PFBI 2005 10-K
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

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

For the fiscal year ended December 31, 2005

or

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

For the transition period from ___________ to ___________

Commission file number 0-20908

PREMIER FINANCIAL BANCORP, INC.
(Exact name of registrant as specified in its charter)

Kentucky
  
61-1206757
(State or other jurisdiction of incorporation organization)
  
(I.R.S. Employer Identification No.)
     
2883 Fifth Avenue
Huntington, West Virginia
  
 
25702
(Address of principal executive offices)
  
(Zip Code)
     
Registrant’s telephone number (304) 525-1600


Securities registered pursuant to Section 12(b) of the Act:  NONE

Securities registered pursuant to Section 12(g) of the Act:

Title of each class
  
Name of exchange on which registered
Common Stock without par value
  
NASDAQ:NMS

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No þ.

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act Yes o No þ. 

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 þ No o.

Indicate by check mark if 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 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. o


PREMIER FINANCIAL BANCORP, INC.
FORM 10-K
December 31, 2005



Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.
Large accelerated filer o.
Accelerated filer o.
Non-accelerated filer þ

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

As of June 30, 2005, the aggregate market value of the registrant’s common stock held by non-affiliates of the registrant was $56,532,143 based on the closing sale price as reported on the National Association of Securities Dealers Automated Quotation System National Market System.
 
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Title of each class
  
Outstanding at March 15, 2006
Common Stock without par value
  
5,235,564


DOCUMENTS INCORPORATED BY REFERENCE

Document
  
Parts Into Which Incorporated
Proxy Statement for the Annual Meeting of Shareholders to be held on June 21, 2006.
  
Part III
 

 
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PREMIER FINANCIAL BANCORP, INC.
FORM 10-K
December 31, 2005


 
       
   
   
   
   
   
         
       
   
   
   
   
     
     
     
     
     
     
     
         
PART III        
   
   
   
   
   
   
   
         
       
   
     
         





PREMIER FINANCIAL BANCORP, INC.
FORM 10-K
December 31, 2005


PART I

Item 1. Description of Business

THE COMPANY
 
    Premier Financial Bancorp, Inc. (the "Company" or "Premier") is a multi-bank holding company that, as of March 15, 2006, operates ten banking offices in Kentucky, three banking offices in Ohio, and six banking offices in West Virginia. At December 31, 2005, Premier had total consolidated assets of $528.3 million, total consolidated deposits of $435.8 million and total consolidated shareholders' equity of $54.3 million. The banking subsidiaries (the "Banks" or "Affiliate Banks") consist of Citizens Deposit Bank & Trust, Vanceburg, Kentucky; Farmers Deposit Bank, Eminence, Kentucky; Ohio River Bank, Ironton, Ohio; First Central Bank, Inc., Philippi, West Virginia; and Boone County Bank, Inc., Madison, West Virginia.
 
    In 2000 Premier suspended its acquisition strategy in order to focus on improving operations, strengthening capital and management oversight and improving the profitability of the banks previously acquired. While Premier remains committed to its core strategy of rural banking with community oriented and locally named institutions, the Company may dispose of additional corporate assets that no longer meet Premier's geographic or operational performance goals. Effective January 3, 2005, Premier merged two of its subsidiary banks, Citizens Deposit Bank & Trust in Vanceburg, Kentucky and Bank of Germantown, in Germantown, Kentucky. Bank of Germantown was merged into Citizens Deposit Bank, with its facilities continuing to operate as branches of Citizens Deposit Bank.
 
    On June 16, 2003 Premier announced that as a result of an ongoing internal investigation, it had uncovered a systematic disregard for its loan approval and credit administration policies at its Farmers Deposit Bank subsidiary and had accepted the resignation of the bank's former president. On November 7, 2003 Premier disclosed that the Securities and Exchange Commission had requested information about Premier's internal investigation. As the internal investigation progressed, many loans were charged off and additional provisions for loan losses were recorded. Premier's management, with the assistance of outside independent professionals, conducted a further review of those loans for which significant charge offs or additional provisions were required in 2003. The purpose of the review was to determine if the facts or circumstances that gave rise to additional charge offs or provisions had been improperly withheld from senior management or improperly considered in applying management's estimates and judgments as to the adequacy of the allowance for loan losses in financial statement periods prior to 2003. The review did identify instances in which collateral securing loans had been released without proper support or notation in loan files, instances in which obligors on notes had been released from their repayment obligation without proper support or notation in loan files and instances in which delinquent loan reporting systems had been manipulated to prevent problem loans from being identified on a timely basis. Premier's


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PREMIER FINANCIAL BANCORP, INC.
FORM 10-K
December 31, 2005


senior management determined that if these circumstances had been considered in evaluating the adequacy of the allowance for loan losses in prior periods then some of the loan charge offs and additional provisions for loan losses recorded in 2003 should have been reflected in prior periods. Therefore the financial statements for 2002 were restated, as reported in the 2003 Annual Report to Shareholders, to reflect the financial statement effect of the matters that occurred in those periods but which were improperly concealed by subsidiary management.
 
    On December 24, 2003, Premier announced that Farmers Deposit Bank had reached an agreement with the Federal Deposit Insurance Corporation ("FDIC") and the Kentucky Department of Financial Institutions ("KDFI") [collectively referred to as "Supervisory Authorities"] to consent to the issuance of a cease & desist order ("Order") from its Supervisory Authorities. The Order also outlined a number of steps to be taken by Farmers Deposit which were designed to remedy and/or prevent the reoccurrence of events that gave rise to the investigation during the latter half of 2003. The full text of the Order is available on the FDIC website at www.fdic.gov or by calling the FDIC Public Information Center at (877) 275-3342. Having found that Farmers Deposit had fully complied with the Order, the Supervisory Authorities rescinded the Order on December 13, 2005.
 
    The Securities and Exchange Commission ("SEC") investigated the information disclosed in Premier's June 16 and July 31, 2003 Forms 8-K and the June 30, and September 30, 2003 Forms 10-Q regarding Farmers Deposit and requested information about Premier's internal investigation. Premier fully cooperated with the SEC. At the conclusion of its investigation, the SEC issued an administrative cease & desist order regarding Premier’s financial reporting and internal controls concerning Premier’s quarterly 2001 through 2003 and annual 2001 and 2002 public filings. According to the SEC Order, both the remedial acts promptly undertaken by Premier and Premier’s cooperation with the SEC Staff were taken into consideration in reaching the settlement.

In the fourth quarter of 2003, the Company adopted and began to implement a plan to sell its subsidiary Citizens Bank (Kentucky), Inc. ("Citizens Bank") located in Georgetown, Kentucky. On February 13, 2004, the Company announced that it had signed a definitive agreement to sell Citizens Bank in a cash transaction valued at approximately $14,500,000, and on July 1, 2004 the sale transaction closed. In accordance with Financial Accounting Standard 144, "Accounting for the Impairment or Disposal of Long-lived Assets", which became effective for the Company on January 1, 2002, the financial position and results of operations of Citizens Bank are removed from the detail line items in the Company's financial statements and presented separately as "discontinued operations." See Note 2 to the consolidated financial statements included later in this report for a more detailed discussion of discontinued operations.



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PREMIER FINANCIAL BANCORP, INC.
FORM 10-K
December 31, 2005


Beginning in April 2005 and concluding in July 2005, the Company converted each of its Affiliate Banks from an in-house system administered by a wholly-owned subsidiary to an outsourced system administered by FiServ for their data and item processing functions. Subsequent to the conversion, the operations of the Company’s data processing subsidiary, Premier Data Services, Inc. were suspended and the subsidiary became inactive.

Premier is a legal entity separate and distinct from its Affiliate Banks and non-bank 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 non-bank 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 source of Premier's revenue is dividends from its Affiliate Banks and non-bank 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. During 2002, Premier moved its principal executive offices from Georgetown, Kentucky to its present location at 2883 5th Avenue, Huntington, West Virginia, 25702. The purpose of the move was to be more centrally located among Premier's Affiliate Banks and its directorship. Premier's telephone number is (304) 525-1600.


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PREMIER FINANCIAL BANCORP, INC.
FORM 10-K
December 31, 2005


BUSINESS
General
 
    Through the Banks 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. Each Bank retains its local management structure which offers customers direct access to the Bank's president and other officers in an environment conducive to friendly, informed and courteous service. This 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. See additional discussion under "Regulatory Matters" below.
 
    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 accounting, loan review, operations and network support, human resources, 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 services needed by their customers and desirable changes to existing products and services.

Prior to the conversions in mid 2005, the Company's data processing subsidiary, Premier Data Services, Inc., provided centralized data processing services to four of the Banks. Beginning in late 2004 and continuing through the middle of 2005, the Company converted its data processing system to an external third-party provider. Through the conversion process, Company senior management along with each Bank's management reviewed and standardized its offering of products and services, although pricing decisions will remain at the local Bank level. Furthermore, as a result of conversion, the Company through the Banks is able offer more modern products, such as internet banking and check imaging, and will be well positioned to take advantage of emerging technologies such as image exchange to clear items.


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PREMIER FINANCIAL BANCORP, INC.
FORM 10-K
December 31, 2005


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. Farmers Deposit Bank in Eminence, Kentucky, also offers limited trust services and acts as executor, administrator, trustee and in various other fiduciary capacities.

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. Commercial lending activities include loans to small businesses located primarily in the communities in which the Banks are located and surrounding areas. Commercial loans are secured by business assets including real estate, equipment, inventory, and accounts receivable. Some commercial loans are unsecured. Farmers Deposit Bank has previously extended loans to professional athletes and their agents and advisors. This lending activity was curtailed in 2003.

The Banks' range of deposit services includes checking accounts, NOW accounts, savings accounts, money market accounts, club accounts, individual retirement accounts, certificates of deposit and overdraft protection. Customers can access their accounts via traditional bank branch locations as well as Automated Teller Machines (ATM’s) and the internet. The Banks’ also offer bill payment and telephone banking services. Deposits of the Banks are insured by the Bank Insurance Fund administered by the FDIC.

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 have 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 which have substantially greater financial and managerial resources. While the Banks are smaller financial institutions, each of the Banks' competitors include large bank holding companies having substantially greater resources and offering certain services that Premier Banks may 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.



8
 

PREMIER FINANCIAL BANCORP, INC.
FORM 10-K
December 31, 2005


Management believes that each Bank is positioned to compete successfully in its respective primary market area, although no assurances as to ongoing competitiveness 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 or PFBI Capital Trust preferred 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.

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.


9
 

PREMIER FINANCIAL BANCORP, INC.
FORM 10-K
December 31, 2005


The two Affiliate Banks chartered in Kentucky are supervised, regulated and examined by the Kentucky Department of Financial Institutions, the Affiliate Bank chartered in Ohio is supervised, regulated and examined by the Ohio Division of Financial Institutions, and the two Affiliate Banks chartered in West Virginia are supervised, regulated and examined by the West Virginia Division of Banking. 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 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 of the bank's depositors and certain of its other obligations.


10
 

PREMIER FINANCIAL BANCORP, INC.
FORM 10-K
December 31, 2005


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 and "Tier II" capital. "Tier I" capital includes common shareholders' equity, non-cumulative perpetual preferred stock, and related surplus (excluding auction rate issues), minority interests in equity accounts of consolidated subsidiaries and Trust Preferred Securities (subject to certain limitations.) Goodwill, certain identifiable intangible assets and certain other assets are subtracted from these sources of capital to calculate Tier I capital. "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, 2004, Premier met both requirements, with Tier I and total capital equal to 17.8% and 19.1% 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. 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, 2004, Premier's leverage ratio was 10.6%.

On June 9, 1997, PFBI Capital Trust (Trust), a statutory business trust created under Delaware law, issued $28,750,000 of 9.750% Preferred Securities ("Preferred Securities" or "Trust Preferred Securities") with a stated value and liquidation preference of $25 per share. A portion of the Preferred Securities issued by the Trust qualifies as Tier 1 capital for the Company under the Federal Reserve Board's regulatory framework. The Federal Reserve Board recently re-evaluated whether trust preferred securities, in general, would continue to qualify as Tier 1 capital due to deconsolidation of the related trust preferred entity required by FASB Interpretation No. 46, . Its conclusion, issued in a report released on March 1 2005, was to continue to permit trust preferred securities to qualify as Tier I capital with certain restrictions phased in over five-years. Once completely phased-in, the dollar amount of trust preferred securities that will qualify as Tier I capital for bank holding companies of Premier's size will be limited to 25% of equity based Tier I capital net of goodwill. See Note 12 to the consolidated financial statements for additional details regarding the Company's Trust Preferred Securities.


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PREMIER FINANCIAL BANCORP, INC.
FORM 10-K
December 31, 2005


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.

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.

Regulatory Agreements - On September 29, 2000, the Company entered into an agreement with the Federal Reserve that prohibited the Company from paying dividends or incurring any additional debt without the prior written approval of the Federal Reserve. Additionally, the agreement required the Company to develop and monitor compliance with certain operational policies designed to strengthen Board of Director oversight including credit administration, liquidity, internal audit and loan review.


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PREMIER FINANCIAL BANCORP, INC.
FORM 10-K
December 31, 2005


On January 29, 2003, Premier entered into a written agreement with the Federal Reserve Bank of Cleveland in recognition of their common goal to restore the financial soundness of Premier. Among the provisions of the agreement was the continuation of the restriction on Premier's payment of dividends on its common stock (PFBI) without the express written consent of the Federal Reserve Bank of Cleveland and the continuation of the restriction on Premier's payment of quarterly distributions on its Trust Preferred Securities (PFBIP) without the express written consent of the Federal Reserve Bank of Cleveland. The written agreement supersedes and rescinds all previous agreements between Premier and the Federal Reserve Bank of Cleveland. Among other provisions, the agreement required(s) Premier to (i) retain an independent consultant to review its management, directorate and organizational structure, (ii) adopt a management plan responsive to such consultant's report, (iii) update its management succession plan in accordance with any recommendations in such consultant's report, (iv) monitor its subsidiary banks' compliance with bank policies and loan review programs, (v) conduct formal quarterly reviews of its subsidiary banks' allowances for loan losses, (vi) maintain sufficient capital, (vii) submit a plan to the Federal Reserve Bank of Cleveland for improving consolidated earnings over a three-year period, and (viii) submit to the Federal Reserve Bank of Cleveland annual projections of planned sources and uses of the parent company's cash, including a plan to service its outstanding debt and trust preferred securities. Premier's compliance with the written agreement is monitored by a committee consisting of at least three of its outside directors. The agreement, which requires periodic reporting, will remain in force until the FRB is satisfied that the Company and the banks have fully complied with the terms of the agreement.

Two of the Company's subsidiaries, Citizens Deposit Bank & Trust and the Bank of Germantown, entered into similar agreements with their respective primary regulators which, among other things, prohibited the payment of dividends without prior written approval and required significant changes in their credit administration policies. The banks fully complied with the terms of the agreements in 2004 and the agreements were accordingly rescinded by the regulators.

On December 24, 2003, Premier announced that Farmers Deposit Bank had reached an agreement with the Federal Deposit Insurance Corporation ("FDIC") and the Kentucky Department of Financial Institutions ("KDFI") [collectively referred to as "Supervisory Authorities"] to consent to the issuance of a cease & desist order ("Order") from its Supervisory Authorities. The Order also outlined a number of steps to be taken by Farmers Deposit which were designed to remedy and/or prevent the reoccurrence of events that gave rise to the investigation during the latter half of 2003. The full text of the Order is available on the FDIC website at www.fdic.gov or by calling the FDIC Public Information Center at (877) 275-3342. Having found that Farmers Deposit had fully complied with the Order, the Supervisory Authorities rescinded the Order on December 13, 2005.


13
 

PREMIER FINANCIAL BANCORP, INC.
FORM 10-K
December 31, 2005


The Securities and Exchange Commission ("SEC") investigated the information disclosed in Premier's June 16 and July 31, 2003 Forms 8-K and the June 30, and September 30, 2003 Forms 10-Q regarding Farmers Deposit and requested information about Premier's internal investigation. Premier fully cooperated with the SEC. At the conclusion of its investigation, the SEC issued an administrative cease & desist order regarding Premier’s financial reporting and internal controls concerning Premier’s quarterly 2001 through 2003 and annual 2001 and 2002 public filings. According to the SEC Order, both the remedial acts promptly undertaken by Premier and Premier’s cooperation with the SEC Staff were taken into consideration in reaching the settlement.

Dividend Restrictions - Premier is dependent on dividends from its Affiliate Banks for its revenues. Various federal and state regulatory provisions limit the amount of dividends the Affiliate Banks can pay to Premier without regulatory approval. At December 31, 2005, approximately $2.5 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.

On January 29, 2003, Premier entered into a written agreement with the Federal Reserve Bank of Cleveland in recognition of their common goal to restore the financial soundness of Premier. Among the provisions of the agreement was the continuation of the restriction on Premier's payment of dividends on its common stock (PFBI) without the express written consent of the Federal Reserve Bank of Cleveland and the continuation of the restriction on Premier's payment of quarterly distributions on its Trust Preferred Securities (PFBIP) without the express written consent of the Federal Reserve Bank of Cleveland.

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. Additional information regarding dividend limitations can be found in Note 20 of the accompanying audited consolidated financial statements.

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 as 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.


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PREMIER FINANCIAL BANCORP, INC.
FORM 10-K
December 31, 2005


Gramm-Leach-Bliley Act - On November 12, 1999, the Gramm-Leach-Bliley Act (the "Act") was signed into law, eliminating many of the remaining barriers to full convergence of the banking, securities, and insurance industries. The major provisions of the Act took effect March 12, 2000.

The Act enables a broad-scale consolidation among banks, securities firms, and insurance companies by creating a new type of financial services company called a "financial holding company," a bank holding company with dramatically expanded powers. Financial holding companies can offer virtually any type of financial service, including banking, securities underwriting, insurance (both agency and underwriting), and merchant banking. In addition, the Act permits the Federal Reserve and the Treasury Department to authorize additional activities for financial holding companies, but only if they jointly determine that such activities are "financial in nature" or "complementary to financial activities." Premier does not presently qualify to elect financial holding company status.

The Federal Reserve serves as the primary "umbrella" regulator of financial holding companies, with jurisdiction over the parent company and more limited oversight over its subsidiaries. The primary regulator of each subsidiary of a financial holding company depends on the activities conducted by the subsidiary. A financial holding company need not obtain Federal Reserve approval prior to engaging, either de novo or through acquisitions, in financial activities previously determined to be permissible by the Federal Reserve. Instead, a financial holding company need only provide notice to the Federal Reserve within 30 days after commencing the new activity or consummating the acquisition.

Number of Employees

The Company and its subsidiaries collectively had approximately 215 full-time equivalent employees as of December 31, 2005. Its executive offices are located at 2883 5th Avenue, Huntington, West Virginia 25702, telephone number (304) 525-1600 (facsimile number (304) 525-9701).


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PREMIER FINANCIAL BANCORP, INC.
FORM 10-K
December 31, 2005


Item 1A. Risk Factors
 
    Like all financial companies, the Company’s business and results of operations are subject to a number of risks, many of which are outside of the Company’s control. In addition to the other information in this report, readers should carefully consider that the following important factors, among others, could materially impact the Company’s business and future results of operations.

Changes in Interest Rates Could Negatively Impact the Company’s Results of Operations

The earnings of the Company are primarily dependent on net interest income, which is the difference between interest earned on loans and investments, and interest paid on interest-bearing liabilities such as deposits and borrowings. Interest rates are highly sensitive to many factors, including government monetary and fiscal policies; domestic and international economic and political conditions; and, in particular, changes in the discount rate by the Board of Governors of the Federal Reserve System. Conditions such as inflation, recession, unemployment, money supply, government borrowing and other factors beyond management’s control may also affect interest rates. If the Company’s interest-earning assets mature, reprice or prepay more quickly than interest-bearing liabilities in a given period, a decrease in market interest rates could adversely affect net interest income. Likewise, if interest-bearing liabilities mature or reprice, or, in the case of deposits, are withdrawn by the accountholder, more quickly than interest-earning assets in a given period, an increase in market interest rates could adversely affect net interest income. Given the Company’s current mix of assets and liabilities, a declining interest rate environment would negatively impact the Company’s results of operations.

Fixed rate loans increase the Company’s exposure to interest rate risk in a rising rate environment because interest-bearing liabilities would be subject to repricing before assets become subject to repricing. Adjustable rate loans decrease the risks to a lender associated with changes in interest rates but involve other risks. As interest rates rise, the payment by the borrower rises to the extent permitted by the terms of the loan, and the increased payment increases the potential for default. At the same time, for secured loans, the marketability of the underlying collateral may be adversely affected by higher interest rates. In a declining interest rate environment, there is likely to be an increase in prepayment activity on loans as the borrowers refinance their loans at lower interest rates. Under these circumstances, the Company’s results of operations could be negatively impacted.

Changes in interest rates also can affect the value of loans, investments and other interest-rate sensitive assets and the Company’s ability to realize gains on the sale or resolution of assets. This type of income can vary significantly from quarter-to-quarter and year-to-year based on a number of different factors, including the interest rate environment. An increase in interest rates that adversely affects the ability of borrowers to pay the principal or interest on

 
PREMIER FINANCIAL BANCORP, INC.
FORM 10-K
December 31, 2005


loans may lead to an increase in non-performing assets and increased loan loss reserve requirements that could have a material adverse effect on the Company’s results of operations.

Regional Economic Changes in the Company’s Markets Could Adversely Impact Results From Operations

Like all banks, the Company is subject to the effects of any economic downturn, and in particular a significant decline in home values or reduced commercial development in the Company’s markets could have a negative effect on results of operations. The Company’s success depends primarily on the general economic conditions in the counties in which the Company conducts business, and in the West Virginia, southern Ohio and northern Kentucky areas in general. Unlike larger banks that are more geographically diversified, the Company provides banking and financial services to customers primarily in the West Virginia counties of Barbour, Boone, Harrison, Lewis, Lincoln, Logan, Kanawha and Upshur, as well as the southern Ohio counties of Gallia, Lawrence and Scioto and the northern Kentucky counties of Bracken, Fleming, Greenup, Lewis, Mason, and Robertson. The local economic conditions in these market areas have a significant impact on the Company’s ability to originate loans, the ability of the borrowers to repay these loans and the value of the collateral securing these loans. A significant decline in the general economic conditions caused by inflation, recession, unemployment or other factors beyond the Company’s control would affect these local economic conditions and could adversely affect the Company’s financial condition and results of operations. Additionally, a significant decline in home values would likely lead to increased delinquencies and defaults in both the consumer home equity loan and residential real estate loan portfolios and result in increased losses in these portfolios.

New or Revised Tax, Accounting and Other Laws, Regulations, Rules and Standards Could Significantly Impact Strategic Initiatives, Results of Operations and Financial Condition

The financial services industry is highly regulated and laws and regulations may sometimes impose significant limitations on operations. These limitations, and sources of potential liability for the violation of such laws and regulations, are described in Item 1 of Part I of this report under the heading “Business — Regulatory Matters.” These regulations, along with the currently existing tax and accounting laws, regulations, rules and standards, control the methods by which financial institutions conduct business; implement strategic initiatives, as well as past, present, and contemplated tax planning; and govern financial disclosures. These laws, regulations, rules, and standards are constantly evolving and may change significantly over time. The nature, extent, and timing of the adoption of significant new laws, changes in existing laws, or repeal of existing laws may have a material impact on the Company’s results of operations and financial condition, the effects of which are impossible to predict at this time.



17
 

PREMIER FINANCIAL BANCORP, INC.
FORM 10-K
December 31, 2005


The Extended Disruption of Vital Infrastructure Could Negatively Impact the Company’s Results of Operations and Financial Condition

The Company’s operations depend upon, among other things, its technological and physical infrastructure, including its equipment and facilities. While disaster recovery procedures are in place, an extended disruption of its vital infrastructure by fire, power loss, natural disaster, telecommunications failure, computer hacking and viruses, terrorist activity or the domestic and foreign response to such activity, or other events outside of the Company’s control, could have a material adverse impact either on the financial services industry as a whole, or on the Company’s business, results of operations, and financial condition.

Strong Competition Within the Company’s Market Area May Limit Profitability

The Company faces significant competition both in attracting deposits and in the origination of loans, as described under the heading “Business — Competition.” Mortgage bankers, commercial banks, credit unions and other savings institutions, which have offices in the Bank’s market area have historically provided most of the Company’s competition for deposits; however, the Company also competes with financial institutions that operate through Internet banking operations throughout the continental United States. In addition, and particularly in times of high interest rates, the Company faces additional and significant competition for funds from money market and mutual funds, securities firms, commercial banks, credit unions and other savings institutions located in the same communities and those that operate through Internet banking operations throughout the continental United States. Many competitors have substantially greater financial and other resources than the Company. Moreover, credit unions do not pay federal or state income taxes and are subject to fewer regulatory constraints than community banks and as a result, they may enjoy a competitive advantage over the Company. The Banks compete for loans principally on the basis of the interest rates and loan fees they charge, the types of loans they originate and the quality of services they provide to borrowers. This advantage places significant competitive pressure on the prices of loans and deposits.

Loss of Large Checking and Money Market Deposit Customers Could Increase Cost of Funds and Have a Negative Effect on Results of Operations

The Company has a number of large deposit customers that maintain balances in checking, money market and repurchase agreement accounts at the Affiliate Banks. The ability to attract these types of deposits has a positive effect on the Company’s net interest margin as they provide a relatively low cost of funds to the Company compared to certificates of deposits or advances. If these depositors were to withdraw these funds and the Affiliate Banks were not able to replace them with similar types of deposits, the cost of funds would increase and the Company’s results of operation would be negatively impacted.


18
 

PREMIER FINANCIAL BANCORP, INC.
FORM 10-K
December 31, 2005


Extensive Regulation and Supervision

The Company, primarily through its Affiliate Banks, is subject to extensive federal and state regulation and supervision. Banking regulations are primarily intended to protect depositors’ funds, federal deposit insurance funds and the banking system as a whole, not shareholders. These regulations affect Premier’s lending practices, capital structure, investment practices, dividend policy and growth, among other things. The Company is also subject to a number of federal laws, which, among other things, require it to lend to various sectors of the economy and population, and establish and maintain comprehensive programs relating to anti-money laundering and customer identification. Congress and federal regulatory agencies continually review banking laws, regulations and policies for possible changes. Changes to statutes, regulations or regulatory policies, including changes in interpretation or implementation of statutes, regulations or policies, could affect Premier in substantial and unpredictable ways. Such changes could subject the Company to additional costs, limit the types of financial services and products it may offer and/or increase the ability of non-banks to offer competing financial services and products, among other things. Failure to comply with laws, regulations or policies could result in sanctions by regulatory agencies, civil money penalties and/or reputation damage, along with corrective action plans required by regulatory agencies, any of which could have a material adverse effect on the Company’s business, financial condition and results of operations. Premier is currently and certain of its Affiliate Banks have been in the past, subject to such corrective actions plans and therefore there may be some residual reputation damage within the regulatory agencies. While Premier has policies and procedures designed to prevent any such violations, there can be no assurance that such violations will not occur. See the “Regulatory Matters” section in Item 1, “Business” and Notes 3 and 12 to consolidated financial statements included elsewhere in this report.

