333-1702, filed on February 28, 1996 with the Commission and incorporated herein by reference). 10.2 Employment Agreement dated March 16, 1992, between Georgetown Bank & Trust Company and Gardner E. Daniel (included as Exhibit 10.4 to registrant's Registration Statement on Form S-1, Registration No. 333-1702, filed on February 28, 1996 with the Commission and incorporated herein by reference). 10.3 Deferred Compensation Agreement dated December 17, 1992, between Georgetown Bank & Trust Company and Gardner E. Daniel (included as Exhibit 10.5 to registrant's Registration Statement on Form S-1, Registration No. 333-1702, filed on February 28, 1996 with the Commission and incorporated herein by reference). 10.4 Premier Financial Bancorp, Inc. 1996 Employee Stock Ownership Incentive Plan (included as Exhibit 10.6 to registrant's Registration Statement on Form S-1, Registration No. 333-1702, filed on February 28, 1996 with the Commission and incorporated herein by reference). 21 Subsidiaries of registrant 23.1 Consent of Eskew & Gresham, P.S.C. 27 Financial Data Schedule for year ended December 31, 1997 (b Reports on Form 8-K Form 8-K dated December 19, 1997 reporting consummation of the Company's acquisition of The Sabina Bank, Sabina, Ohio, consummation of the acquisition of two branch banks and earnings through December 15, 1997. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, registrant has duly caused this Annual Report on Form 10-K to be signed on its behalf by the undersigned thereunto duly authorized, in the City of Georgetown, Commonwealth of Kentucky, on the 26th day of March, 1998. PREMIER FINANCIAL BANCORP, INC. By: /s/ J. Howell Kelly, President -------------------------------- J. Howell Kelly, President Pursuant to the requirements of the Securities Exchange Act of 1934, this Annual Report on Form 10-K has been signed below by the following persons on behalf of the registrant in the capacities and on the dates indicated. Principal Executive, Financial and March 26, 1998 /s/ J. Howell Kelly Accounting Officer, Director -------------------------- J. Howell Kelly March 26, 1998 /s/ Toney K. Adkins Director -------------------------- Toney K. Adkins March 26, 1998 /s/ Gardner E. Daniel Director -------------------------- Gardner E. Daniel March 26, 1998 /s/ E. V. Holder, Jr. Director -------------------------- E. V. Holder, Jr. March 26, 1998 /s/ Wilbur M. Jenkins Director -------------------------- Wilbur M. Jenkins March 26, 1998 /s/ Benhamin T. Pugh Director -------------------------- Benjamin T. Pugh March 26, 1998 /s/ Marshall T. Reynolds Director -------------------------- Marshall T. Reynolds