Dividend payments by subsidiaries to Premier and by Premier to its shareholders can be restricted.

The Company’s principal source of funds for dividend payments, distributions on its Trust Preferred Securities and its debt service obligations 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 regula-tions, 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 and additional restrictions as discussed in Note 20 to the consolidated financial statements. During 2006 the Banks could, without prior approval, declare dividends of approximately $2.5 million plus any 2006 net profits retained to the date of the dividend declaration.


19
 

PREMIER FINANCIAL BANCORP, INC.
FORM 10-K
December 31, 2005


Allowance for Loan Losses May Be Insufficient

Premier, through the Affiliate Banks, maintains an allowance for loan losses based on, among other things, national and regional economic conditions, historical loss experience and delinquency trends. Premier believes that its allowance for loan losses is maintained at a level adequate to absorb any probable losses in its loan portfolio give the current information known to Management. These determinations are based upon estimates that are inherently subjective, and their accuracy depends on the outcome of future events. Therefore, Premier cannot predict loan losses with certainty and ultimate losses may differ from current estimates. Depending on changes in economic, operating and other conditions, including changes in interest rates, which are generally beyond its control, Premier’s actual losses could exceed its current allowance estimates. Premier can provide no assurance that its allowance is sufficient to cover all charge-offs in future periods. If charge-offs exceed Premier’s allowance, its earnings would decrease. In addition, regulatory agencies review Premier’s allowance for loan losses and may require additions to the allowance based upon their judgment about information available to them at the time of their examination. A required increase in Premier’s allowance for loan losses could reduce its earnings.

Claims and Litigation Pertaining to Fiduciary Responsibility

From time to time, customers make claims and take legal action pertaining to the Company’s and Affiliate Banks’ performance of their fiduciary responsibilities. If such claims and legal actions are not resolved in a manner favorable to the Banks they may result in financial liability and/or adversely affect the market perception of the Banks and their products and services as well as impact customer demand for those products and services. Any financial liability or reputation damage could have a material adverse effect on the Company’s business, which, in turn, could have a material adverse effect on its financial condition and results of operations

Inability to Hire and Retain Qualified Employees

The Company’s performance is largely dependent on the talents and efforts of highly skilled individuals and their ability to attract and retain customer relationships in a community bank environment. There is intense competition in the financial services industry for qualified employees. In addition, the Company faces increasing competition with businesses outside the financial services industry for the most highly skilled individuals. The Company’s business could be adversely affected if it were unable to retain and motivate its existing key employees and management team. Furthermore, the Company’s success may be impacted if it were unable to recruit replacement management and key employees in a reasonable amount of time.


20
 

PREMIER FINANCIAL BANCORP, INC.
FORM 10-K
December 31, 2005


Item 2. Properties
 
    The Company leases its principal executive offices located in Huntington, West Virginia. The Company also owns property located at 104 Jefferson Street, Brooksville, Kentucky, which serves as a branch for Citizen's Deposit Bank (formerly the Bank of Germantown). Except as noted, each of the Banks owns the real property and improvements on which their banking activities are conducted.
 
    Citizens Deposit Bank & Trust, in addition to its main office at 400 Second Street in Vanceburg, Kentucky, has four branch offices in Lewis County, Kentucky, (including one leased facility), one leased branch office in Mason County, Kentucky and the two former locations of the Bank of Germantown, one branch located on Highway 10 in Germantown, Kentucky, and one branch located in Bracken County, Kentucky. Farmers Deposit Bank, in addition to its main office at 5230 South Main Street in Eminence, Kentucky, has two branches in Henry County, Kentucky. Ohio River Bank, in addition to its main office at 221 Railroad Street in Ironton, Ohio, has two branches, one leased facility in Lawrence County, Ohio and one in Scioto County, Ohio. First Central Bank, in addition to its main office at 2 South Main Street in Philippi, West Virginia, has a branch located in Buckhannon, West Virginia. Boone County Bank, in addition to its main office at 300 State Street, Madison, West Virginia, has one leased branch located in Lincoln County, West Virginia and two other branches, one each located in Boone and Logan Counties, West Virginia.

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.
 
    The Securities and Exchange Commission ("SEC") investigated the information disclosed in Premier's June 16 and July 31, 2003 Forms 8-K and the June 30, and September 30, 2003 Forms 10-Q regarding Farmers Deposit and requested information about Premier's internal investigation. Premier fully cooperated with the SEC. At the conclusion of its investigation, the SEC issued an administrative cease & desist order regarding Premier’s financial reporting and internal controls concerning Premier’s quarterly 2001 through 2003 and annual 2001 and 2002 public filings. According to the SEC Order, both the remedial acts promptly undertaken by Premier and Premier’s cooperation with the SEC Staff were taken into consideration in reaching the settlement.

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.


21
 

PREMIER FINANCIAL BANCORP, INC.
FORM 10-K
December 31, 2005


PART II

Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
 
    The Company's common stock is listed on the NASDAQ National Market System under the symbol PFBI. At December 31, 2005, the Company had approximately 674 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
  
Sales Price
  
   
Dividends Paid
  
High
  
Low
  
2004
                    
First Quarter
  
$
-
  
$
9.49
  
$
8.31
  
Second Quarter
    
-
    
10.20
    
8.41
  
Third Quarter
    
-
    
10.28
    
8.50
  
Fourth Quarter
    
-
    
13.35
    
8.80
  
-
                    
                     
2005
                    
First Quarter
  
$
-
  
$
12.75
  
$
10.78
  
Second Quarter
    
-
    
13.00
    
10.00
  
Third Quarter
    
-
    
14.93
    
11.90
  
Fourth Quarter
    
-
    
15.98
    
12.66
  
-
                    
                     
2006
                    
First Quarter (through March 15, 2006)
  
$
-
  
$
16.44
  
$
14.01
  

 
    The Board of Directors suspended the payment of dividends during the second quarter of 2000. In September 2000, as a result of an agreement entered into with the Federal Reserve, the Company agreed not to declare additional dividends without the prior approval of the Federal Reserve. The September 2000 agreement was superceded by a January 29, 2003 written agreement between Premier and the Federal Reserve which continued the restriction on dividends. The Board of Directors anticipates paying dividends at some future date when, in its discretion, financial prudence allows and the Federal Reserve concurs in the payment of such dividends. The January 29, 2003 agreement also restricts Premier's payments of dividends on its PFBI Capital Trust preferred securities. These dividends are cumulative and all deferred distributions must be paid before dividends may be paid to holders of common shares. Even if the Company is able to resume the payment of dividends, there can be no assurance that the amount of the dividends will be what the Company paid before the payment of dividends was suspended.


22
 

PREMIER FINANCIAL BANCORP, INC.
FORM 10-K
December 31, 2005


The payment of dividends by the Company depends 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, 2005 approximately $2.5 million was available for payment as dividends from the Banks to the Company without the need for regulatory approval. 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. See "REGULATORY MATTERS - Capital Requirements" for discussion on capital guidelines.



23
 

PREMIER FINANCIAL BANCORP, INC.
FORM 10-K
December 31, 2005


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 data presented below reflects separately the impact of discontinued operations as more fully described in Note 2 to the consolidated financial statements.
(Dollars in thousands, except per share amounts)
  
At or for the Year Ended December 31
  
   
2005
  
2004
  
2003
  
2002
  
2001
  
Earnings
                      
Net interest income
  
$
19,852
  
$
18,064
  
$
19,182
  
$
20,838
  
$
20,931
  
Provision for loan losses
    
4
    
1,026
    
20,513
    
9,453
    
8,350
  
Non-interest income
    
3,920
    
3,606
    
4,064
    
2,717
    
12,178
  
Non-interest expense
    
17,305
    
17,782
    
17,632
    
17,831
    
20,200
  
Income taxes (benefit)
    
2,029
    
899
    
(5,282
)
  
(1,522
)
  
2,985
  
Income (loss) from continuing operations
    
4,434
    
1,963
    
(9,617
)
  
(2,207
)
  
1,574
  
Income (loss) from discontinued operations
    
-
    
4,734
    
(80
)
  
(1,130
)
  
(380
)
Net income (loss)
  
$
4,434
  
$
6,697
  
$
(9,697
)
$
(3,337
)
$
1,194
  
                                 
Financial Position
                                
Total assets of continuing operations
  
$
528,324
  
$
537,255
  
$
543,229
  
$
590,868
  
$
606,961
  
Total assets of discontinued operations
    
-
    
-
    
79,163
    
84,406
    
104,653
  
Loans, net of unearned income
    
328,717
    
324,937
    
331,794
    
373,099
    
384,940
  
Allowance for loan losses
    
7,892
    
9,384
    
14,300
    
9,698
    
7,371
  
Goodwill and other intangibles
    
15,816
    
15,816
    
15,816
    
15,816
    
15,816
  
Securities
    
137,419
    
153,892
    
147,646
    
144,698
    
143,516
  
Deposits
    
435,843
    
437,798
    
455,474
    
477,724
    
480,991
  
Other borrowings
    
19,053
    
20,536
    
18,307
    
32,600
    
43,724
  
Subordinated debentures
    
15,722
    
20,876
    
26,546
    
29,639
    
29,639
  
Stockholders’ equity
    
54,287
    
51,029
    
45,540
    
56,124
    
58,750
  
                                 
Share Data
                                
Income (loss) from continuing operations - basic
  
$
0.85
  
$
0.37
  
$
(1.84
)
$
(0.42
)
$
0.30
  
Income (loss) from continuing operations - diluted
    
0.84
    
0.37
    
(1.84
)
  
(0.42
)
  
0.30
  
Net income - basic
    
0.85
    
1.28
    
(1.85
)
  
(0.64
)
  
0.23
  
Net income - diluted
    
0.84
    
1.28
    
(1.85
)
  
(0.64
)
  
0.23
  
Book value
    
10.37
    
9.75
    
8.70
    
10.73
    
11.23
  
Cash dividends
    
0.00
    
0.00
    
0.00
    
0.00
    
0.00
  
                                 
Ratios
                                
Return on average assets (1), (2)
    
0.82
%
  
0.36
%
  
(1.66
)%
  
(0.37
)%
  
0.24
%
Return on average equity (2)
    
8.42
%
  
4.06
%
  
(18.46
)%
  
(3.77
)%
  
2.76
%
Dividend payout (2)
    
0.00
%
  
0.00
%
  
0.00
%
  
0.00
%
  
0.00
%
Stockholders’ equity to total assets at period-end (3)
    
10.28
%
  
9.50
%
  
8.38
%
  
9.50
%
  
9.68
%
Average stockholders’ equity to average total assets (1)
    
9.77
%
  
8.23
%
  
7.88
%
  
8.44
%
  
7.37
%
                                 
(1) Computed based on average assets from continuing operations
(2) Computed based on income (loss) from continuing operations
(3) Shareholders’ equity at period-end divided by assets from continuing operations
                                 
 


24
 

PREMIER FINANCIAL BANCORP, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS
December 31, 2005


Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations.

INTRODUCTION
   
    Premier Financial Bancorp, Inc. ("Premier") is a multi-bank holding company headquartered in Huntington, West Virginia. It operates five community bank subsidiaries ranging in size from $80 million to $149 million, each with a local community name and orientation. On July 1, 2004, Premier sold one bank subsidiary, Citizens Bank (Kentucky), Inc. ("Citizens Bank"). As such, and in accordance with Financial Accounting Standard 144, "Accounting for the Impairment or Disposal of Long-lived Assets", which became effective for the Company on January 1, 2002, the financial position and results of operations of Citizens Bank are removed from the detail line items in the Company's consolidated financial statements and this Management's Discussion and Analysis, and are presented separately as "discontinued operations." Premier realized a net profit on the sale of Citizens Bank of $4.7 million which is included in the income from discontinued operations. See Note 2 to the consolidated financial statements presented separately in this annual report for additional information concerning discontinued operations. The remaining banks operate in twenty communities within the states of West Virginia, Ohio and Kentucky and provide their customers with a full range of banking services. On January 3, 2005, Premier merged two of its banks, Citizen's Deposit Bank and Bank of Germantown. Premier is also the parent of a data processing subsidiary which is currently inactive. Prior to Premier’s conversion to an outsourced data services provider in the second quarter of 2005, the data processing subsidiary provided the data processing and management services for four of Premier's affiliate banks and one other non-affiliated bank. As of December 31, 2005, Premier had approximately $528 million in total assets, $329 million in total loans and $436 million in total deposits.
 
    The accompanying consolidated financial statements have been prepared by the management of Premier in conformity with accounting principles generally accepted in the United States of America. The audit committee of the Board of Directors engaged Crowe Chizek and Company LLC independent auditors, to audit the consolidated financial statements, and their report is included elsewhere herein. Financial information appearing throughout this annual report is consistent with that reported in the consolidated financial statements. The following discussion is designed to assist readers of the consolidated financial statements in understanding significant changes in Premier's financial condition and results of operations.
 
    Management's objective of a fair presentation of financial information is achieved through a system of internal accounting controls. The financial control system of Premier is designed to provide reasonable assurance that assets are safeguarded from loss and that transactions are properly authorized and recorded in the financial records. As an integral part of that financial control system, the audit committee of the Board of Directors engaged Arnett & Foster, CPA's in 2004, and 2003 to perform internal audits of the financial records of each of the


25
 

PREMIER FINANCIAL BANCORP, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS
December 31, 2005


subsidiaries on a periodic basis. Their findings and recommendations were reported to Premier’s audit committee as well as the audit committees of the subsidiaries. In 2005, Premier reduced its reliance on third-party internal audit and loan review providers and expanded its internal audit staff at the holding company level. Likewise, their findings and recommendations are reported to Premier's audit committee as well as the audit committees of the subsidiaries. Also, on a regular periodic basis, the subsidiary banks are examined by Federal and State banking authorities for safety and soundness as well as compliance with applicable banking laws and regulations. The activities of both the internal and external audit functions are reviewed by the audit committee of the Board of Directors.


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, collect delinquent loans and attract and retain deposits, the impact of Premier's growth or lack thereof, 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.


CRITICAL ACCOUNTING POLICIES

General
 
    The financial condition and results of operations presented in the Consolidated Financial Statements, accompanying Notes to the Consolidated Financial Statements and management's discussion and analysis are, to a large degree, dependent upon our accounting policies. The selection and application of these accounting policies involve judgments, estimates, and uncertainties that are susceptible to change.

Presented below is a discussion of those accounting policies that management believes are the most important to the presentation and understanding of our financial condition and results of operations. These critical accounting policies require management's most difficult, subjective and complex judgments about matters that are inherently uncertain. In the event that different assumptions or conditions were to prevail, and depending upon the severity of such changes, the possibility of materially different financial condition or results of operations is a reasonable likelihood. See also Note 1 of the accompanying consolidated financial statements presented elsewhere in this annual report.

 
26
 

PREMIER FINANCIAL BANCORP, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS
December 31, 2005


Allowance for Loan Losses
    
    The Company monitors and maintains an allowance for loan losses to absorb an estimate of probable incurred losses inherent in the loan portfolio. The Company maintains policies and procedures that address the systems of control over the following areas of maintenance of the allowance: the systematic methodology used to determine the appropriate level of the allowance to provide assurance that the allowance for loan losses is maintained in accordance with accounting principles generally accepted in the United States of America; the accounting policies for loan charge-offs and recoveries; the assessment and measurement of impairment in the loan portfolio; and the loan grading system.
 
    The Company evaluates various loans individually for impairment as required by Statement of Financial Accounting Standard (SFAS) No. 114, Accounting by Creditors for Impairment of a Loan, and SFAS No. 118, Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosures. Loans evaluated individually for impairment include non-performing loans, such as loans on non-accrual, loans past due 90 days or more, restructured loans and other loans selected by management including loans graded as substandard or doubtful by the internal credit review process. The evaluations are based upon discounted expected cash flows or collateral valuations. If the evaluation shows that a loan is individually impaired, then a specific reserve is established for the amount of impairment. If a loan evaluated individually is not impaired, then the loan is assessed for impairment under SFAS No. 5, Accounting for Contingencies (SFAS 5), with a group of loans that have similar characteristics.
 
    For loans without individual measures of impairment, the Company makes estimates of losses for groups of loans as required by SFAS 5. Loans are grouped by similar characteristics, including the type of loan, the assigned loan grade and the general collateral type. A loss rate reflecting the expected loss inherent in a group of loans is derived based upon estimates of default rates for a given loan grade, the predominant collateral type for the group and the terms of the loan. The resulting estimate of losses for groups of loans are adjusted for relevant environmental factors and other conditions of the portfolio of loans, including: borrower and industry concentrations; levels and trends in delinquencies, charge-offs and recoveries; changes in underwriting standards and risk selection; level of experience, ability and depth of lending management; and national and local economic conditions.

The amount of estimated impairment for individually evaluated loans and groups of loans is added together for a total estimate of probable incurred loan losses. This estimate of losses is compared to the allowance for loan losses of the Company as of the evaluation date and, if the estimate of losses exceeds the allowance, an additional provision to the allowance would be made. If the estimate of losses is less than the allowance, the degree to which the allowance exceeds the estimate is evaluated to determine whether the allowance falls outside a range of estimates. If the estimate of losses were below the range of reasonable estimates, the


27
 

PREMIER FINANCIAL BANCORP, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS
December 31, 2005


allowance would be reduced by way of a credit to the provision for loan losses. The Company recognizes the inherent imprecision in estimates of losses due to various uncertainties and variability related to the factors used, and therefore a reasonable range around the estimate of losses is derived and used to ascertain whether the allowance is too high. If different assumptions or conditions were to prevail and it is determined that the allowance is not adequate to absorb the new estimate of probable incurred losses, an additional provision for loan losses would be made, which amount may be material to the Consolidated Financial Statements.

Impairment of Goodwill
 
    As required by applicable accounting guidance, goodwill is evaluated at least annually to determine if the amount recorded on the Company's balance sheet is impaired. If goodwill is determined to be impaired, the recorded amount would be reduced to estimated fair value by a charge to expense in the period in which impairment is determined. Impairment is evaluated in the aggregate for all of the Company's banking operations. Operating characteristics of the aggregate banking operations are derived and compared to a database of peer group banks that have been sold. Pricing valuation factors that are considered in estimating the fair value of the Company's aggregate banking operations include price-to-total assets, price-to-total book value, price-to-deposits and price-to earnings. Unusual events that have impacted the operating characteristics of the Company's aggregate banking operations are considered to assess the likelihood of recurrence and adjustments to historical performance may be made. Changes in assumptions regarding the likelihood of unusual historical events recurring or the use of different pricing valuation factors could have a material impact on management's impairment analysis.

Realization of Deferred Tax Assets
 
    Deferred tax assets and liabilities are the expected future tax amounts for the temporary differences between carrying amounts and tax bases of assets and liabilities, computed using enacted tax rates. A valuation allowance, if needed, reduces deferred tax assets to the amount expected to be realized. Deferred tax assets for the Company primarily relate to the allowance for loan losses and net operating loss carryforwards. In considering the need for a valuation allowance to reduce deferred tax assets to the amount expected to be realized, management considers the amount of previously paid taxes that may be recoverable and the likelihood of generating sufficient future taxable income to fully utilize expected future tax deductions. At December 31, 2005 management's consideration of the need for a valuation allowance focused on the generation of future taxable income as all available previously paid taxes were recovered from the operating loss reported in 2003. In determining the likelihood of generating future taxable income management considered unusual events that have impacted the Company's historical earnings and whether these events will recur, the Company's operating budget and likely operating results in the near term. Changes in these assumptions could impact the carrying value of deferred tax assets and require a charge to tax expense.


28
 

PREMIER FINANCIAL BANCORP, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS
December 31, 2005


SIGNIFICANT EVENT ARISING IN 2003
 
    On June 16, 2003, Premier announced that as a result of an ongoing internal investigation it had uncovered a systematic disregard for its loan approval and credit administration policies at its wholly owned subsidiary Farmers Deposit Bank and had accepted the resignation of the bank's president. On June 4, 2003, senior management of Premier received from the bank's former president a request to charge-off over $2.0 million in loans. Concerned about the magnitude of the request and the impact on Premier's financial results, Premier management promptly notified the Federal Reserve Bank of Cleveland and the Federal Deposit Insurance Corporation ("FDIC") about the request. Premier's initial investigation indicated that the former president of Farmers Deposit had engaged in conduct which subverted the bank's internal controls and credit administration policies, conduct which appears to have been designed to avoid detection by management and those entities employed by Premier to perform independent reviews of its subsidiaries' accounting records, internal controls, and credit risk.
 
    As a result of the investigation into the conduct of the former president of Farmers Deposit by Premier and the FDIC, Premier charged-off over $17.2 million of loans. The resulting depletion of the allowance for loan losses together with the analysis of additional risk in the loan portfolio warranted significant additional provisions for loan losses at the Bank. In addition to the provision for loan losses, interest income reversals and other non-interest expenses, including bad check write-offs and loan review expenses, were recorded.
    
    Premier's management, with the assistance of outside independent professionals, conducted a further review of those loans for which significant charge offs or additional provisions were required in 2003. The purpose of the review was to determine if the facts or circumstances that gave rise to the additional charge offs or provisions had been improperly withheld from senior management or improperly considered in applying management's estimates and judgments as to the adequacy of the allowance for loan losses in prior financial statement periods. The review did identify instances in which collateral securing loans had been released without proper support or notation in loan files, instances in which obligors on notes had been released from their repayment obligation without proper support or notation in loan files and instances in which delinquent loan reporting systems had been manipulated to prevent problem loans from being identified on a timely basis. Premier's senior management determined that if these circumstances had been considered in evaluating the adequacy of the allowance for loan losses in prior periods then some of the loan charge offs and additional provisions for loan losses recorded in 2003 should have been reflected in prior periods. Therefore, in 2003, the financial statements for 2002 and 2001 were restated to reflect the financial statement effect of the matters that occurred in those periods but which were improperly concealed by subsidiary management.




29
 

PREMIER FINANCIAL BANCORP, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS
December 31, 2005


On December 24, 2003, Premier announced that Farmers Deposit Bank had reached an agreement with the Federal Deposit Insurance Corporation ("FDIC") and the Kentucky Department of Financial Institutions ("KDFI") [collectively referred to as "Supervisory Authorities"] to consent to the issuance of a cease & desist order ("Order") from its Supervisory Authorities. The Order also outlined a number of steps to be taken by Farmers Deposit which were designed to remedy and/or prevent the reoccurrence of events that gave rise to the investigation during the latter half of 2003. The full text of the Order is available on the FDIC website at www.fdic.gov or by calling the FDIC Public Information Center at (877) 275-3342. Having found that Farmers Deposit had fully complied with the Order, the Supervisory Authorities rescinded the Order on December 13, 2005.

The Securities and Exchange Commission ("SEC") investigated the information disclosed in Premier's June 16 and July 31, 2003 Forms 8-K and the June 30, and September 30, 2003 Forms 10-Q regarding Farmers Deposit and requested information about Premier's internal investigation. Premier fully cooperated with the SEC. At the conclusion of its investigation, the SEC issued an administrative cease & desist order regarding Premier’s financial reporting and internal controls concerning Premier’s quarterly 2001 through 2003 and annual 2001 and 2002 public filings. According to the SEC Order, both the remedial acts promptly undertaken by Premier and Premier’s cooperation with the SEC Staff were taken into consideration in reaching the settlement.


SUMMARY FINANCIAL RESULTS
 
    Premier had net income from continuing operations of $4.434 million in 2005 compared to a $1.963 million of net income from continuing operations reported for the year 2004. Net income increased in 2005 as a result of an increase in interest income due to higher yields on earning assets; a decrease in interest expense due to the early retirement of Trust Preferred Securities; a significant decrease in the provision for loan losses; and a reduction in the net operating costs of the company. Net income in 2004 was primarily the result of the continued earnings of Premier's profitable banks partially offset by expenses associated with rehabilitating its subsidiary, Farmers Deposit Bank, conducting Premier's own investigation, cooperating with the SEC investigation, and reducing debt at the holding company. The income in 2004 follows a $9.6 million loss in 2003 primarily due to large provisions for loan losses and bad check losses at Farmers Deposit Bank. Basic earnings per share from continuing operations were $0.85 in 2005 compared to $0.37 in 2004 and a loss of ($1.84) in 2003.
 
    The following table comparatively illustrates the components of ROA and ROE over the previous five years. Return on average assets (ROA) measures how effectively Premier utilizes its assets to produce net income. Premier's net income in 2005 resulted in an ROA of 0.82%, an increase over the 0.36% ROA in 2004 and the (1.66)% net loss ROA reported in 2003. As shown in the table, fully taxable equivalent net interest income (as a percent of average earning assets)


30
 

PREMIER FINANCIAL BANCORP, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS
December 31, 2005


reached its highest level in five years in 2005 at 4.00%. The net losses in 2003 and 2002 were primarily the result of an increase in the provision for loan losses, resulting in negative net credit income for those years. In 2004, net credit income was once again positive and in 2005. In 2005, minimal provisions for loan losses were recorded and thus there was little reduction from net interest income. This increase in net credit income (as a percent of average earning assets) was complemented by the highest level of non-interest income (as a percent of average earning assets) over the past five years and a reduction in non-interest expenses (as a percent of average earning assets) when compared to the previous year. As illustrated in the table, Premier's 2005 fully taxable net interest income as a percent of average earning assets was up to 4.00% from the 3.61% recorded in 2004 as the yield on loans and investments increased in 2005 while interest expense savings were realized due to the early extinguishment of a portion of Premier’s junior subordinated debentures and other borrowed funds late in 2004.


ANALYSIS of RETURN ON ASSETS and EQUITY
  
from continuing operations
  
                       
   
2005
  
2004
  
2003
  
2002
  
2001
  
As a percent of average earning assets
                      
Fully taxable-equivalent net interest income
    
4.00
%
  
3.61
%
  
3.63
%
  
3.84
%
  
3.50
%
Provision for loan losses
    
(0.00
)
  
(0.20
)
  
(3.81
)
  
(1.70
)
  
(1.37
)
Net credit income
    
4.00
    
3.41
    
(0.18
)
  
2.14
    
2.13
  
Gains on the sales of assets & subsidiaries
    
0.00
    
0.02
    
0.11
    
(0.01
)
  
1.48
  
Non-interest income
    
0.78
    
0.69
    
0.62
    
0.50
    
0.52
  
Non-interest expense
    
(3.46
)
  
(3.52
)
  
(3.26
)
  
(3.21
)
  
(3.30
)
Tax equivalent adjustment
    
(0.03
)
  
(0.03
)
  
(0.07
)
  
(0.08
)
  
(0.08
)
Applicable income taxes
    
(0.41
)
  
(0.18
)
  
0.98
    
0.27
    
(0.49
)
Return on average earning assets
    
0.88
    
0.39
    
(1.79
)
  
(0.40
)
  
0.26
  
Multiplied by average earning assets to
average total assets
    
92.84
    
92.39
    
92.86
    
92.34
    
91.98
  
Return on average assets
    
0.82
%
  
0.36
%
  
(1.66
)%
  
(0.37
)%
  
0.24
%
Multiplied by average assets to
average equity
    
10.23X
    
11.33X
    
11.13X
    
10.26X
    
11.68X
  
Return on average equity
    
8.42
%
  
4.06
%
  
(18.46
)%
  
(3.77
)%
  
2.76
%
                                 
 
    The net overhead ratio (non-interest expense less non-interest income as a percent of average earning assets) decreased in 2005 to 2.68% compared to 2.83% in 2004 and 2.64% in 2003, the lowest ratio reported in the five years presented in the table. The decrease in 2005 net overhead was the result of increases in Premier’s non-interest income related to service charges on deposit accounts and secondary market mortgage commissions plus a significant decrease in professional fee expense. The increase in 2004 net overhead was the result of increases in non-interest expense related to the investigation of Farmers Deposit Bank, the loss on the sale of facilities formerly leased to Citizens Bank (which was sold in 2004), and accelerated amortization costs related to the early redemption of Premier's Trust Preferred Securities.


31
 

PREMIER FINANCIAL BANCORP, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS
December 31, 2005


Return on average equity (ROE), another measure of earnings performance, indicates the amount of net income earned in relation to the total equity invested. Premier's 2005 ROE was 8.43%, compare to 4.06% realized in 2004 and (18.46%) reported in 2003. ROE increased primarily due the increase in net income reported in 2005 versus 2004 and the operating losses reported for 2003.

A breakdown of Premier's financial results by quarter for the years ended December 31, 2005 and 2004 is summarized below.


QUARTERLY FINANCIAL INFORMATION
  
(Dollars in thousands, except per share amounts)
  
   
First
  
Second
  
Third
  
Fourth
  
Full Year
  
2005
                      
Interest income
  
$
7,045
  
$
7,172
  
$
7,465
  
$
7,717
  
$
29,399
  
Interest expense
    
2,318
    
2,279
    
2,410
    
2,540
    
9,547
  
Net interest income
    
4,727
    
4,893
    
5,055
    
5,177
    
19,852
  
Provision for loan losses
    
243
    
191
    
(140
)
  
(290
)
  
4
  
Securities gains
    
0
    
0
    
0
    
0
    
0
  
Net overhead
    
3,327
    
3,660
    
3,189
    
3,209
    
13,385
  
Income before income taxes
    
1,157
    
1,042
    
2,006
    
2,258
    
6,463
  
Income from continuing operations
    
803
    
727
    
1,367
    
1,537
    
4,434
  
Income (loss) from discontinued operations
    
0
    
0
    
0
    
0
    
0
  
Net income
    
803
    
727
    
1,367
    
1,537
    
4,434
  
Basic net income per share from continuing operations
    
0.15
    
0.14
    
0.26
    
0.29
    
0.85
  
Diluted net income per share from continuing operations
    
0.15
    
0.14
    
0.26
    
0.29
    
0.84
  
Basic net income per share
    
0.15
    
0.14
    
0.26
    
0.29
    
0.85
  
Diluted net income per share
    
0.15
    
0.14
    
0.26
    
0.29
    
0.84
  
Dividends paid per share
    
0.00
    
0.00
    
0.00
    
0.00
    
0.00
  
                                 
2004
                                
Interest income
  
$
7,055
  
$
6,926
  
$
6,951
  
$
7,189
  
$
28,121
  
Interest expense
    
2,609
    
2,528
    
2,533
    
2,387
    
10,057
  
Net interest income
    
4,446
    
4,398
    
4,418
    
4,802
    
18,064
  
Provision for loan losses
    
135
    
374
    
162
    
355
    
1,026
  
Securities gains
    
10
    
0
    
0
    
90
    
100
  
Net overhead
    
3,626
    
3,337
    
3,599
    
3,714
    
14,276
  
Income before income taxes
    
695
    
687
    
657
    
823
    
2,862
  
Income from continuing operations
    
485
    
474
    
448
    
559
    
1,963
  
Income (loss) from discontinued operations
    
29
    
(25
)
  
4,730
    
0
    
4,734
  
Net income
    
514
    
449
    
5,178
    
559
    
6,697
  
Basic and diluted net income per share from continuing operations
    
0.09
    
0.09
    
0.08
    
0.11
    
0.37
  
Basic and diluted net income per share
    
0.09
    
0.09
    
0.98
    
0.11
    
1.28
  
Dividends paid per share
    
0.00
    
0.00
    
0.00
    
0.00
    
0.00
  


32
 

PREMIER FINANCIAL BANCORP, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS
December 31, 2005


SALE OF SUBSIDIARIES
    
    In 2000 Premier suspended its acquisition strategy in order to focus on improving its subsidiary bank operations by strengthening its management oversight. As part of this change in strategy, Premier elected to dispose of two of its subsidiary banks in 2001.
 
    On January 26, 2001, the company disposed of all the deposits (approximately $110 million), the majority of loans (approximately $92 million) and the premises and equipment (approximately $1.6 million) of the Bank of Mt. Vernon under the terms of a Purchase and Assumption Agreement. As a result of this transaction, the banking charter of the Bank of Mt. Vernon was relinquished and Premier agreed not to compete in the markets previously served by the Bank of Mt. Vernon.
 
    Also, on December 10, 2001, the Company disposed of certain assets and liabilities of The Sabina Bank. The sale included all the loans (approximately $31 million) and all the deposits (approximately $41 million), as well as the premises and equipment (approximately $1.2 million). Certain assets of the bank were retained by Premier pending liquidation of the bank, which occurred in 2002. The operating results of both the Bank of Mount Vernon and The Sabina Bank were included in Premier's 2001 operating results through the respective dates of the sale. However, the operating results subsequent to 2001 do not include any of the operations of these two banks. Comparisons of average balances and income statement categories to 2001 are all affected by the disposition of these two subsidiaries.

In the fourth quarter of 2003, Premier adopted and began to implement a plan to sell its subsidiary Citizens Bank (Kentucky), Inc. ("Citizens Bank") located in Georgetown, Kentucky. On February 13, 2004, the Company announced that it had signed a definitive agreement to sell Citizens Bank in a cash transaction valued at approximately $14,500,000, which was completed on July 1, 2004. The sale of this subsidiary helped to restore the financial position of Premier after the impact of the losses sustained at Farmers Deposit Bank during the second and third quarters of 2003. As a result of the sale, regulatory capital ratios of Premier were restored to the stronger levels management wishes to maintain; cash reserves of the holding company were replenished; a portion of the cash reserves were used to reduce outstanding debt by $9.4 million; and the profit from the sale allowed Premier to utilize a substantial portion of its Federal income tax net operating loss carryforward.



33
 

PREMIER FINANCIAL BANCORP, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS
December 31, 2005


BALANCE SHEET ANALYSIS

Summary
 
    A financial institution's primary sources of revenue are generated by its earning assets, while its major expenses are produced by the funding of these assets with interest bearing liabilities. Effective management of these sources and uses of funds is essential in attaining a financial institution's optimal profitability while maintaining a minimum amount of interest rate risk and credit risk. Information on rate-related sources and uses of funds for each of the three years in the period ended December 31, 2005, is provided in the table below.




34
 

PREMIER FINANCIAL BANCORP, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS
December 31, 2005


AVERAGE CONSOLIDATED BALANCE SHEETS AND NET INTEREST INCOME ANALYSIS
  
(Dollars in thousands)
  
   
2005
  
2004
  
2003
  
   
Average
Balance
  
Interest (2)
  
Yield/
Rate (3)
  
Average
Balance
  
Interest (2)
  
Yield/
Rate (3)
  
Average
Balance
  
Interest (2)
  
Yield/
Rate (3)
  
Assets:
                                      
Interest earning assets
                                                        
U.S. Treasury and federal agency securities
  
$
107,177
  
$
3,278
    
3.06
%
$
112,260
  
$
3,117
    
2.78
%
$
102,856
  
$
3,924
    
2.84
%
States and municipal obligations (1)
    
2,666
    
153
    
5.74
    
4,941
    
338
    
6.84
    
15,589
    
1,015
    
6.51
  
Mortgage backed securities
    
37,050
    
1,583
    
4.27
    
29,803
    
1,183
    
3.97
    
16,757
    
585
    
3.49
  
Other securities
    
3,089
    
148
    
4.79
    
3,216
    
138
    
4.29
    
7,613
    
342
    
4.49
  
Total investment securities
    
149,982
    
5,162
    
3.44
    
150,220
    
4,776
    
3.18
    
142,815
    
4,866
    
3.41
  
Federal funds sold
    
23,083
    
745
    
3.23
    
29,369
    
380
    
1.29
    
42,844
    
469
    
1.09
  
Interest-bearing deposits with banks
    
436
    
12
    
2.66
    
256
    
6
    
2.57
    
568
    
7
    
1.23
  
Loans, net of unearned income (4)(5)
                                                        
Commercial
    
147,398
    
10,291
    
6.98
    
132,785
    
8,913
    
6.71
    
142,768
    
9,944
    
6.97
  
Real estate mortgage
    
132,527
    
9,236
    
6.97
    
145,387
    
10,182
    
7.00
    
151,210
    
11,538
    
7.63
  
Installment
    
46,690
    
4,083
    
8.74
    
47,438
    
4,029
    
8.49
    
58,178
    
5,293
    
9.10
  
Total loans
    
326,615
    
23,610
    
7.23
    
325,610
    
23,124
    
7.10
    
352,156
    
26,775
    
7.60
  
Total interest earning assets
    
500,116
    
29,529
    
5.90
    
505,455
    
28,286
    
5.60
    
538,383
    
32,117
    
5.97
  
Allowance for loan losses
    
(8,998
)
              
(11,413
)
              
(12,704
)
            
Cash and due from banks
    
13,619
                
13,837
                
13,400
              
Premises and equipment
    
7,256
                
7,738
                
8,233
              
Other assets
    
26,697
                
31,490
                
32,474
              
Assets of discontinued operations
    
-
                
39,762
                
81,821
              
Total assets
  
$
538,690
              
$
586,869
              
$
661,607
              
                                                         
Liabilities and Equity:
                                                        
Interest bearing liabilities
                                                        
NOW and money market
  
$
142,501
    
1,409
    
0.99
%
$
158,169
    
1,290
    
0.82
%
$
180,763
    
2,045
    
1.13
%
Savings deposits
    
59,365
    
412
    
0.69
    
62,518
    
521
    
0.83
    
57,327
    
781
    
1.36
  
Certificates of deposit and other time deposits
    
174,057
    
4,904
    
2.82
    
164,932
    
4,455
    
2.70
    
182,542
    
5,677
    
3.11
  
Total interest bearing deposits
    
375,923
    
6,725
    
1.79
    
385,619
    
6,266
    
1.62
    
420,632
    
8,503
    
2.02
  
Short-term borrowings
    
8,422
    
180
    
2.14
    
6,539
    
118
    
1.80
    
4,675
    
51
    
1.09
  
Other borrowings
    
1,586
    
14
    
0.88
    
5,306
    
248
    
4.67
    
8,350
    
379
    
4.54
  
FHLB advances
    
8,775
    
499
    
5.69
    
9,955
    
556
    
5.59
    
15,852
    
826
    
5.21
  
Debentures
    
20,480
    
2,129
    
10.40
    
25,397
    
2,869
    
11.30
    
27,253
    
2,788
    
10.23
  
Total interest-bearing liabilities
    
415,186
    
9,547
    
2.30
%
  
432,816
    
10,057
    
2.32
%
  
476,762
    
12,547
    
2.63
%
Non-interest bearing deposits
    
66,848
                
62,486
                
53,824
              
Other liabilities
    
4,007
                
7,393
                
4,903
              
Liabilities of discontinued operations
    
-
                
35,876
                
74,021
              
Shareholders’ equity
    
52,649
                
48,298
                
52,097
              
Total liabilities and equity
  
$
538,690
              
$
586,869
              
$
661,607
              
                                                         
Net interest earnings (1)
        
$
19,982
              
$
18,229
              
$
19,570
        
Net interest spread (1)
                
3.60
%
              
3.27
%
              
3.33
%
Net interest margin (1)
                
4.00
%
              
3.61
%
              
3.63
%
                                                         
(1) Taxable - equivalent yields are calculated assuming a 34% federal income tax rate
(2) Excludes the interest income and interest expense of discontinued operations
(3) Yields are calculated on historical cost except for yields on marketable equity securities that are calculated used fair value
(4) Includes loan fees, immaterial in amount, in both interest income and the calculation of yield on loans
(5) Includes loans on non-accrual status



35
 

PREMIER FINANCIAL BANCORP, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS
December 31, 2005


In 2005, average earning assets declined by 1.0% or $5.3 million from 2004, following a 6.1% or $32.9 million decline in 2004 from 2003. Average interest bearing liabilities, the primary source of funds supporting the earning assets, decreased 4.1% or $17.6 million in 2005 from 2004, which follows a 9.1% or $43.1 million decline in 2004 from 2003. The 2005 decline in average earning assets was primarily the result of a decline in federal funds sold as those funds were either used to fund loans or to continue the company’s debt reduction strategy. The decline in 2005 average interest bearing liabilities was due to a $9.7 million decrease in average interest bearing deposits and a $6.1 million decrease in average high cost debt and FHLB advances. Nearly half of the decrease in average interest bearing deposit was offset by a $4.4 million increase in non-interest bearing deposits. The decline in 2004 average earning assets was the result of the residual effect of the $16.5 million of loan charge-offs in 2003, the $7.0 million of loan charge-offs in 2004 (primarily at Farmers Deposit in both years), coupled with loan maturities and principal pay downs that were not renewed and the redeployment of other available funds to reduce debt. The decline in interest bearing liabilities was largely due to debt reduction strategies, a continued shift in customer deposits from interest bearing to non-interest bearing, and the non-renewal of certain certificates of deposit at Farmers Deposit Bank in conjunction with Premier's capital restoration plan for that Bank. Additional information on each of the components of earning assets and interest bearing liabilities is contained in the following sections of this report.

Loan Portfolio
 
    Premier's loan portfolio is its largest and highest yielding component of average earning assets, totaling 65.3% of average earning assets during 2005. After several declining years, average loans increased in 2005 by $1.0 million or 0.3%. The marginal increase is largely attributable to the high level of charge-offs and loan collections at Farmers Deposit which nearly offset the increase in loans in Premier’s other markets. The average loans outstanding at Farmers Deposit declined by $14.8 million in 2005. Of the remaining increase, Premier realized an $11.2 million or 7.7% increase in loans in its West Virginia markets, a $2.1 million or 4.7% increase in loans in its Ohio markets, and a $2.5 million or 3.3% increase in average loans in Premier's other Kentucky markets. In 2004, average loans declined by $26.5 million or 7.5%. The decline is again largely attributable to the high level of charge-offs and loan collections at Farmers Deposit. The average loans outstanding at Farmers Deposit declined by $30.5 million in 2004, $4.0 million more than Premier's total decline of $26.5 million. Of the remaining increase, Premier realized a 6.0% increase in loans in its West Virginia markets and an 11.1% increase in loans in its Ohio markets. These increases were partially offset by a 10.0% decline in average loans in Premier's other Kentucky markets. Due to the low interest rate environment in 2003 and 2004, many borrowers sought to refinance their loans to reduce their interest costs. Due to the lackluster economy and the resulting lower demand for loans during much of that time, larger banks began competing more strongly by enticing borrowers with prime rate or below prime rate loans. Therefore, scheduled loan maturities were not necessarily renewed with Premier.


36
 

PREMIER FINANCIAL BANCORP, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS
December 31, 2005


Total loans at December 31, 2005 increased by $3.8 million or 1.2% from the total at December 31, 2004. This increase follows a $6.9 million or 2.1% decrease in 2004 from total loans at December 31, 2003. The increase in 2005 was the result increased loan demand in Premier’s markets which offset $2.2 million of loan charge-offs recorded during the year, (half at Farmers Deposit) and $4.2 million of net loan collections at Farmers Deposit. The decline in 2004 period-end loans was the result of the $7.0 million of loan charge-offs recorded during the year, primarily at Farmers Deposit ($5.5 million).

Loans secured by real estate, which in total constituted approximately 71% of Premier's loan portfolio at December 31, 2005, consist of a diverse portfolio of predominantly single family residential loans and loans for commercial purposes where real estate is part of the collateral, not the primary source of repayment. Residential real estate mortgage loans generally do not exceed 80% of the value of the real property securing the loan. The residential 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. Premier also participates in the solicitation of loans for the secondary market and recognizes the referral fees in non-interest income. Commercial loans are generally made to small-to-medium size businesses located within a defined market area and typically are secured by business assets and guarantees of the principal owners. Additional risks of loss are associated with commercial lending such as the potential for adverse changes in economic conditions or the borrowers' ability to successfully execute their business plan. Consumer loans generally are made to individuals living in Premier's defined market area who are known to the local bank's staff. Consumer loans are generally made for terms of up to seven years on a secured or unsecured basis; however longer terms may be approved in certain circumstances and for revolving credit lines. While consumer loans generally provide the Company with increased interest income, consumer loans may involve a greater risk of default.



37
 

PREMIER FINANCIAL BANCORP, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS
December 31, 2005


The following table presents a five year comparison of loans by type. With the exception of those categories included in the comparison, there are no loan concentrations which exceed 10% of total loans. Additionally, Premier's loan portfolio contains no loans to foreign borrowers nor does it have a material volume of highly leveraged transaction lending.

LOAN SUMMARY
  
(Dollars in thousands)
  
   
As of December 31,
  
   
2005
  
%
  
2004
  
 %
  
2003
  
 %
  
2002
  
 %
  
2001
  
%
  
Summary of Loans by Type
                                          
Commercial, secured by real estate
  
$
85,989
    
26.2
%
$
101,567
    
31.3
%
$
101,325
    
30.5
%
$
109,571
    
29.3
%
$
106,726
    
27.7
%
Commercial, other
    
49,362
    
15.0
    
40,923
    
12.6
    
38,063
    
11.5
    
51,347
    
13.8
    
59,364
    
15.4
  
Real estate construction
    
11,070
    
3.4
    
5,906
    
1.8
    
5,414
    
1.6
    
7,318
    
2.0
    
8,245
    
2.1
  
Real estate mortgage
    
134,570
    
40.9
    
128,243
    
39.5
    
126,134
    
38.0
    
134,271
    
36.0
    
135,937
    
35.4
  
Agricultural
    
1,670
    
0.5
    
2,380
    
0.7
    
3,032
    
0.9
    
4,381
    
1.2
    
5,402
    
1.4
  
Consumer
    
42,096
    
12.8
    
44,470
    
13.7
    
56,216
    
17.0
    
63,534
    
17.0
    
68,300
    
17.7
  
Other
    
3,960
    
1.2
    
1,438
    
0.4
    
1,610
    
0.5
    
2,677
    
0.7
    
966
    
0.3
  
Total loans
  
$
328,717
    
100.0
%
$
324,927
    
100.0
%
$
331,794
    
100.0
%
$
373,099
    
100.0
%
$
385,019
    
100.0
%
                                                               
Non-performing Assets
                                                              
Non-accrual loans
  
$
3,751
        
$
6,847
        
$
11,958
        
$
8,197
        
$
6,302
        
Accruing loans which are    contractually past
    due 90  days or more
    
853
          
739
          
4,137
          
1,238
          
5,612
        
Restructured loans
    
1,540
          
238
          
104
          
129
          
338
        
Total non-performing and restructured loans
    
6,144
          
7,824
          
16,199
          
9,564
          
12,252
        
    Other real estate acquired through foreclosures
    
2,049
          
2,247
          
3,187
          
3,505
          
5,508
        
Total non-performing and restructured
       loans and other real estate
  
$
8,193
        
$
10,071
        
$
19,386
        
$
13,069
        
$
17,760
        
                                                               
Non-performing and restructured loans
    as a % of  total loans
    
1.87
%
        
2.41
  
%
        
4.88
%
        
2.56
  
%
        
3.18
%
      
Non-performing and restructured loans and other
    real estate as a % of total  assets (1)
    
1.55
%
        
1.87
%
        
3.57
%
        
2.21
  
%
        
2.93
  
%
      
                                                               
Allocation of Allowance for Loan Losses
                                                              
Commercial, other
  
$
1,071
    
16.7
%
$
1,734
    
13.7
%
$
4,166
    
12.9
%
$
2,294
    
15.7
%
$
1,379
    
17.1
%
Real estate, construction
    
134
    
3.4
    
83
    
1.8
    
662
    
1.6
    
632
    
2.0
    
488
    
2.1
  
Real estate, other
    
3,810
    
67.1
    
4,276
    
70.8
    
4,886
    
68.5
    
4,341
    
65.3
    
3,235
    
63.1
  
Consumer installment
    
772
    
12.8
    
1,255
    
13.7
    
2,478
    
17.0
    
977
    
17.0
    
1,178
    
17.7
  
Unallocated
    
2,105
          
2,036
          
2,108
          
1,454
          
1,091
        
Total
  
$
7,892
    
100.0
%
$
9,384
    
100.0
%
$
14,300
    
100.0
%
$
9,698
    
100.0
%
$
7,371
    
100.0
%
                                                               
(1) From continuing operations
                                                      



38
 

PREMIER FINANCIAL BANCORP, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS
December 31, 2005


In addition to the loans presented in the loan summary table, Premier also offers certain off-balance sheet products such as letters of credit, revolving credit agreements, and other loan commitments. These products are offered under the same credit standards as the loan portfolio and are included in the risk-based capital ratios used by the Federal Reserve to evaluate capital adequacy. Additional information on off-balance sheet commitments is contained in Note 18 to the consolidated financial statements.
 
    Total non-performing assets, which consist of past-due loans on which interest is not being accrued ("non accrual loans"), foreclosed properties in the process of liquidation ("OREO"), loans with restructured terms to enable a delinquent borrower to repay and accruing loans past due 90 days or more, were $8.2 million, or 1.55% of total assets of continuing operations at year-end 2005. The amount is down significantly from the $10.1 million of non-performing assets (1.87% of total assets of continuing operations) at year-end 2004 and the $19.4 million of non-performing assets (3.57% of total assets of continuing operations) at year-end 2003. The decrease in 2005 was due to the collection or rehabilitation of previously delinquent loans, the charge-offs of loans determined to be uncollectible and the sale of $1.7 million of OREO property. The decrease in 2004 was due to charge-offs of loans determined to be uncollectible, the sale of $4.5 million of OREO property, and the collection or rehabilitation of previously delinquent loans. As management's efforts to collect these loans upon maturity continue, loans are only renewed using Premier's strengthened credit policies. Otherwise, loans may be placed on non-accrual status and foreclosure proceedings begun to obtain and liquidate any collateral securing the past due or matured loans. Premier is committed to continuing to reduce its high level of non-performing assets and implementing strong underwriting standards to help maintain a lower level of non-performing assets in the future. This effort is revealed in the decline in non-performing assets from the end of 2001 to the end of 2002, primarily related to the sale of OREO properties and the decline in loans 90+ days past due. Premier's efforts at its other affiliate banks in 2003 and 2004 are masked by the high level of non-performing assets at Farmers Deposit Bank, which alone totaled $12.5 million at December 31, 2003. At December 31, 2004, the non-performing assets at Farmers Deposit Bank had declined to $6.8 million, leaving $3.3 million of total non-performing assets at the other Affiliate Banks combined. By December 31, 2005, the non-performing assets at Farmers Deposit Bank had declined even further to $4.7 million.
 
    The Loan Summary table presents five years of comparative non-performing asset information. Other than these loans and the impaired loans discussed in Note 6 to the consolidated financial statements, Premier does not have a significant volume of loans whereby management has serious doubts about the borrowers ability to comply with the present repayment terms of the loan.
 
    It is Premier's policy to place loans that are past due over 90 days on non-accrual status, unless the loans are adequately secured and in the process of collection. Premier had no commitments to provide additional funds on non- accrual loans at December 31, 2005. For real


39
 

PREMIER FINANCIAL BANCORP, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS
December 31, 2005


estate loans, upon repossession, the balance of the loan is transferred to "Other Real Estate Owned" (OREO) and carried at the lower of the outstanding loan balance or the fair value of the property based on current appraisals and other current market trends less estimated disposal costs. If a writedown of the OREO property is necessary at the time of foreclosure, the amount is charged against the allowance for loan losses. A periodic review of the recorded property value is performed in conjunction with normal loan reviews, and if market conditions indicate that the recorded value exceeds the fair market value less estimated disposal costs, additional writedowns of the property value are charged directly to operations.
 
    During 2003 Premier recognized $466,000 of OREO writedowns. During 2004, Premier realized a $123,000 net profit on the disposition of OREO properties, net of writedowns, while in 2005 Premier realized $17,000 net profit on the disposition of OREO properties. Although loans may be classified as non-performing, some continue to pay interest irregularly or at less than original contracted terms. During 2005, approximately $93,000 of interest was recognized on non-accrual and restructured loans, while approximately $429,000 would have been recognized in accordance with their original terms.
 
    The allowance for loan losses is maintained to absorb probable incurred losses associated with lending activities. Actual losses are charged against the allowance ("charge-offs") while collections on loans previously charged off ("recoveries") are added back to the allowance. Since actual losses within a given loan portfolio are difficult to predict, management uses a significant amount of estimation and judgment to determine the adequacy of the allowance for loan losses. Factors considered in determining the adequacy of the allowance include an individual assessment of risk on certain loans and total creditor relationships, historical charge-off experience, the type of loan, levels of non-performing and past due loans, and an evaluation of current economic conditions. Loans are evaluated for credit risk and assigned a risk grade. Premier's risk grading criteria are based upon Federal Reserve guidelines and definitions. In evaluating the adequacy of the allowance for loan losses, loans that are assigned passing grades are grouped together and multiplied by historical charge-off percentages to determine an estimated amount of potential losses and a corresponding amount of allowance. Loans that are assigned marginally passing grades are grouped together and allocated slightly higher percentages to determine the estimated amount of potential losses due to the identification of increased risk(s). Loans that are assigned a grade of "substandard" or "doubtful" are usually determined to be impaired.
 
    A loan is categorized and reported as impaired when it is probable that the creditor will be unable to pay all of the principal and interest amounts according to the contractual terms of the loan agreement. In determining whether a loan is impaired, management considers such factors as past payment history, recent economic events, current and projected financial condition and other relevant information that is available at the time. Impairment is evaluated in total for smaller-balance loans of similar nature such as residential mortgage, consumer, and credit card loans, and on an individual basis for other loans. If a loan is deemed to be impaired


40
 

PREMIER FINANCIAL BANCORP, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS
December 31, 2005


an evaluation of the amount of estimated loss is performed assessing the present value of estimated future cashflows using the loan's existing rate or assessing the fair and realizable value of the loan collateral if repayment is expected solely from the collateral. The estimation of loss is assigned to the impaired loan and is used in determining the adequacy of the allowance for loan losses. For impaired loans, this estimation of loss is reevaluated quarterly and, if necessary, adjusted based upon the current known facts and circumstances related to the loan and the borrower. Additional information on Premier's impaired loans is contained in Note 6 to the consolidated financial statements. The sum of the calculations and estimations of the risk of loss in a given loan portfolio is compared to the recorded balance of the allowance for loan losses. If the total allowance is deemed to be inadequate a charge to earnings is recorded to increase the allowance. Conversely, should an evaluation of the allowance result in a lower estimate of the risk of loss in the loan portfolio and the allowance is deemed to be more than adequate, a reversal of previous charges to earnings ("a negative provision") may be warranted in the current period. Events that may lead to negative provisions included greater than anticipated recoveries, a reduction in the historical loss ratios, securing more collateral on an impaired loan during the collection process, or receiving payment in full on an impaired loan.
 
    At December 31, 2005, the allowance for loan losses was $7.9 million or 2.40% of total year-end loans. This ratio is a decrease from the prior year’s 2.89% and the 4.31% at the end of 2003. The decrease in the allowance in 2005 was the result of charge-offs of loans previously identified as impaired partially offset by $719,000 of recoveries. The decrease in the allowance in 2004 was the result of charge-offs of loans previously identified as impaired partially offset by $1.1 million of recoveries and $1.0 million of additional provisions for loan losses during 2004. In management's opinion, the allowance for loan losses is adequate to absorb the current estimated risk of loss in the existing loan portfolio. The summary of the allowance for loan losses allocated by loan type is presented in the Loan Summary Table above.
 
    The following table provides a detailed history of the allowance for loan losses, illustrating charge-offs and recoveries by loan type, and the annual provision for loan losses over the past five years. The provision for loan losses in 2005 was only $4,000. During the third and fourth quarters of 2005, negative provisions were recorded substantially offsetting the provisions recorded during the first half of the year. During the latter half of 2005, Premier realized collections of previously impaired loans whereby estimated losses were previously assigned to the loan as well as recoveries of previously charged-off loans. These positive events as well as the ongoing reduction in Premier’s historical loss ratios resulted in a lower estimate of the risk of loss in the loan portfolio and, thus, negative provisions were warranted. Future provisions to the allowance for loan losses, positive or negative, will depend on future improvement or deterioration in estimated credit risk in the loan portfolio as well as whether additional payments are received on loans having significant credit risk.  The provision for loan losses in 2004 was $1.0 million, down significantly from the $20.5 million provision in 2003. The provision in 2004 was the result of newly identified impaired loans and increases in the volume of loans outstanding at the banks located in West Virginia. The high level of provision in 2003


41
 

PREMIER FINANCIAL BANCORP, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS
December 31, 2005


was the result of the net charge-offs and increase in impaired loans at Farmers Deposit. Premier continually evaluates the adequacy of its allowance for loan losses, and changes in the provision are based on the estimated probable incurred loss of the loan portfolio.

SUMMARY OF LOAN LOSS EXPERIENCE
  
(Dollars in thousands)
  
   
For the Year Ended December 31
  
   
2005
  
2004
  
2003
  
2002
  
2001
  
Allowance for loan losses, beginning of period
  
$
9,384
  
$
14,300
  
$
9,698
  
$
7,371
  
$
6,617
  
Amounts charged off:
                                
Commercial, financial and agricultural loans
    
736
    
1,520
    
4,417
    
4,080
    
2,585
  
Real estate construction loans
    
0
    
5
    
0
    
833
    
480
  
Real estate loans - other
    
549
    
2,413
    
6,427
    
1,072
    
3,013
  
Consumer installment loans
    
930
    
3,054
    
5,669
    
1,904
    
1,725
  
Total charge-offs
    
2,215
    
6,992
    
16,513
    
7,889
    
7,803
  
                                 
Recoveries on amounts previously charged-off:
                                
Commercial, financial and agricultural loans
    
91
    
264
    
145
    
138
    
163
  
Real estate construction loans
    
1
    
1
    
37
    
16
    
1
  
Real estate loans - other
    
84
    
87
    
74
    
163
    
10
  
Consumer installment loans
    
543
    
698
    
346
    
446
    
299
  
Total recoveries
    
719
    
1,050
    
602
    
763
    
473
  
                                 
Net charge-offs
    
1,496
    
5,942
    
15,911
    
7,126
    
7,330
  
Provision for loan losses
    
4
    
1,026
    
20,513
    
9,453
    
8,350
  
Balance of disposed subsidiaries
    
0
    
0
    
0
    
0
    
(266
)
                                 
Allowance for loan losses, end of period
  
$
7,892
  
$
9,384
  
$
14,300
  
$
9,698
  
$
7,371
  
                                 
Average total loans
  
$
326,615
  
$
325,610
  
$
352,156
  
$
382,763
  
$
424,903
  
Total loans at year-end
    
328,717
    
324,927
    
331,794
    
373,099
    
384,940
  
                                 
As a percent of average loans
                                
Net charge-offs
    
0.46
%
  
1.82
%
  
4.52
%
  
1.86
%
  
1.73
%
Provision for loan losses
    
0.00
%
  
0.32
%
  
5.83
%
  
2.47
%
  
1.97
%
Allowance for loan losses
    
2.42
%
  
2.88
%
  
4.06
%
  
2.53
%
  
1.73
%
                                 
As a percent of total loans at year-end
                                
Allowance for loan losses
    
2.40
%
  
2.89
%
  
4.31
%
  
2.60
%
  
1.91
%
                                 
As a multiple of net charge-offs
                                
Allowance for loan losses
    
5.28X
    
1.58X
    
0.90X
    
1.36X
    
1.01X
  
Income before tax and provision for loan losses
    
4.32X
    
0.65X
    
0.35X
    
0.80X
    
1.76X
  
                                 



42
 

PREMIER FINANCIAL BANCORP, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS
December 31, 2005


Net charge-offs in 2005 decreased to $1.5 million, down $4.4 million or 75% from the $5.9 million of net charge-offs experienced in 2004. Approximately $641,000 or 43% of the 2005 net charge-offs and $4.8 million or 81% of the 2004 net charge-offs were at Farmers Deposit Bank. In 2003 net charge-offs totaled $15.9 million with approximately $14.3 million or 90% of the 2003 net charge-offs at Farmers Deposit Bank. While all categories of loan charge-offs were down in 2005, consumer loan charge-offs continued to exceed the other categories of loan charge-offs. Although management believes it has identified the significant remaining credit risk in the loan portfolio, additional charge-offs may be recorded in the coming months due to the high level of non-performing loans and the resolution of collection efforts on those loans. These factors are considered in determining the adequacy of the allowance for loan losses, which at December 31, 2005 was 2.40% of total loans outstanding and 128% of non-performing loans.

The following table presents the maturity distribution and interest sensitivity of selected loan categories at December 31, 2005. Maturities are based upon contractual terms.

LOAN MATURITIES and INTEREST SENSITIVITY
  
December 31, 2005
  
(Dollars in thousands)
  
                   
   
Projected Maturities*
      
   
One Year or Less
  
One Through Five Years
  
Over
Five Years
  
Total Loans
  
Commercial, secured by real estate
  
$
30,208
  
$
45,447
  
$
10,334
  
$
85,989
  
Commercial, other
    
26,889
    
19,011
    
3,462
    
49,362
  
Real estate construction
    
5,519
    
4,111
    
1,440
    
11,070
  
Agricultural
    
803
    
603
    
264
    
1,670
  
Total
  
$
63,419
  
$
69,172
  
$
15,500
  
$
148,091
  
                           
Fixed rate loans
  
$
14,656
  
$
31,427
  
$
6,106
  
$
52,189
  
Floating rate loans
    
48,763
    
37,745
    
9,394
    
95,902
  
Total
  
$
63,419
  
$
69,172
  
$
15,500
  
$
148,091
  
                           
Fixed rate loans projected to mature after one year
                    
$
37,533
  
Floating rate loans projected to mature after on year
                      
47,139
  
Total
                    
$
84,672
  
                           
(*) Based on scheduled or approximate repayments
                          



43
 

PREMIER FINANCIAL BANCORP, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS
December 31, 2005


Investment Portfolio and
Other Earning Assets
 
    Investment securities averaged $150.0 million in 2005, relatively unchanged from the $150.2 million averaged in 2004. This increase follows a 5.2% increase from the $142.8 million averaged in 2003. While average investments remained relatively unchanged in 2005, the amount of investments at December 31, 2005 was down $16.5 million from the balance at December 31, 2004. As investments matured in 2005 not all funds were reinvested in the investment portfolio. Some funds were used to satisfy loan growth, deposit withdrawals and debt payments. The increase in average investments in 2004 was the result of weak loan demand and funds from loan paydowns and payoffs at Farmers Deposit Bank. These funds were not used to fund new loans but were instead invested in high-quality debt and mortgage- backed securities.

The following table presents the carrying values of investment securities.

FAIR VALUE OF SECURITIES AVAILABLE FOR SALE
  
(Dollars in thousands)
  
   
As of December 31
  
   
2005
  
2004
  
2003
  
U.S. Treasury securities
  
$
3,941
  
$
250
  
$
652
  
U.S. Agency securities
    
95,300
    
115,514
    
106,845
  
States and political subdivisions
    
2,514
    
2,751
    
6,868
  
Mortgage-backed securities
    
35,639
    
34,942
    
31,810
  
Corporate securities
    
25
    
435
    
1,471
  
Total securities
  
$
137,419
  
$
153,892
  
$
147,646
  
                     
 
    As sources of funds (deposits, federal funds purchased, and repurchase agreements with corporate customers) fluctuate, excess funds are initially invested in federal funds sold and other short-term investments. Based upon analyses of asset/liability repricing, interest rate forecasts, and liquidity requirements, funds are periodically reinvested in high-quality debt securities, which typically mature over a longer period of time. At the time of purchase, management determines whether the securities will be classified as trading, available-for-sale, or held-to-maturity. At December 31, 2005 all of Premier's investments were classified as available-for-sale and carried on the books at market value.
 
    As shown in the following Securities Maturity and Yield Analysis table, the average maturity period of the securities available-for-sale at December 31, 2005 was 4 years 2 months, lengthened somewhat by the 10 year 11 month average final maturity of the mortgage-backed securities portfolio. The table uses a final maturity method to report the average maturity of mortgage-backed securities, which excludes the effect of monthly payments and prepayments. Approximately 72% of Premier's investment securities are U.S. Government agency or Treasury
 
 
PREMIER FINANCIAL BANCORP, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS
December 31, 2005


securities that have an average maturity of 1 year 10 months. The average maturity of the investment portfolio is managed at a level to maintain a proper matching with interest rate risk guidelines. During 2004, Premier sold a portion of the securities classified as available-for-sale as part of its management of interest rate risk, as shown in the Statements of Cash Flows. Premier does not have any securities classified as trading or held-to-maturity and it has no plans to establish such classifications at the present time. Other information regarding investment securities may be found in the following table and in Note 5 to the consolidated financial statements.

SECURITIES MATURITY AND YIELD ANALYSIS
  
December 31, 2005
  
(Dollars in thousands)
  
   
Market Value
  
Average Maturity (yrs/mos)
  
Taxable Equivalent Yield*
  
U.S. Treasury securities
              
After one but within five years
  
$
3,941
          
4.31
%
Total U.S. Treasury Securities
    
3,941
    
2/8
    
4.31
  
                     
U.S. Government Agencies securities
                    
Within one year
    
32,674
          
2.47
  
After one but within five years
    
62,626
          
3.51
  
Total U.S. Government Agencies securities
  
$
95,300
    
1/9
    
3.15
  
                     
States and political subdivisions
                    
Within one year
    
417
          
4.75
  
After one but within five years
    
1,477
          
4.66
  
After five but within ten years
    
241
          
4.16
  
Over ten years
    
379
          
5.51
  
Total states and political subdivisions securities
  
$
2,514
    
3/3
    
4.75
  
                     
Mortgage-backed securities**
                    
Within one year
    
2,754
          
3.54
  
After one but within five years
    
2,071
          
3.93
  
After five but within ten years
    
1,776
          
4.08
  
Over ten years
    
29,038
          
4.56
  
Total mortgage-backed securities
  
$
35,639
    
10/11
    
4.42
  
                     
Corporate securities
  
$
25
              
                     
Total securities available-for-sale
  
$
137,419
    
4/2
    
3.54
%
                     
(*) Fully tax-equivalent using the rate of 34%
                    
(**) Maturities for mortgage-backed securities are based on final maturity
                    
                     



45
 

PREMIER FINANCIAL BANCORP, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS
December 31, 2005


Premier's average investment in federal funds sold and other short-term investments decreased by 21.4% in 2005. This follows a 31.5% decrease in 2004. Averaging $23.1 million in 2005, federal funds sold and other short-term investments decreased $6.3 million from the $29.4 million averaged in 2004, and were lower than the $42.8 million averaged during 2003. The decrease in average federal funds sold in 2005 and 2004 was the result of investing more of Premier's available funds into higher yielding investments and using a portion of the funds to reduce outstanding debt and satisfy deposit withdrawals. Fluctuations in federal funds sold and other short-term investments reflect management's goal to maximize asset yields while maintaining proper asset/liability structure, as discussed in greater detail above and in other sections of this report.
 
Funding Sources
 
    In 2005, Premier began raising the rates paid on it interest bearing deposits in response to the increase in market interest rates. However, as Premier has been able to reduce a portion of its high rate long-term borrowings, the average rates paid on interest bearing liabilities remained relatively unchanged in 2005. The average rate paid on interest bearing liabilities decreased to 2.30% in 2005, down from the 2.32% paid in 2004. The decrease is largely due to the early redemption of $5.5 million of Premier’s 9.75% Trust Preferred Securities late in 2004 and the payment of 10 quarters of deferred distributions on the Trust Preferred Securities in March 2005. The interest savings more than offset the increase in interest expense due to the rise in rates paid on NOW and money market transactional deposit accounts and on certificates of deposit. In 2004, Premier decreased the rates paid on its interest bearing deposits in response to the decline in market interest rates. The average rate paid on interest bearing liabilities decreased to 2.32% in 2004, down from the 2.63% paid in 2003. The decrease is largely due to declines in rates paid on time deposits as higher rate certificates of deposits were either not renewed at maturity or were redeposited at lower rates in conjunction with the decline in market interest rates. Similarly, rates paid on NOW and money market transactional deposit accounts also declined. Due to alternative sources of investment and an ever increasing sophistication of customers in funds management techniques to maximize return on their money, competition for funds has become more intense. Premier's banks periodically offer special rate products to attract additional deposits.
 
    Premier’s deposits, on average, decreased by 1.2% or $5.3 million in 2005. The 2005 decrease follows at 5.6% or $26.4 million decrease in 2004 from the average in 2003. In 2005, $13.3 million of the decline in deposits was at Farmers Deposit Bank, partially due to Premier's capital restoration plan as certain deposits were not renewed as part of the plan to reduce the size of the Bank. In Premier’s other markets, deposits, on average, increased by 2.2% or $8.0 million. In 2004, $20.8 million of the decline in deposits was at Farmers Deposit Bank, again partially due to Premier's capital restoration plan to reduce the size of the Bank. The remaining $5.6 million decline in average deposits was largely due to the withdrawal of some public fund deposits which were reestablished as repurchase agreements. Average repurchase agreements


46
 

PREMIER FINANCIAL BANCORP, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS
December 31, 2005


at Affiliate Banks other than Farmers Deposit increased by $5.8 million during 2004 offsetting the remaining decline in average deposits in 2004.
 
    In 2005, non-interest bearing deposits increased 7.0% or $4.4 million on average when compared to 2004. In 2004, non-interest bearing deposits increased by 16.1% or $8.7 million on average when compared to 2003. Since no interest is paid on these deposits, an increase in non-interest bearing deposits helps to increase Premier's net interest margin and its profitability. Non-interest bearing deposits are more susceptible to withdrawal and therefore may provide challenges to maintaining adequate liquidity. (See the additional discussion on liquidity below.) In 2005, interest bearing deposits decreased by 2.5% or $9.7 million on average when compared to 2004. The decrease was largely due to a $13.6 million decrease in average interest bearing deposits at Farmers Deposit Bank. The remaining increase was the result of internal growth in Premier’s other markets. In 2004, interest bearing deposits decreased by 8.3% or $35.0 million on average when compared to 2003. The decrease was primarily due to a $21.6 million decrease in average interest bearing deposits at Farmers Deposit Bank. The remaining decrease was the result of the non-renewal of certain high rate time deposits in 2003 that had a carryover effect on 2004 and a decrease in average interest bearing transaction deposits.

The following table provides information on the maturities of time deposits of $100,000 or more at December 31, 2005.

MATURITY OF TIME DEPOSITS $100,000 OR MORE
  
December 31, 2005
  
(Dollars in thousands)
  
       
Maturing 3 months or less
  
$
6,655
  
Maturing over 3 months
    
6,728
  
Maturing over 6 months
    
12,530
  
Maturing over 12 months
    
16,256
  
Total
  
$
42,169
  
         
 
    Other funding sources for Premier include short and long-term borrowings. Premier's short-term borrowings primarily consist of federal funds purchased from other banks, and securities sold under agreements to repurchase with commercial customers. These short-term borrowings fluctuate depending on near term funding needs and as part of Premier's management of its asset/liability mix. In 2005, short-term borrowings averaged $8.4 million, up $1.9 million from the average in 2004 due to an increase in public fund repurchase agreements.  In 2004, short-term borrowings averaged $6.5 million, up $1.9 million again from the average in 2003. Near the end of 2003, Farmers Deposit Bank reduced its short-term borrowings to zero as part of Premier's recapitalization plan. This event had the effect of reducing Premier's average short-term borrowings in 2004 by approximately $4.3 million. This decline in short-term borrowings was more than offset by the public fund repurchase agreements established at the Affiliate Banks in 2004 as discussed above.


47
 

PREMIER FINANCIAL BANCORP, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS
December 31, 2005


Long-term borrowings consist of Federal Home Loan Bank (FHLB) borrowings by Premier's banks, other borrowings by the parent holding company and debt issued in the form of subordinated debentures to an unconsolidated trust subsidiary. FHLB advances, on average, declined by 11.9% or $1.2 million in 2005, following a 37.2% or $5.9 million decrease in 2004. Premier uses fixed rate FHLB advances from time-to-time to fund certain residential and commercial loans as well to maximize investment opportunities as part of its interest rate risk management. In 2004, Premier elected not to renew most of its maturing FHLB advances and prepaid a limited number of other FHLB advances in order to reduce its outstanding debt. In 2005, Premier made all of its scheduled principal payments and took advantage of penalty free prepayment opportunities as they became available. At December 31, 2005, FHLB advances totaled $8.3 million and had repayment schedules from five to seven years with $4.0 million maturing in 2010. Other borrowings, on average, declined by 70.1% or $3.7 million in 2005 and 36.5% or $3.0 million in 2004 as the parent company began using available funds to aggressively pay down its outstanding debt in late 2001. At December 31, 2005, other borrowings totaled $1.4 million which consisted of two $701,000 subordinated notes with a 0% interest rate. These notes can only be repaid with the permission of the FRB. For more information on other borrowings, see Note 11 to the consolidated financial statements.

PAYMENTS DUE ON CONTRACTUAL OBLIGATIONS
  
December 31, 2005
  
(Dollars in thousands)
  
   
For the Year Ended December 31
  
   
Total
  
Less than one year
  
1-3
years
  
3-5
years
  
More than five years
  
Federal Home Loan Bank advances
  
$
8,334
  
$
675
  
$
1,457
  
$
5,614
  
$
588
  
Notes payable
    
1,402
    
1,402
    
0
    
0
    
0
  
Guaranteed subordinated debentures
    
15,722
    
0
    
0
    
0
    
15,722
  
Operating lease obligations
    
332
    
165
    
148
    
17
    
2
  
Data and item processing contracts*
    
5,940
    
1,320
    
2,640
    
1,980
    
0
  
Total
  
$
31,730
  
$
3,562
  
$
4,245
  
$
7,611
  
$
16,312
  
                                 
* Data and item processing contractual obligations are estimated using the average billing for the last three months of 2005.
 
    On December 20, 2004, Premier entered into a sixty-three month contract with Fiserv Solutions, Inc. (Fiserv) whereby Fiserv will provide data processing and item processing services to Premier. Conversions by Premier's subsidiary banks to Fiserv systems began on April 15, 2005 and were completed by July 31, 2005. Based upon the average billings of the last three months of 2005, the estimated payments to Fiserv for these services will be approximately $1,320,000 per year beginning in 2006. Actual results may vary depending upon the number and type of accounts actually processed and future customer activity.


48
 

PREMIER FINANCIAL BANCORP, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS
December 31, 2005


Premier's Trust Preferred Securities represent beneficial interests in the assets of PFBI Capital Trust (NASDAQ/NMS-PFBIP). The trust holds $15.7 million of 9.75% Junior Subordinated Deferrable Interest Debentures ("Subordinated Debentures") due in 2027. This total is down from the $20.9 million outstanding at December 31, 2004 due to $5.2 million of early redemptions during the fourth quarter of 2005. Quarterly cash distributions on the Preferred Securities are made to the extent interest on the debentures is received by the trust.
 
    As previously disclosed, pursuant to an agreement entered into with the Federal Reserve Bank of Cleveland on September 29, 2000, as superseded by an agreement with the Federal Reserve Bank of Cleveland dated January 29, 2003, Premier is required to request approval for the payment of distributions due on the Trust Preferred Securities. During the quarter ended June 30, 2002, Premier was notified by the Federal Reserve Bank of Cleveland that due to the deterioration of core earnings of the Company, among other issues, the FRB would not allow the payment of the distribution due June 30, 2002 on Premier's Trust Preferred Securities. In response, Premier reached an agreement with the Federal Reserve Bank of Cleveland whereby Premier's Chairman of the Board, who is also its largest shareholder, agreed to loan the company the amount of the distribution, $701,000, so that Premier, with the Federal Reserve Bank's approval, could make the distribution. The loan is unsecured at a zero interest rate with no defined maturity date. The loan cannot be repaid without the prior approval of the Federal Reserve Bank. A similar agreement was reached for the payment of the distribution due September 30, 2002. Premier's President and Chief Executive Officer, who is also a director, agreed to loan the Company the amount of the September 30 distribution, $701,000. This loan is also unsecured at a zero interest rate with no defined maturity date. The loan also cannot be repaid without the prior approval of the Federal Reserve Bank of Cleveland.
 
    In December 2002, The Federal Reserve Bank of Cleveland ("FRB") denied Premier's request to make the fourth quarter distribution. Accordingly, Premier exercised its right to defer the payment of interest on the Subordinated Debentures related to the Trust Preferred Securities for an indefinite period (which can be no longer than 20 consecutive quarterly periods). Premier continued to defer the payment of interest throughout 2003 and 2004. In the first quarter of 2005, Premier sought and received approval from the FRB to make the first quarter 2005 distribution and all nine previously deferred quarterly distributions. During the deferral period, the deferred distributions also accrued interest at an annual rate of 9.75%. The payment was disbursed on March 31, 2005 to shareholders of record on March 15, 2005. The accrued interest on the deferred distributions was also paid when the deferred distributions were paid on March 31, 2005. The FRB has also approved the payment of current distributions due through March 31, 2006. Although the FRB has approved the payment of the deferred and current distributions through March 31, 2006, Premier is still bound by the Written Agreement and will be required to request the FRB’s approval to pay future distributions. No assurance can be given that the FRB will grant such approval.



49
 

PREMIER FINANCIAL BANCORP, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS
December 31, 2005


As part of a Debt Reduction and Profitability plan presented on January 6, 2003 to the Federal Reserve Bank of Cleveland ("Federal Reserve"), Premier requested and received approval from the Federal Reserve to redeem $3,000,000 of the then outstanding $28,750,000 Trust Preferred Securities. The goal of the redemption was to use a portion of Premier's cash on hand to reduce its total interest cost and thus improve profitability. The redemption reduced Premier's interest cost by approximately $292,000 per year. However, this benefit was partially offset due to the interest accrued in 2003 on the deferred quarterly distributions. In 2004, Premier requested and received approval from the Federal Reserve to redeem $4.5 million of Trust Preferred Securities on October 15, 2004 and another $1.0 million on December 31, 2004. These two redemptions reduced Premier's interest cost by approximately $536,000 per year. In 2005, Premier requested and received approval from the Federal Reserve to redeem $5.0 million of Trust Preferred Securities on December 31, 2005. It is anticipated that this redemption will reduce Premier’s interest cost by approximately $487,000 per year. Future early redemptions, if any, will also require Federal Reserve approval, pursuant to a previously disclosed Written Agreement entered into with the Federal Reserve Bank of Cleveland on January 29, 2003.

Asset/Liability Management and Market Risk
 
    Asset/liability management is a means of maximizing net interest income while minimizing interest rate risk by planning and controlling the mix and maturities of interest related assets and liabilities. Premier has established an Asset/Liability Management Committee (ALCO) for the purpose of monitoring and managing interest rate risk and to evaluate investment portfolio strategies. Interest rate risk is the earnings variation that could occur due to changes in market interest rates. The Board of Directors has established policies to monitor and limit exposure to interest rate risk. Premier monitors its interest rate risk through the use of an earnings simulation model prepared by an independent third party to analyze net interest income sensitivity.
 
    The earnings simulation model uses assumptions, maturity patterns, and reinvestment rates provided by Premier and forecasts the effect of instantaneous movements in interest rates of both 100 (1.00%) and 200 (2.00%) basis points. The most recent earnings simulation model projects net interest income would increase by approximately 0.5% over the projected stable rate net interest income if interest rates rise by 100 basis points over the next year. Conversely, the simulation projects an approximate 0.6% decrease in net interest income if interest rates fall by 100 basis points over the next year. Within the same time frame, but assuming a 200 basis point movement in interest rates, the simulation projects that net interest income would increase by 0.9% over the projected stable rate net interest income in a rising rate scenario and would decrease by 1.3% in a falling rate scenario. Under both the 100 and 200 basis point simulations, the percentage changes in net interest income are within Premier's ALCO guidelines.



50
 

PREMIER FINANCIAL BANCORP, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS
December 31, 2005


The model simulation calculations of present value have certain acceptable shortcomings. The discount rates and prepayment assumptions 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 the model simulations, and therefore, actual results could likely result in different discount rates, prepayment experiences and present values. The discount rates used for deposits and borrowings are based upon available alternative types and sources of funds which may not necessarily be indicative of the present value of Premier's deposits and borrowings. Premier's deposits have customer relationship advantages that are difficult to simulate. A higher or lower interest rate environment will most likely result in different investment and borrowing strategies by Premier which would be designed to further mitigate any negative effects on the value of, and the net interest earnings generated on Premier's net assets.

The following table presents summary information about the simulation model's interest rate risk measures and results.

 
Year-end
2005
Year-end
2004
ALCO Guidelines
       
Projected 1-year net interest income
      
-100 bp change vs. base rate
-0.6%
-0.9%
10%
+100 bp change vs. base rate
0.5%
0.4%
10%
Projected 1-year net interest income
      
-200 bp change vs. base rate
-1.3%
-1.9%
10%
+200 bp change vs. base rate
0.9%
0.8%
10%


Liquidity
 
    Liquidity is the ability to satisfy demands for deposit withdrawals, lending commitments, and other corporate needs. Premier's liquidity is based on the stable nature of consumer core deposits held by the banking subsidiaries. Likewise, additional liquidity is available from holdings of investment securities and short-term investments which can be readily converted into cash. Furthermore, Premier's banks continue to have the ability to attract short-term sources of funds such as federal funds and repurchase agreements.
 
    Premier generated $2.1 million of cash from operations in 2005, which compares to $11.5 million in 2004 and $12.2 million in 2003. The decrease in 2005 was primarily the result of the payment of the deferred distributions of the Trust Preferred Securities in March 2005, which came out of cash from operations. Total cash from operations along with the proceeds from the sale and maturity of securities and the repayment of loans were used to purchase securities, satisfy deposit withdrawals, fund new loans and reduce outstanding debt during those years. Net cash provided by liquidating investing activities totaled $7.9 million in 2005, $7.5 million in


51
 

PREMIER FINANCIAL BANCORP, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS
December 31, 2005


2004 and $29.5 million in 2003. Net cash used to satisfy deposit withdrawals and reduce debt totaled $8.4 million in 2005, $20.9 million in 2004, and $39.5 million in 2003. Details on the sources and uses of cash can be found in the Consolidated Statements of Cash Flows in the consolidated financial statements.

At December 31, 2005, the parent company had over $3.2 million in cash held with its subsidiary banks. This balance along with cash dividends expected to be received from its subsidiaries is sufficient to cover the operating costs of the parent, service its existing other debt and to pay the deferred Trust Preferred distributions approved by the Federal Reserve in the first quarter of 2006. During 2005, the parent company generated $1.5 million of cash from operations and used $5.8 million to redeem a portion of the Trust Preferred Securities outstanding and payoff its outstanding other debt. During 2004, the parent company received $14.3 million from the sale of its subsidiary, Citizens Bank and generated $2.3 million from operations. Premier used a portion of these proceeds to complete the necessary capital injections into Farmers Deposit Bank to maintain the Bank's capital ratios required by the FDIC in accordance with the Order. Premier used a substantial portion of the proceeds to reduce its borrowed funds and redeem a portion of the Trust Preferred Securities outstanding. The remainder was held for future use. Additional information on parent company cash flows and financial statements is contained in Note 21 to the consolidated financial statements.

Capital Resources
 
    Premier's consolidated average equity-to-asset ratio increased to 9.77% during 2005, up from 8.23% in 2004 and from 7.87% during 2003. The ratios for all three years are considered adequate for a company of Premier's size. The increase in 2005 was largely due to increase in net income in 2005 and the decline in average assets due to the sale of Citizen’s Bank Kentucky on July 1, 2004. The increase in 2004 was largely due to the decline in average total assets due to the sale of Citizen's Bank Kentucky. The Federal Reserve's risk-based capital guidelines and leverage ratio measure the capital adequacy of banking institutions. The risk- based capital guidelines weight balance sheet assets and off-balance sheet commitments by prescribed factors relative to credit risk, thus eliminating disincentives for holding low risk assets and requiring more capital for holding higher risk assets. At year-end 2005, Premier's risk adjusted capital-to-assets ratio was 19.1% compared to 18.9% at December 31, 2004. Both of these ratios are well above the minimum level of 8.0% prescribed for bank holding companies of Premier's size. The leverage ratio is a measure of total tangible equity to total tangible assets. Premier's leverage ratio at December 31, 2005 was 10.6% compared to 9.7% at December 31, 2004. Both of these ratios are above the recommended 4.0% to 5.0% recommended by the Federal Reserve. The increase in the 2005 ratios was the result of the increase in total capital due to the increase in net income and decline in total assets resulting from the sale of Citizens Bank, coupled with a decrease in disallowed deferred tax assets. In accordance with Federal Reserve guidelines for all banks and bank holding companies, deferred tax assets are subtracted from Premier's available total equity ("disallowed") if they generally cannot be realized through available tax refunds in


52
 

PREMIER FINANCIAL BANCORP, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS
December 31, 2005


a next twelve month timeframe. Premier's capital ratios are the direct result of management's desire to maintain a strong capital position. Additional information on Premier's capital ratios and the capital ratios of its larger banks may be found in Note 20 to the consolidated financial statements.

While dividend payments to its shareholders are currently restricted by agreement with the FRB, the primary source of funds for dividends paid by Premier is the dividends received from its subsidiary banks. Banking regulations limit the amount of dividends that may be paid without prior approval of the regulatory agencies. Under these regulations, the amount of dividends that may be paid without prior approval 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 requirements and additional restrictions more fully described in Note 20 to the consolidated financial statements. During 2006, Premier's banks could, without prior approval, declare and pay to Premier dividends of approximately $2.5 million plus any 2006 net profits retained through the date of declaration by Ohio River Bank, Boone County Bank and First Central Bank. In 2005, Citizens Deposit Bank requested and received approval from the Federal Reserve to pay a $3.0 million dividend in March 2005. This amount was substantially higher than the bank’s prior two years of reported net income. As such, Citizens Deposit Bank must continue to request approval for up to two years to pay any future dividends to the parent company out of its current earnings. Likewise, Farmers Deposit Bank is under a similar restriction on the payment of dividends due to the net cumulative losses it has recorded over the past two years.

Additional information on the capital position of Premier is included in the following table.

SELECTED CAPITAL INFORMATION
  
(Dollars in thousands)
  
   
As of December 31
  
   
2005
  
2004
  
Change
  
Stockholders’ Equity
  
$
54,287
  
$
51,029
  
$
3,258
  
Qualifying capital securities of subsidiary trust
    
15,250
    
17,185
    
(1,935
)
Disallowed amounts of goodwill and other intangibles
    
(15,816
)
  
(15,816
)
  
0
  
Disallowed deferred tax assets
    
(628
)
  
(1,743
)
  
1,115
  
Unrealized loss on securities available for sale
    
1,718
    
527
    
1,191
  
Tier I capital
  
$
54,811
  
$
51,182
  
$
3,629
  
                     
Tier II capital adjustments
                    
Qualifying capital securities of subsidiary trust
    
0
    
3,065
        
Allowable amount of the allowance for loan losses
    
3,899
    
3,916
        
Total capital
  
$
58,710
  
$
58,163
        
                     
Total risk-weighted assets
  
$
307,951
  
$
307,805
        
                     
Ratios
                    
Tier I capital to risk-weighted assets
    
17.80
%
  
16.63
%
      
Total capital to risk-weighted assets
    
19.06
%
  
18.90
%
      
Leverage at year-end
    
10.61
%
  
9.74
%
      
                     



53
 

PREMIER FINANCIAL BANCORP, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS
December 31, 2005


INCOME STATEMENT ANALYSIS
Net Interest Income
 
    Net interest income, the amount by which interest generated from earning assets exceeds the expense associated with funding those assets, is Premier's most significant component of earnings. Net interest income on a fully tax-equivalent basis was $20.0 million in 2005, up 9.6% from the $18.2 million earned in 2004 which follows a 6.9% decrease in 2004 from 2003. When net interest income is presented on a fully tax-equivalent basis, interest income from tax-exempt earning assets is increased by the amount equivalent to the federal income taxes which would have been paid if this income were taxable at the statutory federal tax rate of 34% for companies of Premier's size. The increase in net interest income in 2005 is largely due to an increase in interest income from loans and investments due to higher yields and a decrease in interest expense due to a reduction in outstanding debt. As shown in the Rate Volume Analysis table below, increases in the yields on loans, investments and other earning assets increased Premier’s interest income by $1.2 million. This increase was complemented by interest expense savings of over $1.0 million due to the reduction of outstanding debt, FHLB borrowings and other borrowings. Some of this interest expense savings was offset by higher interest paid on deposits and other short-term borrowings due to overall higher rates paid on deposits and an increase average certificates of deposit outstanding. The combined effect was to increase net interest income by $1,752,000 for the year.

The decrease in net interest income in 2004 is largely due to a decrease in the volume of loans outstanding coupled with a decline in loan interest income resulting from the high level of non-accrual loans at Farmers Deposit. As shown in the Rate Volume Analysis table below, decreases in the volume of earning assets (primarily loans) in 2004 reduced Premier's interest income by $1.8 million. This decrease was partially offset by the lower volume of interest bearing liabilities in 2004 resulting in a $1.3 million decline in interest expense. The net effect was to reduce net interest income by $571,000 for the year. Similarly, the lower interest rate environment in 2004, coupled with the decline in interest income for loans placed on non-accrual resulted in reduced interest income of $2.0 million. This decline was partially offset by reduced interest expense of $1.2 million which resulted primarily from the lower interest rate environment and the resulting lower rate paid on deposits. During the latter half of 2004, interest rates began to rise, which resulted in increases in the interest paid on Premier's long and short term borrowings. The overall effect of declining volumes and declining rates was a decrease in net interest income of $1.3 million in 2004 when compared to 2003.




54
 

PREMIER FINANCIAL BANCORP, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS
December 31, 2005


RATE VOLUME ANALYSIS OF CHANGES IN NET INTEREST INCOME
  
(Dollars in thousands on a tax equivalent basis)
  
   
2005 vs 2004
  
2004 vs 2003
  
   
Increase (decrease) due to change in
  
Increase (decrease) due to change in
  
   
Volume
  
Rate
  
Net Change
  
Volume
  
Rate
  
Net Change
  
Interest income*:
                          
Loans
  
$
72
  
$
414
  
$
486
  
$
(1,947
)
$
(1,704
)
$
(3,651
)
Investment securities
    
(8
)
  
394
    
386
    
311
    
(401
)
  
(90
)
Federal funds sold
    
(61
)
  
426
    
365
    
(211
)
  
122
    
(89
)
Deposits with banks
    
5
    
0
    
5
    
0
    
(1
)
  
(1
)
Total interest income
  
$
8
  
$
1,234
  
$
1,242
  
$
(1,847
)
$
(1,984
)
$
(3,831
)
                                       
Interest expense:
                                      
Deposits
                                      
NOW and money market
  
$
(104
)
$
223
  
$
119
  
$
(234
)
$
(521
)
$
(755
)
Savings
    
(25
)
  
(84
)
  
(109
)
  
79
    
(339
)
  
(260
)
Certificates of deposit
    
252
    
197
    
449
    
(517
)
  
(705
)
  
(1,222
)
Short-term borrowings
    
38
    
24
    
62
    
25
    
42
    
67
  
Other borrowings
    
(108
)
  
(126
)
  
(234
)
  
(143
)
  
12
    
(131
)
FHLB borrowings
    
(67
)
  
10
    
(57
)
  
(335
)
  
65
    
(270
)
Debt
    
(524
)
  
(216
)
  
(740
)
  
(100
)
  
181
    
81
  
Total interest expense
  
$
(539
)
$
29
  
$
(510
)
$
(1,225
)
$
(1,265
)
$
(2,490
)
Net interest income*
  
$
547
  
$
1,205
  
$
1,752
  
$
(622
)
$
(719
)
$
(1,341
)
                                       
(*) Fully taxable equivalent using the rate of 34%
Note - Changes to rate/volume are allocated to both rate and volume on a proportional dollar basis
 
    As net interest income dollars increased in 2005, Premier’s net interest margin also increased. In 2005, the yield earned on investment securities increased 26 basis points to 3.44% while the average yield on the loan portfolio increased 13 basis points to 7.23%. The yield on federal funds sold increased 194 basis points to 3.23%. The net result on all earning assets was to increase the yield 30 basis points to 5.90% in 2005, up from the 5.60% earned in 2004 but still down slightly from the 5.97% earned in 2003. Similarly, in 2005 Premier increased the average rate paid on its deposits by 17 basis points to keep competitive with national and local market rates. Premier also increased the rates paid on its short-term borrowings by 34 basis points. However, these rate increases were offset by reductions in other borrowings, FHLB advances and Premier’s subordinated debentures. Furthermore, due to the payment of the cumulative deferred Trust Preferred distributions in March, the effective rate on the outstanding principal balance of the debt decreased by 90 basis points to 10.40%. The overall effect on all interest bearing liabilities was to actually reduce the cost of funds 2 basis points to 2.30% in 2005, down from 2.32% in 2004 and2.63% in 2003. As a result Premier's net interest spread increased by 33 basis points and its net interest margin increased by 39 basis points to 4.00% in 2005, up from 3.61% in 2004 and 3.63% in 2003. Further discussion of interest income is included in the section of this report entitled "Balance Sheet Analysis."


55
 

PREMIER FINANCIAL BANCORP, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS
December 31, 2005


Non-interest Income and Expense
 
    Non-interest income has been and will continue to be an important factor for improving profitability. Recognizing this importance, management continues to evaluate areas where non-interest income can be enhanced. As shown in the table of Non-interest Income and Expense below, total fees and other income increased by 11.8% or $414,000 in 2005. The increase in 2005 is largely due to an increase in service charges of deposit accounts and secondary market mortgage commissions (reported in other income.) In 2004, total fees and other income increased by 1.7% or $58,000 in 2004. The increase in 2004 is largely due to an increase in service charges on deposit accounts, substantially offset by declines in insurance commissions and other sources of non-interest income. Service charges on deposit accounts increased to $2,732,000 in 2005, an increase of 8.7% or $219,000. This increase follows a 16.0% or $346,000 increase in 2004 over 2003. The increases are the result of changes in the way Premier charges customers for over drawing their checking accounts and a general increase in customers and activity. Insurance commissions increased in 2005 by $15,000 following a $70,000 decline in 2004. The increase in 2005 is largely due to an increase in new loan generations as loan demand increased in 2005. The decline in 2004 was largely due to lower new loan generations resulting from lower loan demand and stiffer competition from larger banks. Other income increased 19.2% or $180,000 in 2005 largely due to an increase in the commissions from originating secondary market mortgage loans, an increase in debit and ATM card transaction fees and an increase in revenue from other traditional banking services such as checkbook sales and safe box rental. These increases were partially offset by lower data processing revenue from non-affiliate banks as Premier’s data processing subsidiary ceased providing these services in late 2004 and early 2005. Other income decreased 18.8% or $218,000 in 2004 from the high amount of other income reported in 2003. This is primarily the result of a lower volume of commissions from originating secondary market mortgage loans, lower data processing revenue from non-affiliate banks, and a high level of 2003 collections of loans retained from the Bank of Mt. Vernon and Sabina Bank sales.
 
    In 2005, Premier did not execute any sales of investment securities. In 2004, Premier realized $100,000 in net gains on securities sales. These securities were sold as part of Premier's management of its asset/liability position and to liquidate certain tax exempt investments in order to generate future taxable income. In 2003, Premier realized $616,000 in net gains on securities sales. Again, these securities were sold as part of Premier's management of its asset/liability position and to liquidate the tax-exempt investments at Farmers Deposit Bank in order to generate taxable income in the future.



56
 

PREMIER FINANCIAL BANCORP, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS
December 31, 2005


The following table is a summary of non-interest income and expense for each of the years the three-year period ending December 31, 2005.

NON-INTEREST INCOME AND EXPENSE
  
(Dollars in thousands)
  
               
Increase (Decrease) Over Prior Year
  
               
2005
  
2004
  
   
2005
  
2004
  
2003
  
Amount
  
Percent
  
Amount
  
Percent
  
Non-interest income:
                              
Service charges on deposit accounts
  
$
2,732
  
$
2,513
  
$
2,167
  
$
219
    
8.71
  
$
346
    
15.97
  
Insurance income
    
69
    
54
    
124
    
15
    
27.78
    
(70
)
  
(56.45
)
Other
    
1,119
    
939
    
1,157
    
180
    
19.17
    
(218
)
  
(18.84
)
Total fees and other income
  
$
3,920
  
$
3,506
  
$
3,448
    
414
    
11.81
  
$
58
    
1.65
  
Investment securities gains (losses)
    
0
    
100
    
616
    
(100
)
        
(516
)
      
Total non-interest income
  
$
3,920
  
$
3,606
  
$
4,064
  
$
314
    
8.71
  
$
(458
)
  
(11.27
)
                                             
Non-interest expense:
                                            
Salaries and wages
  
$
7,443
  
$
7,103
  
$
6,768
  
$
340
    
4.79
  
$
335
    
4.95
  
Employee benefits
    
1,642
    
1,633
    
1,955
    
9
    
0.55
    
(322
)
  
(16.47
)
Total staff costs
    
9,085
    
8,736
    
8,723
    
349
    
3.99
    
13
    
0.15
  
Occupancy and equipment
    
2,262
    
2,141
    
2,260
    
121
    
5.65
    
(119
)
  
(5.27
)
Outside data processing
    
1,505
    
1,023
    
1,062
    
482
    
47.12
    
(39
)
  
(3.67
)
Professional fees
    
554
    
2,271
    
1,338
    
(1,717
)
  
(75.61
)
  
933
    
69.73
  
Taxes, other than payroll, property and income
    
423
    
589
    
534
    
(166
)
  
(28.18
)
  
55
    
10.30
  
OREO losses and expenses
    
52
    
(45
)
  
540
    
97
    
(215.56
)
  
(585
)
  
(108.33
)
Bad check losses
    
36
    
94
    
461
    
(58
)
  
(61.70
)
  
(367
)
  
(79.61
)
Supplies
    
362
    
365
    
379
    
(3
)
  
(0.82
)
  
(14
)
  
(3.69
)
Accelerated amortization of Trust Preferred issuance costs
    
184
    
214
    
124
    
(30
)
  
(14.02
)
  
90
    
72.58
  
Other expenses
    
2,842
  
$
2,394
  
$
2,211
  
$
448
    
18.71
  
$
183
    
8.28
  
Total non-interest expenses
  
$
17,305
  
$
17,782
  
$
17,632
  
$
477
    
(2.68
)
$
150
    
0.85
  
                                             
 
    Just as management continues to evaluate areas where non-interest income can be enhanced, it strives to find ways to improve the efficiency of its operations and utilize the economies of scale of the consolidated entity to reduce its operating costs. Premier’s 2005 net overhead ratio, or non-interest expense less non-interest income excluding securities transactions and other similar non-operating transactions to average earning assets was 2.67%, a decrease from the 2.82% realized in 2004 but still higher than the 2.62% ratio realized in 2003. The actual dollars of net overhead declined by 6.2% or $891,000 in 2005 which reduced the ratio by 15 basis points. In 2004, the ratio increased by 20 basis points, while the actual dollars of net overhead expense increased by only 0.7% or $95,000. The primary reason for the increase in the net overhead ratio in 2004 was the 6.1% decrease in average earning assets without a corresponding decrease in operating costs. For the year 2005, net overhead was $13.4 million, down $891,000 from the $14.3 million of 2004 net overhead. The current year increase follows a $95,000 or 0.7% increase in 2004 from the $14.2 million of net overhead in 2003.


57
 

PREMIER FINANCIAL BANCORP, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS
December 31, 2005


Total non-interest expense in 2005 decreased by $477,000, or 2.7% from 2004 as decreases in professional fees, taxes not on income, and bad check losses were only partially offset by higher data processing fees, staff costs, OREO expenses, occupancy and equipment expenses and other operating expenses. Total non-interest expense in 2004 increased by $150,000, or 0.9% from 2003 as decreases in OREO losses, bad check losses and occupancy and equipment expenses were essentially offset by increased professional fees, taxes not on income and other operating expenses.

Staff costs increased by $349,000 or 4.0% in 2005 versus 2004. Normal salary and wage increases in 2005 were increased by the addition of full time internal audit staff at the parent company. The use of employees to perform the internal audits of the company helped to reduce professional fees paid to outside which performed the function in 2004 and earlier. Staff costs increased by only $13,000 or 0.2% in 2004 versus 2003. Increases in salaries and wages were essentially offset by reductions in medical insurance and other benefit costs. In the second quarter of 2003, employees were required to contribute a percentage of the overall medical insurance premium as Premier changed its benefit structure to be more in-line with its competitors. The percentage of employee contribution was phased in over a two year period.

Occupancy and equipment expenses increased by $121,000 or 5.7% in 2005 due to the costs of operating an additional branch location opened in January 2005 plus an increase in equipment costs related to the write-off of old equipment and the purchase of new technology related to Premier’s conversion to an outside data processor in 2005. Occupancy and equipment expenses decreased by $119,000 or 5.3% in 2004 as lower equipment depreciation and maintenance costs were complemented by lower occupancy costs.

Outside data processing expense increased by $482,000 or 47.1% in 2005 as Premier transitioned its internal data and item processing functions to an outsourced provider. Savings in other expense areas such as staff costs, occupancy and equipment expense and other operating expenses will be realized as a result of the conversion. In 2004, outside data processing costs decreased by $39,000 or 3.7% versus 2003 as costs related to the data processing subsidiary were relatively unchanged from year to year.

Professional fees decreased by $1,717,000 or 75.6% in 2005 versus 2004 largely due to the increased audit costs as well as legal fees and other professional fees associated with Premier's investigation of Farmers Deposit Bank and the related SEC investigation in 2004 as disclosed in previous filings. Professional fees also declined in 2005 as a result of bringing the internal audit function in-house. Professional fees increased by $933,000 or 69.7% in 2004 versus 2003 largely due to legal and audit costs related to the Farmers Deposit Bank investigation.




58
 

PREMIER FINANCIAL BANCORP, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS
December 31, 2005


Taxes not on income decreased by $166,000 or 28.1% in 2005 versus 2004. The decrease in 2005 is largely due to a decrease in the taxable equity of the two Kentucky banks subject to the Kentucky Bank Franchise Tax. Taxes not on income increased by $55,000 or 10.3% in 2004 versus 2003. The increase in 2004 is due to an increase in franchise taxes imposed by the states in which the Banks operate.

OREO writedowns and expenses totaled $52,000 in 2005, a $97,000 increase over the net $45,000 benefit realized in 2004. The 2005 expense represents the costs to operate, maintain and liquidate Other Real Estate through foreclosure in satisfaction of unpaid loans. In 2004, Premier realized $123,000 of net profit from the disposition of OREO properties. A majority of the gains on the disposition of OREO were on properties from which no previous writedowns had occurred. This profit more than offset the costs of maintaining the remaining OREO property held in 2004. The net benefit in 2004 is a $585,000 decrease from the $540,000 of OREO writedowns and expenses recorded in 2003.

Bad check losses declined for the second year in a row to $36,000 in 2005. Bad check losses totaled $94,000 in 2004, a $367,000 decrease from the $461,000 recorded in 2003. The increase in 2003 was primarily the result of bad checks losses at Farmers Deposit Bank related to dishonored checks discovered during investigation. A partial collection of these checks was realized in the first quarter of 2006.

Accelerated Trust Preferred issuance costs were recognized in 2003, 2004 and 2005. At the time of issuance, the costs to originate the Trust Preferred Securities were capitalized. The costs are being amortized over the 30 year life of the securities which mature in 2027 and are recorded as an adjustment to interest expense. In March 2003, Premier redeemed $3.0 million of the Trust Preferred Securities in accordance with the terms of the instrument. At that time an amount of the remaining unamortized issuance costs proportional to the $3.0 million of the then $28.8 million of Trust Preferred Securities outstanding was expensed to non-interest expense. This amount totaled $124,000 in 2003. Likewise, as a result of the $4.5 million early redemption on October 15, 2004 and the additional $1.0 million redeemed on December 31, 2004, Premier expensed $214,000 of the issuance costs. In 2005, as a result of the $5.0 million early redemption on December 31, 2005, Premier expensed $184,000 of the issuance costs. Additional information on the Trust Preferred Securities is contained in Note 12 to the consolidated financial statements.

Other expenses totaled $2.8 million in 2005, an 18.7% or $448,000 increase from the $2.4 million recorded in 2004. The increase in 2005 is largely due to costs and fees related to Premier’s conversion to an outsource data and item processing provider. These costs include the travel and training of employees, fees and travel expense reimbursements paid to Fiserv to convert Premier’s data and costs associated with upgrading Premier’s computer networks. In 2004, other expenses increased $183,000 or 8.3% from the $2.2 million of other expenses recorded in 2003. The increase in 2004 is largely due to a $165,000 writedown of the former headquarters of Premier located in Georgetown Kentucky prior to its sale.


59
 

PREMIER FINANCIAL BANCORP, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS
December 31, 2005


An analysis of the allowance for loan losses and related provision for loan losses is included in the Loan Portfolio section of the Balance Sheet Analysis of this report.

Applicable Income Taxes
 
    Premier recognized $2.0 million of income tax expense related to continuing operations in 2005. This amount compares to $899,000 of income tax expense recorded in 2004 and the $5.3 million income tax benefit recognized in 2003. The benefit in 2003 was due to the pretax losses realized by Premier. Premier's effective tax rate was 31.4% in 2005 and 2004, down from the negative (35.5%) in 2003. Premier's effective tax rate in 2003 was increased by the benefits of holding tax-exempt investments and other tax saving instruments. These tax saving benefits helped to reduce Premier's positive tax rate in 2005 and 2004 to 31.4% from the 34.0% statutory rate. Additional information regarding income taxes is contained in Note 13 to the consolidated financial statements.

Effects of Changing Prices
 
    The results of operations and financial condition presented in this report are based on historical cost, unadjusted for the effects of inflation. Inflation affects Premier in two ways. One is that inflation can result in increased operating costs which must be absorbed or recovered through increased prices for services. The second effect is on the purchasing power of the corporation. Virtually all of a bank's assets and liabilities are monetary in nature. Regardless of changes in prices, most assets and liabilities of the banking subsidiaries will be converted into a fixed number of dollars. Non-earning assets, such as premises and equipment, do not comprise a major portion of Premier's assets; therefore, most assets are subject to repricing on a more frequent basis than in other industries.
 
    Premier's ability to offset the effects of inflation and potential reductions in future purchasing power depends primarily on its ability to maintain capital levels by adjusting prices for its services and to improve net interest income by maintaining an effective asset/liability mix. Management's efforts to meet these goals are described in other sections of this report.


SUMMARY RESULTS OF OPERATIONS
FOURTH QUARTER 2005
 
    Income from continuing operations for the three months ended December 31, 2005 totaled $1,537,000, a $978,000 or 175% increase from the $559,000 of income from continuing operations reported for the fourth quarter of 2004. On a per share basis, Premier's income from continuing operations for the fourth quarter of 2005 was 29 cents per share, compared to 11 cents per share for the same quarter last year.


60
 

PREMIER FINANCIAL BANCORP, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS
December 31, 2005


Net interest income totaled $5,177,000 for the fourth quarter of 2005, an increase of $375,000 or 7.8% from the net interest income earned in the same quarter of 2004. The increase is the result of higher interest income on loans and investments largely due to higher yields. This increase in interest income was partially offset by an increase in interest expense. An increase in interest expense on deposits as a result of higher rates paid was partially reduced by a decrease in interest expense on borrowings due to lower outstanding balances. During the fourth quarter of 2005, Premier reversed $290,000 of previously recorded provisions for loan losses (negative provisions). This compares to $355,000 of positive provisions in the fourth quarter of 2004. The negative provisions in the fourth quarter of 2005 were the result of continued improvement in the estimated credit risk at banks formerly subject to regulatory agreements and payments on loans previously identified as having significant credit risk at Farmers Deposit Bank. Future provisions to the allowance for loan losses, positive or negative, will depend on future improvement or deterioration in estimated credit risk in the loan portfolio as well as whether additional payments are received on loans having significant credit risk.  Non-interest income excluding securities transactions totaled $1,036,000 in the fourth quarter of 2005, an increase of $166,000 or 19.1% from the $870,000 in the fourth quarter of 2004. The increase was largely due to an increase in service charge revenue on deposit accounts as well as increases in debit card and ATM transaction fees and secondary market mortgage commissions. Non-interest expense totaled $4,245,000 in the fourth quarter of 2005, a $339,000 or 7.4% decrease from the $4,584,000 reported for the fourth quarter of 2004. A decrease in professional fees was only partially offset by increases in outside data processing costs, OREO expenses and writedowns, and other operating expenses. Additional quarterly financial data is provided in Note 22 to the consolidated financial statements.


ADOPTION OF NEW ACCOUNTING STANDARDS
 
    Recently Issued Accounting Standards Not Yet Adopted - FAS 123, Revised, requires all public companies to record compensation cost for stock options provided to employees in return for employee service. The cost of stock options is measured at the fair value of the options when granted. This cost will be required to be expensed over the employee service period, which is normally the vesting period of the options. This Standard will apply to stock option awards granted or modified beginning in 2006. Compensation cost will also be recorded for options already granted that have a vesting period beyond December 31, 2005. The effect on results of operations will depend on the level of future option grants and the calculation of the fair value of the options granted. The effect of existing options that will continue to vest after the adoption date is anticipated to be $27 in 2006 and $9 in 2007. The will also be no significant effect on the financial position of the Company as total equity will not change as a result of the required recording of compensation cost.



61
 

PREMIER FINANCIAL BANCORP, INC.
FORM 10-K
December 31, 2005


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:

Report of Independent Registered Public Accounting Firm                                         
 
Financial Statements:
Consolidated Balance Sheets - December 31, 2005 and 2004                                         
Consolidated Statements of Operations - Years Ended December 31, 2005, 2004, and 2003                 
Consolidated Statements of Comprehensive Income - Years Ended December 31, 2005, 2004, and 2003         
Consolidated Statements of Changes in Stockholders' Equity - Years ended
December 31, 2005, 2004, and 2003                                                 
Consolidated Statements of Cash Flows - Years ended December 31, 2005, 2004, and 2003
Notes to Consolidated Financial Statements









62
.

 







PREMIER FINANCIAL BANCORP, INC.


CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2005, 2004 and 2003

 
 
 
 

 



 

REPORT OF INDEPENDENT REGISTERED
PUBLIC ACCOUNTING FIRM


Board of Directors and Shareholders
Premier Financial Bancorp, Inc.
Huntington, West Virginia


We have audited the accompanying consolidated balance sheets of Premier Financial Bancorp, Inc. as of December 31, 2005 and 2004, and the related consolidated statements of operations, comprehensive income, changes in stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2005. 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 the standards of the Public Company Accounting Oversight Board (United States). 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, 2005 and 2004, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2005, in conformity with U.S. generally accepted accounting principles.




Crowe Chizek and Company LLC


Columbus, Ohio
March 17, 2006



PREMIER FINANCIAL BANCORP, INC.
CONSOLIDATED BALANCE SHEETS
December 31, 2005 and 2004
(In Thousands, Except Per Share Data)


   
2005
  
2004
  
ASSETS
             
Cash and due from banks
 
$
16,080
  
$
14,474
  
Federal funds sold
   
18,812
    
17,342
  
Securities available for sale
    
137,419
    
153,892
  
Loans
    
328,717
    
324,927
  
Allowance for loan losses
    
(7,892
)
  
(9,384
)
Net loans
    
320,825
    
315,543
  
Federal Home Loan Bank and Federal Reserve Bank stock
    
3,060
    
2,611
  
Premises and equipment, net
    
7,126
    
7,257
  
Real estate and other property acquired through foreclosure
    
2,049
    
2,247
  
Interest receivable
    
2,661
    
2,740
  
Goodwill
    
15,816
    
15,816
  
Other assets
    
4,476
    
5,333
  
Total assets
  
$
528,324
  
$
537,255
  
               
LIABILITIES AND STOCKHOLDERS' EQUITY
              
Deposits
              
Non-interest bearing
  
$
69,856
  
$
68,380
  
Time deposits, $100,000 and over
    
42,169
    
40,213
  
Other interest bearing
    
323,818
    
329,205
  
Total deposits
    
435,843
    
437,798
  
Federal funds purchased
    
-
    
1,838
  
Securities sold under agreements to repurchase
   
9,317
    
7,208
  
Federal Home Loan Bank advances
    
8,334
    
9,288
  
Other borrowed funds
    
-
    
800
  
Notes payable
    
1,402
    
1,402
  
Guaranteed junior subordinated interest debentures
    
15,722
    
20,876
  
Interest payable
    
724
    
5,532
  
Other liabilities
    
2,695
    
1,484
  
Total liabilities
    
474,037
    
486,226
  
Commitments and contingent liabilities
    
-
    
-
  
               
Stockholders' equity
              
Preferred stock, no par value; 1,000,000 shares authorized;
              
none issued or outstanding
    
-
    
-
  
Common stock, no par value; 10,000,000 shares authorized;
              
5,233,897 shares issued and outstanding
    
1,105
    
1,103
  
Surplus
    
43,458
    
43,445
  
Retained earnings
    
11,442
    
7,008
  
Accumulated other comprehensive income (loss)
    
(1,718
)
  
(527
)
Total stockholders' equity
    
54,287
    
51,029
  
Total liabilities and stockholders' equity
  
$
528,324
  
$
537,255
  

 
 
See accompanying notes.
65

PREMIER FINANCIAL BANCORP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
Years Ended December 31
(In Thousands, Except Per Share Data)


   
2005
  
2004
  
2003
  
Interest income
                    
Loans, including fees
  
$
23,532
  
$
23,073
  
$
26,731
  
Investment securities
                    
Taxable
    
5,014
    
4,444
    
3,871
  
Tax-exempt
    
96
    
217
    
651
  
Federal funds sold
    
745
    
380
    
469
  
Other interest income
    
12
    
7
    
7
  
Total interest income
    
29,399
    
28,121
    
31,729
  
                     
Interest expense
                    
Deposits
    
6,725
    
6,267
    
8,503
  
Repurchase agreements and other
    
180
    
115
    
51
  
FHLB advances and other borrowings
    
513
    
807
    
1,205
  
Debentures
    
2,129
    
2,868
    
2,788
  
Total interest expense
    
9,547
    
10,057
    
12,547
  
                     
Net interest income
    
19,852
    
18,064
    
19,182
  
Provision for loan losses
    
4
    
1,026
    
20,513
  
Net interest income after provision for loan losses
    
19,848
    
17,038
    
(1,331
)
                     
Non-interest income
                    
Service charges
    
2,732
    
2,513
    
2,167
  
Insurance commissions
    
69
    
54
    
124
  
Securities gains
    
-
    
100
    
616
  
Other
    
1,119
    
939
    
1,157
  
     
3,920
    
3,606
    
4,064
  
Non-interest expenses
                    
Salaries and employee benefits
    
9,085
    
8,736
    
8,723
  
Occupancy and equipment expenses
    
2,262
    
2,141
    
2,260
  
Outside data processing
    
1,505
    
1,023
    
1,062
  
Professional fees
    
554
    
2,271
    
1,338
  
Taxes, other than payroll, property and income
    
423
    
589
    
534
  
Write-downs, expenses, sales of other real estate owned
    
52
    
(45
)
  
540
  
Supplies
    
362
    
365
    
379
  
Bad check losses
    
36
    
94
    
461
  
Other expenses
    
3,026
    
2,608
    
2,335
  
     
17,305
    
17,782
    
17,632
  
Income (loss) from continuing operations before income taxes
    
6,463
    
2,862
    
(14,899
)
Provision (benefit) for income taxes
    
2,029
    
899
    
(5,282
)
                     
Income (loss) from continuing operations
    
4,434
    
1,963
    
(9,617
)
                     
Discontinued operation
                    
Income (loss) from operations of discontinued component
    
-
    
4
    
(127
)
Gain on sale of discontinued component
    
-
    
6,664
    
-
  
Provision (benefit) for income taxes
    
-
    
1,934
    
(47
)
Income (loss) from discontinued operation
    
-
    
4,734
    
(80
)
                     
Net income (loss)
  
$
4,434
  
$
6,697
  
$
(9,697
)


(continued)
 
66


PREMIER FINANCIAL BANCORP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS (Continued)
Years Ended December 31
(In Thousands, Except Per Share Data)


   
2005
  
2004
  
2003
  
Weighted average shares outstanding:
                    
Basic
    
5,233
    
5,232
    
5,232
  
Diluted
    
5,248
    
5,237
    
5,232
  
                     
Earnings per share from continuing operations:
                    
Basic
  
$
0.85
  
$
0.37
  
$
(1.84
)
Diluted
    
0.84
    
0.37
    
(1.84
)
                     
Earnings (loss) per share from discontinued operation:
                    
Basic
  
$
-
  
$
0.90
  
$
(0.01
)
Diluted
    
-
    
0.90
    
(0.01
)
                     
Net earnings per share:
                    
Basic
  
$
0.85
  
$
1.28
  
$
(1.85
)
Diluted
    
0.84
    
1.28
    
(1.85
)
                     


See accompanying notes.
67

PREMIER FINANCIAL BANCORP, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Years Ended December 31
(In Thousands, Except Per Share Data)


   
2005
  
2004
  
2003
  
Net income (loss)
  
$
4,434
  
$
6,697
  
$
(9,697
)
                     
Other comprehensive income (loss):
                    
Unrealized gains and (losses) arising during the period
    
(1,805
)
  
(1,730
)
  
(726
)
Reclassification of realized amount
    
-
    
(100
)
  
(618
)
Net change in unrealized gain (loss) on securities
    
(1,805
)
  
(1,830
)
  
(1,344
)
Less tax impact
    
(614
)
  
(622
)
  
(457
)
Other comprehensive income (loss):
    
(1,191
)
  
(1,208
)
  
(887
)
                     
Comprehensive income (loss)
  
$
3,243
  
$
5,489
  
$
(10,584
)
                     


See accompanying notes.
 
68

PREMIER FINANCIAL BANCORP, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
Years Ended December 31, 2005, 2004 and 2003
(In Thousands, Except Per Share Data)


   
Common
Stock
  
Capital
Surplus
  
Retained
Earnings
  
Accumulated
Other
Comprehensive
Income
  
Total
  
Balances, January 1, 2003
  
$
1,103
  
$
43,445
  
$
10,008
  
$
1,568
  
$
56,124
  
Net change in unrealized gains (losses)
on securities available for sale
    
-
    
-
    
-
    
(887
)
  
(887
)
Net loss
    
-
    
-
    
(9,697
)
  
-
    
(9,697
)
Balances, December 31, 2003
    
1,103
    
43,445
    
311
    
681
    
45,540
  
Net change in unrealized gains (losses)
on securities available for sale
    
-
    
-
    
-
    
(1,208
)
  
(1,208
)
Net income
    
-
    
-
    
6,697
    
-
    
6,697
  
Balances, December 31, 2004
    
1,103
    
43,445
    
7,008
    
(527
)
  
51,029
  
Net change in unrealized gains (losses)
on securities available for sale
    
-
    
-
    
-
    
(1,191
)
  
(1,191
)
Stock options exercised, 1,667 shares
    
2
    
13
    
-
    
-
    
15
  
Net income
    
-
    
-
    
4,434
    
-
    
4,434
  
Balances, December 31, 2005
  
$
1,105
  
$
43,458
  
$
11,442
  
$
(1,718
)
$
54,287
  
                                 



 
See accompanying notes.
 
 
69


PREMIER FINANCIAL BANCORP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31
(In Thousands, Except Per Share Data)


   
2005
  
2004
  
2003
  
Cash flows from continuing operating activities
              
Income (loss) from continuing operations
  
$
4,434
  
$
1,963
  
$
(9,617
)
Adjustments to reconcile income (loss) to net cash from
continuing operating activities
                    
Depreciation and impairment of real estate
    
976
    
904
    
989
  
Provision for loan losses
    
4
    
1,026
    
20,513
  
Amortization, net
    
236
    
496
    
567
  
FHLB stock dividends
    
(113
)
  
(90
)
  
(139
)
Writedowns (gains) on other real estate owned
    
(17
)
  
(123
)
  
466
  
Securities gains
    
-
    
(100
)
  
(616
)
Changes in :
                    
Interest receivable
    
79
    
708
    
1,806
  
Deferred income taxes
    
1,119
    
3,334
    
(1,693
)
Other assets
    
201
    
1,774
    
(2,862
)
Interest payable
    
(4,808
)
  
1,630
    
2,347
  
Other liabilities
    
(18
)
  
(20
)
  
398
  
Net cash from continuing operating activities
    
2,093
    
11,502
    
12,159
  
                     
Cash flows from continuing investing activities
                    
Purchases of securities available for sale
    
(18,486
)
  
(76,861
)
  
(141,891
)
Proceeds from sales of securities available for sale
    
-
    
1,911
    
21,926
  
Proceeds from maturities and calls of securities
   available for sale
    
34,143
    
66,675
    
115,770
  
Purchase of FHLB stock, net of redemptions
    
(336
)
  
(31
)
  
1,466
  
Proceeds from sale of subsidiary
    
-
    
14,311
    
-
  
Net change in federal funds sold
    
(1,470
)
  
(291
)
  
7,696
  
Net change in loans
   
(6,120
)
  
311
    
22,788
  
Purchases of loan participations from other banks
    
(1,197
)
  
(2,943
)
  
-
  
Payments on loan participations with other banks
    
589
    
10
    
-
  
Purchases of premises and equipment, net
    
(845
)
  
(205
)
  
(473
)
Proceeds from sale of other real estate acquired
through foreclosure
    
1,658
    
4,610
    
2,190
  
Net cash from continuing investing activities
    
7,936
    
7,497
    
29,472
  




 
(continued)
 
 
70


PREMIER FINANCIAL BANCORP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
Years Ended December 31
(In Thousands, Except Per Share Data)


   
2005
  
2004
  
2003
  
Cash flows from continuing financing activities
              
Net change in deposits
    
(1,955
)
  
(17,676
)
  
(22,250
)
Advances from Federal Home Loan Bank
    
-
    
-
    
2,750
  
Repayment of Federal Home Loan Bank advances
    
(954
)
  
(1,417
)
  
(10,288
)
Early redemption of debentures, net
    
(5,000
)
  
(5,500
)
  
(3,000
)
Repayment of other borrowed funds
    
(800
)
  
(5,400
)
  
(1,500
)
Proceeds from stock option exercises
    
15
    
-
    
-
  
Net change in federal funds purchased
    
(1,838
)
  
1,838
    
-
  
Net change in agreements to repurchase securities
    
2,109
    
7,208
    
(5,255
)
Net cash from continuing financing activities
    
(8,423
)
  
(20,947
)
  
(39,543
)
                     
Net change in cash and cash equivalents from continuing activities
    
1,606
    
1,948
    
2,088
)
                     
Cash and cash equivalents of continuing operations at beginning of year
    
14,474
    
16,422
    
14,334
  
                     
Cash and cash equivalents of continuing operations at end of year
  
$
16,080
  
$
14,474
  
$
16,422
  
                     
Supplemental disclosures of cash flow information:
                    
Cash paid during year for -
                    
Interest
  
$
14,354
  
$
8,428
  
$
10,201
  
Income taxes paid (refunded)
    
191
    
(3,946
)
  
(549
)
                     
Loans transferred to real estate acquired through foreclosure
  
$
1,443
  
$
3,547
  
$
2,338
  
                     
Cash and cash equivalents of discontinued operations
                    
Beginning of year
  
$
-
  
$
5,306
  
$
3,710
  
Net cash from operating activities
    
-
    
432
    
829
  
Net cash from investing activities
    
-
    
(2,636
)
  
5,815
  
Net cash from financing activities
    
-
    
(3,102
)
  
(5,048
)
End of year
  
$
-
  
$
-
  
$
5,306
  
                     


 
See accompanying notes.
 
 
71


PREMIER FINANCIAL BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2005, 2004, and 2003
(Dollars in Thousands, Except Per Share Data)


NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The consolidated financial statements include the accounts of Premier Financial Bancorp, Inc. (the Company) and its wholly-owned subsidiaries:
 
           
Unaudited 
  
           
December 31, 2005 
  
Subsidiary
  
Location
  
Year
Acquired
  
Total
Assets
  
Net
Income
  
Citizens Deposit Bank & Trust
    
Vanceburg, Kentucky
    
1991
  
$
118,211
  
$
1,826
  
Farmers Deposit Bank
    
Eminence, Kentucky
    
1996
    
80,839
    
129
  
Ohio River Bank
    
Ironton, Ohio
    
1998
    
80,116
    
843
  
First Central Bank, Inc.
    
Philippi, West Virginia
    
1998
    
98,779
    
1,490
  
Boone County Bank, Inc.
    
Madison, West Virginia
    
1998
    
148,791
    
2,388
  
Mt. Vernon Financial Holdings, Inc.
    
Huntington, West Virginia
    
1999
    
1,864
    
(22
)

The Company also owns an inactive data processing subsidiary, Premier Data Services, Inc. All material intercompany transactions and balances have been eliminated.

Nature of Operations: The subsidiary banks (Banks) operate under state bank charters and provide traditional banking services, including trust services, to customers primarily located in the counties and adjoining counties in Kentucky, Ohio, and West Virginia in which the Banks operate. Chartered as state banks, the Banks are subject to regulation by their respective state banking regulators and the Federal Deposit Insurance Corporation (FDIC) or the Federal Reserve Bank for member banks. The Company is also subject to regulation by the Federal Reserve Bank.

Estimates in the Financial Statements: The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America 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. The allowance for loan losses, the identification and evaluation of impaired loans, impairment of goodwill, realizability of deferred tax assets, and fair values of financial instruments are particularly subject to change.

Cash Flows: For purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks and interest-earning balances with banks with an original maturity less than ninety days. Net cash flows are reported for loans, federal funds sold, deposits, and other borrowing transactions.



 
(continued)
 
 
72

PREMIER FINANCIAL BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2005, 2004, and 2003
(Dollars in Thousands, Except Per Share Data)


NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Securities: The Company classifies its securities portfolio as either securities available for sale or securities held to maturity. Securities held to maturity are carried at amortized cost.

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 accumulated other comprehensive income on securities available for sale. Other securities such as Federal Home Loan Bank stock are carried at cost.

Interest income includes amortization of purchase premium or discount computed using the level 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. Securities are written down to fair value when a decline in fair value is not temporary.

Declines in the fair value of securities below their cost that are other than temporary are reflected as realized losses. In estimating other-than-temporary losses, management considers: (1) the length of time and extent that fair value has been less than cost, (2) the financial condition and near term prospects of the issuer, and (3) the Company’s ability and intent to hold the security for a period sufficient to allow for any anticipated recovery in fair value.

Loans: Net 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 non-accrual 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.

All interest accrued but not received for loans placed on non-accrual is reversed against interest income. Interest received on such loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

The allowance for loan losses is a valuation allowance for probable incurred credit losses increased by a provision for loan losses charged to expense. The allowance is an amount that management believes will be adequate to absorb probable incurred losses on existing loans 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

 
(continued)
 
 
73

PREMIER FINANCIAL BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2005, 2004, and 2003
(Dollars in Thousands, Except Per Share Data)


NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

management believes that the collection of principal is unlikely. Subsequent recoveries, if any, are credited to the allowance.

A loan is impaired when full payment under the loan terms is not expected. Impairment is evaluated in total for smaller-balance loans of similar nature such as residential mortgage, consumer, and credit card loans, and on an individual loan basis for other loans. If a loan is impaired, a portion of the allowance is allocated so that the loan is reported, net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral.

Premises and Equipment: Land is carried at cost. Premises and equipment are stated at cost less accumulated depreciation. Depreciation is recorded principally by the straight-line method with useful lives ranging from 7 to 40 years for premises and from 3 to 15 years for equipment.

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.

Long-term Assets: Premises and equipment and other long-term assets are reviewed for impairment when events indicate that the carrying amount may not be recoverable from future undiscounted cash flows. If impaired, the assets are recorded at fair value.

Repurchase Agreements: Substantially all repurchase agreement liabilities represent amounts advanced by various customers. Securities are pledged to cover these liabilities, which are not covered by federal deposit insurance.

Goodwill: Goodwill results from prior business acquisitions and represents the excess of the purchase price over the fair value of acquired tangible assets and liabilities and identifiable intangible assets. Goodwill is assessed at least annually for impairment and any such impairment will be recognized in the period identified. Impairment is evaluated using the aggregate of all banking operations. To evaluate impairment, management uses pricing valuation factors such as price-to-total assets and price-to-total deposits from databases of actual peer group bank sales. These valuation factors are applied to the comparable factors of the Company’s aggregate banking operations to arrive at estimated fair value. The Company does not have any identifiable intangible assets such as core deposit intangibles.

 
(continued)
 
 
74

PREMIER FINANCIAL BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2005, 2004, and 2003
(Dollars in Thousands, Except Per Share Data)


NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

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

   
2005
  
2004
  
2003
  
Income (loss) from continuing operations
  
$
4,434
  
$
1,963
  
$
(9,617
)
Deduct: Stock based compensation expense determined under fair value based method
    
(61
)
  
(33
)
  
(18
)
Pro forma income (loss)
  
$
4,373
  
$
1,930
  
$
(9,635
)
                     
Basic earnings (loss) per share from continuing operations
  
$
0.85
  
$
0.37
  
$
(1.84
)
Pro forma basic earnings (loss) per share
    
0.84
    
0.37
    
(1.84
)
                     
Diluted earnings (loss) per share from continuing operations
  
$
0.84
  
$
0.37
  
$
(1.84
)
Pro forma basic earnings (loss) per share
    
0.83
    
0.37
    
(1.84
)

On January 19, 2005, 35,000 incentive stock options were granted out of the 2002 Plan at an exercise price of $11.62. These options vest in three equal annual installments ending on January 19, 2008. On February 18, 2004, 28,200 incentive stock options were granted out of the 2002 Stock Option Plan at an exercise price of $9.30. These options vest in three equal annual installments ending on February 18, 2007. On January 15, 2003, 28,650 incentive stock options were granted out of the 2002 Stock Option Plan at an exercise price of $7.96. These options vested in three equal annual installments and were fully vested on January 15, 2006. Proforma stock-compensation expense is being amortized over the three-year vesting period for each of these grants.

 

 
(continued)
 
 
75

PREMIER FINANCIAL BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2005, 2004, and 2003
(Dollars in Thousands, Except Per Share Data)


NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

The pro forma effects are computed using option pricing models, using the following weighted-average assumptions as of grant date.

   
2005
  
2004
  
2003
  
Risk-free interest rate
    
3.70
%
  
3.15
%
  
3.10
%
Expected option life (yrs)
    
5.00
    
5.00
    
5.00
  
Expected stock price volatility
    
0.25
    
0.25
    
0.42
  
Dividend yield
    
0.00
%
  
0.00
%
  
0.00
%
Weighted average fair value of options granted during the year
  
$
3.48
  
$
2.64
  
$
3.30
  

Income Taxes: Income tax expense is the total of the current year income tax due or refundable and the change in deferred tax assets and liabilities. Deferred tax assets and liabilities are the expected future tax amounts for the temporary differences between carrying amounts and tax bases of assets and liabilities, computed using enacted tax rates. A valuation allowance, if needed, reduces deferred tax assets to the amount expected to be realized.

Off Balance Sheet Financial Instruments: Financial instruments include off-balance sheet credit instruments, such as commitments to make loans and standby letters of credit, issued to meet customer financing needs. The face amount for these items represents the exposure to loss, before considering customer collateral or ability to repay. Such financial instruments are recorded when they are funded.

Earnings Per Common Share: Basic earnings per common share is net income divided by the weighted average number of common shares outstanding during the period. Diluted earnings per common share includes the dilutive effect of additional potential common shares issuable under stock options. Earnings and dividends per share are restated for all stock splits and dividends through the date of issuance of the financial statements.

Comprehensive Income: Comprehensive income consists of net income and other comprehensive income. Other comprehensive income includes unrealized gains and losses on securities available for sale which are also recognized as a separate component of equity.

Fair Value of Financial Instruments: Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed in a separate note. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments, and other factors, especially in the absence of broad markets for particular items. Changes in assumptions or in market conditions could significantly affect the estimates.
 
 
 
(continued)
 
 
76

PREMIER FINANCIAL BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2005, 2004, and 2003
(Dollars in Thousands, Except Per Share Data)


NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Operating Segments: All of the Company’s operations are considered by management to be aggregated into one reportable operating segment. While the chief decision-makers monitor the revenue streams of the various products and services, the identifiable segments are not material. Operations are managed and financial performance is evaluated on a Company-wide basis.

Reclassifications: Some items in the prior year financial statements were reclassified to conform to the current presentation.

Recently Issued Accounting Standards Not Yet Adopted: FAS 123, Revised, requires all public companies to record compensation cost for stock options provided to employees in return for employee service. The cost of stock options is measured at the fair value of the options when granted. This cost will be required to be expensed over the employee service period, which is normally the vesting period of the options. This Standard will apply to stock option awards granted or modified beginning in 2006. Compensation cost will also be recorded for options already granted that have a vesting period beyond December 31, 2005. The effect on results of operations will depend on the level of future option grants and the calculation of the fair value of the options granted. The effect of existing options that will continue to vest after the adoption date is anticipated to be $27 in 2006 and $9 in 2007. There will also be no significant effect on the financial position of the Company as total equity will not change as a result of the required recording of compensation cost.


 
(continued)
 
 
77

PREMIER FINANCIAL BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2005, 2004, and 2003
(Dollars in Thousands, Except Per Share Data)


NOTE 2 - DISCONTINUED OPERATIONS

In the fourth quarter of 2003, the Company adopted and began to implement a plan to sell its subsidiary Citizens Bank (Kentucky), Inc. (“Citizens Bank”) located in Georgetown, Kentucky. On February 13, 2004, the Company announced that it had signed a definitive agreement to sell Citizens Bank in a cash transaction valued at approximately $14,500. The sale was completed on July 1, 2004. In accordance with Financial Accounting Standard 144, “Accounting for the Impairment or Disposal of Long-lived Assets”, which became effective for the Company on January 1, 2002, the financial position and results of operations of Citizens Bank are removed from the detail line items in the Company’s financial statements and presented separately as “discontinued operations.”

A condensed statement of operations for Citizens Bank follows:

   
For the six months
ended June 30, 2004
  
For the year ended
December 31, 2003
  
           
Interest income
  
$
2,021
  
$
4,643
  
Interest expense
    
732
    
1,873
  
Net interest income
    
1,289
    
2,770
  
Provision for loan losses
    
-
    
240
  
Non-interest income
    
434
    
938
  
Non-interest expense
    
1,718
    
3,595
  
Income tax (benefit)
    
(1
)
  
(47
)
Net (loss)
 
$
4
  
$
(80
)
               

Activity in the allowance for loan losses for Citizens Bank follows (in thousands):

   
2004
  
2003
  
Balance, beginning of year
  
$
2,164
  
$
2,685
  
Loans charged-off
    
(283
)
  
(1,012
)
Recoveries
    
124
    
251
  
Provision for loan losses
    
-
    
240
  
Sale of subsidiary
    
(2,005
)
  
-
  
Balance, end of year
  
$
-
  
$
2,164
  
               


 
(continued)
 
 
78

PREMIER FINANCIAL BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2005, 2004, and 2003
(Dollars in Thousands, Except Per Share Data)


NOTE 3 - REGULATORY MATTERS

On January 29, 2003, the Company entered into a written agreement with the Federal Reserve Bank (FRB) which superseded and rescinded a previous agreement between the Company and the FRB. Among the provisions of the agreement was the continuation of the restriction on the Company’s payment of dividends on its common stock without the express written consent of the FRB and the continuation of the restriction on the Company’s payment of quarterly distributions on its Trust Preferred Securities without the express written consent of the FRB. Among other provisions, the agreement required(s) the Company to retain an independent consultant to review its management, directorate and organizational structure, adopt a management plan responsive to such consultant's report, update its management succession plan in accordance with any recommendations in such consultant's report, monitor its subsidiary banks' compliance with bank policies and loan review programs, conduct formal quarterly reviews of its subsidiary Banks' allowances for loan losses, maintain sufficient capital, submit a plan to the FRB for improving consolidated earnings over a three-year period, and submit to the FRB annual projections of planned sources and uses of the Company's cash, including a plan to service its outstanding debt and trust preferred securities. The Company’s compliance with the written agreement is monitored by a committee consisting of three of its outside directors. As of December 31, 2005 management believes the Company is operating in compliance with the provisions of the written agreement.

On December 22, 2003, the Company’s subsidiary Farmers Deposit Bank - Eminence, Kentucky (the Bank), was issued a Cease and Desist order (Order) by the Federal Deposit Insurance Corporation (FDIC) and the Kentucky Department of Financial Institutions (KDFI) [collectively referred to as “Supervisory Authorities”] related to activities of the bank’s former president. Farmers Deposit Bank has fully complied with the Order and, accordingly, the Order was rescinded by the Supervisory Authorities on December 13, 2005.

The Securities and Exchange Commission ("SEC") investigated the information disclosed in Premier's June 16 and July 31, 2003 Forms 8-K and the June 30, and September 30, 2003 Forms 10-Q regarding Farmers Deposit and requested information about Premier's internal investigation. Premier fully cooperated with the SEC. At the conclusion of its investigation, the SEC issued an administrative cease & desist order regarding Premier’s financial reporting and internal controls concerning Premier’s quarterly 2001 through 2003 and annual 2001 and 2002 public filings. According to the SEC Order, both the remedial acts promptly undertaken by Premier and Premier’s cooperation with the SEC Staff were taken into consideration in reaching the settlement.


 
(continued)
 
 
79

PREMIER FINANCIAL BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2005, 2004, and 2003
(Dollars in Thousands, Except Per Share Data)


NOTE 4 - 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 balance requirement at December 31, 2005 and 2004 was $3,100 and $3,000.

NOTE 5 -SECURITIES

Amortized cost and fair value of securities available for sale and the related gross unrealized gains and losses recognized in accumulated other comprehensive income (loss) were as follows:

2005
  
Amortized Cost
  
Unrealized Gains
  
Unrealized Losses
  
Fair Value
  
Available for sale
                  
U. S. Treasury securities
  
$
3,952
  
$
3
  
$
(14
)
$
3,941
  
U. S. agency securities
    
97,209
    
-
    
(1,909
)
  
95,300
  
Obligations of states and political
subdivisions
    
2,487
    
31
    
(4
)
  
2,514
  
Mortgage-backed securities
    
36,349
    
2
    
(712
)
  
35,639
  
Corporate securities
    
25
    
-
    
-
    
25
  
Total available for sale
  
$
140,022
  
$
36
  
$
(2,639
)
$
137,419
  


2004
  
Amortized Cost
  
Unrealized Gains
  
Unrealized Losses
  
Fair Value
  
Available for sale
                  
U. S. Treasury securities
  
$
250
  
$
-
  
$
-
  
$
250
  
U. S. agency securities
    
116,427
    
127
    
(1,040
)
  
115,514
  
Obligations of states and political
subdivisions
    
2,661
    
90
    
-
   
2,751
  
Mortgage-backed securities
    
34,921
    
171
    
(150
)
  
34,942
  
Corporate securities
    
428
    
7
    
-
   
435
  
Total available for sale
  
$
154,687
  
$
395
  
$
(1,190
)
$
153,892
  


 
(continued)
 
 
80

PREMIER FINANCIAL BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2005, 2004, and 2003
(Dollars in Thousands, Except Per Share Data)


NOTE 5 -SECURITIES (Continued)

The amortized cost and fair value of securities at December 31, 2005 by 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
Cost
  
Fair
Value
  
Available for sale
          
Due in one year or less
  
$
33,519
  
$
33,091
  
Due after one year through five years
    
69,485
    
68,012
  
Due after five years through ten years
    
266
    
273
  
Due after ten years
    
403
    
404
  
Mortgage-backed securities
    
36,349
    
35,639
  
Total available for sale
  
$
140,022
  
$
137,419
  
               

There were no sales of securities in 2005. Proceeds from sales of securities during 2004 and 2003 were $1,911 and $21,926. Gross gains of $101 and $653, and gross losses of $1 and $37 were realized on those sales.

Securities with an approximate carrying value of $75,396 and $78,339 at December 31, 2005 and 2004 were pledged to secure public deposits, trust funds, securities sold under agreements to repur-chase and for other purposes as required or permitted by law.

Securities with unrealized losses at year-end 2005 aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, are as follows:

   
Less than 12 Months
  
12 Months or More
  
Total
  
Description of Securities
  
Fair Value
  
Unrealized Loss
  
Fair Value
  
Unrealized Loss
  
Fair Value
  
Unrealized Loss
  
                           
U.S. treasury securities
  
$
968
  
$
(14
)
$
-
  
$
-
  
$
968
  
$
(14
)
U.S. agency securities
    
22,096
    
(332
)
  
73,204
    
(1,577
)
  
95,300
    
(1,909
)
Obligations of states and
political subdivisions
    
397
    
(4
)
  
-
    
-
    
397
    
(4
)
Mortgage-backed securities
    
22,328
    
(341
)
  
11,968
    
(371
)
  
34,297
    
(712
)
                                       
Total temporarily impaired
  
$
45,789
  
$
(691
)
$
85,172
  
$
(1,948
)
$
130,962
  
$
(2,639
)


 
(continued)
 
 
81

PREMIER FINANCIAL BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2005, 2004, and 2003
(Dollars in Thousands, Except Per Share Data)


NOTE 5 -SECURITIES (Continued)

Securities with unrealized losses at year-end 2004 aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, are as follows:

   
Less than 12 Months
  
12 Months or More
  
Total
  
Description of Securities
  
Fair Value
  
Unrealized Loss
  
Fair Value
  
Unrealized Loss
  
Fair Value
  
Unrealized Loss
  
                           
U.S. agency securities
  
$
93,557
  
$
(959
)
$
3,928
  
$
(81
)
$
97,485
  
$
(1,040
)
Mortgage-backed securities
    
13,099
   
(54
)
  
5,284
   
(96
)
  
18,383
   
(150
)
                                       
Total temporarily impaired
  
$
106,656
  
$
(1,013
)
$
9,212
  
$
(177
)
$
115,868
  
$
(1,190
)

The investment portfolio is predominately high quality interest-bearing bonds with defined maturity dates backed by the U.S. Government or Government sponsored entities. The unrealized losses at December 31, 2005 and December 31, 2004 are price changes resulting from changes in the interest rate environment and are considered to be temporary declines in the value of the securities. Their fair value is expected to recover as the bonds approach their maturity date and/or market conditions improve.


NOTE 6 - LOANS

Loans at year-end were as follows:

   
2005
  
2004
  
Commercial, secured by real estate
  
$
85,989
  
$
101,567
  
Commercial, other
    
49,362
    
40,923
  
Real estate construction
    
11,070
    
5,906
  
Residential real estate
    
134,570
    
128,243
  
Agricultural
    
1,670
    
2,380
  
Consumer and home equity
    
42,092
    
44,470
  
Other
    
3,964
    
1,438
  
   
$
328,717
  
$
324,927
  

Certain directors and executive officers of the Banks and companies in which they have beneficial ownership, were loan customers of the Banks during 2005 and 2004. Such related party loans are governed by federal banking regulations which require such loans  to be made in the ordinary course of business at the Banks’ normal credit terms and interest rates.


 
(continued)
 
 
82

PREMIER FINANCIAL BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2005, 2004, and 2003
(Dollars in Thousands, Except Per Share Data)


NOTE 6 - LOANS (Continued)

An analysis of the 2005 activity with respect to all director and executive officer loans is as follows (in thousands):

Balance, December 31, 2004
  
$
15,114
  
Additions, including loans now meeting disclosure requirements
    
8,650
  
Amounts collected, including loans no longer meeting disclosure requirements
    
(9,096
)
Balance, December 31, 2005
  
$
14,668
  

Activity in the allowance for loan losses was as follows:
   
2005
  
2004
  
2003
  
Balance, beginning of year
  
$
9,384
  
$
14,300
  
$
9,698
  
Loans charged off
    
(2,215
)
  
(6,992
)
  
(16,513
)
Recoveries
    
719
    
1,050
    
602
  
Provision for loan losses
    
4
    
1,026
    
20,513
  
Balance, end of year
  
$
7,892
  
$
9,384
  
$
14,300
  
                     

 
Impaired loans were as follows:
   
2005
  
2004
  
2003
  
Impaired loans at year-end with an allowance
  
$
7,926
  
$
12,918
  
$
17,071
  
Impaired loans at year-end with no allowance
    
291
    
263
    
3,849
  
Amount of the allowance for loan losses allocated
    
1,921
    
2,915
    
8,418
  
Average of impaired loans during the year
    
10,819
    
16,069
    
12,756
  
Interest income recognized during impairment
    
583
    
640
    
444
  
Cash-basis interest income recognized
    
499
    
620
    
515
  
                     

Nonperforming loans at year end were as follows:
   
2005
  
2004
  
2003
  
Loans past due over 90 days still on accrual
  
$
853
  
$
739
  
$
4,137
  
Non-accrual loans
    
3,751
    
6,847
    
11,958
  
Restructured loans
    
1,540
    
238
    
104
  
                     

Nonperforming loans include some impaired loans and smaller balance homogeneous loans, such as residential mortgage and consumer loans, that are collectively evaluated for impairment. Loan impairment is reported when full payment under the loan terms is not anticipated, which can include loans that are current or less than 90 days past due.

 
(continued)
 
 
83

PREMIER FINANCIAL BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2005, 2004, and 2003
(Dollars in Thousands, Except Per Share Data)


NOTE 7 - PREMISES AND EQUIPMENT

Year-end premises and equipment were as follows:
   
2005
  
2004
  
Land and improvements
  
$
1,618
  
$
1,583
  
Buildings and leasehold improvements
    
6,218
    
6,077
  
Furniture and equipment
    
7,039
    
7,402
  
     
14,875
    
15,062
  
Less: accumulated depreciation
    
(7,749
)
  
(7,805
)
   
$
7,126
  
$
7,257
  
               


NOTE 8 - DEPOSITS

At December 31, 2005  the scheduled maturities of time deposits are as follows:

2006
  
$
114,263
  
2007
    
42,505
  
2008
    
10,925
  
2009
    
6,271
  
2010 and thereafter
    
4,583
  
   
$
178,547
  

Certain directors and executive officers of the Banks and companies in which they have beneficial ownership were deposit customers of the Banks during 2005 and 2004. The balance of such deposits at December 31, 2005 and 2004 were approximately $8,090 and $9,189.


NOTE 9 - 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:

   
2005
  
2004
  
Year-end balance
  
$
9,317
  
$
7,208
  
Average balance during the year
  
$
8,201
  
$
6,186
  
Average interest rate during the year
    
2.10
%
  
1.82
%
Maximum month-end balance during the year
  
$
9,378
  
$
7,334
  
Weighted average interest rate at year-end
    
2.39
%
  
2.66
%
               

 
(continued)
 
 
84

PREMIER FINANCIAL BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2005, 2004, and 2003
(Dollars in Thousands, Except Per Share Data)


NOTE 10 - 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.

All advances are paid either on a monthly basis or at maturity, over remaining terms of five to seven years, with interest rates ranging from 4.10% to 6.64%. Advances are secured by the FHLB stock, certain pledged investment securities and substantially all single family first mortgage loans of the participating Banks. Scheduled principal payments due on advances during the five years subsequent to December 31, 2005 are as follows:
 
2006
  
$
675
  
2007
    
710
  
2008
    
747
  
2009
    
786
  
2010
    
4,828
  
Thereafter
    
588
  
   
$
8,334
  
         

 
NOTE 11 - NOTES PAYABLE AND OTHER BORROWED FUNDS

The Company had a promissory note with a commercial bank which is secured by Boone County Bank common stock. The interest rate was prime plus 2.00%. The balance payable on this note was $800 at December 31, 2004. The note was fully repaid in March 2005.

In 2002, the Company also entered into notes payable with the Company’s Chairman of the Board and President. Due to the restriction on the Company to pay its Trust Preferred distributions as discussed in Note 12, the Company reached an agreement with the FRB whereby the Company's Chairman of the Board, who is also the Company's largest shareholder, agreed to loan the Company the amount of the distribution, $701, so that the Company, with the FRB's approval, could make its second quarter 2002 distribution. A similar agreement was reached with the FRB for the payment of the distribution due for the third quarter 2002. The Company's President, who is also a director, agreed to loan the Company the amount of the distribution, $701. Thus, the balance of notes payable at December 31, 2005, was $1,402. Both loans are unsecured at a zero percent interest rate with no defined maturity date. The loans cannot be repaid without the prior approval of the FRB.


 
(continued)
 
 
85

PREMIER FINANCIAL BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2005, 2004, and 2003
(Dollars in Thousands, Except Per Share Data)


NOTE 12 - GUARANTEED JUNIOR SUBORDINATED INTEREST DEBENTURES

On June 9, 1997, PFBI Capital Trust (Trust), a statutory business trust created under Delaware law, issued $28,750 of 9.750% Preferred Securities (“Preferred Securities” or “Trust Preferred Securities”) with a stated value and liquidation preference of $25 per share. The Trust’s obligations under the Preferred Securities issued are fully and unconditionally guaranteed by the Company. The proceeds from the sale of the Preferred Securities of the Trust, as well as the proceeds from the issuance of common securities to the Company, were utilized by the Trust to invest in $29,639 of 9.750% Junior Subordinated Deferrable Interest Debentures (the “Debentures”) of the Company. The Debentures, which mature on June 30, 2027 are unsecured obligations and rank subordinate and junior to the right of payment to all senior indebtedness, liabilities and obligations of the Company. The Debentures represent the sole assets of the Trust. Distributions on the Preferred Securities are payable at an annual rate of 9.750% of the stated liquidation amount of $25 per Preferred Security, payable quarterly. Cash distributions on the Preferred 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 Debentures are redeemable in whole. Otherwise, the Debentures are generally redeemable by the Company in whole or in part on or after June 30, 2002 at 100% of the liquidation amount. Proceeds from any redemption of the Debentures would cause a mandatory redemption of the Preferred Securities and the common securities having an aggregate liquidation amount equal to the principal amount of the Debentures redeemed. Debt issuance costs of $1,478 have been capitalized by the Trust and are being amortized over the life of the debenture.
 
The Company determined that the Trust meets the definition of a variable interest entity and that the Company is not the primary beneficiary of the Trust’s activities. Accordingly, the Trust is not consolidated with the Company and the Company does not report the Preferred Securities issued by the Trust as liabilities. Instead the Company reports as liabilities the Debentures issued by the Company and held by the Trust, as these are no longer eliminated in consolidation. The amounts are reported as “Guaranteed junior subordinated interest debentures” and continue to be presented in liabilities on the balance sheet.

 
 
(continued)
 
 
86

PREMIER FINANCIAL BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2005, 2004, and 2003
(Dollars in Thousands, Except Per Share Data)


NOTE 12 - GUARANTEED JUNIOR SUBORDINATED INTEREST
DEBENTURES (Continued)

A portion of the Preferred Securities issued by the Trust qualify as Tier 1 capital for the Company under the Federal Reserve Board’s regulatory framework. The Federal Reserve Board recently re-evaluated whether trust preferred securities would continue to qualify as Tier 1 capital due to deconsolidation of the related trust preferred entity. Its conclusion, issued in a press release on March 1, 2005, was to continue to permit trust preferred securities to qualify as Tier I capital with certain restrictions phased in over five-years. Once completely phased-in, the dollar amount of trust preferred securities that will qualify as Tier I capital will be limited to 25% of equity based Tier I capital net of goodwill. As of December 31, 2005, $15,250 of the Preferred Securities were included in the Company’s Tier I capital. Had the Federal Reserve Board’s new limitations been completely phased in at December 31, 2005, the amount of Preferred Securities includable in the Company’s Tier I capital would have been limited to $10,047.

As previously disclosed, pursuant to an agreement entered into with the Federal Reserve Bank (FRB) described in Note 3 the Company is required to request approval for the payment of distributions due on the Debentures and Trust Preferred Securities. As part of a Debt Reduction and Profitability plan presented on January 6, 2003, the Company requested and received approval from the FRB to redeem $3,000 of the $28,750 outstanding Debentures and Trust Preferred Securities. Thus, on February 24, 2003, the Company announced its plans to redeem $3,000 (120,000 shares) of the 9.75% Trust Preferred Securities as of March 31, 2003. The FRB denied the Company’s requests to make further distributions on the remaining Debentures and Trust Preferred Securities. During 2004, the Company requested and received approval from the FRB to redeem, and redeemed $4,500 (180,000 shares) on October 15, 2004 and an additional $1,000 (40,000 shares) on December 31, 2004. During 2005, the Company requested and received approval from the FRB to redeem, and redeemed $5,000 (200,000 shares) on December 31, 2005.


 
(continued)
 
 
87

PREMIER FINANCIAL BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2005, 2004, and 2003
(Dollars in Thousands, Except Per Share Data)


NOTE 12 - GUARANTEED JUNIOR SUBORDINATED INTEREST
DEBENTURES (Continued)

On January 31, 2006, the Company redeemed $7,000 (280,000 shares) of the 9.75% Trust Preferred Securities with funds obtained from a long-term bank borrowing. The bank borrowing bears an interest rate floating with the Prime Rate, currently 7.50%, and requires monthly principal payments of $50.

Premier exercised its right to defer the payment of interest on the 9.75% Trust Preferred Securities for the quarter ending December 31, 2002 and all subsequent quarters through December 31, 2004, and for an indefinite period, which can be no longer than 20 consecutive quarterly periods. These deferred distributions accrued interest at an annual rate of 9.750%. In March 2005, Premier received approval from the FRB to pay the first quarter 2005 current distribution and all prior deferred distributions. The payment was disbursed on March 31, 2005 to shareholders of record on March 15, 2005. The accrued interest on the deferred distributions was also paid when the deferred distributions were paid on March 31, 2005. The FRB has also approved the payment of current distributions due through December 31, 2005. Although the FRB has approved the payment of the deferred and current distributions through December 31, 2005, Premier is still bound by the Written Agreement and will be required to request the FRB’s approval to pay future distributions. No assurance can be given that the FRB will grant such approval.


NOTE 13 - INCOME TAXES 

The components of the provision (benefit) for income taxes are as follows:

   
2005
  
2004
  
2003
  
Current
  
$
910
  
$
(2,435
)
$
(3,589
)
Deferred
    
1,119
    
3,334
    
(1,693
)
Provision (benefit) for income taxes
  
$
2,029
  
$
899
  
$
(5,282
)
                     

 
(continued)
 
 
88

PREMIER FINANCIAL BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2005, 2004, and 2003
(Dollars in Thousands, Except Per Share Data)


NOTE 13 - INCOME TAXES (Continued)

The Company’s deferred tax assets and liabilities at December 31 are shown below. No valuation allowance for the realization of deferred tax assets is considered necessary.

   
2005
  
2004
  
Deferred tax assets
          
Allowance for loan losses
  
$
2,683
  
$
3,191
  
Net operating loss carryforward
    
0
    
239
  
AMT and other credit carryforwards
    
359
    
460
  
Write-downs of other real estate owned
    
9
    
19
  
Unrealized loss on investment securities
    
885
    
272
  
Other
    
113
    
129
  
Total deferred tax assets
    
4,049
    
4,310
  
               
Deferred tax liabilities
              
Amortization of intangibles
  
$
1,660
  
$
1,320
  
Depreciation
    
101
    
236
  
Federal Home Loan Bank dividends
    
270
    
206
  
Other
    
105
    
129
  
Total deferred tax liabilities
    
2,136
    
1,891
  
               
Net deferred tax assets, included in other assets
  
$
1,913
  
$
2,419
  
               

An analysis of the differences between the effective tax rates and the statutory U.S. federal income tax rate is as follows:
 


   
2005
  
2004
  
2003
  
U.S. federal income tax rate
  
$
2,197
    
34.0
%
$
973
    
34.0
%
$
(5,066
)
  
(34.0
)%
Changes from the statutory rate
                                      
Tax-exempt interest income
    
(81
)
  
(1.3
)
  
(131
)
  
(4.6
)
  
(221
)
  
(1.5
)
Non-deductible interest expense
related to carrying tax-exempt
interest earning assets
    
5
    
0.1
    
5
    
0.2
    
11
    
0.1
  
Tax credits
    
(10
)
  
(0.2
)
  
-
    
0.0
    
(71
)
  
(0.5
)
Other
    
(82
)
  
(1.2
)
  
52
    
1.8
    
65
    
0.4
  
   
$
2,029
    
31.4
%
$
899
    
31.4
%
$
(5,282
)
  
(35.5)%
                                       
 


 
(continued)
 
 
89

PREMIER FINANCIAL BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2005, 2004, and 2003
(Dollasrs in Thousands, Except Per Share Data)


NOTE 14 - EMPLOYEE BENEFIT PLANS

The Company has qualified profit sharing plans that cover substan-tially all employees. Contributions to the plans consist of a Company match and additional amounts at the discretion of the Company’s Board of Directors. Total contributions to the plans were $229, $197 and $197` in 2005, 2004 and 2003.

The Company also maintains Employee Stock Ownership incentive Plans (the Plans) whereby certain employees of the Company are eligible to receive incentive stock options. The Plans are accounted for in accordance with Accounting Principles Board Opinion (APB) No. 25, “Accounting for Stock Issued to Employees”, and related interpretations. Pursuant to the Plans, a maximum of 600,000 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.

A summary of the Company’s stock option activity is as follows:

   
----------2005----------
  
----------2004----------
  
----------2003----------
  
       
Weighted
Average
Exercise
      
Weighted
Average
Exercise
      
Weighted
Average
Exercise
  
   
Options
  
Price
  
Options
  
Price
  
Options
  
Price
  
Outstanding at beginning of year
    
83,650
  
$
10.65
    
55,450
  
$
11.33
    
35,000
  
$
14.03
  
Grants
    
35,000
    
11.62
    
28,200
    
9.30
    
28,650
    
7.96
  
Exercises
    
(1,667
)
  
8.50
                          
Forfeitures
    
(5,233
)
  
9.31
    
-
    
0.00
    
(8,200
)
  
11.08
  
Outstanding at year-end
    
111,750
  
$
11.05
    
83,650
  
$
10.65
    
55,450
  
$
11.33
  
                                       
Exercisable at year-end
    
54,180
  
$
11.61
    
39,821
  
$
12.65
    
32,000
  
$
13.80
  
Weighted average remaining life
    
6.2
          
6.2
          
5.7
        
Weighted average fair value of
options granted during the year
  
$
3.48
        
$
2.64
        
$
3.30
        
                                       


 
(continued)
 
 
90

PREMIER FINANCIAL BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2005, 2004, and 2003
(Dollars in Thousands, Except Per Share Data)


NOTE 14 - EMPLOYEE BENEFIT PLANS (Continued)

Options outstanding at year-end 2005 were as follows:

   
Outstanding
  
Exercisable
  
Range of Exercise Prices
  
Number
  
Weighted Average Remaining Contractual Life
  
Weighed Average Exercise Price
  
Number
  
Weighed Average Exercise Price
  
$7.50 to $10.00
    
45,750
    
7.6
  
$
8.69
    
22,180
  
$
8.46
  
$10.01 to $12.50
    
55,000
    
5.7
    
11.91
    
21,000
    
12.38
  
$15.01 to $17.50
    
11,000
    
3.0
    
16.50
    
11,000
    
16.50
  
Outstanding at year-end
    
111,750
    
6.2
    
11.05
    
54,180
    
11.61
  


NOTE 15 - RELATED PARTY TRANSACTIONS

During 2005, 2004, and 2003, the Company paid approximately $191, $358, and $272 for printing, supplies, furniture, and equipment to a company affiliated by common ownership. The Company also paid another affiliate approximately $499, $489, and $892 in 2005, 2004, and 2003 to permit the Company’s employees to participate in that entity’s employee medical benefit plan.

During 2005, 2004 and 2003, the Company paid approximately $52, $52, and $51 to lease its headquarters facility at 2883 Fifth Avenue, Huntington, West Virginia from River City Properties, LLC, an entity 12.5% owned by the Company’s Chairman of the Board.



 
(continued)
 
 
91

PREMIER FINANCIAL BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2005, 2004, and 2003
(Dollars in Thousands, Except Per Share Data)


NOTE 16- 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 2004, 2003 and 2002 is presented below:

   
2005
  
2004
  
2003
  
Basic earnings per share from continuing operations
              
Income (loss) available to common stockholders
  
$
4,434
  
$
1,963
  
$
(9,617
)
Weighted average common shares outstanding
    
5,233
    
5,232
    
5,232
  
Earnings (loss) per share
  
$
0.85
  
$
0.37
  
$
(1.84
)
                     
Diluted earnings per share from continuing operations
                    
Income (loss) available to common stockholders
  
$
4,434
  
$
1,963
  
$
(9,617
)
Weighted average common shares outstanding
    
5,233
    
5,232
    
5,232
  
Add dilutive effects of assumed exercise of stock options
    
15
    
5
    
-
  
Weighted average common and dilutive potential
Common shares outstanding
    
5,248
    
5,237
    
5,232
  
Earnings (loss) per share assuming dilution
  
$
0.84
  
$
0.37
  
$
(1.84
)
                     
Basic earnings per share
                    
Income (loss) available to common stockholders
  
$
4,434
  
$
6,697
  
$
(9,697
)
Weighted average common shares outstanding
    
5,233
    
5,232
    
5,232
  
Earnings (loss) per share
  
$
0.85
  
$
1.28
  
$
(1.85
)
                     
Diluted earnings per share
                   
Income (loss) available to common stockholders
  
$
4,434
  
$
6,697
  
$
(9,697
)
Weighted average common shares outstanding
    
5,233
    
5,232
    
5,232
  
Add dilutive effects of assumed exercise of stock options
    
15
    
5
    
-
  
Weighted average common and dilutive potential
Common shares outstanding
    
5,248
    
5,237
    
5,232
  
Earnings (loss) per share assuming dilution
  
$
0.84
  
$
1.28
  
$
(1.85
)
                     


Stock options for 55,450 shares of common stock for 2003 were not included in the computation of earnings per share assuming dilution because their impact was anti-dilutive.


 
(continued)
 
 
92

PREMIER FINANCIAL BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2005, 2004, and 2003
(Dollars in Thousands, Except Per Share Data)


NOTE 17 - DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS

The fair values of the Company’s financial instruments at year-end are as follows: 

   
2005
  
2004
  
   
Carrying
Amount
  
Fair
Value
  
Carrying
Amount
  
Fair
Value
  
Financial assets
                  
Cash and due from banks
  
$
16,080
  
$
16,080
  
$
14,474
  
$
14,474
  
Federal funds sold
    
18,812
    
18,812
    
17,342
    
17,342
  
Securities available for sale
    
137,419
    
137,419
    
153,892
    
153,892
  
Loans, net
    
320,825
    
304,589
    
315,543
    
312,496
  
Federal Home Loan Bank and
Federal Reserve Bank stock
    
3,060
    
3,060
    
2,611
    
2,611
  
Interest receivable
    
2,661
    
2,661
    
2,740
    
2,740
  
                           
Financial liabilities
                          
Deposits
  
$
(435,843
)
$
(434,459
)
$
(437,798
)
$
(438,440
)
Federal funds purchased
    
-
    
-
    
(1,838
)
  
(1,838
)
Securities sold under agreements to repurchase
    
(9,317
)
  
(9,317
)
  
(7,208
)
  
(7,208
)
Federal Home Loan Bank advances
    
(8,334
)
  
(7,355
)
  
(9,288
)
  
(8,636
)
Other borrowed funds
    
-
    
-
    
(800
)
  
(803
)
Notes payable
    
(1,402
)
  
(1,319
)
  
(1,402
)
  
(1,332
)
Guaranteed junior subordinated Interest debentures
    
(15,722
)
  
(14,997
)
  
(20,876
)
  
(21,655
)
Interest payable
    
(724
)
  
(724
)
  
(5,532
)
  
(5,532
)
                           

Carrying amount is the estimated fair value for cash and cash equivalents, Federal funds sold, Federal Home Loan Bank and Federal Reserve Bank stock, accrued interest receivable and payable, demand deposits, short-term debt, and variable rate loans or deposits that reprice frequently and fully. Security fair values are based on market prices or dealer quotes, and if no such information is available, on the rate and term of the security and information about the issuer. For fixed rate loans or deposits and for variable rate loans or deposits with infrequent repricing or repricing limits, fair value is based on discounted cash flows using current market rates applied to the estimated life and credit risk. Fair values for impaired loans are estimated using discounted cash flow analysis or underlying collateral values. Fair value of debt is based on current rates for similar financing. The fair value of commitments to extend credit and standby letters of credit is not considered material.


 
(continued)
 
 
93

PREMIER FINANCIAL BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2005, 2004, and 2003
(Dollars in Thousands, Except Per Share Data)


NOTE 18 - 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 obliga-tions as they do for on-balance sheet instruments. In addition, the Banks offer a service whereby deposit customers for a fee are permitted to overdraw their accounts up to a certain deminimus amount, also known as “bounce protection” or “overdraft protection”. The aggregate unused portion of “bounce protection” was $4,927 at December 31, 2005.

At December 31, 2005 and 2004, the Banks had the following financial instruments whose approximate contract amounts represent credit risk:

   
2005
  
2004
  
Standby letters of credit
  
$
949
  
$
896
  
               
Commitments to extend credit
              
Fixed
  
$
8,303
  
$
5,694
  
Variable
    
24,158
    
17,118
  
               

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. Outstanding commitments are at current market rates. Fixed rate loan commitments have interest rates ranging from 5.0% to 18.0%. 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.


 
(continued)
 
 
94

PREMIER FINANCIAL BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2005, 2004, and 2003
(Dollars in Thousands, Except Per Share Data)


NOTE 19 - 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, 2005 management is unaware of any legal proceedings for which the expected outcome would have a material adverse effect upon the consolidated financial statements of the Company.

NOTE 20 - STOCKHOLDERS’ EQUITY

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 regula-tions, 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 and additional restrictions as discussed below. During 2006 the Banks could, without prior approval, declare dividends of approximately $2.5 million plus any 2006 net profits retained to the date of the dividend declaration.

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 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.

These quantitative measures established by regulation to ensure capital adequacy require the Company and Banks to maintain minimum amounts and ratios (set forth in the following table) 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, 2005, the Company and the Banks meet all quantitative capital adequacy requirements to which they are subject.



 
(continued)
 
 
95

PREMIER FINANCIAL BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2005, 2004, and 2003
(Dollars in Thousands, Except Per Share Data)


NOTE 20 - STOCKHOLDERS’ EQUITY (Continued)

The capital amounts and classifications are also subject to qualitative judgments by the regulators. As a result of these qualitative judgments, the Company has entered into an agreement with the applicable regulatory authorities which provide for additional restrictions on their respective capital levels and the payment of dividends. The Company entered into an agreement with the Federal Reserve Bank (FRB), as discussed in Note 3, restricting the Company from declaring or paying dividends without prior approval from the FRB. An additional provision of this agreement requires prior approval from the FRB before the Company increases its borrowings or incurs any debt. This agreement is in effect until terminated by the FRB.

Effective January 1, 2004, Farmers Deposit Bank (Farmers Deposit) was issued a C&D order by the FDIC and KDFI restricting Farmers Deposit from declaring or paying dividends, without prior approval, if its Tier I capital to average assets falls below 8.00%. The order also required Farmers Deposit to maintain a minimum 5.0% Tier I capital to average assets ratio and submit a written capital restoration plan to increase the ratio to 8.0% by December 31, 2004. Having determined that Farmers had fully complied with all of the provisions of the order, the KDFI and FDIC rescinded the order on December 13, 2005. Farmers Deposit’s Tier I capital to average assets was 11.4% at December 31, 2005.

As of December 31, 2005, the most recent notification from the Federal Reserve Bank categorized the Company and its subsidiary banks 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.


 
(continued)
 
 
96

PREMIER FINANCIAL BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2005, 2004, and 2003
(Dollars in Thousands, Except Per Share Data)


NOTE 20 - STOCKHOLDERS’ EQUITY (Continued)

The Company’s and the subsidiary Banks’ capital amounts and ratios as of December 31, 2005 are presented in the table below:

           
To Be Well Capitalized
  
       
For Capital
  
Under Prompt Corrective
  
   
Actual
  
Adequacy Purposes
  
Action Provisions
  
2005
  
Amount
  
Ratio
  
Amount
  
Ratio
  
Amount
  
Ratio
  
Total Capital (to Risk-Weighted Assets):
                          
Consolidated (1)
  
$
58,710
    
19.1
%
$
24,636
    
8
%
$
30,795
    
10
%
Boone County Bank
    
15,778
    
20.8
    
6,073
    
8
    
7,591
    
10
  
Citizens Deposit Bank
    
12,318
    
17.0
    
5,801
    
8
    
7,251
    
10
  
Farmers Deposit Bank
    
9,398
    
12.7
    
3,470
    
8
    
4,337
    
10
  
Ohio River Bank
    
6,978
    
16.3
    
3,434
    
8
    
4,292
    
10
  
First Central Bank
    
8,584
    
12.1
    
5,658
    
8
    
7,073
    
10
  
                                       
Tier I Capital (to Risk-Weighted Assets):
                                      
Consolidated (1)
  
$
54,811
    
17.8
%
$
12,318
    
4
%
$
18,477
    
6
%
Boone County Bank
    
14,927
    
19.7
    
3,036
    
4
    
4,555
    
6
  
Citizens Deposit Bank
    
11,396
    
15.7
    
2,900
    
4
    
4,351
    
6
  
Farmers Deposit Bank
    
8,823
    
20.3
    
1,735
    
4
    
2,602
    
6
  
Ohio River Bank
    
6,482
    
15.1
    
1,717
    
4
    
2,575
    
6
  
First Central Bank
    
7,690
    
10.9
    
2,829
    
4
    
4,244
    
6
  
                                       
Tier I Capital (to Average Assets):
                                      
Consolidated (1)
  
$
54,811
    
10.6
%
$
20,660
    
4
%
$
25,826
    
5
%
Boone County Bank
    
14,927
    
10.3
    
5,772
    
4
    
7,216
    
5
  
Citizens Deposit Bank
    
11,396
    
9.7
    
4,699
    
4
    
5,873
    
5
  
Farmers Deposit Bank
    
8,823
    
11.4
    
3,096
    
4
    
3,870
    
5
  
Ohio River Bank
    
11,303
    
12.5
    
3,606
    
4
    
4,507
    
5
  
First Central Bank
    
7,690
    
8.2
    
3,771
    
4
    
4,713
    
5
  
                                       
  (1) Consolidate company is not subject to Prompt Corrective Actoin Provisions  


 
 
(continued)
 
 
97

PREMIER FINANCIAL BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2005, 2004, and 2003
(Dollars in Thousands, Except Per Share Data)


NOTE 20 - STOCKHOLDERS’ EQUITY (Continued)

The Company’s and the subsidiary Banks’ capital amounts and ratios as of December 31, 2004 are presented in the table below:

           
To Be Well Capitalized
  
       
For Capital
  
Under Prompt Corrective
  
   
Actual
  
Adequacy Purposes
  
Action Provisions
  
2004
  
Amount
  
Ratio
  
Amount
  
Ratio
  
Amount
  
Ratio
  
Total Capital (to Risk-Weighted Assets):
                          
Consolidated (1)
  
$
58,163
    
18.9
%
$
24,624
    
8
%
$
30,781
    
10
%
Boone County Bank
    
15,270
    
19.7
    
6,208
    
8
    
7,761
    
10
  
Citizens Deposit Bank
    
12,016
    
21.6
    
4,442
    
8
    
5,553
    
10
  
Farmers Deposit Bank
    
9,056
    
18.6
    
3,906
    
8
    
4,882
    
10
  
Ohio River Bank
    
6,730
    
15.4
    
3,504
    
8
    
4,380
    
10
  
First Central Bank
    
8,007
    
12.6
    
5,099
    
8
    
6,374
    
10
  
                                       
Tier I Capital (to Risk-Weighted Assets):
                                      
  Consolidated (1)
  
$
51,182
    
16.6
%
$
12,312
    
4
%
$
18,468
    
6
%
Boone County Bank
    
14,299
    
18.4
    
3,104
    
4
    
4,656
    
6
  
Citizens Deposit Bank
    
11,303
    
20.4
    
2,221
    
4
    
3,332
    
6
  
Farmers Deposit Bank
    
8,406
    
17.2
    
1,953
    
4
    
2,929
    
6
  
Ohio River Bank
    
6,254
    
14.3
    
1,752
    
4
    
2,628
    
6
  
First Central Bank
    
7,271
    
11.4
    
2,549
    
4
    
3,824
    
6
  
                                       
Tier I Capital (to Average Assets):
                                      
Consolidated (1)
  
$
51,182
    
9.7
%
$
21,009
    
4
%
$
26,261
    
5
%
Boone County Bank
    
14,299
    
9.2
    
6,212
    
4
    
7,765
    
5
  
Citizens Deposit Bank
    
11,303
    
12.5
    
3,606
    
4
    
4,507
    
5
  
Farmers Deposit Bank
    
8,406
    
9.5
    
3,560
    
4
    
4,450
    
5
  
Ohio River Bank
    
6,254
    
7.7
    
3,236
    
4
    
4,046
    
5
  
First Central Bank
    
7,271
    
8.6
    
3,366
    
4
    
4,208
    
5
  
                                       
  (1) Consolidate company is not subject to Prompt Corrective Actoin Provisions  


 
(continued)
 
 
98


PREMIER FINANCIAL BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2005, 2004, and 2003
(Dollars in Thousands, Except Per Share Data)


NOTE 21 - PARENT COMPANY FINANCIAL STATEMENTS

CONDENSED BALANCE SHEETS
  
December 31
  
   
2005
  
2004
  
ASSETS
          
Cash
  
$
3,248
  
$
7,666
  
Investment in subsidiaries
    
66,936
    
70,683
  
Premises and equipment
    
541
    
514
  
Other assets
    
1,106
    
599
  
               
Total assets
  
$
71,831
  
$
79,462
  
               
LIABILITIES AND STOCKHOLDERS’ EQUITY
              
Other liabilities
  
$
420
    
5,355
  
Notes payable
    
1,402
    
1,402
  
Subordinated debentures issued to trust
    
15,722
    
20,876
  
Other borrowed funds
    
-
    
800
  
Total liabilities
    
17,544
    
28,433
  
               
Stockholders’ equity
              
Preferred stock
    
-
    
-
  
Common stock
    
1,105
    
1,103
  
Surplus
    
43,458
    
43,445
  
Retained earnings
    
11,442
    
7,008
  
Accumulated other comprehensive income
    
(1,718
)
  
(527
)
Total stockholders’ equity
    
54,287
    
51,029
  
               
Total liabilities and stockholders’ equity
  
$
71,831
  
$
79,462
  
               




 
(continued)
 
 
99

PREMIER FINANCIAL BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2005, 2004, and 2003
(Dollars in Thousands, Except Per Share Data)


NOTE 21 - PARENT COMPANY FINANCIAL STATEMENTS (Continued)

Condensed Statement of Operations
  
Years Ended December 31
  
   
2005
  
2004
  
2003
  
Income
              
Dividends from continuing subsidiaries
  
$
8,405
  
$
5,800
  
$
7,853
  
Interest and dividend income
    
45
    
46
    
14
  
Other income
    
450
    
367
    
472
  
Total income
    
8,900
    
6,213
    
8,339
  
                     
Expenses
                    
Interest expense
    
2,142
    
3,117
    
3,121
  
Salaries and employee benefits
    
1,180
    
726
    
597
  
Professional fees
    
17
    
1,607
    
550
  
Accelerated trust preferred issuance costs
    
184
    
214
    
124
  
Other expenses
    
327
    
514
    
295
  
Total expenses
    
3,850
    
6,178
    
4,687
  
                     
Income from continuing operations before
income taxes and equity in undistributed
income of subsidiaries
    
5,050
    
35
    
3,652
  
                     
Income tax (benefit)
    
(1,314
)
  
(2,071
)
  
(1,631
)
                     
Income from continuing operations before
equity in undistributed income of subsidiaries
    
6,364
    
2,106
    
5,283
  
Equity in undistributed income of subsidiaries
continuing in operation
    
(1,930
)
  
(143
)
  
(14,900
)
Net income (loss) from continuing operations
    
4,434
    
1,963
    
(9,617
)
Net income (loss) from discontinued operations
    
-
    
4,734
    
(80
)
Net income (loss)
  
$
4,434
  
$
6,697
  
$
(9,697
)
                     
 


 
(continued)
 
 
100

PREMIER FINANCIAL BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2005, 2004, and 2003
(Dollars in Thousands, Except Per Share Data)


NOTE 21 - PARENT COMPANY FINANCIAL STATEMENTS (Continued)

Condensed Statement of Cash Flows
  
Years Ended December 31
  
   
2005
  
2004
  
2003
  
Cash flows from operating activities
              
Net income (loss) from continuing operations
  
$
4,434
  
$
1,963
  
$
(9,617
)
Adjustments to reconcile net income (loss) to
Net cash from operating activities
                    
Depreciation
    
83
    
91
    
71
  
(Gain) loss from sales of assets
    
(3
)
  
159
    
21
  
Dividends in excess of net income of
Subsidiaries continuing in operation
    
1,930
    
143
    
14,900
  
Change in other assets
    
(35
)
  
(1,436
)
  
144
  
Change in other liabilities
    
(4,934
)
  
1,406
    
2,470
  
Net cash from operating activities
    
1,475
    
2,326
    
7,989
  
                     
Cash flows from investing activities
                    
Capital contributed to subsidiaries continuing in operation
    
-
    
(1,831
)
  
(8,108
)
Proceeds from liquidation of subsidiary
    
-
    
14,311
    
-
  
Proceeds from sales of assets, net of purchases
    
(108
)
  
192
    
216
  
Net cash from investing activities
    
(108
)
  
12,672
    
(7,882
)
                     
Cash flows from financing activities
                    
Early redemption of subordinated note
    
(5,000
)
  
(5,500
)
  
(3,000
)
Issuance of common stock
    
15
    
-
    
-
  
Payments on other borrowed funds
    
(800
)
  
(5,400
)
  
(1,500
)
Net cash from financing activities
    
(5,785
)
  
(10,900
)
  
(4,500
)
                     
Net change in cash and cash equivalents
    
(4,418
)
  
4,098
    
(4,393
)
                     
Cash and cash equivalents at beginning of year
    
7,666
    
3,568
    
7,961
  
Cash and cash equivalents at end of year
  
$
3,248
  
$
7,666
  
$
3,568
  
                     





 
(continued)
 
 
101


PREMIER FINANCIAL BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2005, 2004, and 2003
(Dollars in Thousands, Except Per Share Data)


NOTE 22 - QUARTERLY FINANCIAL DATA (UNAUDITED)
 
   
From Continuing Operations
  
 Earnings per Share
  on Continuing Operations
  
 
 
Interest
Income
 
 Net Interest Income 
 
 Net
Income 
 
 Basic 
  
 Fully
Diluted 
  
2005
                                
First Quarter
  
$
7,045
  
$
4,727
  
$
803
  
$
0.15
  
$
0.15
  
Second Quarter
    
7,172
    
4,893
    
727
    
0.14
    
0.14
  
Third Quarter
    
7,465
    
5,055
    
1,367
    
0.26
    
0.26
  
Fourth Quarter
    
7,717
    
5,177
    
1,537
    
0.29
    
0.29
  
                                 
2004
                                
First Quarter
  
$
7,055
  
$
4,446
  
$
482
  
$
0.09
  
$
0.09
  
Second Quarter
    
6,926
    
4,398
    
474
    
0.09
    
0.09
  
Third Quarter
    
6,951
    
4,418
    
448
    
0.08
    
0.08
  
Fourth Quarter
    
7,189
    
4,802
    
559
    
0.11
    
0.11
  

 
In 2005, interest income improved each quarter as yields on investments and federal funds sold rose and loan balances outstanding increased. The improvement in interest income drove the improvement in net interest income. Net income was also impacted positively in the third and fourth quarters by the recording of reversals of the provision for loan losses due to improvements in the Company’s historical loan loss ratios and the collection of impaired loans with previous allocations of the allowance for loan losses that were no longer needed.

In 2004, interest income continued to be negatively impacted by the level of non-accrual loans at Farmers Deposit Bank. However, due to interest expense savings, net interest income began a gradual resurgence beginning with the second quarter. Net income was impacted positively in the fourth quarter by the improvement in the net interest margin and gains on the disposition of other real estate owned.


 

102
 

PREMIER FINANCIAL BANCORP, INC.
FORM 10-K
December 31, 2005


PART III


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.

Item 9A. Controls and Procedures

Premier management, including the Chief Executive Officer and Chief Financial Officer, has conducted an evaluation of the effectiveness of disclosure controls and procedures pursuant to Exchange Act Rule 13a-15c as of the end of the period covered by this annual report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the disclosure controls and procedures are effective in ensuring that all material information required to be filed in this annual report has been made known to them in a timely fashion.
 
    "Internal controls" are procedures, which are designed with the objective of providing reasonable assurance that (1) transactions are properly authorized; (2) assets are safeguarded against unauthorized or improper use; and (3) transactions are properly recorded and reported, all so as to permit the preparation of reports and financial statements in conformity with generally accepted accounting principles. Premier management uses the financial reports of its subsidiaries to make decisions about the allocation of the Company's resources, to implement strategies to improve the Company's performance, and to prepare the consolidated financial statements of the Company for its shareholders and regulatory authorities. However, a control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their cost. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. The design of any system of controls is also based, in part, upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, a control may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected. Finally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control.


103
 

PREMIER FINANCIAL BANCORP, INC.
FORM 10-K
December 31, 2005


It is this "management override of controls" that led to the significant charge-offs and provisions for loan losses at Farmers Deposit in 2003 and the financial statement restatement for years 2002 and 2001. Premier's policies and procedures related to the evaluation of a borrower's creditworthiness prior to making or renewing a loan, the reporting of new loan activity and delinquent loans to the bank's board of directors, and the guidelines for assessing the credit risk of existing loans were overridden by local management. The systematic disregard for these controls was sophisticated enough to avoid detection during routine reviews of that bank's records as directed by the Company and the regulatory authorities of the banking industry.
 
    During late 2003 and throughout 2004, Premier management implemented corrective actions to remedy the deficiencies identified at Farmers Deposit. In addition to the steps identified in the cease and desist order of the FDIC and KDFI, Premier

• hired a new President and CEO of Farmers Deposit in 2003 who has experience restoring troubled banks to safe and sound banking practices,
• hired a Chief Financial Officer for the bank in 2003, a new position, to segregate the lending and accounting functions of the bank,
• formed a collections department to pursue delinquent borrowers and, when possible, to collect on loans previously charged-off, and
• begun using system generated reports to the bank's board of directors rather than manually generated reports whenever possible.
 
    Premier management also implemented additional processes and procedures throughout its network of banking subsidiaries in an effort to minimize the likelihood that improper management overrides go undetected. These included:

• hiring a credit analyst at the holding company level to review all loan requests over $400,000,
• forming loan approval committees made up of the bank presidents and the President of Premier to review all loan requests over $750,000,
• incorporating "whistleblower" provisions into the employee code of ethics and conduct,
• dispatching members of the Audit Committee of the Company's board of directors, at their request, to conduct employee meetings emphasizing the importance of each employee's responsibilities in maintaining the financial integrity of the Company's books and records, that overriding of internal controls will not be tolerated, and the employees' obligation to report improprieties to senior management or the Audit Committee in accordance with the employee code of ethics,
• hiring an internal audit department at the holding company level to, among other duties assigned, conduct various tests for data integrity and compliance with internal control procedures, and
• evaluating the internal audit program to incorporate tests designed to specifically detect the abuses uncovered during the Farmers Deposit investigation.


104
 

PREMIER FINANCIAL BANCORP, INC.
FORM 10-K
December 31, 2005


In 2005, Premier reduced its reliance on third-party internal audit and loan review providers and expanded its internal audit staff at the holding company level. Management believes a full-time internal audit and loan review staff will be able to provide more specific and more thorough testing of the books and records of the company and the effectiveness of its internal controls. Management also believes that having internal auditors on staff will provide more immediate reporting of findings to management, a source of on-location training of best practices for employees at the Affiliate Banks during the conduct of an audit and a rapid response team to address issues raised by employees under the "whistleblower" provisions of the employee code of ethics and conduct.
 
    Beginning in April 2005 and concluding in July 2005, Premier's affiliate banks converted to a third-party data processing and item processing provider. As part of the conversion process, system processes, workflows and procedures were reviewed and potentially revised in an effort to standardize the way the Banks conduct business and record transactions in the various modules of the software. While no significant changes to Premier's key controls were made as a result of these reviews, holding company staff now has direct on-line access to the financial books and records of the Banks.

In late 2005 and continuing in early 2006, Premier’s internal audit staff and senior management began a review of all outstanding policies of the Affiliate Banks. The policies were standardized across the company as much as practicable, with minor variances permitted to accommodate the different markets in which the Banks operate. New policies and procedures were also developed to govern the new outsourced data and item processing functions, the integrated data network, and the addition of internet banking products.
 
    Other than the steps identified above, which are in various stages of implementation, there were no changes in internal controls over financial reporting during the fourth fiscal quarter that have materially affected or are reasonably likely to materially affect Premier's internal controls over financial reporting.


Item 10, 11, 12, 13 and 14. Directors and Executive Officers of the Registrant; Executive Compensation; Security Ownership of Certain Beneficial and Management and Related Stockholder Matters; Certain Relationships and Related Transactions; and Principal Accountant Fees and Services
 
    The information required by these Items is omitted because the Company 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 Company's proxy statement is incorporated herein by reference.




105
 

PREMIER FINANCIAL BANCORP, INC.
FORM 10-K
December 31, 2005


PART IV

Item 15. Exhibits and Financial Statement Schedules

(a) The following documents are filed as part of this report:

1. 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
2.1
Stock Purchase Agreement dated February 13, 2004 among Citizens Bank (Kentucky), Inc., Premier Financial Bancorp, Inc. and Farmers Capital Bank Corporation is incorporated herein by reference to Form 8-K filed by Registrant on February 19, 2004.
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).



106
 

PREMIER FINANCIAL BANCORP, INC.
FORM 10-K
December 31, 2005


Exhibit
Number
Description of Document
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
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).
*** 10.2
Premier Financial Bancorp, Inc.'s 2002 Employee Stock Ownership Incentive Plan, filed as Annex A to definitive proxy statement dated May 17, 2002, filed on April 30, 2002 with the Commission, is incorporated herein by reference.
*** 10.3
Form of Stock Option Agreement pursuant to 2002 Employee Stock Ownership Incentive Plan, filed as Exhibit 10.1 to form 8-K filed January 24, 2005, is incorporated herein by reference.
10.4
Premier Financial Bancorp, Inc. written agreement with the Federal Reserve Bank of Cleveland dated January 29, 2003, filed as Exhibit 10.4 to form 10-K filed on March 27, 2003, is incorporated herein by reference.
10.5
Premier Financial Bancorp, Inc. contract with Fiserv Solutions, Inc. dated December 20, 2004, filed as Exhibit 10 to form 8-K filed December 23, 2004, is incorporated herein by reference.
10.6
Loan Agreement between Premier Financial Bancorp, Inc. and First Guaranty Bank, Hammond, Louisana
10.7
Promissory Note to First Guaranty Bank, Hammond, Louisana
10.8
Collateral Agreement with First Guaranty Bank, Hammond Louisana



107
 

PREMIER FINANCIAL BANCORP, INC.
FORM 10-K
December 31, 2005


Exhibit
Number
Description of Document
14.1
Premier Financial Bancorp, Inc. Code of Ethics for the Chief Executive Officer, Chief Financial Officer and Chief Accounting Officer, filed as Exhibit 14.1 to form 10-K filed on April 14, 2004, is incorporated herein by reference.
14.2
Premier Financial Bancorp, Inc. Code of Business Conduct and Ethics, filed as Exhibit 14.2 to form 10-K filed on April 14, 2004, is incorporated herein by reference.
21
Subsidiaries of registrant
23
Consent of Independent Registered Public Accounting Firm
31.1
Principal Executive Officer Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 - Robert W. Walker
31.2
Principal Executive Officer Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 - Brien M. Chase
32
Robert W. Walker and Brien M. Chase Certification Pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act 2002.
   
*** Denotes executive compensation plans and arrangements.



108
 

PREMIER FINANCIAL BANCORP, INC.
FORM 10-K
December 31, 2005


SIGNATURES

Pursuant to the requirements of the Section 13 or 15(d) of the Securities Exchange Act of 1934, registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 
PREMIER FINANCIAL BANCORP, INC.
   
 
By: /s/ Robert W. Walker, President
 
Robert W. Walker, President
   
 
Date: March 30, 2006
   



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PREMIER FINANCIAL BANCORP, INC.
FORM 10-K
December 31, 2005


Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant in the capacities and on the dates indicated.

/s/ Robert W. Walker
Principal Executive and Director
March 30, 2006
Robert W. Walker
    
     
/s/ Brien M. Chase
Principal Financial and Accounting
March 30, 2006
Brien M. Chase
Officer
  
     
/s/ Toney K. Adkins
Director
March 15, 2006
Toney K. Adkins
    
     
/s/ Hosmer A. Brown, III
Director
March 15, 2006
Hosmer A. Brown, III
    
     
/s/ Edsel Burns
Director
March 15, 2006
Edsel Burns
    
     
/s/ E. V. Holder, Jr.
Director
March 15, 2006
E. V. Holder, Jr.
    
     
/s/ Keith F. Molihan
Director
March 15, 2006
Keith F. Molihan
    
     
/s/ Marshall T. Reynolds
Chairman of the Board
March 15, 2006
Marshall T. Reynolds
    
     
 /s/ Neal Scaggs
Director
March 29, 2006
Neal Scaggs
    
     
/s/ Thomas W. Wright
Director
March 15, 2006
Thomas W. Wright
    
     


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